SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 26, 2000
Commission file number: 0-21154
CREE, INC.
(Exact name of registrant as specified in its charter)
North Carolina 56-1572719
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
4600 Silicon Drive
Durham, North Carolina 27703
(Address of principal executive offices) (Zip Code)
(919) 313-5300
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. [ X] Yes [ ] No
The number of shares outstanding of the registrant's common stock, par value
$0.0025 per share, as of April 19, 2000 was 33,142,278.
<PAGE>
CREE, INC.
FORM 10-Q
For the quarterly period ended March 26, 2000
INDEX
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at March 26, 2000 (unaudited)
and June 27, 1999 3
Consolidated Statements of Income for the three and nine
months ended March 26, 2000 and March 28, 1999 (unaudited) 4
Consolidated Statements of Cash Flow for the nine months
ended March 26, 2000 and March 28, 1999 (unaudited) 5
Notes to Consolidated Financial Statements (unaudited) 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk 19
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 20
Item 6. Exhibits and Reports on Form 8-K 20
Signatures 21
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
CREE, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands)
March 26, June 27,
2000 1999
--------- --------
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents $108,033 $ 42,506
Marketable securities 122,594 6,145
Accounts receivable, net 24,576 16,285
Inventories 7,082 3,977
Deferred income tax 296 296
Prepaid expenses and other current assets 1,175 558
--------- --------
Total current assets 263,756 69,767
Long term marketable securities 77,984 --
Property and equipment, net 108,514 69,884
Patent and license rights, net 2,124 1,731
Deferred income taxes 2,827 2,827
Other assets 15 8
--------- --------
Total assets $455,220 $144,217
========= ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable, trade $ 6,987 $ 7,487
Accrued salaries and wages 2,865 819
Deferred income tax 13,213 --
Other accrued expenses 1,685 1,239
--------- --------
Total current liabilities 24,750 9,545
Long term liabilities:
Long term liability 30 --
Deferred income tax 4,650 4,650
--------- --------
Total long term liabilities 4,680 4,650
Shareholders' equity:
Preferred stock, par value $0.01; -- --
3,000 shares authorized at March 26,
2000 and June 27, 1999; none issued
and outstanding
Common stock, par value $0.0025; 83 73
60,000 shares authorized; shares
issued and outstanding 33,142
and 29,258 at March 26, 2000 and
June 27, 1999, respectively
Additional paid-in-capital 380,716 111,136
Retained earnings 44,991 18,813
--------- --------
Total shareholders' equity 425,790 130,022
--------- --------
Total liabilities and shareholders'
equity $455,220 $144,217
========= ========
The accompanying notes are an integral part of the
consolidated financial statements.
<PAGE>
CREE, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited) (Unaudited)
Three Months Ended Nine Months Ended
--------------------- -----------------------
March 26, March 28, March 26, March 28,
2000 1999 2000 1999
--------- --------- --------- ----------
Revenue:
Product revenue, net $ 26,195 $ 14,084 $ 66,588 $ 37,609
Contract revenue, net 2,168 1,951 5,754 4,743
-------- --------- --------- ----------
Total revenue 28,363 16,035 72,342 42,352
Cost of revenue:
Product revenue 10,977 6,794 30,549 18,586
Contract revenue 1,541 1,503 3,799 3,755
-------- --------- --------- ----------
Total cost of revenue 12,518 8,297 34,348 22,341
-------- --------- --------- ----------
Gross profit 15,845 7,738 37,994 20,011
Operating expenses:
Research and development 2,245 1,515 5,087 3,442
Sales, general and 2,828 1,568 7,393 4,236
administrative
Other (income) expense 673 311 767 878
-------- --------- --------- ----------
Income from operations 10,099 4,344 24,747 11,455
Interest income, net 3,772 347 4,912 482
-------- --------- --------- ----------
Income before income taxes 13,871 4,691 29,659 11,937
Income tax expense 4,716 1,314 10,084 3,343
-------- --------- --------- ----------
Net income $ 9,155 $ 3,377 $ 19,575 $ 8,594
======== ========= ========= ==========
Other comprehensive income,
net of tax:
Unrealized holding gain (loss) 7,039 -- 6,603 --
-------- --------- --------- ----------
Comprehensive income $ 16,194 $ 3,377 $ 26,178 $ 8,594
======== ========= ========= ==========
Earnings per share:
Basic $ 0.28 $ 0.12 $ 0.64 $ 0.33
======== ========= ========= ==========
Diluted $ 0.26 $ 0.11 $ 0.60 $ 0.31
======== ========= ========= ==========
Shares used in per share
calculation:
Basic 32,169 27,266 30,364 26,258
======== ========= ========= ==========
Diluted 34,612 29,770 32,473 27,978
======== ========= ========= ==========
The accompanying notes are an integral part of the
consolidated financial statements.
<PAGE>
<TABLE>
CREE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(In thousands)
<CAPTION>
Nine Months Ended
----------------------
March 26, March 28,
2000 1999
--------- ---------
(Unaudited)
<S> <C> <C>
Operating activities:
Net income $ 19,575 $ 8,594
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 7,231 3,679
Loss on disposal of property, equipment and patents 1,212 1,284
Amortization of patent rights 105 86
Proceeds from sale of marketable trading securities 2,280 1,421
Purchase of marketable trading securities (1,786) (234)
Loss (gain) on marketable trading securities (494) (141)
Changes in operating assets and liabilities:
Accounts receivable (8,291) (3,862)
Inventories (3,105) (1,337)
Prepaid expenses and other assets (624) 861
Accounts payable , trade (500) (986)
Accrued expenses 12,334 2,010
--------- ---------
Net cash provided by operating activities 27,937 11,375
--------- ---------
Investing activities:
Purchase of short term marketable securities (106,445) --
Purchase of long term marketable securities (77,984) --
Purchase of property and equipment (47,072) (24,816)
Proceeds from sale of property and equipment -- 189
Purchase of patent rights (499) (246)
--------- ---------
Net cash used in investing activities (232,000) (24,873
--------- ---------
Financing activities:
(Retirement) Proceeds of long-term debt -- (8,545)
Net proceeds from issuance of common stock 269,590 60,285
Receipt of Section 16(b) common stock profits -- 594
Repurchase of common stock -- (3,214)
--------- ---------
Net cash provided by financing activities 269,590 49,120
--------- ---------
Net increase in cash and cash equivalents 65,527 35,622
Cash and cash equivalents:
Beginning of period 42,506 17,680
========= =========
End of period $108,033 $ 53,302
======== =========
Supplemental disclosure of cash flow information:
Cash paid for interest, net amounts capitalized -- $ 387
======== =========
Cash paid for income taxes $ 268 $ 1,563
======== =========
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
<PAGE>
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Basis of Presentation
- ---------------------
The consolidated balance sheet as of March 26, 2000, the consolidated statements
of income for the three and nine months ended March 26, 2000 and March 28, 1999,
and the consolidated statements of cash flow for the nine months ended March 26,
2000 and March 28, 1999 have been prepared by the Company and have not been
audited. In the opinion of management, all normal and recurring adjustments
necessary to present fairly the financial position, results of operations and
cash flow at March 26, 2000, and for all periods presented, have been made. The
balance sheet at June 27, 1999 has been derived from the audited financial
statements as of that date.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. It is suggested that these condensed financial
statements be read in conjunction with the financial statements and notes
thereto included in the Company's fiscal 1999 Form 10-K. The results of
operations for the period ended March 26, 2000 are not necessarily indicative of
the operating results that may be attained for the entire fiscal year.
Accounting Policies
- -------------------
Fiscal Year
The Company's fiscal year is a 52 or 53 week period ending on the last Sunday in
the month of June. Accordingly, all quarterly reporting reflects a 13 week
period in fiscal 2000 and fiscal 1999. The Company's current fiscal year extends
from June 28, 1999 through June 25, 2000.
Investments
Investments are accounted for in accordance with Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities" ("SFAS No. 115"). This statement requires certain securities
to be classified into three categories:
(a) Securities Held-to-Maturity -- Debt securities that the entity has the
positive intent and ability to hold to maturity are reported at
amortized cost.
(b) Trading Securities -- Debt and equity securities that are bought and
held principally for the purpose of selling in the near term are
reported at fair value, with unrealized gains and losses included in
earnings.
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<PAGE>
(c) Securities Available-for-Sale -- Debt and equity securities not
classified as either securities held-to-maturity or trading securities
are reported at fair value with unrealized gains and losses excluded
from earnings and reported in retained earnings.
At March 26, 2000, and June 27, 1999, the Company held a short-term equity
investment in common stock of Microvision, Inc. ("MVIS"). The Company purchased
268,600 common shares in a private equity transaction in May 1999 at a price of
$16.75 per share, or $4.5 million. Since management views this transaction as an
investment, the shares are accounted for as "available for sale" securities
under SFAS 115. Therefore unrealized gains or losses are excluded from earnings
and are recorded directly in retained earnings. As of March 26, 2000 and June
27, 1999, the Company recorded unrealized holding gains on this investment of
$11.7 million and $1.6 million, respectively. Pursuant to an agreement signed
March 17, 2000, the Company committed to increase its equity position in MVIS by
investing an additional $12.5 million in MVIS common stock. This additional
investment was completed on April 13, 2000, when the Company purchased 250,000
shares at a price of $50.00 per share.
As of March 26, 2000, the Company's short-term investments also include $106.4
million in high-grade corporate commercial paper, corporate bonds, government
securities, and other securities that mature within one year. The Company
purchased the investments with a portion of the proceeds from its public stock
offering in January 2000. The Company has the intent and ability to hold these
securities until maturity; therefore, they are accounted for as "securities
held-to-maturity" under SFAS 115. The securities are reported on the balance
sheet at amortized cost, as a marketable security with unpaid interest included
in accounts receivable.
As of March 26, 2000, the Company's long-term investments consisted of $78.0
million in high- grade corporate bond holdings that mature beginning April 9,
2001. The Company purchased the corporate bonds with a portion of the proceeds
from the public stock offering in January 2000. The Company has the intent and
ability to hold these securities until maturity; therefore, they are accounted
for as "securities held-to-maturity" under SFAS 115. The securities are reported
on the balance sheet at amortized cost, as long-term marketable securities with
unpaid interest included in accounts receivable if interest is due in less than
12 months, and as a long term receivable if interest is due in more than 12
months. As of March 28, 1999, the Company had no long-term investments.
During the three months ended March 26, 2000, the Company purchased equity
securities that were subsequently sold in the same period. The purchase and sale
of these securities resulted in the Company recording a realized gain on the
sale of stock of $494,000 for the three and nine months ended March 26, 2000.
Long Term Debt
In November 1997, the Company entered into a term loan with a commercial bank
for up to $10.0 million to finance the purchase and upfit of its principal
facility in Durham, North Carolina. Approximately $3.0 million was disbursed
under the loan to finance the initial purchase of the facility with the
remaining proceeds disbursed on a monthly basis based on actual expenditures
incurred. The loan, which was collateralized by the purchased property and
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<PAGE>
subsequent upfits, accrued interest at a fixed rate of 8% and carried customary
covenants, including the maintenance of a minimum tangible net worth and other
requirements. On February 17, 1999, the entire $10.0 million indebtedness was
repaid with proceeds received from a public stock offering.
During the three and nine months ended March 28, 1999, the Company capitalized
interest on funds used to construct property, plant and equipment in connection
with the facility. Interest capitalized for the three and nine months ended
March 28, 1999 was $9,000 and $128,000, respectively.
Inventories
Inventories are stated at the lower of cost or market, with cost determined
under the first-in, first-out (FIFO) method. Inventories consist of the
following:
March 26, June 27,
2000 1999
--------- --------
(In thousands)
Raw materials $ 2,324 $ 1,290
Work-in-progress 2,512 1,675
Finished goods 2,246 1,012
--------- --------
Total Inventories $ 7,082 $ 3,977
========= ========
Research and Development Accounting Policy
The U.S. Government provides funding for several of the Company's current
research and development efforts. The contract funding may be based on either a
cost-plus or a cost-share arrangement. The amount of funding under each contract
is determined based on cost estimates that include direct costs, plus an
allocation for research and development, general and administrative and the cost
of capital expenses. Cost-plus funding is determined based on actual costs plus
a set percentage margin. For the cost-share contracts, the actual costs are
divided between the U.S. Government and the Company based on the terms of the
contract. The government's cost share is then paid to the Company. Activities
performed under these arrangements include research regarding silicon carbide
and gallium nitride materials. The contracts typically require the submission of
a written report that documents the results of such research.
The revenue and expense classification for contract activities is based on the
nature of the contract. For contracts where the Company anticipates that funding
will exceed direct costs over the life of the contract, funding is reported as
contract revenue and all direct costs are reported as costs of contract revenue.
For contracts under which the Company anticipates that direct costs will exceed
amounts to be funded over the life of the contract, costs are reported as
research and development expenses and related funding as an offset of those
expenses. The following table
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<PAGE>
details information about contracts for which direct expenses exceed funding by
period as included in research and development expenses:
Three Months Ended Nine Months Ended
------------------ -----------------
March 26, March 28, March 26, March 28,
2000 1999 2000 1999
--------- --------- --------- ---------
(In thousands)
Net R&D costs $ 164 $ - $ 298 $ -
Government funding 227 - 625 -
--------- --------- --------- ---------
Total direct costs incurred $ 391 $ - $ 923 $ -
========= ========= ========= =========
Significant Sales Contract
In September 1996, the Company entered into a Purchase Agreement with Siemens AG
("Siemens"), pursuant to which Siemens agreed to purchase light emitting diode
("LED") chips made with the Company's gallium nitride-on-silicon carbide
technology. In April 1997, December 1997 and September 1998, contract amendments
were executed that provided for enhanced product specifications requested by
Siemens and larger volume requirements, respectively. In December 1998, the
Purchase Agreement was further amended to provide for additional shipments of
LED products through September 1999. The Purchase Agreement was subsequently
assigned to an indirect subsidiary of Siemens, OSRAM Opto Semiconductors GMBH &
Co. OHG ("Osram"), effective as of January 1, 1999. All shipments under this
Purchase Agreement have been concluded.
In August 1999, the Company entered into a new Purchase Agreement with Osram,
pursuant to which Osram agreed to purchase and the Company is obligated to ship
stipulated quantities of both the standard brightness and the high brightness
LED chips and silicon carbide wafers through September 2000.
The agreement calls for certain quantities of standard brightness and high
brightness LED chips to be delivered by month. In the event the Company
materially defaults in delivering shipments, Osram may recover liquidated
damages of one percent per week of the purchase price of the delayed product,
subject to a maximum of ten percent of the purchase price. If product shipments
are delayed six weeks or more due to circumstances within the Company's control,
then in lieu of liquidated damages, Osram may claim damages actually resulting
from the delay up to 40% of the purchase price of delayed products.
The contract also gives Osram limited rights to defer shipments. For products to
be shipped in more than 24 weeks after initial notice, Osram can defer 30% and
20% of standard brightness and high brightness LEDs, respectively. For products
to be shipped in more than 12 weeks, but less than 24 weeks, Osram may defer 10%
of scheduled quantities for both standard brightness and high brightness LEDs.
Also, additional quantities of high brightness LEDs stipulated in the contract
may be deferred to the next quarter with 60 days notice at the election of
Osram. In all cases, Osram would be
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<PAGE>
required to accept all products within 90 days of the original shipment date.
Additionally, the Purchase Agreement provides for higher per unit prices early
in the contract with reductions in unit prices being available as the cumulative
volume shipped increases. The higher prices were negotiated by the Company to
offset higher per unit costs expected earlier in the contract.
Development Agreement Amendment
On March 17, 2000, the company signed an amendment to its development agreement
with Microvision, Inc. which became effective on April 12, 2000. The development
agreement, which was originally signed May 5, 1999, covers research directed to
the development of edge-emitting light emitting diodes, and laser diodes, and
committed MVIS to fund a one-year program at Cree for $2.6 million. With the
amendment, MVIS has committed to fund an additional two-year program for a total
of $10 million. Under the agreement, MVIS will fund $4.5 million payable in
quarterly installments to Cree for the first year commencing on April 13, 2000.
In addition, the amendment provides that MVIS will fund an additional $5.5
million payable in quarterly installments to Cree for the second year beginning
April 13, 2001. All costs incurred under the program will be charged as research
and development expenses with related funding offsetting these costs. Several
milestones have been identified in the amendment to the development agreement.
Cree is obligated to use best efforts to achieve all milestones; however, Cree
is not obligated to incur costs in excess of funding paid under the agreement.
The agreement provides that failure to achieve milestones is not grounds for
termination of the agreement or to withhold payment of the development fee, that
Cree has no liability for the failure to achieve any milestone, and that any
funding received by Cree is nonrefundable. Cree has also granted exclusive
rights to MVIS for the purchase of products developed in the program for use in
scanned beam applications for seven years after the commencement of the amended
development agreement or expiration of the agreement, subject to certain
conditions.
Depreciation
The Company has adopted lower useful lives on new manufacturing equipment. The
useful life for all manufacturing equipment purchased since the beginning of
fiscal year 2000 is estimated to be 5 years. No changes have been made to the
estimated useful life of 9 years for manufacturing equipment placed in service
prior to fiscal 2000. In management's estimate, this policy change was necessary
due to technology changes anticipated with the future development of larger
diameter wafers. Based on information available at this time, management
estimates that the change in policy may reduce the Company's fiscal 2000 net
income by $660,000 or $0.02 per share, but actual results may vary.
Income Taxes
The Company has established an estimated tax provision based upon an effective
rate of 34%. The estimated effective rate was based upon projections of income
for the fiscal year and the Company's ability to utilize remaining net operating
loss carryforwards and other tax credits. However, the actual effective rate may
vary depending upon actual pre-tax book income for the year or other factors.
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Earnings Per Share
- ------------------
The Company presents earnings per share in accordance with Statement of
Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"). SFAS
128 required the Company to change its method of computing, presenting and
disclosing earnings per share information. All prior period data presented has
been restated to conform to the provisions of SFAS 128.
The following computation reconciles the differences between the basic and
diluted presentations:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------ -----------------
March 26, March 28, March 26, March 28,
2000 1999* 2000 1999*
--------- --------- --------- ---------
(In thousands, except per share amounts)
<S> <C> <C> <C> <C>
Net income $ 9,155 $ 3,377 $19,575 $ 8,594
Weighted average common shares 32,169 27,266 30,364 26,258
--------- --------- --------- ---------
Basic earnings per common share $ 0.28 $0.12 $0.64 $0.33
========= ========= ========= =========
Net income $ 9,155 $ 3,377 $19,575 $ 8,594
Diluted weighted average common shares:
Common shares outstanding 32,169 27,266 30,364 26,258
Dilutive effect of stock options and warrants 2,443 2,504 2,109 1,720
--------- --------- --------- ---------
Total diluted weighted average common shares 34,612 29,770 32,473 27,978
--------- --------- --------- ---------
Diluted earnings per common share $ 0.26 $0.11 $0.60 $0.31
========= ========= ========= =========
</TABLE>
* Weighted average shares and per share amounts have been adjusted for the two
for one stock split effective July 26, 1999.
Potential common shares that would have the effect of increasing diluted income
per share are considered to be antidilutive. In accordance with SFAS No. 128,
these shares were not included in calculating diluted income per share. As of
March 26, 2000 and March 28, 1999, there were no potential shares considered to
be antidilutive.
On July 13, 1999 the Company filed a Form 8-K announcing a two-for-one split of
its common stock. The stock split was effected by an amendment to the Company's
Articles of Incorporation that became effective at the close of business on July
26, 1999. With the effectiveness of the amendment, each issued and unissued
authorized share of common stock, $0.005 par value per share, was automatically
split into two whole shares of common stock, $0.0025 par value per share. On
July 30, 1999, the Company issued to each holder of record of common stock a
certificate evidencing the additional shares of common stock resulting from the
stock split. All references in this document to common stock and per common
share data have been adjusted to reflect the common stock split.
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<PAGE>
Shareholders' Equity
- --------------------
On January 20, 2000, the Company completed a public offering of 3,289,000 shares
of its common stock at a price to the public of $85.125 per share. The Company
received net aggregate proceeds of approximately $266.7 million after deducting
underwriting discounts and commissions and estimated offering costs. The net
proceeds will be used primarily for manufacturing facility expansion and
purchase of additional equipment, the acquisition of an additional facility,
research and development, and general corporate purposes.
Subsequent Events
- -----------------
On April 11, 2000, the Company announced it had signed a definitive agreement to
acquire privately held Nitres, Inc. ("Nitres"), a company engaged in research
and development of nitride-based semiconductor devices with offices in Goleta
and West Lake Village, California. Under the terms of the agreement, the Company
will acquire all of the outstanding and vested shares of Nitres stock in
exchange for approximately 1.5 million shares of the Company's common stock in a
pooling of interests transaction. In connection with the transaction, the
Company will issue approximately 350,000 unvested common shares in exchange for
unvested Nitres shares and assume all outstanding Nitres stock options and
warrants which will be exercisable for approximately 150,000 shares of the
Company's common stock. As a result of the acquisition, Nitres will become a
wholly-owned subsidiary of the Company called "Cree Lighting Company." The
transaction is expected to be completed by the end of May 2000 subject to
satisfaction of customary closing conditions. As a result of the transaction,
the Company expects to take a one-time charge of approximately $3.5 million for
the quarter ended June 25, 2000 for fees and other costs relating to the
acquisition.
On April 13, 2000, the Company purchased 250,000 shares of common stock of MVIS
in a private equity transaction at $50.00 per share, or $12.5 million. MVIS has
filed a registration statement to register the shares. Cree will account for its
investment in MVIS under FAS 115 as an "available for sale" security.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Information set forth in this Form 10-Q, including Management's Discussion and
Analysis of Financial Condition and Results of Operations, contains various
"forward looking statements" within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Act of 1934. These statements
represent our judgment concerning the future and are subject to risks and
uncertainties that could cause our actual operating results and financial
position to differ materially. Forward looking statements are typically
identified by the use of such terms as "may," "will," "anticipate," "believe,"
"plan," "estimate," "expect," and "intend" and similar words, although some
forward looking statements are expressed differently. Our actual operating
results could differ materially from those contained in the forward looking
statements due to a number of factors, including the risk our customers may fail
to honor
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<PAGE>
contractual purchase commitments, fluctuations in our operating results,
production yields in our manufacturing processes, whether we can produce
sufficient quantities to meet delivery requirements, the risk that demand for
our high brightness LED products may be less than we expect, the risk of price
reductions or other actions by competitors that may impair sales, uncertainty
whether we can continue to meet margin goals, risk of manufacturing delays or
increased costs due to variability in the complex processes used to manufacture
our products, risk of unanticipated facility or equipment outages, our
dependence on a few customers, whether new customers will emerge, whether we can
develop, introduce and create market demand for new products, the ability to
complete the Nitres acquisition and integrate it with Cree's current operations,
the ability to continue Nitres' research and development successfully and
commercialize products on a timely and cost effective basis, the actual costs of
combining the businesses, whether we can manage our growth effectively,
assertion of intellectual property rights by others or loss of pending patent
litigation and the risk of adverse economic conditions. See Exhibit 99.1 for
additional factors that could cause our actual results to differ.
Overview
- --------
Cree, Inc. is the world leader in developing and manufacturing semiconductor
materials and electronic devices made from silicon carbide ("SiC"). We recognize
product revenue at the time of shipment or in accordance with the terms of the
relevant contract. We derive the largest portion of our revenue from the sale of
blue and green LED products. We offer LEDs at two brightness levels: high
brightness blue and green products and standard brightness blue products. Our
LED devices are utilized by end users for automotive dashboard backlighting,
liquid crystal display ("LCD") backlighting, including wireless handsets and
other consumer products, indicator lamps, miniature white lights, indoor sign
and arena displays, outdoor full color displays, traffic signals and other
lighting applications.
During the first nine months of fiscal 2000, revenues derived from sales of high
brightness LEDs were greater than 70% of the total LED sales mix. Historically,
we have experienced low margins with many new product introductions, including
the high brightness products. We have continued to make improvements to output
and yield since the high brightness products were introduced in fiscal 1999.
During the first nine months of fiscal 2000, we continued to make progress
towards our fiscal 2000 goal of a 50% cost reduction for high brightness LED
products through a 44% reduction in unit costs from June 1999. During the fourth
quarter of fiscal 2000, we plan to continue our focus on reducing unit costs
through higher production yields and increased volume.
We derive revenue from the sale of SiC wafers that are used for device
production and research and development. In addition, we sell SiC crystals to
C3, Inc., or "C3" which uses them in gemstone applications. In the fall of 1999,
C3 announced lower sales and higher inventory levels than anticipated. C3 also
launched a new marketing campaign for its gemstone products. In the second
quarter of fiscal 2000, we agreed that C3 could reschedule approximately
one-half of its purchase commitments from the first half of calendar 2000 to the
second half of the year. As a result, sales to C3 declined 34% during the third
quarter of fiscal 2000. We anticipate that overall sales to C3 will decrease to
less than 10% of our revenue for the fourth quarter of fiscal 2000, and will
continue to decline as a percentage of revenue through the first half of fiscal
2001.
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The balance of our revenue is derived from government contract funding. Under
various programs, U.S. Government entities support the development of our
technology by supplementing our research and development funding. We retain
ownership of patent rights on technology developed under such contracts, subject
to certain license rights retained by the government. Contract revenue includes
funding of direct research and development costs and a portion of our general
and administrative expenses and other operating expenses for contracts under
which we expect funding to exceed direct costs over the life of the contract.
For contracts under which we anticipate that direct costs will exceed amounts to
be funded over the life of the contract (i.e., certain cost-share arrangements),
we report direct costs as research and development expenses with related
reimbursements recorded as an offset to those expenses.
In 1999, we announced the introduction of the first of a family of RF and
microwave transistor products made from SiC. These products are designed for use
in a variety of power amplification applications. A second phase of transistor
products is expected to be available in calendar 2000. We expect that these
products will be marketed to a variety of amplifier producers for a number of
uses, including wireless base station and digital broadcast applications. While
distribution of these products on a sample basis commenced in early fiscal 2000,
we believe that these products will be sold in limited quantities as evaluation
kits during fiscal 2000 since design cycles for the target applications
generally exceed six months. There can be no assurance that customers will
develop applications requiring commercially significant volumes of our RF
products or that such products will be successful in the market.
In September 1996, we entered into an agreement with Siemens under which Siemens
agreed to purchase a fixed quantity of our blue LED chips. In December 1998,
this agreement was amended to provide for additional shipments of LED products
through September 1999. This contract was assigned to Osram, an indirect
subsidiary of Siemens, effective January 1, 1999. In August 1999, we entered
into a new purchase agreement with Osram pursuant to which Osram agreed to
purchase, and we are obligated to ship, stipulated quantities of both standard
brightness and high brightness LED chips, as well as SiC wafers, through
September 2000. This contract gives Osram limited rights to defer shipments. It
also provides for recovery of liquidated damages, and actual damages in some
instances, if we materially default in meeting shipment schedules. The contract
provides for higher unit prices early in the contract term, with unit price
reductions becoming available as the cumulative volume of products shipped
increases.
Results of Operations
- ---------------------
Three Months Ended March 26, 2000 and March 28, 1999
Revenue. Revenue increased 77% from $16.0 million in the third quarter of fiscal
1999 to $28.4 million in the third quarter of fiscal 2000. This increase was
attributable to an increase in product revenue of 86% from $14.1 million in the
third quarter of fiscal 1999 to $26.2 million in the third quarter of fiscal
2000. This rise in product revenue was a result of the 149% increase in sales of
our LED products in the third quarter of fiscal 2000 compared to the third
quarter of fiscal 1999. LED volume grew 74% during the same period compared to
the prior year due to a significant increase in demand for high brightness blue
and green LED products. These high brightness products represented over 80% of
total LED sales for the third quarter of fiscal 2000.
-14-
<PAGE>
As a result of the increasing mix of high brightness products, average LED sales
prices have increased 44% in the third quarter of fiscal 2000 compared to the
third quarter of fiscal 1999.
Revenue attributable to sales of SiC materials was 4% higher in the third
quarter of fiscal 2000 than in the same period of fiscal 1999. In the second
quarter of fiscal 2000, we agreed to spread shipments of gemstone products for
the remainder of fiscal 2000 over the next twelve months, which resulted in
lower revenue from C3 sequentially, but slightly higher amounts over the prior
year. The reduced orders from C3 have been offset with additional LED revenue in
the third quarter of fiscal 2000, and we believe that additional LED revenue in
the fourth quarter of fiscal 2000 will again offset these reduced orders.
Contract revenue from the U.S Government agencies increased 11% during the third
quarter of fiscal 2000 compared to the third quarter of fiscal 1999 due to
additional awards received in late fiscal 1999 and in the first quarter of
fiscal 2000.
Gross Profit. Gross margin was 56% of revenue during the third quarter of fiscal
2000 as compared to 48% during the third quarter of fiscal 1999. This increase
is due primarily to the increases in LED sales volumes and average sales price
per chip for LEDs discussed above. In addition, higher throughput and
manufacturing yield on high brightness LEDs and materials products have resulted
in lower unit costs. Wafer costs for SiC material sales also declined during the
third quarter of fiscal 2000 compared to the third quarter of fiscal 1999. Over
the next few quarters, we target gross margin to decline slightly from levels
attained in the third quarter of fiscal 2000, due to the initial integration of
our three-inch wafer into device manufacturing.
Research and Development. Research and development expenses increased 48% in the
third quarter of fiscal 2000 to $2.2 million from $1.5 million in the third
quarter of fiscal 1999. Much of this increase was caused by greater investments
for research in the RF and microwave and optoelectronics programs. In addition,
spending under the MVIS contract was higher than funding received. On March 17,
2000, the Company agreed to an amendment of its original agreement with MVIS,
signed in May 1999. Under the terms of the amended agreement, MVIS will commit
$10.0 million in funding over a two-year period for the continued development of
edge-emitting LEDs and laser devices. As development costs are incurred under
this contract, funding from MVIS is offset against these expenses. This amended
development agreement became effective on April 13, 2000. We expect internal
research and development expenses to grow in future periods.
Sales, General and Administrative. Sales, general and administrative expenses
increased 81% in the third quarter of fiscal 2000 to $2.8 million from $1.6
million in the third quarter of fiscal 1999, due to greater spending to support
the overall growth of the business. We anticipate that total sales, general and
administrative expenses will increase in connection with the growth of our
business; however, we believe that as a percentage of revenue they will remain
relatively constant.
Other (Income) Expense. Other (income) expense has increased 117% to $673,000
during the third quarter of fiscal 2000 from $311,000 for the third quarter of
fiscal 1999. During the third quarter of fiscal 2000, we recorded $1.2 million
in write-down charges for the retirement of manufacturing equipment and other
building improvements. This loss was offset by gains realized on the sale of
trading securities bought and sold during the quarter. In the third quarter
-15-
<PAGE>
of fiscal 1999, we realized impairments to leasehold costs as a result of
management's decision to move equipment from our leased facility to our new
manufacturing site.
Interest Income, Net. Interest income, net has increased to $3.8 million in the
third quarter of fiscal 2000 from $347,000 in the third quarter of fiscal 1999
due to a higher available cash balance following the completion of our public
stock offering in January 2000. Higher interest rates in fiscal 2000 also
contributed to increased interest income. A portion of the proceeds from the
February 1999 public stock offering was used to repay the $10.0 million term
loan from NationsBank in the third quarter of fiscal 1999; therefore, no
interest expense was incurred in the third quarter of fiscal 2000. Interest
expense incurred with the term loan was capitalized as a part of the
construction improvements made to the facility in fiscal 1999. However, the
majority of the interest incurred in the third quarter of fiscal 1999 was
expensed.
Income Tax Expense. Income tax expense for the third quarter of fiscal 2000 was
$4.7 million compared to $1.3 million in the third quarter of fiscal 1999. This
increase resulted from higher profitability during the third quarter of fiscal
2000 over the same period in fiscal 1999 and a higher effective tax rate. Our
tax rate during the third quarter of fiscal 2000 was 34% compared to 28% in the
third quarter of fiscal 1999, due to a reduction in the reserve for deferred tax
assets.
Nine Months Ended March 26, 2000 and March 28, 1999
Revenue. Revenue increased 71% from $42.4 million in the first nine months of
fiscal 1999 to $72.3 million in the first nine months of fiscal 2000. This
increase resulted from an increase in product revenue of 77% from $37.6 million
in the first nine months of fiscal 1999 to $66.6 million in the first six months
of fiscal 2000. This rise in product revenue was largely a result of the 118%
increase in sales of our LED products in the first nine months of fiscal 2000
compared to the first nine months of fiscal 1999. Our high brightness LED
products experienced the heaviest demand. While our LED chip sales volume has
grown 82% in the first nine months of fiscal 2000 over units shipped in the
first nine months of fiscal 1999, our average sales prices for LEDs have also
increased 35% in the first nine months of fiscal 2000 over the same period in
the prior year. The greater average sales price reflects a significant shift in
mix to the higher priced high brightness LED products. For the first nine months
of fiscal 2000, more than 70% of LED sales were attributable to high brightness
products. For the first nine months of fiscal 1999, approximately 10% of LED
sales were from high brightness products.
Revenue attributable to sales of SiC material was 28% higher in the first nine
months of fiscal 2000 than in the same period of fiscal 1999 due to a
significant increase in sales to C3 for gemstone applications. During the fourth
quarter of fiscal 1999 and the first quarter of fiscal 2000, C3 purchased
additional equipment from us to increase our capacity to manufacture gemstone
products for them. In the second quarter of fiscal 2000, we agreed to spread
shipments of gemstone products for the remainder of fiscal 2000 over the next
twelve months. These reduced orders from C3 have been offset with additional LED
revenue in the third quarter of fiscal 2000, and we believe that additional LED
revenue in the fourth quarter of fiscal 2000 will again offset these reduced
orders. Contract revenue received from U.S. Government agencies increased 21%
during the first nine months of fiscal 2000 compared to the first nine months of
-16-
<PAGE>
fiscal 1999 due to new contracts that have been awarded to the Company in late
fiscal 1999 and in the first quarter of fiscal 2000.
Gross Profit. Gross profit increased 90% from $20.0 million in the first nine
months of fiscal 1999 to $38.0 million in the first nine months of fiscal 2000.
This increase is due primarily to the increases in LED sales volumes and average
sales price per chip for LEDs discussed above. During the first nine months of
fiscal 2000, the average cost to manufacture high brightness LEDs has been
reduced 44%. Margins on wafer and gemstone products have also improved during
the first nine months of fiscal 2000 as higher quality materials are being
produced with greater yields.
Research and Development. Research and development expenses increased 48% in the
first nine months of fiscal 2000 to $5.1 million from $3.4 million in the first
nine months of fiscal 1999. Much of this increase was caused by a greater
investment made for research in the RF and microwave and optoelectronics
programs. In addition, spending under the MVIS contract was higher than funding
received. As development costs are incurred under this contract, funding from
MVIS is offset against these expenses.
Sales, General and Administrative. Sales, general and administrative expenses
increased 74% in the first nine months of fiscal 2000 to $7.4 million from $4.2
million in the first nine months of fiscal 1999, due to greater spending to
support the overall growth of the business.
Other (Income) Expense. Other (income) expense decreased 11% to $767,000 during
the first nine months of fiscal 2000 from $878,000 for the first nine months of
fiscal 1999. During the third quarter of fiscal 2000, we recorded $1.2 million
in write-down charges for the retirement of manufacturing equipment and other
building improvements. This loss was offset by gains realized on the sale of
trading securities bought and sold during the quarter. In the first nine months
of fiscal 1999, we realized impairments to leasehold costs as a result of
management's decision to move equipment from our leased facility to our new
manufacturing site. This was offset somewhat by investment income recognized on
stock held in C3.
Interest Income, Net. Interest income, net increased 920% to $4.9 million in the
first nine months of fiscal 2000 from $482,000 in the first nine months of
fiscal 1999 due to a higher available cash balance following the completion of
our public stock offerings in January 2000 and February 1999. Higher interest
rates in fiscal 2000 also contributed to increased interest income. A portion of
the proceeds from the February 1999 public stock offering was used to repay the
$10.0 million term loan from NationsBank in the third quarter of fiscal 1999.
Income Tax Expense. Income tax expense for the first nine months of fiscal 2000
was $10.1 million compared to $3.3 million in the first nine months of fiscal
1999. This increase resulted from higher profitability during the first nine
months of fiscal 2000 over the first nine months of fiscal 1999 and a higher
effective tax rate. Our tax rate during the first nine months of fiscal 2000 was
34% compared to 28% in the first nine months of fiscal 1999.
-17-
<PAGE>
Liquidity and Capital Resources
- -------------------------------
We have funded our operations to date through sales of equity, bank borrowings
and revenue from product and contract sales. As of March 26, 2000, we had
working capital of $239.0 million, including $231.0 million in cash and
short-term investments. Not included in working capital is an additional $78.0
million in high-grade marketable securities included as a long-term investment.
Operating activities generated $27.9 million for the first nine months of fiscal
2000 compared with $11.4 million generated during the comparative period in
fiscal 1999. This increase was primarily attributable to higher profitability.
We invested $47.1 million in capital expenditures during the first nine months
of fiscal 2000 compared to $24.8 million during the same period in the prior
fiscal year. The majority of the increase in spending was due to new facilities
and equipment additions to increase manufacturing capacity in our crystal
growth, epitaxy, and package and test areas. In the second quarter of fiscal
2000, we completed a 42,000 square foot facility expansion at our production
site near Research Triangle Park, North Carolina. Also, during the third quarter
of fiscal 2000, we purchased a 120,000 square foot facility on 17.5 acres of
land adjacent to the existing production site that will support administration
and portions of research and development. The cost to acquire this facility was
$8.1 million.
We are currently engaged in construction activities relating to a 250,000 square
foot expansion of our main facility to provide added capacity for our LED and
materials and future product lines. Phases of this project will be finished
beginning in December 2000, with the balance targeted for completion within 18
months. We anticipate total costs for these facilities to be between $40.0
million and $50.0 million. Estimates for equipment costs relating to this
expansion total between $30.0 million and $40.0 million. We plan to fund this
expansion with the net proceeds of the January 2000 stock offering and cash from
operations.
From time to time we evaluate potential acquisitions of and investments in
complementary businesses and anticipate continuing to make such evaluations.
Except for the acquisition of Nitres, which is anticipated to be completed by
the end of May 2000, we have no present commitments or agreements with respect
to the potential acquisition of or investment in another business.
Cash provided by financing activities during the first nine months of fiscal
2000 reflected the receipt of $266.7 million in net proceeds from the January
2000 stock offering and $2.9 million in proceeds from the exercise of stock
options from our employee stock option plan.
At September 27, 1998, we had a loan outstanding for $10.0 million from a
commercial bank to finance portions of the upfit of the production facility. The
final draw to this loan was made during the first quarter of fiscal 1999 for
$1.3 million. The loan was subsequently paid off in the third quarter of fiscal
1999. We also committed $3.2 million during the first quarter of fiscal 1999 to
repurchase common stock.
We anticipate that internally generated cash plus the proceeds of the January
2000 stock offering will be sufficient to fund our capital requirements for the
next 12 months.
-18-
<PAGE>
Impact of the Year 2000
- -----------------------
Even though the date is now past January 1, 2000 and we have not experienced any
immediate adverse impact from the transition to the Year 2000, we cannot provide
assurance that our suppliers and customers have not been affected in a manner
that is not yet apparent. As a result, we will continue to monitor our Year 2000
compliance and the Year 2000 compliance of our suppliers and customers.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
During the third quarter of fiscal 2000, the Company invested some of the
proceeds from the public offering into high-grade corporate debt, commercial
paper, government securities and other investments at interest rates that vary
by security. No other material changes in market risk have been identified
during the most recent quarter.
-19-
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company's report on Form 10-Q for the period ended December 26, 1999
describes a lawsuit pending in Tokyo District Court brought by Nichia
Corporation against Sumitomo Corporation, one of the Company's distributors in
Japan. As previously reported, the complaint in this proceeding is directed to
the Company's standard brightness LED products and alleges that the products
infringe a Japanese patent owned by Nichia. The suit seeks a permanent
injunction against further distribution of the products in Japan. The Company
has intervened in the proceeding and filed a response denying the allegations of
infringement. Nichia subsequently commenced additional proceedings against
Sumitomo in Tokyo District Court in which it alleges that the Company's high
brightness LED products infringe a second Japanese patent owned by Nichia. The
new proceedings, filed April 10, 2000 and served on Sumitomo thereafter, seek
preliminary and permanent injunctions prohibiting Sumitomo from further sales of
the products in Japan. The Company has intervened in the new preliminary
injunction proceeding and intends to seek intervention in the related case. No
monetary damages for infringement have been sought in any of the lawsuits
brought by Nichia against Sumitomo. Management believes that the infringement
claims are without merit and that the lawsuits are motivated by competitive
factors. The Company intends to vigorously defend its products against these
claims.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
27.1 Financial Data Schedule
99.1 Risk Factors
(b) Reports on Form 8-K:
The Company filed a report on Form 8-K on January 3, 2000
regarding its financial results for the period ended December 26,
1999.
-20-
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CREE, INC.
Date: April 25, 2000 By: /s/ Cynthia B. Merrell
------------------------------------
Cynthia B. Merrell
Chief Financial Officer and Treasurer
(Authorized Officer and Chief Financial
and Accounting Officer)
-21-
<PAGE>
EXHIBIT INDEX
Exhibit No.
27.1 Financial Data Schedule
99.1 Risk Factors
-22-
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EXHIBIT 99.1
Certain Business Risks and Uncertainties
Described below are various risks and uncertainties that may affect our
business. The risks and uncertainties described below are not the only ones we
face. Additional risks and uncertainties not presently known to us, that we
currently deem immaterial or that are similar to those faced by other companies
in our industry or business in general may also impair our business operations.
If any of the following risks actually occurs, our business, financial condition
or results of future operations could be materially and adversely affected.
Our operating results may fluctuate significantly and we may not be able to
maintain our existing growth rate.
Although we have had significant revenue and earnings growth in recent quarters,
we may not be able to sustain these growth rates and we may experience
significant fluctuations in our revenue and earnings in the future. Our
operating results will depend on many factors, including the following:
o our ability to develop, manufacture and deliver products in a timely
and cost-effective manner;
o our ability to produce enough usable product during each manufacturing
step (our "yield");
o our ability to expand our production of silicon carbide, or SiC,
wafers and devices;
o our ability to complete our pending acquisition of Nitres, Inc. and
integrate the combined businesses into our current operations;
o demand for our products, particularly our high brightness light
emitting diodes, or LEDs;
o demand for our customers' products;
o competition; and o general industry and global economic conditions.
Our future operating results could be adversely affected by these or other
factors. Additionally, if our future operating results are below the
expectations of equity analysts or our investors, our stock price may decline.
If we experience poor production yields, our operating results may suffer.
Our SiC products are manufactured using technologies that are highly complex.
Our customers incorporate our products into high volume applications such as
automotive dashboards, wireless handsets and other consumer products, and they
insist that our products meet exact specifications for quality, performance and
reliability.
The number of usable crystals, wafers and devices that result from our
production processes can fluctuate as a result of many factors, including the
following:
o impurities in the materials used;
o contamination of the manufacturing environment;
o equipment failure, power outages or variations in the manufacturing
process; and
o losses from human error.
Because many of our manufacturing costs are fixed, if our yields decrease our
operating results would be adversely affected.
In the past, we have experienced difficulties in achieving acceptable yields on
both new and older products, and poor yields have adversely affected our
operating results. We may experience similar problems in the future and we
cannot predict when they may occur or their severity. Such problems could
significantly affect our future operating results.
If we are unable to produce adequate quantities of our high brightness LEDs, our
operating results may suffer.
We have made and continue to make substantial investments in equipment and
facilities to manufacture high brightness blue and green LEDs. We have accepted
orders for these products in quantities that have sold out our existing and
planned increases in production capacity for the next few quarters. These
significant volumes also require improved production yields for the products to
meet customer demand. Successful production of these products is subject to a
number of risks, including the following:
o our ability to consistently manufacture the products in volumes large
enough to cover our fixed costs and satisfy our customers'
requirements; and
o our ability to improve our yields and reduce the costs associated with
the manufacture of the products.
Our inability to produce adequate quantities of our high brightness blue and
green LEDs would have a material adverse effect on our business, results of
operations and financial condition. For example, our current contract with our
largest LED customer provides that the customer may recover liquidated damages,
or in some cases actual damages, if we materially default in meeting delivery
commitments.
The markets in which we operate are highly competitive.
The markets for our products are highly competitive. Our competitors offer blue
and green LEDs made from sapphire wafers that are brighter than the high
brightness LEDs we currently produce. In addition, some of our customers could
compete with us. For example, Osram Opto Semiconductors GMBH and Co. OHG, or
Osram, an indirect subsidiary of Siemens AG, and Shin-Etsu Handotai Co. Ltd., or
Shin-Etsu, license some of our LED technology. Osram currently purchases large
volumes of our standard brightness blue LEDs but also manufactures some of its
volume requirements for these LEDs. Shin-Etsu may also seek to enter our LED
markets. The market for SiC wafers is likewise becoming competitive as other
firms have in recent years begun offering SiC wafer products or announced plans
to do so.
Also, other firms may develop new or enhanced products that are more effective
than any that we have developed or may develop. These firms may develop
technologies that enable the production of commercial products with
characteristics similar to SiC-based products but at a lower cost. Many existing
and potential competitors have far greater financial, marketing and other
resources than we do. We believe that present and future competitors will
aggressively pursue the development and sale of competing products. We also
expect significant competition for products we are currently developing, such as
those for use in microwave communications.
We expect competition to increase. This could mean lower prices or reduced
demand for our products and a corresponding reduction in our ability to recover
development, engineering and manufacturing costs. Any of these developments
could have an adverse effect on our business, results of operations and
financial condition.
Our operating results are substantially dependent on the development of new
products based on our core SiC technology.
Our future success depends on our ability to develop new SiC solutions for
existing and new markets. We must introduce new products in a timely and
cost-effective manner and secure production orders from our customers. The
development of new SiC products is a highly complex process, and we have
historically experienced delays in completing the development and introduction
of new products. Products currently under development include high power radio
frequency, or RF, and microwave devices, power devices, blue laser diodes and
high temperature devices. Through our proposed acquisition of Nitres, we also
anticipate continuing its research and development efforts to develop new
products. The successful development and introduction of these products depends
on a number of factors, including the following:
o achievement of technology breakthroughs required to make commercially
viable devices;
o the accuracy of our predictions of market requirements and evolving
standards;
o acceptance of our new product designs;
o our ability to recruit qualified development personnel;
o our timely completion of product designs and development;
o our ability to develop repeatable processes to manufacture new
products in sufficient quantities and at satisfactory costs for
commercial sales; and
o acceptance of our customers' products by the market.
If any of these or other factors become problematic, we may not be able to
develop and introduce these new products in a timely or cost-effective manner.
We depend on a few large customers.
Historically, a substantial portion of our revenue has come from large purchases
by a small number of customers. We expect this trend to continue. For example,
for fiscal 1999 our top five customers accounted for 81% of our total revenue.
(These percentages consider sales to a distributor as sales to one customer).
Sales to Osram accounted for 37% of our total revenue in fiscal 1999. In
addition, sales to C3, Inc., or C3, accounted for 19% of our total revenue in
fiscal 1999. Accordingly, our future operating results depend on the success of
our largest customers and on our success in selling large quantities of our
products to them.
The concentration of our revenues with a few large customers makes us
particularly dependent on factors affecting those customers. For example, if
demand for their products decreases, they may stop purchasing our products and
our operating results will suffer. Our customers use our products as components
in their products. If other aspects of our customers' products infringe a third
party's intellectual property rights, and our customers are then prohibited from
selling their products, our business could be adversely affected. If we lose a
large customer and fail to add new customers to replace lost revenue, our
operating results may not recover.
Under an exclusive supply agreement with an initial term extending to 2005, C3
must purchase from us each calendar quarter at least 50% (by dollar volume) of
its requirements for SiC materials for use in production of gemstones during the
quarter. In the fall of 1999, C3 announced lower sales and higher inventory
levels than anticipated, as well as the launch of a new marketing campaign. In
the second quarter of fiscal 2000, we agreed that C3 could reschedule
approximately one-half of its purchase commitments from the first half of
calendar 2000 to the second half of the year. We anticipate that sales to C3
will decrease in calendar 2000. We may use excess capacity from C3-dedicated
equipment for other applications, but if we are not able to replace these
revenues with sales from other areas of our business, our financial results may
be materially adversely affected.
Our operations could infringe upon the intellectual property rights of others.
Other companies may hold or obtain patents on inventions or may otherwise claim
proprietary rights to technology necessary to our business. We cannot assure you
that third parties will not attempt to assert infringement claims against us
with respect to our current or future products, including our core products. We
cannot predict the extent to which such assertions may require us to seek
licenses or, if required, whether such licenses will be offered or offered on
acceptable terms or that disputes can be resolved without litigation. One of our
distributors in Japan was named in a lawsuit, filed in Japan in December 1999 by
one of our competitors, alleging infringement of a Japanese patent and seeking
an injunction that, if granted, would preclude the distributor from selling our
standard brightness blue LED product in Japan. We have intervened in the action
to participate in the defense against the claim of infringement. In April 2000,
the same competitor commenced additional proceedings against our distributor
alleging that our high brightness LEDs infringe a second patent and seeking
preliminary and permanent injunctions against distribution of these products in
Japan. A result adverse to the distributor would impair our ability to sell
these products in Japan. Subject to contractual limitations, we have an
obligation to indemnify our distributor for certain patent infringement claims.
Litigation to determine the validity of infringement claims alleged by third
parties could result in significant expense to us and divert the efforts of our
technical and management personnel, whether or not the litigation is ultimately
determined in our favor. We cannot predict the occurrence of future intellectual
property claims that may prevent us from selling products, result in litigation
or give rise to indemnification obligations or damage claims.
We face challenges relating to expansion of our production and manufacturing
capacity.
In order to increase production, we must expand our existing facilities or
acquire new facilities, as well as purchase new manufacturing equipment. We are
beginning to construct 250,000 square feet of additional space at our
manufacturing facility and have purchased another 120,000 square foot facility
under construction on a 17.5-acre site near our existing facility. Expansion
activities such as these are subject to a number of risks, including the
following:
o unforeseen environmental or engineering problems relating to existing
or new facilities;
o unavailability or late delivery of the advanced, and often customized,
equipment used in the production of our products;
o work stoppages and delays; and
o delays in bringing production equipment on-line.
These and other risks may affect the ultimate cost and timing of our current
construction, as well as the acquisition of new facilities, which could
adversely affect our business, results of operations and financial condition.
For example, if we are not successful in meeting milestones associated with this
expansion, we could have difficulty making shipments of previously ordered
products; consequently, we could be in default under contracts with our
customers and/or subject to penalties.
We face significant challenges managing our growth.
We have experienced a period of significant growth that has strained our
management and other resources. We have grown from 188 employees on December 31,
1996 to 478 employees on December 26, 1999 and from revenues of $29.0 million
for the fiscal year ended June 30, 1997 to $60.1 million for the fiscal year
ended June 27, 1999. To manage our growth effectively, we must continue to:
o implement and improve operational systems;
o maintain adequate manufacturing facilities and equipment to meet
customer demand;
o add experienced senior level managers; and
o attract and retain qualified people with experience in engineering,
design, technical marketing and support.
We will spend substantial amounts of money in supporting our growth and may have
additional unexpected costs. Our systems, procedures or controls may not be
adequate to support our operations, and we may not be able to expand quickly
enough to exploit potential market opportunities. Our future operating results
will also depend on expanding sales and marketing, research and development, and
administrative support. If we cannot attract qualified people or manage growth
effectively, our business, operating results and financial condition could be
adversely affected.
Our operating results could be adversely affected if we encounter problems
transitioning LED production to a larger wafer size.
Beginning in the second half of calendar 2000, we plan to begin shifting LED
production from two-inch wafers to three-inch wafers. We must first qualify our
production processes on systems designed to accommodate the larger wafer size,
and some of our existing production equipment must be refitted for the larger
wafer size. Delays in this process could have an adverse effect on our business.
In addition, in the past we have experienced lower yields for a period of time
following a transition to a larger wafer size until use of the larger wafer is
fully integrated in production and we begin to achieve production efficiency. We
anticipate that we will experience similar temporary yield reductions during the
transition to the use of three-inch wafers, and we have factored this into our
plan for production capacity. If this transition phase takes longer than we
expect or if we are unable to attain expected yield improvements, our operating
results may be adversely affected.
The ongoing operation of our manufacturing facility is critical to our business.
Our principal manufacturing facility in Durham, North Carolina currently
includes a total of 214,000 square feet. The ongoing operation of this facility
is crucial to our strategy of expanding manufacturing capacity to meet demand
for our SiC products now and in the future. We began commercial production of
products from our present facility in August 1998. We expect that production
from this facility will increase throughout the remainder of fiscal 2000 and
into fiscal 2001. Our inability to use all or a significant portion of our
facilities for prolonged periods of time for any reason could have an adverse
impact on our business. For example, a fire or explosion caused by our use of
combustible chemicals and high temperatures during certain of our manufacturing
processes would render some or all of our facility inoperable for an indefinite
period of time. Our manufacturing process requires highly specialized customized
equipment that is not easily replaced. Consequently, damage to or destruction of
any or all of our facility could impair our ability to manufacture products for
our customers.
We rely on a few key suppliers.
We depend on a limited number of suppliers for certain raw materials, components
and equipment used in manufacturing our SiC products, including key materials,
components and equipment used in critical stages of our manufacturing processes.
We generally purchase these limited source items with purchase orders, and we
have no guaranteed supply arrangements with our suppliers. If we were to lose
such key suppliers, our manufacturing efforts could be hampered significantly.
Although we believe our relationship with our suppliers is good, we cannot
assure you that we will continue to maintain good relationships with such
suppliers or that such suppliers will continue to exist.
Our business may suffer if government agencies or other customers discontinue
their funding for our research and development.
In the past, government agencies and other customers have funded a significant
portion of our research and development activities. If this support is
discontinued or reduced, our ability to develop or enhance products could be
limited and our business, results of operations and financial condition could be
adversely affected.
We depend heavily on key personnel.
Our success depends in part on keeping key technical and management personnel.
For example, some of the equipment used in the production of our products must
be modified before it is put to use and only a limited number of employees
possess the expertise needed to perform these modifications. Furthermore, the
number of individuals with experience in the production of SiC and related
products is limited, and our future success depends in part on retaining those
individuals who are already employees. We must also continue to attract
qualified personnel. The competition for qualified personnel is intense, and the
number of people with the experience that we need is limited. We cannot be sure
that we will be able to continue to attract and retain other skilled personnel
in the future.
There are limitations on the protection of our intellectual property.
Our proprietary technology is critical to our business, and our business could
suffer if we are unable to sufficiently protect our intellectual property
rights. Our intellectual property position is based in part on patents owned by
us and on patents exclusively licensed to us by North Carolina State University,
also known as N.C. State. Through our proposed acquisition of Nitres, we
anticipate acquiring important technology still in development which is subject
to pending patent applications.
We intend to continue to file patent applications in the future, where
appropriate, and to pursue such applications with U.S. and foreign patent
authorities, but we cannot be sure that any other patents will be issued on such
applications or that our patents will not be contested. In the past, one of the
important patents we license from N.C. State relating to SiC crystal growth was
subject to a reissue proceeding in the U.S.; however, the patent was
successfully reissued. Currently, a corresponding European patent is being
challenged, which means that we could lose patent protection in Europe for this
particular method. There is no assurance that other of our patents will not be
contested. Also, because issuance of a valid patent does not prevent other
companies from using alternative, non-infringing technology, we cannot be sure
that any of our patents (or patents issued to N.C. State or other parties and
licensed to us) will provide significant commercial protection. In addition to
patent protection, we also rely on trade secrets, technical know-how and other
unpatented proprietary information relating to our product development and
manufacturing activities. We try to protect this information through the use of
confidentiality agreements with our employees and other parties. We cannot be
sure that these agreements will not be breached, that we would have adequate
remedies for any breach or that our trade secrets and proprietary know-how will
not otherwise become known or independently discovered by others.
We may initiate litigation in the future to enforce our intellectual property
rights. Litigation can be protracted, costly and distracting to key personnel.
We cannot assure you that we will prevail in any litigation we initiate and, if
we are not successful, the scope of our rights to important intellectual
property could be diminished or eliminated.
We are subject to risks associated with international sales.
Sales to customers located outside the U.S. accounted for about 79% of our
revenue in fiscal 1997, about 74% of our revenue in fiscal 1998 and about 62% of
our revenue in fiscal 1999. We expect that revenue from international sales will
continue to be a significant part of our total revenue. International sales are
subject to a variety of risks, including risks arising from currency
fluctuations, trends in use of the Euro, trading restrictions, tariffs, trade
barriers and taxes. Also, export laws restrict sales of some of our products to
customers in certain countries because of national security or other concerns.
Because all of our foreign sales are denominated in U.S. dollars, our products
become less price competitive in countries with currencies that are low or are
declining in value against the U.S. dollar. Also, we cannot be sure that our
international customers will continue to place orders denominated in U.S.
dollars. If they do not, our reported revenue and earnings will be subject to
foreign exchange fluctuations.
We are subject to stringent environmental regulation.
We are subject to a variety of government regulations pertaining to chemical and
waste discharges and other aspects of our manufacturing process. For example, we
are responsible for the management of the hazardous materials we use and
disposal of hazardous waste resulting from our manufacturing process. The proper
handling and disposal of such hazardous material and waste requires us to comply
with certain government regulations. We believe we are in full compliance with
such regulations as of the date of this report, but any failure, whether
intentional or inadvertent, to comply with such regulations could have an
adverse effect on our business. In addition, these regulations may affect our
ability to expand or change our manufacturing facility.
We face risks concerning year 2000 issues.
Even though the date is now past January 1, 2000, and we have not experienced
any immediate adverse impact from the transition to the Year 2000, we cannot
provide assurance that our suppliers and customers have not been affected in a
manner that is not yet apparent. As a result, we will continue to monitor our
Year 2000 compliance and the Year 2000 compliance of our suppliers and
customers.
