UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 2002
27, 2004
CREE, INC.
(Exact
(Exact name of registrant as specified in its charter)
North Carolina 0-21154 56-1572719
(State or other jurisdiction (Commission File No.) (I.R.S. Employer
of incorporation) Identification Number)
| North Carolina | 0-21154 | 56-1572719 | ||
(State or other jurisdiction of incorporation) | (Commission File No.) | (I.R.S. Employer Identification Number) |
4600 Silicon Drive, Durham, North Carolina 27703
(Address
(Address of principal executive offices)
(919) 313-5300
(Registrant's
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.00125 par value
--------------------------------
(Title of Class)
Common Stock, $0.00125 par value |
| (Title of Class) |
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. Yes [X]x No [_]
¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant'sregistrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]
¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yesx No¨
The aggregate market value of common stock held by non-affiliates of the registrant as of August 1, 2002December 26, 2003 was approximately $1,019,706,031$1,065,738,993 (based on the closing sale price of $14.49$17.50 per share).
The number of shares of the registrant'sregistrant’s Common Stock, $0.00125 par value per share, outstanding as of August 1, 2002July 28, 2004 was 72,728,948.
73,296,397.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement to be delivered to shareholders in connection with the Annual Meeting of Shareholders to be held October 29, 2002November 4, 2004 are incorporated by reference into Part III.
FORM 10-K
For the Fiscal Year Ended June 30, 2002
27, 2004
INDEX
Information set forth in this Annual Report on Form 10-K contains various “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, (Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended, (Exchange Act). All information contained in the following discussion relative to future markets for our products and trends in and anticipated levels of revenue, gross margins, and expenses, as well as other statements containing words such as “may,” “will,” “anticipate,” “target,” “plan,” “estimate,” “expect,” and “intend” and other similar expressions constitute forward-looking statements. These forward-looking statements are subject to business, economic and other risks and uncertainties, both known and unknown, and actual results may differ materially from those contained in the forward-looking statements.
Factors that could cause or contribute to such differences include: our ability to complete development and commercialization of products under development, such as our pipeline of brighter light emitting diodes (LEDs); our ability to lower costs; potential changes in demand; the risk that price stability, improved operational efficiencies, and the favorable product mix we have recently experienced will not continue; the risk that, due to the complexity of our manufacturing processes, we may experience production delays that preclude us from shipping sufficient quantities to meet customer orders or that result in higher production costs and lower margins; risks associated with the ramp up of our production for our new products; risks resulting from the concentration of our business among few customers, including the risk that customers may reduce or cancel orders or fail to honor purchase commitments; the rapid development of new technology and competing products that may impair demand or render our products obsolete; the potential lack of customer acceptance for our products; and risks associated with our pending securities and other litigation. See, “Certain Business Risks and Uncertainties” in Item 7 of this report, as well as other risks and uncertainties referenced in this report, for additional risk factors that could cause actual results to differ.
Introduction
Cree, Inc., a North Carolina corporation was established in 1987, to
commercialize semiconductor wafersdevelops and devices made from silicon carbide, or
SiC. Today, we are the world-leader in developing and manufacturing compoundmanufactures semiconductor materials and electronic devices made frombased on silicon carbide (SiC), Group III nitrides (GaN), silicon, and related compounds. Our SiC and a leading
developerGaN materials technology is the basis for many of the devices that we develop and manufacturer of optoelectronicproduce. The physical and electronic devices made from
gallium nitride, or GaN, and related materials. We also produce RF power
transistor components and modules for wireless infrastructure applications using
silicon-based bipolar and laterally diffused metal oxide semiconductor, or
LDMOS, process technologies. We operate our business in two segments, the Cree
segment, which consistsproperties of our SiC-based products and research contracts, and
the Cree Microwave segment, which consists of RF transistors and RF transistor
modules based on a silicon platform. SiC and GaN-based devicesGaN offer technical advantages over competitive products
made fromtraditional silicon, gallium arsenide or GaAs,(GaAs), sapphire and other materials for certain electronic applications.applications, which enable devices to attain a higher voltage level and higher thermal conductivity. We usefocus our wide bandgap compound semiconductor
technology to make enablingexpertise in SiC and GaN materials on four product areas: LEDs, including blue, green and near ultraviolet (UV) LED chips and high power packaged LEDs, power switching products, such asradio frequency (RF) and microwave devices, and near ultra-violet (products with
wavelengths between 380 and 410 nanometers), or UV blue and green light
emitting diodes, or LEDs. We sell our LEDs to customers who package them for use
in applications such as wireless handsets, backlighting for automotive
dashboards and other consumer products. Other applications for our LEDs include
indoor and outdoor full color displays, such as video boards in arenas and
stadiums, billboards and message signs. Our LEDs are also used in traffic
signals, indicator lights for consumer or industrial equipment and miniature
white lights used for illumination applications.lasers. We have developed several
generationsproducts commercially available in each of LED products, including our MegaBright(TM) and XBright(TM) LEDs
released during fiscal 2002. Based on our own measurements, we believe that our
XBright(TM) product family includes the highest brightness (which is defined as
the optical power output from a chip at 20 milliamps of drive current)these categories except for near UV blue
and green LEDs commercially available. All of our SiC-based GaN UV, blue and
green LEDs offer benefits to our customers over competing products, which
include a vertical chip structure, improved resistance to electrostatic
discharge and small size.lasers. We also manufacture SiC material products, including
SiC wafers, whichsilicon RF transistors and modules.
As of the end of fiscal 2004, we sell for use in manufacturing LEDs and power devices and
for research directed to optoelectronics (which includes LEDs and laser diodes),
microwave and power devices, and bulk SiC material, which we sell for use in
gemstone applications. The remainderderive the majority of our Cree segment revenue is derivedrevenues from sales of laser diodes and power diodes, and sales from industrial contracts and
government contracts for research work performed for the U.S. Government.
Our entry into the wireless infrastructure market as a component supplier
occurred with our acquisition in December 2000 of the UltraRF business of
Spectrian Corporation, or Spectrian. We renamed the UltraRF business Cree
Microwave during fiscal 2002. Cree Microwave operates its own wafer fabrication
facility that utilizes silicon substrates to create bipolar and LDMOS devices to
produce high-power, high performance radio frequency, or RF, power
semiconductors for use in wireless infrastructure equipment.
We have new product initiatives aimed at developing LEDs with higher luminous
efficiency to expand our existing family of optoelectronic devices. We believe
that if certain significant milestones are achieved, the LED chips currently in
development may enable our customers to produce white lamps designed to compete
in the lighting market. Some of our customers are already offering early
illumination products using our devices.products. We also have new product initiatives
for RF and microwave transistors using
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technology. We believematerials, and we earn revenue under government contracts that these products may be useful insupport certain of our research and development programs to the extent the contract funding exceeds our direct cost of performing those activities. In addition, we derive a varietysmall portion of applications, including power amplifiersrevenue from our sales of materials used for next generationgemstones and devices for wireless infrastructure and solid state radar. In addition, we are developing and
sampling high power rectifiers for power conversion and switching uses, which we
believe will allow for more efficient use of energy in certain applications over
alternative silicon-based semiconductor solutions.applications. We currently are working on the
development of a high-poweredto develop near UV laser diodelasers that are targeted for use in next generation
high-density digital versatile disk, or DVD, and otherfuture optical storage applications. At Cree Microwave, we are developing higher performance LDMOS
devices for next generation power amplifiers for base station infrastructure
applications.
BACKGROUND
markets.
Most semiconductor devices are fabricated on wafers made from silicon crystals. Silicon isevolved as the dominant semiconductor material because the technology has
evolvedit is relatively easy to the point where it can be growngrow into large, high quality single crystals that are suitable for fabricating many types of electronic devices. Alternative materials,semiconductors such as GaAs have emergedwere developed to enable the fabrication of newimproved RF devices with characteristics that could not be obtained using silicon, including certain
RF, microwave, LED, laser and other semiconductor devices. However, GaAs,
silicon and other commercially available semiconductor materials have physical
and electronic characteristics that limit their usefulness in certain
applications. For example, conventional silicon and GaAs-based semiconductors
have not demonstrated the ability to enable short wavelength (UV, blue or green)
LED or laser devices. In addition, the power handling capabilities of silicon
and GaAs-based microwave transistors can limit the power and performance of
microwave systems used in certain commercial and military applications. With the
possibility of allowing higher power densities, SiC and GaN-based wireless
systems may use fewer transistors per base station with less complex circuitry,
which may result in a lower system cost. Furthermore, few silicon or GaAs
devices can operate effectively at temperatures above 400(degrees) Fahrenheit.
This is a significant limitation for applicationsoptoelectronic products such as advanced electronic
systems for high power electric motorsred
LEDs and high frequency RF devices.
Substantial research and development efforts have been undertaken to explore the
properties of other potential semiconductor materials. These efforts have
identified few candidate materials that are capable of being grownlasers. Wide bandgap semiconductors, such as low defect
single crystals, a requirement in the production of most semiconductors. The
properties of SiC and GaN, make them excellent materials for extending existing
semiconductor device technology where high power, high temperature or UV, blue
and green wavelengths are important for performance.
SiC AND GaN OVERVIEW
Wide bandgap semiconductors are an emerging class of semiconductors that enable
a variety ofhave emerged to provide improved capabilities for solid statesolid-state devices. Two of the most common wide
bandgap semiconductors are SiC and GaN. SiC is most commonly targeted for power
devices and RF devices, while GaN is generally targeted for optoelectronic applications such as blue, green or UV LEDs and near UV lasers, as well as higher frequency microwave power devices. SiC makes an
excellent substrate for growing layers of GaN due to its material properties.
For GaN optoelectronic devices, conductive SiC substrates allow the fabrication
of vertical devices (a single contact on top and bottom), as opposed to the use
of insulating sapphire substrates where devices need both diode contacts placed
on the top of the die. This allows GaN-on-SiC LEDs to be smaller in size than
the two top contact devices made on sapphire. For high power GaN RF devices, the
high thermal conductivity of SiC allows for very efficient heat dissipation.
This is important for the high power densities generated in these devices.
SiC has many physical characteristics that make it difficult to produce. For
example, in a typical semiconductor manufacturing process, the semiconductor
material is grown as a single crystal and sliced
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into wafers. The wafers are then polished and chemically etched, coated with
thin crystalline films containing controlled levels of impurities and fabricated
into devices. Because SiC can form many different atomic arrangements and must
be grown at process temperatures above 3,500(degrees) Fahrenheit to achieve our
desired crystal structure, it is difficult to grow large single crystals that
have a homogeneous structure. In addition, the high temperatures required to
grow SiC make the control of impurity levels in SiC crystals and thin films
difficult. "Micropipes", or small diameter holes, may appear in the crystals
during their growth, affecting the electrical integrity of the wafer and
reducing the usability of portions of the wafer for certain applications.
Slicing and polishing SiC wafers is hindered by the intrinsic hardness of the
material. Similarly, its inherent chemical resistance makes SiC a difficult
material to etch.
The characteristics discussed below distinguish SiC and GaN from conventional
silicon and GaAs-based semiconductor materials, resulting in significant
advantages if production hurdles can be overcome.
WIDE ENERGY BANDGAP. Bandgap is the amount of energy required to ionize an
electron from the valence band to the conduction band. SiC and GaN are
classified as wide bandgap semiconductor materials, meaning that more energy is
required for ionization. Electronic devices made from these materials can
operate more efficiently and at much higher temperatures than devices made from
other common semiconductor materials. The wider energy bandgap also enables the
generation of shorter wavelength (UV, blue and green) light in optoelectronic
devices.
HIGH BREAKDOWN ELECTRIC FIELD. The "breakdown electric field" is the amount of
voltage per unit distance that a material can withstand and still effectively
operate as a semiconductor device. SiC and GaN have much higher breakdown
electric fields than silicon or GaAs. This characteristic allows wide bandgap
devices to operate at much higher voltage levels. Additionally, it allows SiC
power devices to be significantly smaller while carrying the same or greater
power levels than comparable silicon and GaAs-based devices. This same advantage
holds true for SiC and GaN RF power devices.
HIGH THERMAL CONDUCTIVITY. SiC is an excellent thermal conductor compared to
other commercially available semiconductor materials. This enables a SiC-based
device to operate at high power levels and still dissipate the excess heat
generated. It also enables efficient heat dissipation when used as a substrate
for GaN-based devices such as RF transistors.
HIGH SATURATED ELECTRON DRIFT VELOCITY. SiC and GaN have "saturated electron
drift velocities" higher than that of silicon or GaAs. The saturated electron
drift velocity is the maximum speed at which electrons can travel through a
material. This characteristic, combined with a high breakdown electric field,
allows the fabrication of SiC and GaN-based microwave transistors that operate
at RF frequencies with significantly higher power density levels than current
silicon and GaAs-based devices.
ROBUST MATERIAL. SiC has an extremely high melting point and is one of the
hardest known materials in the world. As a result, SiC can withstand much higher
electrical pulses and is more radiation-resistant than silicon or GaAs. SiC and
GaN are also extremely resistant to chemical breakdown and can operate in harsh
environments.
THE CREE SOLUTION
Some of the same physical characteristics that make SiC an excellent material
for certain semiconductor applications also make the material a technical
challenge to produce. Through our 15 years of development and manufacturing
experience, we have succeeded in overcoming many of the difficulties involved in
processing SiC substrates for commercial use. We believe that our proprietary
process
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techniques and the inherent attributes of both SiC and GaN give our products
significant advantages over competing products for certain electronic
applications. These advantages include:
UV, BLUE AND GREEN LIGHT EMISSION. We produce high efficiency UV, blue and green
LEDs using GaN and other nitrides grown on SiC substrates. Most other
manufacturers of nitride-based LEDs currently use sapphire substrates, other
than Osram Opto Semiconductors GmbH, a subsidiary of Osram GmbH, or Osram, which
has licensed the ability to manufacture SiC-based devices and buys SiC wafers
for use in their manufacturing process, from us. The conductive properties of
SiC enable us to fabricate a single top contact LED chip that is smaller than
the "two top contact" products made by competitors who use sapphire substrates.
Our chips made with SiC substrates can be packaged the same way as red, green
and amber LED chips made from other materials that are widely used in the LED
industry. We believe that the single top contact design of our chip affords our
customers flexibility for certain package types. We are also continuing
development of nitride-based UV laser diodes grown on SiC. The principal
advantages of SiC over sapphire substrate materials for UV laser diodes are the
high thermal conductivity attributes of the material and the ability for the
material to be easily cleaved, providing an excellent surface for laser light
emission.
ENABLING SUBSTRATE PROPERTIES. The inherent attributes of SiC as a substrate
enable researchers to work on developing new optoelectronic, microwave and power
devices that offer significant advantages over competing products and which
could not be produced as effectively on other substrate materials. We
manufacture SiC wafers for both internal use and for sale to external
development programs to further new product development. The majority of our
current production is on two-inch diameter (50 millimeter) material. We also
have released three-inch diameter (75 millimeter) wafers and demonstrated a
four-inch diameter (100 millimeter) prototype wafer.
HIGH POWER RF AND MICROWAVE OPERATION. We have demonstrated SiC RF and microwave
transistors that can operate at much higher voltages than silicon or GaAs
because of SiC's high breakdown electric field, allowing much higher power
operation at high frequencies. Similar advantages exist for microwave devices
made using GaN on SiC substrates, which can also operate at much higher
frequencies than SiC-only devices. In fiscal 2000 we first began shipping sample
quantities of SiC RF devices which have potential applications in wireless
infrastructure systems. We have continued development efforts directed to
improving the performance and reliability of our SiC RF devices which has
increased their attractiveness to wireless system manufacturers. As the
performance of silicon-based LDMOS products continued to improve, we determined
that near term wireless infrastructure power transistors were likely to be
manufactured with silicon-based products rather than our SiC-based devices. As a
result, we acquired the business now comprising Cree Microwave in December 2000
to participate in the RF power transistor market in the near term. We believe
our SiC transistors will likely be more desirable for broadband amplifiers that
can cover the entire DCS/PCS/UMTS frequency band of 1.8-2.2 gigahertz, or GHz.
Additional applications include wide bandwidth military radio and test and
instrumentation equipment. In addition, we continue to develop GaN-based devices
for high frequency wireless infrastructure and other commercial and defense
related applications. We are also pursuing the development of monolithic
microwave integrated circuit, or "MMIC", power amplifiers in both SiC and GaN
for a variety of military applications.
HIGH POWER, HIGH VOLTAGE OPERATION. We are producing small quantities of a
product family of SiC Schottky diodes that have a greater breakdown voltage than
Schottky diodes made from other semiconductor materials currently available. We
believe our Schottky diodes offer inherent system benefits beyond these
competitive products because of the significant reduction of reverse recovery
current at similar breakdown voltages. We believe that our SiC power diodes
operate with significantly lower switching losses than those made with silicon
or GaAs, for the same breakdown voltage. In
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addition, we believe that our SiC power transistors under development operate
with lower resistive losses and lower switching losses than those made with
silicon or GaAs.
PRODUCTS
We operate our business in two segments, the Cree segment, which consists of our SiC and GaN-based products and research contracts, and the Cree Microwave segment, which consists ofincludes silicon-based RF transistors and RF transistor modules. Our Cree Microwave segment began operations with the December 2000 acquisition of the UltraRF business from Spectrian Corporation (Spectrian). The UltraRF acquisition was accounted for under the purchase method. We renamed the UltraRF business Cree Microwave during fiscal 2002. Additionally, our Cree segment acquired Nitres, Inc. (Nitres) in May 2000 in a business combination accounted for as a pooling of interests. In the fourth quarter of fiscal 2004, the Cree segment acquired the GaN substrate and epitaxy business of Advanced Technology Materials, Inc. (ATMI). We accounted for this acquisition under the purchase method.
The majority of our Cree segment products are manufactured in Durham, North Carolina in a six-part process, which includes: SiC crystal growth, wafering, polishing, epitaxial deposition, fabrication and testing. The GaN substrate and epitaxy business acquired from ATMI in the fourth quarter of fiscal 2004 is currently operating at an ATMI facility in Danbury, Connecticut. We anticipate moving this business to Durham, North Carolina during fiscal 2005. The Cree segment also operates a research and development facility called the Santa Barbara Technology Center (SBTC) in Goleta, California. Our Cree Microwave products are produced in Sunnyvale, California at our silicon wafer fabrication facility, where we buy silicon wafers from third parties, fabricate devices in a clean room environment and test and package finished products. Subcontractors located domestically and in foreign countries also package some of our products.
Products and Products under Development
Cree Segment:
The Cree segment produces LEDs, SiC and GaN materials products, SiC-based power transistor componentsdevices and modules.
THE CREE SEGMENT:RF microwave transistors using our SiC and GaN materials. In addition, we currently are developing near UV BLUE AND GREEN laser devices in this segment.
LEDs
Blue, Green and Near UV LED Chips. Our LED chip products include blue, green and near UV devices made from GaN and related materials grown on SiC substrates. LEDs are solid-state electronic components used in miniature packages in
everydaya number of applications, including backlighting for handheld mobile appliances such as cell phones and automotive dashboards. In addition, groups of LEDs make up single or full-color electronic displays, including display signs or traffic signals, or they can be used as indicator lights on televisions, radios, printers,
computersfor gaming equipment, consumer products and other electronic equipment. Some of our customers package our blue LEDs generallywith a phosphor coating to create white LEDs. Our customers’ white LED products are used in various applications for mobile appliances, including the backlight for full color display screens; white keypads and the camera flash function. Our customers’ white LEDs also are used as a light source for a number of specialized lighting applications. LEDs offer substantialseveral advantages over small incandescent bulbs, including longer life, lower maintenance cost and energy consumption, and smaller space requirements. Groups of LEDs can make up
single or full-color electronic displays. In 1989 we introduced the first
commercially viable blue LED made using a SiC only design. Subsequently, we have
developed and released several generations of LED products, including UV, blue
and green LEDs made from GaN and related materials on SiC substrates. With the
initial release of our XBright(TM) LEDs in fiscal 2002, we believe we have
introduced the brightest commercially available UV, blue and green product
family of LEDs. Our customers are currently in the qualification stages of
packaging XBright(TM) chips and some have encountered challenges in qualifying
their packaging process. We target a ramp-up to commercial production levels
during the first half of fiscal 2003.
We will continue to work to improve the brightness of our UV, blue and green
chips to achieve higher performance than currently available. Over the next five
to ten years or perhaps longer, we believe these yet to be developed products
could be used to produce white lamps to compete with conventional lighting
products for certain applications. We believe that LEDs made using SiC
substrates offer important benefits over competitive devices using sapphire
substrates including:
- an industry standard vertical chip structure requiring a single wire
bond that permits more efficient LED assembly;
- a smaller area chip size; and
- higher performance in terms of brightness.
Presently, our LED chips are used for backlighting purposes in applications such
as wireless handsets and automotive dashboard lighting. They are also used in
white light products designed for specialty indoor illumination and for the
illumination of outdoor buildings and structures and in landscape lighting. In
addition, they are used in consumer products and office equipment as indicator
lighting, in full color video displays, such as arena replay screens, billboards
and moving message advertising and informational signs and as the green light in
traffic signals. Our standard brightness LED products, offered in blue
wavelengths only, are primarily used in indoor applications, automotive designs
or as indicator lights. Some customers manufacture solid-state LED components
that emit white light using our blue LEDs. Customers are also working to develop
white light components using our UV LEDs. By passing blue or UV LED light
through certain conversion materials such as phosphors, or by using blue in
combination with LEDs of other appropriate colors, white light emission can be
obtained from lamps made with blue or UV LEDs. We currently sell blue LED chipsthe majority of our LEDs in chip form to customers who produce packaged components that emit white light. Current
commercial applicationspackage them in a variety of whiteapplications. LEDs using Cree's blue
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LEDs include backlighting applications for automobile dashboardsrepresented 78%, 75% and instrumentation, backlighting for wireless handsets and early general
illumination applications. During fiscal 2002, we received our QS 9000
registration, which signifies that our quality systems met a set of requirements
established by international auto manufacturers.
We believe that our products are well positioned to take advantage of recent
trends in the wireless handset market. Although the global market for wireless
handsets may be flat to declining due to a slow global economy, we believe our
share of this market could increase as a result of changes in backlighting
applications. Handset manufacturers recently have begun to use blue or white
backlighting in new models, rather than traditional yellow-green backlighting
that has been common during the last several years. We believe that our chips
meet the blue and or white lighting characteristics that the market is now
demanding. In addition, we believe that the development of full color displays
for mobile handsets will increase demand for white LEDs in order to maximize the
effectiveness of the full color display.
We are focusing current development efforts on further improving the efficiency
as well as lowering our cost to manufacture our LEDs and improving other
performance characteristics of the devices for certain markets, such as thinner
chips and lower forward voltages. Responding to a market trend towards devices
with a lower forward voltage, we undertook major development initiatives during
fiscal year 2002 as we trailed sapphire-based LEDs in this important area for
new high-volume cell phone applications. The current "two top contact"
sapphire-based devices have certain advantages compared to our single top
contact design in terms of lower forward voltage and thinner chips. We believe
that increased brightness will continue to be necessary to develop new
applications and market opportunities for LEDs, and may eventually lead to
products marketed for commercial lighting applications. LED products represented
58%, 65% and 63% of our revenue for the fiscal years ended June 27, 2004, June 29, 2003 and June 30, 2002, respectively.
Our LED chips are currently available in three brightness ranges, which we refer to as standard brightness, mid-brightness and our high-brightness range. Our standard brightness LED chips, offered in blue wavelengths only, target applications requiring high quality and high volume availability at a lower price
point. End customers use this product for applications where higher brightness may not be required, such as for indoor applications, certain automotive designs or as indicator lights. In fiscal 2004, these products comprised 8% of our LED revenues.
Our mid-brightness range includes our UltraBright® and SuperBright™ LEDs. Our mid-brightness LEDs provide an option for applications that require a higher level of brightness than provided by our standard brightness LEDs, but still need a low price point. End user applications include the backlight source for mobile appliances, which includes the keypad area of mobile phones and other small hand-held devices, and automotive dashboards. Our customers also use mid-brightness LEDs in gaming displays, consumer products, office equipment and full color video displays. In order to respond to market demand for keypad handset applications, we released the UT230 product in the fourth quarter of fiscal 2004. This product provides a thin form factor and a lower forward voltage, which is designed to extend battery life over standard LEDs. The UT230 is targeted for the mobile appliance market as it offers a lower selling price than our other mid-brightness LEDs. Our mid-brightness LEDs are offered in blue, traffic green, and true green. In fiscal 2004, this category of product comprised 43% of our LED revenue.
Our high-brightness products include our MegaBright®, XBright® and XThin™ and our XBright XB900 and XB500 power chip LED products. Some of our customers use our high-brightness LEDs to create white light from blue LEDs by combining them with phosphors. Target applications for blue LEDs that are converted to white light consist of mobile appliances, including backlighting for full color displays, white keypads and camera flashes, as well as miniature white lights and other illumination applications. Some of our customers also use our high-brightness LEDs for traffic signals, video screens and automotive backlighting. In order to address the markets for higher power LEDs, we developed the XB900 power chip. These LEDs are approximately nine times larger than industry standard size (300 x 300 microns) LEDs and aim to deliver approximately 10 times the light output due to operation at a much higher input power than our standard XBright chips. As a result, these chips could be used in a new range of lighting applications. In fiscal 2004, we announced the release of an XBright XB500 power chip for applications in the one-half watt power range. Both the XB900 and XB500 chips are currently available. Our high-brightness LEDs are offered in blue, traffic green, true green and near UV wavelengths. In fiscal 2004, this category of LEDs comprised 49% of our LED revenue.
High Power Packaged LEDs. We are developing high power packaged LEDs that are designed to compete with incandescent lighting technology for certain specialty lighting applications. In the near term, we do not anticipate that our LEDs will be able to compete with incandescent and fluorescent bulbs for conventional lighting markets due to their cost, efficiency, brightness and other factors. However, in some applications, such as architectural lighting, LEDs can be advantageous because of their design flexibility and can be less expensive than incandescent bulbs due to lower energy requirements, longer life and reduced maintenance costs.
In October 2003, we announced the introduction of our XLamp™ family of high power packaged LEDs, which are designed for emerging lighting applications. We started shipping the 7090 series XLamp product in June 24, 20012004. The 7090 series product combines our XB900 power chip with a high power surface mount package that is designed to operate up to one watt of power. We also introduced our 4550 series XLamp product, which incorporates our XB500 chip and June 25, 2000, respectively.
MATERIALS PRODUCTSis targeted to operate at up to one half watt of electrical power. The 7090 and 4550 XLamp series are designed for architectural lighting and specialty illumination applications such as channel letter lighting, appliance lighting and reading lamps. The future targeted applications for our power chip and XLamp packaged products include solid-state illumination applications, automotive lighting and backlighting for large format liquid crystal display (LCD) screens.
Materials Products
Our materials products consist of SiC and GaN wafer and epitaxy products and bulk SiC materials used for gemstone applications.
SiC and GaN Wafers. We manufacture SiC wafers for sale to corporate customers thatwho use the wafers in manufacturing products for optoelectronic and power device applications. Corporate, government and university programs also buy SiC and GaN wafers for research and development directed to optoelectronic, microwave and high power devices. Our
SiC wafer products may be soldWe sell our wafers as a bare wafer or a customized by addingwafer with epitaxial films of SiC or GaN materials, depending upon the nature of our customer’s needs. We currently sell both two-inch and three-inch wafers. Wafer products represented 7%, 9% and 11% of our revenue for the customer's
needs. Sincefiscal years ended June 27, 2004, June 29, 2003 and June 30, 2002, respectively.
Over the company's inception in 1987,past few years, we have worked continuouslycontinued to improve the quality of our SiC wafers while also increasing wafer diameter. In
October 1999, we introduced our first three-inch wafer and we have recently
expandedexpand our product line of three-inch wafers, which are better suited for the manufacture of power and microwave devices. We currently sellcontinue to develop SiC wafers that are larger and of higher quality. These wafers have potential for higher yield and lower cost for devices made from them. As a result, we plan to Osram and Infineon
Technologies AG, or Infineon,migrate the majority of the manufacture of our LED products to a three-inch wafer platform during fiscal 2005.
Bulk Materials Used for the production of LED and power products,
respectively.Gemstones. We manufacture SiC crystals in near colorless form for use in gemstone applications. Single crystalline SiC has characteristics that are similar to diamond, including properties relating to color, hardness and brilliance. We manufacture
SiC crystals in near colorless form for use in gemstone applications. We sell SiC in bulk crystal form exclusively to Charles & Colvard, or C&C; a company founded to
produceLtd. (C&C), which produces and marketmarkets gemstone products made from SiC crystals. C&C cuts and facets
the SiC crystals to fabricate gemstones targeted at customers who desire
alternative colorless, affordable, high-quality jewelry. Sales of gemstone
crystals have re-emerged as a stronger product line in the second half of fiscal
2002, due to heavier demand from C&C. Future demand for this product is
dependent on C&C's ability to cut, facet and effectively market its gemstone
products. Our SiC wafer products are marketed through executive sales while
materials usedsold for gemstone applications are exclusively sold to C&C. Waferrepresented 2%, 3%, and other material products represented 13%, 14% and 26%2% of our revenue for the fiscal years ended June 27, 2004, June 29, 2003 and June 30, 2002, June 24, 2001 and June 25, 2000, respectively.
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POWER DEVICES
In fiscal 2002, we announced the commercial release of the first products in our
planned line of
SiC-based Power Devices
SiC-based power devices. devices can operate at significantly higher breakdown voltages than silicon-based power devices and provide faster switching speeds than comparable silicon-based power devices at similar breakdown voltages. These attributes create a lower switching loss, which yields power savings due to higher efficiency, enabling smaller and more efficient systems.
Our initialSiC-based power products are 300-volt Schottky diodes for output rectifiers and power factor correction in power supplies. We also offer 600-volt Schottky diodes offeredfor applications such as power supplies used in limited quantities at 1, 4, 6computer servers and 10 amp ratings.
During the first quarter of fiscal 2003, we have released a 20 amp device.1200-volt Schottky diodes targeted for motor control applications. We are marketing these products to manufacturers of power conditioning and power switching equipment as potential replacements for silicon-based power devices in certain applications. SiC-based power devices represented 1% of our revenue for the fiscal year ended June 27, 2004. SiC-based power devices represented less than 1% of our revenue for the fiscal years ended June 29, 2003 and June 30, 2002.
We are developing additional prototype SiC-based power devices, including PIN diodes and power MOSFETs, which could have themany potential to handle
significantlyuses such as power conditioning and power switching applications.
RF and Microwave Transistors
RF and microwave devices made from SiC can operate at higher voltages, which allows for higher power densities as compared to silicon or GaAs-based devices. Additionally, this characteristic allows SiC-based devices to be significantly smaller while carrying the same or greater power levels than existing silicon-based or GaAs-based devices. Currently, there is a higher cost associated with SiC than silicon or GaAs-based devices for RF and microwave transistors.
We currently offer a 10-watt SiC transistor product, or metal-semiconductor field effect transistor (MESFET) product. We also have sampled 60-watt SiC MESFET chips to select customers. Additionally, we provide a foundry service for wide bandgap monolithic microwave integrated circuits (MMICs). These SiC-based RF circuits can operate at significantly higher voltages with superior switching capabilities,
yielding power savings due to higher efficiency. Potential applications include
power factor correction and switch mode power supplies typicallybe used in telecommunicationsa variety of wide bandwidth communications applications, high-power radar amplifiers, electronic warfare, and computer servers,wireless infrastructure. The MMIC foundry service allows a
customer to design its own custom SiC RF circuit to be fabricated in our MMIC foundry, or have us provide custom MMIC design for the customer and heavy industrial uses. Other
applications include industrial motor controls, high frequencyfabricate the chips. We intend to focus future development efforts in this area on creating higher power suppliesSiC MESFETs and medical applications.
Revenue growth from these devices is dependent on the results of customer
evaluations of the Schottky diode deviceGaN RF devices. SiC MESFET and whether the products are designed
into customer applications. We believe that revenue growth will be slow
initially because our technology is not a "drop in" replacement and is currently
much more expensive than silicon devices. In addition, with the slowdown of the
global economy, we believe many companies have reduced their research and
development budgets, which has impacted our growth. Finally, our Schottky
devices are a new technology, and it will take time to penetrate existing
markets. PowerMMIC devices represented less than 1% of revenue for each of the fiscal years ended June 30, 2002,27, 2004, June 24, 200129, 2003 and June 25, 2000.
RF AND MICROWAVE TRANSISTORS
During fiscal year 2002, we offered a new 10-watt transistor product made30, 2002.
Near UV Laser Diodes
We have demonstrated near UV lasers (sometimes referred to as blue lasers) that operate at power levels ranging from SiC3 milliwatts to customers in prototype quantities. We believe that thesegreater than 100 milliwatts. Our development activity continues to focus on developing more reliable and higher performance devices. The primary target market for our lasers is optical disk drives for next generation digital versatile disk (DVD) and computer data storage applications. The shorter wavelength of near UV products can be
used in a varietyenables significantly higher storage capacity than the current generation of power amplifier applications,optical drives, which employ red lasers. At this point, numerous standards are being proposed for the next generation of DVDs including wireless
infrastructure, home-based subscriber units, digital broadcastBlu-ray and military
broadband radio applications. Revenue growth from sales of these devices is
dependent on the results of customer evaluations of SiC RF products, further
improvements in device performance, further expansion of our SiC RF product
family, and whether the products are designed into customer applications.
THE CREE MICROWAVE SEGMENT:
RF AND MICROWAVE TRANSISTORS
We believe that silicon bipolar and LDMOS technology is complementary to our SiC
and GaN-based microwave devices. High Density Digital Versatile Disk (HD-DVD).
Cree Microwave Segment:
Our Cree Microwave segment produces bipolar and LDMOSlaterally diffused metal oxide semiconductor (LDMOS) devices made from silicon.silicon substrates. These products enable us to provideoffer our customers an array of power amplifier semiconductor devicestransistors designed to meet a broad spectrum of the current and potential wireless infrastructure markets now and inmarkets.These products represent the future. Cree Microwave offers
products for use in a range of systems. These systems include Advanced Mobile
Phone Services, or AMPS, Time Division Multiple Access, or TDMA, Code Division
Multiple Access, or CDMA, Global System for Mobile Communications, or GSM,
Universal Mobile Telephone Service, or UMTS and Enhanced Data Rates for GSM
Evolution, or EDGE systems. Cree Microwave is one of only a few major
manufacturers of LDMOS RF devices.
The market for cellular communications services has grown substantially during
the past decade due to decreasing prices for wireless handsets, increasing
competition among service providers and a greater availability of high quality
services. In recent quarters, the cellular communications market has been
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declining due to the global economic slowdown, which has caused carriers to
reduce infrastructure spending. However, we believe that significant long-term
market opportunities exist.
A typical wireless communication system comprises a geographic region containing
a number of cells, each of which contains a base station. The cells are
networked to form a service provider's coverage area. Each base station houses
the equipment that sends telephone calls to and from the switching office of the
local wire line telephone company and transmits and receives calls to the
wireless users within the cell. Base stations may be configured as single
carrier or multi-carrier designs.
Digital systems, which convert voice transmission into bits of electronic
information, enable data transmission among other things. The four dominant
digital transmission modulation formats for cellular networks include GSM, TDMA,
CDMA and EDGE systems and operate in frequency ranges from 900 megahertz, or
MHz, to 2400 MHz. These systems have a call capacity of three to eight times
that of analog networks. The implementation of these digital networks has
resulted in increased demand for network infrastructure equipment. Cree
Microwave is able to produce both bipolar and LDMOS products that are used in
the manufacture of power amplifiers for both analog and digital base stations.
Cree Microwave produces themain semiconductor content of a power amplifier, which is used in a base station to boost the power of a signal so that it can reach a wireless phone or other device within a designated geography. During fiscal 2002, we developed an amplifier module that incorporates our
LDMOS-based transistors2004, Cree Microwave also began to sell products targeted for the military and is designed to simplify the design and assembly of
power amplifiers using the LDMOS products. We believe that this module product
can deliver a lower system cost to our customer due to less costly packaging, a
smaller design and relative ease of manufacture for our customer.aeronautics (mil-aero) markets. Cree Microwave’s RF products represented 16%3%, 1%, and 11%16% of our revenue for the fiscal years ended June 27, 2004, June 29, 2003 and June 30, 2002, and June 24, 2001, respectively. The Cree Microwave business
segment was acquired from Spectrian in December 2000. The majority of
Prior to fiscal 2003, sales from
this segment were to Spectrian during fiscalrepresented 99% of Cree Microwave’s revenue. In November 2002, and 2001. The loss of or a
decline in sales to this customer would have a material adverse effect on this
segment.
PRODUCTS UNDER DEVELOPMENT
THE CREE SEGMENT:
LEDs WITH HIGHER OUTPUT POWER
Cree Lighting, based in Goleta, California, is engaged in the development of new
LED device technology, with the goal of developing higher efficiency LEDs to
compete with incandescent and fluorescent lighting technology for conventional
lighting markets. During fiscal 2002, we more than doubled the typical
brightness of our LED products with the introduction of our XBright(TM) and
MegaBright(TM) products. In order to compete with incandescent and fluorescent
lighting technology for conventional lighting markets, the brightness of our
products will need to increase significantly over the brightness of our products
available today. We do not anticipate that our products can achieve the
necessary level of brightness in a cost competitive product over the next few
years; however, we believe we can achieve a greater level of brightness to
enable interim illumination applications, such as miniature incandescent
lighting replacements. One such interim step during fiscal 2002 was the
introduction of our XBright(TM) 900 Power Chip LED. At 900 x 900 microns nominal
gross die size, the XBright(TM) Power Chip is significantly larger than industry
standard (300 x 300 microns) LEDs and is the first large area version of our
XBright(TM) chip technology. These chips deliver more than 10 times the light
output at a higher current than our standard XBright(TM) chips and we believe
these high-power LEDs could help
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enable a new range of lighting applications. These chips will require our
customers to develop new packages to support these higher-powered chips. The
targeted application for these devices is the solid state illumination market.
BLUE AND UV LASER DIODES
We continue to focus on the development of blue and UV laser diodes. SiC has
inherent attributes, including its natural cleavability and high thermal
conductivity that make it an excellent substrate material for the development of
such short wavelength laser diodes. The storage capacity of optical disk drives
can be increased significantly by utilizing a laser diode capable of emitting
shorter wavelength light. We have shipped sample UV laser diodes, fabricated
from nitride materials deposited on SiC substrates, which have a shorter
wavelength than that of the red or infrared lasers used in applications today.
We believe that the shorter wavelength of UV light could potentially result in
storage capacity for optical disk drives that is significantly greater than the
capacity permitted by red light. We also believe that UV laser technology may be
used in miniature optical devices for compact sized electronics, such as digital
cameras. We have demonstrated a prototype UV laser with 3 milliwatts of power
and a projected lifetime of 10,000 hours. We believe that this laser meets the
current power requirement of a "read" laser; however, additional development is
required to commercialize this product. We continue to work on developing a
"read/write" UV laser, which will require approximately 30 milliwatts of
continuous wave, or CW, power, and we are targeting our first product to be
released for customer sampling during fiscal 2003. A consortium of DVD
manufacturers is currently creating standards for blue and UV laser devices
named the Blu-Ray Disc format. Once these standards are completed, we believe
that the demand for diodes that meet the standards may increase.
POWER DEVICES
We are developing additional prototype high power devices that we believe have
many potential uses. Such devices could be employed in applications involving
power conditioning as well as power switching. We intend to release higher
voltage Schottky products within the next fiscal year, targeted for motor
control and snubber applications. In fiscal 1999, we entered into a three-year
projectan agreement with Kansai Electric Power Company, oneSpectrian to terminate our supply contract. During fiscal 2004, the majority of the largest power companies
in the world,segment’s revenues represented sales to new customers for the developmentLDMOS designs for wireless infrastructure and mil-aero business.
Financial Information about Segments and Geographic Areas of SiC-based devices for use in power
transmission networks. This project was completed during fiscal 2002. During
this project we demonstrated record results with a 6 kV MOSFET
(metal-oxide-semiconductor field effect transistor)Customers and a 5.5 kV junction field
effect transistor that had on-resistances that were 1/25th and 1/65th lower,
respectively, of the theoretical limit for an equivalent silicon device.
Additionally, high voltage SiC PIN diodes were demonstrated with blocking
voltages up to 19 kV, a 50% increase over our previous record and almost double
what is commercially available in silicon. We continue to work on higher power
devices such as Schottky and PIN diodes as well as power switches. However, we
are not planning to release PIN diodes or power switches suitable for power
transmission in the near term.
RF AND MICROWAVE DEVICES
We are currently developing additional SiC-based transistors that operate at
radio and microwave frequencies. We believe these devices will have applications
in future generation wireless base stations, solid-state broadcast systems, wide
bandwidth military radio, and radar search and detection equipment. These
SiC-based devices are targeted for frequencies from 30 MHz to 4 GHz. We believe
that future SiC transistors in development, with higher power density than
current silicon and GaAs-based devices, may allow wireless systems to operate
across a wider band and use fewer transistors per base station, resulting in
less complex circuitry, higher linearity, better efficiency and lower cost.
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We are also developing GaN-based microwave transistors on SiC substrates that
are targeted for higher gain and/or higher frequency applications including
cellular base stations and solid-state radar systems. In December 2001, we
reported CW performance for GaN of 108 watts at 2 GHz, which we believe to be
the highest publicly reported CW power output for a single device at this
frequency. This demonstrates its potential for infrastructure applications. We
developed GaN MMICs that demonstrated 24 watts of power at 16 GHz. This power
level is higher than that achieved with equivalent GaAs-based devices. We do not
anticipate that a commercial device capable of emitting power at this level will
be available in the near term.
THE CREE MICROWAVE SEGMENT:
RF AND MICROWAVE DEVICES
We continue to enhance the capabilities of our silicon-based LDMOS products and
are working towards the release of next generation devices that we believe will
allow for more linearity and increased power and be comparable to the best in
class products of our competitors. We are targeting these products to be
available in fiscal 2003. We are also continuing to develop additional module
devices to meet advanced needs of our customers. The module configuration allows
us to produce more of the circuit for the power transistor and the product is
more competitively priced than our regular LDMOS devices because the module
configuration features a lower cost package compared with the traditional
ceramic package used for discrete devices. We are targeting these products to be
produced in commercial volumes in fiscal 2003. Additionally we are working with
certain customers on advanced modulation products.
FINANCIAL INFORMATION ABOUT SEGMENTS AND GEOGRAPHIC AREAS OF CUSTOMERS AND
ASSETS
Assets
For financial information about business segments please see Note 2, "Summary
of Significant Accounting Policies and Other Matters" to our consolidated
financial statements included in Item 8 of this report. For financial
information about the geographical areas of customers, please see Note 2, "Summary“Summary of Significant Accounting Policies and Other Matters"Matters” to our consolidated financial statements included in Item 8 of this report. All of our long-lived tangible assets currently are currently maintained in the United States.
GOVERNMENT CONTRACT FUNDING
Government Contract Funding
We derive a portion of our revenue from funding fromthat we receive pursuant to research contracts with various agencies of the U.S. Government. ForWe had 33, 19 and 18 government contracts in effect during the fiscal years ended June 27, 2004, June 29, 2003 and June 30, 2002, June 24, 2001 and
June 25, 2000, government funding represented 12%, 10% and 11% of total revenue,
respectively.
These contracts typically cover work performed over several months up to threefive years. These contracts may be modified or terminated at the convenience of the government. Therefore, these programs may begovernment and typically are subject to government budgetary fluctuations.appropriation and allocation of the required funding on an annual basis. The revenue that we recognize pursuant to these contracts represents reimbursement by various U.S. Government entities that aid in the development of new technology. The applicable contracts generally provide that we may elect to retain title toownership of inventions made in performing the course of research, withwork, subject to a non-exclusive license retained by the government obtaining a nonexclusive licenseU.S. Government to practice suchuse the inventions for government purposes.
RESEARCH AND DEVELOPMENT
Contract funding may be based on either a fixed price or cost type award. Cost awards include cost, cost-plus fixed fee or cost-share arrangements. The amount of funding under each contract is determined based on cost estimates that include direct costs, plus an allocation for research and development expenses, general and administrative expenses and cost of capital expenses. The specific reimbursement provisions of the contracts, including the portion of our general and administrative expenses and other operating expenses that are reimbursed, vary by contract. Cost-plus funding is determined based on actual costs plus a fixed fee. For the cost-share contracts, based on the terms of the contract, the actual costs relating to activities we are to perform under the contract are divided between the U.S. Government and us. The U.S. Government’s cost share is then paid to us. The contracts typically require the submission of a written report that documents the results of the research, as well as some material deliverables.
The revenue and expense classification for contract activities is based on the nature of the contract. For contracts where we anticipate that the U.S. Government funding will exceed our direct costs relating to the program 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 we anticipate that direct costs of the activities subject to the contract will exceed the amounts to be funded over the life of the contract, costs are reported as research and development expenses and related funding is reported as an offset of those expenses. For the fiscal years ended June 27, 2004, June 29, 2003 and June 30, 2002, U.S. Government funding represented 9%, 12% and 12% of total revenue, respectively.
We generally must compete with other companies for funding awards from the U.S. Government. In certain cases, such as when the value of a U.S. Government contract exceeds $100,000 and when highly technical research is required, the U.S. Government issues a request for proposal (RFP). In a typical RFP, the U.S. Government requests a product or service and solicits proposals from prospective contractors on how they intend to carry out that request, and at what price. Proposals received in response to an RFP can be subject to negotiation after they have been submitted. Many U.S. Government contracts are awarded on a type of RFP called a broad agency announcement (BAA). In a BAA, the U.S. Government requests a broad range of research and development services. Contractors submit bids for research in any of the technical areas mentioned in the BAA. Then the U.S. Government may select winners of the awards and negotiate contracts with those parties. The U.S. Government uses many methods to select contractors to receive awards. Some of these methods include choosing vendors who offer products or services that provide the best value, lowest price and highest level of technology. We also may be the recipients of a sole source contract from the U.S. Government if the U.S. Government determines that we are the only viable source for the work to be performed. In this case, the U.S. Government would publish its intent to award a sole source contract to us, and if there are no viable challenges made to that publication, the U.S. Government might award the contract to us without a competitive bid process.
In May 2004, the Army Research Laboratories (ARL) awarded us a contract through the Robert Morris Acquisition Center, providing for funding up to $15.9 million over five years. This contract focuses on the development of manufacturing technology for high-temperature high-power SiC semiconductor material and power devices for use in electric traction drive power components and associated power conditioning and control electronics for the next-generation of combat vehicles. The contract contemplates research regarding the manufacture, processing, and performance of high-temperature SiC high power devices for electric traction drive systems. Specifically, our research efforts under the contract will focus on improving the quality of SiC material (substrates and epi-layers) and the design, development, and operation of SiC power devices for high-temperature, high power motor drive applications. For the year ended June 27, 2004, we recorded $351,000 of revenue associated with this contract.
Also in May 2004, through the ARL Robert Morris Acquisition Center we were awarded a contract providing up to $9.9 million of funding over five years. This contract focuses on the development of high-temperature SiC semiconductor high power devices and power modules for use in electric traction drive power components and associated power conditioning and control electronics for the next-generation of
combat vehicles. The contract also contemplates research regarding device development of SiC power devices and power modules for electric traction drive systems, including SiC power device and power module design, fabrication and operation at high-temperature and high power in motor drive power conditioning, control and power distribution applications. The overall goal of this program is to provide high-temperature power modules with a 1200 V, 600 A rating. For the year ended June 27, 2004, we recorded $161,000 of revenue associated with this contract.
In June 2002, the Office of Naval Research (ONR) awarded us two contracts with a total value of approximately $14.4 million as part of the Wide Bandgap Semiconductor Technology Initiative of the Defense Advance Research Projects Agency (DARPA). The first contract provided for up to $8.8 million in U.S. Government funding over an 18-month period for work directed to microwave and related technologies. This contract focuses on the development of high quality four-inch semi-insulating substrates, SiC MESFET and GaN HEMT epitaxial processes on large diameter wafers, and studies correlating material advances with device performance. In December 2003, DARPA committed an additional $2.9 million to the program for a six-month extension, bringing its total funding commitment under the contract to $11.7 million.
The second ONR/DARPA contract provided for up to $5.6 million in U.S. Government funding over an 18-month period for work directed to SiC high voltage, high power switching devices for high power conversion and distribution technology. This contract focuses on the development of low defect density four-inch, n-type 4H-SiC substrates, more uniform, thick SiC epitaxial processes, and power device development focused on high reliability, high voltage SiC PIN rectifiers and MOSFETs. In December 2003, DARPA committed an additional $1.9 million to the program for a six-month extension. In June 2004, DARPA awarded an expanded effort to the program, committing an additional $800,000. This additional funding brings the total funding commitment under the contract to $8.3 million.
We may enter into a number of contracts for different projects with a single agency or enter into contracts addressing different parts of the same project with more than one agency. For example, we currently have several large contracts with the ONR and the Air Force Research Laboratories (AFRL). In July 2002, we were awarded U.S. Government contracts totaling $26.5 million, if fully funded, over a three-year period from ONR and AFRL for SiC MMIC process development. The U.S. Navy, the Missile Defense Agency and the Department of Defense’s Title III program jointly fund these contracts. Under our previously existing Title III contract with AFRL, the project added $3.2 million through a contract modification for additional tasks focused on improving yields of the three-inch diameter high purity semi-insulating SiC substrates to be used for MMIC devices. The remaining $23.3 million is being provided through the contract with ONR. The goal of this contract is to provide enhanced producibility of SiC materials, both substrates and epitaxy, and clean room processing, in support of high-power MMIC amplifiers used in military radar applications. The majority of the work is directed to yield enhancement and cost reduction for MMICs fabricated on three-inch diameter SiC wafers. In fiscal 2004, revenues under the specific contracts (DARPA, MMIC Producibility and AFRL) with the ONR, AFRL and ARL combined were approximately 4% of total revenue.
Additionally, we were awarded with another contract in June 2002 funded by DARPA through the ARL Robert Morris Acquisition Center to pursue the development of UV LEDs and lasers for a variety of military communications and bio-threat detection applications under DARPA’s Semiconductor Ultraviolet Optical Sources (SUVOS) program. This DARPA SUVOS contract provides for up to $14.4 million in U.S. Government funding over a four-year period. In fiscal 2004, DARPA committed an additional $3.0 million toward this program, bringing the total funding commitment under the contract to $17.4 million. In fiscal 2004, this DARPA SUVOS contract accounted for approximately 2% of total revenue.
The specific contracts mentioned above are all cost share arrangements. The contracts require us to conduct the research effort described in the statement of work section of the contract. The contracts also require that we pay a contractually agreed upon portion of the costs of the work with the U.S. Government
paying the balance. There are no milestones to be reached for payments from the U.S. Government. We invoice the U.S. Government monthly for their share of the costs of the work performed based on costs incurred for that month.
Distributorship Agreement with Sumitomo Corporation
In April 2002, we entered into a distributorship agreement with Sumitomo Corporation (Sumitomo), which was amended in March 2003, amended and restated in May 2004 and amended in July 2004. Under the agreement, as amended, Sumitomo became our strategic partner and is now the exclusive distributor of our LED and wafer products in Japan through fiscal 2007. Prior to the beginning of each fiscal year, the distributorship agreement requires Sumitomo to commit in advance to purchase a specified dollar value of our products during the next fiscal year. For fiscal year 2004, Sumitomo’s advance purchase commitment was approximately $100 million, and revenue recognized from Sumitomo was $101.8 million. For fiscal year 2005, Sumitomo’s current advance purchase commitment is approximately $160 million; however, Sumitomo’s purchase commitment may vary under certain circumstances subject to end customer demand and other terms and conditions. For example, the distributorship agreement provides that Sumitomo may decrease its advance purchase commitment and/or terminate the agreement if its inventory of Cree products reaches a specified level. If Sumitomo does not purchase at least half of its advance purchase commitment for any fiscal quarter as a result of this inventory limitation, we have the option of terminating the distributorship agreement.
The distributorship agreement also requires us to establish two rolling reserves at the time we ship LED products to Sumitomo, each based upon a percentage of the total purchase price of the products. We defer revenue recognition on the amounts added to both rolling reserves each fiscal quarter. These reserves are used to reimburse Sumitomo for certain sales costs incurred in selling our products and for managing its inventory, up to the balance in these reserves. If Sumitomo makes a valid claim against these reserves, we write off or reduce the amount of the claim against the applicable reserve. Except to the extent Sumitomo makes a valid claim against the reserves, amounts added to these reserves during a fiscal quarter will expire on a rolling basis by at least the end of the second following fiscal quarter, and we recognize revenue equal to the expired amount at that time.
Research and Development
We invest significant resources in research and development aimed at improving our semiconductor materials and developing new device and production technology. Our core SiC materials research is directed to improving the quality and diameter of our SiC and GaN substrates. We also are also working to improve the quality of the SiC and nitride epitaxial materials we grow to produce devices and to improve device -12-
on-goingongoing projects focused on brighter LED chips, high power packaged LEDs, higher power, power/higher linearity RF and microwave devices, near UV laser devices and higher power diodes and diodes/switches as discussed above.
We spent $51.2recorded $36.9 million in fiscal 2002, $38.42004, $31.2 million in fiscal 20012003 and $20.0$28.0 million in fiscal 20002002 for direct expenditures relating to research and development activities. Off-settingThe amount of recorded expenditures is supplemented by funding received from our customers and the U.S. Government, in certain cases, which is recorded as a reduction in research and development expenditures. When we receive payments from our customers for sponsoring research and development programs, we offset those payments against direct research and development expenditures. In addition, when we receive payments from the U.S. Government under contracts where direct expenses of the contract are estimated to exceed the funding award over the life of the program, we offset the payment against reported research and development expenditures. In fiscal 2004, 2003 and 2002, customers funded zero, $500,000 and $9.0 million, respectively for programs that offset research and development costs. The majority of this funding was received from companies in which we have made investments. For example, an affiliate of Lighthouse Technologies, Limited (Lighthouse) in
which we have an investment, was our only source of customer funding in fiscal 2003. In fiscal 2002, Microvision, Inc. (Microvision), the Lighthouse affiliate and Xemod, Inc. (Xemod) funded $4.4 million, $3.0 million and $492,000, respectively, of our research and development. We held an investment in each of these expenditures were $19.5companies at the time that they provided research and development funding to us. In addition, Spectrian, historically the largest customer for our Cree Microwave segment, also participated in funding our research and development programs for $1.1 million in fiscal 2002, $19.0 million2002. When customers participate in fiscal 2001funding our research and $12.7 million in fiscal 2000development programs, we record the amount funded as a reduction of
U.S. Government funding for direct and indirect research and development expenses. In addition, certain customers have also sponsored research activities
related to the development of new products. Customers contributed $9.0 million
in fiscal 2002, $11.9 million in fiscal 2001 and $5.5 million in fiscal 2000
towards our productAt this time, we do not expect funding for research and development activities.
SALES AND MARKETING
during fiscal 2005 from these or any other customers or any third parties in which we invested. U.S. Government funding that offset costs included as research and development was zero, zero and $276,000 for fiscal 2004, 2003 and 2002, respectively.
Sales and Marketing
We actively market our LED, wafer, RF, microwave and power products through targeted promotions, telemarketing, select advertising and attendance at trade shows. We
have a smallOur direct sales force and senior management actively workswork with customers around the world. We believe that this approach is preferable in view
of our current customer base and product mix, particularly since theThe production of lamp and display products incorporating LED chips is concentrated among a relatively small number of LED packaging manufacturers. Additionally, theOur sales and marketing team has been expandedis based in fiscal 2002 to includeour Durham, North Carolina facility with additional sales support offices in Hong Kong and Tokyo, Japan. In June 2002, we opened an officeWe also have a salesperson based in Tokyo,Taiwan. We believe that our sales in Asia have increased as a direct result of localizing our Asian sales presence.
Supported by our Japan through our subsidiary Cree
Japan, Inc., to bring our technology and engineering support closer to the
Japanese customer base. In connection with the opening of our new office, Sumitomo Corporation, or Sumitomo, was named asis our strategic partner to
distribute our products in Japan. Sumitomo has exclusive distribution rights in
Japanpartner for our nitride LED chip productschips and SiC wafer products for a minimum of
three years. Our personneland GaN wafers in Japan will work with and support the sales
activities of the Sumitomo team dedicated to our product line.Japan. We also use sales representativesdistributors to market our LED products in Hong Kong, China and Taiwan and South Korea. However, as a result of the introduction of many
new products during fiscal 2002, we perceived the need for more frequent
interactionin coordination with our customers. As a result, we opened a Southeast Asian sales support office in Kowloon, Hong Kong, through our subsidiary Cree Asia-Pacific, Inc., to
facilitate business transactions and act as the liaison between our Asia Pacific
customers and our U.S. corporate office. Territorial responsibilities for the
Cree-Asia Pacific sales office include Hong Kong, China, Taiwan and Malaysia. In
addition, the Hong Kong sales office oversees the day-to-day administration of
our sales agents in Hong Kong and Taiwan as well as assisting our direct
customerssalesperson based in the region.Taiwan. We use a separate network of distributors and sales representatives to market our GaN materials, RF and microwave devices, power devices and high power packaged LED products in North America, Japan, Europe and Asia. We sell SiC crystal materials for use in gemstone applications directly to C&C under an exclusive supply agreement. We
Customers
During fiscal 2004, revenues from Sumitomo (which represent sales to approximately 20 Japanese LED customers as well as a number of wafer customers) accounted for 33% of our total revenue. Sumitomo assists in managing customer relationships and imports, handles orders, distributes our products and manages accounts receivable for the Japanese customer base. For fiscal 2004, four of our top ten end customers were located in Japan and their sales, as well as sales to our other Japanese customers, are using both directreported as sales to Sumitomo. Cree Japan’s sales team is actively involved with Sumitomo in the sales process to accounts in Japan. Our relationship with our end customers in Japan is critical to our future success. Sales to OSRAM Opto Semiconductors GmbH (OSRAM) and sales
representative arrangementsAgilent Technologies (Malaysia) Sdn Bhd, (Agilent) during fiscal 2004 were 13% and 13%, of revenue, respectively.
Sumitomo, OSRAM and Agilent were our only customers that comprised 10% or more of our revenue for fiscal 2004. In October 2003, we signed an agreement with OSRAM, which was amended in March 2004. Under the agreement, OSRAM committed to market RF productspurchase at least 500 million LEDs through June 2005. The loss of OSRAM, Agilent or any of Sumitomo’s large customers could have a material adverse effect on our business and results of operation. Revenue from the U.S. Government, representing funding from several agencies, made up 9% of total revenue for Cree Microwave, includingfiscal 2004. As our U.S. Government contracts are with multiple agencies, the U.S. Government does not act as a new distributor agreement signed with Arrow Manufacturing insingle customer, and we do not regard it as such. During fiscal 2002.
CUSTOMERS2003, revenues from three customers, Sumitomo, OSRAM and Agilent were 24%, 21%, and 10%, of total revenue, respectively. Revenue from the U.S. Government, representing funding from several agencies, made up 12% of total revenue for fiscal 2003. During fiscal 2002, revenues from fourthree customers, Osram, OSRAM,
Spectrian and Sumitomo, (which represents sales to several Japanese customers)were 19%, 16% and 14%, of total revenue, respectively. Revenue from the U.S. Government, each accounted for more than 10%representing funding from several agencies, made up 12% of total revenue for fiscal 2002. Prior to fiscal 2003, sales to Spectrian, which was purchased in 2002 by Remec, Inc. (REMEC), were 99% of Cree Microwave’s revenue. DuringIn fiscal 2002, we signed
new supply agreements with Osram and Sumitomo, which extend into fiscal 2003.
Spectrian is a customer2004, sales to Remec made up 43% of the Cree Microwave sales. We continue to pursue new customers for our Cree Microwave business and have had some recent success on designs with our newer products serving the wireless infrastructure and mil-aero markets. Based upon conversations with our customer, we target sales to Remec to decline in fiscal 2005 and therefore new customer orders will be critical to continue to grow revenue for this segment. During fiscal 2001,
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revenues from three customers, Osram, Sumitomo and Spectrian, each accounted for
more than 10% of total revenue. For the year ended June 25, 2000, revenue from
Osram, Sumitomo, C&C and the U.S. Government each accounted for more than 10% of
total revenue. Forfurther financial information about foreign and domestic sales, please see Note 2, "Summary“Summary of Significant Accounting Policies and Other Matters"Matters,” to our consolidated financial statements included in Item 8 of this report.
BACKLOG
Backlog
As of June 30, 2002,27, 2004, we had a backlog believed to be firm of approximately $138.7$248.5 million, consisting of approximately $86.9$192.8 million of product orders and $51.8$55.7 million under research contracts signed with the U.S. Government, for which a portion of the contracted funds have not yet been appropriated. This
comparesThe backlog includes the full amount of Sumitomo’s purchase commitment for fiscal 2005, which may vary under certain circumstances subject to a firmend customer demand and other terms and conditions described above under the caption “Distributorship Agreement with Sumitomo Corporation.” We estimate our entire backlog ascould be filled during fiscal 2005, with the exception of approximately $33.7 million in U.S. Government funded contracts. As of June 24, 2001,29, 2003, we had a backlog of approximately $86.5$152.5 million consisting of approximately $69.9$108.9 million of product orders and $16.6$43.6 million under research contracts signed with the U.S. Government, for which a portion whichof the contracted funds had not yet been funded through appropriations. Backlogappropriated. This backlog included the full amount of Sumitomo’s purchase commitment. Our backlog could be adversely affected if Sumitomo or other customers fail to honor their purchase commitments or reduce or cancel orders or if the U.S. Government exercises its rights to terminate the government contracts or does not appropriate and allocate all of the funding contemplated by the contracts. We believe
In May 2004, we amended and restated our existing distributorship agreement with Sumitomo extending the entire backlog could be filled during fiscal
2003, with the exception of approximately $9.7 million of product orders and
$23.9 million in U.S. Government funded contracts. The reported backlog amounts
include $16.2 million ordered from Spectrian under their supply agreement. If we
are not able to produce LDMOS 8 products that meet qualification specifications,
this amount of revenue may be reduced or may not be realized at all.
MANUFACTURING
Our SiC products are manufactured in a seven-part process, which include: SiC
crystal growth, wafer slicing, polishing, epitaxial deposition, fabrication,
testing and packaging. SiC crystals are grown using a high temperature process
designed to produce uniform crystals in a single crystalline form. Crystals used
for gemstones exit the manufacturing process at this stage. Crystals used for
other products are then sliced into wafers. The wafers are polished and then
processed using our epitaxial deposition processes, which require that we grow
thin layers of SiC, GaN or other materials on the polished wafer, depending on
the natureterm of the device under production. SiC wafer products may leave the
manufacturing process either after polishing or epitaxy. Following epitaxy, LED,
poweragreement through 2007. For fiscal year 2005, Sumitomo’s current advance purchase commitment is approximately $160 million, subject to adjustment and RF chips are fabricated in a clean room environment. The final step
includes testingcancellation provisions and sawing prior to shipment to the customer. Power chips are
then forwarded to a third party where they are assembled into industry standard
packages and returned to us prior to shipment to our customers. SiC RF
transistors are currently packaged and tested in our Durham, North Carolina
facility. However, we believe that this process will be transferred to the Cree
Microwave facility in Sunnyvale, California during fiscal 2003. In manufacturingend customer demand.The orders cover demand for our products in Japan and represent sales to over twenty LED packagers including Stanley Electric Co., Ltd. (Stanley), Citizen Electronics Co., Ltd. (Citizen), Sharp Corporation (Sharp) and Rohm Co., Ltd. (Rohm). In October 2003, we depend substantially on our custom-manufactured equipment and
systems, somesigned a purchase agreement with OSRAM, which was amended in March 2004. The agreement covers shipments through June 2005, but does not specify specific products to be purchased by OSRAM each quarter. Therefore, we only account for amounts set forth in purchase orders from OSRAM as firm backlog.As of which are manufactured internally and someJune 27, 2004 we had approximately six weeks of which we acquireorders from third parties and customize ourselves.
Cree Microwave produces both silicon LDMOS and silicon bipolar junction
transistor, or BJT, structures at its wafer fabrication facility in Sunnyvale,
California. Both product families use silicon wafers that are acquired from
third parties and the devices are fabricated in a clean room environment. The
clean room steps employ multiple stagesOSRAM as firm backlog.
Sources of photolithography, diffusion, thin
film metal deposition and both wet and dry etch process in the manufacturing
cycle. Finished wafers are electrically tested and may be shipped to customers
at this point. Transistor die from wafers, which continue in the manufacturing
process, are assembled into thermally conductive packages or modules and tested
prior to shipment to customers.
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SOURCES OF RAW MATERIALS
Raw Materials
We depend on a limited number of suppliers for certain raw materials, components and equipment used in our products, including certain key materials and equipment used in our crystal growth, wafering, polishing, epitaxial deposition, device fabrication and device assembly processes. We generally purchase these limited source items pursuant to purchase orders and have limited guaranteed supply arrangements with our suppliers. In addition, the availability of these
materials, components and equipment to us is dependent in part
Competition
Our success depends on our ability to provide our supplierskeep pace with accurate forecaststhe evolving technology standards of our future requirements. We
endeavor to maintain ongoing communication with our suppliers to guard against
interruptions in supply and, to date, generally have been able to obtain
adequate supplies in a timely manner from our existing sources. However, any
interruption in the supply of these key materials, components or equipment could
have a significant adverse effect on our operations.
COMPETITION
The semiconductor industry is intensely competitive and isindustries that we serve. These industries are characterized by rapid technological change, price erosionfrequent introduction of new products, short product life cycles and substantial foreign competition.
We believe that our Cree segment currently enjoys a favorable positionchanges in the
existing markets for SiC-based productsend-user and materials. We also believe that our
Cree Microwave segment can become competitive in the market for silicon-based
LDMOS devices if it succeeds in qualifying its most recently introduced LDMOS
devices for volume production. However, we face actual and potential competition
from a number of established domestic and international compound semiconductor
companies. Manycustomer requirements.
The evolving nature of these companiesindustries may render our existing or future products obsolete, noncompetitive or unmarketable. Any of these developments could have greater engineering, manufacturing,
marketingan adverse effect on our business, results of operations and financial resources than we have.
Ourcondition.
LEDs
Blue, Green and Near UV LED Chips. The primary competition for our optoelectronicLED chip products comes from companies that manufacture and or sell nitride basednitride-based LED chips. We expect many LED competitors to substantially increase their capacity to manufacture LED chips during the next twelve months. We also consider Nichia Corporation or Nichia, Toyoda Gosei Co. Ltd.(Nichia), or Toyoda,which sells packaged LEDs and Lumileds Lighting
LLC, a joint venture between Agilent Technologies and Philips Lightingmost often competes directly with our chip customers, to be our
primary competitors. These companiesa competitor. Nichia currently marketsells the majority of its packaged LED products madeto markets requiring white LEDs, which Nichia fabricates using nitride materials on sapphire substrates, and Nichia markets short wavelength
nitride-based laser diodes. In addition, American Xtal Technology, Epistar,
Arima, UEC and other Asian based companies in recent years have begun production
of UV,its efficient phosphor solution for blue and green LEDs, all on sapphire substrates. We attempt to closely
monitor the progress of Taiwanese competitors.LEDs. We believe that these new
competitorsNichia currently has the largest market share for nitride-based LEDs based on conversations with our customers. We see an opportunity to improve our customers’ ability to compete with Nichia’s white LED products and increase our chip sales with our recently introduced XT-21 chip, based on reports from customers that they are able to produce a white LED with our XT-21 chip that is similar in output to Nichia’s white LED. However, this opportunity also depends upon our customers’ ability to source or develop efficient phosphor solutions for the conversion to white light that can compete with Nichia’s solution.
Many Asia-based chip producers also produce blue, green and near UV LED products. They have had some successbeen successful in securing new business, overprimarily in Asia for the last few
quartersblue keypad backlight for mobile appliances and could potentially become significantother cost sensitive applications. Some of these Asia-based competitors in the future.
Historically, some ofoffer chips with brightness similar to our existing competitorshigh-brightness products.
Our customers indicate that they base their nitride LED purchases on a combination of factors. These factors include price, performance, reliability, quality, usability and stability of supply, intellectual property, customer service and overall customer relationships. Based on conversations with our customers, we believe that our products have beenan advantage over our competitors’ chips in many of these areas and that we are more successful inwhen end customers value a combination of these factors. The particular combination and importance of specific factors that drive customers’ purchasing decisions at any time varies, depending on market conditions, requirements for end user applications and demand for those applications. Overall, we believe that price and performance are the market for outdoor display applications because, prior to the release of our
MegaBright(TM) and XBright(TM) products, some sapphire devices were brighter
than our LEDs. We believe our new MegaBright(TM) and XBright(TM) devices will
enable usmost significant factors to compete successfully in the nitride LED market and that our products are well positioned to meet the market demands. We continually strive to improve our competitive position by developing brighter and higher performance LED chips and focusing on lowering costs. For example, we target to migrate the majority of our LED production to three-inch wafers from two-inch wafers during fiscal 2005, which is intended to increase our LED production yield and lower our overall LED chip cost.
High Power Packaged LEDs. The market for power chip products and high power packaged lamps is currently limited to specialty lighting applications. Lumileds Lighting, LLC (Lumileds) currently is positioned as the leader in this market.market since they have been the only production supplier of high power packaged LEDs for the last few years. Lumileds sells high power packaged LEDs that compete indirectly with our target customers for power chip products and directly with our XLamp family of high power packaged lamps. Several other companies have announced intentions to enter this market with products designed to compete with our XLamp products. We believeare positioning our approachXLamp product to manufacturing UV; bluecompete in this market based on price, performance and green LEDs using usability.
SiC substrates enables usand GaN Materials Products
The market for SiC wafers has become more competitive in recent years, as other companies have begun to offer SiC wafer products or have announced plans to do so. To our knowledge, none of these competitors currently offer SiC wafers that are being used for device production. We sell SiC wafers to
OSRAM and Infineon, which compete with us in the LED and power diode markets, respectively. In addition to being a cost-effective chip design. Our customers'
desired product attributes for nitride based LEDs are generally price and the
brightnesslarge customer of the devices for the intended applications. At times other factors
such as size or forward voltage of the device are also competitive factors.
Osram,our LED chips, OSRAM, which licensed certain LED technology from us in 1995, currently is currently producing LEDs using nitride materials on SiC substrates. Shin-Etsu Handotai Co.
Ltd. also licensed certain LED technology from ussubstrates for use in 1996 but never began
commercial production undertheir packages. We are not aware of any other company who produces SiC materials for use in gemstones although we believe there are some companies pursuing research and development in this license.area. The market for SiCbulk GaN wafers also is becoming moreincreasingly competitive as other companies
in recent years have begun to offer SiC wafer products or announced plans to do
so, including Sterling Semiconductors, II-VI, SixonSumitomo Electric and other small
manufacturers. To our knowledge, none of these competitorsothers are currently -15-
offering SiCselling wafers for use in device production, as their materials are
generally not considered to have production level quality. these markets.
SiC-based Power Devices
Our SiC-based power devices
which are currently available in limited quantities, compete with similar devices offered by Infineon. There are also a number of other companies developing SiC-based power devices. Our products also compete with existing silicon-based power devices offered by a variety of manufacturers.
RF and Microwave Transistors
Currently, there are no companies offering products that compete directly with our SiC MESFET products and MMIC foundry service although a few companies have products under development. Although there are no direct competitors using SiC technology, our products face competition from existing silicon and GaAs-based products. We do not currently offer GaN microwave devices, but we are working to develop these products. In the GaN microwave area, there are a number of companies working to develop these products.
The markets served by Cree Microwave'sMicrowave’s LDMOS and bipolar products are highly competitive. Motorola Incorporated, or Motorola, Infineon,Currently Motorola’s LDMOS business (which was recently spun out into Freescale Semiconductor, Inc.) dominates this marketplace, which recently
acquired LDMOS capabilities from Telefonaktiebolaget LM Ericsson, and Royal
Philips Electronic NV, or Phillips, currently manufacture competing products.
Currently, we believe Motorola dominates the marketplace with over 80% market
shareis due to superiorthe performance and pricing. Cree Microwavepricing of its products in comparison to our products and others currently available in the market.
Near UV Laser Diodes
We currently do not offer any laser products commercially. The major competitors in the near UV laser market are Nichia and Sony Corporation, as well as a number of other companies that have announced development activities in this area. The market for blue laser products is targetingjust beginning to releaseemerge. In addition to our development efforts, there are also a new linenumber of improved LDMOS products during the first quarter of fiscal
2003 that is intended to be comparable with the performance of Motorola parts at
a competitive price.
PATENTS AND PROPRIETARY RIGHTS
companies working on developing near UV laser diodes.
Patents and Proprietary Rights
We seek to protect our proprietary technology by applying for patents where appropriate and in other cases by preserving the technology and related know-how and information as trade secrets. We have also from time to time acquired, through license grants or assignments, rights to patents on inventions originally developed by others. At June 30, 2002,As of July 15, 2004, we owned or held exclusive rights licensed under a total of 133251 issued U.S. patents, subject in some cases to nonexclusivenon-exclusive license rights held by third parties. These patents expire between 2007 and 2020. Two2022. We jointly own four of these patents are jointly owned with a third party. Twenty-sixparties. Thirty-six of these patents relate primarily to our Cree Microwave segment. In addition, we own or hold exclusive license rights under corresponding patents and patent applications in various foreign countries.
Among the patent licenses we hold are exclusive licenses granted by North Carolina State University or NCSU,(NCSU) to its U.S. and corresponding foreign patents and patent applications that relate to SiC materials and device technology and to GaN growth technology. These licenses include rights under patents and patent applications relating to processes for growing single crystal SiC and low defect GaN materials. The licenses are worldwide, exclusive licenses to manufacture, use and sell products and processes covered by the claims
of patents issued on applications filed by NCSU relating to the licensed inventions. The U.S. Government holds a non-exclusive licenselicenses from us to practiceuse for government purposes certain of theour inventions for government purposes.that were developed under contracts with them. The licenses relating to the growth of bulk single crystal SiC and to other SiC materials and device technology are fully-paid, while the licenses relating to growth of low defect GaN materials require us to pay NCSU royalties on sales of products made using the licensed processes.
The patents that we have licensed from NCSU relating to bulk SiC growth expire beginning in 2007, and we may face increased competition in the market for SiC materials as these patents expire. In addition, in the event our licenses to the U.S. patents owned by NCSU relating to SiC growth were to be terminated under the terms of our license agreement, we could potentially be enjoined from practicing the patented process. In that event the business of our entire Cree segment could be disrupted since the segment is critically dependent on our ability to manufacture bulk single crystal SiC material. Similarly, if our license to the patents relating to growth of low defect GaN materials were to be terminated, it could have a material adverse effect on our ability to produce GaN-based laser diodes or other future products manufacturedwe expect to manufacture using the patented process.
processes.
We also have also entered into license agreements with the licensing agencies of other universities, and with other companies, under which we have obtained exclusive or non-exclusive rights to practice inventions claimed in various patents and applications issued or pending in the U.S. and other foreign countries. We do not believe the financial obligations under any of these agreements, or the loss of the licensed rights under any of these agreements, would have a material adverse effect on our business, financial condition or -16-
One of theseThese license agreements includesinclude a patent cross-license agreement covering GaN-based optoelectronic technology that we entered into with Nichia in November 2002 in connection with a settlement of patent and related litigation then pending between the parties in the United States and Japan. These license agreements also include license rights granted to our Cree Lighting subsidiaryus by the Trustees of Boston University or
Boston University,(Boston University) under certain U.S. patents and corresponding foreign patents and patent applications which relate to the manufacture of certain GaN-based structures on sapphire and other substrates. The license agreement with Boston University grants Cree Lightingus an exclusive, worldwide royalty-bearing license under these patents and patent applications, subject to royalty payments and other obligations under the license agreement. As described in Item 3 "Legal
Proceedings", at page 27, at June 30, 2002, Cree Lighting and Boston University
are parties to pending litigation in which they have alleged that Nichia and its
subsidiary, Nichia America Corporation, are infringing one of the licensed
patents. Termination of the license to this patent by Boston University would end Cree Lighting'sour right to assert the patent against future infringements.
For proprietary technology whichthat is not patented or otherwise published, we seek to protect the technology and related know-how and information as trade secrets and to maintain it in confidence through appropriate non-disclosure agreements with employees and others to whom the information is disclosed. There can be no assurance that these agreements will provide meaningful protection against unauthorized disclosure or use of our confidential information or that our proprietary technology and know-how will not otherwise become known or independently discovered by others. We also rely upon other intellectual property rights such as trademarks and copyright where appropriate.
Environmental Regulation
We have
registered "Cree" and the Cree logo as a trademark for certain products in the
U.S. We have also applied for registration of several trademarks for our
products in the U.S. and other countries.
Because of rapid technological developments in the semiconductor industry, the
intellectual property position of any semiconductor materials or device
manufacturer, including Cree is subject to uncertainties and may involve complex
legal and factual issues. There can be no assurance that patents will be issued
on any of the pending applications owned or licensed to us or that claims
allowed in any patents issued or licensed to us will not be contested or
invalidated. There is likewise no assurance that patent rights owned or
exclusively licensed to us will provide significant commercial protection since
issuance of a patent does not prevent other companies from using alternative,
non-infringing technology. Further, we earn a material amount of our revenues in
overseas markets. While we hold and have applied for patent protection for
certain of our technologies in these markets, there can be no assurance that we
will obtain protection in all commercially significant foreign markets or that
our intellectual property rights will provide adequate protection in all such
markets.
Frequent claims and litigation involving patents and intellectual property
rights are common in the semiconductor industry. As of June 30, 2002, we were
parties to complex intellectual property litigation in the United States and
Japan with one of our competitors in the LED business, as described in Item 3
"Legal Proceedings", at page 27. We may become parties to other litigation in
the future to enforce our intellectual property rights or to defend against
claims of infringement. Such litigation can be protracted and costly and divert
the attention of key personnel. There can be no assurance that third parties
will not attempt to assert infringement claims against us with respect to our
current or future products. We from time to time receive correspondence
asserting that our products or processes are or may be infringing patents or
other intellectual property rights of others. Our practice is to investigate
such claims to determine whether the assertions have merit and, if so, we take
appropriate steps to seek to obtain a license or to avoid the infringement.
However, we cannot predict whether past or future assertions of infringement may
result in litigation or the extent to which such assertions may require us to
seek a license under the rights asserted or whether a license would be available
or available on acceptable terms. Likewise, we cannot predict the occurrence of
future assertions of infringement that may prevent us from selling products,
result in litigation or require us to pay damage awards.
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ENVIRONMENTAL REGULATION
The Company is subject to a variety of federal, state and local provisions enacted or adopted regulating the discharge of materials into the environment or otherwise relating to the protection of the environment. These include statutory and regulatory provisions under which we are responsible for the management of hazardous materials we use and the disposition of hazardous wastes resulting from our manufacturing processes. Failure to comply with such provisions, whether intentional or inadvertent, could result in fines and other liabilities to the government or third parties, injunctions requiring us to suspend or curtail operations or other remedies, and could have a material adverse effect on our business.
EMPLOYEES
Employees
As of June 30, 2002,27, 2004, we employed 8931,235 people, consisting of regular full time and temporary employees, including 678965 in manufacturing operations, 146196 in research and development and 6974 in sales and general administration. None of our employees are represented by a labor union or subject to collective bargaining agreements.
Available Information
We maintain a website at the address www.cree.com. We are not including the information contained on our website as a part of, or incorporating it by reference into, this Annual Report on Form 10-K. We make available free of charge through our website our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after we electronically file such material with, or furnish such material to, the Securities and Exchange Commission (SEC). These reports may be accessed by following the link under “News & Investor—SEC Filings” on our website.
We own our facilities in Durham, North Carolina where the business for our Cree segment is conducted. We presently maintain approximately 48 acres of developed land, with total facility square footage of 521,747. This includes 289,772 square feet for production, 81,751 square feet for service and warehousing, and 150,224 square feet for administrative support. We also own approximately 80 acres of undeveloped land near our production facilities potentially for future expansion.
We maintain a three-year lease through our Cree Japan subsidiary for an office in Tokyo, Japan for sales and marketing activities that expires in June 2005. We also contract the use of a facility for sales and marketing efforts for our Cree Asia-Pacific subsidiary in Kowloon, Hong Kong that expires in July 2005.
The facility used for our Cree Microwave segment is approximately 49,600 square feet of administrative and manufacturing space located in Sunnyvale, California. Our Cree Microwave subsidiary currently maintains this space under a sublease agreement that expires in 2011. We have guaranteed the obligations of our subsidiary under the sublease.
We lease a facility for our Santa Barbara Technology Center in Goleta, California (formerly Cree Lighting Company) for our Cree segment. The lease for this facility, which covers 35,840 square feet, has been extended until August 2010. This facility is used for research and development and administration. Our previously reported sublease of 10,217 square feet of this facility to a third party expired in July 2004.
In re Cree, Inc. Securities Litigation
Between June 16 and August 18, 2003, nineteen purported class action lawsuits were filed in the United States District Court for the Middle District of North Carolina by certain alleged purchasers of our stock. The lawsuits name us, certain of our officers and current and former directors as defendants. On December 17, 2003, the court entered an order consolidating these actions and appointing a lead plaintiff and lead counsel for the consolidated cases. The lead plaintiff filed a consolidated amended complaint on January 16, 2004. The amended complaint asserts, among other claims, violations of federal securities laws, including violations of Section 10(b) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5, and violations of Section 20(a) and Section 18 of the Exchange Act against the individual defendants and also asserts claims against certain of our officers under Section 304 of the Sarbanes-Oxley Act of 2002. The amended complaint alleges that we made false and misleading statements concerning our investments in
certain public and privately held companies, our acquisition of the UltraRF division of Spectrian, our supply agreement with Spectrian, our agreements with C&C, and our employment relationship with Eric Hunter and that our financial statements did not comply with the requirements of the securities laws during the class period. The amended complaint requests certification of a plaintiff class consisting of purchasers of Cree stock between August 12, 1998 and June 13, 2003 and seeks, among other relief, unspecified damages and disgorgement of profits by the individual defendants, plus costs and expenses, including attorneys’, accountants’ and experts’ fees. In February 2004, we moved that the court dismiss the consolidated amended complaint on the grounds that it fails to state a claim upon which relief can be granted and does not satisfy the pleading requirements under applicable law. The motion is currently pending.
We believe that the claims set forth in the amended complaint are without merit. However, we are unable to predict the final outcome of these matters with certainty. Our failure to successfully defend against these allegations could have a material adverse effect on our business, financial condition and results of operations.
SEC and Nasdaq Inquiries
In July 2003, the SEC initiated an informal inquiry regarding us and requested that we voluntarily provide certain information. We have cooperated with the SEC in this informal inquiry. In August 2003, the Nasdaq National Market (Nasdaq) requested information from us regarding the informal inquiry being conducted by the SEC and our then pending litigation, and we have provided information to Nasdaq in response to these requests. We are unable to predict whether these inquiries will continue or result in any adverse action.
Other Matters
We are currently a party to other legal proceedings incidental to our business. Although the final resolution of these other matters cannot be predicted with certainty, management’s present judgment is that the final outcome of these matters will not likely have a material adverse effect on our consolidated financial condition or results of operations. If an unfavorable resolution occurs in these legal proceedings, our business, results of operations and financial condition could be materially adversely affected.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth quarter of fiscal 2004.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Common Stock Market Information. Our common stock is traded in the Nasdaq National Market and is quoted under the symbol CREE. The following table sets forth, for the quarters indicated, the high and low sales prices as reported by Nasdaq. Quotations represent interdealer prices without an adjustment for retail markups, markdowns or commissions.
| FY 2004 | FY 2003 | |||||||||||
| High | Low | High | Low | |||||||||
First Quarter | $ | 23.640 | $ | 11.700 | $ | 17.720 | $ | 10.870 | ||||
Second Quarter | 22.750 | 16.000 | 25.420 | 8.989 | ||||||||
Third Quarter | 29.000 | 17.500 | 20.640 | 14.701 | ||||||||
Fourth Quarter | 23.450 | 18.060 | 26.880 | 15.500 | ||||||||
Holders and Dividends. There were approximately 777 holders of record of our common stock as of July 29, 2004.
We have never paid cash dividends on our common stock and do not anticipate that we will do so in the foreseeable future. There are no contractual restrictions in place that currently materially limit, or are likely in the future to materially limit, us from paying dividends on our common stock, but applicable state law may limit the payment of dividends. Our present policy is to retain earnings, if any, to provide funds for the operation and expansion of our business.
Sale of Unregistered Securities. There were no sales of unregistered securities during fiscal 2004, 2003 or 2002.
Purchases of Equity Securities by the Company and Affiliated Purchasers. The following table lists all repurchases (both open market and private transactions) during the fourth quarter of fiscal 2004 of any of our securities registered under Section 12 of the Exchange Act, by or on behalf of us, or any affiliated purchaser.
Issuer Purchases of Equity Securities
Period | Total Number of Shares Purchased | Average Price Paid Per Share | Total Number of Shares Purchased as Part of Publicly Announced Programs(1) | Maximum Number of Shares that May Yet Be Purchased Under the Programs | |||||
March 29-April 25, 2004 | 230,000 | $ | 20.3443 | 230,000 | 2,767,498 | ||||
April 26-May 23, 2004 | 833,500 | $ | 18.8144 | 833,500 | 7,000,000 | ||||
May 24-June 27, 2004 | 100,000 | $ | 19.8586 | 100,000 | 6,900,000 | ||||
Total | 1,163,500 | $ | 19.9230 | 1,163,500 | 6,900,000 | ||||
| (1) | On January 18, 2001, we announced the authorization by our Board of Directors of a program to repurchase up to four million shares of our outstanding common stock. In March 2001, the Board of Directors increased the repurchase limits by an additional three million shares. In May 2004 the Board of Directors authorized an additional five million shares for repurchase under the program. As of June 27, 2004, there are an aggregate of 6.9 million shares remaining that are authorized for future repurchases. The repurchase program will expire on February 5, 2005 unless extended by the Board of Directors. |
Item 6. Selected Financial Data
The consolidated statement of operations data set forth below with respect to the fiscal years ended June 27, 2004, June 29, 2003 and June 30, 2002 and the consolidated balance sheet data at June 27, 2004 and June 29, 2003 are derived from, and are qualified by reference to, the audited consolidated financial statements included elsewhere in this report and should be read in conjunction with those financial statements and notes thereto. The consolidated statement of operations data for the fiscal years ended June 24, 2001 and June 25, 2000 and the consolidated balance sheet data at June 30, 2002, June 24, 2001 and June 25, 2000 are derived from audited consolidated financial statements not included herein. All consolidated statement of operations and consolidated balance sheet data shown below are adjusted to reflect the acquisition of Nitres, effective May 1, 2000. This transaction was accounted for under the pooling of interests method. We acquired the business comprising the Cree Microwave segment in December 2000. This transaction was accounted for under the purchase method. We acquired the GaN substrate and epitaxy business of ATMI in the fourth quarter of 2004. This acquisition was accounted for under the purchase method. All share amounts have been restated to reflect our two-for-one stock splits effective July 26, 1999 and December 1, 2000.
Selected Consolidated Financial Data
(In thousands, except per share data)
| Years Ended | ||||||||||||||||
June 27, 2004 | June 29, 2003 | June 30, 2002 | June 24, 2001 | June 25, 2000 | ||||||||||||
Statement of Operations Data: | ||||||||||||||||
Product revenue, net | $ | 279,923 | $ | 202,962 | $ | 136,230 | $ | 159,533 | $ | 96,742 | ||||||
Contract revenue, net | 26,947 | 26,860 | 19,204 | 17,694 | 11,820 | |||||||||||
Total revenue | 306,870 | 229,822 | 155,434 | 177,227 | 108,562 | |||||||||||
Net income (loss) | $ | 57,960 | $ | 34,901 | $ | (101,723 | ) | $ | 27,843 | $ | 30,520 | |||||
Net income (loss) per share, basic | $ | 0.78 | $ | 0.48 | $ | (1.40 | ) | $ | 0.39 | $ | 0.46 | |||||
Net income (loss) per share, diluted | $ | 0.77 | $ | 0.46 | $ | (1.40 | ) | $ | 0.37 | $ | 0.43 | |||||
Weighted average shares outstanding: | ||||||||||||||||
Basic | 74,008 | 73,196 | 72,718 | 72,243 | 65,930 | |||||||||||
Diluted | 75,745 | 75,303 | 72,718 | 75,735 | 70,434 | |||||||||||
| As of | ||||||||||||||||
June 27, 2004 | June 29, 2003 | June 30, 2002 | June 24, 2001 | June 25, 2000 | ||||||||||||
Balance Sheet Data: | ||||||||||||||||
Working capital | $ | 189,911 | $ | 181,063 | $ | 151,851 | $ | 244,178 | $ | 265,957 | ||||||
Total assets | 628,000 | 563,694 | 504,195 | 615,123 | 486,202 | |||||||||||
Long-term obligations | — | — | — | — | — | |||||||||||
Shareholders’ equity | $ | 579,132 | $ | 535,371 | $ | 482,104 | $ | 589,097 | $ | 463,142 | ||||||
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation
Business Overview
We develop and manufacture semiconductor materials and electronic devices made from SiC, GaN, silicon and related compounds. The majority of our products are currently produced in our factory in Durham, North Carolina. We derive the largest portion of our revenue from the sale of blue, green and near UV LED chips. We currently offer LED chips at three brightness levels:
| • | high-brightness blue, traffic green, true green and near UV products, which include our MegaBright®, XBright® and XThin chips and our XB900 and XB500 power chip devices; |
| • | mid-brightness blue, traffic green and true green products, which include UltraBright™ and SuperBright™ devices; and |
Our LED chips are packaged by our customers and used by manufacturers as a lighting source for mobile appliances such as cell phones, automotive dashboard lighting, indicator lamps, miniature white lights, indoor and outdoor full color displays, traffic signals and other lighting applications. Some of our customers package our blue LEDs with a phosphor coating to create white LEDs. In July 2004, we released a family of new high power packaged LEDs called our XLamp products, that are designed to compete with conventional lighting technology for certain specialty lighting applications. We currently are marketing these products for use in architectural lighting, appliance lighting, channel letters and reading lamps and target that future versions of XLamp will be used in emerging applications such as automotive headlamps and backlighting for large format LCD screens. LED products represented 78% of our revenue in fiscal 2004 and 75% in fiscal 2003.
We also derive revenue from the sale of semiconductor wafers and epitaxy products made from SiC and GaN that our customers use for manufacturing LEDs and power devices or for research and development. Sales of SiC and GaN wafer and epitaxy products represented 7% of our revenue in fiscal 2004 and 9% of our revenue in fiscal 2003. We also sell SiC materials in bulk crystal form to C&C for use in gemstones. Sales of SiC crystals for gemstones represented 2% of our revenue in fiscal 2004 and 3% of our revenue in fiscal 2003. Our other products include SiC-based power and RF devices. We received 1% of our revenue in fiscal 2004 and less than 1% of total revenue in fiscal 2003 from sales of power devices or SiC-based RF devices.
Through our Cree Microwave segment, based in Sunnyvale, California, we also develop and manufacture RF power transistors and modules using silicon technology. During fiscal 2004 and fiscal 2003, approximately 3% and 1%, respectively, of our revenue came from the sale of RF devices from our Cree Microwave segment. These RF power transistors are a key semiconductor component for power amplifiers that are used in base stations to boost the power of a signal so that it can reach a wireless phone or other device within a designated geography.
The balance of our revenue, 9% for fiscal 2004 and 12% for fiscal 2003, is derived from contract research funding. Under various programs, U.S. Government entities assist us in the development of new technology by funding our research and development efforts. Contract revenue includes funding for 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, we report direct costs as research and development expenses with related reimbursements recorded as an offset to those expenses.
Fiscal 2004 Overview
We reported our highest annual revenue and earnings in fiscal 2004 primarily due to customer demand for our LED chip products for the mobile appliance, automotive and LED display markets. Our LED revenue and units sold increased 40% and 65%, respectively, in fiscal 2004 over the previous fiscal year. We saw the most significant increase in sales of our high-brightness LED chips, which we estimate were used mostly in the keypads and LCD backlights of mobile appliances, LED video screens and automobile dashboards. We introduced new higher performance chips during fiscal 2004, including the XThin family, which is targeted for white LED applications in mobile appliances. We also introduced the MegaBright Plus LED, which is designed to provide our customers with a higher level of brightness than our standard chip design. LED revenue also benefited from continued growth in sales of our original MegaBright product line, which was introduced in fiscal 2003. Our high-brightness products made up 49% and 35% of our LED revenue in fiscal 2004 and 2003, respectively.
Although total revenue for our mid-brightness LED chips increased in fiscal 2004, mid-brightness products represented 43% of LED revenue in fiscal 2004 as compared to 55% in fiscal 2003. Our increase in sales of mid-brightness LEDs primarily was due to chip products that are used for blue keypad backlighting applications, including the introduction in fiscal 2004 of our RazerThin LED chip. The RazerThin product offers a smaller and thinner design and a lower forward voltage than our standard chips. The thin design offers more flexibility for smaller phones, while the lower forward voltage extends the battery lifetime for mobile appliances.
Revenue for our standard brightness devices increased 23% in fiscal 2004 in comparison to fiscal 2003. These standard brightness devices are used for automotive and indicator light applications requiring high quality and a competitive price point. Standard brightness products were approximately 8% and 10% of our LED revenue in fiscal 2004 and 2003, respectively.
During fiscal 2004, SiC and GaN materials revenue increased 11% over the prior fiscal year due to a 17% increase in the average sales price received for our wafers and epitaxy products. The higher average sales price resulted from a change in our product mix. Additionally, materials revenue included $398,000 of GaN wafer and epitaxy sales, which is part of the business we acquired from ATMI in April 2004. Revenue from sales of SiC materials for use in gemstones was 32% lower in fiscal 2004 due to lower yields and reduced customer demand. SiC gemstone materials sales were 2% of our overall fiscal 2004 revenue. Sales of our SiC-based power devices and SiC RF and microwave devices combined increased 338% in fiscal 2004; however, these sales only made up 1% of our total revenue.
Cree Microwave’s revenue for silicon-based microwave products increased 176% in fiscal 2004. This growth was achieved due to new design wins for bipolar and LDMOS devices that service the wireless infrastructure and mil-aero markets.
Government contract revenue was flat in fiscal 2004 as compared to fiscal 2003, as increased cost-sharing provisions on existing and new contracts offset new awards realized during fiscal 2004. In May 2004, we were awarded two contracts through the Robert Morris Acquisition Center, providing for up to $25.8 million over five years. These contracts focus on the development of manufacturing technology for high-temperature, high-power SiC semiconductor material and power devices for use in electric traction drive power components and associated power conditioning and control electronics for the next-generation of combat vehicles. Additionally, fiscal 2004 revenues included $782,000 of fourth quarter contract sales from the business unit we acquired from ATMI in April 2004.
In fiscal 2005, we anticipate that selling blue LED chips for white LED lamps in mobile appliances and other applications will be an important growth opportunity. Based on trends in the industry, we believe that a greater percentage of cell phones and other handheld electronics will use white LEDs as a backlight for the keypad and for full color screens in fiscal 2005. We recently have introduced a family of XThin LED devices
that target these and other applications. We also are working to increase the brightness for the XThin family of products from 21 milliwatts to 27 milliwatts in the first half of fiscal 2005. If we are successful in developing brighter LEDs, we believe that we have an opportunity to gain market share in the color LCD backlight market for cell phones that use white LEDs. We believe that we currently have low penetration in this particular market because previously, when our customers packaged our LEDs as white LEDs, they were not as bright as some of the packaged white products sold by Nichia. Nichia currently has an efficient phosphor solution that makes its white conversion products brighter than our customers’ products. With our higher performance XThin chips, we target that white products packaged by some of our customers can be as bright or brighter than products sold by Nichia. Based on information available to us, we believe markets for our high-brightness LED applications, such as specialty lighting, displays, automotive and other applications, will continue to grow in fiscal 2005.
We also recently introduced our XLamp family of high-power packaged LED products in July 2004. We target these new products for specialty lighting markets, including channel letters, appliance lights and reading lights. As automotive headlight and large screen LED applications emerge, we intend to position our XLamp products to serve these markets.
We believe that our competitors around the world are increasing their capacity for the LED market and we factor these considerations into our expansion plans. Despite the evolving competitive pressures and additional capacity that is anticipated to come on-line in the next year from us and our competitors, we target that our business will increase if we are successful in developing higher performance, low cost LED chips. We believe our proprietary SiC platform and vertically integrated factory provides us with the opportunity to increase our brightness and lower our cost by scaling to larger sized wafers. Currently, some of our significant challenges for fiscal 2005 include increasing the output from our factory and expanding our facilities, migrating LED production to three-inch wafers and developing brighter XThin and other LED products. We are planning to invest $100-120 million during fiscal 2005 in capital equipment additions and increasing employee headcount to expand our factory output and to improve our yields. We plan to migrate the majority of our LED production from two-inch to three-inch SiC wafers over the next four quarters, which we target to greatly increase the number of LED chips per wafer and therefore lower our overall LED chip cost. However, the initial three-inch conversion may cause short-term yield challenges as we work to fully integrate the larger wafer size into production. We also target to increase the brightness for the XThin family of products in fiscal 2005, and we must work with our customers to get these and other products designed into key applications so that we can assist them to gain market share with these products.
Critical Accounting Policies
The following discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. In preparing our financial statements, we must make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of our financial statements. Critical accounting policies include those policies that are reflective of significant judgments and uncertainties, which potentially could produce materially different results under different assumptions and conditions. We believe that our critical accounting policies are limited to those described below.
Valuation of Long-Lived Assets, Intangible Assets and Goodwill. We have approximately $393.1 million of long-lived assets as of June 27, 2004, including approximately $293.2 million related to fixed assets and capitalized patents, $72.7 million in long-term investments held to maturity, $22.0 million in long-term marketable securities available for sale and $5.2 million of other long term assets, including net investments in privately held companies of $2.9 million and long-term deposits of $2.3 million. In addition to the original cost of these assets, their recorded value is impacted by a number of management estimates that are determined based on our judgment, including estimated useful lives, salvage values and, in 2002, impairment charges. In accordance with Statement of Financial Accounting Standards (SFAS) No. 144,
“Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS 144), we record impairment charges on long-lived assets used in operations when events and circumstances indicate that the assets have been impaired. In making these determinations, we utilize certain assumptions, including, but not limited to: (i) estimations of the fair market value of the assets, and (ii) estimations of future cash flows expected to be generated by these assets, which are based on additional assumptions such as asset utilization, length of service the asset will be used in our operations and estimated salvage values. For example, we recorded an impairment charge for long-lived assets of $790,000 for the three months ended June 27, 2004 for obsolete production equipment that was taken out of service and destroyed. During the second and third quarters of fiscal 2004, our Cree Microwave segment identified certain equipment that was written off because we determined the equipment would not be used and it was unable to sell the equipment to a third party. The total amount of this write-off was $173,000. We also recorded a $1.4 million impairment charge for the three months ended December 29, 2002, due to the election by management to discontinue a novel epitaxy reactor project. During fiscal 2002, we determined certain property and equipment was impaired under SFAS No.121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of”, which was the relevant accounting pronouncement at the time, and as a result, we recorded impairment charges of $19.0 million.
During the third quarter of fiscal 2002, we completed an impairment analysis of the intangible assets and goodwill related to the acquisition of Cree Microwave. This analysis was performed due to significant changes in business conditions at the operating segment. First, Cree Microwave amended its supply agreement with Spectrian effective March 31, 2002, which resulted in a significant reduction in quarterly revenue expectations. In addition, Cree Microwave’s outlook for acquiring additional customers in the near term weakened due to delays in the development of LDMOS8 technology, the overall deteriorating economic conditions and long product qualification cycles. Also, the principal products that Spectrian indicated it would consider purchasing from Cree Microwave in the future were not fully qualified and, subsequently not released to production at the time. As a result of this impairment analysis, we estimated that the future cash flows of the Cree Microwave business would not be sufficient to provide for recovery of the carrying value of its intangible assets and goodwill. Therefore, the remaining balance of intangible assets and goodwill of $76.5 million was deemed fully impaired and was written off in March 2002. In November 2002, we entered into an agreement terminating our supply contract with Spectrian, and, due to the changed circumstances, management performed an impairment analysis of the tangible assets at Cree Microwave as of June 27, 2004 and June 29, 2003 in accordance with SFAS 144. Based on estimations of the fair market value of the assets, and estimations of future cash flows, we determined that the estimated undiscounted cash flow exceeded the amount of the book value of the long-term tangible assets. As a result, no additional Cree Microwave assets were deemed impaired or written down at that time.
We also review our capitalized patent portfolio and record impairment charges when circumstances warrant, such as when issued patents have been abandoned or patent applications are no longer being pursued. As of June 27, 2004, June 29, 2003 and June 30, 2002, we had no impairments of our patents.
Accounting for Non-Marketable and Marketable Equity Securities. From time to time, we make strategic investments in the equity securities of privately held companies. Since we do not have the ability to exercise significant influence over the operations of these companies, these investment balances are carried at cost and accounted for using the cost method of accounting. The shares of stock we received in these investments are not presently publicly traded and there is no other established market value for these securities. We have a policy in place to estimate the fair value of these investments on a regular basis to evaluate the carrying value of such investments. This policy includes, but is not limited to, reviewing each company’s cash position, estimates of the company’s market capitalization based on recent financing transactions, its earnings and revenue outlook, operational performance, management or ownership changes and competition. The evaluation process is based on information that we are provided by these privately held companies. Since these companies are not subject to the same disclosure regulations as U.S. public companies, the basis for these evaluations is subject to the timing and the accuracy of the data received from these companies. If the carrying value of an investment is determined to be an amount in excess of our
estimate of fair value, and we have determined that the decline is other-than-temporary, it is our policy to record a write-down of the investment. This write-down is estimated based on the information described above, and it is recorded as an investment loss on our consolidated statements of operations. During fiscal 2002, we recorded a write-down on these investments of $20.4 million, representing our estimate of other-than-temporary declines in value based on a review of these factors described above. Estimating the fair value of non-marketable investments in early-stage technology companies is inherently subjective and may contribute to significant volatility in our reported results of operations. There were no adjustments made to investment losses on our consolidated statements of operations during fiscal 2004 and 2003 relating to our investments in privately held companies. In June 2004, the common stock of one of the privately held companies in which we held an investment, Color Kinetics Incorporated (Color Kinetics), became publicly traded. As a result, we reclassified our investment, valued at cost at $12.7 million, from other long-term assets to a long-term marketable security on our consolidated balance sheet.
From time to time, we evaluate strategic opportunities and potential investments in complementary businesses, and as a result we may invest in marketable equity securities. We classify marketable securities that are not trading or held-to-maturity securities as available-for-sale. We carry these investments at fair value, based on quoted market prices, and unrealized gains and losses, net of taxes, are included in accumulated other comprehensive income, which is reflected as a separate component of shareholders’ equity on the consolidated balance sheet. Realized gains and losses are recognized when realized upon sale or disposition. Declines in value that are deemed to be other-than-temporary in accordance with SFAS No. 115, “Accounting for Investments in Certain Debt and Equity Securities,” (SFAS 115) are recorded as an investment loss on our consolidated statements of operations. We have a policy in place to review our equity holdings on a periodic basis to evaluate whether or not each security has experienced an other-than-temporary decline in fair value. Our policy requires, among other things, a review of each company’s cash position, stock price performance, liquidity, ability to raise capital and any management changes. Based on this review, if we believe that an other-than-temporary decline exists in the value of one of our marketable equity securities, it is our policy to write-down these equity investments to the market value. In addition, we record a write-down for investments in publicly held companies for an other-than-temporary impairment any time the market price of the security has remained below our average cost for two consecutive fiscal quarters, unless strong positive evidence exists that makes it clear that an other-than-temporary write-down would be inappropriate under the guidance of SFAS 115. Any related write-down would then be recorded as an investment loss on our consolidated statements of operations.
During the fourth quarter of fiscal 2004, the common stock of Color Kinetics became publicly traded and as a result, we have accounted for this investment as a marketable security that is available-for-sale under SFAS 115 as of June 27, 2004. Our investment in Color Kinetics is valued at $22.0 million, which represents the $12.7 million cost, plus a $9.3 million unrealized gain in the security based on the closing share price on June 25, 2004. As an available-for-sale security, any unrealized gain or loss is accounted for as a comprehensive income item in the equity section of the consolidated balance sheet and on the consolidated statement of shareholders’ equity and is not recorded through earnings. At June 29, 2003, we held no marketable equity securities. During the second quarter of fiscal 2003, we sold our entire position in two publicly traded companies. We sold 356,000 common shares in Microvision, Inc. (Microvision) for $1.8 million, with a net loss on the sale of $36,000 recognized during the second quarter of fiscal 2003. We also sold 691,000 common shares in Emcore Corporation (Emcore) for $2.1 million, with a net loss on the sale of $2.0 million recognized during the second quarter of fiscal 2003. During fiscal 2002, we recorded an other-than-temporary investment loss of $22.0 million related to available-for-sale marketable securities based primarily on sustained reductions in stock price performance for our investments in Microvision and Emcore.
Inventories. Inventories are stated at the lower of cost or market, cost being determined using the first-in, first-out method for finished goods and work in process accounts and the average cost method is used for raw materials for the Cree segment. The Cree Microwave segment uses a standard cost inventory costing method. We evaluate our ending inventories for excess quantities, impairment of value and obsolescence on
a monthly basis. This evaluation includes analysis of sales levels by product and projections of future demand based upon input received from our customers, sales team and management estimates. We reserve for inventories on hand that are greater than twelve months old, unless there is an identified need for the inventory. In addition, we write-off inventories that are considered obsolete based upon changes in customer demand, manufacturing process changes that result in existing inventory obsolescence or new product introductions, which eliminate demand for existing products. Remaining inventory balances are adjusted to approximate the lower of our manufacturing cost or market value. If future demand or market conditions are less favorable than our estimates, additional inventory write-downs may be required and would increase cost of revenue in the period the revision is made.
During fiscal 2004, we recorded a $258,000 reserve for slow moving inventory in Cree Microwave and a $252,000 reserve for slow moving inventory in the Cree segment. In fiscal 2003, as a result of the termination of the supply agreement with Spectrian, we recorded a $1.3 million reserve in the Cree Microwave segment for inventory that was slow moving or specifically identified to be sold to Spectrian, including customized parts. We also reserved an additional $522,000 of other slow moving inventory at Cree Microwave. This inventory charge was taken because of change in demand from Spectrian, as Spectrian initially indicated that it would have strong demand for a type of transistor and later determined that the demand had significantly weakened. During the three months ended December 29, 2002, we reserved $784,000 in the Cree segment for slow moving LED and wafer inventory. In the third quarter of fiscal 2002, we recorded a $4.5 million reserve at our Cree Microwave segment for non-LDMOS and older LDMOS devices as a result of contract negotiations with Spectrian that identified these devices as obsolete. All of these adjustments were recorded through cost of revenue. In addition, we also wrote off $1.0 million of costs associated with initial XBright products and $417,000 of costs associated with LDMOS devices as research and development expenses in the first quarter of fiscal 2003. The $1.0 million write-down was attributable to early generation XBright devices that were later determined to be non-saleable because of design deficiencies. The $417,000 write-down was associated with LDMOS products that were on hand and determined not to be saleable for similar reasons. In both cases, our customers had initially accepted the devices and we produced initial amounts of the product. Based on history with our customers, normally once products are accepted, they are ultimately qualified. Thus we concluded that capitalizing the cost of these items as inventory was appropriate. However, in both cases, our customers later rejected the products. Therefore, we wrote off the entire amount of inventory as research and development expenses, because the materials were never qualified as completed devices or ultimately sold to customers. In the case of the LED devices, our customers returned all products shipped of that technology.
Revenue Recognition and Accounts Receivable. Revenue on product sales is recognized when persuasive evidence of a contract exists, such as when a purchase order or contract is received from the customer, the price is fixed, title of the goods has transferred and there is a reasonable assurance of collection of the sales proceeds. We obtain written purchase authorizations from our customers for a specified amount of product at a specified price and consider delivery to have occurred at the time of shipment. The majority of our products have shipping terms that are free on board (FOB) or free carrier alongside (FCA) shipping point, which means that we fulfill the obligation to deliver when the goods are handed over and into the charge of the carrier at our shipping dock. This means that the buyer bears all costs and risks of loss of or damage to the goods from that point. The difference between FOB and FCA is that under FCA terms, the customer designates a shipping carrier of choice to be used. In certain cases, we ship our product cost insurance and freight (CIF). Under this arrangement, revenue is recognized under FOB shipping point terms, however, we are responsible for the cost of insurance to transport the product as well as the cost to ship the product. For all of our sales other than those with CIF terms, we invoice our customers only for shipping costs necessary to physically move the product from our place of business to the customer’s location. The costs primarily consist of overnight shipping charges. We incur the direct shipping costs on behalf of the customer and invoice the customer to obtain direct reimbursement for such costs. We currently account for our shipping costs by recording the amount of freight that is invoiced to customers as revenue, with the corresponding cost recorded as cost of revenue. In fiscal 2004, we recognized $117,000 as revenue for shipping and handling costs. In fiscal years 2003 and 2002, we accounted for such costs as a cost of revenue
with the reimbursement of these costs reflected as a direct offset and reduction of cost of revenue. Such shipping costs were not material in those fiscal years. Except for consigned inventory, revenue is recognized from our customers at shipment. If inventory is maintained at a consigned location, revenue is recognized when our customer pulls product for its use and the title of the goods is transferred to the customer. We provide our customers with limited rights of return for non-conforming shipments and warranty claims for up to 36 months for Cree Microwave products. We accrue estimated warranty expense as a cost of revenue. We also record a reserve for estimated sales returns as a reduction of revenue at the time of revenue recognition. Significant judgments and estimates made by management are used in connection with establishing the allowance for sales returns. Material differences may result in the amount and timing of our revenue for any period if management made different judgments or utilized different estimates. The allowance for sales returns at June 27, 2004 was $798,000. For two customers, Sumitomo and OSRAM, we defer revenue equal to levels specified in contractual arrangements. This deferred revenue, which predominantly arises under the Sumitomo contract, amounted to $8.4 million and $5.5 million as of June 27, 2004 and June 29, 2003, respectively. Please see the discussion in Item 1 of this report under “Distributorship Agreement with Sumitomo Corporation” for further information.
Revenue from government contracts and certain private entities is recorded on the proportional performance method as contract expenses are incurred. Contract revenue represents reimbursement by various U.S. Government entities to aid in the development of new technology. The applicable contracts generally provide that we may elect to retain ownership of inventions made in performing the work, subject to a non-exclusive license retained by the government to practice the inventions for government purposes. 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 relating to the activities to be performed by us under the contract are divided between the U.S. Government and us based on the terms of the contract. The government’s cost share is then paid to us. Activities performed under these arrangements include research regarding SiC and Group III nitride materials and devices. The contracts typically require the submission of a written report that documents the results of such research, as well as some material deliverables.
The revenue and expense classification for contract activities is based on the nature of the contract. For contracts where we anticipate 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 we anticipate that direct costs of the activities subject to the contract will exceed amounts to be funded over the life of the contract, costs are reported as research and development expenses and related funding is reported as an offset of those expenses.
Accruals for Liabilities and Warranties. We make estimates for the amount of costs that have been incurred but not yet billed for general services, including legal and accounting fees, costs pertaining to our self-funded medical insurance, warranty costs and other expenses. Many of these expenses are estimated based on historical experience or information gained directly from the service providers.
Valuation of Deferred Tax Assets and Liabilities. As of June 27, 2004, we had $2.6 million recorded as a short-term deferred tax asset and $3.9 million as a long-term deferred tax liability. This asset was recorded as a result of tax benefits associated with write-downs and reserves recorded for accounts receivable and inventory reserves that are deferred for tax purposes. The liability provides amounts due as a result of the timing difference for depreciation between book and tax purposes being offset by deferred tax benefits associated with write-downs taken for goodwill and other intangible assets, other-than-temporary charges taken on our investments and other write-downs taken in prior years. We have a reserve for taxes that may become payable in the future included in deferred tax liabilities. A valuation allowance has been established on capital loss carryforwards and unrealized losses on certain securities as we believe that it is more likely than not that the tax benefits of the items will not be realized.
It is our policy to establish reserves for taxes that may become payable in future years, and we currently have a reserve of $8.5 million for such deferred tax liabilities. We establish the reserves based upon management’s assessment of exposure associated with the tax return deduction. We analyze the tax reserves at least annually and make adjustments as events occur that warrant adjustment to the reserve. For example, if the statutory period for assessing tax on a given tax return lapses, we reduce the reserve associated with that period. Similarly, if tax authorities provide administrative guidance or a decision is rendered in the courts, we make appropriate adjustments to our tax reserve. The tax reserve was unchanged in fiscal 2004. The tax reserve increased by $3.0 million for the year ended June 29, 2003.
The above listing is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by generally accepted accounting principles, with no need for management’s judgment in its application. There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result. See our audited consolidated financial statements and notes thereto included in this Annual Report on Form 10-K which contain a discussion of our accounting policies and other disclosures required by accounting principles generally accepted in the United States.
Results of Operations
The following table shows our consolidated statements of operations data expressed as a percentage of total revenue for the periods indicated:
| Years Ended | |||||||||
| June 27, 2004 | June 29, 2003 | June 30, 2002 | |||||||
Revenue: | |||||||||
Product revenue, net | 91.2 | % | 88.3 | % | 87.6 | % | |||
Contract revenue, net | 8.8 | 11.7 | 12.4 | ||||||
Total revenue | 100.0 | 100.0 | 100.0 | ||||||
Cost of Revenue: | |||||||||
Product revenue, net | 44.4 | 47.7 | 50.3 | ||||||
Contract revenue, net | 7.2 | 9.1 | 8.9 | ||||||
Total cost of revenue | 51.6 | 56.8 | 59.2 | ||||||
Gross margin | 48.4 | 43.2 | 40.8 | ||||||
Operating expenses: | |||||||||
Research and development | 12.0 | 13.6 | 18.0 | ||||||
Sales, general and administrative | 10.3 | 11.5 | 16.5 | ||||||
Intangible asset amortization | — | — | 4.4 | ||||||
Impairment of goodwill | — | — | 49.2 | ||||||
Loss on disposal of fixed assets | 0.4 | 0.7 | 12.2 | ||||||
Other expense | — | 0.1 | 1.2 | ||||||
Total operating expense | 22.7 | 25.9 | 101.5 | ||||||
(Gain) on termination of supply agreement | — | (2.2 | ) | — | |||||
Income (loss) from operations | 25.7 | 19.5 | (60.7 | ) | |||||
Non-operating income (expense): | |||||||||
(Loss) gain on investments in marketable securities | — | (0.9 | ) | (13.8 | ) | ||||
(Loss) on long term investments | — | — | (13.1 | ) | |||||
Other non-operating income | 0.3 | 0.1 | — | ||||||
Interest income, net | 1.2 | 1.8 | 3.7 | ||||||
Income (loss) before income taxes | 27.2 | 20.5 | (83.9 | ) | |||||
Income tax expense (benefit) | 8.3 | 5.3 | (18.5 | ) | |||||
Net income (loss) | 18.9 | % | 15.2 | % | (65.4 | )% | |||
Comparison of Fiscal Years Ended June 27, 2004 and June 29, 2003
Revenue. Revenue increased 34% to $306.9 million in fiscal 2004 from $229.8 million in fiscal 2003. Higher revenue was primarily attributable to greater product revenue, which increased 38% to $279.9 million in fiscal 2004 from $203.0 million in fiscal 2003. Much of the increase in revenue resulted from significantly higher unit shipments of our LED products due to stronger demand from our customers primarily for mobile appliance, display and automotive applications. LED revenue was $241.3 million and $172.3 million for fiscal 2004 and 2003, respectively. The most significant increase in revenue in fiscal 2004 came from sales to our Japanese distributor, Sumitomo. Revenue from sales to Sumitomo increased by 86% or $47.6 million in fiscal 2004 as compared to fiscal 2003 due to strong demand among Japanese manufacturers for our products for mobile appliance, displays, automotive, consumer products and indicator light applications. During fiscal 2004, four of our top ten end customers were located in Japan. The sales to these companies were reported in our revenue from Sumitomo. For fiscal year 2004, Sumitomo’s advance purchase commitment was approximately $100 million, and revenue recognized from Sumitomo was $101.8 million. For fiscal year 2005, Sumitomo’s advance purchase commitment is approximately $160 million; however, Sumitomo’s purchase commitment is subject to end customer demand and other terms and conditions.
Revenue from sales to Agilent increased by 71% or $16.5 million, in fiscal 2004 over the prior fiscal year. Much of this increased business resulted from demand for our products to be used in mobile appliance keypads, displays and other consumer product applications. Revenue from sales to OSRAM declined by 14%, or $6.5 million in fiscal 2004 due to changes in their customer’s demand and other factors. During fiscal 2004, we continued to see an increase in business from a number of Asian LED packagers who serve a variety of mobile appliance and other consumer applications. With respect to our Cree Microwave segment, sales to Remec increased $2.7 million, or 460%, for fiscal 2004 as compared to fiscal 2003. A portion of our sales to Remec in fiscal 2004 was for legacy Spectrian designs under “last time buy” arrangements that may not continue after the first quarter of fiscal 2005.
Two of our customer arrangements provide for product exchanges and reimbursement of certain sales costs. For these customers, we defer revenue equal to the level specified in these contractual arrangements and recognize the related revenue less any claims made against the reserves when the customers’ exchange rights expire and the deferred revenue reserves are released. The reserve expires no later than two quarters from the date of the original sale. In connection with our distributorship agreement with Sumitomo, such deferred revenue amounted to $7.9 million and $5.3 million as of June 27, 2004 and June 29, 2003, respectively. In connection with our purchase agreement with OSRAM, such deferred revenue amounted to $471,000 and zero as of June 27, 2004 and June 29, 2003, respectively.
Our LED revenue increased 40% in fiscal 2004 as compared to fiscal 2003 and made up 78% of our total revenue in fiscal 2004. Our blended average LED sales price declined 16% for the twelve months ended June 2004 compared to the prior fiscal year. Our average sales price for LEDs was lower due to increasing price competitiveness in the marketplace, which was somewhat offset by a change in the product mix of our sales toward higher brightness products that have a higher average sales price. For fiscal 2004, our LED chip volume increased 65% over prior year shipments. Sales of our high-brightness LED products more than doubled in fiscal 2004 over fiscal 2003 as our customers designed them into more LED packages for white light applications such as for keypads in mobile appliances, LCD backlights and camera flashes. High-brightness products also are used for automotive, displays and other illumination applications. These products include our XThin, XBright, MegaBright and power chip LED products. The majority of these products were introduced in the last two fiscal years.
Revenue from our mid-brightness products, including our UltraBright and SuperBright chips, also increased in fiscal 2004 as compared to fiscal 2003 due to new designs for keypads in mobile appliances, as well as automotive applications, displays and consumer product applications. In fiscal 2004, we introduced the RazerThin and UT230 chips for mobile appliances that offer a smaller and thinner design and a lower
forward voltage than our standard chips. The thin design offers more flexibility for smaller phones, while the lower forward voltage extends the battery lifetime for mobile appliances. Shipments of our standard brightness products were slightly higher in fiscal 2004 in comparison to the prior fiscal year due to stable demand for automotive and indicator light applications.
SiC wafer and epitaxy revenue was $21.7 million and $19.5 million for fiscal 2004 and 2003, respectively. Wafer revenue increased 11% over the prior year due to increased sales to corporate and university research customers for wafers with epitaxy layers. Wafer units declined 5% while the average sales price increased 17% during fiscal 2004. Additionally, fiscal 2004 revenues included $398,000 of fourth quarter GaN product sales from the unit we acquired from ATMI in April 2004. Wafer revenue made up 7% of our total revenue in fiscal 2004.
SiC materials revenue for gemstone use was $5.0 million and $7.4 million for fiscal 2004 and 2003, respectively. Revenue from sales of our SiC materials for use in gemstones decreased 32% during fiscal 2004 as compared to fiscal 2003 due to a combination of lower demand and lower overall product yields. We achieved improvements in our product yield in the second half of fiscal 2004. Revenue from gemstone materials was 2% of our total sales for fiscal 2004.
Revenue from Cree Microwave products was $7.7 million and $2.8 million for fiscal 2004 and 2003, respectively. Cree Microwave revenue made up 3% of our total revenue for fiscal 2004. Revenue from these products increased 176% during fiscal 2004 over fiscal 2003 due to incremental orders from new customers for our newer LDMOS devices designed for wireless infrastructure and mil-aero markets. In addition, Cree Microwave’s sales to Remec were $2.7 million in fiscal 2004 compared to $587,000 in fiscal 2003. Some of these sales to Remec were for legacy Spectrian applications under “last time buy” arrangements that may not continue after the first quarter of fiscal 2005. During fiscal 2004, we had better success in gaining new customers for our Cree Microwave products as the economic environment for wireless infrastructure spending improved.
Product sales mix for our LDMOS devices made up 55% of microwave revenue for fiscal 2004 and fiscal 2003, respectively. Revenue attributable to bipolar devices was 41% and 23% for fiscal 2004 and 2003, respectively. Engineering service revenue decreased to 4% in fiscal 2004 from 22% in fiscal 2003 due to the prior year’s work achieving design wins and generating product sale growth in fiscal 2004. Overall, our average sales price for Cree Microwave products decreased 14% compared to the prior fiscal year while our unit shipments increased 222%.
Contract revenue was 9% of total revenue for fiscal 2004. Contract revenue received from U.S. Government agencies increased by less than 1% during fiscal 2004 compared to fiscal 2003, as we continued to perform under multi-year contract awards that we received at the end of fiscal 2002 and the beginning of fiscal 2003. In May 2004, we were awarded two contracts through the Robert Morris Acquisition Center, providing for up to $25.8 million over five years. These contracts focus on the development of manufacturing technology for high-temperature high-power SiC semiconductor material and power devices for use in electric traction drive power components and associated power conditioning and control electronics for the next-generation of combat vehicles. In fiscal 2004, we recorded $512,000 of revenue associated with these two new contracts. Additionally, fiscal 2004 revenues included $782,000 of fourth quarter contract sales from the business unit we acquired from ATMI in April 2004.
We target contract revenue to increase slightly during fiscal 2005 as a result of the award of additional funding under existing contracts and the award of the new contracts in the fourth quarter of fiscal 2004.
Gross Profit. Gross profit increased 50% to $148.4 million in fiscal 2004 from $99.2 million in fiscal 2003. Compared to the prior fiscal year, gross margins increased from 43% to 48% of revenue. In fiscal 2004, our blended average sales prices declined 16% while our blended average LED costs decreased 22%
compared to fiscal 2003. Therefore, gross margins improved in fiscal 2004 primarily because of these significantly lower costs for LEDs. LED costs declined faster than blended average prices due to improved yields, greater scale and throughput and other process improvements.
Our wafer sales also were more profitable in fiscal 2004 than fiscal 2003 due to a higher percentage of wafers sold with epitaxy. Wafer costs for our SiC materials sales were 9% lower in fiscal 2004 than fiscal 2003, due to the shift in product mix and a $169,000 reduction in wafer inventory reserves. Contract margins declined from 22% in fiscal 2003 to 17% in fiscal 2004 due to a higher percentage of cost-share work performed during the year.
Our Cree Microwave segment reported negative gross profit of $2.9 million and $9.3 million for fiscal 2004 and fiscal 2003, respectively. Higher revenue in fiscal 2004 contributed to reduce the segment’s negative gross profit. Factory throughput due to increased sales volume also has improved our cost per unit. During fiscal 2004, Cree Microwave’s gross margin also benefited from adjustments totaling $398,000 for a revision of standard costs and a prior year reversal of the warranty expense accrual.
In fiscal 2004, we increased our allowance for sales returns by $154,000 due to business growth, and the Cree segment established a $507,000 reserve for potential future product warranty claims, which lowered gross profit by $661,000. In fiscal 2003, gross profit included a $1.8 million write-down of inventory at Cree Microwave due to the termination of the supply agreement with Spectrian and other slow moving products. We also recorded a $1.0 million increase to inventory reserves for LED and wafer products in fiscal 2003. In addition, reserves for allowance for sales returns were increased by $189,000 in fiscal 2003.
Research and Development. Research and development expenses increased 18% in fiscal 2004 to $36.9 million from $31.2 million in fiscal 2003. The increase in research and development spending supported our three-inch process development, our thin chip products (XThin, RazerThin and UT230), X-class and power chip LEDs (XB900 and XB500), our XLamp™ high power packaged LEDs and other high brightness LED research programs. In addition, we funded ongoing development for higher power/higher linearity RF and microwave devices, near UV laser devices and higher power diodes/switches. During fiscal 2003, we included a $1.0 million charge for costs associated with initial XBright chips that were made in previous quarters and were never fully qualified by customers. From time to time, our customers and companies that we invest in participate in research and development funding for specific programs. We record this customer and third party funding as an offset against research and development expenses. Customers and third parties in whom we invested funded zero and $500,000 in fiscal 2004 and fiscal 2003, respectively. The funding we received in fiscal 2003 came from an affiliate of Lighthouse, in which we hold a private company equity investment. At this time, we do not expect funding for research and development during fiscal 2005 from this or any other customer or third party in which we invested.
Sales, General and Administrative. Sales, general and administrative expenses increased 20% in fiscal 2004 to $31.7 million from $26.3 million in fiscal 2003. The increase in expenses primarily resulted from the increasing general expense associated with the growth of our business and a higher level of funding for our employee profit sharing program. During fiscal 2004, we incurred approximately $800,000 of incremental legal and other costs associated with litigation and costs of a special committee investigation conducted by the Board of Directors. Fiscal 2003 includes legal costs associated with the patent infringement case with Nichia, which was settled in November 2002.
Loss on Disposal of Fixed Assets. Loss on the disposal of fixed assets decreased 35% to $1.0 million in fiscal 2004 from $1.6 million recorded in fiscal 2003. During fiscal 2004, we identified certain equipment that was obsolete and no longer in service. We wrote-off the value of these assets and disposed of them. During fiscal 2003, we recorded a $1.4 million write-down for fixed assets associated with a novel epitaxy equipment project that we discontinued before the vendor delivered the equipment to us. The amount represented a deposit that we paid for the equipment. We also disposed of $200,000 of other assets during fiscal 2003.
Severance Charges. In the first quarter of fiscal 2003, we incurred $400,000 of severance charges at our Cree Microwave segment for employees who were laid off and received their severance payments during the same period.
Gain on Termination of Supply Agreement. In the second quarter of fiscal 2003, we received a $5.0 million one-time payment from Spectrian associated with the termination of the supply agreement between Cree Microwave and Spectrian. We did not receive any similar payments in fiscal 2004.
Loss on Investments in Marketable Securities. We recorded a $2.1 million loss in fiscal 2003 related to marketable securities that we sold during the second quarter of fiscal 2003. There were no realized gains or losses on investments in marketable securities recorded in fiscal 2004.
Other Non-operating Income. Other non-operating income increased 128% to $1.0 million in fiscal 2004 from $442,000 in fiscal 2003. During fiscal 2004, we recorded non-operating income for a contractually agreed upon payment from one of our customers for a foreign currency translation adjustment included in the applicable sales contract. During the third quarter of fiscal 2004, we recognized a one-time technology license fee. In the fourth quarter of fiscal 2003, we recorded and received a contractually agreed upon payment from one of our customers for a foreign currency translation adjustment included in the applicable sales contract.
Interest Income, Net. Interest income, net decreased 10% to $3.7 million in fiscal 2004 from $4.1 million in fiscal 2003. The reduction resulted primarily from lower interest rates available for our liquid cash and securities-held-to-maturity over the applicable period.
Income Tax Expense. Income tax expense for fiscal 2004 was $25.6 million compared to $12.3 million in fiscal 2003, an increase of 109%. The increase resulted mainly from our greater pre-tax profitability in fiscal 2004, which increased 77% over fiscal 2003. In addition, our effective income tax rate increased to 30.7% for fiscal 2004 compared to a 26% rate for fiscal 2003. The fiscal 2004 effective rate was higher than the fiscal 2003 effective tax rate as we benefited from tax credits and other permanent tax differences in fiscal 2003. Historically, our reported taxable income has been significantly lower than income reported for financial reporting purposes. The primary reasons for this difference are the timing differences for depreciation, stock option deductions for tax purposes and other tax planning strategies which are net of impairment charges expensed for financial accounting purposes that are not tax deductible.
Comparison of Fiscal Years Ended June 29, 2003 and June 30, 2002
Revenue. Revenue increased 48% to $229.8 million in fiscal 2003 from $155.4 million in fiscal 2002. Higher revenue was primarily attributable to greater product revenue, which increased 49% to $203.0 million in fiscal 2003 from $136.2 million in fiscal 2002. Much of the increase in revenue resulted from significantly higher unit shipments of our LED products due to stronger demand from our customers primarily for mobile appliance and automotive applications. LED revenue was $172.3 million and $90.5 million, for fiscal 2003 and 2002, respectively. The most significant increase in revenue in fiscal 2003 came from sales to our Japanese distributor, Sumitomo. Revenue from sales to Sumitomo increased by 153% or $33.3 million in fiscal 2003 as compared to fiscal 2002 due to strong demand among Japanese manufacturers for our products for mobile appliance, automotive, consumer products and indicator light applications. Revenue from sales to OSRAM and Agilent also increased by 63% or $19.4 million and 64% or $8.9 million, respectively, in fiscal 2003 over the prior year comparative period. Much of this increased business was caused by demand for our products used in mobile appliances as well as automotive and other applications. During fiscal 2003, we also noted an increase in business from several Asian LED packagers as our customer base became more diversified. The only significant decline in revenue came from Spectrian, which was acquired by Remec in December 2002, where revenue from sales declined 96% or $23.5 million in fiscal 2003 as compared to fiscal 2002. Spectrian or Remec purchases silicon RF transistors from our Cree Microwave segment.
Certain of our customer arrangements provide for product exchanges and reimbursement of certain sales costs. For Sumitomo, we defer revenue equal to the level specified in these contractual arrangements and recognize the related revenue less any claims made against the reserves when the customers’ exchange rights expire and the deferred revenue reserves are released. The reserve expires no later than two quarters from the date of the original sale. Deferred revenue amounted to $5.3 million and $741,000 as of June 29, 2003 and June 30, 2002, respectively.
Our LED revenue increased 90% in fiscal 2003 as compared to fiscal 2002 and made up 75% of our total revenue in fiscal 2003. Our average LED sales price declined 9% for the twelve months ended June 2003 compared to the prior year. Our average sales price for LEDs also was lower due to increasing price competitiveness in the marketplace and a change in the product mix of our sales to customers. For fiscal 2003, our LED chip volume increased 111% over prior year shipments. The most significant increase to revenue occurred in our mid-brightness range of LED products. Our lower range mid-brightness LED products have been incorporated into new designs in the keypads of several mobile phone models that feature a blue color as well as blue LEDs that are used as the backlight for blue displays. In addition, these LED chips are now used in other products targeting gaming equipment, consumer products and office automation applications. The introduction of the MegaBright blue, green and UV products in fiscal 2002 also generated new design wins for our customers. MegaBright’s product performance in fiscal 2003 generated new opportunities in other markets, particularly mobile appliance applications for blue and white LED backlight designs. Blue and white LEDs replaced a portion of the yellow-green LEDs that have traditionally backlit mobile handsets as more handsets began offering blue backlit keypads and full color displays backlit by white LEDs. The MegaBright product line also was used in new automotive designs from both European and Asian manufacturers for the 2003 model year.
During fiscal 2002, we introduced our XBright family of LEDs, including blue, green and near UV devices. These products offer a higher brightness than our MegaBright products. We completed the introduction of these devices in the second half of fiscal 2002; however, we continued to work with customers to optimize our chip design for use in their packages. Shipments of our standard brightness products were flat in fiscal 2003 in comparison to the prior year due to stable demand for automotive and indicator light applications.
SiC wafer revenue was $19.5 million and $17.5 million, for fiscal 2003 and 2002, respectively. Wafer revenue increased 11% over the prior year due to greater sales to corporate and university research customers. Wafer units declined 6% while the average sales price increased 19% during fiscal 2003, due to a lower mix of shipments to OSRAM, which uses wafers in commercial production. Since OSRAM uses the wafers in commercial high volume production, it receives volume discounts on its purchases; therefore, these sales have a lower average sales price. We also sold more wafers with epitaxial layers during fiscal 2003 to customers such as Infineon Technologies (Infineon), which contributed to a higher average sales price. Wafer revenue made up 9% of our total revenue in fiscal 2003.
Revenue from sales of our SiC materials for use in gemstones increased 190% during fiscal 2003 as compared to fiscal 2002 as C&C increased its orders to us. SiC materials revenue from materials sold for gemstone use was $7.4 million and $2.6 million for fiscal 2003 and 2002, respectively. Revenue from gemstone materials was 3% of our total sales for fiscal 2003.
Revenue from silicon-based microwave products was $3.0 million and $25.1 million, for fiscal 2003 and 2002, respectively. Microwave revenue made up 1% of our total revenue for fiscal 2003. Revenue from these products decreased 88% to $3.0 million in fiscal 2003 from $24.8 million in fiscal 2002. The decrease in revenue resulted from the termination of the supply agreement with Spectrian in November 2002. Approximately 99% of Cree Microwave revenues were derived from shipments to Spectrian in fiscal 2002. Prior to the termination of the supply agreement, Spectrian had reduced its purchase obligations beginning in March 2002 because our LDMOS8 products had not been qualified. We amended our agreement with Spectrian in March 2002, which resulted in Spectrian ordering fewer products each quarter until the
agreement was terminated in November 2002. We also had little success in gaining new customers in fiscal 2003 due to the poor economic environment for wireless infrastructure spending. Our LDMOS8 products were released to production in November 2002, but these products did not contribute significantly to revenue since design cycles can be 12 to 18 months for wireless infrastructure applications.
Product sales mix for our Cree Microwave products remained constant as LDMOS made up 55% and 54% of microwave revenue for fiscal 2003 and fiscal 2002, respectively. Revenue attributable to bipolar devices was 23% and 45% for fiscal 2003 and 2002, respectively. Approximately 22% of Cree Microwave’s revenue was from engineering services for fiscal 2003 as we continued to work with new customers toward design wins. Overall, our average sales price for Cree Microwave products was fairly stable compared to the prior fiscal year. The most significant factor impacting revenue for our Cree Microwave segment was the 89% decline in units sold as a result of the termination of the Spectrian supply agreement and the overall slowdown in Spectrian’s business prior to the termination of the supply agreement.
Contract revenue was 12% of total revenue for fiscal 2003. Contract revenue received from U.S. Government agencies increased 40% during fiscal 2003 compared to fiscal 2002, due to additional contract awards that we received in fiscal 2002. In June 2002, we were awarded two contracts by ONR, with a total value of approximately $14.4 million as part of the Wide Bandgap Semiconductor Technology Initiative of DARPA. In July 2002, we were awarded government contracts totaling $26.5 million, if fully funded, over a three-year period from ONR and the AFRL. In fiscal 2003, we recognized approximately $16.1 million in revenue from these contracts. Additionally, we were awarded with another contract in June 2002 funded by DARPA, through the United States Army Robert Morris Acquisition Center, to pursue the development of UV LEDs and lasers for a variety of military communications and bio-threat detection applications under DARPA’s SUVOS program. In fiscal 2003, this DARPA SUVOS contract from ARL accounted for approximately $5.7 million in total revenue.
Gross Profit. Gross profit increased 57% to $99.2 million in fiscal 2003 from $63.4 million in fiscal 2002. Compared to the prior year, gross margins increased from 41% to 43% of revenue. In fiscal 2003, gross profit included a $1.3 million write-down of inventory at Cree Microwave due to the termination of the supply agreement with Spectrian. In fiscal 2002, gross profit included a $5.1 million charge relating to an inventory write-off and other related costs that were recorded as a part of the downsizing of Cree Microwave’s operations. In fiscal 2003, gross margins were impacted by higher LED margins being offset by negative margins from the Cree Microwave segment. LED margins improved as our average sales price decreased by 9% while the average cost of our LEDs decreased by 17% due to higher throughput in the factory and improved yields. Because a significant portion of our factory cost is fixed, higher throughput typically results in lower costs per unit produced. In addition, during fiscal 2002, our LED costs per unit were higher than during fiscal 2003 due to inefficiencies typically associated with new product introductions as we released both the MegaBright and XBright family of products during the year.
Negative gross profits were $9.3 million for our Cree Microwave business during fiscal 2003 as compared to gross profits of $10.1 million recorded during fiscal 2002, despite the $5.1 million write-off of inventory discussed above. Low factory throughput due to significantly reduced sales volume dramatically impacted our cost per unit.
Wafer costs for our SiC materials sales were 19% higher in fiscal 2003 than 2002, due to the shift in product mix of wafers sold with epitaxy as compared to production volume wafers sold to OSRAM. Contract margins declined from 28% in fiscal 2002 to 22% in fiscal 2003 due to a higher percentage of cost-share contracts being worked on during the year.
Research and Development. Research and development expenses increased 11% in fiscal 2003 to $31.2 million from $28.0 million in fiscal 2002. The increase in research and development spending supported our XBright, MegaBright Plus, XBright Plus, and RazerThin product lines; and our power chip
LEDs as well as higher brightness LED research programs. In addition, we funded development of our LDMOS, SiC and Group III nitride microwave devices, our Schottky diode power program and our near UV lasers. While research and development spending increased, customer support of certain research and development programs decreased by $8.5 million, thereby further increasing costs. From time to time, our customers and companies that we invest in participate in research and development funding for specific programs. We record this third party funding as an offset against research and development expenses. Customers and third parties in whom we invested funded $500,000 and $9.0 million in fiscal 2003 and fiscal 2002, respectively. The majority of this funding was received from companies in which we have made investments. In fiscal 2003, the entire customer funding we received came from an affiliate of Lighthouse, in which we hold a private company equity investment. In fiscal 2002, Microvision, the Lighthouse affiliate, and Xemod funded $4.4 million, $3.0 million and $492,000, respectively, of our research and development. We held an investment in each of these companies at the time that they provided research and development funding to us. In addition, Spectrian, our largest customer for our Cree Microwave segment, also participated in funding our research and development programs for $1.1 million. When customers participate in funding our research and development programs, we record the amount funded as a reduction of research and development expenses.
Sales, General and Administrative. Sales, general and administrative expenses increased 3% in fiscal 2003 to $26.3 million from $25.6 million in fiscal 2002. The increase in expenses was due mostly to higher premiums for insurance and greater spending to support the growth of the business, including increased performance based compensation plans for all employees.
Intangible Asset Amortization. Intangible asset amortization decreased 100% to zero during fiscal 2003 from $6.8 million during fiscal 2002. Nine months of intangible asset amortization was included in fiscal 2002 resulting from the acquisition of Cree Microwave in December 2000. In March 2002 an analysis of goodwill and other intangible assets indicated that the carrying values of such assets had been fully impaired under SFAS 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of” (see “Impairment of Goodwill and Loss on Disposal of Fixed Assets” below). Therefore, we wrote off the entire amount of goodwill and other intangible assets in March 2002. Prior to the write-off of goodwill and intangible assets, we were amortizing these assets over periods ranging from five to ten years.
Impairment of Goodwill and Loss on Disposal of Fixed Assets. Impairment of goodwill decreased 100% to zero during fiscal 2003 from $76.5 million during fiscal 2002. In March 2002, we determined that impairment existed and wrote off the entire balance of goodwill and other intangible assets. An analysis was performed at that date and indicated that the carrying values of such assets had been fully impaired under SFAS 121. The analysis was performed as several impairment indicators had occurred during the March 2002 quarter as discussed below. One of the significant impairment indicators related to a change in outlook for business at Cree Microwave related to the supply agreement between Cree Microwave and Spectrian. Under the original terms of the agreement, if Cree Microwave were unable to supply components deemed competitive with components available from third party suppliers within a certain period, Spectrian’s quarterly minimum purchase commitment would be reduced each quarter by the dollar volume of the component that Spectrian purchased from other vendors. Cree Microwave and Spectrian agreed to enter into the first amendment to the supply agreement in October 2001 because Cree Microwave was delayed in fully qualifying and completing development of its new LDMOS8 technology. Technology similar to LDMOS8 was made available to Spectrian from a competitor in early 2001. As a result, Cree Microwave agreed to reduce Spectrian’s commitments for the December 2001 quarter. In addition, we amended the supply agreement to provide that if competitive components meeting the applicable requirements were not available from Cree Microwave on or after April 1, 2002, Spectrian’s quarterly minimum purchase commitment thereafter would be reduced by any purchases of such products from other vendors.
By March 2002, Cree Microwave had not yet completed development and qualification testing of any of the components using its LDMOS8-based transistors and thus had not released the components to
production. Cree Microwave then executed a second amendment to the supply agreement with Spectrian in March 2002 and agreed to reduce minimum quarterly purchase commitments from Spectrian in return for additional time in which to complete development and qualification testing of the LDMOS8 components. In addition, many of the products that Spectrian indicated that it would purchase in the future had not yet been released to production. Under the amended supply agreement with Spectrian if Cree Microwave was not able to produce LDMOS8 devices in a timely manner, revenue from Spectrian would be significantly reduced after the June 2002 quarter. In addition, the outlook for acquiring additional customers decreased due to the overall weakened economy and the length of qualification cycles. Due to the change in outlook for business at Cree Microwave and the reduction in expected revenue per quarter, we performed an asset impairment analysis under SFAS 121. As a result of this analysis, the full amount of goodwill and intangible assets of $76.5 million was written off and recorded as “impairment of goodwill” under operating expenses on our consolidated statements of operations. Please refer to theBusiness Combinationssection underGoodwill and Intangible AssetsNote 2, “Summary of Significant Accounting Policies and Other Matters,” in the consolidated financial statements included in Item 8 of this report for further information about the valuation of Cree Microwave.
Loss on the disposal of fixed assets decreased 92% to $1.6 million in fiscal 2003 from $19.0 million recorded in fiscal 2002. During fiscal 2003, we recorded a $1.4 million write-down for fixed assets associated with a novel epitaxy equipment project that we discontinued before the equipment was delivered to us. The amount represented a deposit that we paid for the equipment. We also disposed of $200,000 of other assets during the year. During fiscal 2002, we took a $19.0 million charge to write down fixed assets due to decisions made based on changes in technology. This impairment reflected management’s decision to focus our technology in certain directions based on feedback from our research and development teams. After extensively testing certain reactor technology equipment, we narrowed a preference for certain processes, and as a result, we wrote-off non-producing reactor equipment that did not use the preferred processes. Also, in December 2001, management prepared for a three-inch wafer transition and as a result, wrote-off non-convertible two-inch crystal growth equipment that was not being used. Finally, yield improvements in our existing facility also resulted in the obsolescence of certain other equipment. All equipment written off in the second quarter of fiscal 2002 was dismantled and destroyed, if proprietary in nature, or sold by June 2002.
Severance Charges and Other Operating Expense. Severance charges declined from $875,000 in fiscal 2002 to $400,000 in fiscal 2003. In the first quarter of fiscal 2003, we incurred $400,000 of severance charges at our Cree Microwave segment. In the third quarter of fiscal 2002, we recorded an $875,000 severance charge also associated with Cree Microwave. In both periods we recorded the severance charge in the same period that the employees were laid off and received their severance payments.
Other operating expense decreased to zero in fiscal 2003 from $840,000 in fiscal 2002. This reduction was primarily caused by a $700,000 one-time retention bonus paid to Cree Microwave employees pursuant to a contractual commitment made as a part of the acquisition of Cree Microwave from Spectrian in the second quarter of fiscal 2002.
Other Operating Income-Gain on Termination of Supply Agreement. Gain on termination of supply agreement increased to $5.0 million in fiscal 2003 from zero in fiscal 2002. In the second quarter of fiscal 2003, we received a $5.0 million one-time payment from Spectrian associated with the termination of the supply agreement between Cree Microwave and Spectrian.
Loss on Investments in Marketable Securities and Loss on Long-term Investments. Loss on investments in marketable securities declined 90% to $2.1 million in fiscal 2003 from $21.5 million recorded in fiscal 2002. The $2.1 million recorded in fiscal 2003 related to marketable securities that we sold during the second quarter of fiscal 2003. The $21.5 million loss recorded in fiscal 2002 related to an entry to reclassify other comprehensive losses from equity to “loss on investments in marketable securities” in our
consolidated statements of operations. In addition, we also recorded additional write-downs for “other-than-temporary” declines in the market value of these investments in these companies as well as the overall stock market decline. This charge was partially offset by a gain on the sale of marketable trading securities of $558,000.
Loss on long-term investments declined to zero in fiscal 2003 from $20.4 million recorded in fiscal 2002. In fiscal 2002, we recorded write-downs for some investments we had made in privately held companies as many of the companies were experiencing deteriorating financial conditions and/or an inability to raise additional capital, which represented significant indicators of value impairment. In the second quarter of fiscal 2002, we recorded a write-down of $12.4 million in privately held investments. The majority of the write-down was taken on our investment in Xemod based on data regarding the company’s valuation. We recorded an $8.4 million write-down on the investment to bring the market capitalization estimate for the entire company to $3.8 million. In 2002, a third party purchased Xemod for approximately $4.5 million. We also took an additional $1.8 million write down on our investment in Lighthouse based on data regarding the company’s valuation. A $2.1 million write-down was also taken on our investment in World Theatre, Inc. (World Theatre) based on data regarding the company’s valuation. World Theatre also attempted to raise capital during the December 2001 quarter and only raised one half of the amount expected in a convertible debt round.
In the fourth quarter of 2002, we wrote down an additional $8.0 million related to our privately held investments. Our investment in EMF Ireland Limited (EMF) was fully written down by $1.1 million based on data regarding the company’s valuation. We further wrote down our Lighthouse investment by $3.4 million, based on data regarding the company’s valuation. During the fourth quarter of 2002, we also fully wrote down our investment in World Theatre based on data regarding the company’s valuation. The amount of the additional write-down was $2.1 million. World Theatre filed for bankruptcy protection in 2003. A $1.4 million charge was also taken to fully write down our investment in Kyma Technologies Inc. (Kyma) based on data regarding the company’s valuation.
Other Non-operating Income. Other non-operating income increased to $442,000 in fiscal 2003 from zero in fiscal 2002. In the fourth quarter of fiscal 2003, we received a contractually agreed upon payment from one of our customers, representing a settlement for a foreign currency translation adjustment included in our sales contract.
Interest Income, Net. Interest income, net decreased 28% to $4.1 million in fiscal 2003 from $5.7 million in fiscal 2002. The reduction resulted primarily from lower interest rates available for our liquid cash over the applicable period.
Income Tax Expense (Benefit). Income tax expense for fiscal 2003 was $12.3 million compared to a $28.7 million tax benefit recorded in fiscal 2002. The income tax benefit resulted from the $130.4 million net pre-tax loss resulting mainly from the charges taken during the period. These charges included write-downs for the impairment of fixed assets of $19.0 million, a $20.4 million charge to reserve for the decline in value of investments in privately held companies, a $21.4 million write down for “other than temporary” declines in the fair market value of our marketable securities, a $76.5 million write down of goodwill and other intangibles and a $5.1 million reserve taken for inventory and other items. Our effective income tax rate was 26% for fiscal 2003 compared to a 22% rate during fiscal 2002 due to greater tax benefits in fiscal 2002 associated with the losses reported in that year. At June 29, 2003, we recorded $22.8 million in net deferred tax assets.
Liquidity and Capital Resources
We have funded our operations, to date, through sales of equity, bank borrowings and from product and contract gross profits. As of June 27, 2004, we had working capital of $189.9 million, including $158.2 million in cash, cash equivalents and short-term investments held to maturity. As of June 27, 2004, we held
investments of $72.7 million in long-term securities held to maturity in order to receive a higher interest rate on our cash and investments. Operating activities generated $152.4 million in fiscal 2004 compared with $89.6 million generated during fiscal 2003. This increase was primarily attributable to our increased profitability in fiscal 2004 as net income grew 66% to $58.0 million. Included in the increase in cash from operations is a non-cash charge of $20.4 million related to deferred income taxes. During fiscal 2004, we generated $10.6 million from managing our working capital. We normally target our accounts receivable balance to average between 45 and 60 days outstanding; however, through focused collection efforts we decreased our days sales outstanding to 34 days at June 27, 2004 versus 57 days outstanding at June 29, 2003, based on our monthly revenue profile calculation. Therefore, while our overall revenues increased 34% for fiscal 2004, our accounts receivable balance only grew 9% or $3.9 million. Our inventory remained low at 41 days on hand versus 46 days at June 29, 2003, and therefore our inventory balance only grew $1.1 million or 10% during fiscal 2004. Depreciation and amortization increased by $12.9 million in fiscal 2004 due to new equipment purchased to support our business growth.
Cash used in investing activities in fiscal 2004 was $112.4 million. Net investments of $18.6 million were made in securities held to maturity and $77.3 million was invested in property and equipment and in additional deposits for property and equipment. The majority of the increase in spending related to new equipment additions to increase manufacturing capacity in our crystal growth, epitaxy, clean room, die test and XLamp manufacturing areas. We spent $10.7 million on the ATMI GaN business acquisition in the fourth quarter of fiscal 2004. Finally, $5.9 million was invested in patents and the purchase of patent rights resulting mostly from the purchase of patents from Asea Brown Boveri, Ltd. and other patent investments.
Cash used in financing activities included the repurchase of $34.7 million of our common stock and was partly offset by the receipt of $11.4 million for the exercise of stock options and shares issued under our employee stock purchase program.
We target approximately $100 to $120 million in capital spending in fiscal 2005, which is greater than fiscal 2004. The capital additions will be primarily for equipment to increase our LED chip production capacity and continued investment in the high power packaged LED XLamp line. We also target to spend $300 million and hire 300 new employees over the next five years. We anticipate that cash from operations will fund the majority of our expenditures. We target that our cash from operations will be higher in fiscal 2005 than it was in fiscal 2004 due to higher profitability resulting from greater targeted revenue. Therefore, we plan to meet the cash needs for the business for fiscal 2005 through cash from operations and cash on hand. We also anticipate that long term cash needs will be met with cash flow from operations or cash on hand over the next two fiscal years. Actual results may differ from our targets for a number of reasons as we discuss herein. We may also issue additional shares of common stock for the acquisition of complementary businesses or other significant assets. From time to time, we evaluate potential acquisitions in complementary businesses as strategic opportunities and anticipate continuing to make such evaluations.
As of June 27, 2004, our cash and cash equivalents and short-term investments held to maturity combined increased by $18.1 million or 13% over balances reported as of June 29, 2003 due to increased cash flow from operations. Our accounts receivable balance increased by $3.9 million or 9% over the accounts receivable balance as of June 29, 2003, which resulted from the overall increase in revenue offset partly by strong collections management during fiscal 2004. Our revenue in the fourth quarter of fiscal 2004 was $90.9 million, which was 42% higher than the fourth quarter of fiscal 2003 revenue of $64.1 million. Our net property and equipment has also increased by $22.0 million or 9% since June 29, 2003 due to investments made to expand production capacity. These investments are intended to aid us in meeting current and what we view as increasing future customer product demands on a cost-effective basis. We target that these investments in additional equipment will allow us to meet any increase in demand for our products and thus may lead to higher revenue for us. The higher property investment will also result in higher depreciation expense. Net deferred income taxes changed by $20.2 million due to accelerated depreciation and taxes on unrealized gains. Other assets declined by $10.9 million or 68% since June 29, 2003, while marketable
securities available for sale increased by $22.0 million or 100% since the end of fiscal 2003 due to the reclassification of our Color Kinetics investment, subsequent to the public offering of Color Kinetics common stock, from “other assets” on our consolidated balance sheet valued at cost of $12.7 million to marketable securities available for sale. Consequently, the investment is now recorded at fair market value under SFAS No. 115. The net unrecognized gain of $9.3 million has been recorded as a comprehensive income item in the shareholders’ equity section of our consolidated balance sheet. This $12.7 million reclassification from other assets was offset by a $1.9 million increase in deposits that were related to fixed asset additions. Our deferred revenue account increased by $2.9 million to $8.4 million at June 27, 2004 as a result of the terms of our agreements with Sumitomo and OSRAM, which require us to establish reserves at the time we ship LED products to Sumitomo and OSRAM based upon a percentage of the total purchase price of such products.
Contractual Obligations
At June 27, 2004, payments to be made pursuant to significant contractual obligations are as follows (000’s omitted):
Contractual Obligations | Total | Less Than One Year | One to Three Years | Three to Five Years | More Than Five Years | ||||||||||
Long-term debt obligations | $ | — | $ | — | $ | — | $ | — | $ | — | |||||
Capital lease obligations | — | — | — | — | — | ||||||||||
Operating lease obligations | 11,931 | 2,103 | 3,340 | 3,338 | 3,150 | ||||||||||
Purchase obligations | 26,310 | 25,626 | 684 | — | — | ||||||||||
Other long-term liabilities | — | — | — | — | — | ||||||||||
Total | $ | 38,241 | $ | 27,729 | $ | 4,024 | $ | 3,338 | $ | 3,150 | |||||
Purchase obligations are generally for the purchase of goods and services in the ordinary course of business such as raw materials, supplies and capital equipment. We use blanket purchase orders to communicate expected requirements to certain of our vendors. Purchase obligations reflect vendor commitments under purchase orders where the commitments are firm.
Operating leases include rental amounts due on our four leased facilities. These facilities are comprised of both office and manufacturing space. The first facility has a remaining lease term for approximately seven and one half years. The second facility lease expires in approximately six years. The third and fourth leases are for sales offices that expire in June 2005 and July 2005, respectively. We are also subject to a transition services agreement with ATMI, pursuant to which ATMI licensed a portion of its facility to us for our use through April 2005. All of the remaining lease agreements provide for rental adjustments for increases in base rent (up to specific limits) property taxes and general property maintenance that would be recorded as rent expense if applicable.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
As of June 27, 2004, we held a long-term investment in the equity securities of Color Kinetics, which is treated for accounting purposes under SFAS 115 as available-for-sale securities. This investment is carried at fair market value based upon quoted market price of that investment as of June 27, 2004, with net unrealized gains or losses excluded from earnings and reported as a separate component of shareholders’ equity.
It is our policy to write down these types of equity investments to their market value and record the related write down as an investment loss on our consolidated statements of operations if we believe that an other-than-temporary decline existed in our marketable equity securities. As of June 27, 2004, we do not believe that an other-than-temporary decline existed in our investment in Color Kinetics as the market value of the security was above our cost. This investment is subject to market risk of equity price changes. The fair market value of this investment as of June 27, 2004, using the closing sale price as of June 25, 2004, was $22.0 million.
As of June 27, 2004, we hold investments in the equity of private companies valued at $2.9 million, with our investment in Lighthouse being the only remaining investment that has a net carrying value recorded on our consolidated balance sheet. An adverse movement of equity market prices would likely have an impact on our investment in Lighthouse, although the impact cannot be directly quantified. Such a movement and the related underlying economic conditions could negatively affect the prospects of Lighthouse, its ability to raise additional capital and the likelihood of our being able to realize this investment through liquidity events such as initial public offerings, mergers and private sales.
We hold and expect to continue to consider investments in minority interests in companies having operations or technology in areas within our strategic focus. We generally are not subject to material market risk with respect to our investments classified as marketable securities as such investments are readily marketable, liquid and do not fluctuate substantially from stated values. Many of our investments are in early stage companies or technology companies where operations are not yet sufficient to establish them as profitable concerns. One of our investments is in a publicly traded company whose share prices are subject to market risk. Management continues to evaluate its investment positions on an ongoing basis. See Note 7, “Investments” in the consolidated financial statements included in Item 8 of this report for further information on our policies regarding investments in private and public companies.
We have invested some of the proceeds from our January 2000 public offering into high-grade corporate debt, commercial paper, government securities and other investments at fixed interest rates that vary by security. These investments are A grade or better in accordance with our cash management policy. At June 27, 2004, we had $149.4 million invested in these securities. Although these securities generally earn interest at fixed rates, the historical fair values of such investments have not differed materially from the amounts reported on our consolidated balance sheets. Therefore, we believe that potential changes in future interest rates will not create material exposure for us from differences between the fair values and the amortized cost of these investments.
We currently have no debt outstanding. With two of our larger customers, we maintain a foreign currency adjustment to our sales price if certain exchange rates against the U.S. dollar are not maintained. During fiscal 2004 and fiscal 2003, we recognized $489,000 and $442,000, respectively, of other non-operating income associated with proceeds received from one of these customers for foreign currency adjustments. These revenue adjustments represent our main risk with respect to foreign currency, since our contracts and purchase orders are denominated in U.S. dollars. We have no commodity risk.
CERTAIN BUSINESS RISKS AND UNCERTAINTIES
Described below are various risks and uncertainties that may affect our business. These risks and uncertainties are not the only ones we face. Additional risks and uncertainties, not presentlyboth known to us,and unknown, including ones that we currently deem immaterial or that are similar to those faced by other companies in our industry or business in general, may also affect our business. If any of the risks described below actually occurs,occur, our business, financial condition or results of future operations could be materially and adversely affected.
Our operating results and margins may fluctuate significantly.
Although we experienced significant revenue and earnings growth in the past years,year, we may not be able to sustain such growth or maintain our margins, and we may experience significant fluctuations in our revenue, earnings and margins in the future. For example, historically, the prices of our LEDs have declined based on market trends. We have attemptedattempt to maintain our margins by constantly developing improved or new products, which command higher prices or lowerby lowering the cost of our LEDs. If we are unable to do so, our margins will decline. Our operating results and margins may vary significantly in the future due to many factors, including the following:
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These or other factors could adversely affect our future operating results and margins. If our future operating results, or margins are below the expectations of stock market analysts or our investors, our stock price maywill likely decline.
Our LED revenues are highly dependent on our customers’ ability to source or develop efficient phosphor solutions to enable them to use our LED chips to produce competitive white LED products.
Some of our customers package our blue LEDs with a phosphor coating to create white LEDs. Nichia currently has the majority of the market share for white LEDs because it has developed a white LED lamp solution that includes an efficient phosphor solution to create a bright white output and it has a number of patents that cover portions of the technology. The phosphor solutions that our customers use in their products are generally not as efficient as the phosphor solution that Nichia uses in its products. As a result, the white LEDs that our customers produce historically have not been as bright as Nichia’s white LEDs. We are assisting our customers in their efforts to develop or gain access to more competitive phosphor solutions. Even if our customers are able to develop or secure more competitive phosphor solutions, there can be no assurance that they will be able to compete with Nichia, which has an established market presence. Growth in sales of our high-brightness LED chips used in these applications is dependant upon our customers’ ability to develop, secure and implement more competitive phosphor solutions.
We are highly dependent on trends in mobile appliances to drive a substantial percentage of LED demand.
Our results of operations could be adversely affected by reduced customer demand for LED products for use in mobile appliances. In the fourth quarter of fiscal 2004, we derived nearly one-half of our LED revenue and approximately 40% of our overall revenue from sales of our products into mobile appliance applications. Our ability to maintain or increase our LED product revenue depends in part on the number of models into which our customers design our products and the overall demand for these products. Also, design cycles in the handset industry are short and demand is volatile, which makes production planning difficult to forecast. However, our design wins are spread over a broad model and customer base.
If we experience poor production yields, our margins could decline and our operating results may suffer.
Our SiC materialand GaN materials products and our LED, power and RF device products are manufactured using technologies that are highly complex. We manufacture our SiC wafer products from bulk SiC crystals, and we use these SiC wafers to manufacture our LED products and our SiC-based RF and power semiconductors. Our Cree Microwave subsidiary manufactures its RF semiconductors on silicon wafers purchased from others. During our manufacturing process, each wafer is processed to contain numerous "die,"die, which are the individual semiconductor devices, and the RF, power devices and XLamp products are further processed by incorporating them into a packagepackages for sale as a packaged component.components. The number of usable crystals, wafers, diedies and packaged components that result from our production processes can fluctuate as a result of many factors, including but not limited to the following:
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We refer to the proportion of usable product produced at each manufacturing step relative to the gross number that could be constructed from the materials used as our manufacturing "yield." Since many of our manufacturing costs are fixed,
ifyield.
If our yields decrease, our margins could decline and our operating results would be adversely affected. In the past, we have experienced difficulties in achieving acceptable yields on new products, which has adversely affected our operating results. We may experience similar problems in the future, and we cannot predict when they may occur or their severity. For example, in the upcoming fiscal year, we may encounter short-term yield challenges in our LED production as we convert the majority of our production from two-inch wafers to three-inch wafers. In some instances, we may offer products for future delivery at prices based on planned yield improvements. Reduced yields or failure to achieve planned yield improvements could significantly affect our future margins and operating results.
The markets in which we operate are highly competitive and have evolving technology standards.
The markets for our LED, RF and microwave, and power semiconductor products are highly competitive. In the LED market, we compete with companies that manufacture or sell nitride-based LED chips as well as those that sell packaged LEDs. Competitors are offering new UV, blue, green and white LEDs with aggressive prices and improved performance. In the RF power semiconductor field, the products manufactured by Cree Microwave compete with products offered by substantially larger competitors who
have dominated the market to date based on product quality and pricing. The market for SiC wafers is also becoming competitive as other firms in recent years have begun offering SiC wafer products or announced plans to do so. We also expect significant competition for our other products, such as those for use in microwave communications and power switching.
We expect competition to increase. This could mean lower prices for our products, reduced demand for our products and a corresponding reduction in our ability to recover development, engineering and manufacturing costs. Competitors also could invent new technologies that may make our products obsolete. Any of these developments could have an adverse effect on our business, results of operations and financial condition.
Litigation and SEC matters could adversely affect our operating results and financial condition.
We and certain of our officers and current or former directors are defendants in pending litigation (as described in Item 3. Legal Proceedings of this report) that alleges, among other things, violations of federal securities laws. Defending against existing and potential securities and class action litigation will likely require significant attention and resources and, regardless of the outcome, result in significant legal expenses, which will adversely affect our results unless covered by insurance or recovered from third parties. If our defenses are ultimately unsuccessful, or if we are unable to achieve a favorable resolution, we could be liable for damage awards that could materially adversely affect our results of operations and financial condition.
In addition, the SEC in July 2003 initiated an informal inquiry of us and requested that we voluntarily provide certain information to the SEC staff. We have cooperated with the SEC in this informal inquiry. If the SEC elects to pursue a formal investigation of us, responding to any such investigation and any resulting enforcement action could require significant diversion of management’s attention and resources in the future as well as significant legal expense and exposure to possible penalties or fines that could materially adversely affect our results of operations.
Our business and our ability to produce our products may be impaired by claims that we infringe intellectual property rights of others.
Vigorous protection and pursuit of intellectual property rights characterize the semiconductor industry. These traits have resulted in significant and often protracted and expensive litigation. Litigation to determine the validity of patents or claims by third parties of infringement of patents or other intellectual property rights could result in significant expense and divert the efforts of our technical personnel and management, even if the litigation results in a determination favorable to us. In the event of an adverse result in such litigation, we could be required to:
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There can be no assurance that third parties will not attempt to assert infringement claims against us with respect to our current or future products. From time to time we consider it necessaryreceive correspondence asserting that our products or desirable, weprocesses are or may seek licenses underbe infringing patents or other intellectual property rights.rights of others. Our practice is to investigate such claims to determine whether the assertions have merit and, if so, we take appropriate steps to seek to obtain a license or to avoid the infringement. However, we cannot be certain that
licensespredict
whether a license will be available or that we would find the terms of licensesany license offered acceptable or commercially reasonable. Failure to obtain a necessary license could cause us to incur substantial liabilities and costs and to suspend the manufacture of products. In addition, if adverse results in litigation made it
necessary for us to seek a license or to develop non-infringing products or
processes, there is no assurance we would be successful in developing such
products or processes or in negotiating licenses upon reasonable terms or at
all. Our results of operations, financial condition and business could be harmed
if such problems were not resolved in a timely manner.
Our distributor in Japan is presently a party to patent litigation in Japan
brought by Nichia, in which the plaintiff claims that certain of our LED
products infringe Japanese patents it owns. The complaints in the proceedings
seek injunctive relief that would prohibit our distributor from further sales of
these products in Japan. The district court ruled in our favor in both lawsuits,
but Nichia has appealed these rulings. An adverse result in either of these
cases would impair our ability to sell the particular LED products at issue in
Japan and could cause customers not to purchase other LED products from us in
Japan and elsewhere. Subject to contractual limitations, we have an obligation
to defend and indemnify our distributor for patent infringement claims.
We have also initiated patent infringement litigation in the United States
District Court for the Eastern District of North Carolina against Nichia and one
of its subsidiaries, asserting patent infringement with respect to certain
Nichia nitride-based semiconductor products, including laser diode products.
Nichia has responded with counterclaims alleging, among other things, patent
infringement claims against us based on four U.S. patents directed to nitride
semiconductor technology. In addition, Nichia alleges trade secret
misappropriation and related claims against Cree Lighting and a former Nichia
researcher who is now employed by Cree Lighting on a part-time basis and Cree.
The court has directed that the claims against Cree Lighting be transferred to
the United States District Court for the Central District of California. The
court has orally granted our motion for summary judgment in which we requested
dismissal of Nichia's trade secret and related claims against Cree. An adverse
result under Nichia's patent infringement counterclaims, which remain in the
case, may impair our ability to sell our LED and laser diode products and could
include a substantial damage award against us.
We also have been named as a defendant to a counterclaim of Nichia in a lawsuit
pending in the U.S. District Court for the Eastern District of Pennsylvania. The
complaint in the underlying action, which was brought by Rohm Co., Ltd., or Rohm
against Nichia Corporation and Nichia America Corporation, alleges that Nichia
is infringing certain U.S. patents owned by Rohm. Nichia's counterclaim alleges
that Rohm and we violated antitrust laws by conspiring to exclude Nichia from
the U.S. market for high brightness LEDs. The counterclaim seeks actual and
treble damages, attorneys' fees and court costs. We have moved to dismiss the
counterclaim for lack of personal jurisdiction.
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Our Cree Lighting subsidiary has also initiated litigation, now pending in the
United States District Court for the Eastern District of North Carolina against
Nichia and one of its subsidiaries asserting patent infringement with respect to
gallium nitride-based semiconductor technology useful in manufacturing certain
LEDs and laser diode devices. The lawsuit seeks damages and an injunction
against infringement.
We believe the claims asserted against our products in the Japanese cases and
the claims asserted against us in the U.S. cases are without merit, and we
intend to vigorously defend against the charges. However, we cannot be certain
that we will be successful, and litigation may require us to spend a substantial
amount of time and money and could distract management from our day-to-day
operations. Litigation costs to date in these cases have been substantial, and
variability in these costs could adversely affect our financial results. If any
of these cases were decided against us, the result would have a material adverse
effect on our operations and financial condition.
There are limitations on our ability to protect our intellectual property.
Our intellectual property position is based in part on patents owned by us and patents exclusively licensed to us by NCSU, Boston University and others. The licensed patents include patents relating to the SiC crystal growth process that is central to our SiC materials and device business. 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.
However, we cannot be sure that patents will be issued on such applications or that our existing or future patents will not be successfully contested by third parties. Also, since 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 others and licensed to us) will provide significant commercial protection.
protection, especially as new competitors enter the market.
In addition to patent protection, we also rely on trade secrets and other non-patented proprietary information relating to our product development and manufacturing activities. We try to protect this information through appropriate efforts to maintain its secrecy, including requiring employees and third parties to sign confidentiality agreements. We cannot be sure that these efforts will be successful or that the confidentiality agreements will not be breached. We also can notcannot be sure that we would have adequate remedies for any breach of such agreements or other misappropriation of our trade secrets, or that our trade secrets and proprietary know-how will not otherwise become known or be independently discovered by others.
Where necessary, we may initiate litigation to enforce our patent or other intellectual property rights, but there is no assurancerights. For example, this past fiscal year we settled a patent infringement action that we will be
successful in anyour Cree Lighting subsidiary and the Trustees of Boston University filed against AXT, Inc., seeking enforcement of a patent relating to semiconductor devices manufactured using a GaN-based buffer technology. Any such litigation. Moreover, litigation may require us to spend a substantial amount of time and money and could distract management from our day-to-day operations. Moreover, there is no assurance that we will be successful in any such litigation.
If we are unable to produce and sell adequate quantities of our MegaBright(TM)high-brightness and XBright(TM)mid-brightness LED chip products and improve our yields, our operating results may suffer.
We believe that achievingour ability to gain customer acceptance of our high-brightness and mid-brightness LED chip products and to achieve higher volume production and lower production costs for our MegaBright(TM) and XBright(TM) LEDthose products, will be important to our future operating results. We must reduce costs of these products to avoid margin reductions from the lower selling prices we may offer due to our competitive environment and/or to satisfy prior contractual commitments. Achieving greater volumes and lower costs requires improved production yields for these products. We recently redesignedare continuing to work with our XBright(TM) LED productcustomers to address certain
difficulties indevelop and expand our XBright products to help meet their market and packaging the devices identified by some customers following the
introduction of the product, and we are planning to manufacture the redesigned
products in
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volume. requirements.We may encounter manufacturing difficulties as we ramp up our capacity to make theseour newest products. Our failure to produce adequate quantities and improve the yields of any of these products could have a material adverse effect on our business, results of operations and financial condition. In addition,Some of our customers may encounter difficulties with their manufacturing processes using our XBright(TM)XBright and XThin devices due to the non-standard die attachment processes required, which could increase product returns and impact customer demand, each of which would have a material 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 and GaN technology.
Our future success will depend on our ability to develop new SiC and GaN solutions for existing and new markets. We must introduce new products in a timely and cost-effective manner, and we must secure production orders from our customers. The development of new SiC and GaN products is a highly complex process, and we historically have
historically experienced delays in completing the development and introduction of new products. Products currently under development include larger, highhigher quality substrates and epitaxy, high power RF and microwave devices in both SiC and GaN, SiC power devices, bluenear UV laser diodes, and higher brightness, thinner LED products.products and high powered packaged LEDs. The successful development and introduction of these products depends on a number of factors, including the following:
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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-efficient manner.
We face risks of reduced revenue undermust generate new customer demand for our contract with Spectrian if we cannot
complete product qualification on a timely basis or ramp up productionLDMOS products in order to offset expenses of our LDMOS 8 products.
Cree Microwave segment.
Revenues of our Cree Microwave segment are dependentwill depend on our amended Supply
Agreement with Spectrian. If we are unableability to completeattract new customers for our LDMOS products. Due to the full productcurrent market environment for microwave devices and the lengthy customer design-in and qualification process and ramp up production of our recently released LDMOS 8
products adequately, Spectrian may reduce the amount it purchases during the
applicable quarter under the agreement, subject to the satisfaction of certain
conditions. Consequently, our results of operations could be adversely affected
by further delays in qualifyingfor our LDMOS 8 products. In addition, ifproducts, it may take many quarters to develop new customers for our Cree Microwave segment and we are
unable to supply othermay not succeed in doing so. Until we develop sufficient new business for Cree Microwave’s products, that meet orour expenses for this segment will exceed the specifications of
certain competitive parts designated by Spectrian, Spectrian may purchase those
products from other vendors. In that case, the purchased quantities will be
deducted from the minimum quantities required to be purchased from us under the
Supply Agreement. The resulting reduction in revenue could have an adverse
effect on our results of operations.
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We depend on a few large customers.
customers and our revenues can be affected by their contract terms.
Historically, a substantial portion of our revenue has come from large purchases by a small number of customers. For example, for fiscal 2002 our top five
customers (excluding government contracts and including Sumitomo, which
represents several Japanese customers) accounted for 64% of our total revenue. 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 limit or stop purchasing our products and our operating results willcould suffer. In addition, our Sumitomo contract provides that Sumitomo may decrease its purchase commitment or terminate the contract if its inventory of our products reaches a specified level. The contract also requires us to establish two rolling reserves based upon a percentage of the total purchase price of our products. We defer revenue recognition on the amounts added to reserves. If claims are made against reserves, we lose a large customermay recognize lesser amounts of revenue or no revenue on substitute sales to Sumitomo and fail to add new customers to replace lost revenue, our operating resultsany product returned may not recover.
Whenbe salable at the same price or at all. Another example is our OSRAM contract, which allows OSRAM to decrease its purchase commitment if we do not offer prices at certain specified levels or as agreed to by the parties. Contract terms with other large customers provide only limited advance notice of firm orders, our business
and results of operations may be adversely affected by changesalso operate in customer
demand.
We sell to our largest LED customer based on a rolling forecast of which only a
limited period reflects firm orders. Any change in this customer's demand or
forecastmanner that could have a material adversenegative impact on our business as the timing and
quantities of our production may not match demand or our overall demand may
decline. For example, we may be left with additional inventory on hand or we may
not have sufficient capacity to satisfy all of our contractual commitments,
which could have adverse consequences under our existing contracts.
Recently, we have experienced a trend towards smaller customers gaining design
wins from our larger customers for finished products incorporating our LEDs.
While in the short term, this trend may lead to increased sales to smaller
customers and an increase in the portion of our revenue that they represent, the
long term effects of this trend are uncertain. In addition, smaller customers
typically do not commit up front to purchase a specified volume over a long
period of time, which reduces our ability to predict and maintain a steady
stream of orders and revenue as sales to smaller customers increase as a
percentage of revenue.
The markets in which we operate are highly competitive.
The markets for our LED, laser and RF and microwave power semiconductor products
are highly competitive. New firms have begun offering UV, blue and green LEDs.
In the RF power semiconductor field, the products manufactured by Cree Microwave
compete with products offered by substantially larger competitors which have
dominated the market to date based on product quality and pricing. The market
for SiC wafers is also becoming competitive as other firms have in recent years
begun offering SiC wafer products or announced plans to do so. We also expect
significant competition for products we are currently developing, such as those
for use in microwave communications and power switching.
We expect competition to increase. This could mean lower prices for our
products, reduced demand for our products and a corresponding reduction in our
ability to recover development, engineering and manufacturing costs. Or
competitors could invent disruptive technology that may make our products
obsolete. Any of these developments could have an adverse effect on our
business, results of operations and financial condition.
results.
We face significant challenges managing our growth.
We have experienced a period of significant growth that has challenged our management and other resources. We have grown from 248390 employees on June 28,
199827, 1999 to 8931,235 employees on June 30, 200227, 2004 and from revenues of $44.0$60.1 million for the fiscal year ended June 28, 199827, 1999 to $155.4$306.9 million for the fiscal year ended June 30, 2002.27, 2004. To manage our growth effectively, we must continue to:
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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 weWe 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.
Performance of our investments in other companies could negatively affect our financial condition.
From time to time, we have made investments in public and private companies that engage in complementary businesses. Should the value of theseany such investments we hold decline, the related write-down in value could have a material adverse effect on our financial condition as reflected in our consolidated balance sheets. In addition, if the decline in value is determined to be "other than temporary",other-than-temporary, the related write-down could have a material adverse effect on our reported net income. For example, in the fourth quarter of fiscal 2002 we recorded a non-operating charge of $30.1$22 million (pre-tax) relating to the declines in the value of equity investments determined to be "other than temporary"other-than-temporary as a result of continued depressed market conditions. On June 27, 2004, we held interests in one public company as well as several private companies. Each of these investments is subject to the risks inherent in the business of the company in which we have invested and to trends affecting the equity markets as a whole. Our private company investments are subject to additional risks relating to the limitations on transferability of our interests due to the lack of a public market and to other transfer restrictions. Our publicinvestment in a publicly held company investments are subjectexposes us to market risks and also cancould be subject to contractual limitations on transferability.For example, we are restricted from selling our shares in Color Kinetics for a period of 180 days from June 22, 2004, the date of their initial public offering. As a result, we may not be able to reduce the size of our positions or liquidate our investments when we deem appropriate to limit our downside risk.
Our manufacturing capacity may not be sufficient to keep up with customer demand.
We experienced significant growth in fiscal 2004 and are operating near capacity for LED products. Although we are taking steps to address our manufacturing capacity concerns, if we are not able to increase our capacity quickly enough to respond to customer demand or if our expansion plans are not adequate enough to address our capacity constraints, or if ramping up new capacity costs more than we anticipate, our business and results of operation could be adversely affected ifaffected.
As part of our initiative to address these capacity concerns, we encounter difficulty
transitioning production to a larger wafer size.
We are in the process of graduallytransitioning our production process in several ways. First, we are shifting production of somethe majority of our LED products from two-inch wafers to two and one quarter and three-inch wafers.wafers over the course of fiscal 2005. We must first qualify our production processes for each product 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 two and one quarter and three-inch wafers, andwafers. If we have factored this into our plan for production capacity. If thisexperience delays in the qualification process, the transition phase takes longer than we expect, or if we are unable to attain expected yield improvements, our operating results may be adversely affected.
We also are in the process of qualifying our Sunnyvale, California location to produce SiC Schottky diode products and transitioning production of Schottky diode products to that location over the next several quarters. We may experience a transition period as we start to ramp up production in which our yields are low or our production costs do not meet our expectations. If we experience delays in qualifying this facility for production of SiC Schottky diodes, if this transition period extends longer than we expect, or if we are not able to achieve the production levels and margins we expect, our operating results could be adversely affected.
We also are exploring ways to expand our manufacturing capacity and plan to make certain expenditures in the coming fiscal year to acquire new equipment. Any potential expansion projects may be delayed, cost more than we anticipate or require long transition periods, any of which could impact our ability to meet our customers’ demands and affect our operating results.
We rely on a few key suppliers.
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We depend on a limited number of suppliers for certain raw materials, components, services and equipment used in manufacturing our products, including key materials 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 such suppliers. If we were to lose such key suppliers, our manufacturing operations could be interrupted or hampered significantly.
If government agencies or other customers discontinue or curtail their funding for our research and development programs our business may suffer.
Changes in Federal budget priorities could adversely affect our contract revenue. In the past, government agencies and other customers have funded a significant portion of our research and development activities. Government contracts are subject to the risk that the government agency may not appropriate and allocate all funding contemplated by the contract. In addition, our government contracts generally permit the contracting authority to terminate the contracts for the convenience of the government, and the full value of the contracts would not be realized if they are prematurely terminated. Furthermore, we may be unable to incur sufficient allowable costs to generate the full estimated contract values, and there is some risk that any technologies developed under these contracts may not have commercial value. If government and customer funding 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.
If our products fail to perform or meet customer requirements, we could incur significant additional costs.
The manufacture of our products involves highly complex processes. Our customers specify quality, performance and reliability standards that we must meet. If our products do not meet these standards, we may be required to replace or rework the products. In some cases our products may contain undetected defects or flaws that only become evident after shipment. We have experienced product quality, performance or reliability problems from time to time. Defects or failures may occur in the future. If failures or defects occur, we could:
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We are subject to risks from international sales.
Sales to customers located outside the U.S. accounted for aboutapproximately 83%, 80% and 65%, 69% and 69% of our revenue in fiscal 2002, 20012004, 2003 and 2000,2002, respectively. We expect that revenue from international sales will continue to be a significant partthe majority of our total revenue. International sales are subject to a variety of risks, including risks arising from currency fluctuations, trading restrictions, tariffs, trade barriers and taxes. Also, U.S. Government export controls could restrict or prohibit the exportation of products with defense applications. Because all of our foreign sales are denominated in U.S. dollars, our productsprices become less
price competitive in countries with currencies that are low or are declining in value against the U.S. dollar. Also, if we experience substantial changes in the
U.S. dollar currency exchange as compared to the Japanese yen, our sales
opportunities may be reduced as our primary competitors may offer more favorable
pricing. 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.
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If we fail to integrate acquisitionsevaluate and implement strategic opportunities successfully, our business will be harmed.
We completed two strategic acquisitions during calendar year 2000. We will
continuemay suffer.
From time to time we evaluate strategic opportunities available to us and we may pursue
otherfor product, technology or business acquisitions. Such acquisitions can
present many typesFor example, in fiscal 2004 we acquired the gallium nitride substrate and epitaxy business of ATMI. If we choose to make an acquisition, we face certain risks, includingsuch as failure of the following:
- we may fail to successfully integrateacquired business in meeting our performance expectations, diversion of management attention, retention of existing customers of the acquired business, and difficulty in integrating the acquired business’s operations, and personnel of
newly acquired companies with our existing business;
- we may experience difficulties integrating ourand financial and operating systems;
-systems into our ongoing business may be disrupted or receive insufficient
management attention;
- we may not cost-effectively and rapidly incorporate acquired
technology;
- wecurrent business. We may not be able to recognize cost savings or other financial
benefits we anticipated;
- acquired businesses may fail to meet our performance expectations;
- we may lose key employees of acquired businesses;
- we may not be able to retain the existing customers of newly acquired
operations;
- our corporate culture may clash with that of the acquired businesses;
and
- we may incur undiscovered liabilities associated with acquired
businesses that are not covered by indemnification we may obtain from
the seller.
We may not successfully address these risks or any other problems that arise from our recent or future acquisitions. In addition, in connection with future
acquisitions, we may issue equity securitiesAny failure to successfully evaluate strategic opportunities and address risks or other problems that could dilute the percentage
ownership of our existing shareholders, we may incur debt and we may be required
to amortize expensesarise related to intangible assets that may negativelyany acquisition could adversely affect our results or operations.
We depend on design trends in mobile phones to drive a large percentage of LED
demand.
Ourbusiness, results of operations and financial condition.
These or other factors could be adversely affected by reduced customer demand
for LED products for use in wireless handsets. We derive a significant portion
of our LED product revenue from sales to customers who use our LED products in
wireless handsets, and customer demand is dependent upon trends in the wireless
market. We believe the growth for the global market for wireless handsets has
slowed and may be declining. As a result, our ability to maintain or increase
our LED product revenue depends on the number of models into which customers
design our products. Also, design cycles in the handset industry are short, and
demand is volatile, which makes production planning difficult to forecast.
Item 2. Properties
We own our facilities in Durham, North Carolina where the business for our Cree
segment is conducted. In November 1997, we acquired our present manufacturing
facility, a 30-acre industrial site in Durham, North Carolina, which originally
consisted of a 139,000 square foot production building and 33,000 square feet of
service and warehouse buildings. In fiscal 2000 and fiscal 2002, we completed
two expansions that increased the size of these facilities by 42,000 square feet
and 147,000 square feet, respectively. During fiscal 1999 we purchased
approximately 80 acres of undeveloped land near our production facilities for
potential expansion purposes. We have installed a small electrical substation on
this site for use in transmitting power to our production facilities but have
not otherwise developed the
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land. During fiscal 2000, we purchased a 120,000 square foot building on 17.5
acres of land near our existing production site. We subsequently upfitted
approximately two-thirds of the building for use as meeting rooms and
administrative offices and as an employee services center.
We lease a separate building in Durham, North Carolina that was recently used by
our Cree segment for production of SiC-based RF and microwave devices and
related research and development. We have relocated these operations to our main
production site and no longer use the space. This lease expires in September
2002 and will not be renewed.
We lease through our Cree Japan subsidiary, a sales and marketing office in
Tokyo, Japan that is used to support our Japan distributor's sales of Cree
segment products. This three-year lease agreement expires in June 2005. We also
contract, through our Cree Asia-Pacific subsidiary, office space in Kowloon,
Hong Kong that is used in our Cree segment to provide sales and marketing
support in Southeast Asia. The agreement for use of this space expires in
February 2003 unless renewed by the parties.
The Cree Microwave facility is approximately 49,600 square feet of
administrative and manufacturing space located in Sunnyvale, California. We
sublease the premises from Spectrian through our Cree Microwave subsidiary,
which entered into the sublease agreement with Spectrian in December 2000 in
connection with our acquisition of the Cree Microwave business. Spectrian leased
the facility from its landlord in November 1996 for a 15-year term under lease
terms that included three options to extend the lease for up to an additional
fifteen years. Under the sublease between Cree Microwave and Spectrian, if
Spectrian exercises its option to extend the term of its master lease with its
landlord, Cree Microwave may also exercise an option to extend the sublease. We
have guaranteed the obligations of our subsidiary under the sublease.
Cree Lighting leases two facilities in Goleta, California for our Cree segment.
One facility, which covers 35,840 square feet, has a five-year lease that was
signed in August 2000 with an option to extend the lease for another five-year
period. This facility is used for research and development and administration.
Cree has guaranteed the obligations of its subsidiary under this lease. Cree
Lighting has sub-leased 10,217 square feet of this facility to a third party.
This two-year sub-lease agreement was entered into in October 2000 and was
terminated in July 2002. A new two-year sub-lease for 10,217 square feet with a
new tenant was entered into in July 2002 and will expire in July 2004. Cree
Lighting also leases an additional facility on a month to month basis that is
used for research and development. We have given notice to terminate this lease
in August 2002.
Item 3. Legal Proceedings
Foreign Legal Proceedings
Nichia Corporation v. Sumitomo Corporation: In December 1999, one of our
distributors, Sumitomo, was named in a lawsuit filed by Nichia in Japan in the
Tokyo District Court. The complaint in the proceeding was directed to our
standard brightness LED products and alleged that these products infringe a
Japanese patent owned by Nichia, Japanese Patent No. 2,918,139. The suit sought
a permanent injunction against further distribution of the products in Japan. We
intervened in the proceeding and filed a response denying the allegations of
infringement. In May 2001 the Tokyo District Court ruled in favor of Cree and
Sumitomo, finding no infringement, and dismissed the complaint. Nichia has
appealed the ruling to the Tokyo High Court.
In April 2000, Nichia commenced two additional lawsuits against Sumitomo in
Tokyo District Court in which it alleged that our high brightness LED products
infringe a second Japanese patent owned by
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Nichia, Japanese Patent No. 2,778,405. The suits sought preliminary and
permanent injunctions against further distribution of the products in Japan. We
intervened in the proceeding and filed responses denying the allegations of
infringement. In October 2001, following an adverse ruling in a separate case on
the validity of the patent, Nichia dismissed the complaint seeking a preliminary
injunction, leaving the complaint for a permanent injunction pending. In
December 2001 the Tokyo District Court ruled in favor of Cree and Sumitomo in
the remaining lawsuit, finding no infringement, and dismissed the complaint.
Nichia has appealed the ruling to the Tokyo High Court.
Rohm Co., Ltd. v Nichia Corporation: In July 2001, Rohm Co., Ltd., or Rohm,
filed a complaint against Nichia in the Tokyo District Court. Rohm seeks a
ruling that sales of its products that incorporate our standard brightness LED
products do not infringe the patent that was the subject of Nichia's December
1999 lawsuit, Japanese Patent No. 2,918,139. We intervened in this proceeding in
December 2001 to assist in showing that our standard brightness LED products do
not infringe the patent. The case remains pending before the district court.
Domestic Legal Proceedings
North Carolina State University and Cree, Inc. v. Nichia Corporation and others:
On September 22, 2000, NCSU and Cree commenced a patent infringement lawsuit
against Nichia and its subsidiary, Nichia America Corporation, or Nichia
America, in the U.S. District Court for the Eastern District of North Carolina.
The complaint seeks enforcement of a patent, U.S. Patent No. 6,051,849, relating
to GaN-based semiconductors manufactured using lateral epitaxial overgrowth
technology, which permits the growth of high quality GaN-based materials useful
in manufacturing certain laser diodes and other devices. The patent was issued
to NCSU in April 2000 and is licensed to Cree on an exclusive basis under an
agreement executed in June 1999.
In their answer to the complaint, Nichia and Nichia America denied infringement
and asserted a counterclaim seeking a declaratory judgment that the subject
patent is invalid and not infringed. Nichia further alleged in its counterclaim
that we are infringing four of its U.S. patents relating to nitride
semiconductor technology, U.S. Patent Nos. 5,306,662; 5,578,839; 5,747,832; and
5,767,581. Nichia also asserted misappropriation of trade secrets and related
claims against Cree and a former Nichia researcher now employed by one of our
subsidiaries, Cree Lighting, on a part-time basis. In addition, as subsequently
amended, Nichia's counterclaim named Cree Lighting as a counterclaim defendant
on trade secret and related claims and asserted claims under the Computer Fraud
and Abuse Act against the Cree Lighting employee.
We have replied to the patent infringement claims of Nichia's amended
counterclaim, denying any infringement and asserting a claim seeking a
declaratory judgement that the four Nichia patents at issue are invalid,
unenforceable and not infringed. The Cree Lighting employee and we have also
replied to the trade secret and related claims in the amended counterclaim,
denying any liability. We included with our reply a claim for damages in which
we have alleged that Nichia's actions in bringing the counterclaim for patent
infringement were not taken for any legitimate purpose and constitute unfair
competition in violation of North Carolina law.
In response to Nichia's amended counterclaim, the Cree Lighting employee named
as a counterclaim co-defendant also moved to dismiss the claims against him
under the Computer Fraud and Abuse Act. The court granted the motion in April
2002 and dismissed the claims, finding that Nichia had failed to state
claims upon which relief could be granted. Cree Lighting also moved to dismiss,
or in the alternative to transfer, Nichia's claims against it for lack of proper
venue. In March 2002 the court found that it lacked
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venue over the claims Nichia had asserted against Cree Lighting and directed
that the claims be transferred to the U.S. District Court for the Central
District of California.
In December 2000 Nichia America filed a motion for summary judgement seeking
dismissal of the patent infringement claims Cree and NCSU have asserted. In
support of the motion Nichia argued that the relevant claims of the patent, U.S.
Patent No. 6,051,849, which relate to certain lateral epitaxial overgrowth
technology, were invalid as a matter of law on grounds of indefiniteness. The
North Carolina district court denied the motion April 2002, and the claims NCSU
and we asserted under this patent remain pending.
In January 2002, Cree and the Cree Lighting employee named as a counterclaim
co-defendant moved for summary judgment dismissing Nichia's trade secret
misappropriation and related claims. The motion sought dismissal on the ground
that Nichia had failed to specify any trade secrets that would support the
claims. At a hearing in July 2002, the North Carolina district court orally
informed counsel that the court was granting the motion. Although a written
order confirming the ruling has not yet been entered, we understand that the
trade secret misappropriated claims against Cree and the Cree Lighting employee,
and at least some of the related non-patent claims, have been or will be
dismissed upon entry of a written order confirming the court's oral ruling.
Also in January 2002, Nichia moved to strike certain of our defenses to its
patent infringement claims and to preclude us from obtaining or using any
evidence concerning those defenses. Nichia alleged in support of the motion that
the defenses were based upon information improperly disclosed by the Cree
Lighting employee and counterclaim co-defendant. Nichia filed an amended motion
to strike in May 2002 in which it sought the same relief. At a hearing in July
2002, the court advised counsel orally that the motion to strike was denied. As
a result our patent infringement defenses Nichia challenged remain available to
us to prove in future proceedings in the case.
Although there can be no assurances of success, we believe the counterclaims
asserted in the North Carolina case are without merit and we intend to defend
against them vigorously.
Trustees of Boston University and Cree Lighting Company v. Nichia Corporation
and others: On May 3, 2001, Boston University and Cree Lighting commenced a
patent infringement lawsuit against Nichia and Nichia America in the U.S.
District Court for the Northern District of California. The defendants moved to
transfer the case to the U.S. District Court for the Eastern District of North
Carolina, and the case was transferred to the North Carolina district court in
October 2001.
In their complaint Boston University and Cree Lighting allege that Nichia and
Nichia America infringe a patent, U.S. Patent No. 5,686,738, relating to
GaN-based semiconductor technology useful in manufacturing certain LED and other
semiconductor devices. The patent was issued to Boston University in 1997 and is
licensed to Cree Lighting under a March 2001 agreement. In the complaint, Cree
Lighting and Boston University allege that the defendants are infringing the
patent by, among other things, importing, selling and offering for sale in the
United States certain GaN-based light emitting devices covered by one or more
claims of the patent. The complaint seeks damages and an injunction against
infringement.
Rohm Co. Ltd, v. Nichia Corporation and others: In November 2001, we were served
with pleadings in which Cree was named as a defendant to a counterclaim of
Nichia and Nichia America in a lawsuit pending in the U.S. District Court for
the Eastern District of Pennsylvania. The complaint in the underlying action,
which was brought by Rohm against Nichia and Nichia America, alleges that Nichia
is infringing certain U.S. patents owned by Rohm. Nichia's counterclaim, as
amended in December 2001,
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names both Rohm and us as counterclaim defendants and alleges that we violated
antitrust laws by conspiring with Rohm to exclude Nichia from the U.S. market
for high brightness LEDs. The counterclaim seeks actual and treble damages,
attorneys' fees and court costs. We have moved to dismiss the counterclaim for
lack of personal jurisdiction. Rohm has separately moved to dismiss certain
counts of the counterclaims, including those asserted against us, for failure to
state a claim on which relief can be granted. Both motions remain pending.
Although there can be no assurances of success, we believe the claims asserted
in the Pennsylvania case are without merit and we intend to defend against them
vigorously.
Other Litigation: We are also a party to certain other pending litigation
arising in the normal course of business. While we cannot predict the final
outcome of such litigation with certainty, we believe, based on consultation
with legal counsel, that the outcome of such other matters would not materially affect our financial conditionfuture operating results and margins. If our future operating results, or resultsmargins are below the expectations of operations.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth
quarter of fiscal 2002.
PART II
Item 5. Market Price for Registrant's Common Equity and Related Stockholder
Matters
Common Stock Market Information. Our common stock is traded in the Nasdaq
National Market and is quoted under the symbol "CREE". The following table sets
forth, for the quarters indicated the high and low sales prices as reported by
Nasdaq. Quotations represent interdealer prices without an adjustment for retail
markups, markdownsmarket analysts or commissions and may not represent actual transactions.
FY 2002 FY 2001*
------- --------
High Low High Low
---- --- ---- ---
First Quarter $ 27.500 $ 14.090 $ 81.719 $ 42.375
Second Quarter 29.730 13.761 64.125 27.750
Third Quarter 33.320 12.400 40.500 14.870
Fourth Quarter 14.340 10.350 36.650 12.210
*As adjusted for the two-for-one split effective on December 1, 2000.
Holders and Dividends. There were approximately 718 holders of record of our common stock as of August 1, 2002.
We have never paid cash dividends oninvestors, our common stock and do not anticipate that
we will do so in the foreseeable future. There are no contractual restrictions
in place that currently materially limit, or are likely in the future to
materially limit, us from paying dividends on our common stock, but applicable
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state law may limit the payment of dividends. Our present policy is to retain
earnings, if any, to provide funds for the operation and expansion of our
business. There were no sales of unregistered securities during fiscal 2002.
Equity Compensation Plan information will be provided under Item 12.
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Item 6. Selected Financial Data
The consolidated statement of operations data set forth below with respect to
the years ended June 30, 2002, June 24, 2001 and June 25, 2000 and the
consolidated balance sheet data at June 30, 2002 and June 24, 2001 are derived
from, and are qualified by reference to, the audited consolidated financial
statements included elsewhere in this report and should be read in conjunction
with those financial statements and notes thereto. The consolidated statement of
operations data for the years ended June 27, 1999 and June 28, 1998 and the
consolidated balance sheet data at June 25, 2000, June 27, 1999 and June 28,
1998 are derived from audited consolidated financial statements not included
herein. All consolidated statement of operations and consolidated balance sheet
data shown below are adjusted to reflect the acquisition of Nitres, now known as
Cree Lighting, effective May 1, 2000. This transaction was accounted for under
the "pooling of interests" method. We acquired the business comprising the Cree
Microwave segment in December 2000. This transaction was accounted for under the
purchase method. All share amounts have been restated to reflect our two-for-one
stock splits effective July 26, 1999 and December 1, 2000.
Selected Consolidated Financial Data
(In thousands, except per share data)
Years Ended
----------------------------------------------------------------------
June 30, June 24, June 25, June 27, June 28,
2002 2001 2000 1999 1998
-------- -------- -------- -------- --------
Statement of Operations Data:
Product revenue, net $ 136,230 $159,533 $ 96,742 $ 53,424 $ 34,891
Contract revenue, net 19,204 17,694 11,820 8,977 9,071
------- ------- ------- ------ ------
Total revenue 155,434 177,227 108,562 62,401 43,962
Net (loss) income ($101,723) $ 27,843 $ 30,520 $ 12,448 $ 6,243
Net (loss) income per share, basic ($ 1.40) $ 0.39 $ 0.46 $ 0.21 $ 0.11
Net (loss) income per share, diluted ($ 1.40) $ 0.37 $ 0.43 $ 0.20 $ 0.11
Weighted average shares outstanding:
Basic 72,718 72,243 65,930 58,030 55,452
Diluted 72,718 75,735 70,434 60,864 57,974
As of
----------------------------------------------------------------------
June 30, June 24, June 25, June 27, June 28,
2002 2001 2000 1999 1998
-------- -------- -------- -------- -------
Balance Sheet Data:
Working capital $151,851 $244,178 $265,957 $ 59,889 $28,265
Total assets 504,195 615,123 486,202 145,933 74,379
Long-term obligations -- -- -- 4,650 11,046
Shareholders' equity 482,104 589,097 463,142 131,003 55,905
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Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
All statements, trend analysis and other information contained in the following
discussion relative to markets for our products and trends in revenue, gross
margins, and anticipated expense levels, as well as other statements, including
words such as "may," "will," "anticipate," "believe," "plan," "estimate,"
"expect," and "intend" and other similar expressions constitute forward-looking
statements. These forward-looking statements are subject to business, economic
and other risks and uncertainties, both known and unknown, and our actual
results of operations may differ materially from those contained in the
forward-looking statements. Factors that could cause or contribute to such
differences include, but are not limited to, those discussed in "Certain
Business Risks and Uncertainties" in Item 1 of this report, as well as other
risks and uncertainties referenced in this report.
Business Overview
We are the world leaders in developing and manufacturing compound semiconductor
materials and electronic devices made from SiC and a leading developer and
manufacturer of optoelectronic and electronic devices made from GaN and related
materials on SiC substrates. We derive the largest portion of our revenue from
the sale of near ultra-violet, or UV, blue and green light emitting diodes or
LEDs. We currently offer LEDs at three brightness levels:
- XBright(TM)UV, blue and green products;
- mid-brightness UV, blue and green products, which include
MegaBright(TM), UltraBright(TM) and high brightness InGaN devices; and
- standard brightness blue products.
Our LED devices are utilized by end users as a lighting source for wireless
handsets, automotive dashboard lighting, indicator lamps, miniature white
lights, indoor and outdoor full color displays and signs, traffic signals and
other lighting applications. We recognize product revenue at the time of
shipment in accordance with the terms of the relevant contract. When our
inventory is maintained at a consigned location, revenue is recognized when our
customer pulls products for their use. LED products represented 58% of our
revenue in fiscal 2002 and 65% in fiscal 2001.
During fiscal 2002 and fiscal 2001, approximately 16% and 11%, respectively, of
our revenue came from the sales of RF and microwave devices from our Cree
Microwave segment. These RF power transistors are the semiconductor content for
power amplifiers that are used in base stations for cellular networks. We also
derive revenue from the sale of advanced materials made from SiC that are used
for manufacturing LEDs and power devices by our customers, or for research and
development for new semiconductor applications. Sales of SiC material products
represented 13% of our revenue in fiscal 2002 and approximately 14% during
fiscal 2001. We received no significant revenues from sales of power devices or
SiC based RF devices in fiscal 2002 or fiscal 2001.
The balance of our revenue, 12% for fiscal 2002 and 10% in fiscal 2001 is
derived from contract funding. Under various programs, U.S. Government entities
further the development of our technology by funding our research and
development efforts. Contract revenue includes funding for 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
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the contract, we report direct costs as research and development expenses with
related reimbursements recorded as an offset to those expenses.
Fiscal 2002 Overview
We completed the introduction of our MegaBright(TM) LED line during fiscal 2002
with the commercial release of three new products: the MegaBright(TM) UV device,
the traffic signal green device and the true green device used for display signs
and other lighting applications. The MegaBright(TM) blue device was released in
the fourth quarter of fiscal 2001. The UV device offers an alternative path to
white light compared to the MegaBright(TM) blue LED. Some customers prefer a
blue LED covered with a yellow-emitting phosphor to create white light. Other
customers believe the UV LED with red, green and blue-emitting phosphors
provides a preferable white light emission. Combining a red, green and blue LED,
or a blue and yellow LED, in an appropriate package are other means of creating
white light solid state lamps. A traffic signal made of green LEDs offers lower
power consumption at 6-12 watts versus 85-150 watts for an incandescent bulb in
certain cases. Consequently, municipalities and other government organizations
are choosing to install LED traffic signals due to reduced energy consumption
resulting in lower electricity bills and reduced maintenance costs due to the
longer lifetimes of LEDs. Applications for the true green device target full
color indoor and outdoor video displays including sports stadiums and large
advertising panels. The use of blue and green LEDs in full-color outdoor signs
is a well-established market, and one of the primary applications for nitride
LEDs. The MegaBright(TM) product line was an important revenue stream for fiscal
2002 and has replaced some demand for our older high brightness products. Our
high brightness product line had the biggest percentage decline in revenue
compared to fiscal 2001. For fiscal 2003, we will combine results for our
MegaBright(TM), UltraBright(TM) and high brightness devices for reporting
purposes and reflect these sales as our mid-brightness products. During the
fourth quarter of fiscal 2002, our mid-brightness chips comprised 88% of LED
sales.
We also introduced the XBright(TM) family of LEDs during fiscal 2002. This new
product family delivers to our customers increased brightness by approximately
40 percent over the MegaBright(TM) family of LEDs. Target applications for the
XBright(TM) devices include miniature white lights, traffic signals and video
screens. The XBright(TM) LED technology incorporates a flip chip design and
utilizes the optical benefits of SiC while maintaining the vertical structure
advantages of a single top contact. This allows for a standard size chip similar
to our other devices. We offer a complete product family of XBright(TM) LEDs:
UV, blue, traffic green and true green. During the fourth quarter of fiscal
2002, we continued to work through packaging difficulties encountered by some of
our customers in using our XBright(TM) products. As a result, XBright(TM) LEDs
comprised only 1% of LED revenue in the quarter. We modified the chip after its
initial introduction in response to customer packaging suggestions, and we
target to increase the sales volume of this product in the first half of fiscal
2003. Customer interest in the product remains strong, as we believe the
XBright(TM) chip is the brightest (which is defined as the optical power output
from a chip at 20 milliamps of drive current based on our internal measurement)
nitride LED currently available in the marketplace.
Shipments of our standard brightness devices remained stable in fiscal 2002 in
comparison to fiscal 2001 and were supported by automotive and indicator light
designs. During the fourth quarter of fiscal 2002, standard brightness products
were approximately 11% of LED revenue.
Revenue from Cree Microwave was $24.8 million during fiscal 2002. Our biggest
challenge for Cree Microwave will be to diversify our Spectrian-concentrated
business. However, due to the weak economic environment for microwave devices
and the long qualification process for our products, we believe that this
diversification will develop over many quarters. In the near term, our goal is
to complete qualification of the new laterally diffused metal oxide
semiconductor, or LDMOS 8 products during the
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first quarter of fiscal 2003. If we fail to attain this goal, revenue from this
segment will likely decline in future quarters. Our Supply Agreement with
Spectrian, Cree Microwave's largest customer, allows the customer to reduce its
purchase obligations significantly.
Overall, for fiscal 2002, materials revenue declined 19% over the prior year due
to a 57% reduction in gemstone sales and a 6% decrease in wafer sales. Sales of
material for use in gemstones were lower in the current year as Charles &
Colvard, or C&C, our sole customer for such materials, had built up inventory in
fiscal 2001 as their sales slowed. During fiscal 2002, wafer volume for our
material sales increased 8% while average sales prices declined 12% year over
year due to greater sales to volume customers using our product for commercial
applications.
Government contract revenue increased 9% in fiscal 2002 over the prior year as
we received several new contract awards during fiscal 2002. Our government
contract backlog exceeds $51.0 million as of June 30, 2002, and we target
contract revenue to increase during fiscal 2003 due to these new awards, subject
to the government's ability to terminate or reduce funding under the contracts.
During the past year, we utilized a greater proportion of our equipment and
infrastructure to perform research and development work to support the
commercialization of new products as reflected in the introduction of our
MegaBright(TM) and XBright(TM) products. We believe that, over the next several
quarters, this production capacity will be required to support the growth in
demand generated by our customers' recent design wins incorporating our
products. During fiscal 2003, we target to increase our throughput, subject to
the acceptance of our products by our customers and market conditions. As volume
throughput rises, our cost of LED chips and unit wafer costs are anticipated to
decline as fixed costs are spread over more units.
Critical Accounting Policies.
The following discussion and analysis of our financial condition and results of
operations is based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. In preparing our financial statements, we must make estimates and
judgments that affect the reported amounts of assets and liabilities, revenues
and expenses, and related disclosure of contingent assets and liabilities at the
date of our financial statements. Actual results may differ from these estimates
under different assumptions or conditions.
Critical accounting policies include those policies that are reflective of
significant judgments and uncertainties, which potentially could produce
materially different results under different assumptions and conditions. We
believe that our critical accounting policies are limited to those described
below.
Valuation of Long-Lived Assets, Intangible Assets and Goodwill. We have
approximately $330.3 million of long-lived assets as of June 30, 2002, including
approximately $211.7 million related to fixed assets and $64.2 million in
long-term investments held to maturity. In addition to the original cost of
these assets, their recorded value is impacted by a number of our policy
elections, including estimated useful lives, salvage values and in 2002,
impairment charges. In accordance with SFAS 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed of", or SFAS 121,
we record impairment charges on long-lived assets used in operations when events
and circumstances indicate that the assets have been impaired. In making these
determinations, the Company utilizes certain assumptions, including, but not
limited to: (i) estimations of the fair market value of the assets, and (ii)
estimations of future cash flows expected to be generated by these assets, which
are based on additional assumptions such as asset utilization, length of service
the asset will be used in the Company's operations
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and estimated salvage values. During 2002, we determined certain property and
equipment was impaired under SFAS 121 and as a result, we recorded impairment
charges of $19.0 million.
In addition, during the third quarter of 2002, we completed an impairment
analysis of the intangible assets and goodwill related to the acquisition of
Cree Microwave. This analysis was performed due to significant changes in
business conditions at the operating segment. First, Cree Microwave amended its
supply agreement with Spectrian effective March 31, 2002, which resulted in a
significant reduction in quarterly revenue expectations. In addition, Cree
Microwave's outlook for acquiring additional customers in the near term weakened
due to the deteriorating economic conditions and long product qualification
cycles. Also, many of the products that Spectrian indicated it would purchase in
the future have not yet been released to production. Under the amended supply
agreement, if Cree Microwave is not able to produce LDMOS 8 devices qualified
for Spectrian's applications in a timely manner, revenue from Spectrian may be
significantly reduced after the June 2002 quarter. As a result of this
impairment analysis, the remaining balance of intangible assets and goodwill of
$76.5 million was deemed fully impaired and was written off.
Accounting for Marketable and Non-Marketable Equity Securities. We classify our
marketable securities that are not trading or "held-to-maturity" securities as
"available-for-sale". We carry these investments at fair value, based on quoted
market prices, and unrealized gains and losses, net of taxes, are included in
accumulated other comprehensive income, which is reflected as a separate
component of shareholders' equity. Realized gains and losses are recognized when
realized upon sale or disposition or when declines in value are deemed to be
other than temporary in accordance with SFAS 115 "Accounting for Certain Debt
and Equity Securities". We have a policy in place to review our equity holdings
on a regular basis to evaluate whether or not each security has experienced an
"other-than-temporary" decline in fair value. Our policy requires, among other
things, a review of each of the companies' cash position, earnings/revenue
outlook, stock price performance, liquidity, ability to raise capital and
management/ownership. Based on this review, if we believe that an
"other-than-temporary" decline exists in the value of one of our marketable
equity securities, it is our policy to write down these equity investments to
the market value. The related write-down will then be recorded as an investment
loss on our consolidated statements of operations. During 2002, we recorded an
"other-than-temporary" investment loss of $22.0 million related to our
available-for-sale marketable securities based primarily on sustained reductions
in stock price performance.
We also make strategic investments in the equity of privately held companies.
Since we do not have the ability to exercise significant influence over the
operations of these companies, these investment balances are carried at cost and
accounted for using the cost method of accounting. Since the shares of stock we
received in these investments are not publicly traded, there is no established
market for these securities. We have a policy in place to review the fair value
of these investments on a regular basis to evaluate the carrying value of such
investments. This policy includes, but is not limited to, reviewing each of the
companies' cash position, financing needs, earnings/revenue outlook, operational
performance, management/ownership changes, and competition. The evaluation
process is based on information that we request from the privately held
companies. This information is not subject to the same disclosure regulations as
U.S. public companies, and as such, the basis for these evaluations is subject
to the timing and the accuracy of the data received from these companies. If we
believe that the carrying value of an investment is at an amount in excess of
fair value, it is our policy to record a write-down of the investment. This
write-down is estimated based on the information described above, and it is
recorded as an investment loss on our consolidated statements of operations.
During 2002, we recorded a write-down on these investments of $20.4 million,
representing our best estimate of "other-than-temporary" declines in value based
on a review of those factors described above. Estimating the fair value of
non-marketable
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investments in early-stage technology companies is inherently subjective and may
contribute to significant volatility in our reported results of operations.
Inventories. Inventories are stated at the lower of cost or market, cost being
determined using the first-in, first-out method. We evaluate our ending
inventories for excess quantities, impairment of value and obsolescence. This
evaluation includes analysis of sales levels by product and projections of
future demand based upon input received from our customers, sales team and
management estimates. We generally reserve for inventories on hand that are
greater than twelve months old, unless there is an identified need for the
inventory. In addition, we write off inventories that are considered obsolete
based upon changes in customer demand, manufacturing process changes that result
in existing inventory obsolescence or new product introductions, which eliminate
demand for existing products. Remaining inventory balances are adjusted to
approximate the lower of our manufacturing cost or market value. If future
demand or market conditions are less favorable than our projections, additional
inventory write-downs may be required and would be reflected in cost of sales in
the period the revision is made. We evaluate the adequacy of these reserves
quarterly. In the third quarter of fiscal 2002, we recorded a $4.5 million
reserve at our Cree Microwave segment for non-LDMOS and older LDMOS devices as a
result of contract negotiations with Spectrian that identified these devices as
obsolete. In the fourth quarter of fiscal 2002, we recorded inventory
write-downs of $690,000 related to our initial shipments of the XBright(TM)
family of products due to a packaging issue identified by some of our customers.
Revenue Recognition and Accounts Receivable. Revenue on product sales is
recognized when persuasive evidence of an arrangement exists, such as when a
purchase order or contract is received from the customer, the price is fixed,
title to the goods has changed and there is a reasonable assurance of collection
of the sales proceeds. We obtain written purchase authorizations from our
customers for a specified amount of product at a specified price and consider
delivery to have occurred at the time of shipment. In some cases our inventory
is maintained at a consigned location, in that situation, revenue is recognized
as our customer pulls inventory for their use. We provide our customers with a
limited right of return. Revenue is recognized at shipment or when product is
pulled from consigned inventory, and we record a reserve for sales returns. We
make estimates of potential future product returns related to current period
product revenue. We analyze historical returns, current economic trends and
changes in customer demand and acceptance of our products when evaluating the
adequacy of the allowance for sales returns. Significant judgments and estimates
made by management are used in connection with establishing the allowance for
sales returns. Material differences may result in the amount and timing of our
revenue for any period if management made different judgments or utilized
different estimates. The allowance for sales returns at June 30, 2002 was
$455,000.
Accruals for Liabilities and Warranties. At times, we must make estimates for
the amount of costs that have been incurred but not yet billed for general
services, including legal and accounting fees, costs pertaining to our
self-funded medical insurance, warranty costs at Cree Microwave and other
expenses. Many of these expenses are estimated based on historical experience or
averages and information gained directly from the service providers. Material
differences may result in the amount and timing of our expenses for any period
if management made different judgments or utilized different estimates.
Valuation of Deferred Tax Assets. As of June 30, 2002, the Company had $28.5
million recorded as deferred tax assets. These assets were recorded as a result
of tax benefits associated with the $143.9 million of significant charges taken
in fiscal 2002. These charges were recorded for the write-off of property and
equipment, the impairment of goodwill and intangible assets at Cree Microwave
and other charges resulting from the downturn in business and the "other than
temporary" charges taken on our investments. We did not record a reserve against
these deferred tax assets as we target a return to
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profitable operations over the next several periods and target being able to use
the deferred tax assets in their entirety.
The above listing is not intended to be a comprehensive list of all of our
accounting policies. In many cases, the accounting treatment of a particular
transaction is specifically dictated by generally accepted accounting
principles, with no need for management's judgement in its application. There
are also areas in which management's judgement in selecting any available
alternative would not produce a materially different result. See our audited
consolidated financial statements and notes thereto included in this Annual
Report on Form 10-K which contain a discussion of our accounting policies and
other disclosures required by accounting principles generally accepted in the
United States.
Results of Operations
The following table shows our consolidated statement of operations data
expressed as a percentage of total revenue for the periods indicated:
Years Ended
--------------------------------------------------------
June 30, 2002 June 24, 2001 June 25, 2000
---------------- --------------- ----------------
Revenue:
Product revenue, net ................ 87.6% 90.0% 89.1%
Contract revenue, net ............... 12.4 10.0 10.9
---------------- --------------- ----------------
Total revenue ................... 100.0 100.0 100.0
Cost of Revenue:
Product revenue, net ................ 50.3 43.3 40.0
Contract revenue, net ............... 8.9 7.3 8.2
---------------- --------------- ----------------
Total cost of revenue ........... 59.2 50.6 48.2
---------------- --------------- ----------------
Gross margin ............................. 40.8 49.4 51.8
Operating expenses:
Research and development ............ 18.0 7.3 6.5
Sales, general and administrative ... 16.5 10.2 10.2
Intangible asset amortization ....... 4.4 2.6 --
In-process research and development
costs ............................ -- 9.8 --
Other expense ....................... 62.6 -- 1.2
---------------- --------------- ----------------
(Loss) income from operations ............ (60.7) 19.5 33.9
Other non-operating (expense) income ..... (26.9) -- 0.6
Interest income, net ..................... 3.7 8.8 8.6
---------------- --------------- ----------------
(Loss) income before income taxes ........ (83.9) 28.3 43.1
Income tax (benefit) expense ............. (18.5) 12.6 15.0
---------------- --------------- ----------------
Net (loss) income ........................ (65.4%) 15.7% 28.1%
================ =============== ================
Fiscal Years Ended June 30, 2002 and June 24, 2001
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Revenue. Revenue declined 12% to $155.4 million in fiscal 2002 from $177.2
million in fiscal 2001. This decrease was attributable to lower product revenue,
which declined 15% to $136.2 million in fiscal 2002 from $159.5 million in
fiscal 2001. Excluding results of Cree Microwave, due to its mid-year
acquisition in fiscal 2001, revenue for fiscal 2002 would have decreased 17%
over the prior year comparative results. Much of the decrease in revenue from
our traditional business resulted from lower average selling prices for our LED
and SiC wafer products.
Average LED sales prices declined 24% for the twelve months ended June 2002
compared to the prior year. This decrease was related to contractual volume
discounts given to customers and increasing price competitiveness in the
marketplace due to weakness in the worldwide economy. We believe that the
overall demand for nitride LEDs declined during our fiscal 2002. However, our
overall market share has recently increased as a result of our lower pricing and
the introduction of higher brightness products. For fiscal 2002, our LED chip
volume increased 5% over prior year shipments. The introduction of the
MegaBright(TM) UV, blue, and green products in fiscal 2002 has generated new
design wins for our customers. The MegaBright(TM) product is approximately two
times brighter than our previous generation devices and is similar to the
brightness that is currently offered by our primary competitors. Prior to the
introduction of the MegaBright(TM) product line, our products were not as bright
as those offered by our competition. The MegaBright(TM) product line was not
fully introduced until February 2002, when our green devices were released.
These products have replaced some existing demand for our previous generation
high brightness devices; however, due to the product's higher performance, it
has also generated new demand, particularly in the mobile handset market. We
believe that volume shipments of the MegaBright(TM) product will increase in
fiscal 2003 due to new design wins primarily in the mobile handset market.
Several large wireless phone manufacturers have recently introduced new products
that feature a blue backlight of the keypad and, at times, a blue color for the
display. In addition, newer designs now offer white backlighting for full color
screens that require white LEDs. We believe that our products are featured in
several of these models of phones, and blue and white backlit phones have grown
significantly as a percentage of handsets currently offered by major
manufacturers. We also believe that the blue and white LEDs have replaced a
portion of the yellow-green LEDs that have traditionally backlit mobile
handsets. Our products will also target new automotive designs in fiscal 2003 as
well as other consumer product applications.
During fiscal 2002, we also introduced our new XBright(TM) families of LEDs,
including UV, blue and green devices. These products offer approximately 40%
higher brightness than our MegaBright(TM) products, and we believe they are
currently the highest brightness UV, blue and green products available in the
market place. We completed the introduction of these devices in the second half
of fiscal 2002. These devices did not contribute significantly to revenue in
fiscal 2002, as we continue to work with customers to optimize our chip design
in packaged solutions. We are targeting these products to be more significant to
revenue in fiscal 2003 for high brightness applications such as display signs,
traffic signals and lighting applications.
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Shipments of our standard brightness products were flat in fiscal 2002 in
comparison to the prior year due to stable demand for automotive and indicator
light applications. We target that our LED revenue may grow significantly in our
first quarter of fiscal 2003 as compared to the fourth quarter of fiscal 2002,
due to increased volume shipments. We also believe that average sales prices for
LEDs will decline in fiscal 2003. However, we are targeting unit shipments to
grow at a faster rate than average sales price declines, and as a result, we
target higher revenue in fiscal 2003 over fiscal 2002. LED revenue visibility
beyond the first quarter of fiscal 2003 is limited due to short lead times given
to us by customers. In addition, we must complete additional improvements to our
chip design and performance in order to succeed with our LED revenue targets for
fiscal 2003.
Revenue from Cree Microwave increased 29% to $24.8 million in fiscal 2002 from
$19.2 million in fiscal 2001. The increase in revenue represents an additional
six months of sales for the segment due to our mid-year acquisition of Cree
Microwave from Spectrian in fiscal 2001. Our average quarterly revenue in fiscal
2002 was lower than fiscal 2001 due to the current market environment for
wireless infrastructure spending. Product mix shifted to LDMOS during fiscal
2002, which comprised 54% of microwave revenue, an increase of 13% from fiscal
2001. Revenue attributable to bipolar devices was 45% and 1% related to other
products during fiscal 2002. Over 90% of Cree Microwave revenues were derived
from shipments to Spectrian in fiscal 2002 as well as fiscal 2001. Overall, our
average sales prices for this business segment were fairly stable with quarterly
average volume being reduced in fiscal 2002 as compared to fiscal 2001. Cree
Microwave continues to work with Spectrian to qualify and deliver new LDMOS 8
products for next generation wireless base station applications. If we are
unable to deliver qualified LDMOS 8 products to Spectrian on a timely basis, the
amount of our contractual supply agreement with Spectrian may be reduced
significantly. Specifically, until we complete the qualification of LDMOS 8
parts and the parts are accepted by Spectrian, we anticipate minimal revenue
from this segment of our business. If our revenue is reduced substantially, it
could have an adverse effect on our results of operations for this segment of
business. We continue to work on new customer design wins; however, due to long
product qualification cycles in the RF industry, progress in this area will
require a longer time commitment. As a result of continued weakness in market
conditions for wireless infrastructure spending, combined with a reduced supply
agreement with Spectrian that calls for a remaining $16.3 million of revenue
through June 2003, we target revenue from this segment to decline in fiscal 2003
from fiscal 2002.
Overall, for fiscal 2002, materials revenue declined 19% over the prior year due
to a 57% reduction in gemstone sales and a 6% decrease in wafer sales. SiC wafer
sales decreased 6% from the prior year due to lower pricing for wafers sold to
corporate and research communities, including certain customers using our wafers
for commercial production. Wafer units sold increased 8%, while average sales
prices declined 12% due to a higher mix of volume sales related to wafers used
in commercial production. For fiscal 2003, we target wafer sales revenue to be
even with fiscal 2002 results. Sales of gemstone products declined 57% during
fiscal 2002 as compared to fiscal 2001. During the fourth quarter of fiscal
2002, we experienced a modest recovery in revenue from C&C and target revenue
improvement from this customer during fiscal 2003.
Contract revenue received from U.S. Government agencies and non-governmental
customers increased 9% during fiscal 2002 compared to fiscal 2001, due to
additional contract awards. We anticipate that contract revenue will increase
during fiscal 2003 as a result of new contract awards received in the second
half of fiscal 2002.
Gross Profit. Gross profit decreased 28% to $63.4 million in fiscal 2002 from
$87.5 million in fiscal 2001. Compared to the prior year, gross margins declined
from 49% to 41% of revenue. In fiscal 2002,
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gross profit included a $5.1 million charge relating to an inventory write-off
and other related costs that were recorded as a part of the downsizing of Cree
Microwave's operations. Without this adjustment, gross profit and gross margin
for fiscal 2002 would have been $68.5 million and 44%, respectively. Lower
margins resulted from a combination of lower revenue and reduced profitability
for LED and wafer products and lower profitability at Cree Microwave related to
weak demand for RF devices. LED margins declined due to average sales prices
decreasing at a faster rate than average costs. During fiscal 2002, LED average
sales prices declined 24%, which was in line with our plans, while costs were
only 16% lower. LED costs did not decline as quickly as revenue due to reduced
worldwide demand for UV, blue and green LED products, which put pressure on
average sales prices and lowered our factory throughput. Because a significant
portion of our factory cost is fixed, lower throughput typically results in
higher costs per unit produced. In addition, our LED costs per unit were higher
due to inefficiencies typically associated with new product introductions as we
released both the MegaBright(TM) and XBright(TM) family of products during the
year. In our fourth quarter of fiscal 2002, we had product returns and inventory
write-downs that netted to a $948,000 reduction in gross profit related to
packaging issues identified by some customers after the release of the
XBright(TM) family of products. We have redesigned our XBright(TM) chips and are
planning to manufacture the products in volume in the first half of fiscal 2003.
Despite the lower throughput of volume and new product inefficiencies, we were
still able to reduce LED costs by 16% due to improved yield, cost cutting
measures and other efficiencies.
Gross margins at Cree Microwave were 19% during fiscal 2002 and were impacted by
the $5.1 million write-off of inventory discussed above. Excluding this write
down, gross margin would have been 40% of revenue for the Cree Microwave segment
compared to 44% in fiscal 2001. Low factory throughput due to reduced sales
volumes and the qualification of LDMOS 8 has significantly impacted our cost per
unit. Our greatest opportunity to improve margins would be in yield improvements
and the achievement of greater throughput levels in our factory.
For fiscal 2003, we target gross margins to improve slightly as a result of
higher throughput in our Durham, North Carolina facility as well as improved
yields due to higher anticipated volume. Depending on our success with the
introduction of the LDMOS 8 devices at Cree Microwave, our margins for that
segment may increase, remain stable or may decline.
Research and Development. Research and development expenses increased 116% in
fiscal 2002 to $28.0 million from $13.0 million in fiscal 2001. The increase in
research and development spending supported our MegaBright(TM) and XBright(TM)
product lines; our large chip LED devices as well as new higher brightness LED
research programs. In addition, we funded development of our next generation
LDMOS, SiC and GaN microwave devices, our Schottky diode power program and our
UV lasers. While research and development spending increased, customer support
of certain programs decreased, thereby further increasing costs. Finally, the
mid-year acquisition of Cree Microwave during fiscal 2001 also contributed to
the higher spending variance. Without the impact of Cree Microwave, research and
development spending would have increased 99% over the prior year. We believe
our research and development during fiscal 2002 is critical to our future
revenue growth. For example, we target that more than 70% of our revenue goal
for fiscal 2003 will be met with technology developed in fiscal 2002. We believe
that internal funding for the development of new products will stabilize during
fiscal 2003.
Sales, General and Administrative. Sales, general and administrative expenses
increased 41% in fiscal 2002 to $25.6 million from $18.1 million in fiscal 2001.
The increase in expenses was due mostly to costs associated with ongoing
intellectual property litigation. In addition, costs were higher due to the mid
year acquisition of Cree Microwave during fiscal 2001, higher premiums for
directors' and officers' insurance and greater spending to support the growth of
the business. Without the impact of Cree
-41-
Microwave, sales and general and administrative expenses would have increased by
38% year over year. For fiscal 2003, we target that sales, general and
administrative costs to remain stable depending on developments in our ongoing
patent litigation.
Intangible Asset Amortization and In-Process Research and Development Costs.
Intangible asset amortization increased 49% to $6.8 million during fiscal 2002
from $4.5 million during fiscal 2001. Nine months of intangible asset
amortization was included in fiscal 2002 and six months of amortization was
included in fiscal 2001 resulting from the acquisition of Cree Microwave in
December 2000. Intangible asset amortization ceased during the fourth quarter of
fiscal 2002. An analysis of goodwill and other intangible assets indicated that
the carrying values of such assets had been fully impaired under Statement of
Financial Accounting Standards No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of" (SFAS 121) (see
"Other Expense"). Prior to the write-off of goodwill and intangible assets, we
were amortizing these assets over periods ranging from five to ten years.
As a result of the acquisition of Cree Microwave in December 2000, we recorded a
charge of $17.4 million in the third quarter of fiscal 2001 associated with
acquired in-process research and development costs.
Other Expense. Other expense increased to $97.2 million during fiscal 2002 from
$62,000 in fiscal 2001. This charge was primarily made up of a $76.5 million
charge for goodwill and intangible assets relating to Cree Microwave in response
to several impairment indicators. Cree Microwave amended its supply agreement
with Spectrian in the third quarter of fiscal 2002, which reduced quarterly
revenue expectations. Also, many of the products that Spectrian indicated that
it would purchase in the future have not yet been released to production. Under
the amended supply agreement with Spectrian, if Cree Microwave is not able to
produce LDMOS 8 devices in a timely manner, revenue from Spectrian may be
significantly reduced after the June 2002 quarter. In addition, the outlook for
acquiring additional customers in the near term has decreased due to the
weakened economy and the long qualification cycles. Due to the change in outlook
for business at Cree Microwave and the reduction in expected revenue per
quarter, we performed an asset impairment analysis under SFAS 121. As a result
of this analysis, the full amount of goodwill and intangible assets of $76.5
million was written off and recorded as other expense on our consolidated
statements of operations. Also included in other expense was $875,000 related to
severance payments and other expenses related to the downsizing in the Cree
Microwave business. In addition, a $19.0 million write-off of property and
equipment was recorded to reflect changes in technology that resulted in their
obsolescence.
Other Non-Operating (Loss) Income. Other non-operating (loss) income was a loss
of $41.8 million in fiscal 2002 compared to $82,000 of income in fiscal 2001.
The fiscal 2002 loss was attributable to a $42.4 million write-down of
investments made in publicly traded and privately held equity securities. For
publicly traded securities, we reclassified other comprehensive losses from
equity to non-operating losses in our consolidated statements of operations and
recorded additional write-downs for the "other-than-temporary" declines in the
market value of these investments as the stock market has sustained significant
declines in value. In the case of privately held investments, many of the
companies were experiencing deteriorating financial conditions and/or an
inability to raise additional capital, which represented significant indicators
of value impairment. The fiscal 2002 other non-operating loss was partially
offset by a $558,000 gain on the sale of marketable securities during the second
quarter of fiscal 2002.
During fiscal 2001, a $4.6 million write-down was taken to establish a reserve
for investments made in privately held companies that were considered to have an
"other than temporary" impairment to value. In
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addition, we made a one-time pledge of a charitable contribution of $1.2 million
to the University of California at Santa Barbara to endow a Cree chair in solid
state lighting and displays and for other uses. Finally, a $100,000 charge was
recorded related to one-time charges for expenses incurred for the acquisition
of Nitres. These charges were offset by a $6.0 million gain on the sale of
marketable securities during the year.
Interest Income, net. Interest income, net has decreased 64% to $5.7 million in
fiscal 2002 from $15.7 million in fiscal 2001 due to significantly lower
interest rates available in fiscal 2002. In addition, slightly lower cash
amounts were available as $20.3 million was used to repurchase our own stock
during fiscal 2002.
Income Tax (Benefit) Expense. Income tax (benefit) expense for fiscal 2002 was a
benefit of $28.7 million compared to an expense of $22.3 million in fiscal 2001.
The fiscal 2002 income tax benefit resulted from significant charges of $143.9
million taken during the year. These charges included the write-off of property
and equipment due to changes in technology, the impairment of goodwill and
intangible assets at Cree Microwave and other charges relating to the downturn
in business, and an "other than temporary" decline in fair value of marketable
and privately held securities. Our effective tax rate during fiscal 2002 was 22%
compared to 33% in fiscal 2001. At June 30, 2002, we also maintained $28.5
million of deferred tax assets that were not reserved for by us as we target to
return to profitable operations over the next several periods and target being
able to use the assets in their entirety.
The minimum amount of future taxable income that will be required to realize
existing deferred tax assets is approximately $66 million, $20 million of which
will need to occur within the next 20 years to offset existing net operating
losses. The new tax act, "The Job Creation and Workers' Assistance Act of 2002"
will allow us to recover past alternative minimum tax that has been paid. This
amount has been recorded as a tax receivable. The new legislation also allows us
more favorable depreciation. Historically, reported taxable income has been
significantly lower than income reported for financial reporting purposes. The
primary reasons for this difference are the timing differences for depreciation,
stock option deductions for tax purposes, other tax planning strategies, and
impairment charges expensed for financial accounting purposes, which are not tax
deductible.
Fiscal Years Ended June 24, 2001 and June 25, 2000
Revenue. Revenue grew 63% to $177.2 million in fiscal 2001 from $108.6 million
in fiscal 2000. This increase was attributable to higher product revenue, which
rose 65% to $159.5 million in fiscal 2001 from $96.7 million in fiscal 2000.
Without the acquisition of Cree Microwave in December 2000, revenue for fiscal
2001 would have increased 46% over the prior year comparative results. Much of
the increase in revenue from our traditional business resulted from demand for
our LED and SiC wafer products. LED chip volume increased 104% over units
delivered in the prior year. The largest increase occurred as a result of the
introduction of our UltraBright(TM) product line in fiscal 2001. During fiscal
2000 only our high brightness and standard brightness product lines were
available for sale. Our standard brightness products also increased 65% in
fiscal 2001 in terms of units shipped over the prior year due to strong demand
for automotive and indicator light applications. Average LED sales prices
declined 18% for the twelve months ended June 2001 compared to the prior year
average due to expected contractual volume discounts given to customers.
SiC wafer sales increased 71% over the prior year due to demand from corporate
and research customers, including certain customers using our wafers for
commercial production. Wafer units sold increased 107%, while average sales
prices declined 16% due to a higher mix of volume sales related to wafers
-43-
used in commercial production. Sales of gemstone products declined 63% during
fiscal year 2001 as compared to fiscal 2000 due to inventory reduction efforts
at C&C.
Revenue from Cree Microwave was $19.2 million for fiscal 2001. This represents
six months of sales for the unit as it was acquired in December 2000 and
accounted for using the purchase method of accounting. Since we acquired Cree
Microwave in December 2000, there were no sales for this unit in fiscal 2000.
Contract revenue received from U.S. Government agencies and non-governmental
customers increased 50% during fiscal 2001 compared to fiscal 2000, due to
additional contract awards. Seven new contract awards were received during
fiscal 2001.
Gross Profit. Gross profit increased 56% to $87.5 million in fiscal 2001 from
$56.2 million in fiscal 2000. Compared to the prior year, gross margins declined
from 52% to 49% of revenue. Lower margins resulted from a combination of reduced
profitability for LED devices and the acquisition of Cree Microwave. LED margins
declined due to average sales prices decreasing at a faster rate than average
costs. During fiscal 2001 average LED costs declined 11% while average sales
prices were reduced 18%. LED costs did not decline as quickly as revenue due to
lower yields as a result of new product introductions and chip modifications
made to our products in the second half of the year. In addition, factory
throughput was reduced during the fourth quarter of fiscal 2001, which resulted
in higher costs per chip. The margins for Cree Microwave averaged 44% as a
percentage of revenue due to the competitive environment for LDMOS chips. Cree
Microwave was 11% of total revenue in fiscal 2001.
Research and Development. Research and development expenses increased 84% in
fiscal 2001 to $13.0 million from $7.1 million in fiscal 2000. Much of this
increase resulted from the acquisition of Cree Microwave, as well as greater
investment made for research in the RF and microwave, power and optoelectronic
programs. Without the acquisition of Cree Microwave, research and development
expenses would have increased 62% over the prior year.
Sales, General and Administrative. Sales, general and administrative expenses
increased 63% in fiscal 2001 to $18.1 million from $11.1 million in fiscal 2000.
This increase in expenses is due to the acquisition of Cree Microwave and
greater spending to support the overall growth of the business, as well as costs
associated with ongoing intellectual property litigation. Without the
acquisition of Cree Microwave, sales, general and administrative expenses would
have increased 44% over the prior year.
Intangible Asset Amortization and In-Process Research and Development Costs. The
purchase of Cree Microwave generated goodwill and other intangible assets, which
will be amortized over periods ranging from five to ten years. In addition, as a
result of the acquisition of Cree Microwave, we recorded a one-time charge of
$17.4 million in the third quarter of fiscal 2001 associated with acquired
in-process research and development costs.
Other Expense. Other expense decreased 95% to $62,000 during fiscal 2001 from
$1.3 million in fiscal 2000. The decrease was attributable to fewer fixed asset
disposals.
Other Non-Operating Income. Other non-operating income decreased 88% to $82,000
in fiscal 2001 from $656,000 in fiscal 2000. This decrease was attributable to a
$4.6 million write down taken in the fourth quarter of fiscal 2001 to establish
a reserve for investments made in private companies that was considered to be an
"other-than-temporary" decline in fair value. In addition, we made a one-time
pledge of a charitable contribution of $1.2 million to the University of
California at Santa Barbara to endow a Cree chair in solid state lighting and
displays, and for other uses, in the first quarter of fiscal 2001.
-44-
Finally, a $100,000 charge was recorded related to one-time charges for expenses
incurred for the acquisition of Nitres. These charges were offset by a $6.0
million gain on the sale of investment securities during the year. During fiscal
2000, a $4.1 million gain was recognized on the sale of securities. This gain
combined with one-time proceeds from an insurance recovery of $400,000, more
than offset a $3.8 million one-time charge for expenses incurred with the
acquisition of Nitres.
Interest Income, net. Interest income, net has increased 67% to $15.7 million in
fiscal 2001 from $9.4 million in fiscal 2000 due to higher average cash balances
being available in fiscal 2001 as a result of the public stock offering
completed in January 2000. Higher interest rates in fiscal 2001 also contributed
to increased interest income.
Income Tax Expense. Income tax expense for fiscal 2001 was $22.3 million
compared to $16.3 million in fiscal 2000. This increase resulted from increased
profitability during fiscal 2001 over fiscal 2000, as adjusted for the cost of
in-process research and development which is non-deductible in the current
period for tax purposes. Our effective tax rate during fiscal 2001 was 33%
compared to 35% in fiscal 2000.
Liquidity and Capital Resources
We have funded our operations to date through sales of equity, bank borrowings
and from product and contract gross profits. As of June 30, 2002, we had working
capital of $151.8 million, including $106.1 million in cash, cash equivalents
and short-term investments held to maturity. As of June 30, 2002, we invested
$64.2 million in long term securities held to maturity in order to receive a
higher interest rate on our cash. Operating activities generated $39.1 million
in fiscal 2002 compared with $74.8 million generated during fiscal 2001. This
decrease was primarily attributable to a $31.2 million increase in deferred
income tax assets that was generated from the $143.9 million in pretax charges
taken in fiscal 2002. Depreciation and amortization increased by $13.0 million
in fiscal 2002, due to new equipment purchased primarily in fiscal 2001. Tax
benefits from stock options were also $4.3 million lower in fiscal 2002. These
inflows of cash were partly offset by a $2.8 million increase in inventory due
to increased shipments anticipated for early fiscal 2003 and inventory being
maintained at an offsite location, and a $3.8 million increase to prepaid
expenses mostly for higher insurance premiums.
Cash used by investing activities in fiscal 2002 was $116.9 million. Net
investments of $51.8 million were made in securities held to maturity and $13.8
million was invested in available for sale securities. $41.7 million was
invested in property and equipment and in additional deposits for property and
equipment. The majority of the increase in spending was due to new equipment
additions to increase manufacturing capacity in our epitaxy, clean room and
package and test areas. Finally, $9.1 million was invested in other long-term
assets during fiscal 2002 and reflects strategic investments made in private
companies.
Cash used in financing activities included common stock repurchases of 1.49
million shares of our common stock on the open market for $20.3 million or an
average cost of $13.63 per share. This was partially offset by the receipt of
$7.2 million for the exercise of stock options and shares issued under our
employee stock purchase program.
We target approximately $50.0-60.0 million in capital spending for fiscal 2003.
We anticipate that the majority of the expenditures will be made for new
equipment and will be funded by cash from operations. We may also issue
additional shares of common stock for the acquisition of complementary
-45-
businesses or other significant assets. From time to time, we evaluate potential
acquisitions of and investments in complementary businesses and anticipate
continuing to make such evaluations.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Quantitative Disclosures:
As of June 30, 2002, we maintain investments in equity securities that are
treated for accounting purposes under SFAS 115 as "available-for-sale"
securities. These investments are normally carried at fair market value based
upon the quoted market price of that investment at the end of the reporting
period, with net unrealized gains or losses excluded from earnings and reported
as a separate component of shareholder's equity. It is our policy to write down
these equity investments to their market value and record the related write-down
as an investment loss on our consolidated statements of operations when the
investment has an "other-than-temporary" decline in value. At June 30, 2002, we
believe that an "other-than-temporary" decline existed in our marketable equity
securities and we recorded an "other-than-temporary" investment loss of $22.0
million related to our available for sale marketable securities. These
investments are subject to market risk of equity price changes. Management views
these stock holdings as an investment; therefore, the shares are accounted for
as "available for sale" securities under SFAS 115. The fair market value of
these investments as of June 30, 2002, using the closing sale price as of June
28, 2002, was $6.0 million. These equity securities are held for purposes other
than trading. Our equity portfolio consists of securities with characteristics
that most closely match the Nasdaq National Market. The Nasdaq Composite Index
has shown a 72% decline over the past two years, therefore if there was a 72%
adverse change in the market prices, our portfolio would decrease in value by
$4.3 million.
An adverse movement of equity market prices would also have an impact on our
portfolio of non-marketable strategic equity securities, although the impact
cannot be directly quantified. Such a movement and the related underlying
economic conditions would negatively affect the prospects of the companies we
invest in, their ability to raise additional capital and the likelihood of our
being able to realize our investments through liquidity events such as initial
public offerings, mergers and private sales. At June 30, 2002, our
non-marketable strategic equity securities had a carrying amount of $16.0
million.
We have invested some of the proceeds from our January 2000 public offering into
high-grade corporate debt, commercial paper, government securities and other
investments at fixed interest rates that vary by security. At June 30, 2002, the
Company had $157.6 million invested in these securities. We currently have no
debt outstanding.
Qualitative Disclosures:
Our investments in publicly traded equity securities are subject to the market
risk of equity price changes. While we cannot predict or manage the future
market price for such stock, management continues to evaluate our investment
position on an on-going basis.
-46-
Item 8. Financial Statements and Supplementary Data
Index to Consolidated Financial Statements
| Page | ||
| 49 | ||
| 50 | ||
| 51 | ||
| 52 | ||
| 53 | ||
Notes to Consolidated Financial Statements | 54 | |
REPORT OF INDEPENDENT AUDITORS
REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Cree, Inc.
We have audited the accompanying consolidated balance sheets of Cree, Inc. as of June 30, 200227, 2004 and June 24, 2001,29, 2003, and the related consolidated statements of operations, shareholders'shareholders’ equity and cash flows for each of the three years in the period ended June 30, 2002.27, 2004. These financial statements are the responsibility of the Company'sCompany’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditingthe standards generally accepted
inof the United States.Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Cree, Inc. at June 30, 200227, 2004 and June 24, 2001,29, 2003, and the consolidated results of its operations and its cash flows for each of the three years in the period ended June 30, 2002,27, 2004, in conformity with accounting principlesU.S. generally accepted accounting principles.
As discussed in Note 2 to the United States.
/s/ Ernst & Young LLP
consolidated financial statements, in fiscal 2003 the Company adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets and changed its method of accounting for goodwill.
Raleigh, North Carolina
July 24, 2002
-48-
CONSOLIDATED BALANCE SHEETS
(In
(In thousands, except per share amounts)
June 30, June 24,
2002 2001
----------- ------------
ASSETS
Current assets:
Cash and cash equivalents $ 73,744 $ 164,562
Short-term investments held to maturity 32,396 36,965
Marketable securities available for sale 6,008 6,675
Accounts receivable, net 34,592 34,850
Interest receivable 2,083 1,270
Inventories, net 17,966 15,202
Deferred income taxes 1,122 4,172
Prepaid expenses and other current assets 5,994 2,220
----------- ------------
Total current assets 173,905 265,916
Property and equipment, net 211,685 226,920
Goodwill and intangible assets, net -- 83,282
Long-term investments held to maturity 64,225 7,971
Deferred income taxes 27,365 --
Patent and license rights, net 4,251 3,246
Other assets 22,764 27,788
----------- ------------
Total assets $ 504,195 $ 615,123
=========== ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable, trade $ 13,075 $ 14,147
Accrued salaries and wages 4,010 2,435
Other accrued expenses 4,969 5,156
----------- ------------
Total current liabilities 22,054 21,738
Long term liabilities:
Deferred income taxes -- 3,850
Other long-term liabilities 37 438
----------- ------------
Total long-term liabilities 37 4,288
Shareholders' equity:
Preferred stock, par value $0.01; 3,000 shares authorized at
June 30, 2002 and June 24, 2001; none issued and outstanding -- --
Common stock, par value $0.00125; 200,000 shares authorized at
June 30, 2002 and June 24, 2001; 72,729 and 72,907 shares issued
and outstanding at June 30, 2002 and June 24, 2001, respectively 90 91
Additional paid-in-capital 508,432 518,781
Deferred compensation (696) (1,211)
(Accumulated deficit) retained earnings (25,722) 76,001
Accumulated other comprehensive loss, net of tax -- (4,565)
----------- ------------
Total shareholders' equity 482,104 589,097
----------- ------------
Total liabilities and shareholders' equity $ 504,195 $ 615,123
=========== ============
June 27, 2004 | June 29, 2003 | ||||||
ASSETS | |||||||
Current assets: | |||||||
Cash and cash equivalents | $ | 81,472 | $ | 64,795 | |||
Short-term investments held to maturity | 76,691 | 75,242 | |||||
Accounts receivable, net | 47,766 | 43,901 | |||||
Interest receivable | 1,752 | 1,650 | |||||
Inventories, net | 19,428 | 17,674 | |||||
Deferred income taxes | 2,560 | 1,863 | |||||
Prepaid expenses and other current assets | 5,224 | 4,230 | |||||
Total current assets | 234,893 | 209,355 | |||||
Property and equipment, net | 273,342 | 251,346 | |||||
Long-term investments held to maturity | 72,730 | 58,794 | |||||
Marketable securities available for sale | 22,002 | — | |||||
Deferred income taxes | — | 20,934 | |||||
Patent and license rights, net | 19,831 | 7,146 | |||||
Other assets | 5,202 | 16,119 | |||||
Total assets | $ | 628,000 | $ | 563,694 | |||
LIABILITIES AND SHAREHOLDERS’ EQUITY | |||||||
Current liabilities: | |||||||
Accounts payable, trade | $ | 25,102 | $ | 14,916 | |||
Accrued salaries and wages | 8,125 | 5,756 | |||||
Deferred revenue | 8,437 | 5,533 | |||||
Other accrued expenses | 3,318 | 2,087 | |||||
Total current liabilities | 44,982 | 28,292 | |||||
Long term liabilities: | |||||||
Deferred income taxes | 3,886 | — | |||||
Other long-term liabilities | — | 31 | |||||
Total long-term liabilities | 3,886 | 31 | |||||
Commitments and contingencies (Notes 12 and 14) | |||||||
Shareholders’ equity: | |||||||
Preferred stock, par value $0.01; 3,000 shares authorized at June 27, 2004 and June 29, 2003; none issued and outstanding | — | — | |||||
Common stock, par value $0.00125; 200,000 shares authorized at June 27, 2004 and June 29, 2003; 73,245 and 74,127 shares issued and outstanding at | 91 | 92 | |||||
Additional paid-in-capital | 506,275 | 526,318 | |||||
Deferred compensation | — | (218 | ) | ||||
Other comprehensive income, net of taxes | 5,627 | — | |||||
Retained earnings | 67,139 | 9,179 | |||||
Total shareholders’ equity | 579,132 | 535,371 | |||||
Total liabilities and shareholders’ equity | $ | 628,000 | $ | 563,694 | |||
The accompanying notes are an integral part of the consolidated financial statements.
-49-
CONSOLIDATED STATEMENTS OF OPERATIONS
(In
(In thousands, except per share amounts)
Year Ended
--------------------------------------------------------------
June 30, June 24, June 25,
2002 2001 2000
------------------- ------------------ -----------------
Revenue:
Product revenue, net $ 136,230 $ 159,533 $ 96,742
Contract revenue, net 19,204 17,694 11,820
------------------- ------------------ -----------------
Total revenue 155,434 177,227 108,562
Cost of revenue:
Product revenue, net 78,249 76,734 43,399
Contract revenue, net 13,827 12,967 8,963
------------------- ------------------ -----------------
Total cost of revenue 92,076 89,701 52,362
------------------- ------------------ -----------------
Gross profit 63,358 87,526 56,200
Operating expenses:
Research and development 28,026 12,980 7,054
Sales, general and administrative 25,618 18,111 11,091
Intangible asset amortization 6,765 4,537 --
In-process research and development costs -- 17,400 --
Impairment charges and other expense 97,223 62 1,305
------------------- ------------------ -----------------
(Loss) income from operations (94,274) 34,436 36,750
Other non-operating (expense) income (41,848) 82 656
Interest income, net 5,708 15,668 9,400
------------------- ------------------ -----------------
(Loss) income before income taxes (130,414) 50,186 46,806
Income tax (benefit) expense (28,691) 22,343 16,286
------------------- ------------------ -----------------
Net (loss) income ($101,723) $ 27,843 $ 30,520
=================== ================== =================
(Loss) earnings per share:
Basic ($1.40) $ 0.39 $ 0.46
=================== ================== =================
Diluted ($1.40) $ 0.37 $ 0.43
=================== ================== =================
Shares used in per share calculation:
Basic 72,718 72,243 65,930
=================== ================== =================
Diluted 72,718 75,735 70,434
=================== ================== =================
| Year Ended | |||||||||||
June 27, 2004 | June 29, 2003 | June 30, 2002 | |||||||||
Revenue: | |||||||||||
Product revenue, net | $ | 279,923 | $ | 202,962 | $ | 136,230 | |||||
Contract revenue, net | 26,947 | 26,860 | 19,204 | ||||||||
Total revenue | 306,870 | 229,822 | 155,434 | ||||||||
Cost of revenue: | |||||||||||
Product revenue, net | 136,112 | 109,726 | 78,249 | ||||||||
Contract revenue, net | 22,342 | 20,926 | 13,827 | ||||||||
Total cost of revenue | 158,454 | 130,652 | 92,076 | ||||||||
Gross profit | 148,416 | 99,170 | 63,358 | ||||||||
Operating expenses: | |||||||||||
Research and development | 36,886 | 31,203 | 28,026 | ||||||||
Sales, general and administrative | 31,654 | 26,326 | 25,618 | ||||||||
Intangible asset amortization | — | — | 6,765 | ||||||||
Impairment of goodwill | — | — | 76,489 | ||||||||
Loss on disposal of property and equipment | 1,016 | 1,569 | 19,019 | ||||||||
Severance charges | — | 400 | 875 | ||||||||
Gain on termination of supply agreement | — | (5,000 | ) | — | |||||||
Other expense | — | — | 840 | ||||||||
Total operating expenses | 69,556 | 54,498 | 157,632 | ||||||||
Income (loss) from operations | 78,860 | 44,672 | (94,274 | ) | |||||||
Non-operating income (expense): | |||||||||||
(Loss) gain on investments in marketable securities | — | (2,067 | ) | (21,471 | ) | ||||||
Loss on long term investments | — | — | (20,377 | ) | |||||||
Other non-operating income | 1,008 | 442 | — | ||||||||
Interest income, net | 3,725 | 4,117 | 5,708 | ||||||||
Income (loss) before income taxes | 83,593 | 47,164 | (130,414 | ) | |||||||
Income tax expense (benefit) | 25,633 | 12,263 | (28,691 | ) | |||||||
Net income (loss) | $ | 57,960 | $ | 34,901 | $ | (101,723 | ) | ||||
Earnings (loss) per share: | |||||||||||
Basic | $ | 0.78 | $ | 0.48 | $ | (1.40 | ) | ||||
Diluted | $ | 0.77 | $ | 0.46 | $ | (1.40 | ) | ||||
Shares used in per share calculation: | |||||||||||
Basic | 74,008 | 73,196 | 72,718 | ||||||||
Diluted | 75,745 | 75,303 | 72,718 | ||||||||
The accompanying notes are an integral part of the consolidated financial statements.
-50-
CONSOLIDATED STATEMENTS OF CASH FLOW
(In
(In thousands)
Year Ended
--------------------------------------------------------------
June 30, June 24, June 25,
2002 2001 2000
-------------- --------------- ---------------
Operating activities:
Net (loss) income ($ 101,723) $ 27,843 $ 30,520
Adjustments to reconcile net (loss) income to net
cash provided by operating activities:
Depreciation and amortization 32,400 21,948 10,803
Loss on retirement of property and equipment and
patents 18,298 134 1,256
Amortization of patent rights 293 194 145
Amortization of intangible assets 6,796 4,537 --
Amortization of premium on securities held to maturity 157 -- --
Write-off of goodwill and other intangible assets 76,488 -- --
Acquired in-process research & development -- 17,400 --
Write-down of long-term investments 20,377 4,600 --
Purchase of marketable trading securities (1,546) (17,498) (1,786)
Proceeds from sale of marketable trading securities 2,104 23,498 2,280
Gain on marketable trading securities (558) (6,000) (494)
Loss (gain) on available for sale securities 22,028 -- (3,567)
Deferred income taxes (31,200) 13,514 (11,617)
Income tax benefits from stock option exercises 2,712 7,022 27,336
Amortization of deferred compensation 515 544 980
Changes in operating assets and liabilities:
Accounts and interest receivable (555) (18,432) (91)
Inventories (2,764) (2,035) (5,334)
Prepaid expenses and other current assets (3,773) (735) (263)
Other long-term assets (833) -- --
Accounts payable, trade (1,073) (924) 6,447
Accrued expenses and other liabilities 987 (842) 6,356
-------------- --------------- ---------------
Net cash provided by operating activities 39,130 74,768 62,971
-------------- --------------- ---------------
Investing activities:
Purchase of available for sale securities (13,761) -- (12,500)
Proceeds from sale of available for sale securities -- -- 6,291
Costs associated with the acquisition of Cree
Microwave -- (1,946) --
Purchase of securities held to maturity (118,807) (7,971) (195,883)
Proceeds from maturities of securities held to
maturity 66,965 147,461 11,457
Purchase of and deposits for property and equipment (41,635) (106,194) (78,047)
Proceeds from sale of property and equipment 721 123 --
Purchase of patent rights (1,318) (1,150) (727)
Increase in other long-term assets (9,051) (26,910) (5,141)
-------------- --------------- ---------------
Net cash (used in) provided by investing
activities (116,886) 3,413 (274,550)
-------------- --------------- ---------------
Financing activities:
Net repayment of long-term debt -- -- (47)
Net proceeds from issuance of common stock 7,235 10,346 272,924
Net proceeds from sale of put options -- 2,860 --
Repurchase of common stock (20,297) (30,668) --
-------------- --------------- ---------------
Net cash (used in) provided by financing
activities (13,062) (17,462) 272,877
-------------- --------------- ---------------
Net (decrease) increase in cash and cash equivalents (90,818) 60,719 61,298
Cash and cash equivalents:
Beginning of year 164,562 103,843 42,545
-------------- --------------- ---------------
End of year $ 73,744 $ 164,562 $ 103,843
============== =============== ===============
Supplemental disclosure of cash flow information:
Cash paid for interest, net of amounts capitalized $ -- $ -- $ 13
============== =============== ===============
Cash paid for income taxes $ 1,901 $ 1,492 $ 272
============== =============== ===============
Non-cash investing and financing activities:
Deferred compensation $ 515 $ 544 $ 1,768
============== =============== ===============
Conversion of note payable to common stock $ -- $ -- $ 431
============== =============== ===============
Issuance of common stock in connection with the
acquisition of Cree Microwave $ -- $ 113,717 $ --
============== =============== ===============
| Year Ended | ||||||||||||
| June 27, 2004 | June 29, 2003 | June 30, 2002 | ||||||||||
Net income (loss) | $ | 57,960 | $ | 34,901 | $ | (101,723 | ) | |||||
Adjustments to reconcile net income (loss) to net cash provided by operating activities: | ||||||||||||
Depreciation and amortization | 54,570 | 41,705 | 32,400 | |||||||||
Loss on disposal of property and equipment and patents | 1,065 | 1,512 | 18,298 | |||||||||
Amortization of patent rights | 994 | 394 | 293 | |||||||||
Amortization of intangible assets | — | — | 6,796 | |||||||||
Amortization of premium on investments held to maturity | 3,224 | 2,328 | 157 | |||||||||
Write-off of goodwill and other intangible assets | — | — | 76,488 | |||||||||
Write-down of long-term investments | — | — | 20,377 | |||||||||
Purchase of marketable trading securities | — | — | (1,546 | ) | ||||||||
Proceeds from sale of marketable trading securities | — | — | 2,104 | |||||||||
Loss on available for sale securities | — | 2,067 | 21,470 | |||||||||
Deferred income taxes | 20,448 | 5,709 | (31,200 | ) | ||||||||
Income tax benefits from stock option exercises | 3,142 | 5,188 | 2,712 | |||||||||
Stock based compensation | 393 | 478 | 515 | |||||||||
Changes in operating assets and liabilities: | ||||||||||||
Accounts and interest receivable | (3,967 | ) | (13,289 | ) | (555 | ) | ||||||
Inventories | (1,107 | ) | 292 | (2,764 | ) | |||||||
Prepaid expenses and other current assets | (994 | ) | 1,764 | (3,773 | ) | |||||||
Other long-term assets | — | 368 | (833 | ) | ||||||||
Accounts payable, trade | 10,186 | 1,840 | (1,073 | ) | ||||||||
Accrued expenses and other liabilities | 6,474 | 4,392 | 987 | |||||||||
Net cash provided by operating activities | 152,388 | 89,649 | 39,130 | |||||||||
Investing activities: | ||||||||||||
Purchase of available for sale securities | — | — | (13,761 | ) | ||||||||
Proceeds from sale of available for sale securities | — | 3,921 | — | |||||||||
Purchase of ATMI assets | (10,684 | ) | — | — | ||||||||
Purchase of long-term investments held to maturity | (128,683 | ) | (118,934 | ) | (118,807 | ) | ||||||
Proceeds from maturities of investments held to maturity | 110,072 | 84,253 | 66,965 | |||||||||
Purchase of and deposits for property and equipment | (77,280 | ) | (77,643 | ) | (41,635 | ) | ||||||
Proceeds from sale of property and equipment | 8 | 635 | 721 | |||||||||
Purchase of patent rights | (5,916 | ) | (3,289 | ) | (1,318 | ) | ||||||
Decrease (increase) in other long-term assets | 133 | (241 | ) | (9,051 | ) | |||||||
Net cash used in investing activities | (112,350 | ) | (111,298 | ) | (116,886 | ) | ||||||
Financing activities: | ||||||||||||
Net proceeds from issuance of common stock | 11,376 | 12,700 | 7,235 | |||||||||
Repurchase of common stock | (34,737 | ) | — | (20,297 | ) | |||||||
Net cash (used in) provided by financing activities | (23,361 | ) | 12,700 | (13,062 | ) | |||||||
Net increase (decrease) in cash and cash equivalents | 16,677 | (8,949 | ) | (90,818 | ) | |||||||
Cash and cash equivalents: | ||||||||||||
Beginning of year | 64,795 | 73,744 | 164,562 | |||||||||
End of year | $ | 81,472 | $ | 64,795 | $ | 73,744 | ||||||
Supplemental disclosure of cash flow information: | ||||||||||||
Cash paid for income taxes | $ | 3,047 | $ | 800 | $ | 1,901 | ||||||
Non-cash investing and financing activities: | ||||||||||||
Deferred compensation | $ | 393 | $ | 478 | $ | 515 | ||||||
The accompanying notes are an integral part of the consolidated financial statements.
-51-
CONSOLIDATED STATEMENTS OF SHAREHOLDERS'SHAREHOLDERS’ EQUITY
YEARS ENDED JUNE 30, 2002, JUNE 24, 2001 AND JUNE 25, 2000
(In
(In thousands)
(Accumulated Accumulated
Common Additional Deficit) Other Total
Stock Paid-in Deferred Retained Comprehensive Shareholders'
Par Value Capital Compensation Earnings Income/(Loss) Equity
----------- ------------- -------------- ------------- ---------------- ---------------
Balance at June 27, 1999 $ 77 $ 113,268 $ (967) $ 17,638 $ 987 $ 131,003
Common stock options and warrants
exercised for cash, 954 shares 3 6,750 6,753
Employees granted stock options, 137
shares 785 (785) --
Employees granted stock, 171 shares 983 (983) --
Common stock warrants granted, 16 shares 31 31
Loan converted to common stock, 169
shares 431 431
Issuance of common stock for cash, 3,289
shares 8 266,132 266,140
Income tax benefits from stock option
exercises 27,336 27,336
Amortization of deferred compensation 980 980
Net income 30,520 30,520
Unrealized loss on securities available
for sale, net of tax of $27 (52) (52)
-------------
Comprehensive income 30,468
----------- ------------- -------------- ------------- ---------------- ---------------
Balance at June 25, 2000 88 415,716 (1,755) 48,158 935 463,142
Common stock options and warrants
exercised for cash, 870 shares 2 7,368 7,370
Issuance of common stock for cash, 113
shares 2,976 2,976
Issuance of common stock in connection
with purchase business combination,
2,657 shares 3 113,505 113,508
Purchase and retirement of 1,850
treasury shares (2) (30,666) (30,668)
Income tax benefits from stock option
exercises 7,022 7,022
Amortization of deferred compensation 544 544
Premium Received Put Option buy back 2,860 2,860
Net income 27,843 27,843
Unrealized loss on securities available
for sale, net of tax of $3,667 (5,500) (5,500)
---------------
Comprehensive income 22,343
----------- ------------- -------------- ------------- ---------------- ---------------
Balance at June 24, 2001 91 518,781 (1,211) 76,001 (4,565) 589,097
Common stock options exercised for cash,
1,053 shares 1 4,229 4,230
Issuance of common stock for cash, 245
shares 3,005 3,005
Purchase and retirement of 1,489
treasury shares (2) (20,295) (20,297)
Income tax benefits from stock option
exercises 2,712 2,712
Amortization of deferred compensation 515 515
Net loss (101,723) (101,723)
Unrealized losses on securities
available for sale, net of taxes of
$3,174 (11,253) (11,253)
Losses on available for sale securities
reclassified from other comprehensive
income, net of taxes of $6,210 due to an
other than temporary decline in value 15,818 15,818
---------------
Comprehensive loss (97,158)
----------- ------------- -------------- ------------- ---------------- ---------------
Balance at June 30, 2002 $ 90 $ 508,432 $ (696) $ (25,722) $ -- $ 482,104
=========== ============= ============== ============= ================ ===============
Common Stock Par Value | Additional Paid-in Capital | Deferred Compensation | Retained Earnings (Accumulated Deficit) | Accumulated Other Comprehensive Income/(Loss) | Total Shareholders’ Equity | |||||||||||||||||||
Balance at June 24, 2001 | $ | 91 | $ | 518,781 | $ | (1,211 | ) | $ | 76,001 | $ | (4,565 | ) | $ | 589,097 | ||||||||||
Common stock options exercised for cash, 1,053 shares | 1 | 4,229 | — | — | — | 4,230 | ||||||||||||||||||
Issuance of common stock for cash, 245 shares | — | 3,005 | — | — | — | 3,005 | ||||||||||||||||||
Purchase and retirement of 1,489 treasury shares | (2 | ) | (20,295 | ) | — | — | — | (20,297 | ) | |||||||||||||||
Income tax benefits from stock option exercises | — | 2,712 | — | — | — | 2,712 | ||||||||||||||||||
Amortization of deferred compensation | — | — | 515 | — | — | 515 | ||||||||||||||||||
Net loss | — | — | — | (101,723 | ) | — | (101,723 | ) | ||||||||||||||||
Unrealized loss on securities available for sale, net of tax of $3,174 | — | — | — | — | (11,253 | ) | (11,253 | ) | ||||||||||||||||
Losses on available for sale securities reclassified from other comprehensive income, net of taxes of $6,210 due to an other than temporary decline in value | — | — | — | — | 15,818 | 15,818 | ||||||||||||||||||
Comprehensive loss | — | — | — | — | — | (97,158 | ) | |||||||||||||||||
Balance at June 30, 2002 | 90 | 508,432 | (696 | ) | (25,722 | ) | — | 482,104 | ||||||||||||||||
Common stock options exercised for cash, 1,093 shares | 2 | 9,591 | — | — | — | 9,593 | ||||||||||||||||||
Issuance of common stock for cash, 306 shares | — | 3,107 | — | — | — | 3,107 | ||||||||||||||||||
Income tax benefits from stock option exercises | — | 5,188 | — | — | — | 5,188 | ||||||||||||||||||
Amortization of deferred compensation | — | — | 478 | — | — | 478 | ||||||||||||||||||
Net income and comprehensive income | — | — | — | 34,901 | — | 34,901 | ||||||||||||||||||
Balance at June 29, 2003 | 92 | 526,318 | (218 | ) | 9,179 | — | 535,371 | |||||||||||||||||
Common stock options exercised for cash, 701 shares | 1 | 7,684 | — | — | — | 7,685 | ||||||||||||||||||
Issuance of common stock for cash, 245 shares | — | 3,691 | — | — | — | 3,691 | ||||||||||||||||||
Purchase and retirement of 1,828 treasury shares | (2 | ) | (34,735 | ) | — | — | — | (34,737 | ) | |||||||||||||||
Income tax benefits from stock option exercises | — | 3,142 | — | — | — | 3,142 | ||||||||||||||||||
Stock based compensation | — | 175 | (175 | ) | — | — | — | |||||||||||||||||
Amortization of deferred compensation | — | — | 393 | — | — | 393 | ||||||||||||||||||
Net income | — | — | — | 57,960 | — | 57,960 | ||||||||||||||||||
Unrealized gain on marketable securities, net of tax of $3,674 | — | — | — | — | 5,627 | 5,627 | ||||||||||||||||||
Comprehensive income | — | — | — | — | — | 63,587 | ||||||||||||||||||
Balance at June 27, 2004 | $ | 91 | $ | 506,275 | $ | — | $ | 67,139 | $ | 5,627 | $ | 579,132 | ||||||||||||
The accompanying notes are an integral part of the consolidated financial statements.
-52-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2002
27, 2004
1. NATURE OF BUSINESS
Nature of Business
Cree, Inc., the "Company,"“Company,” or "Cree,"“Cree,” a North Carolina corporation, develops, manufactures, and markets silicon carbide ("SiC")(SiC) and group III nitrides (GaN) including gallium nitride ("GaN") based semiconductor materials and devices, as well as radio frequency ("RF")(RF) and microwave devices made from silicon. Revenues are primarily derived from the sale of blue, green and near ultra-violet, ("UV"), blue and green(UV) light emitting diodes ("LEDs"),(LEDs) and SiC and GaN based materials and RF and microwave devices.materials. The Company markets its blue, green and near UV blue and green LED chip products principally to customers who incorporate them into packaged lamps for resale to original equipment manufacturers. The Company also sells SiC and GaN material products primarily to corporate, government, and university research laboratories. RF and microwave
devices are sold primarily to power amplifier manufacturers. In addition, the Company is engaged in a variety of research programs related to the advancement of SiC and GaN process technology and the development of electronic and optoelectronic devices that take advantage of these materials'materials’ unique physical and electronic properties. The Company has historically recovered the costs
2. Summary of a
significant portion of its researchSignificant Accounting Policies and development efforts from revenues on
contracts with agencies of the U.S. Federal government.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND OTHER MATTERS
Other Matters
Principles of Consolidation
The consolidated financial statements include the accounts of Cree, Inc., and its wholly-owned subsidiaries, Cree Microwave, Inc. ("Cree Microwave")(Cree Microwave), Cree Lighting Company ("Cree Lighting")(Cree Lighting), Cree Research FSC, Inc. ("FSC")(FSC), Cree Funding, LLC ("Cree Funding")(Cree Funding), Cree Employee Services Corporation, Cree Technologies, Inc., CI Holdings, Limited, Cree Asia-Pacific, Inc and Cree Japan, Inc. FSC was dissolved effective July 10, 2002, Cree Lighting was merged into the Company effective June 29, 2003 and Cree Funding was merged into the Company effective June 27, 2004. All material intercompany accounts and transactions have been eliminated in consolidation.
Business Combination
On December 29, 2000,
The Company acquired the GaN substrate and epitaxy business of Advanced Technology Materials, Inc. (ATMI) effective March 31, 2004. The Company completedsigned a definitive agreement to purchase the acquisitionintellectual property, fixed assets and inventory of this business for $10.3 million in cash. The Company accounted for this transaction under the purchase method and there was no resulting goodwill. The operating results of the Cree
Microwave division (formerly known as UltraRF) of Spectrian Corporation, or
Spectrian, through the purchase of assets of the business by Cree's wholly owned
subsidiary, Cree Microwave, Inc. in a business combination accounted for using
the purchase method. Under the terms of the Asset Purchase Agreement, Cree
Microwave acquired substantially all of the net assets of the business from Spectrian in exchange for a total of 2,656,917 shares of Cree common stock
valued at $113.5 million. Of the total shares issued, 191,094 shares were placed
in escrow and proceeds from the sale of such shares were retained in escrow to
secure Spectrian's representations, warranties and covenants under the Asset
Purchase Agreement. Under the terms of the escrow arrangement, one-half of the
funds were released to Spectrian in June 2001 and the balance was released in
December 2001 because no claims were made against the escrowed assets. The
results of operations of Cree Microwave have beenATMI are included in the accompanying consolidated resultsstatement of the Company sinceoperations from the date of acquisition.
In connection with the acquisition of the Cree Microwave business, the Company
recognized a one-time charge of $17.4 million during fiscal 2001 representing
the write-off of the appraised value of certain acquired in-process research and
development costs as of the acquisition date.
-53-
Pro Forma Summary Data
The following pro forma summary data for the twelve months ended June 24, 2001
presents the consolidated results of operations as if the acquisition of Cree
Microwave made during 2001 had occurred as of June 26, 2000. These pro forma
results have been prepared for comparative purposes only and do not purport to
be indicative of what would have occurred had the acquisition been made as of
June 26, 2000 or of results that may occur in the future.
Year Ended June 24, 2001
(in 000's except per share
data)
--------------------------
Pro forma revenue $ 194,357
Pro forma net income 42,065
Pro forma basic net income per share $ 0.58
Pro forma diluted net income per share $ 0.56
On May 1, 2000, the Company acquired Nitres, Inc. ("Nitres") in a business
combination accounted for as a pooling of interests. Nitres, became a wholly
owned subsidiary (Cree Lighting Company) of the Company through the exchange of
3,695,492 shares of the Company's common stock for all of the outstanding stock
of Nitres. In addition, the Company assumed outstanding stock options and
warrants, which after adjustment for the exchange represented a total of 304,446
options and warrants to purchase shares of Cree's common stock. The accompanying
consolidated financial statements for fiscal 2000 are based on the assumption
that the companies were combined for the full year. All prior period
consolidated financial statements have been restated to include the results of
operations, financial position and cash flows of Nitres, as though Nitres had
been a part of the Company for all periods presented.
Reconciliation of Previously Reported Operations - Selected Financial Data
The following table reflects the summarized results of operations of the
separate companies for the nine months ended March 26, 2000, the nearest
practical reporting period prior to the business combination on May 1, 2000. In
addition, a reconciliation of the amounts of net sales and net income previously
reported with restated amounts is included.
-54-
(Unaudited)
Nine months ended
March 26, 2000
(in 000's)
-------------------
Net sales and other revenue:
As previously reported by Cree, Inc. $ 72,342
Nitres, Inc. 2,887
Elimination of intercompany transactions (27)
-------------------
As restated $ 75,202
===================
Net income (loss):
As previously reported by Cree, Inc. $ 19,575
Nitres, Inc. (392)
Elimination of intercompany transactions (20)
-------------------
As restated $ 19,163
===================
Elimination of Prior Intercompany Transactions
Prior to May 1, 2000, the Company and Nitres, in the normal course of business,
entered into certain transactions for the purchase and sale of merchandise.
These intercompany transactions have been eliminated in the accompanying
restated consolidated financial statements.
Business Segments
The Company operates in two business segments, Cree and Cree Microwave. The Cree segment incorporates its proprietary technology to produce wide bandgap compound semiconductors using SiC and GaN.GaN technology. Products from this segment are sold for useused in cellular handsets,mobile appliances, automotive backlighting, indicator lamps, full color LED displays and other lighting applications as well as microwave and power applications. The Cree segment also sells SiC and GaN material products to corporate, government and university research laboratories and generates revenue from contracts with agencies of the U.S. Federal government.
The Cree Microwave segment designs, manufactures and markets a line of silicon-based laterally diffused metal oxide semiconductors or LDMOS(LDMOS) and bipolar radio frequency power semiconductors and modules, thea critical component utilized in building power amplifiers for wireless infrastructure applications.
applications as well as products serving military and aeronautics markets.
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
June 27, 2004
Summarized financial information concerning the reportable segments as of and for the years ended June As of and for the Year Ended June 27, 2004 (in 000’s) Highlights from the Statement of Operations: Product revenue Contract revenue Total revenue Cost of revenue Gross profit (loss) Research and development Selling, general and administrative Interest income Income (loss) before income taxes Income tax expense (benefit) Depreciation and amortization Other financial information: Inventories, net Property and equipment, net Additions to property and equipment Total assets As of and for the Year Ended June 29, 2003 (in 000’s) Highlights from the Statement of Operations: Product revenue Contract revenue Total revenue Cost of revenue Gross profit (loss) Research and development Selling, general and administrative Interest income Income (loss) before income taxes Income tax expense (benefit) Depreciation and amortization Other financial information: Inventory, net Property and equipment, net Additions to property and equipment Total assets CREE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued) June 27, 2004 As of and for the Year Ended June 30, 2002 (in 000’s) Cree Microwave Highlights from the Statement of Operations: Product revenue Contract revenue Total revenue Cost of revenue Gross profit Research and development Selling, general and administrative Amortization of purchased intangibles Write-off of intangible assets Write-off of fixed assets Loss on marketable securities and long term asset investments Interest income Loss before income taxes Income tax benefit Depreciation and amortization Other financial information: Inventory, net Property and equipment, net Additions to property and equipment Total assets Reclassifications Certain fiscal 2003 and30, 200227, 2004, June 29, 2003 and June 24, 200130, 2002 is shown in the following table. There were no intercompany sales between the Cree segment and the Cree Microwave segment during fiscal 2004, 2003 or 2002. The "Other"“Other” column represents amounts excluded from specific segments such as interest income, and write-downs for investments made in publiclymarketable equity securities or long-term investments held to maturity and privately held equitygains or losses on the sale of marketable securities. In addition, the "Other"“Other” column also includes corporate assets such as cash and cash equivalents, short-term investments held to maturity, marketable securities, interest receivable and long-term investments held to maturity which have not been allocated to a specific segment.
-55-
As of Cree Cree
Microwave Other Total $ 272,205 $ 7,718 $ — $ 279,923 26,947 — — 26,947 299,152 7,718 — 306,870 147,858 10,596 — 158,454 151,294 (2,878 ) — 148,416 32,878 4,008 — 36,886 28,718 2,936 — 31,654 — — 3,725 3,725 89,835 (9,967 ) 3,725 83,593 27,548 (3,058 ) 1,143 25,633 $ 51,947 $ 2,623 — $ 54,570 $ 17,588 $ 1,840 $ — $ 19,428 264,123 9,219 — 273,342 77,007 273 — 77,280 $ 372,246 $ 13,621 $ 242,133 $ 628,000 Cree Cree
Microwave Other Total $ 200,165 $ 2,797 $ — $ 202,962 26,860 — — 26,860 227,025 2,797 — 229,822 118,677 11,975 — 130,652 108,348 (9,178 ) — 99,170 26,682 4,521 — 31,203 23,558 2,768 — 26,326 — — 4,117 4,117 57,000 (11,886 ) 2,050 47,164 14,820 (3,090 ) 533 12,263 $ 39,450 $ 2,255 $ — $ 41,705 $ 17,257 $ 417 $ — $ 17,674 239,525 11,821 — 251,346 76,385 1,258 — 77,643 $ 334,049 $ 13,576 $ 216,069 $ 563,694 Cree Other Total $ 111,435 $ 24,795 $ — $ 136,230 19,204 — — 19,204 130,639 24,795 — 155,434 71,994 20,082 — 92,076 58,645 4,713 — 63,358 22,699 5,327 — 28,026 21,920 3,698 — 25,618 — 6,765 — 6,765 — 76,489 — 76,489 18,917 102 — 19,019 — — (41,848 ) (41,848 ) — — 5,708 5,708 (4,891 ) (89,384 ) (36,139 ) (130,414 ) (1,076 ) (19,664 ) (7,951 ) (28,691 ) $ 30,168 $ 2,232 $ — $ 32,400 $ 14,835 $ 3,131 $ — $ 17,966 198,855 12,830 — 211,685 34,617 7,018 — 41,635 $ 289,921 $ 19,187 $ 195,087 $ 504,195 for the Year Ended Cree
June 30, 2002 (in 000's) Cree Microwave Other Total
------------------------------------------------- --------------- ---------------- ---------------- ---------------
Revenue $ 130,639 $ 24,795 $ -- $ 155,434
Depreciation and amortization 30,168 2,232 -- 32,400
Loss before income taxes (4,891) (89,384) (36,139) (130,414)
Assets $ 289,921 $ 19,187 $ 195,087 $ 504,195
As of and for the Year Ended Cree
June 24, 2001 (in 000's) Cree Microwave Other Total
------------------------------------------------- --------------- ---------------- ---------------- ---------------
Revenue $ 157,999 $ 19,228 $ -- $ 177,227
Depreciation and amortization 20,991 957 -- 21,948
Income (loss) before income taxes 51,743 (17,225) 15,668 50,186
Assets $ 298,495 $ 99,185 $ 217,443 $ 615,123
QUARTERLY RESULTS OF OPERATIONS - UNAUDITED
The following is a summary of the Company's consolidated quarterly results
of operations for each of the fiscal years ended June 30, 2002 and June
24, 2001 (in thousands, except per share data).
September 23, December 23, March 24, June 30, Fiscal Year
2001 2001 2002 2002 2002
---------------------------------- ------------------------------------------------
Net revenue $43,166 $ 41,092 $ 33,376 $ 37,800 $ 155,434
Cost of revenue 23,262 21,717 24,999 22,098 92,076
Net income (loss) $ 6,460 $(17,376) $(68,286) $(22,521) $(101,723)
Earnings (loss) per share:
Basic $ 0.09 ($0.24) ($0.94) ($0.31) ($1.40)
Diluted $ 0.09 ($0.24) ($0.94) ($0.31) ($1.40)
September 24, December 24, March 25, June 24, Fiscal Year
2000 2000 2001 2001 2001
-------------- ------------- ------------ ------------- ------------
Net revenue $37,642 $ 41,494 $ 53,365 $ 44,726 $ 177,227
Cost of revenue 17,076 19,420 27,668 25,537 89,701
Net income (loss) $12,655 $ 13,861 $ (5,182) $ 6,509 $ 27,843
Earnings (loss) per share:
Basic $ 0.18 $ 0.19 ($0.07) $ 0.09 $ 0.39
Diluted $ 0.17 $ 0.18 ($0.07) $ 0.09 $ 0.37
Reclassifications
Certain 2001 and 2000 amounts in the accompanying consolidated financial statements have been reclassified to conform to the 2002fiscal 2004 presentation. These reclassifications had no effect on previously reported net income (loss) or shareholders'shareholders’ equity.
Fiscal Year
The Company'sCompany’s fiscal year is a 52 or 53-week period ending on the last Sunday in the month of June. Fiscal 2002The Company’s 2004 fiscal year extended from June 30, 2003 through June 27, 2004 and was a 53-week52-week fiscal year. The Company’s 2003 fiscal year that ended onextended from July 1, 2002 through June 30, 2002.
-56-
Estimates
The preparation of the consolidated financial statements in conformity with accounting principlesU.S. generally accepted in the United Statesaccounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities, at June 30, 200227, 2004 and June 24, 2001,29, 2003, and the reported amounts of revenues and expenses during the years ended June 30, 2002,27, 2004, June 24, 200129, 2003 and June 25, 2000.30, 2002. Actual amounts could differ from those estimates.
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
June 27, 2004
Revenue Recognition
Revenue on product sales is recognized when persuasive evidence of an
arrangementa contract exists, such as when a purchase order or contract is received from the customer, the price is fixed, title of the goods has transferred and there is a reasonable assurance of collection of the sales proceeds. We obtainThe Company obtains written purchase authorizations from ourits customers for a specified amount of product at a specified price and considerconsiders delivery to have occurred at the time of shipment. The majority of the Company’s products have shipping terms that are free on board (FOB) or free carrier alongside (FCA) shipping point, which means that the Company fulfills the obligation to deliver when the goods are handed over and into the charge of the carrier at our shipping dock. This means that the buyer bears all costs and risks of loss of or damage to the goods from that point. The difference between FOB and FCA is that under FCA terms, the customer designates a shipping carrier of choice to be used. In certain cases, the Company ships its products cost insurance and freight (CIF). Under this arrangement, revenue is recognized under FOB shipping point terms, however, the Company is responsible for the cost of insurance to transport the product as well as the cost to ship the product. For all of our sales other than those with CIF terms, the Company invoices its customers only for shipping costs necessary to physically move the product from its place of business to the customer’s location. The costs primarily consist of overnight shipping charges. The Company incurs the direct shipping costs on behalf of the customer and invoices the customer to obtain direct reimbursement for such costs. The Company accounts for its shipping costs by recording the amount of freight that is invoiced to customers as revenue, with the corresponding cost recorded as cost of revenue. In fiscal 2004, the Company recognized $117,000 as revenue for shipping and handling costs. In fiscal years 2003 and 2002, the Company accounted for such costs as a cost of revenue with the reimbursement of these costs reflected as a direct offset and reduction of cost of revenue. Such shipping costs were not material in those fiscal years. If inventory is maintained at a consigned location, revenue is recognized when ourthe Company’s customer pulls product for their use. We provide ouruse and the title of the goods is transferred to the customer. The Company provides its customers with limited rights of return for non-conforming shipments and warranty claims for up to 36 months for Cree Microwave products. The Company accrues estimated warranty expense as a limited rightcost of return. Revenue is recognized at shipment, and
we recordrevenue. The Company also records a reserve for estimated sales returns as a reduction of revenue at the time of revenue recognition. Significant judgments and estimates made by management are used in connection with establishing the allowance for sales returns. Material differences may result in the amount and timing of the Company’s revenue for any period if management made different judgments or utilized different estimates. The allowance for sales returns at June 27, 2004 and June 30, 2003 was $798,000 and $644,000, respectively. For two customers, Sumitomo and OSRAM, the Company defers revenue equal to levels specified in contractual arrangements. This deferred revenue amounted to $8.4 million and $5.5 million as of June 27, 2004 and June 29, 2003, respectively, which predominantly related to amounts deferred under the Sumitomo contract.
Revenue from government contracts and certain private entities is recorded on the percentage-of-completionproportional performance method as contract expenses per contract are incurred. Contract revenue represents reimbursement by various U.S. Government entities to aid in the development of the Company'snew technology. The applicable contracts generally provide that the Company may elect to retain ownership of inventions made in performing the work, subject to a non-transferable, non-exclusive license retained by the government to practice the inventions for government purposes. Contract revenue includesThe 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, costs and a portion of the Company's general and administrative expenses and other operating expenses for contracts under whichthe cost of capital expenses. Cost-plus funding is expecteddetermined based on actual costs plus a set percentage margin. For the cost-share contracts, the actual costs relating to the activities to be performed by the Company under the contract 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
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
June 27, 2004
research regarding SiC and Group III nitride materials and devices. The contracts typically require the submission of a written report that documents the results of such research, as well as some material deliverables.
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. The specific reimbursement
provisionscontract, funding is reported as contract revenue and all direct costs are reported as costs of the contracts, including the portion of the Company's general and
administrative expenses and other operating expenses that are reimbursed, vary
by contract. Such reimbursements are recorded as contract revenue. For contracts under which the Company anticipates that direct costs of the activities subject to the contract will exceed amounts to be funded over the life of the contract, (i.e., certain cost share arrangements),
the Company reports direct costs are reported as research and development expenses withand related reimbursements recordedfunding is reported as an offset toof those expenses.
Cash and Cash Equivalents
Cash and cash equivalents consist of unrestricted cash accounts and highly liquid investments with an original maturity of three months or less when purchased.
Fair Value of Financial Instruments
The carrying amounts of cash and cash equivalents, short-term and long-term
investments, available for sale securities, accounts and interest receivable, accounts payable debt, and other liabilities approximate fair values at June 30, 200227, 2004 and June 24, 2001.
Investments
Investments are accounted for in accordance with Statement of Financial
Accounting Standards 115 "Accounting for Certain Investments in Debt and Equity
Securities" ("SFAS 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.
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(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.
(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 or losses excluded
from earnings and reported as a separate component of shareholders'
equity.
At June 30, 2002, the Company held marketable equity securities
available-for-sale of two public companies. At June 30, 2002, the Company owned
356,000 common shares in the first public company at an average cost of $40.10
per share, or a total cost of $14.3 million. These shares were purchased through
two transactions between May 1999 and April 2000. In June 2000, 162,600 shares
were sold for $6.3 million, with a gain on the sale recognized for $3.6 million.
The fair market value of the remaining shares held as of June 30, 2002 was $1.9
million.
At June 30, 2002, the Company owned 691,000 common shares in the second public
company at an average cost of $19.91 per share, or a total cost of $13.8
million. These shares were purchased between June 2001 and October 2001. The
fair market value of these shares as of June 30, 2002 was $4.1 million.
Management views these transactions as strategic investments and the shares are
accounted for as "available-for-sale" securities under SFAS 115. The Company
carries these investments at fair value, based on quoted market prices, and
unrealized gains and losses, net of taxes, are included in accumulated other
comprehensive income (loss), which is reflected as a separate component of
shareholders' equity. Realized gains and losses are recognized upon sale or when
declines in value are deemed to be "other than temporary" on our consolidated
statements of operations. The Company reviews equity holdings on a regular basis
to evaluate whether or not each security has experienced an
"other-than-temporary" decline in fair value. This policy requires, among other
things, a review of each of the companies' cash position, earnings\revenue
outlook, stock price performance, liquidity, ability to raise capital and
management\ownership. Based on this review, if the Company determines that an
"other-than-temporary" decline exists in the value of one of our marketable
equity securities, it is the Company's policy to write-down these equity
investments to the respective market value. The related write-down will then be
recorded as an investment loss on the Company's consolidated statements of
operations. As of June 30, 2002, the Company believed that an
"other-than-temporary" decline in market value had occurred in both of these
marketable equity investments. Accordingly, the Company has written down these
equity investments to their market values as of June 30, 2002 and recorded the
unrealized losses previously recorded as comprehensive items as a non-operating
loss on our consolidated statements of operations. The total amount of the
charge to non-operating expenses in the consolidated statements of operations
for the year ended June 30, 2002 relating to these investments was $22.0
million. One of the companies the Company invested in funded a research and
development project for custom LEDs and lasers. The amount of funding received
by the Company was $4.4 million; $4.7 million and $3.1 million for the fiscal
years ended June 30, 2002, June 24, 2001 and June 25, 2000, respectively. The
amount of the research and development funding received from the company was
recorded as an offset to research and development expense. The Company does not
anticipate additional funding from this company.
As of June 30, 2002, the Company's short-term investments held to maturity
included $32.4 million in high-grade corporate bonds and other debt securities
that mature within one year. As of June 24, 2001, the Company's short-term
investments held to maturity totaled $36.9 million consisting of high-grade
corporate bonds. The Company purchased these 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
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securities are reported on the consolidated balance sheets at amortized cost, as
a short-term investment with unpaid interest included in interest receivable.
As of June 30, 2002, the Company's long-term investments held to maturity
consisted of $64.2 million in high-grade corporate bond holdings and other debt
securities that mature after June 29, 2003. As of June 24, 2001, the Company's
long-term investments held to maturity consisted of $7.9 million in high-grade
corporate bond holdings. 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 consolidated balance sheets at amortized
cost, as a long-term held to maturity investment with unpaid interest included
in interest receivable if interest is due in less than 12 months, and as a
long-term other asset if interest is due in more than 12 months. These
investments mature over periods ranging from 13 months to 2 years.
As of June 30, 2002, the Company maintained $16.0 million of net investments in
privately held companies, which are included in other assets on the consolidated
balance sheet. Since the Company does not have the ability to exercise
significant influence over the operations of these companies, these investment
balances are carried at cost and accounted for using the cost method of
accounting. Because the shares of stock the Company received in these
investments are not publicly traded, there is no established market for these
securities. The Company has a policy to review the fair value of these
investments on a regular basis to evaluate the carrying value of such
investments. This policy includes, but is not limited to, reviewing each of the
companies' cash position, financing needs, earnings\revenue outlook, operational
performance, management\ownership changes and competition. The evaluation
process is based on information requested from the privately held companies by
the Company. This information is not subject to the same disclosure regulations
as U.S. public companies, and as such, the basis for these evaluations is
subject to the timing and the accuracy of the data received from these
companies. If the Company determines that the carrying value of an investment is
at an amount in excess of fair value, it is the Company's policy to record a
write-down of the investment. This write-down is estimated based on the
information described above, and it is recorded as an investment loss on the
Company's consolidated statements of operations. During fiscal 2002 and fiscal
2001, the Company recognized write-downs of these investments of $20.4 million
and $4.6 million, respectively, representing the Company's best estimate of
"other-than-temporary" declines in value. Two of the companies we invested in
funded research and development projects. One of the projects was for brighter
LEDs; the other project was for SiC RF transistors. The total amount of funding
received by the Company was $3.5 million, $5.2 million and $0 for the fiscal
years ended June 30, 2002, June 24, 2001 and June 25, 2000, respectively. The
amount of the research and development funding received from the companies was
recorded as an offset to research and development expense. We anticipate
$500,000 of additional funding in fiscal 2003 under the remaining program.
During the first half of fiscal 2002, the Company purchased 150,000 common
shares in a public company at an average cost of $10.31 per share, or a total
cost of $1.5 million. These shares were purchased between September 2001 and
October 2001. The Company sold all of these common shares in November 2001 and
December 2001 at an average price of $14.03 per share, or total proceeds of $2.1
million. The sale of these marketable trading securities resulted in the Company
recording a realized gain on the sale of stock of $558,000. These securities
were classified as trading securities due to the short time they were owned by
the Company. During fiscal 2001, the Company purchased and sold marketable
available-for-sale securities that resulted in the Company recording a realized
gain on the sale of stock of $6.0 million, using the specific identification
method of cost determination for such investments.
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Inventories
Inventories are stated at the lower of cost or market, with cost determined underusing the first-in, first-out (FIFO) method.(“FIFO”) method for finished goods and work in process accounts. The Company uses the average cost method to value raw materials for the Cree segment. The Cree Microwave segment uses a standard cost method to value its inventory. It is the Company'sCompany’s policy to record a reserve against inventory once it has been determined that conditions exist which may not allow the Company to sell the inventory for its intended purpose, the inventory'sinventory’s value is determined to be less than cost or it is determined to be obsolete. The charge for the inventory reserves is recorded in cost of revenue on the statementconsolidated statements of operations. In the event the Company later sells inventory
that had been covered by a specific inventory reserve, the sale is recorded at
the actual selling price and the related cost of goods sold at the full
inventory cost. The Company evaluates inventory levels at least quarterly against sales forecasts on a part-by-part basis, and evaluatesin addition to determining its overall inventory risk. Reserves are adjusted monthly to reflect inventory values in excess of forecasted sales, as well as overall inventory risk assessed by management.
As of June 30, 2002, the Company maintained a $2.3 million reserve for
inventory. Of the total reserve amount, $1.8 million is attributable to the Cree
Microwave segment and $477,000 is attributable to the Cree segment.
The majority of the reserve at Cree Microwave was recorded during the third
quarter of fiscal 2002, due to information that was obtained during contract
negotiations with Spectrian, its significant customer, regarding specific order
needs over the next several quarters. Spectrian has purchased more than 90% of
the products sold by Cree Microwave since it was acquired from Spectrian in
December 2000. During these contract negotiations, Spectrian indicated that it
would only purchase the latest generation LDMOS devices from Cree Microwave
after the fourth quarter of fiscal 2002. As a result, the Company fully reserved
for inventories of non-LDMOS and other older devices deemed unsaleable in the
third quarter of fiscal 2002. The Company disposed of a portion of this
inventory during the fourth quarter of fiscal 2002, and the remainder will be
disposed of within the next twelve months.
In the fourth quarter of fiscal 2002, the Company had inventory write-downs of
$690,000 related to a packaging issue identified by some customers for the
XBright(TM) family of products. At June 30, 2002, the Cree segment reserve
consisted of $477,000 for raw materials, LED and wafer finished goods inventory.
Property and Equipment
Property and equipment are recorded at cost and depreciated on a straight-line basis over the assets’ estimated useful lives, of the assets, which range from three to forty years. Leasehold improvements are amortized over the lesser of the asset life or the life of the related lease. Expenditures for repairs and maintenance are charged to expense as incurred. The costs for major renewals and improvements are capitalized and depreciated over their estimated useful lives. The cost and related accumulated depreciation of the assets are removed from the accounts upon disposition and any resulting gain or loss is reflected in operations. During the years ended June 30, 2002,27, 2004, June 24, 200129, 2003 and June 25,
2000, the Company recorded $19.0 million, $100,000 and $1.3 million,
respectively, as losses on retirement or impairments of property and equipment
reflected in other operating expense on the consolidated statements of
operations.
During October 1999, the Company entered into two agreements with Charles and
Colvard, or C&C, to sell crystal growth equipment manufactured by the Company to
C&C at cost plus a reasonable overhead allocation. As a result of these
transactions, the Company recognized $227,000 in fiscal 2000 as "other operating
income" for the overhead allocation portion of the sales price. In May 2000, the
Company agreed to purchase all of the crystal growth equipment previously sold
to C&C for a purchase price of $5.0 million, which was less than the Company's
direct cost to manufacture the equipment.
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In the second quarter of fiscal 2000, the Company completed a 42,000 square foot
facility expansion at its production site near Research Triangle Park, North
Carolina. In the third quarter of fiscal 2000, the Company purchased a 120,000
square foot facility on 17.5 acres of land adjacent to the existing production
site. The Company uses this facility for general and administrative purposes as
well as for general employee services functions. The cost to acquire this
facility was $8.1 million. In addition, in fiscal 2002, the Company completed
construction of a 147,000 square foot expansion of its main facility.
During fiscal 2000, the Company changed its depreciation policy to reflect lower
useful lives on new manufacturing equipment. The useful lives have been reduced
from nine years to five years for all manufacturing equipment purchased since
the beginning of fiscal year 2000. In management's estimate, this new policy was
necessary due to the changes in estimated useful lives of new equipment caused
by technology changes anticipated with the future development of larger diameter
wafers. Management estimates that the change in policy reduced the Company's
fiscal 2000 net income by $889,000 or $0.03 per share.
Impairment of Property and Equipment
In accordance with SFAS 121, the Company reviews long-lived assets for
impairment based on changes in circumstances that indicate their carrying
amounts may not be recoverable. During the year ended June 30, 2002, the Company recorded impairment$1.0 million, $1.6 million, and $19.0 million, respectively, as losses on disposals or impairments of property and equipment. These charges forare reflected in loss on disposal of property and equipment totaling $19.0 million
related to assets to be disposed of, which is included as an other operating
expense onin the accompanying consolidated statements of operations. These
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
June 27, 2004
Impairment of Long-Lived Assets
In accordance with Statement of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, the Company records impairment charges wereon long-lived assets used in operations when events and circumstances indicate that the assets have been impaired. In making these determinations, the Company utilizes certain assumptions, including, but not limited to: (i) estimations of the fair market value of the assets, and (ii) estimations of future cash flows expected to be generated by these assets, which are based on additional assumptions such as asset utilization, length of service the asset will be used in our operations and estimated salvage values. The Company recorded an impairment charge for long-lived assets of $790,000 for the three months ended June 27, 2004 for obsolete production equipment that was taken out of service and destroyed. During the second and third quarters of fiscal 2004, the Cree Microwave segment identified certain equipment that was written off because the Company determined the equipment would not be used and it was unable to sell the equipment to a third party. The total amount of this write-off was $173,000. The Company also recorded a $1.4 million impairment charge for the three months ended December 29, 2002, due to technology decisionsthe election by management to discontinue a novel epitaxy reactor project. During fiscal 2002, the Company determined certain property and equipment was impaired under SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of”, which was the relevant accounting pronouncement at the time, and as a result, it recorded impairment charges of $19.0 million.
The Company also reviews its capitalized patent portfolio and records impairment charges when circumstances warrant, such as when patents have been abandoned or changes resulting inare no longer being pursued. During the obsolescence of the
assets. All of these assets were sold or disposed of byyears ended June 27, 2004, June 29, 2003 and June 30, 2002.
2002, the Company had no impairments of its patents.
Patent and License Rights
Patent rights reflect costs incurred to enhance and maintain the Company'sCompany’s intellectual property position. License rights reflect costs incurred to use the intellectual property of others. Both are amortized on a straight-line basis over the lesser of 20 years from the date of patent application or over the license period. The related amortization expense was $293,000, $194,000$994,000, $394,000 and $145,000$293,000 for the years ended June 30, 2002,27, 2004, June 24, 200129, 2003 and June 25, 2000,30, 2002, respectively. Total accumulated amortization for patents and license rights was approximately $1.3$2.7 million and $990,000$1.7 million at June 30, 200227, 2004 and June 24, 2001,29, 2003, respectively.
Goodwill and Intangible Assets
During the third quarter of fiscal 2002, the Company determined thatcompleted an impairment analysis of the intangible assets and goodwill related to the acquisition of Cree Microwave. This analysis was performed due to significant changes in business conditions for its Cree Microwave segment had changed due to several factors.at the operating segment. First, Cree Microwave amended its supply agreement with Spectrian effective March 31, 2002, which resulted in a significant reduction in quarterly revenue expectations. In addition, Cree Microwave'sMicrowave’s outlook for acquiring additional customers in the near term weakened due to delays in the development of LDMOS8 technology, the overall deteriorating economic conditions and long product qualification cycles. Also, many of the principal products that Spectrian initially indicated it would purchaseconsider purchasing from Cree Microwave in the future havewere not yet beenfully qualified and, subsequently not released to production. Underproduction at the amended supply agreement, if Cree Microwave is not able
to produce LDMOS 8 devices qualified for Spectrian's applications in a timely
manner, revenue from Spectrian may be significantly reduced after the June 2002
quarter. If our revenue declines significantly, it would have an adverse effect
on our results of operations from this segment of business. Based on these
impairment indicators, the Company performed an asset impairment analysis in
accordance with SFAS 121, "Accounting for the Impairment of Long-Lived Assets
and Long-Lived Assets to be Disposed of".time. As a result of this impairment analysis, the Company estimated that the future cash flows of the Cree Microwave business would not be sufficient to provide for recovery of the carrying value of its intangible assets and goodwill. Therefore, the remaining balance of goodwillintangible assets and intangible assetsgoodwill of $76.5 million was deemed
to be fully impaired and was written off during the third quarter of fiscalin March 2002. This write-
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offwrite-off was recorded as "other expense" onimpairment of goodwill in the accompanying consolidated statements of operations. See "Significant Sales Contracts" for further discussion
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
June 27, 2004
In November 2002, the Company entered into an agreement terminating its supply contract with Spectrian, and, due to the changed circumstances, management performed an impairment analysis of the Spectrian contract.
tangible assets at Cree Microwave as of June 27, 2004 and June 29, 2003 in accordance with SFAS 144. Based on estimations of the fair market value of the assets, and estimations of future cash flows, the Company determined that the estimated undiscounted cash flow exceeded the amount of the book value of the long-term tangible assets. As a result, no additional Cree Microwave assets were deemed impaired or written down at that time.
Prior to the impairment charge that was recorded duringdescribed in the third quarter of
fiscal 2002,preceding paragraph, intangible assets included goodwill, current technology and workforce-in-place associated with the acquisition of Cree Microwave accounted for under the purchase method in December 2000. Goodwill was capitalized at $81.5 million and represented the excess of cost over the fair value of assets acquired and was amortized using the straight-line method over ten years. CurrentOther intangible assets included current technology and workforce-in-place represented assets have beenwhich were assigned values of $5.5 million and $800,000, respectively. These intangibles were being amortized underusing the straight-line method over eight and five years, respectively. During the first three-quarters of fiscal 2002, prior to the impairment charge, the expense for intangible asset amortization was $6.8 million. During fiscal 2001, the Company recorded $4.5 million of intangible
asset amortization.
Research and Development
The U.S. Government providesand certain private entities have provided funding through research contracts for several of the Company'sCompany’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'sgovernment’s cost share is then paid to the Company. Activities performed under these arrangements include research regarding SiC and GaN materials and devices. The contracts typically require the submission of a written report that documents the results of such research, as well as some material deliverables.
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 details information about contracts for which direct expenses exceeded funding by period as included in research and development expenses:
| Year Ended (in 000’s) | |||||||||
| June 27, 2004 | June 29, 2003 | June 30, 2002 | |||||||
Net research and development costs | $ | — | $ | — | $ | 17 | |||
Government funding | — | — | 276 | ||||||
Total direct costs incurred | $ | — | $ | — | $ | 293 | |||
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
June 27, 2004
Non-government contract related research and development is expensed as incurred. Customers contributed zero in fiscal 2004, $500,000 in fiscal 2003 and $9.0 million in fiscal 2002 $11.9 million in fiscal 2001
and $5.5 million in fiscal 2000 toward product research and development activities. In addition, customers are committedThese amounts were recorded as an offset to spend an additional $462,000
in fiscal 2003 for research and development activities.
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Credit Risk, Major Customers and Major Suppliers
Financial instruments, which may subject the Company to a concentration of credit risk, consist principally of short-term and long-term investments, marketable securities, cash equivalents and accounts receivable. Short-term and long-term investments consist primarily of high-grade corporate debt, commercial paper, government securities and other investments at interest rates that vary by security. The Company'sCompany’s cash equivalents consist primarily of money market funds. Certain bank deposits may at times be in excess of the FDIC insurance limits.
The Company sells its products on account to manufacturers and researchers worldwide and generally requires no collateral. TheWhen title has transferred and the earnings process is complete, the Company maintains reservesrecords revenue and related accounts receivable. In addition, at the time of sale, the Company records an allowance for potential
credit losses,sales returns, which is recorded as an offset to accounts receivable and such losses,reduction in revenue. Such returns, in the aggregate, have generally been within management'smanagement’s expectations. The Company presently derives its contract revenue from contracts with the U.S. Government. Approximately 18% and 10%
The Company has the following percentage of the
Company'sits accounts receivable balance at June 30, 2002 and June 24, 2001,
respectively, was due from the U.S. Government. The Company had amounts due from
Osram Opto Semiconductors GmbH, or Osram totaling 13% and 18%,following customers as of accounts
receivable balances at June 30, 2002 and June 24, 2001, respectively. The
Company had amounts due from Spectrian totaling 8% and 9% of accounts receivable
balances at June 30, 2002 and June 24, 2001, respectively. The Company had
amounts due from Sumitomo Corporation totaling 9% and 14% of accounts receivable
balances at June 30, 2002 and June 24, 2001, respectively.
each year-end:
| As of | ||||||
June 27, 2004 | June 29, 2003 | |||||
Sumitomo Corporation | 22 | % | 29 | % | ||
OSRAM Semiconductors GmbH | 12 | % | 20 | % | ||
Agilent Corporation | 9 | % | 6 | % | ||
U.S. Government | 12 | % | 5 | % | ||
The Company has derived its product and contract revenue from sales in the United States, Malaysia, Japan, Other Asian countries, and Europe based on ship-to locations for ourits products as follows:
| Year ended | |||||||||
June 27, 2004 | June 29, 2003 | June 30, 2002 | |||||||
United States | 17 | % | 20 | % | 35 | % | |||
Malaysia | 23 | % | 28 | % | 23 | % | |||
Japan | 33 | % | 24 | % | 14 | % | |||
Other Asian Countries | 21 | % | 21 | % | 20 | % | |||
Europe | 6 | % | 7 | % | 8 | % | |||
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
June 27, 2004
The Company has derived its product and 26%contract revenue from sales to 10% customers as follows:
| Year ended | |||||||||
June 27, 2004 | June 29, 2003 | June 30, 2002 | |||||||
Sumitomo Corporation | 33 | % | 24 | % | 14 | % | |||
OSRAM Semiconductors GmbH | 13 | % | 21 | % | 19 | % | |||
Agilent Corporation | 13 | % | 10 | % | 9 | % | |||
Remec, Inc. (purchased Spectrian Corporation) | 1 | % | 1 | % | 16 | % | |||
U.S. Government | 9 | % | 12 | % | 12 | % | |||
In May 2004, the Company amended and restated its supply agreement with Sumitomo extending the term of revenuethe agreement to 2007. The amount of Sumitomo’s purchase commitment for fiscal 2002, 2001,2005 is $160 million, subject to adjustments and 2000, respectively. A secondcancellation provisions and end customer accounteddemand. Sumitomo orders cover demand for 14%, 22%,the Company’s products in Japan and 25%represent sales to approximately 20 LED packagers including Stanley Electronics, Citizen Electronics, Sharp Corporation and Rohm, Inc. The Company also has a purchase agreement with OSRAM that expires in June 2005. Agilent sales are placed with the Company through purchase orders that are received quarterly. The loss of revenue for fiscal 2002, 2001, and 2000, respectively. A third customer
accounted for 2%, 3%, and 15%OSRAM, Agilent or any of revenue for fiscal 2002, 2001, and 2000,
respectively. A fourth customer accounted for 16%, 11%, and 0% of revenue fiscal
2002, 2001, and 2000, respectively. The U.S. Government accounted for 12%, 9%,
and 11% of revenues during fiscal 2002, 2001, and 2000, respectively.
Sumitomo’s large customers could have a material adverse effect on the Company.
The Company depends on single or limited source suppliers for a number of raw materials, equipment and components used in manufacturing its products. Any interruption in the supply of these key materials or components could have a significant adverse effect on the Company'sCompany’s operations.
Over 90%
Investments
Investments are accounted for using the specific identification method and in accordance with Statement of Cree Microwave revenues were derived from shipmentsFinancial Accounting Standards 115 “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS 115”). This statement requires certain securities to Spectrian in
fiscal 2002 as well as fiscal 2001. The Company's supply contract with Spectrian
commits them to a minimum purchase level of $16.3 million in fiscal 2003. If the
Company is unable to deliver qualified LDMOS 8 products; the amount of the
contractual supply agreement with Spectrian may be reduced significantly.
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| (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. |
| (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 or losses excluded from earnings and reported as a separate component of shareholders’ equity. |
Earnings (Loss) Earnings Per Share
Basic earnings (loss) earnings per common share is computed using the weighted average number of common stock shares outstanding. Diluted earnings (loss) earnings per common share is computed using the weighted average number of common stock shares outstanding adjusted for the incremental shares attributed to outstanding options and warrants to purchase common stock, unless such incremental shares would be antidilutive.
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
June 27, 2004
Accounting for Stock Based Compensation
In accordance with Accounting Principles Board Opinion No. 25, "Accounting“Accounting for Stock Issued to Employees" ("Employees” (“APB 25"25”), no compensation expense is recorded for stock options or other stock-based awards that are granted to employees with an exercise price equal to or above the common stock price on the grant date.
In October 1995, the Financial Accounting Standards Board ("FASB"(“FASB”) issued Statement of Financial Accounting Standards 123, "Accounting“Accounting for Stock Based Compensation" ("Compensation” (“SFAS 123"123”). SFAS 123 establishes fair value as the measurement basis for equity instruments issued in exchange for goods or services and stock-based compensation plans. Fair value may be measured using quoted market prices, option-pricing models or other reasonable estimation methods. SFAS 123 permits the Company to choose between adoption of the fair value based method or disclosing pro forma net income (loss)
income information. The Statement is effective for transactions entered into after December 31, 1995. The Company continues to account for stock-based compensation in accordance with APB 25, as amended, and provides the pro forma disclosures required by SFAS 123 as amended by Statements of Financial Accounting Standards 148 “Accounting for Stock-Based Compensation Incentive and Disclosure” (“SFAS 148”).
Pro forma information regarding net income (loss) and net income (loss) per share is required by SFAS 123. The Company computes fair value for this purpose using the Black-Scholes option valuation model. The Black-Scholes model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. The Company’s options have characteristics significantly different from traded options, and the input assumptions used in the model can materially affect the fair value estimate. The assumptions used in this model to estimate fair value and resulting values are as follows:
| Stock Option Plans | Employee Stock Purchase Plan | |||||||||||||||||||||||
| June 27, 2004 | June 29, 2003 | June 30, 2002 | June 27, 2004 | June 29, 2003 | June 30, 2002 | |||||||||||||||||||
Expected dividend yield | 0.0 | % | 0.0 | % | 0.0 | % | 0.0 | % | 0.0 | % | 0.0 | % | ||||||||||||
Risk-free interest rate | 3.4 | % | 2.8 | % | 4.6 | % | 1.3 | % | 1.2 | % | 2.2 | % | ||||||||||||
Expected volatility | 70.0 | % | 90.0 | % | 90.0 | % | 70.0 | % | 90.0 | % | 90.0 | % | ||||||||||||
Expected life (in years) | 5.5 | 5.0 | 4.8 | 0.8 | 0.8 | 0.8 | ||||||||||||||||||
Weighted-average fair value per share | $ | 12.51 | $ | 9.64 | $ | 14.52 | $ | 7.36 | $ | 8.96 | $ | 6.50 | ||||||||||||
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
June 27, 2004
The following table illustrates the effect on net income (loss) and net income (loss) per share if the Company had applied the fair value recognition provisions of SFAS 123 (in thousands, except per share amounts):
| Year ended | ||||||||||||
| June 27, 2004 | June 29, 2003 | June 30, 2002 | ||||||||||
Net income (loss), as reported | $ | 57,960 | $ | 34,901 | $ | (101,723 | ) | |||||
Add: Stock-based employee compensation expense included in reported net income (loss), net of related tax effects | 152 | 317 | 341 | |||||||||
Deduct: Stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects | (32,174 | ) | (44,865 | ) | (62,269 | ) | ||||||
Pro forma net income (loss) | $ | 25,938 | $ | (9,647 | ) | $ | (163,651 | ) | ||||
Basic earnings (loss) per share as reported | $ | 0.78 | $ | 0.48 | $ | (1.40 | ) | |||||
Pro forma basic net income (loss) per share | $ | 0.35 | $ | (0.13 | ) | $ | (2.25 | ) | ||||
Diluted earnings (loss) per share as reported | $ | 0.77 | $ | 0.46 | $ | (1.40 | ) | |||||
Pro forma diluted net income (loss) per share | $ | 0.34 | $ | (0.13 | ) | $ | (2.25 | ) | ||||
Income Taxes
Income taxes have been accounted for using the liability method in accordance with FASB StatementsStatement of Financial Accounting Standards 109 "Accounting“Accounting for Income Taxes"Taxes” (“SFAS 109”). Deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax bases of assets and liabilities and their reported amounts.
Contingencies
3. Earnings (Loss) Per Share
The Company is involvedfollowing computation reconciles the differences between the basic and diluted earnings per share presentations:
| Year Ended (in 000’s, except per share data) | ||||||||||
June 27, 2004 | June 29, 2003 | June 30, 2002 | ||||||||
Basic: | ||||||||||
Net income (loss) | $ | 57,960 | $ | 34,901 | $ | (101,723 | ) | |||
Weighted average common shares | 74,008 | 73,196 | 72,718 | |||||||
Basic earnings (loss) per share | $ | 0.78 | $ | 0.48 | $ | (1.40 | ) | |||
Diluted: | ||||||||||
Net income (loss) | $ | 57,960 | $ | 34,901 | $ | (101,723 | ) | |||
Weighted average common shares-basic | 74,008 | 73,196 | 72,718 | |||||||
Dilutive effect of stock options and warrants | 1,737 | 2,107 | — | |||||||
Weighted average common shares-diluted | 75,745 | 75,303 | 72,718 | |||||||
Diluted earnings (loss) per share | $ | 0.77 | $ | 0.46 | $ | (1.40 | ) | |||
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
June 27, 2004
Potential common shares that would have the effect of increasing diluted earnings per share are considered to be antidilutive. In accordance with Statement of Financial Accounting Standards 128, “Earnings Per Share”, (“SFAS 128”) these shares were not included in various legal proceedings related to the protectioncalculating diluted earnings per share. As of its intellectual property. Although the final resolution of these matters
cannot be determined, management's opinion isJune 27, 2004, June 29, 2003 and June 30, 2002, there were 7.7 million, 9.2 million and 10.4 million shares, respectively, that the final outcome of these
matters willare not have a material adverseincluded in calculating diluted earnings per share because their effect on the Company's consolidated
financial position or results of operations.
3. ACCOUNTS RECEIVABLE, NET
was antidilutive.
4. Accounts Receivable, Net
The following is a summary of the components of accounts receivable, net:
Year Ended (in 000's)
-------------------------------------
June 30, 2002 June 24, 2001
---------------- ------------------
Billed trade receivables $32,708 $31,982
Unbilled contract receivables 2,339 3,218
---------------- ------------------
35,047 35,200
Allowance for sales returns (455) (350)
---------------- ------------------
Total accounts receivable, net $34,592 $34,850
================ ==================
-64-
| As of (in 000’s) | ||||||||
June 27, 2004 | June 29, 2003 | |||||||
Billed trade receivables | $ | 44,972 | $ | 42,702 | ||||
Unbilled contract receivables | 3,592 | 1,843 | ||||||
| 48,564 | 44,545 | |||||||
Allowance for sales returns | (798 | ) | (644 | ) | ||||
Total accounts receivable, net | $ | 47,766 | $ | 43,901 | ||||
The following table summarizes the changes in the Company'sCompany’s allowance for sales returns for the years ended June 30, 2002,27, 2004, June 24, 200129, 2003 and June 25, 2000:
| Year Ended (in 000’s) | |||||||||
| June 27, 2004 | June 29, 2003 | June 30, 2002 | |||||||
Balance at beginning of year | $ | 644 | $ | 455 | $ | 350 | |||
Charges to cost and expenses | 154 | 189 | 105 | ||||||
Balance at end of year | $ | 798 | $ | 644 | $ | 455 | |||
5. Inventories, Net
The following is a summary of inventory:
Year Ended (in 000's)
------------------------------------
inventories:
| As of (in 000’s) | ||||||||
June 27, 2004 | June 29, 2003 | |||||||
Raw materials | $ | 4,227 | $ | 4,410 | ||||
Work-in-progress | 8,083 | 5,397 | ||||||
Finished goods | 7,813 | 9,944 | ||||||
| 20,123 | 19,751 | |||||||
Inventory reserve | (695 | ) | (2,077 | ) | ||||
Total inventories, net | $ | 19,428 | $ | 17,674 | ||||
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
June 30, June 24,
2002 2001
--------------- -----------------
Raw materials $ 3,908 $ 4,538
Work-in-progress 6,629 6,206
Finished goods 9,724 5,251
--------------- -----------------
20,261 15,995
Inventory reserve (2,295) (793)
--------------- -----------------
Total inventory, net $17,966 $15,202
=============== =================
27, 2004
The following table summarizes the changes in the Company'sCompany’s inventory reserve for the years ended June 30, 2002,27, 2004, June 24, 200129, 2003 and June 25, 2000:
| Year Ended (in 000’s) | ||||||||||||
| June 27, 2004 | June 29, 2003 | June 30, 2002 | ||||||||||
Balance at beginning of year | $ | 2,077 | $ | 2,295 | $ | 793 | ||||||
Charges to cost and expenses | 510 | 2,659 | 6,234 | |||||||||
Disposals (write-offs to reserve) | (1,892 | ) | (2,877 | ) | (4,732 | ) | ||||||
Balance at end of year | $ | 695 | $ | 2,077 | $ | 2,295 | ||||||
The majority of the inventory reserve at Cree Microwave as of June 29, 2003 was recorded during the second quarter of fiscal 2003 resulting from the termination of the supply agreement with Spectrian Corporation (Spectrian). In exchange for a one-time payment of $5.0 million recorded as “other operating income” on the consolidated statements of operations, the Company relieved Spectrian of further obligations to purchase product under the supply agreement that was originally signed in December 2000. For the three months ended December 29, 2002, Cree Microwave recorded an additional reserve of $1.3 million for inventory targeted for sale to Spectrian, which included some customized parts.The Company destroyed the majority of the inventory reserved during fiscal 2003 and 2004, and as a result, the related items were taken out of inventory and the related reserve. There was no financial impact to the consolidated statements of operations when these items were destroyed. The Company still maintains some inventory included in the reserve that are no longer available from third party suppliers or are available only with lengthy lead timeframes. The Company also has “last time buy” contracts with Remec, Inc. (which purchased Spectrian) for devices that use this inventory. However, the Company plans to dispose of this remaining inventory when the “last time buy” rights expire. Therefore, with the exception of certain inventory covered under “last time buy” obligations, all items previously reserved have now been scrapped and removed from inventory along with the related reserve account. These reserves were recorded as a cost of revenue when they were established. In addition, $417,000 of LDMOS8 product was also written off as a research and development expenditure during the first quarter of fiscal 2003 as it related to prototype devices that were initially accepted by Spectrian and later rejected. These parts were never sold.
Cree segment results for fiscal 2003 include a $784,000 additional reserve for LED and wafer inventories; as management assessed the inventory to be slow moving or obsolete. The Company also recorded a $185,000 lower of cost or market adjustment to certain LED products based on management’s estimate of an average sales price for the products. These adjustments were recorded to cost of revenue. During fiscal 2003, the Company also wrote off $1.0 million of the initial XBright® chips that were developed during fiscal 2002. An improved chip had replaced these devices and this write-down was recorded as a research and development expense as the initial devices were prematurely launched and not commercially viable. In addition, customers had returned the entire product line that was initially shipped after determining that the chips did not meet their specifications.
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
June 27, 2004
6. Property and Equipment, Net
The following is a summary of property and equipment:
| As of (in 000’s) | ||||||||
| June 27, 2004 | June 29, 2003 | |||||||
Furniture and fixtures | $ | 6,736 | $ | 5,552 | ||||
Land and buildings | 116,523 | 99,917 | ||||||
Machinery and equipment | 267,727 | 210,872 | ||||||
Computer hardware and software | 9,023 | 7,160 | ||||||
Leasehold improvements & other | 5,691 | 5,903 | ||||||
| 405,700 | 329,404 | |||||||
Accumulated depreciation | (162,887 | ) | (111,483 | ) | ||||
| 242,813 | 217,921 | |||||||
Construction in progress | 30,529 | 33,425 | ||||||
Property and equipment, net | $ | 273,342 | $ | 251,346 | ||||
Depreciation and amortization of property and equipment totaled $32.4 million;
$21.9$54.6 million, $41.7 million and $10.8$32.4 million for the years ended June 27, 2004, June 29, 2003 and June 30, 2002, respectively.
7. Investments
As of June 24,27, 2004, the Company held a long-term equity investment in the common stock of Color Kinetics, Incorporated (Color Kinetics). In fiscal 2001 and 2002, the Company purchased an aggregate of 2,202,442 shares of Color Kinetics stock in private investment rounds for an aggregate of $12.7 million. On June 22, 2004, the shares of Color Kinetics’ stock were approved for quotation on the Nasdaq National Market. The Company accounts for its shares in Color Kinetics as available-for-sale securities under SFAS 115 because management views the purchase of the shares as a long-term investment and the Company has the intent and the ability to hold these shares. Accordingly, unrealized gains or losses on Color Kinetics’ shares are excluded from earnings and are recorded in other comprehensive income, net of tax. For the year ended June 27, 2004, the Company had recorded a cumulative unrealized holding gain on its investment in Color Kinetics of $9.3 million (or $5.6 million, net of tax). This unrealized gain was based on the fair market value of the Company’s investment as of June 27, 2004 of $22.0 million, using the closing stock price as of June 25, 2004. The Company is restricted from selling its shares in Color Kinetics for a period of 180 days from June 22, 2004, the date of Color Kinetics’ initial public offering and considers its investment in Color Kinetics as a long-term investment. The Company has recorded sales to Color Kinetics of $761,000, $1,681,000 and $164,000 for the fiscal years ended June 27, 2004, June 29, 2003 and June 30, 2002, respectively. The Company does not have any sales contract with Color Kinetics and believes that its sales to Color Kinetics were made on no more favorable terms than to any third party. Color Kinetics also buys LED products from competitors of the Company. As of June 29, 2003, the Company’s investment in Color Kinetics was carried at cost and included in other assets.
During the second quarter of fiscal 2003, the Company sold its remaining positions in Microvision, Inc. (“Microvision”) and Emcore Corporation (“Emcore”), two publicly traded companies. The Company recorded a charge through non-operating expense on the consolidated statements of operations in June 2002, for an other-than-temporary decline in value, which reduced the value of the Microvision investment to
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
June 27, 2004
$1.9 million, which was the market value as of June 28, 2002. These shares were sold during the three months ended December 29, 2002 for $1.9 million, with a net loss on the sale recognized for $36,000 during the second quarter of fiscal 2003.
During the second quarter of fiscal 2003, the Company also sold 691,000 common shares of Emcore. These shares were purchased between June 2001 and October 2001. The Company recorded a charge through non-operating expense on the consolidated statements of operations in June 2002, for an other-than-temporary decline in value, which reduced the value of this investment to $4.1 million, which was the market value as of June 28, 2002. These shares were sold during the three months ended December 29, 2002 for $2.1 million, with a net loss on the sale recognized for $2.0 million during the second quarter of fiscal 2003.
Management viewed both of these investments as strategic in nature, and therefore, the shares were accounted for as available-for-sale securities under SFAS 115. The Company carried these investments at fair value, based on quoted market prices, while unrealized gains and losses, net of taxes, were included in accumulated other comprehensive income (loss), which is a separate component of shareholders’ equity. Realized gains and losses were recognized upon sale. Declines in value, which were deemed to be other-than-temporary, were recognized as losses on the consolidated statements of operations. The Company reviews equity holdings on a regular basis to evaluate whether or not each security has experienced an other-than-temporary decline in fair value. The Company’s policy requires, among other things, the Company to review each company’s cash position, stock price performance, liquidity, ability to raise capital and management and ownership and other relevant considerations. If the Company determines that an other-than-temporary decline existed in the value of marketable equity securities, it is the Company’s policy to write-down these equity investments to the respective market value. Any related write-down is recorded as an investment loss in the Company’s consolidated statements of operations. In the fourth quarter of fiscal 2002, the Company determined that an other-than-temporary decline in market value had occurred in Microvision and Emcore marketable equity investments. Accordingly, the Company wrote down these equity investments to their market values at June 30, 2002 and recorded the unrealized losses, most of which had previously been recorded as a comprehensive loss in shareholders’ equity, as a non-operating loss on the Company’s consolidated statements of operations for the year then ended. The total amount of the charge to non-operating expenses in the consolidated statements of operations for the year ended June 30, 2002 relating to these investments was $22.0 million on a pre-tax basis. A corresponding amount that would have been recorded through other comprehensive income (loss) was $17.2 million on an after-tax basis. The amount reported through other comprehensive income (loss) on an after-tax basis was $15.8 million as the losses from the June 2002 period were directly charged to non-operating loss on the statement of operations. The Company recorded a combined realized net loss of $2.1 million to non-operating expense in the consolidated statement of operations for the fiscal year ended June 29, 2003 for the sale of these securities. The Company also recorded a $558,000 realized gain on the sale of other marketable trading securities in the second quarter of fiscal 2002.
When the Company performed its review to determine whether an other-than-temporary decline had occurred in the fair value of the Company’s investments in Emcore and Microvision, the Company considered that both investments had been made with a long-term investment horizon. The Emcore stock was determined to have experienced an other-than-temporary decline after Emcore indicated declining revenue as well as charges for write-downs taken in the quarter for inventory and other restructuring charges. Although Emcore’s stock price was less than the Company’s average cost for a period of time at the end of March 2002, the Company determined that the decline was not other-than-temporary at that time in light of the high volatility of Emcore’s stock trading price, the significant potential advancements represented by its core technologies, its growth potential, the overall decline in the NASDAQ market, and the fact that none of the analysts following Emcore downgraded the stock during the quarter ended in March 2002.
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
June 27, 2004
The Company determined that the decline in its investment in Microvision was other-than-temporary at June 30, 2002 because the stock began trading negatively when compared to the NASDAQ market at that time. Moreover, a number of analysts forecasted in June 2002 that the technology sector would not rebound until after the third quarter of 2002. Prior to that time, the Microvision stock had traded below the Company’s average cost for a prolonged time but the Company determined that the decline in Microvision’s stock prior to June 30, 2002 was not other-than-temporary for a number of reasons. First, the Company concluded that there were no Microvision specific factors that indicated that Microvision was not executing on its plan as expected. Microvision was incurring losses, but they were expected and the Company concluded that Microvision’s product development efforts were on track. The downward trend in Microvision’s stock price was reflective of the technology sector in general and, to the Company’s knowledge, did not result from reduced expectations of Microvision’s performance. Furthermore, each quarter prior to June 30, 2002, Microvision made public statements positively and aggressively promoting its current results and future prospects. The Company also considered that the Microvision stock price was highly volatile. Thus, the Company concluded that with high volatility and continued positive performance, a rapid rise in the stock price was possible.
The Company weighed these factors against the Microvision stock price decline and the decline in the overall market. The Company noted that the Microvision stock had experienced 100% volatility and that the analysts’ recommendations at the time included upgrades, not merely maintaining a buy rating. As far as the overall market, the events of September 11, 2001 required the Company to determine whether an other-than-temporary decline in the overall market had occurred. In September 2001, it was clear that the market and Microvision’s stock price had reacted to the events of that day. What was not clear, however, was whether the decline caused by September 11 was other-than-temporary. In fact, in the fourth quarter of calendar 2001, both the overall market and Microvision’s stock rose significantly. At year-end, Microvision’s stock price was at its quarterly high, with the prospects that the overall market and the Microvision stock price could continue to improve in the first quarter of calendar 2002. Accordingly, it was not until a number of analysts concluded in June 2002 that the technology sector would not rebound until after the third quarter of 2002 and the Microvision stock price fell below the NASDAQ trendline that the Company concluded that an other-than-temporary decline had occurred in the overall stock market and in the Company’s Microvision investment.
Microvision entered into a contract with the Company to fund a research and development project for custom light emitting diodes, or LEDs, and laser diodes. The amount of funding received by the Company in connection with the contracts was $4.4 million for the fiscal year ended June 30, 2002. The amount of the research and development funding received from Microvision was recorded as an offset to research and development expense. The Company received no funding from Microvision during the fiscal years ending June 27, 2004 and June 29, 2003 as the contract expired during fiscal 2002. The Company does not anticipate additional funding for research and development from this company in the future.
As of June 27, 2004, the Company’s short-term investments held to maturity included $76.7 million in high-grade corporate bonds and other debt securities that mature within one year. As of June 29, 2003, the Company’s short-term investments held to maturity totaled $75.2 million consisting of high-grade corporate bonds and other debt securities that mature within one year. The Company purchased these investments with a portion of the proceeds from its public stock offering in January 2000 and cash flow from operations. 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 consolidated balance sheets at amortized cost, as a short-term investment with unpaid interest included in interest receivable. The Company believes that there is no difference between the amortized cost of these securities and their fair value at the
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
June 27, 2004
time the security is purchased because premiums or discounts are assigned to the securities if a different interest rate is paid than the current prevailing market rate. This premium or discount is amortized or accreted over the remaining life of the security and charged as an increase or decrease to interest income. If interest rates continue to decline, the fair value of the security may be higher than the book value as the interest rate less the premium may be higher than current interest rates. As of June 27, 2004, the Company calculated market value to be less than book value by approximately $0.8 million on combined short-term and long-term asset balances of $149.4 million. The Company does not consider this reduction in value to be other-than-temporary as the market value of these type of securities fluctuates and the Company plans to hold these investments until maturity. At that time, the securities will be redeemed for the full book value. As of June 29, 2003, the Company calculated market value to be in excess of book value by approximately $1.1 million, on combined short-term and long-term asset balances of $134.0 million.
As of June 27, 2004, the Company’s long-term investments held to maturity consisted of $72.7 million in high-grade corporate bond holdings and other debt securities that mature after June 26, 2005. As of June 29, 2003, the Company’s long-term investments held to maturity consisted of $58.8 million in high-grade corporate bond holdings and other debt securities that mature after June 28, 2004. The Company purchased the corporate bonds with a portion of the proceeds from the public stock offering in January 2000 and cash from operations. 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 consolidated balance sheets at amortized cost, as a long-term held to maturity investment with unpaid interest included in interest receivable if interest is due in less than 12 months, and as a long-term other asset if interest is due in more than 12 months. These investments mature over periods ranging from 13 to 36 months.
As of June 27, 2004, the Company maintained $2.9 million of net investments in privately held companies, which are included in other assets on the consolidated balance sheets. Since the Company does not have the ability to exercise significant influence over the operations of these companies, these investment balances are carried at cost and accounted for using the cost method of accounting. Because the shares of stock the Company received in these investments are not publicly traded, there is no established market for these securities. The Company reviews the fair value of these investments on a regular basis to evaluate the carrying value of such investments. This review includes, but is not limited to, an analysis of each of the companies’ cash position, financing needs, earnings and revenue outlook, operational performance, management or ownership changes and competition. The evaluation process is based on information requested from the privately held companies by the Company. These companies are not subject to the same disclosure regulations as U.S. public companies, and as such, the basis for these evaluations is subject to the timing and the accuracy of the data received from these companies. If the Company determines that the carrying value of an investment is at an amount in excess of fair value, it is the Company’s policy to record a write-down of the investment. This write-down is estimated based on the information described above, and it is recorded as an investment loss on the Company’s consolidated statement of operations. During fiscal 2002, the Company recorded write-downs of these investments of $20.4 million pre-tax, representing the Company’s best estimate of other-than-temporary declines in value. These impairment charges were included as an “other non-operating loss” on the consolidated statements of operations. During the fiscal year ended June 29, 2003, there were no additional write-downs taken on these investments and one of the private companies was sold to another company during the second quarter of fiscal 2003 with proceeds of $636,000 received from the sale. The Company’s investment in this company was written down to reflect the fair value based on the expected sales proceeds in the fourth quarter of fiscal 2002. During the fiscal years ended June 27, 2004 or June 29,2003, there were no additional write-downs taken on these investments.
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
June 27, 2004
Two of these private companies, of which the Company was a shareholder, entered into contracts to fund development programs conducted by the Company. During the first quarter of fiscal 2003, one of these companies, Lighthouse Technologies, Limited (“Lighthouse”), completed funding of a development program that commenced in a prior year and was directed to the development of brighter LEDs. Another of these companies, Xemod, Inc. (“Xemod”) also commenced a research and development-funding project in a prior year directed to the development of SiC RF transistors. The total amount of funding received by the Company from these companies was zero, $500,000 and $3.5 million for the fiscal years ended June 27, 2004, June 29, 2003 and June 30, 2002, respectively. 6. ACCRUED EXPENSES
The amount of the research and development funding received from the companies was recorded as an offset to research and development expense. The Company does not anticipate additional funding from these companies in the future as both programs have now ended.
8. Accrued Expenses
The following table reflects the components of other accrued expenses:
Year ended (in 000's)
-------------------------------------
June 30, 2002 June 24, 2001
---------------- ----------------
| As of (in 000’s) | ||||||
| June 27, 2004 | June 29, 2003 | |||||
Accrued legal fees | $ | 598 | $ | 444 | ||
Accrued taxes | 1,118 | 805 | ||||
Accrued warranty costs | 680 | 341 | ||||
Accrued relocation liability for former ATMI business and employees | 285 | — | ||||
Other accrued liabilities | 637 | 497 | ||||
Total accrued expenses | $ | 3,318 | $ | 2,087 | ||
Accrued legal fees $1,806 $1,356
Accrued taxes 945 1,357
Deferredexpenses include amounts accrued for product warranty expenses at both the Cree, Inc. and Cree Microwave segments. Cree Microwave accrues 0.5% of product revenue 741 91
Other accrued liabilities 1,477 2,352
---------------- ----------------
Total accrued expenses $4,969 $5,156
================ ================
7. SHAREHOLDERS' EQUITY
On January 18, 2001,as a warranty liability each month and maintains the reserve for 36 months after the date of sale pursuant to our warranty terms with our customers. The Cree announced that its Board of Directors had authorized
the repurchase ofsegment records warranty expense up to four21 months based on an experience factor for product returns and pursuant to warranty terms with its customers. During fiscal year 2004, approximately $547,000 was accrued for additional warranty expense, while $208,000 was reversed out of the liability due to the use or expiration of the warranty period.
9. Shareholders’ Equity
As of June 27, 2004, there remained approximately 6.9 million shares of its outstandingthe Company’s common stock through January 2002. Additionally, on March 22, 2001, Cree announced that its
Board of Directors had increased theapproved for repurchase limits under the stocka repurchase program announced in January 2001 to include an additional three
million shares. In February 2002,authorized by the Board of Directors approved the renewal of
this programthat extends through January 2003.May 4, 2005. During fiscal year ended June 30, 2002,27, 2004, the Company repurchased 1.5 million1,828,000 shares at an average price of $13.63$19.01 per share with an aggregate value of approximately $20.3$34.7 million. Since the inception of the stock repurchase program in January 2001, Cree has repurchased 3.35.2 million shares of its common stock at an average price of $15.26$16.59 per share, with an aggregate value of $51.0$85.7 million.
The Company intends to use available cash to finance purchases under the program. At the discretion of the Company'sCompany’s management, the repurchase program can be implemented through open market or privately negotiated transactions. The Company will determine the time and extent of repurchases based on its evaluation of market conditions and other factors.
On January 20, 2000, the Company completed a public offering of 6,578,000 shares
of its common stock. The price received in the offering was $42.56 per share.
The Company received net aggregate proceeds of approximately $266.1 million
after deducting underwriting discounts and commissions and estimated offering
costs. The net proceeds are being used primarily for manufacturing facility
expansion and purchase of additional equipment, the acquisition of an additional
facility, research and development, and general corporate purposes.
At
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
June 27, 1999, the Articles of Incorporation of the Company authorized the
Company to issue up to 30,000,000 shares of common stock, with a par value of
$0.005 per share, and 3,000,000 shares of preferred stock, with a par value of
$0.01 per share. The preferred stock may be issued in one or more classes or
series with the number of shares, designation, relative rights, preferences, and
limitations of each class or series to be determined by resolution of the Board
of Directors. The Articles of Incorporation were amended, effective at the close
of business on July 26, 1999, to effect a two-for-one split of the common stock.
Effective November 14, 2000 the Articles of Incorporation were amended to
-66-
increase the authorized number of common shares to 100,000,000, with a par value
of $0.0025. In addition, the Company split its stock again on December 1, 2000.
As a result, as of December 1, 2000, the Articles of Incorporation authorize the
Company to issue up to 200,000,000 shares of common stock, with a par value of
$0.00125 per share. The amendments did not change the number of authorized
shares or other provisions relating to the preferred stock. On July 30, 1999 and
December 1, 2000, 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 two common stock splits.
2004
On May 29, 2002, the Company's boardCompany’s Board of directorsDirectors adopted a shareholder rights plan, pursuant to which stock purchase rights were distributed to shareholders at a rate of one right with respect to each share of common stock held of record as of June 10, 2002. The rights plan is designed to enhance the board'sboard’s ability to prevent an acquirer from depriving shareholders of the long-term value of their investment and to protect shareholders against attempts to acquire the Company by means of unfair or abusive takeover tactics. The rights become exercisable based upon certain limited conditions related to acquisitions of stock, tender offers and certain business combinations involving the Company. The Company amended the Articles of Incorporation to designate 200,000 shares of preferred stock as "Series“Series A Preferred Stock"Stock” in connection with the implementation of a shareholders'the shareholders’ rights plan. At June 30, 2002, rights to purchase 100,000 shares of Preferred Stock had been distributed to shareholders.
At June 30, 2002,27, 2004, the Company had reserved a total of 18,202,00015,886,558 shares of its common stock and 100,000 shares of its Series A preferred stock for future issuance as follows:
| Number of shares | ||
For exercise of outstanding common stock options | 13,517,870 | |
For future common stock option awards | 2,006,773 | |
For | 361,915 | |
Total common shares reserved | 15,886,558 | |
Series A Preferred Stock reserved for exercise of rights issued under | 100,000 | |
10. Employee Stock Purchase Plan
The Company adopted an Employee Stock Purchase Plan (the "ESPP"“ESPP”) on November 2, 1999. The ESPP provides employees of the Company, and its majority-owned subsidiaries, with anthe opportunity to purchase common stock, through payroll deductions. The purchase price is set at the lower of 85% of the fair market value of common stock at the beginning of the participation period or 85% of the price on the purchase date, whichever is lower.date. Contributions are limited to 15% of an employee'semployee’s compensation. The participation periods have a 12 month12-month duration, with new participation periods beginning in November and May of each year. Each participation period has two purchase dates, one in October and the other in April. The Board of Directors has reserved 600,0001,350,000 shares of common stock for issuance under the ESPP. As of June 30, 2002, 437,30527, 2004, 988,085 shares of common stock had been purchased under the ESPP.
9. STOCK OPTIONS AND STOCK WARRANTS
11. Stock Options and Stock Warrants
The Company has stock option plans to provide incentives to eligible employees, officers, and directors in the form of incentive stock options and non-qualified stock options. The Board of Directors determines the option price (not to be less than fair market value) at the date of grant. Options, particularly those assumed or exchanged as a result of acquisitions, have various vesting schedules and -67-
The majorityMost of the options vest and become exercisable over three to five years and have seven to ten year terms.
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
June 27, 2004
Stock option activity during the periods ending as indicated is as follows (in 000's,000’s, except per share data):
| June 27, 2004 | June 29, 2003 | June 30, 2002 | ||||||||||||||||
| Number of Options | Weighted Average Price | Number of Options | Weighted Average Price | Number Options | Weighted Average Price | |||||||||||||
Outstanding—beginning of year | 12,804 | $ | 21.77 | 14,684 | $ | 25.86 | 13,522 | $ | 26.93 | |||||||||
Granted | 2,128 | $ | 20.00 | 1,521 | $ | 13.64 | 3,375 | $ | 20.48 | |||||||||
Exercised | (701 | ) | $ | 10.96 | (1,093 | ) | $ | 8.67 | (1,054 | ) | $ | 4.01 | ||||||
Forfeited | (713 | ) | $ | 25.31 | (2,308 | ) | $ | 48.65 | (1,159 | ) | $ | 42.50 | ||||||
Outstanding—end of year | 13,518 | $ | 21.86 | 12,804 | $ | 21.77 | 14,684 | $ | 25.86 | |||||||||
Exercisable—end of year | 8,705 | $ | 22.71 | 6,628 | $ | 21.35 | 5,947 | $ | 20.39 | |||||||||
As permitted by SFAS 123, the Company has elected to follow APB 25 and related interpretations and amendments in accounting for its employee stock option plans. In connection with restricted stock grants and discounted stock options assumed by the options obtained through theCompany in its acquisition of Nitres, Inc. (Nitres) on May 1, 2000, the Company recognized compensation expense of $218,000, $478,000 and $515,000 during the years ended June 27, 2004, June 29, 2003 and June 30, 2002, respectively. As of June 27, 2004, June 29, 2003 and June 30, 2002, the Company had deferred compensation balances of $696,000, $1.2 million,zero, $218,000 and $1.8 million at June 30, 2002, June 24, 2001, and June 25, 2000,$696,000, respectively. This amount represents the difference between the grant price and the deemed fair value of stock and stock options granted previously. Of thisAs of June 27, 2004, the Company has fully expensed all deferred compensation $515,000, $501,000,associated with the acquisition of Nitres.
The Company recognized compensation expense of $175,000 and $980,000 was amortized for$50,000 during the fiscal years ended June 30, 2002, June 24, 2001,27, 2004 and June 25, 2000, respectively.
Pro forma information regarding net income29, 2003, respectively as the Company accelerated the vesting of stock options for a terminated employee in connection with the settlement of a lawsuit, and earnings per share is requiredgranted stock options to another employee within six months of canceling other stock options held by SFAS 123the employee. Both of these transactions were subject to variable accounting rules. The Company recognized compensation expense and has been determinedincluded zero and $11,000 in deferred compensation as ifof June 27, 2004 and June 29, 2003, respectively. The aforementioned options were exercised or forfeited during the Company had accounted for its
employee stock options under the fair value method of that Statement. The
Company computes fair value for this purpose using the Black-Scholes pricing
model. The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions, including the expected stock price
volatility. The Company's options have characteristics significantly different
from traded options, and the input assumptions used in the model can materially
affect the fair value estimate. The assumptions used in this model to estimate
fair value and resulting values are as follows:
Selected information regarding stock options as of June 30, 200227, 2004 is as follows (in 000's,000’s, except per share data):
| Options Outstanding | Options Exercisable | |||||||||||
Range of Exercise Prices | Number of Options | Weighted-Average Remaining Life in Years | Weighted-Average Exercise Price | Number of Options | Weighted-Average Exercise Price | |||||||
$ 0.01-$ 12.49 | 2,510 | 3.91 | $ | 4.78 | 2,234 | $ | 4.22 | |||||
$ 12.50-$ 18.88 | 2,946 | 5.18 | $ | 15.35 | 1,492 | $ | 16.31 | |||||
$ 18.89-$ 21.75 | 2,724 | 5.58 | $ | 20.06 | 928 | $ | 20.16 | |||||
$ 21.76-$ 33.50 | 2,795 | 4.53 | $ | 25.09 | 1,750 | $ | 25.12 | |||||
$ 34.63-$ 71.53 | 2,543 | 6.14 | $ | 44.66 | 2,301 | $ | 44.00 | |||||
| 13,518 | 5.07 | $ | 21.86 | 8,705 | $ | 22.71 | ||||||
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
June 27, 2004
On March 17, 2003, the Company issued warrantsmade an offer to exchange options to purchase 1.2 millionan aggregate of 3,482,128 shares of the Company'sCompany’s common stock.
These warrants had a 5-year termstock held by eligible employees (“the Offer”). Directors and executive officers were not eligible to participate in the Offer. The options subject to the Offer were granted under the Company’s Equity Compensation Plan and 2001 Stock Option Bonus Plan granted at exercise prices greater than $30.00 per share. On April 12, 2003, the Company accepted for cancellation options to purchase 1,663,600 shares of its common stock, tendered by 91 eligible employees, representing approximately 48% of the options that were eligible to be tendered in the Offer. Subject to the terms and conditions of the Offer, the Company granted new options to purchase approximately 559,998 shares of its common stock on October 13, 2003 in exchange for the options tendered and accepted. The new options were granted under the Company’s Equity Compensation Plan with an exercise price equal to the last sale price of $6.81 per share, which
represents fair valuethe Company’s common stock reported by the Nasdaq National Market on the new option grant date of grant. Warrants to purchase 462,000, and
54,000, shares of common stock were exercised during the fiscal years ended June
24, 2001, and June 25, 2000, respectively. As of June 24, 2001, all warrants
issued under this private placement had been exercised. In conjunction with the
Company's acquisition of Nitres in May 2000, the Company assumed outstanding
warrants that had been previously issued by Nitres in February 2000. These
warrants had a 7-year term and an exercise price of $1.28or $19.88 per share. DuringThe new options remained not vested until April 13, 2004. After this date, the year ended June 24, 2001,vesting schedule of each new option became the remaining warrants to purchase 31,360 shares ofsame as the Company's common stock were exercised.
10. LEASE COMMITMENTS
corresponding canceled option in percentage terms.
12. Lease Commitments
The Company currently leases sixfour facilities. These facilities are comprised of both office and manufacturing space. The first facility has a remaining lease term for the first facility began
in September 1995approximately seven and a renewal option was exercised in September 1999.one half years. The lease on this facility expires in September 2002. The lease for the second
facility runs month to month with a 90-day termination clause, which has been
exercised, and will terminate in August 2002. The third facility lease expires in approximately threesix years. The third and fourth facility has a remaining sub-lease termleases are for approximately nine and one-half years. The lease for the fifth facility
expiressales offices that expire in June 2005.2005 and July 2005, respectively. The leaseCompany is also subject to a transition services agreement with ATMI, pursuant to which ATMI licensed a portion of its facility to the Company for the sixth facility expires in February 2003.its use through April 2005. All of the remaining lease agreements provide for rental adjustments for increases in base rent (up to specific limits) property taxes and general property maintenance.
-69-
Rent expense associated with these and other expired operating leases totaled $1.7$1.9 million, $1.2$1.8 million and $420,000$1.7 million for the years ended June 30, 2002,27, 2004, June 24,
2001,29, 2003 and June 25, 2000,30, 2002, respectively. Sublease income was $224,000, $166,000$198,000, $173,000 and $0$224,000 for the years ended June 30, 2002,27, 2004, June 24, 200129, 2003 and June 25, 2000,30, 2002, respectively. Future minimum rentals as of June 30, 200227, 2004 under these leases are as follows:
Minimum Rental
Amount
Fiscal Years Ended (in 000's)
----------------------------- ---------------------
June 29,
Fiscal Years Ended | Minimum Rental (in 000’s) | ||
June 26, 2005 | $ | 2,103 | |
June 25, 2006 | 1,671 | ||
June 24, 2007 | 1,669 | ||
June 30, 2008 | 1,669 | ||
June 28, 2009 | 1,669 | ||
Thereafter | 3,150 | ||
Total | $ | 11,931 | |
During July 2003, $ 1,732Cree entered into an agreement to lease certain research and development equipment to a customer for the following twelve-month period. In May 2004, this agreement was amended and extended for an additional three months. Thereafter, the agreement will continue on a month-to-month basis until cancelled. As of June 27, 2004, 1,697
June 26, 2005 1,697
June 25, 2006 1,029
June 24, 2007 907
Thereafter 4,006
---------------------
Total $ 11,068
=====================
Income generated from subleasesthe equipment cost is targeted to be $185,000 and $191,000$1.7 million with accumulated depreciation of $976,000. During fiscal 2004, Cree received $484,000 in payments for the fiscal years ended June 29, 2003 andlease of this equipment. The future minimum rental income as of June 27, 2004 respectively.
11. LONG-TERM DEBT
In December 1998, Cree Lighting (previously Nitres) received a $431,000 bridge
loan from a group of investors to finance its working capital needs. The bridge
loan was made to Cree Lighting subject to conversion rights that would result in
conversion to shares of Nitres common stock in the event of a financing or one
year passing. In February 2000, the $431,000 bridge loan was converted to shares
of Nitres common stock, which were converted into 168,750 shares of the
Company's common stock at the time of the Company's acquisition of Nitres in May
2000.
In November 1997, the Company entered into a term loan with a commercial bankunder this lease is $128,000 for up to $10.0 million to finance the purchase and upfit of the new main
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
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 the public stock offering. Interest expense
was $0, $0 and $13,000 for the years ended fiscal 2005.
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
June 30, 2002, June 24, 2001 and June
25, 2000, respectively.
12. INCOME TAXES
27, 2004
13. Income Taxes
The Company accounts for its income taxes under the provisions of SFAS 109. Under the asset and liability method of SFAS 109, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. Under SFAS 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
-70-
The actual income tax expense for the years ended June 30, 2002,27, 2004, June 24, 2001,29, 2003 and June 25, 2000,30, 2002, differed from the amounts computed by applying the U.S. federal tax rate of 35% to pretax earnings as a result of the following:
| Year Ended (in 000’s) | ||||||||||||
June 27, 2004 | June 29, 2003 | June 30, 2002 | ||||||||||
Federal income tax provision at statutory rate | $ | 29,258 | $ | 16,507 | $ | (45,644 | ) | |||||
State tax provision | 2,547 | 318 | (3,009 | ) | ||||||||
Increase (decrease) in income tax expense Resulting from: | ||||||||||||
Foreign sales corporation | (5,270 | ) | (1,800 | ) | — | |||||||
Investments | — | — | 20,562 | |||||||||
Research and development | (593 | ) | (2,285 | ) | (600 | ) | ||||||
Amortization | (406 | ) | (406 | ) | — | |||||||
Other | 97 | (71 | ) | — | ||||||||
Income tax expense (benefit) | $ | 25,633 | $ | 12,263 | $ | (28,691 | ) | |||||
The following are the components of the provision for income taxes for the years ended June 30, 2002,27, 2004, June 24, 200129, 2003 and June 25, 2000:
| Year Ended (in 000’s) | ||||||||||
June 27, 2004 | June 29, 2003 | June 30, 2002 | ||||||||
Current: | ||||||||||
Federal | $ | 4,385 | $ | 1,874 | $ | (2,200 | ) | |||
State | 955 | 388 | — | |||||||
| 5,340 | 2,262 | (2,200 | ) | |||||||
Deferred: | ||||||||||
Federal | 18,596 | 9,291 | (23,482 | ) | ||||||
State | 1,697 | 710 | (3,009 | ) | ||||||
| 20,293 | 10,001 | (26,491 | ) | |||||||
Income tax expense (benefit) | $ | 25,633 | $ | 12,263 | $ | (28,691 | ) | |||
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
June 27, 2004
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows:
-71-
Year Ended (in 000's)
June 30, 2002 June 24, 2001 June 25, 2000
------------------ ------------------ --------------------
Current deferred tax asset (liability):
Compensation $ 522 $ 491 $ 268
Inventory 374 544 202
Bad debt 230 129 93
Marketable equity securities and other (4) 3,008 (1,018)
------------------ ------------------ --------------------
Net current deferred tax asset (liability) 1,122 4,172 (455)
Non current deferred tax asset (liability):
Alternative minimum tax -- 2,295 1,690
Net operating loss carryforwards 9,059 421 11,641
Research tax credits 2,869 2,369 785
Fixed assets (12,763) (7,925) (6,060)
Goodwill 31,501 -- --
State tax credits and other (3,301) (1,010) 2,568
------------------ ------------------ --------------------
Net non current deferred tax asset
(liability) 27,365 (3,850) 10,624
------------------ ------------------ --------------------
Net deferred tax asset $ 28,487 $ 322 $ 10,169
================== ================== ====================
| As of (in 000’s) | ||||||||
| June 27, 2004 | June 29, 2003 | |||||||
Current deferred tax asset: | ||||||||
Compensation | $ | 660 | $ | 578 | ||||
Inventory | 1,585 | 1,068 | ||||||
Bad debt | 315 | 275 | ||||||
Marketable equity securities and other | — | (58 | ) | |||||
Net current deferred tax asset | 2,560 | 1,863 | ||||||
Non current deferred tax asset (liability): | ||||||||
Alternative minimum tax | 5,965 | 2,448 | ||||||
Federal capital loss carryforward | 13,916 | 13,916 | ||||||
Impairments on investments | 3,678 | 3,678 | ||||||
State net operating loss carryforwards | 1,384 | 4,150 | ||||||
Research tax credits | 3,849 | 5,046 | ||||||
Fixed assets | (33,389 | ) | (16,421 | ) | ||||
Goodwill | 26,587 | 28,898 | ||||||
Unrealized gains on marketable securities | (3,674 | ) | — | |||||
Reserves, state tax credits and other | (4,607 | ) | (3,187 | ) | ||||
| 13,709 | 38,528 | |||||||
Valuation allowance | (17,594 | ) | (17,594 | ) | ||||
Net non current deferred tax (liability) | (3,885 | ) | 20,934 | |||||
Net deferred tax (liability) asset | $ | (1,325 | ) | $ | 22,797 | |||
As of June 30, 2002,27, 2004, the Company has Federal net operatinga federal capital loss carryforwardscarryover of approximately $20.0$39.8 million and state net economic loss carryovers of approximately $26.0$30.9 million. The Federal net operating loss will begin to expire
in 2021. The state net economic loss carryforward will expire beginning in 2011. Research and development tax credits begin to expire in 2011. State incentive tax credits begin to expire in 2004. 13. RETIREMENT PLAN
A valuation allowance has been established on capital loss carryforwards and unrealized losses on certain securities as the Company believes that it is more likely than not that the tax benefits of the items will not be realized.
It is the Company’s policy to establish reserves for taxes that may become payable in future years, and it currently has a reserve of $8.5 million for such deferred tax liabilities. The Company establishes the reserves based upon management’s assessment of exposure associated with the tax return deduction. The Company analyzes the tax reserves at least annually and makes adjustments as events occur that warrant adjustment to the reserve. For example, if the statutory period for assessing tax on a given tax return lapses, the Company expects to reduce the reserve associated with that period. Similarly, if tax authorities provide administrative guidance or a decision is rendered in the courts, the Company makes appropriate adjustments to the tax reserve. The tax reserve was unchanged in fiscal 2004. The tax reserve increased by $3.0 million for the year ended June 29, 2003.
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
June 27, 2004
14. Contingencies
In re Cree, Inc. Securities Litigation
Between June 16 and August 18, 2003, nineteen purported class action lawsuits were filed in the United States District Court for the Middle District of North Carolina by certain alleged purchasers of the Company’s stock. The lawsuits names the Company, certain of its officers and current and former directors as defendants. On December 17, 2003, the court entered an order consolidating these actions and appointing a lead plaintiff and lead counsel for the consolidated cases. The lead plaintiff filed a consolidated amended complaint on January 16, 2004. The amended complaint asserts, among other claims, violations of federal securities laws, including violations of Section 10(b) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5, and violations of Section 20(a) and Section 18 of the Exchange Act against the individual defendants and also asserts claims against certain of the Company’s officers under Section 304 of the Sarbanes-Oxley Act of 2002. The amended complaint alleges that the Company made false and misleading statements concerning its investments in certain public and privately held companies, its acquisition of the UltraRF division of Spectrian, its supply agreement with Spectrian, its agreements with Charles & Colvard, and its employment relationship with Eric Hunter and that the Company’s financial statements did not comply with the requirements of the securities laws during the class period. The amended complaint requests certification of a plaintiff class consisting of purchasers of Cree stock between August 12, 1998 and June 13, 2003 and seeks, among other relief, unspecified damages and disgorgement of profits by the individual defendants, plus costs and expenses, including attorneys’, accountants’ and experts’ fees. In February 2004, we moved that the court dismiss the consolidated amended complaint on the grounds that it fails to state a claim upon which relief can be granted and does not satisfy the pleading requirements under applicable law. The motion is currently pending.
The Company believes that the claims set forth in the amended complaint are without merit. However, the Company is unable to predict the final outcome of these matters with certainty. The Company’s failure to successfully defend against these allegations could have a material adverse effect on our business, financial condition and results of operations.
SEC and Nasdaq Inquiries
In July 2003, the SEC initiated an informal inquiry regarding the Company and requested that the Company voluntarily provides certain information. The Company has cooperated with the SEC in this informal inquiry. In August 2003, the Nasdaq National Market (Nasdaq) requested information from the Company regarding the informal inquiry being conducted by the SEC and its then pending litigation, and the Company has provided information to Nasdaq in response to these requests. The Company is unable to predict whether these inquiries will continue or result in any adverse action.
Other Matters
The Company is currently a party to other legal proceedings incidental to its business. Although the final resolution of these other matters cannot be predicted with certainty, management’s present judgment is that the final outcome of these matters will not likely have a material adverse effect on the Company’s consolidated financial condition or results of operations. If an unfavorable resolution occurs in these legal proceedings, the Company business, results of operations and financial condition could be materially adversely affected.
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
June 27, 2004
15. Retirement Plan
The Company maintains an employee benefit plan (the "Plan"(“the Plan”) pursuant to Section 401(k) of the Internal Revenue Code. Under the Plan, there is no fixed dollar amount of retirement benefits, and actual benefits received by employees will depend on the amount of each employee'semployee’s account balance at the time of retirement. All employees are eligible to participate under the Plan on the first day of a new fiscal month after date of hire. The Pension Benefit Guaranty Corporation does not insure the Plan. The Company may, at its discretion, make contributions to the Plan. However, the Company did not make any contributions to the Plan during the years ended June 30, 2002,27, 2004, June 24, 200129, 2003 and June 25,
2000.
14. (LOSS) EARNINGS PER SHARE
The following computation reconciles30, 2002.
16. Recent Accounting Pronouncements
Effective July 1, 2002, the differences between the basic and
diluted earnings per share presentations:
Actual results of operations and proforma results of operations for the years ended June 27, 2004, June 29, 2003 and June 30, 2002 had we applied the non-amortization provisions of SFAS 142 willin the period are as follows:
| Year Ended | ||||||||||
June 27, 2004 | June 29, 2003 | June 30, 2002 | ||||||||
| (in 000’s, except per share data) | ||||||||||
Reported net income (loss) | $ | 57,960 | $ | 34,901 | $ | (101,723 | ) | |||
Goodwill and intangible asset amortization, net of tax | — | — | 5,277 | |||||||
Pro forma net income (loss) | $ | 57,960 | $ | 34,901 | $ | (96,446 | ) | |||
Basic net income (loss) per share: | ||||||||||
Reported net income (loss) | $ | 0.78 | $ | 0.48 | $ | (1.40 | ) | |||
Goodwill and intangible asset amortization, net of tax | — | — | 0.07 | |||||||
Pro forma net income (loss) | $ | 0.78 | $ | 0.48 | $ | (1.33 | ) | |||
Diluted net income (loss) per share: | ||||||||||
Reported net income (loss) | $ | 0.77 | $ | 0.46 | $ | (1.40 | ) | |||
Goodwill and intangible asset amortization, net of tax | — | — | 0.07 | |||||||
Pro forma net income (loss) | $ | 0.77 | $ | 0.46 | $ | (1.33 | ) | |||
In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”), an interpretation of Accounting Research Bulletin (ARB) No. 51, which requires a new approach in determining if a reporting entity should consolidate certain legal entities, including partnerships, limited liability companies, or trusts, among others, collectively defined as variable interest entities, or VIE’s. A legal entity is considered a VIE if it does not have sufficient equity at risk to finance its own activities
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
June 27, 2004
without relying on financial support from other parties. If the legal entity is a VIE, then the reporting entity that is the primary beneficiary must consolidate it. Even if a reporting entity is not obligated to consolidate a VIE, then certain disclosures must be made about the VIE if the reporting entity has a significant variable interest. Certain transaction disclosures are required for all financial statements issued after January 31, 2003. The on-going disclosure and consolidation requirements are effective for fiscal yearsall interim financial periods beginning after December 15, 2001, and will be adopted by the Company in fiscal
2003.March 31, 2004. The Company doescompleted its evaluation and has not expectidentified any VIE’s. Therefore, the adoption of SFAS 141 and SFAS 142 to have
a materialFIN 46 did not impact on the Company'sour results of operations or financial position, or
cash flows.
In August 2001, the FASB issued Statementposition.
17. Quarterly Results of Financial Accounting Standards 143,
"Accounting for Asset Retirement Obligations" ("SFAS 143"). SFAS 143 requires an
entity to recordOperations—Unaudited
The following is a liability for an obligation associated with the retirement of
an asset at the time that the liability is incurred. This is done by
capitalizing the cost as partsummary of the carrying value of the related asset and
depreciating it over the remaining useful life of that asset. The standard is
effective for financial statements for fiscal years beginning after June 15,
2002 and will be adopted by the Company in fiscal 2003. The Company does not
expect the adoption of SFAS 143 to have a material impact on the Company'sCompany’s consolidated quarterly results of operations financial position or cash flows.
In October 2001, the FASB issued Statement of Financial Accounting Standards
144, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of" ("SFAS"). SFAS 144 addresses how and when to measure
impairment on long-lived assets and how to account for long-lived assets that an
entity plans to dispose of either through sale, abandonment, exchange or
distribution to owners. The new provisions supersede SFAS 121, which addressed
asset impairment and certain provisions of APB Opinion 30 related to reporting
the effectseach of the disposal of a business segment. This pronouncement requires
expected future operating losses from discontinued operations to be recorded in
the period in which the losses are incurred rather than the measurement date.
Under SFAS 144, more dispositions may qualify for discontinued operations
treatment in the income statement. The provisions of SFAS 144 are effective for
financial statements issued for fiscal years beginning after December 15, 2001.
The Company will adopt SFAS 144 in fiscal 2003. The Company does not expect
-73-
the adoption of SFAS 144 to have a material impact on the Company's results of
operations, financial position, or cash flows.
In April 2002, the FASB issued Statement of Financial Accounting Standards 145,
"Rescission of FASB Statements No. 4, 44,ended June 27, 2004 and 62, Amendment of FASB Statement
No. 13, and Technical Corrections" ("SFAS 145")June 29, 2003 (in thousands, except per share data). SFAS 145 requires gains and
losses on extinguishments of debt to be classified as income or loss from
continuing operations rather than as extraordinary items as previously required
under Statement 4. Extraordinary treatment will be required for certain
extinguishments as provided in APB 30. SFAS 145 also amends Statement 13 to
require certain modifications to capital leases be treated as a sale-leaseback
and modifies the accounting for sub-leases when the original lessee remains a
secondary obligor (or guarantor). In addition, SFAS 145 rescinded Statement 44
addressing the accounting for intangible assets of motor carriers and made
numerous technical corrections. SFAS 145 is effective for all fiscal years
beginning after May 15, 2002 and will be adopted by the Company on July 1, 2003.
The Company does not expect the adoption of SFAS 145 to have a material impact
on the Company's results of operations, financial position, or cash flows.
In July 2002, the FASB issued Statement of Financial Accounting Standards 146,
"Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS 146").
SFAS 146, which nullified EITF Issue 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)", requires that a liability for a
cost associated with an exit or disposal activity be recognized when the
liability is incurred. Under Issue 94-3, a liability for an exit cost was
recognized at the date of an entity's commitment to an exit plan. The provisions
of this Statement are effective for exit or disposal activities that are
initiated after December 31, 2002. The Company does not expect the adoption of
SFAS 146 to have a material impact on the Company's results of operations,
financial position, or cash flows.
September 28, 2003 | December 28, 2003 | March 28, 2004 | June 27, 2004 | Fiscal Year 2004 | ||||||||||||
Net revenue | $ | 66,211 | $ | 72,684 | $ | 77,113 | $ | 90,862 | $ | 306,870 | ||||||
Cost of revenue | 37,995 | 38,839 | 38,282 | 43,338 | 158,454 | |||||||||||
Net income | 8,879 | 13,007 | 15,089 | 20,985 | 57,960 | |||||||||||
Earnings per share: | ||||||||||||||||
Basic | $ | 0.12 | $ | 0.18 | $ | 0.20 | $ | 0.28 | $ | 0.78 | ||||||
Diluted | $ | 0.12 | $ | 0.17 | $ | 0.20 | $ | 0.28 | $ | 0.77 | ||||||
September 29, 2002 | December 29, 2002 | March 30, 2003 | June 29, 2003 | Fiscal Year 2003 | ||||||||||||
Net revenue | $ | 48,811 | $ | 56,727 | $ | 60,223 | $ | 64,061 | $ | 229,822 | ||||||
Cost of revenue | 30,106 | 33,187 | (1) | 32,176 | 35,183 | 130,652 | ||||||||||
Net income | 3,883 | 8,996 | (2) | 10,631 | 11,391 | 34,901 | ||||||||||
Earnings per share: | ||||||||||||||||
Basic | $ | 0.05 | $ | 0.12 | $ | 0.15 | $ | 0.16 | $ | 0.48 | ||||||
Diluted | $ | 0.05 | $ | 0.12 | $ | 0.14 | $ | 0.15 | $ | 0.46 | ||||||
| (1) | Includes a $1.3 million write-down of inventory at Cree Microwave due to the termination of the supply agreement with Spectrian. |
| (2) | Includes a $5.0 million pre-tax ($3.7 million after-tax) one-time gain as we received a payment from Spectrian associated with the termination of the supply agreement between Spectrian and Cree Microwave. |
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934), as amended (the “Exchange Act”) as of the end of the period covered by this Form 10-K. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by Form 10-K, our disclosure controls and procedures provide reasonable assurances that the information we are required to disclose in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time period required by the United States Securities and Exchange Commission’s rules and forms. From time to time, we make changes to our internal controls over financial reporting that are intended to enhance the effectiveness of our internal controls and which do not have a material effect on our overall internal controls. We will continue to evaluate the effectiveness of our disclosure controls and procedures and internal controls over financial reporting on an ongoing basis and will take action as appropriate There have been no changes in our internal controls over financial reporting as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act during the fourth quarter of fiscal 2004 that we believe materially affected, or will be reasonably likely to materially affect, our internal controls over financial reporting.
PART III
Item 10. Directors and Executive Officers
Item 11. Executive Compensation
Item 12. Security Ownership of
Certain Beneficial Owners and Management
Item 13. Certain Relationships and Related Transactions
The information called for in items 10, through11,12, 13 and 14 is incorporated by reference from the Company'sour definitive proxy statement relating to itsour annual meeting of stockholders,shareholders, which will be filed with the Securities and Exchange Commission within 120 days after the end of fiscal 2004.
The Company has adopted a Code of Ethics applicable to its senior financial officers, including its Chief Executive Officer and Chief Financial Officer. The full text of our Code of Ethics is published on our website at www.cree.com. The Company intends to disclose future amendments to, or waivers from, the Code of Ethics consistent with Item 5.05 of Form 8-K on its web site within four business days following the date of such amendment or waiver. The Company will also provide a copy of our Code of Ethics to any person, without charge. All such requests should be in writing and sent to the attention of the Manager, Investor Relations and Corporate Communications, Cree, Inc. 4600 Silicon Drive, Durham, NC 27703.
Item 10. Directors and Executive Officers
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Equity Compensation Plans
The following table provides information, as of June 27, 2004, for all of the Company’s compensation plans (including individual compensation arrangements) under which we are authorized to issue equity securities.
Equity Compensation Plan Information
Plan Category | (a) Number of securities to | (b) Weighted average | (c) Number of securities reflected in column (a))(1) | ||||||
Equity compensation plans approved by security holders | 10,522,961 | (2) | $ | 22.57 | 2,368,688 | (3) | |||
Equity compensation plans not approved by security holders | 2,994,909 | (4) | $ | 19.39 | — | ||||
Total | 13,517,870 | $ | 21.86 | 2,368,688 | |||||
| (1) | Refers to shares of the Company’s common stock. All amounts are as of June 27, 2004. |
| (2) | Includes shares issuable upon exercise of outstanding options under the following plans in the amounts indicated: Equity Compensation Plan—10,342,961 shares; and Stock Option Plan for Non-Employee Directors—180,000 shares. |
| (3) | Includes shares remaining for future issuance under the following plans in the amounts indicated: Equity Compensation Plan—2,006,773 shares and 1999 Employee Stock Purchase Plan—361,915 shares. |
| (4) | Includes shares issuable upon exercise of outstanding options under the following plans in the amounts indicated: 2001 Nonqualified Stock Option Plan—2,622,283 shares; Fiscal 2002 Stock Option Bonus Plan—48,237 shares; Fiscal 2001 Stock Option Bonus Plan—220,075 shares; and Nitres, Inc. 1999 Stock Option/Issuance Plan—104,314 shares. The options outstanding under the Nitres, Inc. 1999 Stock Option/Issuance Plan, which have a weighted average exercise price of $0.005 per share, were assumed by the Company in connection with its acquisition of Nitres, Inc. in May 2000. |
Other than the 1999 Employee Stock Purchase Plan, the only compensation plans or arrangements under which the Company is authorized to issue equity securities are the following (collectively, the “Option Plans”): (1) the Equity Compensation Plan; (2) the 2001 Nonqualified Stock Option Plan; (3) the Fiscal 2002 Stock Option Bonus Plan; (4) the Fiscal 2001 Stock Option Bonus Plan; (5) the Stock Option Plan for Non-Employee Directors; and (6) options assumed under the Nitres, Inc. 1999 Stock Option/Issuance Plan in connection with the Company’s acquisition of Nitres, Inc. in May 2000. The only Option Plan under which the Company remains authorized to make future awards is the Equity Compensation Plan.
The 1999 Employee Stock Purchase Plan and all of the Option Plans, have been previously approved by the shareholders with the exception of the 2001 Nonqualified Stock Option Plan, the two Stock Option Bonus Plans, and the options assumed under the Nitres, Inc. 1999 Stock Option/Issuance Plan. The Equity Compensation Plan was originally adopted by the Board of Directors in 1989 and approved by the shareholders in 1995. As permitted by its terms, the Equity Compensation Plan was amended by the Board of Directors in 1999 and 2000, without a shareholder vote, to authorize an additional 859,800 shares for nonqualified stock option grants to newly hired employees where the grants were deemed essential to induce such individuals to accept employment with the Company. A further amendment of the Equity Compensation Plan, increasing the shares authorized for issuance under the plan since its adoption to a total of 19,819,800 shares (including the 859,800 shares previously authorized by the Board of Directors) was approved by the shareholders in October 2000.
The following description of the Company’s Option Plans is merely a summary of some of their respective terms and provisions, is not intended to be a complete description and is qualified in its entirety by reference to the full text of the applicable plan.
Option Plans—General. The Option Plans are administered under the direction of the Compensation Committee of the Board of Directors, which is comprised entirely of directors not employed by the Company. The Committee has broad discretion to determine the terms and conditions of options granted under the Option Plans and must approve, among other things, recommendations regarding grants and grant guidelines with respect to: (1) the individuals to whom option grants are to be made; (2) the time or times at which options are granted; (3) the number of shares subject to each option; (4) the vesting terms of each option; and (5) the term of each option. The Option Plans prohibit the grant of options with an exercise price less than the fair market value of the Company’s common stock on the date of grant.
Each of the Option Plans provides that the option price, as well as the number of shares subject to options granted or to be granted under the plan, shall be appropriately adjusted in the event of any stock split, stock dividend, recapitalization or other specified events involving a change in the capitalization of the Company. The terms of the Option Plans generally permit the Board of Directors to amend or terminate the plans, provided that no modification or termination may adversely affect prior awards without the participant’s approval and subject, in the case of the Equity Compensation Plan, to obtaining shareholder approval to the extent required for incentive stock option grants under Section 422 of the Internal Revenue Code (the “Code”).
Equity Compensation Plan. The Equity Compensation Plan provides for grants to participants in the form of both incentive stock options and nonqualified stock options. Incentive stock options are awards intended to qualify for certain favorable tax treatment under Section 422 of the Code. To date no incentive stock options have been granted under the plan and none are presently contemplated. The Compensation Committee has the exclusive right to determine those persons eligible to participate in the Equity Compensation Plan. Subject to the foregoing, any of the Company’s employees (including employees of our controlled subsidiaries) or any other person, including directors, may participate in the Equity Compensation Plan if the Committee determines such participation is in the best interest of the Company. As of June 27, 2004, there were outstanding nonqualified stock options to purchase 10,342,961 shares, and 2,006,773 shares remained available for future awards under the plan. During fiscal 2004, options to purchase a total of 2,128,248 shares were granted under the Equity Compensation Plan at an average exercise price of $20.00 per share.
Non-Employee Director Stock Option Plan. The Stock Option Plan for Non-Employee Directors (the “Director Plan”) was adopted by the Board of Directors and approved by the shareholders in 1995. The Director Plan provided for fixed annual grants to the Company’s non-employee directors of nonqualified stock options to purchase shares of the Company’s common stock. The Director Plan was terminated as to future grants in 1997. As of June 27, 2004, there were options to purchase 180,000 shares outstanding under the Director Plan.
2001 Nonqualified Stock Option Plan. The 2001 Nonqualified Stock Plan (the “Nonqualified Plan”) was adopted by the Board of Directors in April 2001. The Nonqualified Plan provided for grants to eligible participants of nonqualified stock options to purchase shares of the Company’s common stock. None of the Company’s directors or officers were eligible to receive awards under the Nonqualified Plan. The Nonqualified Plan terminated as to additional grants in January 2003. As of June 27, 2004, there were options to purchase 2,622,283 shares outstanding under the Nonqualified Plan.
Fiscal 2001 and Fiscal 2002 Stock Option Bonus Plans. The Board of Directors adopted the Fiscal 2001 Stock Option Bonus Plan (“Fiscal 2001 Bonus Plan”) in October 1999 in order to provide for grants of nonqualified stock options to the Company’s eligible employees (including employees of its controlled subsidiaries) for each quarter of fiscal 2001 if the Company achieved pre-established financial targets for the quarter. None of the Company’s directors or officers were eligible to receive awards under the plan, and employees participating in the Company’s cash incentive compensation programs did not participate in the plan. Participants in the Fiscal 2001 Bonus Plan received stock option grants for all four quarters of fiscal 2001 representing rights to purchase a total of 372,400 shares at an average exercise price of $27.85 per share. The Fiscal 2001 Bonus Plan terminated as to additional grants in September 2001. As of June 27, 2004, there were options to purchase 220,075 shares outstanding under the Fiscal 2001 Bonus Plan.
The Fiscal 2002 Stock Option Bonus Plan (“Fiscal 2002 Bonus Plan”) was adopted by the Company’s Board of Directors in July 2001 with substantially the same terms as the Fiscal 2001 Bonus Plan. Under the Fiscal 2002 Bonus Plan, participants received only the first of the four potential option grants for fiscal 2002, with the options awarded representing rights to purchase a total of 84,306 shares at an average exercise price of $18.75 per share. The Fiscal 2002 Bonus Plan terminated as to additional grants in September 2002. -74-
Nitres, Inc. 1999 Stock Option/Issuance Plan. In connection with the acquisition of Nitres, Inc. in May 2000, pursuant to which Nitres became a wholly-owned subsidiary of the Company and changed its name to Cree Lighting Company, the Company assumed certain outstanding stock options granted under the Nitres, Inc. 1999 Stock Option/Issuance Plan (the “Nitres Plan”). Since the closing of the acquisition, no additional stock options have been awarded, nor are any authorized to be awarded, under the Nitres Plan. As of June 27, 2004, there were 104,314 nonqualified stock options outstanding under the Nitres Plan.
Item 13. Certain Relationships and Related Transactions
Item 14. Principal Accountant Fees and Services
Item 14.15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) (1) and (2) Financial statements and financial statement schedule - schedule—the financial statements and reports of independent auditors are filed as part of this report (see index to Consolidated Financial Statements at Part II Item 7 on page 39 of this Form 10-K)8). The financial statement schedules are not included in this item as they are either not applicable or are included as part of the consolidated financial statements.
(a) (3) The following exhibits have been or are being filed herewith and are numbered in accordance with Item 601 of Regulation S-K:
EXHIBIT NO. DESCRIPTION
3.1 Articles of Incorporation, as amended
3.2 Bylaws, as amended (1)
4.1 Specimen Common Stock Certificate
4.2 Rights Agreement dated as of May 30, 2002 between the Company and
American Stock Transfer & Trust Company, including the form of
Rights Certificate and the Summary of Rights to Purchase Preferred
Stock, attached thereto as Exhibits B and C, respectively (2)
10.1
| Exhibit No. | Description | |
| 3.1 | Articles of Incorporation, as amended (1) | |
| 3.2 | Bylaws, as amended (2) | |
| 4.1 | Specimen Common Stock Certificate (1) | |
| 4.2 | Rights Agreement dated as of May 30, 2002 between the Company and American Stock Transfer & Trust Company, including the form of Rights Certificate and the Summary of Rights to Purchase Preferred Stock, attached thereto as Exhibits B and C, respectively (3) | |
| 10.1 | Equity Compensation | |
| 10.2 | Stock Option Plan for Non-Employee Directors (terminated as to future grants pursuant to Board action dated September 1, 1997) (5)* | |
| 10.3 | Nitres, Inc. 1999 Stock Option/Issuance Plan (terminated as to future grants—following the acquisition of Nitres, Inc. by the Registrant effective May 1, 2000) (1)* | |
| 10.4 | 2001 Nonqualified Stock Option Plan (plan expired in January 2003) (1)* | |
| 10.5 | Fiscal 2001 Stock Option Bonus Plan (plan expired September 30, 2001) (1)* | |
| 10.6 | Fiscal 2002 Stock Option Bonus Plan (plan expired September 30, 2002) (1)* | |
| 10.7 | Management Incentive Compensation Program—Fiscal Year 2001 Plan (4)* | |
| 10.8 | Fiscal 2002 Management Incentive Plan (6)* | |
| 10.9 | Fiscal Year 2003 Management Incentive Plan (7)* | |
| 10.10 | Fiscal 2004 Management Incentive Compensation Plan (8)* | |
| 10.11 | License Agreement between the Company and North Carolina State University, dated December 3, 1987 (9) | |
| 10.12 | Amendment to License Agreement between the Company and North Carolina State University, dated September 11, 1989 (9) | |
| 10.13 | Sublease Agreement, dated December 29, 2000, between Zoltar Acquisition Inc. (now Cree Microwave, Inc.) and Spectrian Corporation (10) | |
| 10.14 | Purchase and Supply Agreement, dated December 29, 2000, between Spectrian Corporation and Zoltar Acquisition, Inc. (now Cree Microwave, Inc.) (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) (8) | |
| 10.15 | Amendment of Purchase and Supply Agreement, dated October 19, 2001, between Spectrian Corporation and UltraRF, Inc. (now Cree Microwave, Inc.) (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) (8) | |
| Exhibit No. | Description | |
| 10.16 | Amendment No. 2 to Purchase and Supply Agreement, effective as of March 31, 2002, between Spectrian Corporation and UltraRF, Inc. (now Cree Microwave, Inc.) (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) (8) | |
| 10.17 | Settlement Agreement and Release, effective as of November 15, 2002, among Spectrian Corporation, the Company and Cree Microwave, Inc. (8) | |
| 10.18 | Letter Agreement, dated January 31, 1996, between C3 Diamante, Inc. and the Company (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) (8) | |
| 10.19 | Letter Agreement, dated February 12, 1996, between C3 Diamante, Inc. and the Company (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) (8) | |
| 10.20 | Amended and Restated Exclusive Supply Agreement, effective as of June 6, 1997, between C3, Inc. and the Company (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) (8) | |
| 10.21 | Letter Agreement, dated July 14, 1997, between C3, Inc. and the Company (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) (8) | |
| 10.22 | Letter Agreement, dated July 14, 1997, between C3, Inc. and the Company (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) (8) | |
| 10.23 | Letter Agreement, dated August 5, 2002, between Charles & Colvard, Ltd. and Cree, Inc. (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) (8) | |
| 10.24 | Contract No. N00014-02-C-0302, dated June 28, 2002, between the Company and the Office of Naval Research, as amended (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) (8) | |
| 10.25 | Contract No. N00014-02-C-0306, dated June 28, 2002, between the Company and the Office of Naval Research, as amended (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) (8) | |
| 10.26 | Contract No. N00014-02-C-0250, dated July 3, 2002, between the Company and the Office of Naval Research, as amended (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) (8) | |
| 10.27 | Contract No. F33615-99-C-5316, dated August 30, 1999, between the Company and Air Force Research Laboratories, as amended (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) (8) | |
| 10.28 | Contract No. DAAD17-02-C-0073, dated March 20, 2002, between the Company and US Army Robert Morris Acquisition Center, as amended (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) (8) | |
| Exhibit No. | Description | |
| 10.29 | Letter Agreement, dated December 14, 2003, between Charles & Colvard, Ltd. and the Company (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) (11) | |
| 10.30 | Amendment to Contract No. N00014-02-C-0302, dated December 23, 2003, between the Company and the Office of Naval Research (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) | |
| 10.31 | Amendment to Contract No. N00014-02-C-0302, dated June 30, 2004, between the Company and the Office of Naval Research (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) | |
| 10.32 | Amendment to Contract No. N00014-02-C-0306, dated December 23, 2003, between the Company and the Office of Naval Research (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) | |
| 10.33 | Cooperative Agreement (Agreement No. W911NF-04-2-0021), dated April 29, 2004, between the Company and the U.S. Army Research Laboratory (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) | |
| 10.34 | Cooperative Agreement (Agreement No. W911NF-04-2-0022), dated May 13, 2004, between the Company and the U.S. Army Research Laboratory (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) | |
| 10.35 | Amended and Restated Distributorship Agreement, dated May 14, 2004, between the Company and Sumitomo Corporation (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) | |
| 10.36 | Letter Agreement, dated July 12, 2004, between the Company and Sumitomo Corporation (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) | |
| 21.1 | Subsidiaries of the Registrant | |
| 23.1 | Consent of Registered Public Accounting Firm | |
| 31.1 | Certification by Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
| 31.2 | Certification by Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
| 32.1 | Certification by Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
| 32.2 | Certification by Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
| (1) | Incorporated by reference herein. Filed as an exhibit to the Company’s Annual Report filed on Form 10-K with the Securities and Exchange Commission on August 19, 2002. |
| (2) | Incorporated by reference herein. Filed as an exhibit to the Company’s Annual Report filed on Form 10-K with the Securities and Exchange Commission on August 27, 2001. |
| (3) | Incorporated by reference herein. Filed as an exhibit to the Company’s Registration Statement filed on Form 8-A with the Securities and Exchange Commission on May 30, 2002. |
| (4) | Incorporated by reference herein. Filed as an exhibit to the Company’s Quarterly Report filed on Form 10-Q with the Securities and Exchange Commission on February 2, 2001. |
| (5) | Incorporated by reference herein. Filed as an exhibit to the Company’s Registration Statement filed on Form S-8, Registration No. 33-98958, and effective with the Securities and Exchange Commission on November 3, 1995. |
| (6) | Incorporated by reference herein. Filed as an exhibit to the Company’s Quarterly Report filed on Form 10-Q with the Securities and Exchange Commission on February 5, 2002. |
| (7) | Incorporated by reference herein. Filed as an exhibit to the Company’s Quarterly Report filed on Form 10-Q with the Securities and Exchange Commission on October 29, 2002. |
| (8) | Incorporated by reference herein. Filed as an exhibit to the Company’s Annual Report filed on Form 10-K with the Securities and Exchange Commission on September 25, 2003. |
| (9) | Incorporated by reference herein. Filed as an exhibit to the Company’s Registration Statement filed on Form SB-2, Registration No. 33-55998, and declared effective by the Securities and Exchange Commission on February 8, 1993. |
| (10) | Incorporated by reference herein. Filed as an exhibit to the Company’s Current Report filed on Form 8-K with the Securities and Exchange Commission on January 12, 2001. |
| (11) | Incorporated by reference herein. Filed as an exhibit to the Company’s Quarterly Report filed on Form 10-Q with the Securities and Exchange Commission on February 4, 2004. |
| * | Management Contract or Compensatory Plan |
(b) Reports on Form 8-K.
On May 30, 2002April 15, 2004, the Company filedfurnished a Current Report on Form 8-K announcing a dividend
distribution of one preferred stock purchase rightcontaining its press release on its earnings results for each outstanding
share of the Company's common stock, $.00125 par valuequarter ended March 28, 2004. Information furnished in the Form 8-K referenced in the prior sentence is not deemed to shareholders of
record atbe filed with the close of business on June 10, 2002.
-76-
Pursuant to the requirements of Section 13 or 15(d) of the Securities and 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: August 16, 2002
By: /s/ Charles M. Swoboda
------------------------
Charles M. Swoboda
Chief Executive Officer
20, 2004
| CREE, INC. | ||
By: | /S/ CHARLES M. SWOBODA | |
Charles M. Swoboda Chief Executive Officer | ||
Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature | Title | Date | ||
/S/ F. NEAL HUNTER F. Neal Hunter | Chairman | August | ||
/S/ CHARLES M. SWOBODA Charles M. Swoboda | Chief Executive Officer and Director | August | ||
/S/ CYNTHIA B. MERRELL Cynthia B. Merrell | Chief Financial Officer and | August 20, 2004 | ||
/S/ JAMES E. DYKES James E. Dykes | Director | August | ||
/S/ WILLIAM J. O’MEARA William J. | Director | August | ||
/S/ JOHN W. PALMOUR, PH.D. John W. Palmour, Ph.D. | Director | August | ||
/S/ ROBERT J. POTTER, PH.D. Robert J. Potter, Ph.D. | Director | August | ||
/S/ DOLPH W.VON ARX Dolph W. von Arx | Director | August | ||
/S/ HARVEY A. WAGNER Harvey A. Wagner | Director | August 20, 2004 | ||
EXHIBIT INDEX
| Exhibit No. | Description | |
| 3.1 | Articles of Incorporation, as amended (1) | |
| 3.2 | Bylaws, as amended (2) | |
| 4.1 | Specimen Common Stock Certificate (1) | |
| 4.2 | Rights Agreement dated as of May 30, 2002 | |
| 10.1 | Equity Compensation Plan, as amended and restated December 1, 2000 (4)* | |
| 10.2 | Stock Option Plan for Non-Employee Directors (terminated as to future grants pursuant to Board action dated September 1, 1997) (5)* | |
| 10.3 | Nitres, Inc. 1999 Stock Option/Issuance Plan (terminated as to future grants—following the acquisition of Nitres, Inc. by the Registrant effective May 1, 2000) (1)* | |
| 10.4 | 2001 Nonqualified Stock Option Plan (plan expired in January 2003) (1)* | |
| 10.5 | Fiscal 2001 Stock Option Bonus Plan (plan expired September 30, 2001) (1)* | |
| 10.6 | Fiscal 2002 Stock Option Bonus Plan (plan expired September 30, 2002) (1)* | |
| 10.7 | Management Incentive Compensation Program—Fiscal Year 2001 Plan (4)* | |
| 10.8 | Fiscal 2002 Management Incentive Plan (6)* | |
| 10.9 | Fiscal Year 2003 Management Incentive Plan (7)* | |
| 10.10 | Fiscal 2004 Management Incentive Compensation Plan (8)* | |
| 10.11 | License Agreement between the Company and North Carolina State University, dated December 3, 1987 (9) | |
| 10.12 | Amendment to License Agreement between the Company and North Carolina State University, dated September 11, 1989 (9) | |
| 10.13 | Sublease Agreement, dated December 29, 2000, between Zoltar Acquisition Inc. (now Cree Microwave, Inc.) and Spectrian Corporation (10) | |
| 10.14 | Purchase and Supply Agreement, dated December 29, 2000, between Spectrian Corporation and Zoltar Acquisition, Inc. (now Cree Microwave, Inc.) (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) (8) | |
| 10.15 | Amendment of Purchase and Supply Agreement, dated October 19, 2001, between Spectrian Corporation and UltraRF, Inc. (now Cree Microwave, Inc.) (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) (8) | |
| 10.16 | Amendment No. 2 to Purchase and Supply Agreement, effective as of March 31, 2002, between Spectrian Corporation and UltraRF, Inc. (now Cree Microwave, Inc.) (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) (8) | |
| 10.17 | Settlement Agreement and Release, effective as of November 15, 2002, among Spectrian Corporation, the Company and Cree Microwave, Inc. (8) | |
| 10.18 | Letter Agreement, dated January 31, 1996, between C3 Diamante, Inc. and the Company (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) (8) | |
| 10.19 | Letter Agreement, dated February 12, 1996, between C3 Diamante, Inc. and the Company (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) (8) | |
| 10.20 | Amended and Restated Exclusive Supply Agreement, effective as of June 6, 1997, between C3, Inc. and the Company (asterisks located within the exhibit denote information which has been deleted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission) (8) |