UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 27, 2009
or
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number 0-21154
CREE, INC.
(Exact name of registrant as specified in its charter)
North Carolina | 56-1572719 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) | |
4600 Silicon Drive Durham, North Carolina |
27703 | |
(Address of principal executive offices) | (Zip Code) |
(919) 313-5300
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Large accelerated filer x | Accelerated filer ¨ | |||
Non-accelerated filer ¨ (Do not check if a smaller reporting company) | Smaller reporting company ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
The number of shares outstanding of the registrants common stock, par value $0.00125 per share, as of October 13, 2009, was 103,634,012.
FORM 10-Q
For the Quarterly Period Ended September 27, 2009
INDEX
2
Item 1. | Financial Statements |
CONSOLIDATED BALANCE SHEETS
September 27, 2009 (Unaudited) |
June 28, 2009 | |||||
(Thousands, except per share data) | ||||||
ASSETS |
||||||
Current assets: |
||||||
Cash and cash equivalents |
$ | 695,991 | $ | 290,154 | ||
Short-term investments: |
172,286 | 127,499 | ||||
Total cash, cash equivalents, and short-term investments |
868,277 | 417,653 | ||||
Accounts receivable, net |
93,059 | 103,035 | ||||
Income tax receivable |
1,526 | 1,526 | ||||
Inventories, net |
85,990 | 78,841 | ||||
Deferred income taxes |
10,007 | 10,022 | ||||
Prepaid expenses and other current assets |
19,599 | 18,359 | ||||
Total current assets |
1,078,458 | 629,436 | ||||
Property and equipment, net |
333,576 | 320,110 | ||||
Long-term investments |
20,170 | 29,557 | ||||
Intangible assets, net |
111,315 | 113,328 | ||||
Goodwill |
304,791 | 304,791 | ||||
Other assets |
5,925 | 7,345 | ||||
Total assets |
$ | 1,854,235 | $ | 1,404,567 | ||
LIABILITIES AND SHAREHOLDERS EQUITY |
||||||
Current liabilities: |
||||||
Accounts payable, trade |
$ | 55,177 | $ | 38,770 | ||
Accrued salaries and wages |
20,662 | 16,732 | ||||
Income taxes payable |
9,559 | 8,139 | ||||
Deferred income taxes |
379 | 122 | ||||
Other current liabilities |
8,580 | 7,868 | ||||
Contingent payment due related to COTCO acquisition |
| 57,050 | ||||
Total current liabilities |
94,357 | 128,681 | ||||
Long-term liabilities: |
||||||
Deferred income taxes |
42,737 | 42,752 | ||||
Other long-term liabilities |
8,386 | 8,386 | ||||
Total long-term liabilities |
51,123 | 51,138 | ||||
Commitments and contingencies (Note 12) |
||||||
Shareholders equity: |
||||||
Preferred stock, par value $0.01; 3,000 shares authorized at September 27, 2009 and June 28, 2009; none issued and outstanding |
| | ||||
Common stock, par value $0.00125; 200,000 shares authorized at September 27, 2009 and June 28, 2009; 103,473 and 89,659 shares issued and outstanding at September 27, 2009 and June 28, 2009, respectively |
129 | 112 | ||||
Additional paid-in-capital |
1,319,962 | 857,383 | ||||
Accumulated other comprehensive income, net of taxes |
11,621 | 11,236 | ||||
Retained earnings |
377,043 | 356,017 | ||||
Total shareholders equity |
1,708,755 | 1,224,748 | ||||
Total liabilities and shareholders equity |
$ | 1,854,235 | $ | 1,404,567 | ||
The accompanying notes are an integral part of the consolidated financial statements
3
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
Three Months Ended | ||||||
September 27, 2009 |
September 28, 2008 | |||||
(Thousands, except per share data) | ||||||
Revenue, net |
$ | 169,130 | $ | 140,378 | ||
Cost of revenue, net |
95,352 | 91,015 | ||||
Gross profit |
73,778 | 49,363 | ||||
Operating expenses: |
||||||
Research and development |
20,174 | 17,275 | ||||
Sales, general and administrative |
23,613 | 22,918 | ||||
Amortization of acquistion related intangibles |
3,045 | 4,062 | ||||
Loss on disposal or impairment of long-lived assets |
293 | 405 | ||||
Total operating expenses |
47,125 | 44,660 | ||||
Operating income |
26,653 | 4,703 | ||||
Non-operating income: |
||||||
Gain on sale of investments, net |
| 12 | ||||
Other non-operating income |
131 | 166 | ||||
Interest income, net |
1,630 | 2,792 | ||||
Income from operations before income taxes |
28,414 | 7,673 | ||||
Income tax expense |
7,388 | 1,754 | ||||
Net income |
$ | 21,026 | $ | 5,919 | ||
Earnings per share: |
||||||
Basic net income per share |
$ | 0.23 | $ | 0.07 | ||
Diluted net income per share |
$ | 0.23 | $ | 0.07 | ||
Shares used in per share calculation: |
||||||
Basic |
91,160 | 87,851 | ||||
Diluted |
92,730 | 88,732 | ||||
The accompanying notes are an integral part of the consolidated financial statements
4
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Three Months Ended | ||||||||
September 27, 2009 |
September 28, 2008 |
|||||||
(Thousands) | ||||||||
Cash flows from operating activities: |
||||||||
Net income |
$ | 21,026 | $ | 5,919 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: |
||||||||
Depreciation and amortization |
22,538 | 24,442 | ||||||
Stock-based compensation |
5,612 | 5,433 | ||||||
Excess tax benefit from share-based payment arrangements |
(2,072 | ) | (106 | ) | ||||
Impairment of inventory or loss on disposal or impairment of long-lived assets |
293 | 405 | ||||||
Provision for doubtful accounts |
146 | 265 | ||||||
Gain on sale of investment in securities |
| (12 | ) | |||||
Amortization of premium/discount on investments |
705 | 102 | ||||||
Changes in operating assets and liabilities: |
||||||||
Accounts receivable |
9,747 | 6,955 | ||||||
Inventories |
(7,285 | ) | 602 | |||||
Prepaid expenses and other assets |
176 | (1,894 | ) | |||||
Accounts payable, trade |
4,388 | 3,423 | ||||||
Accrued expenses and other liabilities |
5,914 | (1,583 | ) | |||||
Net cash provided by operating activities |
61,188 | 43,951 | ||||||
Cash flows from investing activities: |
||||||||
Purchases of property and equipment |
(20,389 | ) | (13,700 | ) | ||||
Payment of contingent consideration related to COTCO acquisition |
(57,050 | ) | (60,000 | ) | ||||
Purchases of investments |
(61,435 | ) | (138,688 | ) | ||||
Proceeds from maturities of investments |
25,972 | 84,215 | ||||||
Proceeds from sale of property and equipment |
191 | 18 | ||||||
Proceeds from sale of available-for-sale investments |
| 1,039 | ||||||
Purchases of patent and licensing rights |
(2,142 | ) | (1,978 | ) | ||||
Net cash used in investing activities |
(114,853 | ) | (129,094 | ) | ||||
Cash flows from financing activities: |
||||||||
Net proceeds from issuance of common stock |
457,227 | 3,842 | ||||||
Excess tax benefit from share-based payment arrangements |
2,072 | 106 | ||||||
Repurchases of common stock |
| (2,744 | ) | |||||
Net cash provided by financing activities |
459,299 | 1,204 | ||||||
Effects of foreign exchange changes on cash and cash equivalents |
203 | (250 | ) | |||||
Net increase (decrease) in cash and cash equivalents |
405,837 | (84,189 | ) | |||||
Cash and cash equivalents: |
||||||||
Beginning of period |
$ | 290,154 | $ | 261,633 | ||||
End of period |
$ | 695,991 | $ | 177,444 | ||||
The accompanying notes are an integral part of the consolidated financial statements
5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 1. Basis of Presentation and Changes in Significant Accounting Policies
Description of Business
Cree, Inc. (the Company) develops and manufactures semiconductor materials and devices primarily based on silicon carbide (SiC), gallium nitride (GaN) and related compounds. The Company primarily focuses its expertise in SiC and GaN on light emitting diodes (LED). The Company also develops power and radio frequency (RF) products, including power switching and RF devices. The Companys revenues are classified as follows:
| LED products. The Company derives the largest portion of its revenue from the sale of its LED products. These products consist of LED components, LED chips, LED lighting products and SiC and GaN wafers. Also included are revenues derived from government agencies to support the development of LED lighting. |
| Power and RF products. These products include power switching devices made from SiC, which provide faster switching speeds than comparable silicon-based power devices, and also include RF devices made from SiC or GaN, which allow for higher power densities as compared to silicon or gallium arsenide. Also included are revenues derived from government agencies to support the development of primarily SiC and GaN based technology. |
The majority of the Companys products are produced at its production facilities located in North Carolina and China. In some circumstances, the Company may also use contract manufacturers for certain aspects of product fabrication.
Basis of Presentation
The consolidated balance sheet at September 27, 2009 and the consolidated statements of income for the three months ended September 27, 2009 and September 28, 2008, and the consolidated statements of cash flows for the three months ended September 27, 2009 and September 28, 2008 have been prepared by the Company and have not been audited. In the opinion of management, all normal and recurring adjustments necessary to present fairly the consolidated financial position, results of operations and cash flows at September 27, 2009, and for all periods presented, have been made. The consolidated balance sheet at June 28, 2009 has been derived from the audited financial statements as of that date.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) have been condensed or omitted. It is suggested that these financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Companys Annual Report on Form 10-K for the fiscal year ended June 28, 2009 (fiscal 2009). The results of operations for the period ended September 27, 2009 are not necessarily indicative of the operating results that may be attained for the entire fiscal year ending June 27, 2010 (fiscal 2010).
Certain fiscal 2009 amounts in the accompanying consolidated financial statements have been reclassified to conform to the fiscal 2010 presentation. These reclassifications had no effect on previously reported consolidated net income or shareholders equity.
6
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(UNAUDITED)
Recent Accounting Pronouncements
Accounting for Business Combinations
The Company adopted new U.S. GAAP guidance related to business combinations beginning in its first quarter of fiscal 2010. Earlier adoption was prohibited. The adoption of the new guidance did not have an immediate significant impact on its consolidated financial statements, however it will impact the accounting for any future business combinations. Under the new guidance, an entity is required to recognize the assets acquired, liabilities assumed, contractual contingencies, and contingent consideration at their fair value on the acquisition date. It further requires that acquisition-related costs be recognized separately from the acquisition and expensed as incurred; that restructuring costs generally be expensed in periods subsequent to the acquisition date; and that changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period be recognized as a component of provision for income taxes. In addition, acquired in-process research and development is capitalized as an intangible asset and amortized over its estimated useful life.
Noncontrolling Interests in Consolidated Financial Statements
The Company adopted new U.S. GAAP guidance related to noncontrolling interests in consolidated financial statements beginning in its first quarter of fiscal 2010. Earlier adoption was prohibited. The Companys adoption of this guidance did not have a significant impact on its consolidated financial statements. The guidance revises new accounting and reporting standards for the noncontrolling interest in a subsidiary and the accounting for the deconsolidation of a subsidiary. It also clarifies that changes in a parents ownership interest in a subsidiary that do not result in deconsolidation are equity transactions if the parent retains its controlling financial interest and requires that a parent recognize a gain or loss in net income when a subsidiary is deconsolidated. The gain or loss is measured using the fair value of the noncontrolling equity investment on the deconsolidation date. The guidance also requires expanded disclosures regarding the interest of the parent and the noncontrolling interest.
Determination of the Useful Life of Intangible Assets
The Company adopted new U.S. GAAP guidance concerning the determination of the useful life of intangible assets beginning in its first quarter of fiscal 2010. The Companys adoption of the new guidance did not have a significant impact on its consolidated financial statements. The new guidance amends the factors that are to be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. The new guidance is intended to improve the consistency between the useful life of a recognized intangible asset and the period of expected cash flows originally used to measure the fair value of the intangible asset under U.S. GAAP.
International Financial Reporting Standards
In November 2008, the Securities & Exchange Commission (SEC) released a proposed roadmap regarding the potential use by U.S. issuers of financial statements prepared in accordance with International Financial Reporting Standards (IFRS). IFRS is a comprehensive series of accounting standards published by the International Accounting Standards Board. Under the proposed roadmap, the Company may be required in fiscal 2015 to prepare financial statements in accordance with IFRS. However, the SEC announced it will make a determination in 2011 regarding the mandatory adoption of IFRS. The Company is currently assessing the impact that this potential change would have on its consolidated financial statements, and it will continue to monitor the development of the potential implementation of IFRS.
7
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(UNAUDITED)
Transfers of Financial Assets
In June 2009, the FASB issued new guidance concerning the transfer of financial assets. This guidance amends the criteria for a transfer of a financial asset to be accounted for as a sale, creates more stringent conditions for reporting a transfer of a portion of a financial asset as a sale, changes the initial measurement of a transferors interest in transferred financial assets, eliminates the qualifying special-purpose entity concept and provides for new disclosures. This new guidance will be effective for the Company for transfers of financial assets beginning in its first quarter of fiscal 2011, with earlier adoption prohibited. The Company does not expect the impact of this guidance to be material to its consolidated financial statements.
Determining the Primary Beneficiary of a Variable Interest Entity
In June 2009, the FASB issued new guidance concerning the determination of the primary beneficiary of a variable interest entity (VIE). This new guidance amends current U.S. GAAP by: requiring ongoing reassessments of whether an enterprise is the primary beneficiary of a VIE; amending the quantitative approach previously required for determining the primary beneficiary of the VIE; modifying the guidance used to determine whether an entity is a VIE; adding an additional reconsideration event (e.g. troubled debt restructurings) for determining whether an entity is a VIE; and requiring enhanced disclosures regarding an entitys involvement with a VIE.
This new guidance will be effective for the Company beginning in its first quarter of fiscal 2011, with earlier adoption prohibited. The Company does not expect the impact of this new guidance to be material to its consolidated financial statements.
FASB Accounting Standards Codification
In June 2009, the FASB issued new guidance concerning the organization of authoritative guidance under U.S. GAAP. This new guidance created the FASB Accounting Standards Codification (Codification). The Codification has become the source of authoritative U.S. GAAP recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative U.S. GAAP for SEC registrants. The Codification became effective for the Company in its first quarter of fiscal 2010. As the Codification is not intended to change or alter existing U.S. GAAP, it did not have any impact on the Companys consolidated financial statements. On its effective date, the Codification superseded all then-existing non-SEC accounting and reporting standards. All other nongrandfathered non-SEC accounting literature not included in the Codification will become nonauthoritative.
Interactive Data Filing with the SEC
On January 30, 2009, the SEC released the final rules requiring all registered companies to use eXtensible Business Reporting Language (XBRL) when submitting financial statements to the SEC. The new rules initially will require interactive data reporting only by domestic and foreign large accelerated filers that prepare their financial statements in accordance with U.S. GAAP and have a worldwide public common equity float above $5.0 billion for their first quarterly period ending after June 15, 2009 and all periods thereafter. As the Company does not meet this requirement due to its market capitalization, this reporting requirement will apply to its first quarterly filing period ending after June 15, 2010 and all periods thereafter. Therefore, the Company plans to file its first quarter fiscal 2011 financial statements with the SEC in XBRL in compliance with the new SEC rules.
Measuring Liabilities at Fair Value
In August 2009, the FASB released new guidance concerning measuring liabilities at fair value. The new guidance provides clarification that in circumstances in which a quoted price in an active market for the
8
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(UNAUDITED)
identical liability is not available, a reporting entity is required to measure fair value using certain valuation techniques. Additionally, it clarifies that a reporting entity is not required to adjust the fair value of a liability for the existence of a restriction that prevents the transfer of the liability. This new guidance is effective for the first reporting period after its issuance, however earlier application is permitted. The application of this new guidance is not expected to have a significant impact on the Companys consolidated financial statements.
Note 2. Acquisitions
Acquisition of LED Lighting Fixtures, Inc.
On February 29, 2008 the Company acquired LED Lighting Fixtures, Inc. (now Cree LED Lighting Solutions, Inc.) (LLF) through a wholly owned subsidiary. The Company acquired all of the outstanding share capital of LLF in exchange for total upfront consideration of $80.8 million, consisting of (1) $16.5 million in cash, (2) approximately 1.9 million shares of the Companys common stock valued at $58.8 million, (3) the assumption of fully vested LLF employee stock options valued at $4.5 million, and (4) transaction costs of $1.0 million consisting primarily of professional fees incurred relating to attorneys, accountants and valuation advisors. Under the acquisition terms, additional consideration of up to $26.4 million would become payable to the former shareholders of LLF if defined product development targets and key employee retention measures were achieved over the three calendar years following the acquisition.
LLF achieved the defined employee retention goals and product development targets for the calendar year ended December 31, 2008 and as a result, the Company made a cash payment in the amount of $4.4 million to the former shareholders of LLF in the third quarter of fiscal 2009, thus increasing goodwill in the Companys consolidated financial statements. If LLF meets the remaining defined employee retention goals and product development targets during the following two calendar years, additional contingent cash payments totaling up to $21.9 million would become payable to the former shareholders of LLF. If such contingent payments occur, these will be considered as additional purchase price and result in an increase in goodwill.
The assets, liabilities, and operating results of LLF have been included in the Companys consolidated financial statements from the date of acquisition and are reflected in all periods presented in the accompanying financial statements.
Acquisition of COTCO Luminant Device Limited
On March 30, 2007, the Company acquired COTCO Luminant Device Limited, a Hong Kong company (now Cree Hong Kong Limited) (COTCO), from COTCO Holdings Limited, a Hong Kong company (now United Luminous International (Holdings) Limited) (Holdings). The Company acquired all of the outstanding share capital of COTCO in exchange for consideration consisting of approximately 7.6 million shares of the Companys common stock and $77.3 million cash. Under the acquisition terms, additional consideration would become payable to Holdings or its designees in the event COTCO achieved specific EBITDA targets over the Companys two full fiscal years following the acquisition. For fiscal 2008, the Company made a cash payment in the amount of $60.0 million. For fiscal 2009, the Company made a cash payment in the amount of $57.1 million.
The assets, liabilities, and operating results of COTCO have been included in the Companys consolidated financial statements from the date of acquisition and are reflected in all periods presented in the accompanying financial statements.
9
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(UNAUDITED)
Note 3. Financial Statement Details
Accounts Receivable, net
The following is a summary of the components of accounts receivable, net (in thousands):
September 27, 2009 |
June 28, 2009 |
|||||||
Billed trade receivables |
$ | 105,961 | $ | 113,085 | ||||
Unbilled contract receivables |
1,101 | 2,125 | ||||||
107,062 | 115,210 | |||||||
Allowance for sales return |
(11,289 | ) | (9,644 | ) | ||||
Allowance for bad debts |
(2,714 | ) | (2,531 | ) | ||||
Total accounts receivable, net |
$ | 93,059 | $ | 103,035 | ||||
Inventories, net
The following is a summary of the components of inventories, net (in thousands):
September 27, 2009 |
June 28, 2009 |
|||||||
Raw material |
$ | 18,042 | $ | 14,575 | ||||
Work-in-progress |
42,019 | 38,567 | ||||||
Finished goods |
41,803 | 39,552 | ||||||
101,864 | 92,694 | |||||||
Inventory reserve |
(15,874 | ) | (13,853 | ) | ||||
Total inventories, net |
$ | 85,990 | $ | 78,841 | ||||
Note 4. Investments
Short-term and long-term investments consist of high grade corporate bonds and other debt securities. The Company classifies its marketable securities as available-for-sale. This is based upon managements determination that the underlying cash invested in these securities is available for operations as necessary.
10
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(UNAUDITED)
The following tables provide a summary of short-term and long-term investments as of September 27, 2009 and June 28, 2009 (in thousands):
September 27, 2009 | |||||||||||||
Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized Losses |
Estimated Fair Value | ||||||||||
Short-term investments |
$ | 168,332 | $ | 3,954 | $ | | $ | 172,286 | |||||
Long-term investments |
19,518 | 652 | | 20,170 | |||||||||
Total investments |
$ | 187,850 | $ | 4,606 | $ | | $ | 192,456 | |||||
June 28, 2009 | |||||||||||||
Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized Losses |
Estimated Fair Value | ||||||||||
Short-term investments |
$ | 124,472 | $ | 3,049 | $ | (22 | ) | $ | 127,499 | ||||
Long-term investments |
28,620 | 957 | (20 | ) | 29,557 | ||||||||
Total investments |
$ | 153,092 | $ | 4,006 | $ | (42 | ) | $ | 157,056 | ||||
The following table provides a summary of marketable investments by type as of September 27, 2009 and June 28, 2009 (in thousands):
September 27, 2009 | |||||||||||||
Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized Losses |
Estimated Fair Value | ||||||||||
U.S. government securities |
$ | 13,050 | $ | 345 | $ | | $ | 13,395 | |||||
U.S. agency securities |
20,913 | 561 | | 21,474 | |||||||||
Municipal bonds |
96,356 | 2,981 | | 99,337 | |||||||||
Corporate debt securities |
57,531 | 719 | | 58,250 | |||||||||
$ | 187,850 | $ | 4,606 | $ | | $ | 192,456 | ||||||
June 28, 2009 | |||||||||||||
Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized Losses |
Estimated Fair Value | ||||||||||
U.S. government securities |
$ | 15,054 | $ | 454 | $ | | $ | 15,508 | |||||
U.S. agency securities |
19,895 | 698 | | 20,593 | |||||||||
Municipal bonds |
94,745 | 2,483 | (6 | ) | 97,222 | ||||||||
Corporate debt securities |
23,398 | 371 | (36 | ) | 23,733 | ||||||||
$ | 153,092 | $ | 4,006 | $ | (42 | ) | $ | 157,056 | |||||
11
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(UNAUDITED)
The contractual maturities of marketable investments at September 27, 2009 were as follows (in thousands):
Fiscal Years Ending | |||||||||||||||||||||
June 27, 2010 |
June 26, 2011 |
June 24, 2012 |
June 30, 2013 |
June 29, 2014 |
Thereafter | Total | |||||||||||||||
U.S. government securities |
$ | 5,586 | $ | 7,809 | $ | | $ | | $ | | $ | | $ | 13,395 | |||||||
U.S. agency securities |
5,148 | 11,031 | 3,651 | 1,644 | | | 21,474 | ||||||||||||||
Municipal bonds |
17,948 | 9,288 | 10,887 | 15,558 | 17,685 | 27,971 | 99,337 | ||||||||||||||
Corporate debt securities |
7,111 | 10,641 | 39,522 | 976 | | | 58,250 | ||||||||||||||
$ | 35,793 | $ | 38,769 | $ | 54,060 | $ | 18,178 | $ | 17,685 | $ | 27,971 | $ | 192,456 | ||||||||
Note 5. Fair Value of Financial Instruments
Under U.S. GAAP, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the exit price) in an orderly transaction between market participants at the measurement date. In determining fair value, the Company uses various valuation approaches, including quoted market prices and discounted cash flows. U.S. GAAP also establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are obtained from independent sources and can be validated by a third party, whereas, unobservable inputs reflect assumptions regarding what a third party would use in pricing an asset or liability. The fair value hierarchy is broken down into three levels based on the reliability of inputs as follows:
| Level 1Valuations based on quoted prices in active markets for identical instruments that the Company is able to access. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment. |
| Level 2Valuations based on quoted prices in active markets for instruments that are similar, or quoted prices in markets that are not active for identical or similar instruments, and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets. |
| Level 3Valuations based on inputs that are unobservable and significant to the overall fair value measurement. |
The financial assets for which the Company performs recurring fair value remeasurements are cash equivalents, short-term investments and long-term investments. The financial assets for which the Company may be required to perform non-recurring fair value remeasurements (e.g., an impairment of assets) are any investments in privately-held companies. As of September 27, 2009, financial assets utilizing Level 1 inputs included cash equivalents and investments traded on active securities exchanges. Financial assets utilizing Level 2 inputs included corporate bonds, municipal bonds and other instruments. The Company does not have any significant financial assets requiring the use of Level 3 inputs.
12
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(UNAUDITED)
The following table sets forth financial instruments carried at fair value within the U.S. GAAP hierarchy and using the lowest level of input as of September 27, 2009 (in thousands):
Financial Instruments Carried at Fair Value | ||||||||||||
Quoted Prices in Active Markets for Identical Items (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
Total | |||||||||
Assets: |
||||||||||||
Cash equivalents |
$ | 74,407 | $ | 108,870 | $ | | $ | 183,277 | ||||
Short-term investments |
9,194 | 163,092 | | 172,286 | ||||||||
Long-term investments |
4,201 | 15,969 | | 20,170 | ||||||||
Total assets |
$ | 87,802 | $ | 287,931 | $ | | $ | 375,733 | ||||
Realized gains and losses from the sale of investments are included in Gain on sale of investments, net and unrealized gains and losses are included as a separate component of equity, net of tax, unless the loss is determined to be other-than-temporary.
The Company evaluates its investments for possible impairment or a decline in fair value below cost basis that is deemed to be other-than-temporary on a periodic basis. It considers such factors as the length of time and extent to which fair value has been below cost basis, the financial condition of the investee, and its ability and intent to hold the investment for a period of time that may be sufficient for an anticipated recovery in market value.
Note 6. Intangible Assets and Goodwill
Intangible Assets, net
The following table reflects the components of intangible assets, net (in thousands):
September 27, 2009 |
June 28, 2009 |
|||||||
Customer relationships |
$ | 52,620 | $ | 52,620 | ||||
Developed technology |
51,860 | 51,860 | ||||||
Patent and license rights |
64,744 | 62,733 | ||||||
$ | 169,224 | $ | 167,213 | |||||
Accumulated amortization |
(57,909 | ) | (53,885 | ) | ||||
Intangible assets, net |
$ | 111,315 | $ | 113,328 | ||||
Total amortization expense, including the amortization of acquisition related intangibles, patents and license rights, recognized during the three months ended September 27, 2009 and September 28, 2008 was $4.0 million and $4.9 million, respectively.
13
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(UNAUDITED)
Goodwill
There were no changes in goodwill during the three months ended September 27, 2009.
Note 7. Shareholders Equity
In September 2009, the Company issued and sold 12.65 million shares of its common stock, with net proceeds of approximately $434.2 million.
As of September 27, 2009, there remained approximately 4.5 million shares of the Companys common stock approved for repurchase under a repurchase program authorized by the Board of Directors that extends through June 2010. During the fiscal quarter ended September 27, 2009, the Company did not repurchase any shares.
Note 8. Earnings Per Share
The following computation reconciles the differences between the basic and diluted earnings per share presentations (in thousands, except per share data):
Three Months Ended | ||||||
September 27, 2009 |
September 28, 2008 | |||||
Basic: |
||||||
Net income |
$ | 21,026 | $ | 5,919 | ||
Weighted average common shares |
91,160 | 87,851 | ||||
Basic earnings per share |
$ | 0.23 | $ | 0.07 | ||
Diluted: |
||||||
Net income |
$ | 21,026 | $ | 5,919 | ||
Weighted average common shares - basic |
91,160 | 87,851 | ||||
Dilutive effect of stock options, unvested shares and ESPP purchase rights |
1,570 | 881 | ||||
Weighted average common shares - diluted |
92,730 | 88,732 | ||||
Diluted earnings per share |
$ | 0.23 | $ | 0.07 | ||
Potential common shares that would have the effect of increasing diluted earnings per share are considered to be antidilutive. In accordance with U.S. GAAP, these shares were not included in calculating diluted earnings per share. For the three months ended September 27, 2009 and September 28, 2008 there were 2.9 million and 6.3 million shares, respectively, not included in calculating diluted earnings per share because their effect was antidilutive.
The follow-on public offering resulted in an increase to the Companys diluted weighted average common shares outstanding of approximately 1.4 million shares for the first quarter of fiscal 2010.
14
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(UNAUDITED)
Note 9. Comprehensive Income, net
The following presents a summary of activity in comprehensive income, net (in thousands):
Three Months Ended | |||||||
September 27, 2009 |
September 28, 2008 |
||||||
Net income |
$ | 21,026 | $ | 5,919 | |||
Other comprehensive income (loss): |
|||||||
Foreign currency translation adjustments |
| 386 | |||||
Net unrealized gain (loss) on available-for-sale securities, net of tax expense of $257 and tax benefit of $420, respectively |
385 | (703 | ) | ||||
Total other comprehensive income (loss) |
385 | (317 | ) | ||||
Comprehensive income |
$ | 21,411 | $ | 5,602 | |||
Note 10. Stock-Based Compensation
The Company currently has one equity-based compensation plan from which stock-based compensation awards can be granted to employees and directors. In addition, the Company has plans that have been terminated as to future grants, but under which options are currently outstanding. The Company also has an Employee Stock Purchase Plan that provides employees with the opportunity to purchase the Companys common stock at 85% of the fair market value of the common stock at two designated times each year.
Stock Option Awards
The following table summarizes outstanding option awards as of September 27, 2009, and changes during the three months then ended (in thousands, except per share data):
Number of Shares |
Weighted-Average Exercise Price | |||||
Outstanding at June 28, 2009 |
8,978 | $ | 28.33 | |||
Granted |
1,995 | 35.83 | ||||
Exercised |
(1,025 | ) | 22.46 | |||
Forfeited or expired |
(33 | ) | 29.45 | |||
Outstanding at September 27, 2009 |
9,915 | $ | 30.44 | |||
15
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(UNAUDITED)
Restricted Stock Awards
A summary of nonvested shares of restricted stock awards outstanding under the Companys 2004 Long-Term Incentive Compensation Plan as of September 27, 2009, and changes during the three months then ended, follows (in thousands, except per share data):
Number of Shares |
Weighted- Average Grant- Date Fair Value | |||||
Nonvested at June 28, 2009 |
369 | $ | 23.51 | |||
Granted |
166 | 35.89 | ||||
Vested |
(120 | ) | 23.17 | |||
Forfeited |
| | ||||
Nonvested at September 27, 2009 |
415 | $ | 28.58 | |||
Stock-Based Compensation Valuation and Expense
The Company accounts for its employee stock-based compensation plan using the fair value method. The fair value method requires the Company to estimate the grant date fair value of its stock-based awards and amortize this fair value to compensation expense over the requisite service period or vesting term.
To estimate the fair value of the Companys stock option awards the Company currently uses the Black-Scholes option-pricing model. The determination of the fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by the Companys stock price as well as assumptions regarding a number of complex and subjective variables. These variables include the expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends. Due to the inherent limitations of option-valuation models available today, including future events that are unpredictable and the estimation process utilized in determining the valuation of the stock-based awards, the ultimate value realized by award holders may vary significantly from the amounts expensed in the Companys financial statements.
For restricted stock awards, grant date fair value is based upon the market price of the Companys common stock on the date of the grant. This fair value is then amortized to compensation expense over the requisite service period or vesting term.
Stock-based compensation expense is recorded net of estimated forfeitures such that expense is recorded only for those stock-based awards that are expected to vest. A forfeiture rate is estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from initial estimates.
16
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(UNAUDITED)
Total stock-based compensation expense, net of amounts capitalized into inventory was as follows (in thousands):
Three Months Ended | ||||||
Income Statement Classification |
September 27, 2009 |
September 28, 2008 | ||||
Cost of goods sold |
$ | 825 | $ | 1,302 | ||
Research and development |
1,264 | 1,446 | ||||
Sales, general and administrative |
3,523 | 2,685 | ||||
Total operating expenses |
4,787 | 4,131 | ||||
Total |
$ | 5,612 | $ | 5,433 | ||
Approximately $0.6 million and $0.7 million of stock-based compensation has been recorded in inventory in the Companys consolidated balance sheets as of September 27, 2009 and June 28, 2009, respectively.
Note 11. Income Taxes
The variation between the Companys effective tax rate and the U.S. statutory rate of 35 percent is primarily due to the consolidation of our foreign operations, which are subject to income taxes at lower statutory rates. A change in the mix of pretax income from these various tax jurisdictions can have a significant impact on the Companys periodic effective tax rate.
Under U.S. GAAP, a two-step approach is followed to recognize and measure uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is cumulatively more than 50% likely to be realized upon ultimate settlement. At June 29, 2009, the Company had recorded $10.9 million of unrecognized tax benefits. During the three months ended September 27, 2009, there were no changes to that amount of unrecognized tax benefits. As a result, the total amount of unrecognized tax benefits as of September 27, 2009 is $10.9 million. If any portion of this $10.9 million is recognized, the Company will then include that portion in the computation of its effective tax rate. Although the ultimate timing of the resolution and/or closure of audits is highly uncertain, the Company believes it is reasonably possible that approximately $3.3 million of gross unrecognized tax benefits will change in the next 12 months.
The Companys policy is to include interest and penalties related to unrecognized tax benefits within the income tax expense line item in the consolidated statements of income. As of September 27, 2009, the Company had accrued $1.0 million of interest and penalties.
The Company files U.S. federal, U.S. state, and foreign tax returns. For U.S. federal purposes, the Company is generally no longer subject to tax examinations for fiscal years ended June 24, 2007 and prior. For foreign purposes, the Company is no longer subject to examination for tax periods 2002 and prior. For U.S. state tax returns the Company is generally no longer subject to tax examinations for fiscal years prior to 2004. Certain federal and state carryforward tax attributes generated in prior years remain subject to examination and adjustment. The Company is currently under examination by the Internal Revenue Service for fiscal year 2008. Additionally, the Company is currently under examination by the North Carolina Department of Revenue for fiscal years 2004 2007.
17
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(UNAUDITED)
Note 12. Commitments and Contingencies
Please refer to the section entitled Litigation under Note 13Commitments and Contingencies of the Notes to the Consolidated Financial Statements in Item 8 of the Companys Annual Report on Form 10-K for the fiscal year ended June 28, 2009 for a description of material legal proceedings.
From time to time, various claims and litigation are asserted or commenced against the Company arising from or related to contractual matters, intellectual property matters, product warranties and personnel and employment disputes. Based on information currently available, management does not believe the ultimate outcome of any pending matters will have a material adverse effect on the Companys financial condition, results of operations or cash flows. However, because of the nature and inherent uncertainties of litigation, should the outcome of these actions be unfavorable, the Companys business, financial position, results of operations or cash flows could be materially and adversely affected.
Note 13. Subsequent Events
The Company evaluated subsequent events through the time the financial statements were issued, which was the time of filing this Form 10-Q with the SEC on October 20, 2009.
Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations |
Information set forth in this Quarterly Report on Form 10-Q 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 this report 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 believe, project, 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. Any forward-looking statements we make are as of the date made and we have no duty to update them if our views later change. These forward-looking statements should not be relied upon as representing our views as of any date subsequent to the date of this Quarterly Report. Examples of risks and uncertainties that could cause actual results to differ materially from historical performance and any forward-looking statements include, but are not limited to, those described in Risk Factors in Part II, Item 1A of this Quarterly Report.
The following discussion is designed to provide a better understanding of our unaudited consolidated financial statements, including a brief discussion of our business and products, key factors that impacted our performance, and a summary of our operating results. The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q, and the consolidated financial statements and notes thereto and Managements Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended June 28, 2009. Historical results and percentage relationships among any amounts in the financial statements are not necessarily indicative of trends in operating results for any future periods.
18
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(UNAUDITED)
Overview of our Business and Products
Cree, Inc. (Cree, we, our, or us,) develops and manufactures semiconductor materials and devices primarily based on silicon carbide (SiC), gallium nitride (GaN) and related compounds. We primarily focus our expertise in SiC and GaN on light emitting diodes (LED). We also develop power and radio frequency (RF) products, including power switching and RF devices. Our revenues are classified as follows:
| LED products. We derive the largest portion of our revenue from the sale of our LED products. These products consist of LED components, LED chips, LED lighting products and SiC and GaN wafers. Also included are revenues derived from government agencies to support the development of LED lighting. |
| Power and RF products. These products include power switching devices made from SiC, which provide faster switching speeds than comparable silicon-based power devices, and also include RF devices made from SiC or GaN, which allow for higher power densities as compared to silicon or gallium arsenide. Also included are revenues derived from government agencies to support the development of primarily SiC and GaN based technology. |
The majority of our products are manufactured at our production facilities located in North Carolina and China. We also use contract manufacturers for certain aspects of product fabrication.
Operating Segments
We currently operate our business as one reportable segment.
Industry Dynamics
Our business is primarily focused on selling our LED products. LEDs are currently used in a variety of applications, including energy-efficient indoor and outdoor lighting, liquid crystal display (LCD) backlighting, video screens, gaming, signals, automotive applications and mobile phones. As LED technology continues to develop and improve, we believe the potential market for LED lighting applications will continue to expand.
Select industry factors affecting our business include, among others:
| Overall demand for products and applications using LEDs. Although we have seen an increase in demand for LEDs for lighting products and backlighting in notebook and television applications, the global recession has reduced overall demand for LEDs in other consumer, mobile and automotive applications. The pace of adoption of LED lighting technology in the general illumination market, backlighting and other markets will impact the demand for LEDs as well as other factors. |
| Intense and constantly evolving competitive environment. Competition in the industry is intense. Product pricing pressures exist as market participants often undertake pricing strategies to gain or protect market share. To remain competitive, market participants generally must increase product performance and reduce costs to offset lower average sales prices. |
| Technological innovation and advancement. Innovations and advancements in LED technology continue to expand the potential applications for LEDs. However, new technologies could emerge or improvements could be made in existing technologies that may reduce the demand for LEDs in certain markets. |
19
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(UNAUDITED)
| Rising energy costs and regulatory actions concerning energy efficiency. Government regulations and programs designed to encourage or mandate increased energy efficiency, even in some cases banning forms of incandescent lighting, are advancing the adoption of more energy efficient lighting solutions including LEDs as well as other technologies. |
| Intellectual property issues. Market participants rely on patented and non-patented proprietary information relating to product development, manufacturing capabilities and other core competencies of their business. Protection of intellectual property is critical. As such, steps including patent applications, confidentiality and non-disclosure agreements, as well as other security measures are generally taken. To enforce or protect intellectual property rights, litigation or threatened litigation commonly occurs. |
Highlights of the First Quarter of Fiscal 2010
The following is a summary of our financial results for the three months ended September 27, 2009:
| Our year over year revenues increased approximately 20.5% to $169.1 million; |
| Our year over year gross margin percentage (gross profit as a percent of revenue) increased to 43.6% in the first quarter of fiscal 2010 from 35.2% in the first quarter of fiscal 2009; |
| We achieved operating income of $26.7 million in the first quarter of fiscal 2010 compared to $4.7 million in the first quarter of fiscal 2009. Net income per diluted share was $0.23 compared to $0.07 for the first quarter of fiscal 2009; We raised $434.2 million net of direct expenses through a follow-on public offering of our common stock; |
| We generated positive cash flow from operations of $61.2 million in the first quarter of fiscal 2010 compared to $44.0 million in the first quarter of fiscal 2009; |
| We made the second and final contingent cash payment related to our acquisition of COTCO in the amount of $57.1 million; |
| Combined cash, cash equivalents and marketable investments increased to $888.4 million at September 27, 2009 compared to $447.2 million at June 28, 2009; |
20
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(UNAUDITED)
Results of Operations
The following table sets forth certain consolidated statement of income data for the periods indicated:
Three Months Ended September 27, 2009 |
Three Months Ended September 28, 2008 |
|||||||||||
(Dollars in Thousands, Except Per Share Data) |
Dollars | % of Revenue |
Dollars | % of Revenue |
||||||||
Revenue, net |
$ | 169,130 | 100.0 | % | $ | 140,378 | 100.0 | % | ||||
Cost of revenue, net |
95,352 | 56.4 | % | 91,015 | 64.8 | % | ||||||
Gross profit |
73,778 | 43.6 | % | 49,363 | 35.2 | % | ||||||
Research and development |
20,174 | 11.9 | % | 17,275 | 12.3 | % | ||||||
Sales, general and administrative |
23,613 | 14.0 | % | 22,918 | 16.3 | % | ||||||
Amortization of acquisition related intangibles |
3,045 | 1.8 | % | 4,062 | 2.9 | % | ||||||
Loss on disposal or impairment of long-lived assets |
293 | 0.2 | % | 405 | 0.3 | % | ||||||
Operating income |
26,653 | 15.7 | % | 4,703 | 3.4 | % | ||||||
Gain on sale of investments, net |
| 0.0 | % | 12 | 0.0 | % | ||||||
Other non-operating income |
131 | 0.1 | % | 166 | 0.1 | % | ||||||
Interest income, net |
1,630 | 1.0 | % | 2,792 | 2.0 | % | ||||||
Income before income taxes |
28,414 | 16.8 | % | 7,673 | 5.5 | % | ||||||
Income tax expense |
7,388 | 4.4 | % | 1,754 | 1.2 | % | ||||||
Net income |
21,026 | 12.4 | % | 5,919 | 4.3 | % | ||||||
Diluted earnings per share |
$ | 0.23 | $ | 0.07 | ||||||||
Revenues
Revenues for the first quarter of fiscal 2010 and fiscal 2009 were comprised of the following (in thousands, except percentages):
Three Months Ended | ||||||||||||||
September 27, 2009 |
September 28, 2008 |
Change | ||||||||||||
LED products |
$ | 156,027 | $ | 129,886 | $ | 26,141 | 20 | % | ||||||
Percent of total revenues |
92 | % | 93 | % | ||||||||||
Power and RF products |
13,103 | 10,492 | 2,611 | 25 | % | |||||||||
Percent of total revenues |
8 | % | 7 | % | ||||||||||
Total revenues |
$ | 169,130 | $ | 140,378 | $ | 28,752 | 20 | % | ||||||
LED Products
We derive the largest portion of our revenue from the sale of our LED products which comprised approximately 92% and 93% of our total revenues for the first quarter of fiscal 2010 and fiscal 2009, respectively.
Revenue from our LED products increased approximately 20% to $156.0 million in the first quarter of fiscal 2010 from $129.9 million in the first quarter of fiscal 2009. The continuing adoption of LEDs in general lighting in addition to an increase in demand for LEDs in backlighting applications for notebooks and televisions, drove year over year sales increases in both our LED components and LED chips products. The blended average selling price (ASP) for our LED products decreased by 3.1% in the first quarter of fiscal 2010 from the first quarter of fiscal 2009 due to the ongoing competitive pricing environment for our LED products.
21
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(UNAUDITED)
Power and RF Products
Revenue from power and RF increased approximately 25% to $13.1 million in the first quarter of fiscal 2010 from $10.5 million in the first fiscal quarter of 2009. The increase in our power and RF products revenue was primarily due to an increase in orders for SiC Schottky diodes and GaN RF devices. Revenues from our power and RF products comprised approximately 8% and 7% of our total revenues for the first quarter of fiscal 2010 and fiscal 2009, respectively. The blended ASP for our power and RF products decreased by 43.2% in the first quarter of fiscal 2010 from the first quarter of fiscal 2009 due to a change in product mix to a higher proportion of sales of products with lower selling prices. Included within revenues from power and RF products were revenues related to research contracts which declined approximately 32% from the first quarter of fiscal 2009 to the first quarter of fiscal 2010.
Gross Profit
Cost of revenue includes materials, labor and overhead costs incurred internally or paid to contract manufacturers to produce our products. Gross profit and gross margin (gross profit as a percentage of revenue) were as follows (in thousands, except percentages):
Three Months Ended | ||||||||||||||
September 27, 2009 |
September 28, 2008 |
Change | ||||||||||||
Total gross profit |
$ | 73,778 | $ | 49,363 | $ | 24,415 | 49 | % | ||||||
Total gross margin |
43.6 | % | 35.2 | % |
Gross profit in the first quarter of fiscal 2010 increased approximately 49% to $73.8 million from $49.4 million in the first quarter of fiscal 2009. Our gross margin also increased from 35.2% to 43.6%. Factors contributing to the increase in gross margin were changes in product mix to higher margin products, reduced LED chip pricing pressures and lower production costs across our product lines due to greater utilization and higher production yields.
Research and Development
Research and development (R&D) expenses include costs associated with the development of new products, enhancements of existing products and general technology research. These costs consist primarily of employee salaries and benefits, occupancy costs, consulting costs and the cost of development equipment and supplies.
The following sets forth our research and development expenses in dollars and as a percentage of revenues (in thousands, except percentages):
Three Months Ended | ||||||||||||||
September 27, 2009 |
September 28, 2008 |
Change | ||||||||||||
Research and development |
$ | 20,174 | $ | 17,275 | $ | 2,899 | 17 | % | ||||||
Percent of total revenues |
12 | % | 12 | % |
22
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(UNAUDITED)
Research and development expenses in the first quarter of fiscal 2010 increased 17% to $20.2 million from $17.3 million in the first quarter of fiscal 2009. The increase was due to our continued research and development activities focusing on higher brightness LED chips, new and improved LED products, transition to larger wafers and power and RF initiatives.
Sales, General and Administrative
Sales, general and administrative expenses are composed primarily of costs associated with our sales and marketing personnel and our executive and administrative personnel (for example, legal, finance, information technology and human resources personnel) and consist of 1) salaries and related compensation costs, 2) consulting and other professional services (such as litigation and other outside legal counsel fees, audit and other compliance costs), 3) facilities and insurance costs, and 4) travel and other costs. The following table sets forth our sales, general and administrative expenses in dollars and as a percentage of revenues (in thousands, except percentages):
Three Months Ended | ||||||||||||||
September 27, 2009 |
September 28, 2008 |
Change | ||||||||||||
Sales, general and administrative |
$ | 23,613 | $ | 22,918 | $ | 695 | 3 | % | ||||||
Percent of total revenues |
14 | % | 16 | % |
Sales, general and administrative expenses in the first quarter of fiscal 2010 increased 3% to $23.6 million from $22.9 million in the first quarter of fiscal 2009. The increase was due primarily to increased spending on sales and marketing as we continued to expand our sales channels. Additionally, costs increased due to the general expansion of our business and increased employee compensation costs.
Amortization of Acquisition Related Intangibles
As a result of our acquisitions, we have recorded various intangible assets that require amortization, principally customer relationships and developed technologies. Amortization of intangible assets related to our acquisitions is as follows (in thousands):
Three Months Ended | ||||||||||
September 27, 2009 |
September 28, 2008 |
Change | ||||||||
INTRINSIC |
$ | 186 | $ | 186 | $ | | ||||
COTCO |
2,073 | 3,090 | (1,017 | ) | ||||||
LLF |
786 | 786 | | |||||||
Total |
$ | 3,045 | $ | 4,062 | $ | (1,017 | ) | |||
Amortization of acquisition related intangibles was $3.0 million in the first quarter of fiscal 2010 compared to $4.1 million in the first quarter of fiscal 2009. The year over year decline in amortization expense is attributable to lower amortization expense related to the intangibles acquired through the COTCO acquisition.
Loss on Disposal or Impairment of Long-Lived Assets, net
We operate a capital intensive business. As such, we dispose of a certain level of our equipment in the normal course of business as our production processes change due to production improvement initiatives or product mix changes. Due to the risk of technological obsolescence or changes in our production
23
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(UNAUDITED)
process, we regularly review our equipment for possible impairments in value. The following table sets forth our loss on disposal or impairment of long-lived assets (in thousands):
Three Months Ended | ||||||||||
September 27, 2009 |
September 28, 2008 |
Change | ||||||||
Loss on disposal or impairment of long-lived assets, net |
$ | 293 | $ | 405 | $ | (112 | ) |
We recorded a net loss of $0.3 million on the disposal of long-lived assets in the first quarter of fiscal 2010 compared to a net loss of $0.4 million in the first quarter of fiscal 2009. These losses are due to the impairment or disposal of certain equipment and the impairment of certain capitalized patent costs.
Non-Operating Income
The following table sets forth our non-operating income (in thousands):
Three Months Ended | ||||||||||
September 27, 2009 |
September 28, 2008 |
Change | ||||||||
Gain on sale of investments, net |
$ | | $ | 12 | $ | (12 | ) | |||
Other non-operating income |
$ | 131 | $ | 166 | $ | (35 | ) | |||
Interest income, net |
$ | 1,630 | $ | 2,792 | $ | (1,162 | ) |
During the first quarter of fiscal 2010, we did not have any significant gains or losses realized from the sale of our investments.
We have historically invested portions of our available cash in fixed interest rate securities such as high-grade corporate debt, commercial paper, government securities, and other fixed interest rate investments. The primary objective of our investments is to preserve principal while maximizing our yields.
Net interest income was $1.6 million compared to $2.8 million for the first quarter of fiscal 2010 and fiscal 2009, respectively. Year over year interest income decreased due to declining interest rates on our cash and investments.
Other non-operating income is comprised primarily of foreign exchange gains and losses.
Income Tax Benefit or Expense
The following table sets forth our income tax expense in dollars and our effective tax rate (in thousands, except percentages):
Three Months Ended | |||||||||||
September 27, 2009 |
September 28, 2008 |
Change | |||||||||
Income tax expense |
$ | 7,388 | $ | 1,754 | $ | 5,634 | |||||
Effective tax rate |
26.0 | % | 22.9 | % |
24
CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(UNAUDITED)
The variation between the Companys effective tax rate and the U.S. statutory rate of 35 percent is primarily due to the consolidation of our foreign operations, which are subject to income taxes at lower statutory rates. A change in the mix of pretax income from these various tax jurisdictions can have a significant impact on our periodic effective tax rate.
We recorded income tax expense of $7.4 million for an effective tax rate of 26.0% in the first quarter of fiscal 2010 as compared to income tax expense of $1.8 million for an effective tax rate of 22.8% in the first quarter of fiscal 2009. The increase in our effective tax rate is primarily due to an increase in U.S. taxable profits at the higher U.S. tax rates.
Liquidity and Capital Resources
Overview
We require cash to fund our operating expenses and working capital requirements, including outlays for research and development, and to make capital expenditures, strategic acquisitions and investments. Our principal sources of liquidity are cash on hand, marketable investments and cash generated from operations. Our ability to generate cash from operations has been one of our fundamental strengths and has provided us with substantial flexibility in meeting our operating, financing and investing needs. We have no debt or lines of credit and have minimal lease commitments. Based on past performance and current expectations, we believe our cash and cash equivalents, investments, and cash generated from operations, and our ability to access capital markets will satisfy our working capital needs, capital expenditures, investment requirements, stock repurchases, contractual obligations, commitments and other liquidity requirements associated with our operations through at least the next 12 months.
From time to time, we evaluate strategic opportunities and potential investments in complementary businesses and we anticipate continuing to make such evaluations. We may also access capital markets through the issuance of new debt or additional shares of common stock in connection with the acquisition of complementary businesses or other significant assets or for other strategic opportunities.
Financial Condition
Our liquidity and capital resources depend on our cash flows from operations and our working capital. Our working capital increased to $984.1 million as of September 27, 2009 from $500.8 million at June 28, 2009, primarily due to our public offering of 12.65 million common shares as well as positive cash flows from operations and cash generated through the exercise of employee stock options. The following table presents the components of our cash conversion cycle for our first fiscal quarter of 2010 and fourth fiscal quarter of 2009:
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CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(UNAUDITED)
September 27, 2009 |
June 28, 2009 |
Change | |||||||
Days of sales outstanding (a) |
50 | 63 | (13 | ) | |||||
Days of supply in inventory (b) |
81 | 79 | 2 | ||||||
Days in accounts payable (c) |
(52 | ) | (39 | ) | (13 | ) | |||
Cash conversion cycle |
79 | 103 | (24 | ) | |||||
(a) | Days of sales outstanding (DSO) calculates the average collection period of our accounts receivable. DSO is based on the ending net trade receivables and the most recent quarterly revenue for each period. DSO is calculated by dividing accounts receivable, net of allowance for doubtful accounts and revenue reserves, by average net revenue for the current quarter (90 days). |
(b) | Days of supply in inventory (DSI) measures the average number of days from procurement to sale of our product. DSI is based on net ending inventory and most recent quarterly cost of sales for each period. DSI is calculated by dividing net ending inventory by average cost of goods sold for the current quarter (90 days). |
(c) | Days in accounts payable (DPO) calculates the average number of days our payables remain outstanding before payment. DPO is based on ending accounts payable and most recent quarterly cost of sales for each period. DPO is calculated by dividing accounts payable by average cost of goods sold for the current quarter (90 days). |
Overall our cash conversion cycle, or days to cash, improved by a net 24 days.
As of September 27, 2009, substantially all of our investments had investment grade ratings, and any such investments that were in an unrealized loss position at September 27, 2009 were in such position due to interest rate changes, sector credit rating changes or company-specific rating changes. As we intend and believe that we have the ability to hold such investments for a period of time that will be sufficient for anticipated recovery in market value, we currently expect to receive the full principal or recover our cost basis in these securities. When evaluating our investments for possible impairment, we review factors such as the length of time and extent to which fair value has been below our cost basis, the financial condition of the entity in which the investment is made, and our ability and intent to hold the investment for a period of time that may be sufficient for anticipated recovery in market value. The declines in value of the securities in our portfolio are considered to be temporary in nature and, accordingly, we do not believe these securities are impaired as of September 27, 2009.
We believe our current working capital and anticipated cash flows from operations will be adequate to meet our cash needs for our daily operations and capital expenditures for the remainder of fiscal 2010. We have and may continue to use a portion of our available cash and cash equivalents, or funds underlying our marketable securities, to repurchase shares of our common stock. With our strong working capital position, we believe that we have the ability to continue to invest in further development of our products and, when necessary or appropriate, make selective acquisitions or other strategic investments to strengthen our product portfolio, secure key intellectual properties, or expand our production capacity.
Cash Flows
In summary, our cash flows were as follows (in thousands):
Three Months Ended | |||||||||||
September 27, 2009 |
September 28, 2008 |
Change | |||||||||
Cash provided by operating activities |
$ | 61,188 | $ | 43,951 | $ | 17,237 | |||||
Cash used in investing activities |
(114,853 | ) | (129,094 | ) | 14,241 | ||||||
Cash provided by financing activities |
459,299 | 1,204 | 458,095 | ||||||||
Effects of foreign exchange changes |
203 | (250 | ) | 453 | |||||||
Net increase (decrease) in cash and cash equivalents |
$ | 405,837 | $ | (84,189 | ) | $ | 490,026 |
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CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(UNAUDITED)
The following is a discussion of our primary sources and uses of cash in our operating, investing and financing activities.
Cash Flows from Operating Activities
Net cash provided by operating activities was $61.2 million in the first quarter of fiscal 2010 compared to $44.0 million in the first quarter of fiscal 2009. The increase in cash provided by operating activities during the first quarter of fiscal 2010 compared to the same period of the prior year is primarily due to higher net income in the current year and the timing of cash payments to our vendors, offset somewhat by increases in our inventory in the current year.
Cash Flows from Investing Activities
Net cash used in investing activities was $114.9 million in the first quarter of fiscal 2010 compared to $129.1 million in the first quarter of fiscal 2009. Our investing activities primarily relate to transactions within our investments, strategic acquisitions, purchase of property, plant and equipment and purchase of patent and license rights. Cash used in investing activities also included a $57.1 million cash expenditure related to the second and final contingent consideration payment related to the COTCO acquisition and is comparable to the first contingent consideration payment of $60.0 million made in the first quarter of 2009. In addition we increased expenditures related to the acquisition of property and equipment in the current quarter to $20.4 million.
Cash Flows from Financing Activities
Net cash provided by financing activities was $459.3 million in the first quarter of fiscal 2010 compared to $1.2 million in the first quarter of fiscal 2009. In the current year, cash provided by financing activities increased primarily due to our sale of 12.65 million shares of our common stock with net proceeds of approximately $434.2 million. Our cash flows from financing activities are also composed of cash proceeds from the issuance of common stock including employee stock option exercises and employee stock plan purchases in the amount of $23.2 million.
Off-Balance Sheet Arrangements
We do not use off-balance sheet arrangements with unconsolidated entities or related parties, nor do we use other forms of off-balance sheet arrangements. Accordingly, our liquidity and capital resources are not subject to off-balance sheet risks from unconsolidated entities. As of September 27, 2009, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.
We have entered into operating leases primarily for certain of our facilities in the normal course of business. These arrangements are often referred to as a form of off-balance-sheet financing. Please refer to Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended June 28, 2009, in the section entitled Contractual Obligations for the future minimum lease payments due under our operating leases as of June 28, 2009.
Critical Accounting Policies and Estimates
For information about our other critical accounting policies and estimates, see the Critical Accounting Policies and Estimates section of Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended June 28, 2009.
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CREE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)
(UNAUDITED)
Recent Accounting Pronouncements
See Note 1, Basis of Presentation and Changes in Significant Accounting Policies, to our unaudited financial statements in Part I, Item 1 of this Quarterly Report for a description of recent accounting pronouncements, including the expected dates of adoption and estimated effects, if any, on our consolidated financial statements.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
For quantitative and qualitative disclosures about our market risks, see Item 7A of our Annual Report on Form 10-K for the fiscal year ended June 28, 2009.
Item 4. | 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 Exchange Act) as of the end of the period covered by this Form 10-Q. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this Form 10-Q, our disclosure controls and procedures are effective in that they 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 periods required by the United States Securities and Exchange Commissions rules and forms.
We routinely review our internal control over financial reporting and from time to time make changes intended to enhance the effectiveness of our internal control over financial reporting. We will continue to evaluate the effectiveness of our disclosure controls and procedures and internal control over financial reporting on an ongoing basis and will take action as appropriate. There have been no changes to our internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act, during the first quarter of fiscal 2010 that we believe materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 4T. | Controls and Procedures |
Not applicable.
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Item 1. | Legal Proceedings |
Please refer to Note 13, Commitments and Contingencies, in our consolidated financial statements included in Item 8 of our Annual Report on Form 10-K for the fiscal year ended June 28, 2009 for a description of material legal proceedings.
Other Matters
We are currently a party to other legal proceedings incidental to our business. Although the resolution of these matters cannot be predicted with certainty, managements present judgment is that the final outcome will not likely have a material adverse effect on our consolidated financial condition or results of operations. If an unfavorable resolution occurs, our business, results of operations and financial condition could be materially adversely affected.
Item 1A. | Risk Factors |
Described below are various risks and uncertainties that may affect our business. If any of the risks described below actually occurs, our business, financial condition or results of operations could be materially and adversely affected.
Our business may be adversely affected by the global economic downturn, the continuing uncertainties in the financial markets and our, or our customers or suppliers ability to access the capital markets.
The global economy is currently in a pronounced economic downturn. Global financial markets are continuing to experience disruptions, including severely diminished liquidity and credit availability, declines in consumer confidence, declines in economic growth, increases in unemployment rates, and uncertainty about economic stability. Given these uncertainties, there is no assurance that there will not be further deterioration in the global economy, the global financial markets and consumer confidence. We are unable to predict the likely duration and severity of the current global economic downturn or disruptions in the financial markets. If economic conditions deteriorate further, our business and results of operations could be materially and adversely affected.
Our business and results of operations could also be impacted by a number of follow-on effects of the disruptions in the financial markets, including the inability of our customers, or their customers, to obtain sufficient financing to purchase historical or projected quantities of our products. Our revenues and gross margins are dependent upon customer demand, and if our projections of their expenditures fail to materialize, due to reductions in customer purchases or otherwise, our revenues and gross margins could be adversely affected.
Additionally, the inability of our customers and suppliers to access capital efficiently, or at all, may have other adverse effects on our financial condition. For example, financial difficulties experienced by our customers or suppliers could result in product delays; increased accounts receivable defaults; and an increase in our inventory exposure. These risks may increase if our customers and suppliers do not adequately manage their business or do not properly disclose their financial condition to us.
Although we believe we have adequate liquidity and capital resources to fund our operations internally, our inability to access the capital markets on favorable terms in the future, or at all, may adversely affect our financial performance. The inability to obtain adequate financing from debt or capital sources in the future could force us to self-fund strategic initiatives or even forgo certain opportunities, which in turn could potentially harm our performance.
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Our results of operations, financial condition and business could be harmed if we were unable to balance customer demand and capacity.
As customer demand for our products changes, we must be able to ramp up or adjust our production capacity to meet demand. We are continually taking steps to address our manufacturing capacity needs for our products. If we are not able to increase our capacity or if we increase our capacity too quickly, our business and results of operations could be adversely impacted. If we experience delays or unforeseen costs associated with adjusting our capacity levels, we may not be able to achieve our financial targets.
Conversely, due to the proportionately high fixed cost nature of our business, when demand decreases, we may not be able to reduce manufacturing expenses or overhead costs at the same rate as demand, which could result in lower margins and adversely impact our business and results of operations.
If we fail to evaluate, implement and integrate strategic opportunities successfully, our business may suffer.
From time to time we evaluate strategic opportunities available to us for product, technology or business acquisitions. For example, in July 2006 we acquired INTRINSIC, in March 2007 we acquired COTCO, and in February 2008 we acquired LLF. If we choose to make acquisitions, we face certain risks, such as failure of the acquired business to meet our performance expectations, diversion of management attention, retention of existing customers of our current and acquired businesses, and difficulty in integrating the acquired businesss operations, personnel and financial and operating systems into our current business. For example, through our acquisitions of COTCO and LLF we acquired certain customer relationships, some of which were considered related persons (see Note 16 to our consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended June 28, 2009), that we may not be able to successfully retain.
We may not be able to adequately address these risks or any other problems that arise from our recent or future acquisitions. Any failure to successfully evaluate strategic opportunities and address risks or other problems that arise related to any acquisition could adversely affect our business, results of operations or financial condition.
We face significant challenges managing our growth.
We have experienced a period of significant growth over the past few years that may challenge our management and other resources. We continue to transform our business to support a global components and LED lighting product customer base. In order to manage our growth and change in our strategy effectively, we must continue to:
| maintain, expand and/or purchase adequate manufacturing facilities and equipment to meet customer demand; |
| maintain a sufficient supply of raw materials to support our growth; |
| expand research and development, sales and marketing, technical support, distribution capabilities and administrative functions; |
| expand the skills and capabilities of our current management team; |
| add experienced senior level managers; and |
| attract and retain qualified employees. |
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While we intend to focus on managing our costs and expenses, over the long term we expect to invest substantially to support our growth and may have additional unexpected costs. We may not be able to expand quickly enough to exploit potential market opportunities.
We are also increasingly dependent on information technology to enable us to improve the effectiveness of our operations and to maintain financial accuracy and efficiency. In fiscal 2009, we substantially completed the implementation of our primary financial reporting system at the operations assumed through the LLF and COTCO acquisitions. If we do not allocate and effectively manage the resources necessary to build, implement and sustain the proper technology infrastructure, we could be subject to transaction errors, processing inefficiencies, loss of customers, business disruptions or loss of or damage to intellectual property through security breach.
In connection with our efforts to cost-effectively manage our growth, we have increasingly relied on subcontractors for production capacity, logistics support and certain administrative functions, such as payroll processing. If these service providers do not perform effectively, we may not be able to achieve the expected cost savings and may incur additional costs to correct errors or fulfill customer demand. Depending on the function involved, such errors may also lead to business disruption, processing inefficiencies or the loss of or damage to intellectual property through security breach, or impact employee morale. Our operations may also be negatively impacted if any of these service providers do not have the financial capability to meet our growing needs.
If we are unable to effectively develop, manage and expand our distribution channels for our products, our operating results may suffer.
We have expanded into new business channels that are different from those that we have historically operated in as we grow our business and sell LED lighting products and more LED components versus LED chips. If we are unable to effectively penetrate these new distribution channels to ensure our products are reaching the appropriate customer base, our financial results may be adversely impacted. In addition, if we successfully penetrate these new distribution channels, we cannot guarantee that customers will accept our products or that we will be able to manufacture and deliver them in the timeline established by our customers.
The markets in which we operate are highly competitive and have evolving technical requirements.
The markets for our 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 LED components. Competitors are offering new blue, green and white LEDs with aggressive prices and improved performance. These competitors may reduce average sales prices faster than we are able to reduce costs, and competitive pricing pressures may accelerate the rate of decline of our average sales prices. The market for SiC wafers is also becoming more competitive as other firms in recent years have begun offering SiC and GaN products or announced plans to do so.
As competition increases, in order to achieve our revenue growth objectives in fiscal 2010 and beyond, we need to continue to develop new products that enable our customers to win new designs and increase market share. Additionally, we anticipate that increased competition for these designs will result in pressure to lower the selling prices of our products. Therefore, our ability to continually produce more efficient, higher brightness LEDs that meet the evolving needs of our customers at lower costs will be critical to our success. Competitors may also try to align with some of our strategic customers. 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 could also invent new technologies that may make our products obsolete. Any of these developments could have an adverse effect on our business, results of operations or financial condition.
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Our LED revenues are highly dependent on our customers ability to produce and sell more integrated products using our LED products.
Because our customers generally integrate our LED products into the products that they market and sell, our LED revenues depend on getting our LED products designed into a larger number of our customers products and our customers ability to sell those products. For example, some of our current customers, as well as prospective customers, create white LED components using our blue LEDs, in combination with phosphors. Sales of blue LED chips are highly dependent upon our customers ability to procure efficient phosphors, develop high quality and highly efficient white LED components and gain access to the necessary intellectual property rights. Even if our customers are able to develop competitive white LED components using our blue LED chips, there can be no assurance that our customers will be successful in the marketplace.
We also have current and prospective customers that create lighting systems using our LED components. Sales of LED components for these applications are highly dependent upon our customers ability to develop high quality and highly efficient lighting products, including thermal design, optical design and power conversion. The lighting industry has traditionally not had this level of technical expertise for LED related designs, which may limit the success of our customers products. Even if our customers are able to develop efficient systems, there can be no assurance that our customers will be successful in the marketplace.
As a result of our continued expansion in new markets, such as LED components and LED lighting products, our traditional customers may reduce orders.
Through acquisitions and organic growth, we continue to expand in new markets, such as LED components and LED lighting products. In these new markets, some of our current customers may now perceive us as a competitor. In response, our customers may reduce their orders for our products. This reduction in orders could occur faster than our sales growth in these new markets, which could adversely affect our business, results of operations or financial condition.
Our operating results are substantially dependent on the development and acceptance of new products.
Our future success may depend on our ability to develop new and lower cost solutions for existing and new markets and for customers to accept those solutions. We must introduce new products in a timely and cost-effective manner, and we must secure production orders for those products from our customers. The development of new products is a highly complex process, and we historically have experienced delays in completing the development and introduction of new products. The successful development and introduction of these products depends on a number of factors, including the following:
| achievement of technology breakthroughs required to make commercially viable devices; |
| the accuracy of our predictions for market requirements and evolving standards; |
| acceptance of our new product designs; |
| acceptance of new technology in certain markets; |
| the availability of qualified research and development personnel; |
| our timely completion of product designs and development; |
| our ability to expand sales and influence key customers to adopt our products; |
| our ability to develop repeatable processes to manufacture new products in sufficient quantities and at low enough costs for commercial sales; |
| our ability to effectively transfer products and technology developed in one country to our manufacturing facilities in other countries; |
| our customers ability to develop competitive products incorporating our products; and |
| acceptance of our customers products by the market. |
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If any of these or other factors becomes problematic, we may not be able to develop and introduce these new products in a timely or cost-effective manner.
Litigation could adversely affect our operating results and financial condition.
We are often involved in patent infringement litigation as described in Note 13, Commitments and Contingencies, to our consolidated financial statements included in Item 8 of our Annual Report on Form 10-K for the fiscal year ended June 28, 2009. Defending against existing and potential litigation will likely require significant attention and resources and, regardless of the outcome, result in significant legal expenses, which could 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.
Where necessary, we may initiate litigation to enforce our patent or other intellectual property rights. Any such 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.
Our business may be impaired by claims that we, or our customers, infringe intellectual property rights of others.
Vigorous protection and pursuit of intellectual property rights characterize our 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 legal 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:
| pay substantial damages; |
| indemnify our customers; |
| stop the manufacture, use and sale of products found to be infringing; |
| incur asset impairment charges |
| discontinue the use of processes found to be infringing; |
| expend significant resources to develop non-infringing products or processes; or |
| obtain a license to use third party technology. |
There can be no assurance that third parties will not attempt to assert infringement claims against us, or our customers, with respect to our products. In addition, our customers may face infringement claims directed to the customers products that incorporate our products, and an adverse result could impair the customers demand for our products. We have also promised certain of our customers that we will indemnify them in the event they are sued by our competitors for infringement claims directed to the products we supply. Under these indemnification obligations we may be responsible for future payments to resolve infringement claims against them. From time to time we receive correspondence asserting that our products or processes are or may be infringing patents or other intellectual property rights of others. If we believe the assertions may have merit or in other appropriate circumstances, we take steps to seek to obtain a license or to avoid the infringement. However, we cannot predict whether a license will be available; that we would find the terms of any license offered acceptable; or that we would be able to develop an alternative solution. Failure to obtain a necessary license or develop an alternative solution could cause us to incur substantial liabilities and costs and to suspend the manufacture of affected products.
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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. 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, our existing patents are subject to expiration and we cannot be sure that additional patents will be issued on any new applications around the covered technology 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, 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 cannot 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.
If our products fail to perform or fail to meet customer requirements or expectations, we could incur significant additional costs, including costs associated with the recall of those items.
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. Even if our products meet standard specifications, our customers may attempt to use our products in applications they were not designed for or in products that were not designed or manufactured properly, resulting in product failures and creating customer satisfaction issues.
We have experienced product quality, performance or reliability problems from time to time and defects or failures may occur in the future. If failures or defects occur, we may need to recall our products. These recalls could result in significant losses due to:
| costs associated with the removal, collection and destruction of the product recalled; |
| payments made to replace recalled product; |
| a rise in warranty expense and costs associated with customer support; |
| the write down or destruction of existing inventory subject to the recall; |
| lost sales due to the unavailability of product for a period of time; |
| delays, cancellations or rescheduling of orders for our products; or |
| increased product returns. |
We also may be the target of product liability lawsuits, and could suffer losses from a significant product liability judgment against us if the use of our products at issue is determined to have caused injury. A significant product recall or product liability case could also result in adverse publicity, damage to our reputation, and a loss of customer confidence in our products.
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Our operations in foreign countries, including China and other Asian countries, expose us to certain risks inherent in doing business internationally, which may adversely affect our business, results of operations or financial condition.
As a result of acquisitions and organic growth, we have operations, manufacturing facilities and subcontract arrangements in foreign countries that expose us to certain risks. For example, fluctuations in exchange rates may affect our revenues, expenses and results of operations as well as the value of our assets and liabilities as reflected in our financial statements. We are also subject to other types of risks, including the following:
| protection of intellectual property and trade secrets; |
| tariffs and other barriers; |
| timing and availability of export licenses; |
| rising labor costs; |
| disruptions in the infrastructure of the foreign countries where we operate; |
| difficulties in accounts receivable collections; |
| difficulties in staffing and managing international operations; |
| the burden of complying with foreign and international laws and treaties; and |
| the burden of complying with and changes in international taxation policies. |
In some instances, we have been provided and may continue to receive competing incentives from foreign governments to encourage our investment in certain countries, regions, or areas outside of the United States. In particular, we have received and may continue to receive such incentives in connection with our operations in China, as the Chinese national and local governments seek to encourage the development of the technology industry in China. Government incentives may include tax rebates, reduced tax rates, favorable lending policies and other measures, some or all of which may be available to us due to our foreign operations. Any of these incentives could be reduced or eliminated by governmental authorities at any time. Any reduction or elimination of incentives currently provided to our operations could adversely affect our business and results of operations.
In addition, abrupt political change, terrorist activity and armed conflict pose a risk of general economic disruption in affected countries, which could result in an adverse effect on our business and results of operations.
We are subject to risks related to international purchases and sales.
We expect that revenue from international sales will continue to represent the majority of our total revenue. We also purchase a portion of the materials included in our products from overseas sources. As a result, our international sales and purchases are subject to numerous U.S. and foreign laws and regulations, including, without limitation, tariffs, trade barriers, regulations relating to import-export control, technology transfer restrictions, the International Traffic in Arms Regulation promulgated under the Arms Export Control Act, the Foreign Corrupt Practices Act and the anti-boycott provisions of the U.S. Export Administration Act. If we fail to comply with these laws and regulations, we could be liable for administrative, civil or criminal liabilities, and in the extreme case, we could be suspended or debarred from government contracts or our export privileges could be suspended, which could have a material adverse effect on our business.
International sales and purchases are also subject to a variety of other risks, including risks arising from currency fluctuations, collection issues and taxes. Our international sales are subject to variability as our selling prices become less competitive in countries with currencies that are declining in value against the U.S. Dollar and more competitive in countries with currencies that are increasing in value against the U.S. Dollar. In addition, our international purchases can become more expensive if the U.S. Dollar weakens against the foreign currencies in which we are billed.
We have not entered into any foreign currency derivative financial instruments; however, we may choose to do so in the future in an effort to manage or hedge our foreign exchange rate risk.
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Variations in our production yields and limitations in the amount of process improvements we can implement could impact our ability to reduce costs and could cause our margins to decline and our operating results could suffer.
All of our products are manufactured using technologies that are highly complex. The number of usable items, or yield, from our production processes may fluctuate as a result of many factors, including but not limited to the following:
| variability in our process repeatability and control; |
| contamination of the manufacturing environment; |
| equipment failure, power outages or variations in the manufacturing process; |
| lack of consistency and adequate quality and quantity of piece parts and other raw materials; |
| losses from broken wafers, inventory shrinkage or human errors; |
| defects in packaging either within our facilities or at our subcontractors; and |
| any transitions or changes in our production process, planned or unplanned. |
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.
In addition, our ability to convert volume manufacturing to larger diameter substrates can be an important factor in allowing for a more cost effective manufacturing process. If we are unable to make this transition in a timely or cost effective manner, our results could be negatively impacted.
In some instances, we may offer products for future delivery at prices based on planned yield improvements or increased cost efficiencies from other production advances. Failure to achieve these planned improvements or advances could significantly affect our margins and operating results.
We depend on a limited number of customers for a substantial portion of our revenues, and the loss of, or a significant reduction in purchases by, one or more of these customers could adversely affect our operating results.
We receive a significant amount of our revenues from a limited number of customers. For example, in fiscal 2009, two customers, Seoul Semiconductor Co., Ltd. and Arrow Electronics, Inc. individually accounted for more than 10% of our net revenue, for a combined total of 24% of our total net revenue. Sales to these and most of our other large customers are made on a purchase order basis, which does not generally require any long-term customer commitments. Therefore, these customers may alter their past purchasing behavior with little or no notice to us for various reasons, including: developing their own product solutions; choosing to purchase product from our competitors; or experiencing a reduction in their market share in the markets for which they purchase our products. If our customers alter their past (or expected) purchasing behavior, or if we encounter any problems collecting amounts due from them, our financial condition and results of operations could be negatively impacted.
We rely on a few key sole source and limited source suppliers, and are subject to high price volatility on certain commodity inputs.
We depend on a small number of sole source and limited source 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. Although alternative sources generally exist for these items, qualification of many of these alternative sources could take up to six months or longer. Where possible, we attempt to identify and qualify alternative sources for our sole and limited source suppliers.
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We generally purchase these sole or limited source items with purchase orders, and we have limited guaranteed supply arrangements with such suppliers. We do not control the time and resources that these suppliers devote to our business, and we cannot be sure that these suppliers will perform their obligations to us. In the past, we have experienced decreases in our production yields when suppliers have varied from previously agreed upon specifications that have impacted our cost of sales.
Additionally, the inability of our suppliers to access capital efficiently could cause disruptions in their businesses, thereby negatively impacting ours. This risk may increase if the general economic downturn negatively affects key suppliers or a significant number of our other suppliers. Any delay in product delivery or other interruption or variation in supply from these suppliers could prevent us from meeting commercial demand for our products. If we were to lose key suppliers, our key suppliers were unable to support our demand or we were unable to identify and qualify alternative suppliers, our manufacturing operations could be interrupted or hampered significantly.
In our fabrication process we consume a number of precious metals and other commodities, which are subject to high price volatility. Our operating margins could be significantly affected if we are not able to anticipate price changes correctly, or if we are not able to pass along price increases to our customers.
If government agencies 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. Historically, government agencies have funded a significant portion of our research and development activities. When the government changes budget priorities, such as in times of war or financial crisis, our funding has the risk of being redirected to other programs. Government contracts are also 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. The full value of the contracts would not be realized if they were 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 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.
Our failure to comply with applicable environmental laws and regulations worldwide could harm our business and results of operations.
The manufacturing, assembling and testing of our products require the use of hazardous materials that are subject to a broad array of environmental, health and safety laws and regulations. Our failure to comply with any of these applicable laws or regulations could result in:
| regulatory penalties, fines and legal liabilities; |
| suspension of production; |
| alteration of our fabrication, assembly and test processes; and |
| curtailment of our operations or sales. |
In addition, our failure to manage the use, transportation, emission, discharge, storage, recycling or disposal of hazardous materials could subject us to increased costs or future liabilities. Existing and future environmental laws and regulations could also require us to acquire pollution abatement or remediation equipment, modify our product designs or incur other expenses associated with such laws and regulations. Many new materials that we are evaluating for use in our operations may be subject to regulation under existing or future environmental laws and regulations that may restrict our use of one or more of such materials in our manufacturing, assembly and test processes or products. Any of these restrictions could harm our business and results of operations by increasing our expenses or requiring us to alter our manufacturing processes.
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Changes in our effective tax rate may have an adverse effect on our results of operations.
Our future effective tax rates may be adversely affected by a number of factors including:
| changes in government administrations, such as the Presidency and Congress of the U.S. as well as in the states and countries in which we operate; |
| changes in tax laws or interpretation of such tax laws and changes in generally accepted accounting principles; |
| the jurisdiction in which profits are determined to be earned and taxed; |
| the resolution of issues arising from tax audits with various authorities; |
| changes in the valuation of our deferred tax assets and liabilities; |
| adjustments to estimated taxes upon finalization of various tax returns; |
| increases in expenses not deductible for tax purposes, including write-offs of acquired in-process research and development and impairment of goodwill in connection with acquisitions; |
| changes in available tax credits; |
| the recognition and measurement of uncertain tax positions; |
| the lack of sufficient excess tax benefits (credits) in our additional paid in capital (APIC) pool in situations where our realized tax deductions for certain stock-based compensation awards (such as non-qualified stock options and restricted stock) are less than those originally anticipated; and |
| the repatriation of non-U.S. earnings for which we have not previously provided for U.S. taxes, or any changes in legislation that may result in these earnings being taxed within the U.S., regardless of our decision regarding repatriation of funds. |
For example, current proposals have been made by various U.S. governmental bodies to change the U.S. tax laws that include, among other things, limiting U.S. tax deductions for expenses related to un-repatriated foreign-source income and modifying the U.S. foreign tax credit rules. Although the scope of the proposed changes is unclear, it is possible that these or other changes in U.S. tax laws could increase our U.S. income tax liability and adversely affect our profitability. At this time, we cannot determine the timing that the proposed changes, if enacted, are to become effective.
Any significant increase in our future effective tax rates could adversely impact net income for future periods. In addition, the determination of our income tax provision requires complex estimations, significant judgments and significant knowledge and experience concerning the applicable tax laws. To the extent our income tax liability materially differs from our income tax provisions and accruals due to factors, including the above, which were not anticipated at the time we estimated our tax provision, our net income or cash flows could be adversely affected.
In order to compete, we must attract, motivate and retain key employees, and our failure to do so could harm our results of operations.
In order to compete, we must attract, motivate and retain executives and other key employees, including those in managerial, technical, sales, marketing and support positions. Hiring and retaining qualified executives, scientists, engineers, technical staff and sales personnel are critical to our business, and competition for experienced employees in our industry can be intense. To help attract, motivate and retain key employees, we use stock-based compensation awards such as non-qualified stock options and
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restricted stock. If the value of such stock awards does not appreciate, as measured by the performance of the price of our common stock, or if our share-based compensation otherwise ceases to be viewed as a valuable benefit, our ability to attract, retain and motivate employees could be weakened, which could harm our business and results of operations.
We are exposed to fluctuations in the market value of our investment portfolio and in interest rates, and therefore, impairment of our investments or lower investment income could harm our earnings.
We are exposed to market value and the inherent interest rate risk related to our investment portfolio. We have historically invested portions of our available cash in fixed interest rate securities such as high-grade corporate debt, commercial paper, government securities and other fixed interest rate investments. The primary objective of our investments is to preserve principal and we only acquire investments rated AAA.. However, our investments are not all FDIC insured and may lose value and/or become illiquid regardless of their rating; in addition, declines in underlying interest rates will have a negative impact on the income generated from our investments, which could materially adversely affect our results of operations.
We may be required to record a significant charge to earnings if our goodwill or amortizable intangible assets become impaired.
We are required under generally accepted accounting principles to review our amortizable intangible assets and investments in equity interests for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill is required to be tested for impairment at least annually. Factors that may be considered a change in circumstances indicating that the carrying value of our amortizable intangible assets or goodwill may not be recoverable include a decline in stock price and market capitalization and slower growth rates in our industry. We may be required to record a significant charge to earnings in our consolidated financial statements during the period in which any impairment of our amortizable intangible assets or goodwill is determined to exist. This could adversely impact our results of operations.
Catastrophic events may disrupt our business.
A disruption or failure of our systems or operations in the event of a natural disaster, health pandemic, such as an influenza outbreak within our workforce, or man-made catastrophic event could cause delays in completing sales, continuing production or performing other critical functions of our business, especially in the case of our single site for SiC wafer and LED fabrication. A catastrophic event that results in the destruction or disruption to our supply chain or any of our critical business or information technology systems could severely affect our ability to conduct normal business operations and, as a result, our operating results could be adversely affected.
Our results of operations could vary as a result of the methods, estimates and judgments that we use in applying our accounting policies, including changes in the accounting regulations to be applied.
The methods, estimates and judgments that we use in applying our accounting policies have a significant impact on our results of operations (see Critical Accounting Policies and Estimates in our Managements Discussion and Analysis of Financial Condition and Results of Operations included in Item 7 of our Annual Report on Form 10-K for the fiscal year ended June 28, 2009). Such methods, estimates and judgments are, by their nature, subject to substantial risks, uncertainties and assumptions, and factors may arise over time that lead us to change our methods, estimates and judgments. Changes in those methods, estimates and judgments could significantly affect our results of operations.
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Likewise, our results of operations may be impacted due to changes in the accounting rules to be applied, such as the increased use of fair value measurement rules and the potential requirement that U.S. registrants prepare financial statements in accordance with International Financial Reporting Standards.
Our stock price may be volatile.
Historically, our common stock has experienced substantial price volatility, particularly as a result of significant fluctuations in our revenue, earnings and margins over the past few years and variations between our actual financial results and the published expectations of analysts. If our future operating results or margins are below the expectations of stock market analysts or our investors, our stock price will likely decline.
Speculation in the press or investment community about our strategic position, financial condition, results of operations, or significant transactions can also cause changes in our stock price. In particular, speculation around our market opportunities for energy efficient lighting may have dramatic effects on our stock price, especially as various government agencies announce their planned investments in energy efficient technology, including lighting.
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
Not applicable.
Item 3. | Defaults Upon Senior Securities |
Not applicable.
Item 4. | Submission of Matters to a Vote of Security Holders |
Not applicable.
Item 5. | Other Information |
Not applicable.
Item 6. | Exhibits |
The following exhibits are being filed herewith and are numbered in accordance with Item 601 of Regulation S-K:
Exhibit No. |
Description | |
3.1 | Bylaws, as amended and restated (incorporated herein by reference to Exhibit 3.1 to the Companys Current Report on Form 8-K, dated August 17, 2009, as filed with the Securities and Exchange Commission on August 21, 2009) | |
10.1 | Management Incentive Compensation Plan (incorporated herein by reference to Exhibit 10.1 to the Companys Current Report on Form 8-K, dated August 17, 2009, as filed with the Securities and Exchange Commission on August 21, 2009) | |
10.2 | Notice of Grant to Charles M. Swoboda, dated August 17, 2009 (incorporated herein by reference to Exhibit 10.2 to the Companys Current Report on Form 8-K, dated August 17, 2009, as filed with the Securities and Exchange Commission on August 21, 2009) |
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Exhibit No. |
Description | |
10.3 | Non-Employee Director Stock Compensation and Deferral Program | |
10.4 | Schedule of Compensation for Non-Employee Directors | |
10.5 | Addendum to Form of Master Stock Option Award Agreement Terms and Conditions for Grants of Nonqualified Stock Options to Non-Employee Directors | |
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 |
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
CREE, INC. | ||||
Date: October 20, 2009 |
||||
/S/ JOHN T. KURTZWEIL | ||||
John T. Kurtzweil | ||||
Executive Vice President, Chief Financial Officer and Treasurer | ||||
(Authorized Officer and Principal Financial and Chief Accounting Officer) |
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EXHIBIT INDEX
Exhibit No. |
Description | |
3.1 | Bylaws, as amended and restated (incorporated herein by reference to Exhibit 3.1 to the Companys Current Report on Form 8-K, dated August 17, 2009, as filed with the Securities and Exchange Commission on August 21, 2009) | |
10.1 | Management Incentive Compensation Plan (incorporated herein by reference to Exhibit 10.1 to the Companys Current Report on Form 8-K, dated August 17, 2009, as filed with the Securities and Exchange Commission on August 21, 2009) | |
10.2 | Notice of Grant to Charles M. Swoboda, dated August 17, 2009 (incorporated herein by reference to Exhibit 10.2 to the Companys Current Report on Form 8-K, dated August 17, 2009, as filed with the Securities and Exchange Commission on August 21, 2009) | |
10.3 | Non-Employee Director Stock Compensation and Deferral Program | |
10.4 | Schedule of Compensation for Non-Employee Directors | |
10.5 | Addendum to Form of Master Stock Option Award Agreement Terms and Conditions for Grants of Nonqualified Stock Options to Non-Employee Directors | |
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 |
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