Cree, Inc.
CREE INC (Form: 10-Q, Received: 11/02/2006 16:50:15)
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 10-Q

 


 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 24, 2006

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

(Registrant’s telephone number, including area code)

 


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     x   Yes     ¨   No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):    Large accelerated filer   x      Accelerated filer   ¨     Non-accelerated filer   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     ¨   Yes     x   No

The number of shares outstanding of the registrant’s common stock, par value $0.00125 per share, as of October 25, 2006, was 77,155,196.

 



Table of Contents

CREE, INC.

FORM 10-Q

For the Three Months Ended September 24, 2006

INDEX

 

        Page No.

PART I. FINANCIAL INFORMATION

 

Item 1.

 

Financial Statements

 
 

Consolidated Balance Sheets as of September 24, 2006 (unaudited) and June 25, 2006

  3
 

Consolidated Statements of Income for the three months ended September 24, 2006 (unaudited) and September 25, 2005 (unaudited)

  4
 

Consolidated Statements of Cash Flow for the three months ended September 24, 2006 (unaudited) and September 25, 2005 (unaudited)

  5
 

Notes to Consolidated Financial Statements (unaudited)

  6

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

  16

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

  26

Item 4.

 

Controls and Procedures

  27

PART II. OTHER INFORMATION

 

Item 1.

 

Legal Proceedings

  28

Item 1A.

 

Risk Factors

  28

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

  37

Item 6.

 

Exhibits

  38

SIGNATURE

  39

 

2


Table of Contents

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

CREE, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share amounts)

 

     September 24,
2006
   June 25,
2006
     (Unaudited)     

ASSETS

     

Current assets:

     

Cash and cash equivalents

   $ 51,326    $ 88,768

Short-term investments held-to-maturity

     157,220      167,450

Accounts receivable, net

     72,246      68,363

Inventories, net

     40,171      29,994

Deferred income taxes

     12,416      10,092

Prepaid expenses and other current assets

     9,656      11,437

Assets of discontinued operations

     392      394
             

Total current assets

     343,427      376,498

Property and equipment, net

     360,604      342,238

Long-term investments held-to-maturity

     125,490      119,400

Intangible assets, net

     70,627      30,286

Marketable securities available for sale

     29,305      29,072

Other assets

     3,515      2,706
             

Total assets

   $ 932,968    $ 900,200
             

LIABILITIES AND SHAREHOLDERS’ EQUITY

     

Current liabilities:

     

Accounts payable, trade

   $ 35,711    $ 23,214

Current portion of capital lease obligations

     396      —  

Accrued salaries and wages

     9,015      8,828

Income tax payable

     7,291      —  

Other current liabilities

     2,062      4,256

Liabilities of discontinued operations

     941      1,092
             

Total current liabilities

     55,416      37,390

Long-term liabilities:

     

Deferred income taxes and contingent tax reserves

     33,401      33,310

Capital lease obligations, net of current portion

     791      —  

Long-term liabilities of discontinued operations

     1,772      1,887
             

Total long-term liabilities

     35,964      35,197

Shareholders’ equity:

     

Common stock, par value $0.00125; 200,000 shares authorized at September 24, 2006 and June 25, 2006; 77,101 and 77,227 shares issued and outstanding at September 24, 2006 and June 25, 2006, respectively

     96      96

Additional paid-in-capital

     581,388      580,804

Accumulated other comprehensive income, net of taxes

     11,859      11,758

Retained earnings

     248,245      234,955
             

Total shareholders’ equity

     841,588      827,613
             

Total liabilities and shareholders’ equity

   $ 932,968    $ 900,200
             

The accompanying notes are an integral part of the consolidated financial statements.

 

3


Table of Contents

CREE, INC.

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share amounts)

(Unaudited)

 

     Three Months Ended  
     September 24,
2006
    September 25,
2005
 

Revenue:

    

Product revenue, net

   $ 97,418     $ 96,303  

Contract revenue, net

     6,492       6,599  
                

Total revenue

     103,910       102,902  

Cost of revenue:

    

Product revenue, net

     55,873       46,301  

Contract revenue, net

     5,137       4,434  
                

Total cost of revenue

     61,010       50,735  

Gross profit

     42,900       52,167  

Operating expenses:

    

Research and development

     14,366       12,792  

Sales, general and administrative

     11,946       10,735  

Impairment or loss on disposal of long-lived assets

     97       568  
                

Total operating expenses

     26,409       24,095  

Income from operations

     16,491       28,072  

Non-operating income:

    

(Loss) gain on investments in securities, net

     (1 )     587  

Other non-operating income

     —         3  

Interest income, net

     3,866       2,326  
                

Income from continuing operations before income taxes

     20,356       30,988  

Income tax expense

     6,989       7,759  
                

Income from continuing operations

     13,367       23,229  

Loss from discontinued operations, net of related income tax benefit

     (77 )     (1,509 )
                

Net income

   $ 13,290     $ 21,720  
                

Earnings per share:

    

Basic:

    

Income from continuing operations

   $ 0.17     $ 0.31  
                

Loss from discontinued operations

   $ —       $ (0.02 )
                

Net income

   $ 0.17     $ 0.29  
                

Diluted:

    

Income from continuing operations

   $ 0.17     $ 0.30  
                

Loss from discontinued operations

   $ —       $ (0.02 )
                

Net income

   $ 0.17     $ 0.28  
                

Shares used in per share calculation:

    

Basic

     77,061       75,601  
                

Diluted

     78,039       77,558  
                

The accompanying notes are an integral part of the consolidated financial statements.

 

4


Table of Contents

CREE, INC .

CONSOLIDATED STATEMENTS OF CASH FLOW

(In thousands)

(Unaudited)

 

     Three Months Ended  
     September 24,
2006
    September 25,
2005
 

Cash flows from operating activities:

    

Net income

   $ 13,290     $ 21,720  

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

     19,437       18,389  

Stock-based compensation

     3,707       2,850  

Impairment of inventory or loss on disposal of property, equipment and patents

     91       777  

Loss (gain) on sale of investment in securities

     1       (587 )

Amortization of premium on investments held-to-maturity

     70       431  

Changes in operating assets and liabilities:

    

Accounts and interest receivable

     (3,048 )     (16,790 )

Inventories

     (8,965 )     2,599  

Prepaid expenses and other current assets

     1,447       362  

Accounts payable, trade

     11,881       (3,288 )

Accrued expenses and other liabilities

     4,720       4,514  
                

Net cash provided by operating activities

     42,631       30,977  
                

Cash flows from investing activities:

    

Purchase of property and equipment

     (33,845 )     (13,072 )

Purchase of INTRINSIC Semiconductor Corporation, net of cash acquired

     (43,794 )     —    

Purchase of investments held-to-maturity

     (42,730 )     (59,884 )

Proceeds from maturities of investments held-to-maturity

     42,848       23,700  

Proceeds from sale of property and equipment

     67       160  

Proceeds from sale of investments

     3,952       2,926  

Repayments of capital leases

     (83 )     —    

Purchase of patent and licensing rights

     (1,347 )     (1,063 )
                

Net cash used in investing activities

     (74,932 )     (47,233 )
                

Cash flows from financing activities:

    

Net proceeds from issuance of common stock

     370       1,163  

Repurchase of common stock

     (5,470 )     —    
                

Net cash (used in) provided by financing activities

     (5,100 )     1,163  
                

Effects of foreign exchange changes on cash and cash equivalents

     (41 )     —    
                

Net decrease in cash and cash equivalents

     (37,442 )     (15,093 )

Cash and cash equivalents:

    

Beginning of period

   $ 88,768     $ 70,925  
                

End of period

   $ 51,326     $ 55,832  
                

The accompanying notes are an integral part of the consolidated financial statements.

 

5


Table of Contents

CREE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 24, 2006

(Unaudited)

1. Basis of Presentation

The consolidated balance sheet at September 24, 2006, the consolidated statements of income and the consolidated statements of cash flow for the three months ended September 24, 2006 and September 25, 2005, respectively, have been prepared by Cree, Inc. (collectively with its subsidiaries, 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 for the three months ended September 24, 2006, and for all periods presented, have been made. The consolidated balance sheet at June 25, 2006 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 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 Company’s fiscal 2006 Annual Report on Form 10-K. The results of operations for the period ended September 24, 2006 are not necessarily indicative of the operating results that may be attained for the entire fiscal year.

2. Accounting Policies

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All material intercompany accounts and transactions have been eliminated in consolidation.

Fiscal Year

The Company’s fiscal year is a 52- or 53-week period ending on the last Sunday in the month of June. The Company’s 2007 fiscal year extends from June 26, 2006 through June 24, 2007 and is a 52-week fiscal year. The Company’s 2006 fiscal year extended from June 27, 2005 through June 25, 2006 and was also a 52-week fiscal year.

Reclassifications

Certain fiscal 2006 amounts in the accompanying consolidated financial statements have been reclassified to conform to the fiscal 2007 presentation. These reclassifications had no effect on previously reported consolidated net income or shareholders’ equity.

 

6


Table of Contents

Estimates

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities, at September 24, 2006 and June 25, 2006 and the reported amounts of revenues and expenses during the three months ended September 24, 2006 and September 25, 2005. Actual amounts could differ from those estimates.

Revenue Recognition

The Company provides its customers with limited rights of return for non-conforming shipments and certain of the Company’s contractual sales arrangements provide for limited product exchanges and the potential for reimbursements of certain sales costs. As a result, the Company records an allowance for sales returns at the time of sale, which is recorded as a reduction of product revenue in the consolidated statements of income and as a reduction to accounts receivable in the consolidated balance sheets.

The Company estimates sales returns in accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 48, “Revenue Recognition When Right of Return Exists.” Specifically, the Company reviews historical sales returns as a percentage of total sales. The returns are matched to the quarter when the sales were originally recorded. Based on historical return percentages and other relevant factors, the Company estimates its sales returns that have not yet occurred for product sales that have been recorded. During the three months ended September 24, 2006, the Company reduced its allowance for sales returns by $1.3 million primarily due to actual customer returns. The allowance for sales returns at September 24, 2006 and June 25, 2006 was $4.1 million and $5.4 million, respectively.

In accordance with SFAS 48, the Company also records an estimate for the value of product returns that it believes will be returned to inventory in the future and resold. As of September 24, 2006 and June 25, 2006, the Company estimated the cost of future product returns at $1.4 million and $1.7 million, respectively, which was recorded in prepaid expenses and other current assets in the consolidated balance sheets.

3. Acquisition

Through a wholly owned subsidiary, the Company acquired all of the outstanding capital stock and options of INTRINSIC Semiconductor Corporation (“INTRINSIC”) on July 10, 2006. The acquisition has been accounted for under the purchase method of accounting as prescribed by SFAS No. 141, “Business Combinations.” All related goodwill and other intangible assets have been accounted for in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets.”

The Company changed the name of INTRINSIC to Cree Dulles, Inc., effective July 10, 2006. All financial information of Cree Dulles, Inc., and its wholly owned subsidiary are included in the consolidated financial statements of the Company from the date of acquisition.

 

7


Table of Contents

The total estimated purchase price is as follows (amounts in thousands):

 

Cash consideration paid to INTRINSIC stockholders

   $ 43,330

Fair value of vested INTRINSIC stock options assumed by the Company

     2,163

Estimated direct transaction fees and expenses

     590
      
   $ 46,083
      

The estimated purchase price has been allocated based on estimated fair values of assets acquired and liabilities assumed. The final valuation of net assets acquired is expected to be completed by the end of December 2006, but no later than one year from the acquisition date in accordance with generally accepted accounting principles. The Company’s preliminary estimate of the purchase price allocation is as follows (amounts in thousands):

 

Cash and cash equivalents

   $ 126  

Accounts receivable, net

     364  

Inventories

     1,157  

Deferred tax assets

     2,324  

Other current assets

     213  

Property and equipment, net

     4,198  

Patents, net

     3,014  

Acquisition-related intangible assets

     36,629  

Accounts payable

     (467 )

Accrued expenses

     (66 )

Other liabilities

     (139 )

Capital lease obligations

     (1,270 )
        
   $ 46,083  
        

4. Discontinued Operations

During fiscal 2006, the Company discontinued the operations of its silicon-based radio frequency and microwave semiconductor business conducted by its Cree Microwave subsidiary (“CMI”). As of December 25, 2005, the Company completed production of all last time buy orders for CMI’s silicon products and terminated its remaining employees. In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the Company has reported the operating results of CMI for the three months ended September 24, 2006 and September 25, 2005, and the assets and liabilities of CMI on the balance sheet at September 24, 2006 and June 25, 2006, as a discontinued operation.

 

8


Table of Contents

The Company believes the significant write-downs related to the closure of CMI’s business have been completed; however, there may be future adjustments to the estimate for the accrual of the lease contract obligations. The following table summarizes the changes attributable to costs incurred and charged to expense and costs paid for the three months ended September 24, 2006 related to the exit activities for CMI, which are reflected in liabilities of discontinued operations in the consolidated balance sheets:

 

     Three Months Ended
(in 000s)
    

September 24,

2006

Balance at June 25, 2006

   $ 2,866

Lease obligation payments

     210
      

Balance at September 24, 2006

   $ 2,656
      

The following table summarizes the amounts of revenue and pre-tax losses reported in discontinued operations for the respective income statement periods presented:

 

     Three Months Ended (in 000s)  
     September 24,
2006
    September 25,
2005
 

Product revenue, net

   $ —       $ 954  

Loss before income taxes

   $ (117 )   $ (2,222 )

5. Inventories

Inventories are stated at the lower of cost or market, with cost determined using the first-in, first-out (“FIFO”) method for finished goods and work in process accounts. The Company uses the average cost method to value raw materials. The Company records a reserve against inventory once it has been determined that conditions exist which may not allow the Company to sell the inventory for its intended purpose, the inventory’s value is determined to be less than cost, or it is determined to be obsolete. The charge for the inventory reserves is recorded in cost of revenue in the consolidated statements of income. Reserves are adjusted quarterly to reflect inventory values in excess of forecasted sales, as well as overall inventory risk assessed by management.

 

9


Table of Contents

The following is a summary of the components of inventory:

 

     As of (in 000s)  
     September 24,
2006
    June 25,
2006
 

Raw materials

   $ 8,778     $ 6,425  

Work-in-process

     16,239       12,532  

Finished goods

     16,000       11,668  
                
     41,017       30,625  

Inventory reserve

     (846 )     (631 )
                

Total inventories, net

   $ 40,171     $ 29,994  
                

6. Investments

During the first quarter of fiscal 2006, the Company sold 63,782 shares of Color Kinetics, Incorporated (“Color Kinetics”) common stock for $954,000, and recognized a $587,000 gain. The Company currently holds 1,795,660 shares of Color Kinetics common stock. As of September 24, 2006 and June 25, 2006, the Company had recorded cumulative unrealized holding gains on its investment in Color Kinetics of $18.9 million and $18.7 million, or $11.9 million and $11.8 million, net of tax, respectively. The calculation of the unrealized gains was based on the closing share price of Color Kinetics common stock as of September 22, 2006 and June 23, 2006 to determine the fair market value of the Company’s investment of $29.3 million and $29.1 million, respectively.

7. Intangible Assets

The following table reflects the components of intangible assets:

 

     As of (in 000s)  
     September 24,
2006
    June 25,
2006
 

Acquisition-related intangible assets

   $ 36,629     $ —    

Patent and license rights

     41,473       37,112  
                
     78,102       37,112  

Accumulated amortization

     (7,475 )     (6,826 )
                

Total intangible assets, net

   $ 70,627     $ 30,286  
                

Amortization expense

   $ 647     $ 2,381  
                

 

10


Table of Contents

8. Earnings Per Share

The following computation reconciles the differences between the basic and diluted earnings per share presentations:

 

     Three Months Ended (in 000s,
except per share data)
     September 24,
2006
   September 25,
2005

Basic:

     

Net income

   $ 13,290    $ 21,720
             

Weighted average common shares

     77,061      75,601
             

Basic earnings per share

   $ 0.17    $ 0.29
             

Diluted:

     

Net income

   $ 13,290    $ 21,720
             

Weighted average common shares - basic

     77,061      75,601

Dilutive effect of stock options

     978      1,957
             

Weighted average common shares - diluted

     78,039      77,558
             

Diluted earnings per share

   $ 0.17    $ 0.28
             

Potential common shares that would have the effect of increasing diluted earnings per share are considered to be antidilutive. In accordance with SFAS No. 128, “Earnings per Share,” these shares were not included in calculating diluted earnings per share. For the three months ended September 24, 2006 and September 25, 2005, there were 8.2 million and 5.3 million shares, respectively, not included in calculating diluted earnings per share because their effect was antidilutive.

 

11


Table of Contents

9. Shareholders’ Equity

The following presents a summary of activity in shareholders’ equity for the three months ended September 24, 2006 (dollars and shares in thousands):

 

     Common
Stock
   Additional
Paid-in
Capital
    Retained
Earnings
   Accumulated
Other
Comprehensive
Income
    Total
Shareholders’
Equity
 

Balance at June 25, 2006

   $ 96    $ 580,804     $ 234,955    $ 11,758     $ 827,613  

Exercise of common stock options for cash, 50 shares

     —        370       —        —         370  

Purchase and retirement of 300 shares of common stock

     —        (5,443 )     —        —         (5,443 )

Purchase and retirement of restricted stock awards

     —        (27 )     —        —         (27 )

Assumption of stock options in connection with the acquisition of INTRINSIC, 191 shares

     —        2,163       —        —         2,163  

Income tax benefits from stock option exercises

     —        (38 )     —        —         (38 )

Stock-based compensation (a)

     —        3,559       —        —         3,559  

Net income

     —        —         13,290      —         13,290  

Currency translation loss

     —        —         —        (41 )     (41 )

Unrealized gain on marketable securities, net of tax of $91

     —        —         —        142       142  
                  

Comprehensive income

     —        —         —        —         13,391  
                                      

Balance at September 24, 2006

   $ 96    $ 581,388     $ 248,245    $ 11,859     $ 841,588  
                                      

(a) The difference between total stock-based compensation expense of $3.7 million and the amount credited to additional paid in capital of $3.6 million represents the portion of stock-based compensation expense attributable to the Company’s 2005 Employee Stock Purchase Plan. At September 24, 2006, this amount was classified as a current liability in the consolidated balance sheets in accordance with the provisions of SFAS No. 123R, “Share-Based Payments” and SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.”

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 five 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 (“ESPP”) that provides employees with the opportunity to purchase common stock at 85% of the fair market value of the common stock at two designated times each year.

The Company recorded stock-based compensation of $3.7 million and $2.9 million in the three months ended September 24, 2006 and September 25, 2005, respectively. Approximately $673,000 and $795,000 of stock-based compensation was allocated to inventory in the Company’s consolidated balance sheets as of September 24, 2006 and September 25, 2005, respectively.

 

12


Table of Contents

The fair value of each award is estimated on the date of grant using the Black-Scholes-Merton option-pricing model using the following assumptions:

 

     Three Months Ended  
     September 24,
2006
    September 25,
2005
 

Stock Option Grants:

    

Risk-free interest rate

   4.71 %   3.89 %

Expected life, in years

   4.5     4.5  

Expected volatility

   51.2 %   42.0 %

Dividend yield

   0 %   0 %

Employee Stock Purchase Plan:

    

Risk-free interest rate

   3.20 %   3.20 %

Expected life, in years

   0.5     0.5  

Expected volatility

   42.0 %   42.0 %

Dividend yield

   0 %   0 %

The following table summarizes option activity as of September 24, 2006, and changes during the three months then ended:

 

     Number of Shares
(in 000s)
    Weighted-
Average
Exercise Price
   Weighted-
Average
Remaining
Contractual
Terms
   Average
Intrinsic Value
(in 000s)

Outstanding at June 25, 2006

   10,188     $ 26.27      

Granted

   1,086     $ 18.70      

Assumed

   191     $ 10.66      

Exercised

   (50 )   $ 7.36      

Forfeited or expired

   (116 )   $ 27.61      
                  

Outstanding at September 24, 2006

   11,299     $ 25.34    4.01    $ 18,300
                        

As of September 24, 2006, there was approximately $25.2 million of total unrecognized compensation costs related to stock-based compensation arrangements. The unrecognized compensation cost is expected to be recognized over a weighted-average period of two years. The weighted-average grant-date fair value of options granted during the three months ended September 24, 2006 was $18.70. The total intrinsic value of options exercised during the three months ended September 24, 2006 was $512,000.

 

13


Table of Contents

A summary of nonvested shares of restricted stock awards outstanding under the Company’s 2004 Long-Term Incentive Compensation Plan as of September 24, 2006, and changes during the quarter then ended, follows:

 

     Shares     Weighted-
Average Grant
Date Fair
Value

Nonvested at June 25, 2006

   107,750     $ 25.65

Granted

   125,400     $ 18.00

Vested

   (42,550 )   $ 25.92

Forfeited

   —         —  
            

Nonvested at September 24, 2006

   190,600     $ 20.56
            

As of September 24, 2006, there was approximately $3.9 million of total unrecognized compensation costs related to nonvested restricted stock share-based compensation arrangements. The unrecognized compensation cost is expected to be recognized over a weighted-average period of four years.

11. Income Taxes

There were no significant variations in the relationship between income tax expense and pretax accounting income in the first quarter of fiscal 2007.

In the first quarter of fiscal 2006, the Company recorded a $2.2 million reduction in income tax expense related to realized and unrealized capital gains on its investment in Color Kinetics. In fiscal 2002, the Company recorded a capital loss associated with certain other marketable securities that was carried forward for tax purposes. However, the Company fully reserved the tax benefits associated with the loss because it was more likely than not such benefits would expire unused by the Company. Based on SFAS No. 109, the valuation allowance should be adjusted for any new realizable federal capital gains or losses. The increase in the market value of the Company’s investment in Color Kinetics was an unrealized capital gain that the Company could offset against the fiscal 2002 loss carry forward. For this reason, a portion of the valuation allowance associated with the prior year capital loss was reversed initially and has been adjusted in each subsequent quarter as the market value of the Company’s investment in Color Kinetics changed.

In future periods, the Company will continue to adjust its deferred tax asset valuation allowance in connection with any increase or decrease in the value of its investment in Color Kinetics, which could increase or decrease the income tax expense for such period.

 

14


Table of Contents

12. Recent Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements,” to provide enhanced guidance when using fair value to measure assets and liabilities. SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. The standard applies whenever other standards require or permit assets or liabilities to be measured at fair value and, while not requiring new fair value measurements, may change current practices. The Company is currently evaluating the impact SFAS 157 will have on its consolidated financial statements. The standard is effective for the Company beginning in fiscal year 2009.

The Company continues to assess the impact that FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (“FIN 48”), will have on its consolidated financial statements. Issued by the FASB in June 2006, FIN 48 clarifies the accounting for uncertainty in income taxes by prescribing a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, and disclosure. FIN 48 is effective for fiscal years beginning after December 15, 2006, and is required to be adopted by the Company in the first quarter of fiscal 2008.

13. Commitments and Contingencies

On September 11, 2006, we, together with the Trustees of Boston University as co-plaintiffs, filed a complaint against BridgeLux, Inc. (formerly eLite Optoelectronics) for infringement of two U.S. patents. The two patents are No. 6,657,236, entitled “Enhanced Light Extraction in LEDs through the Use of Internal and External Optical Elements,” which is owned by us, and No. 5,686,738, entitled “Highly Insulating Monocrystalline Gallium Nitride Thin Films,” which we have licensed from the University on an exclusive basis. The suit was filed in the U.S. District Court for the Middle District of North Carolina and seeks monetary damages and injunctive relief to prohibit BridgeLux from infringing these patents. BridgeLux has filed a motion to dismiss the complaint contending that it is not subject to personal jurisdiction of the court and that venue is improper. On October 17, 2006, BridgeLux also filed a complaint against us and the University in the U.S. District Court for the Northern District of California seeking a declaratory judgment of non-infringement and invalidity with respect to the two patents on which we sued BridgeLux and of non-infringement with respect to two additional U.S. patents. The two additional patents are No. 6,600,175, entitled “Solid State White Light Emitter and Display Using Same,” which we own, and U.S. Patent No. 6,953,703, entitled “Method of Making a Semiconductor Device with Exposure of Sapphire Substrate to Activated Nitrogen,” which is owned by the University subject to an exclusive license to us. On October 17, 2006, BridgeLux also filed a complaint against us in the U.S. District Court for the Eastern District of Texas alleging infringement of U.S. Patent No. 6,869,812, entitled “High Power AlInGaN Based Multi-Chip Light Emitting Diode,” and seeking unspecified monetary damages and injunctive relief. Please refer to Part I, Item 3, “Legal Proceedings,” of our Annual Report on Form 10-K for the fiscal year ended June 25, 2006 for descriptions of other material legal proceedings.

 

15


Table of Contents

Item 2. Management’s 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 “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 do not intend 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. To review risk factors that could cause actual results to differ, see “Risk Factors” in Part II, Item 1A, of this report and in Part I, Item 1A, of our Annual Report on Form 10-K for the year ended June 25, 2006.

The following discussion should be read in conjunction with, and is qualified in its entirety by reference to, our consolidated financial statements, including the notes thereto.

Overview

We develop and manufacture semiconductor materials and electronic devices made from silicon carbide, or SiC, gallium nitride, or GaN, and related compounds. The majority of our products are manufactured at our main production facilities in Durham and RTP, North Carolina. We also use subcontractors in Asia to perform some of our manufacturing steps for certain LED and power products. We generate revenues from the following product lines:

 

  LED chips and packaged products . We derive the largest portion of our revenue from the sale of blue, green and near UV LED chips and packaged LEDs.

 

  Materials products . These products include our SiC and GaN wafers which are used in manufacturing LEDs, radio frequency, or RF devices, and power devices or for research and development. It also includes SiC material in bulk crystal form, which is used in gemstone applications.

 

  High-power products . These products include power switching devices made from SiC, which provide faster switching speeds than comparable silicon-based power devices, and also include wide bandgap RF and microwave devices made from SiC or GaN, which allow for higher power densities as compared to gallium arsenide.

 

  Contracts with government agencies . Government agencies assist us in the development of primarily SiC based new technology.

 

16


Table of Contents

Industry Dynamics

Our business is primarily selling high-brightness LED products, which is affected by a number of industry factors, including design trends in mobile products, overall demand in products using high-brightness LEDs, a constantly changing competitive environment and intellectual property issues. Currently, the most significant market for our LED chips is for illumination purposes in mobile products, including LCD backlighting, keypad illumination and flash units for camera phones. LED sales for mobile products are impacted by the number of LEDs used in a product, which varies depending on design trends and the brightness of the LEDs used in an application. Average LED sales prices generally decline each year as market players implement pricing strategies to gain or protect market share. To remain competitive, LED producers generally must increase product performance and reduce costs to support lower average sales prices. Competition has increased in the mobile phone segment over the last several quarters as companies continue to position for increased market share. Finally, vigorous protection and pursuit of intellectual property rights characterize the semiconductor industry. Customers’ purchasing decisions can be influenced by whether a product may infringe valid intellectual property rights.

Highlights of the First Quarter of Fiscal 2007

The following is a summary of our financial results in the three months ended September 24, 2006:

 

    Our revenue from continuing operations was $104 million and reflected continued demand in mid-brightness LED chips, high-brightness LED packaged products, materials and high-power products.

 

    Our gross margin from continuing operations was 41% of revenue from continuing operations.

 

    We reported consolidated net income of $13 million and net income per diluted share of $0.17.

 

    We generated positive cash flow from operations of $43 million.

 

    Our balance sheet remained strong with $334 million in combined cash and investments.

 

    On July 10, 2006, we acquired INTRINSIC Semiconductor Corporation (INTRINSIC). We believe the technology we acquired will enable us to accelerate the commercialization of low-defect 4-inch and 6-inch substrates.

Outlook for Fiscal 2007

For the remainder of fiscal 2007, we plan to work on increasing the brightness of our LED chips and packaged LED products. We plan to continue cost reduction initiatives for both our LED and SiC-based high-power products by converting to four-inch wafer production and increasing production at our subcontractors. In addition, we target to invest $100 million to $115 million in capital expenditures to expand our manufacturing capacity, primarily at our North Carolina sites. This expansion will support unit volume growth and reduce overall product costs in our LED and high-power product lines.

 

17


Table of Contents

We plan to increase sales of our XLamp® high power packaged LED products and our Schottky diode products. We will also be expanding our sales, marketing and distribution teams to support a global components customer base. Also, our investment in research and development efforts will continue for LEDs, low-defect larger diameter wafers and improved high-power devices.

We plan to evaluate strategic investments to expand and strengthen our technology and product portfolio as well as to increase access to our targeted markets.

Critical Accounting Policies

The following discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. In preparing our financial statements, we must make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of our financial statements. We base our assumptions, estimates and judgments on historical experience, current trends, and other factors that management believes to be relevant at the time the consolidated financial statements are prepared. On a regular basis, management reviews our accounting policies, assumptions, estimates and judgments to ensure that our consolidated financial statements are presented fairly and in accordance with generally accepted accounting principles. However, because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and we may be exposed to gains or losses that could be material.

Our significant accounting policies are discussed in Note 2, “Summary of Significant Accounting Policies and Other Matters,” of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of our Annual Report on Form 10-K for the year ended June 25, 2006. Management believes that the following accounting policies are the most critical to aid in fully understanding and evaluating our reported financial results. These policies require management’s most difficult, subjective or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain. Management has reviewed these critical accounting policies and related disclosures with the Audit Committee of our Board of Directors.

 

Description of Policy

  

Judgments and

Uncertainties

  

Effect If Actual Results

Differ From Assumptions

and Adjustments Recorded

Revenue Recognition:

     
We provide our customers with limited rights of return for non-conforming shipments and product warranty claims. In addition, certain of our sales arrangements provide for limited product exchanges and the reimbursement of certain sales costs incurred by our customers. As a result, we record an allowance for    We apply judgment in estimating the amount of product that will be returned in the future. Our estimate of product returns and the amount of those returns that will be placed back in inventory is based primarily on historical transactional experience and judgment regarding market factors and trends.    As of September 24, 2006 and June 25, 2006, the amount of our sales return allowance was $4.1 million and $5.4 million, respectively. During the first quarter of fiscal 2007, we decreased our sales return reserve allowance by $1.3 million primarily due to actual product returns.

 

18


Table of Contents

Description of Policy

  

Judgments and

Uncertainties

  

Effect If Actual Results

Differ From Assumptions

and Adjustments Recorded

sales returns at the time of sale, which is recorded as a reduction of product revenue and accounts receivable.

 

In connection with the allowance for sales returns, we also record an asset for the value of product returns that we believe will be returned to inventory.

     

As of September 24, 2006 and June 25, 2006, we estimated the value of future product returns that would be returned to inventory to be $1.4 million and $1.7 million, respectively.

 

A 10% increase or decrease in our sales return estimates and deferred product costs asset at September 24, 2006 would have affected net income by approximately $182,000 for the first quarter of fiscal 2007.

Accounting for Stock-Based Compensation:

We account for stock-based compensation arrangements in accordance with the provisions of SFAS 123R, Shared-Based Payments. Under SFAS 123R, compensation cost is calculated on the date of the grant using the Black-Scholes-Merton model. The compensation expense is then amortized over the vesting period.    We use the Black-Scholes-Merton model in determining fair value of our options at the grant date and apply judgment in estimating the key assumptions that are critical to the model such as the expected term, volatility and forfeiture rate of an option. Our estimate of these key assumptions is based on historical information and judgment regarding market factors and trends.    If actual results are not consistent with our assumptions and judgments used in estimating key assumptions, we may be required to adjust compensation expense, which could be material to our results of operations.

Valuation of Long-Lived Assets:

We review long-lived assets such as property, equipment, acquired intangible assets, and patents for impairment on a routine basis and when events and circumstances indicate that the carrying value of the assets recorded in our financial statements may not be recoverable. For example, a portion of our equipment may be scrapped; certain of our patents or patent applications may be abandoned. In these cases, we would directly write-off these long-lived assets.

 

In addition, we evaluate all of our long-lived assets for potential impairment by comparing the carrying value of our assets to the estimated future cash flows of the assets (undiscounted and without interest charges). If the estimated future cash flows are less than the carrying value of the asset, we calculate an impairment loss. The impairment loss calculation compares the carrying value of the

   Our impairment loss calculations require management to apply judgment in estimating future cash flows and asset fair values, including estimating useful lives of the assets. To make these judgments, we may use internal discounted cash flow estimates, quoted market prices when available, and independent appraisals as appropriate to determine fair value. We derive the required cash flow estimates from our internal business plans.   

If actual results are not consistent with our assumptions and judgments used in estimating future cash flows and asset fair values, we may be required to record additional impairment losses that could be material to our results of operations.

 

Using this impairment review methodology, we recorded long-lived asset impairment charges of $1,000 during the first quarter of fiscal 2007.

 

19


Table of Contents

Description of Policy

  

Judgments and

Uncertainties

  

Effect If Actual Results

Differ From Assumptions

and Adjustments Recorded

asset to the asset’s estimated fair value, which may be based on estimated future cash flows. We recognize an impairment loss if the amount of the asset’s carrying value exceeds the asset’s estimated fair value. If we recognize an impairment loss, the adjusted carrying amount of the asset will be its new cost basis. For a depreciable (amortized) long-lived asset, the new cost basis will be depreciated (amortized) over the remaining useful life of that asset. We do not restore a previously recognized impairment loss if the asset’s carrying value decreases below its estimated fair value.      

Tax Contingencies:

We are subject to periodic audits of our income tax returns by federal, state and local agencies. These audits include questions regarding our tax filing positions, including the timing and amount of deductions and the allocation of income among various tax jurisdictions. In evaluating the exposures associated with our various tax filing positions, including state and local taxes, we record reserves for what we identify as probable exposures. A number of years may elapse before a particular matter for which we have established a reserve is audited and fully resolved.

 

We have also established a valuation allowance for capital loss carryforwards and unrealized losses on certain securities, as we believe that it is more likely than not that the tax benefits of the items will not be realized.

   The estimate of our tax contingencies reserve contains uncertainty because management must use judgment to estimate the exposures associated with various tax filing positions. To make these judgments, we make determinations about the likelihood that the specific taxing authority may challenge the tax deductions that we have taken on our tax return. Based on information about other tax settlements, we estimate amounts that we may settle with taxing authorities in order to conclude audits.    To the extent we prevail in matters for which reserves have been established, or are required to pay amounts in excess of our reserves, our effective tax rate in a given financial statement period could be materially affected. An unfavorable tax settlement might require use of our cash and result in an increase in our effective rate in the year of resolution. A favorable tax settlement would be recognized as a reduction in our effective tax rate in the year of resolution. When we establish or reduce the valuation allowance against our deferred tax assets, our income tax expense will increase or decrease, respectively, in the period such determination is made. As of September 24, 2006, we had established tax reserves of $17.3 million and a valuation allowance of $8.1 million.

Inventories:

We value our inventory at the lower of cost of the inventory or fair market value by establishing a write-down or an inventory loss reserve.

 

We base our lower of cost or market write-down on the excess carrying value of the inventory, which is typically its cost, over the amount

   Our inventory reserve is based on our analysis of sales levels by product and projections of future customer demand derived from historical order patterns and input received from our customers and our sales team. To mitigate uncertainties, we reserve for all inventory greater than twelve    If our estimates regarding customer demand and physical inventory losses are inaccurate or changes in technology affect demand for certain products in an unforeseen manner, we may be exposed to losses or gains in excess of our established reserves that could be material. A 10% increase or decrease in our

 

20


Table of Contents

Description of Policy

  

Judgments and

Uncertainties

  

Effect If Actual Results

Differ From Assumptions

and Adjustments Recorded

that we expect to realize from the ultimate sale of the inventory based upon our assumptions regarding the average sales price to be received for the product.    months old, unless there is an identified need for the inventory. In addition, we reserve for items that are considered obsolete based on changes in customer demand, manufacturing process changes or new product introductions that may eliminate demand for a product. When inventory is physically destroyed, we remove the inventory and the associated reserve from our financial records.    actual inventory reserve at September 24, 2006 would have affected net income by approximately $56,000 for the first quarter of fiscal 2007.

Accruals for Self-Insured and Other Liabilities:

We make estimates for the amount of costs that have been incurred but not yet billed for our self-funded medical insurance, general services, including legal fees, accounting fees and other expenses.    Our liabilities contain uncertainties because we must make assumptions and apply judgment to estimate the ultimate cost to settle claims and claims incurred but not reported as of the balance sheet date. When estimating our liabilities, we consider a number of factors, including interviewing our service providers for bills that have not yet been received. For self-insured liabilities, we estimate our liabilities based on historical claims experience.    If actual costs billed to us are not consistent with our assumptions and judgments, our expenses could be understated or overstated and these adjustments could materially affect our net income.

 

21


Table of Contents

Results of Operations

The following table shows our consolidated statements of income expressed as a percentage of total revenue from continuing operations for the periods indicated:

 

     Three Months Ended  
     September 24,
2006
    September 25,
2005
 

Revenue:

    

Product revenue, net

   93.8 %   93.6 %

Contract revenue, net

   6.2     6.4  
            

Total revenue

   100.0     100.0  

Cost of revenue:

    

Product revenue

   53.8     45.0  

Contract revenue

   4.9     4.3  
            

Total cost of revenue

   58.7     49.3  
            

Gross profit

   41.3     50.7  

Operating expenses:

    

Research and development

   13.8     12.4  

Sales, general and administrative

   11.5     10.4  

Impairment or loss on disposal of long-lived assets

   0.1     0.6  
            

Total operating expenses

   25.4     23.4  

Income from operations

   15.9     27.3  

Non-operating income:

    

Gain on investments in securities, net

   —       0.6  

Other non-operating income

   —       —    

Interest income, net

   3.7     2.3  
            

Income from continuing operations before income taxes

   19.6     30.2  

Income tax expense

   6.7     7.5  
            

Income from continuing operations

   12.9     22.7  

Loss from discontinued operations, net of related income tax benefit

   (0.1 )   (1.5 )
            

Net income

   12.8 %   21.2 %
            

Comparison of Three Months Ended September 24, 2006 and September 25, 2005

Revenue . Revenue from continuing operations increased 1% to $103.9 million in the first quarter of fiscal 2007 from $102.9 million in the first quarter of fiscal 2006. Product revenue increased slightly to $97.4 million from $96.3 million. The increase in product revenue resulted from the growth in revenue of mid-brightness LED chip products, high-brightness LED packaged products, materials and high-power products offset by a decline in sales of high-brightness LED chip products.

 

22


Table of Contents

LED revenue declined 2% to $82.6 million in the first quarter of fiscal 2007 from $84.6 million in the first quarter of fiscal 2006, making up 80% of our total revenue from continuing operations. While unit shipments of our LED products increased 32% over the first quarter of fiscal 2006 due to higher customer demand for mid-brightness products, our blended average LED sales price decreased 26% due to increasing price competition and changes in product mix for both high-brightness and mid-brightness devices. Sales of our mid-brightness products increased 8.4% in the first quarter of fiscal 2007 and represented 64% of LED revenue, up from 58% in the first quarter of fiscal 2006. The primary driver for the increase in sales of mid-brightness products was a shift in customer demand for mobile products requiring blue and white LEDs in keypads. Sales of our high-brightness products declined 17% and represented 36% of LED revenue, down from 42% in the first quarter of fiscal 2006. The decrease in sales of high-brightness chips was offset by an increase in sales of high-brightness packaged products, which was driven by an increase in the number of units sold during the quarter.

Wafer product revenue increased 28% to $6.6 million in the first quarter of fiscal 2007 from $5.1 million in the first quarter of fiscal 2006 making up 7% of our revenue from continuing operations. The primary driver of the increase in wafer product revenue was a 76% increase in the average sales price due to changes in product and customer mix. The increase in sales price was somewhat offset by a 29% decline in the number of units sold. SiC materials revenue for gemstone use increased 13% to $3.6 million in the first quarter of fiscal 2007 from $3.2 million in the first quarter of fiscal 2006 due to an increase in demand from our sole customer for these products, Charles & Colvard, Ltd. Revenue from gemstone materials represented 3% of our total revenue from continuing operations in the first quarter of fiscal 2007.

Revenue from our high-power devices increased 37% to $4.5 million in the first quarter of fiscal 2007 from $3.3 million in the first quarter of fiscal 2006. The increase in revenue was primarily the result of higher sales of our Schottky diode products. Revenue from high-power devices was 4% of revenue from continuing operations in the first quarter of fiscal 2007.

Gross Profit . Gross profit from continuing operations in the first quarter of fiscal 2007 declined 18% to $42.9 million from $52.2 million in the first quarter of fiscal 2006. Our gross profit percentage decreased from 51% to 41% of revenue from continuing operations in the quarter-to-quarter comparison. The decrease was caused primarily by lower gross profits on sales of LED chip products as average selling prices declined faster than cost reductions due to increasing price competition in the marketplace for our LED chip products.

Research and Development. Research and development expenses from continuing operations increased 12% in the first quarter of fiscal 2007 to $14.4 million from $12.8 million in the prior year quarter. The increase in research and development spending supported our continued development of higher brightness LED chips, high power packaged LEDs, larger wafer process development and ongoing development for high-power devices.

 

23


Table of Contents

Sales, General and Administrative . Sales, general and administrative (“SG&A”) expenses from continuing operations increased 11% in the first quarter of fiscal 2007 to $11.9 million as compared to $10.7 million in the same period of fiscal 2006. During the first quarter of fiscal 2007, SG&A expenses reflected increased spending on sales and marketing to support our incremental growth, the building of our sales and marketing teams, and the continued development of the Cree brand.

Impairment or Loss on Disposal of Long-Lived Assets . Impairment or loss on the disposal of long-lived assets decreased to $97,000 in the first quarter of fiscal 2007 compared to $568,000 in the first quarter of fiscal 2006 as a result of the long-lived assets disposed of in each comparative quarter. The majority of the fiscal 2006 loss represented the impairment of building improvements that were no longer being used at our Durham facility.

(Loss) Gain on Investments in Securities, Net . During the first quarter of fiscal 2007, we recognized a net loss of $1,000 on the sale of two securities. In the first quarter of fiscal 2006, we sold 63,782 shares of Color Kinetics common stock for $954,000 and recognized a $587,000 gain.

Interest Income, Net . Net interest income increased 66% to $3.9 million in the first quarter of fiscal 2007 from $2.3 million in the first quarter of fiscal 2006 due to the combination of the greater balance of our invested assets and the higher interest rates received on our investments.

Income Tax Expense. Income tax expense from continuing operations for the first quarter of fiscal 2007 decreased 10% to $7.0 million from $7.8 million from the first quarter of fiscal 2006 primarily due a decrease in taxable income. However, the decrease in taxable income was offset by an increase in our effective tax rate from 25% to 34%. The increase in our effective tax rate is primarily due to the timing of the expiration of certain IRS statutes. In the first quarter of fiscal 2006, our income tax expense was reduced by $2.2 million as a result of the change in value of our Color Kinetics investment that reduced a previously established valuation allowance. We currently target our effective tax rate for the remainder of fiscal 2007 will be approximately 35%, which does not reflect changes in the market price for shares of Color Kinetics’ common stock, which we treat as a discrete item each quarter.

Loss from Discontinued Operations, Net of Tax. In the first quarter of fiscal 2007, we recorded $117,000 of pre-tax net charges, or $77,000 of after-tax net charges, related to the continued expense arising from the Sunnyvale facility operating lease. In the first quarter of fiscal 2006, we recorded a pre-tax operating loss of $2.2 million, or $1.5 million after-tax, as our Cree Microwave business generated revenue of $954,000 offset by heavy fixed costs incurred to operate the Sunnyvale facility. In addition, in the first quarter of fiscal 2006, we incurred additional charges related to the closure of this business including a $200,000 inventory impairment, a $211,000 impairment of long-lived assets and $392,000 in severance expense.

 

24


Table of Contents

Liquidity and Capital Resources

Our strong cash generating capability and financial condition gives us the financial ability to grow our business. Our principal source of liquidity is operating cash flows, which is derived from net income.

Operating Activities

In the first quarter of fiscal 2007, our operations provided $42.6 million of cash as compared to $31.0 million of cash provided in the first quarter of fiscal 2006. This $11.6 million increase is primarily attributable to an increase in accounts payable and accrued expenses of $15.4 million and a $13.7 million increase in accounts and interest receivable offset by a $8.4 million decrease in net income and a $11.5 million increase in inventory.

As of September 24, 2006, our inventory remained below the industry average of 64 days at 59 days on hand. The increase in inventory during the quarter reflects our efforts to build inventory levels in order to provide flexibility to meet end customer demands. Days sales outstanding was 63 days for the quarter ended September 24, 2006.

Investing Activities

In the first quarter of fiscal 2007, we used $74.9 million for investing activities. We used $43.8 million in connection with the acquisition of INTRINSIC. The remainder was primarily attributable to $35.2 million used for the purchase of property and equipment and patent and licensing rights. The increase in investing activities over the first quarter of 2006 was primarily related to the acquisition of INTRINSIC and a $20.8 million increase in capital expenditures, offset by $19.1 million of cash received from investments held to maturity and a $17.1 million decrease in purchases of investments held to maturity.

Financing Activities

We used $5.1 million for financing activities in the first quarter of fiscal 2007. We repurchased 300,000 shares of our common stock at an average purchase price of $18.14 per share with an aggregate cost of $5.4 million. This use of cash was slightly offset by the proceeds generated from the exercise of stock options during the quarter.

As of September 24, 2006, there remained approximately 5.2 million shares of our common stock approved for repurchase under the repurchase program authorized by the Board of Directors that extends through June 2007. Since the inception of our stock repurchase program in January 2001, we have repurchased 6.9 million shares of our common stock at an average price of $18.28 per share, with an aggregate value of $126.4 million. We intend to use available cash to purchase additional shares under the program. At the discretion of our management, the repurchase program can be implemented through open market or privately negotiated transactions. We will determine the time and extent of repurchases based on our evaluation of market conditions and other factors.

 

25


Table of Contents

Financial Condition

As of September 24, 2006, our cash and cash equivalents and short-term investments combined decreased $47.7 million, or 19%, over balances reported as of June 25, 2006. Our long-term investments held to maturity increased by $6.1 million, or 5%, over balances reported as of June 25, 2006. The net $41.6 million decrease in cash and investments resulted primarily from the purchase of INTRINSIC in the first quarter of fiscal 2007. Our net property and equipment has increased by $18.4 million or 5% since June 25, 2006, as investments made to expand production capacity have been offset by depreciation expense and disposals of fixed assets. During the first quarter of fiscal 2007, we spent $33.9 million on capital additions. We currently have $1.2 million in capital lease obligations outstanding, which were acquired in connection with our purchase of INTRINSIC. We have no off-balance sheet obligations, commitments or contingencies or guarantees and we do not use special purpose entities for any transactions.

We plan to meet the cash needs for the business for fiscal 2007 through cash from operations and cash on hand. Actual results may differ from our targets for a number of reasons addressed in this report. We may also issue additional shares of common stock or use available cash on hand for the acquisition of complementary businesses or other significant assets. From time to time, we evaluate strategic opportunities and potential investments in complementary businesses and anticipate continuing to make such evaluations.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

As of September 24, 2006, we held a long-term investment in the equity securities of Color Kinetics, which is treated for accounting purposes under Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” as an investment in available-for-sale securities. This investment is carried at fair market value based upon the quoted market price of the stock as of September 22, 2006, with net unrealized gains or losses excluded from earnings and reported as a separate component of shareholders’ equity.

It is our policy to write down these types of equity investments to their market value and record the related charge as an investment loss in our consolidated statements of income if we believe that an other-than-temporary decline existed in our marketable equity securities. As of September 24, 2006, we do not believe that an other-than-temporary decline existed in our investment in Color Kinetics because the market value of the security was above our cost. This investment is subject to market risk of equity price changes. The fair market value of this investment as of September 24, 2006, using the closing sales price as of September 22, 2006, was $29.3 million, compared to the fair market value as of June 25, 2006, using the closing sales price as of June 23, 2006, which was $29.1 million. The potential loss in fair value resulting from a hypothetical 10% decrease in quoted equity price was approximately $2.9 million at both September 24, 2006 and at June 25, 2006.

 

26


Table of Contents

We hold and expect to continue to consider investments in minority interests in companies having operations or technology in areas within our strategic focus. We generally are not subject to material market risk with respect to our investments classified as marketable securities as such investments are readily marketable, liquid, and do not fluctuate substantially from stated values. Many of our investments are in early stage companies or technology companies where operations are not yet sufficient to establish them as profitable concerns. Management continues to evaluate its investment positions on an ongoing basis. See Footnote 6, “Investments,” in the consolidated financial statements included in Part 1, Item 1, of this report for further information regarding our investments.

We have invested some of the proceeds from our cash from operations into high-grade corporate debt, commercial paper, government securities, and other investments at fixed interest rates that vary by security. These investments are A grade or better in accordance with our cash management policy. At September 24, 2006, we had $282.7 million invested in these securities, compared to $286.9 million at June 25, 2006. Although these securities generally earn interest at fixed rates, the historical fair values of such investments have not differed materially from the amounts reported in our consolidated balance sheets. Therefore, we believe that potential changes in future interest rates will not create material exposure for us from differences between the fair value and the amortized cost of these investments. The potential loss in fair value resulting from a hypothetical 10% decrease in quoted market price was approximately $28.3 million at September 24, 2006, and $28.7 million at June 25, 2006.

We have no off-balance sheet obligations, commitments, contingencies, or guarantees, nor do we use special-purpose entities for any transactions. With two of our larger customers, we maintain a foreign currency adjustment to our sales price if Japanese yen and euro exchange rates against the U.S. dollar are not maintained. These revenue adjustments represent our main risk with respect to foreign currency since our contracts and purchase orders are denominated in U.S. dollars and have not had a material impact to our results of operations. We have no commodity risk.

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 Commission’s rules and forms. 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.

 

27


Table of Contents

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 2007 that we believe materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

On September 11, 2006, we, together with the Trustees of Boston University as co-plaintiffs, filed a complaint against BridgeLux, Inc. (formerly eLite Optoelectronics) for infringement of two U.S. patents. The two patents are No. 6,657,236, entitled “Enhanced Light Extraction in LEDs through the Use of Internal and External Optical Elements,” which is owned by us, and No. 5,686,738, entitled “Highly Insulating Monocrystalline Gallium Nitride Thin Films,” which we have licensed from the University on an exclusive basis. The suit was filed in the U.S. District Court for the Middle District of North Carolina and seeks monetary damages and injunctive relief to prohibit BridgeLux from infringing these patents. BridgeLux has filed a motion to dismiss the complaint contending that it is not subject to personal jurisdiction of the court and that venue is improper. On October 17, 2006, BridgeLux also filed a complaint against us and the University in the U.S. District Court for the Northern District of California seeking a declaratory judgment of non-infringement and invalidity with respect to the two patents on which we sued BridgeLux and of non-infringement with respect to two additional U.S. patents. The two additional patents are No. 6,600,175, entitled “Solid State White Light Emitter and Display Using Same,” which we own, and U.S. Patent No. 6,953,703, entitled “Method of Making a Semiconductor Device with Exposure of Sapphire Substrate to Activated Nitrogen,” which is owned by the University subject to an exclusive license to us. On October 17, 2006, BridgeLux also filed a complaint against us in the U.S. District Court for the Eastern District of Texas alleging infringement of U.S. Patent No. 6,869,812, entitled “High Power AlInGaN Based Multi-Chip Light Emitting Diode,” and seeking unspecified monetary damages and injunctive relief. Please refer to Part I, Item 3, “Legal Proceedings,” of our Annual Report on Form 10-K for the fiscal year ended June 25, 2006 for descriptions of other material legal proceedings.

Item 1A. Risk Factors

Described below are various risks and uncertainties that may affect our business. These risks and uncertainties are not the only ones we face. Additional risks and uncertainties, both known and unknown, including ones that we currently deem immaterial or that are similar to those faced by other companies in our industry or business in general, may also affect our business. If any of the risks described below actually occur, our business, financial condition or results of operations could be materially and adversely affected.

Our operating results and margins may fluctuate significantly.

Although we experienced significant revenue growth over the past few years, we may not be able to sustain such growth or maintain our margins, and we may experience significant fluctuations in our revenue, earnings and margins in the future. Historically, the prices of our LEDs have declined based on market trends. We attempt to maintain our margins by constantly developing improved or new products, which provide greater value and result in higher prices, or by lowering the cost of our LEDs. If we are unable to do so, our margins will decline. Our operating results and margins may vary significantly in the future due to many factors, including the following:

 

    our ability to develop, manufacture and deliver products in a timely and cost-effective manner;

 

    variations in the amount of usable product produced during manufacturing (our “yield”);

 

    our ability to improve yields and reduce costs in order to allow lower product pricing without margin reductions;

 

    our increased reliance on and our ability to ramp up our subcontractors in Asia;

 

    our ability to ramp up production for our new products;

 

    our ability to convert our substrates used in our volume manufacturing to larger diameters and to transition advance device wafer fabrication to our new RTP facility;

 

28


Table of Contents
    our ability to produce higher brightness and more efficient LED products that satisfy customer design requirements;

 

    our ability to develop new products to specifications that meet the evolving needs of our customers;

 

    changes in demand for our products and our customers’ products;

 

    effects of an economic slow down on consumer spending on such items as cell phones, electronic devices and automobiles;

 

    changes in the competitive landscape, such as availability of higher brightness LED products, higher volume production and lower pricing from Asian competitors;

 

    average sales prices for our products declining at a greater rate than anticipated;

 

    changes in the mix of products we sell, which may vary significantly;

 

    other companies’ inventions of new technology that may make our products obsolete;

 

    product returns or exchanges that could impact our short-term results;

 

    changes in purchase commitments permitted under our contracts with large customers;

 

    changes in production capacity and variations in the utilization of that capacity;

 

    disruptions of manufacturing that could result from damage to our manufacturing facilities from causes such as fire, flood or other casualties, particularly in the case of our single site for SiC wafer and LED production or disruptions from some of our sole source vendors; and

 

    changes in accounting rules, such as recording expenses for stock option grants.

These or other factors could adversely affect our future operating results and margins. If our future operating results or margins are below the expectations of stock market analysts or our investors, our stock price will likely decline.

We face significant challenges managing our growth.

We have experienced a period of significant growth that may challenge our management and other resources. We are also in the process of transforming our business to support a global components customer base. In order to manage our growth and change in our strategy effectively, we must continue to:

 

    implement and improve operating systems;

 

    maintain adequate manufacturing facilities and equipment to meet customer demand;

 

    maintain a sufficient supply of raw materials to support our growth;

 

    improve the skills and capabilities of our current management team;

 

    add experienced senior level managers;

 

    attract and retain qualified people with experience in engineering, design and marketing; and

 

    recruit and retain qualified manufacturing employees.

We will spend substantial amounts of money in supporting our growth and may have additional unexpected costs. We may not be able to expand quickly enough to exploit potential market opportunities. Our future operating results will also depend on expanding sales and marketing, research and development, and administrative functions to support a global components customer base. If we cannot attract qualified people or manage growth and change effectively, our business, operating results and financial condition could be adversely affected.

 

29


Table of Contents

If we are unable to produce and sell adequate quantities of our LED products and improve our yields and reduce costs, our operating results may suffer.

We believe that our ability to gain customer acceptance of our products and to achieve higher volume production and lower production costs for those products will be important to our future operating results. We must reduce costs of these products to avoid margin reductions from the lower selling prices we may offer due to our competitive environment and/or to satisfy prior contractual commitments. Achieving greater volumes and lower costs requires improved production yields for these products. We may encounter manufacturing difficulties as we ramp up our capacity to make our newest high-brightness products. Our failure to produce adequate quantities and improve the yields of any of these products could have a material adverse effect on our business, results of operations and financial condition.

Our operating results are substantially dependent on the development of new products based on our SiC and GaN technology.

Our future success will depend on our ability to develop new SiC and GaN solutions for existing and new markets. We must introduce new products in a timely and cost-effective manner, and we must secure production orders for those products from our customers. The development of new SiC and GaN products is a highly complex process, and we historically have experienced delays in completing the development and introduction of new products. Products currently under development include larger, higher quality substrates and epitaxy, wide bandgap RF and microwave products based on SiC and GaN, SiC power devices, higher brightness LED products such as the new EZBright LED, and high power packaged LEDs. 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 of market requirements and evolving standards;

 

    acceptance of our new product designs;

 

    acceptance of new technology in certain markets;

 

    the availability of qualified development personnel;

 

    our timely completion of product designs and development;

 

    our ability to develop repeatable processes to manufacture new products in sufficient quantities and at low enough costs for commercial sales;

 

    our customers’ ability to develop competitive products incorporating our products; and

 

    acceptance of our customers’ products by the market.

If any of these or other factors become problematic, we may not be able to develop and introduce these new products in a timely or cost-efficient manner.

Our results of operations, financial condition and business would be harmed if we were unable to balance customer demand and capacity.

We are in the process of taking steps to address our manufacturing capacity needs in order to meet current and future customer demand. If we are not able to increase our capacity or if we

 

30


Table of Contents

increase our capacity too quickly, our business and results of operations could be adversely impacted. We are also expanding capacity for our XLamp products and qualifying a subcontractor. If we experience delays or additional unforeseen costs associated with this expansion, we may not be able to achieve our financial targets.

Our LED revenues are highly dependent on our customers’ ability to produce competitive white LED products using our LED chips.

Some of our customers package our blue LEDs in combination with phosphors to create white LEDs. Growth in sales of our high-brightness LED chips used in white light applications is dependent upon our customers’ ability to develop efficient white LED products using our chips. Nichia currently has the majority of the market share for white LEDs and other companies, such as Toyoda Gosei Co., Ltd., have started to offer highly competitive blue chips and white products to compete with Nichia. The white LEDs that our customers produce with our chips historically have not been as bright as Nichia’s white LEDs. Even if our customers are able to develop higher performance white LED products, there can be no assurance that they will be able to compete with Nichia, Toyoda Gosei Co., Ltd., or other competitors.

We are highly dependent on trends in mobile products to drive a substantial percentage of LED demand.

Our results of operations could be adversely affected if we experience reduced customer demand for LED products for use in mobile products. During the first quarter of fiscal 2007, approximately 40% of our LED revenue was from sales of our products into mobile products. Our design wins are spread over numerous models and customers. Our ability to maintain or increase our LED product revenue depends in part on the number of models into which our customers design our products and the overall demand for these products, which is impacted by seasonal fluctuations and market trends. Design cycles in the mobile product industry are short and demand is volatile, which makes production planning difficult to forecast. Brightness performance, smaller size and price considerations are important factors in increasing our market share for mobile products.

If we experience poor production yields or cannot reduce costs, our margins could decline and our operating results may suffer.

Our materials products, our LED products, and our high-power products are manufactured using technologies that are highly complex. We manufacture our SiC wafer products from bulk SiC crystals, and we use these SiC wafers to manufacture our LED products and our SiC-based high-power semiconductors. During our manufacturing process, each wafer is processed to contain numerous die, which are the individual semiconductor devices. Our high-power devices and XLamp products are then further processed by incorporating them into packages for sale as packaged components. The number of usable crystals, wafers, dies and packaged components that result from our production processes can fluctuate as a result of many factors, including but not limited to the following:

 

    variability in our process repeatability and control;

 

    impurities in the materials used;

 

    contamination of the manufacturing environment;

 

    equipment failure, power outages or variations in the manufacturing process;

 

31


Table of Contents
    lack of consistency and adequate quality and quantity of piece parts and other raw materials;

 

    losses from broken wafers or human errors; and

 

    defects in packaging either within our control or at our subcontractors.

We refer to the proportion of usable product produced at each manufacturing step relative to the gross number that could be constructed from the materials used as our manufacturing yield.

If our yields decrease, our cost per wafer could increase, our margins could decline and our operating results would be adversely affected. In the past, we have experienced difficulties in achieving acceptable yields on new products, which has adversely affected our operating results. We may experience similar problems in the future, and we cannot predict when they may occur or their severity. In some instances, we may offer products for future delivery at prices based on planned yield improvements. Reduced yields or failure to achieve planned yield improvements could continue to significantly affect our margins and operating results.

We depend on a few large customers and our revenues can be affected by their contract terms.

Historically, a substantial portion of our revenue has come from large purchases by a small number of customers. Accordingly, our future operating results depend on the success of our largest customers and on our success in selling large quantities of our products to them. The concentration of our revenues with a few large customers makes us particularly susceptible to factors affecting those customers. For example, if demand for their products decreases, they may limit or stop purchasing our products and our operating results could suffer. In addition, the Sumitomo contract provides that Sumitomo may decrease its purchase commitment, as we experienced in fiscal 2006, or terminate the contract if its inventory of our product reaches a specified level. Sumitomo’s inventory of our products can vary materially each quarter based on fluctuations in its customer demand. In general, the success of our relationships with our customers is subject to a number of factors, including the dynamics of the overall market. For example, if some of our competitors were to license technology or form alliances with other parties, our business may be impacted.

Our traditional LED chip customers may reduce orders as a result of our entry into the packaged LED markets.

We began shipping packaged LED devices in fiscal 2005. Some of our customers may reduce their orders for our chips because we are competing with them in the packaged LED business. This reduction in orders could occur faster than our packaged LED business can grow in the near term. This could reduce our overall revenue and profitability.

The markets in which we operate are highly competitive and have evolving technology standards.

The markets for our LED and high-power products are highly competitive. In the LED market, we compete with companies that manufacture or sell nitride-based LED chips as well as those that sell packaged LEDs. Competitors are offering new blue, green and white LEDs with aggressive prices and improved performance. These competitors may reduce average sales prices faster than our cost reduction, and competitive pricing pressures may accelerate the rate of decline of our average sale prices. The market for SiC wafers is also becoming competitive as other firms in recent years have begun offering SiC wafer products or announced plans to do so.

 

32


Table of Contents

Competition is increasing. In order to achieve our revenue growth objectives in fiscal 2007 and beyond, we need to continue to develop new products that enable our customers to win new designs and increase market share in key applications such as mobile products. One major supplier dominates this market and we anticipate that the competition for these designs has intensified and will result in pressure to lower sales prices of our products. Therefore, our ability to provide higher performance LEDs 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 also could invent new technologies that may make our products obsolete. Any of these developments could have an adverse effect on our business, results of operations and financial condition.

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 the semiconductor industry. These traits have resulted in significant and often protracted and expensive litigation. Litigation to determine the validity of patents or claims by third parties of infringement of patents or other intellectual property rights could result in significant expense and divert the efforts of our technical personnel and management, even if the litigation results in a determination favorable to us. In the event of an adverse result in such litigation, we could be required to:

 

    pay substantial damages;

 

    indemnify our customers;

 

    stop the manufacture, use and sale of products found to be infringing;

 

    discontinue the use of processes found to be infringing;

 

    expend significant resources to develop non-infringing products and processes; and/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 current or future products. In addition, our customers may face infringement claims directed to the customer’s products that incorporate our products, and an adverse result could impair the customer’s 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 this indemnification obligation 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. Our practice is to investigate such claims to determine whether the assertions have merit and, if so, we take appropriate steps to seek to obtain a license or to avoid the infringement. However, we cannot predict whether a license will be available or that we would find the terms of any license offered acceptable or commercially reasonable. Failure to obtain a necessary license could cause us to incur substantial liabilities and costs and to suspend the manufacture of products.

 

33


Table of Contents

There are limitations on our ability to protect our intellectual property.

Our intellectual property position is based in part on patents owned by us and patents exclusively licensed to us by North Carolina State University, Boston University and others. The licensed patents include patents relating to the SiC crystal growth process that is central to our SiC materials and device business. We intend to continue to file patent applications in the future, where appropriate, and to pursue such applications with U.S. and foreign patent authorities.

However, we cannot be sure that patents will be issued on such applications or that our existing or future patents will not be successfully contested by third parties. Also, since issuance of a valid patent does not prevent other companies from using alternative, non-infringing technology, we cannot be sure that any of our patents, or patents issued to others and licensed to us, will provide significant commercial protection, 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.

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.

Performance of our investments in other companies could affect our financial results.

From time to time, we have made investments in public and private companies that engage in complementary businesses. Should the value of any such investments we hold decline, the related write-down in value could have a material adverse effect on our financial results as reflected in our consolidated balance sheets. In addition, if the decline in value is determined to be other-than-temporary, the related write-down could have an adverse effect on our reported net income. We currently hold an interest in one public company, Color Kinetics.

We may make investments in companies, which subject us to risks inherent in the business of the company in which we have invested and to trends affecting the equity markets as a whole. Investments in private companies are subject to additional risks relating to the limitations on transferability of the interests due to the lack of a public market and to other transfer restrictions. Investments in publicly held companies are subject to market risks and may not be liquidated easily. As a result, we may not be able to reduce the size of our positions or liquidate our investments when we deem appropriate to limit our downside risk.

Our investments in other companies also may cause fluctuations in our earnings results. In future periods, we will be required to continue to adjust our deferred tax asset valuation allowance in connection with any increase or decrease in the value of our Color Kinetics investment, which could increase or decrease our income tax expense for the period. This may cause fluctuations in our earnings results that do not accurately reflect our results from operations.

 

34


Table of Contents

We rely on a few key sole source and limited source suppliers.

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 are attempting to identify alternative sources for our sole and limited source suppliers.

We generally purchase these sole or limited source items with purchase orders, and we have no 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.

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.

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, 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.

 

35


Table of Contents

If our products fail to perform or meet customer requirements, we could incur significant additional costs.

The manufacture of our products involves highly complex processes. Our customers specify quality, performance and reliability standards that we must meet. If our products do not meet these standards, we may be required to replace or rework the products. In some cases, our products may contain undetected defects or flaws that only become evident after shipment. We have experienced product quality, performance or reliability problems from time to time. Defects or failures may occur in the future. If failures or defects occur, we could:

 

    lose revenue;

 

    incur increased costs, such as warranty expense and costs associated with customer support;

 

    experience delays, cancellations or rescheduling of orders for our products;

 

    write down existing inventory; or

 

    experience product returns.

We are subject to risks from international sales.

We expect that revenue from international sales will continue to be the majority of our total revenue. International sales are subject to a variety of risks, including risks arising from currency fluctuations, trading restrictions, tariffs, trade barriers and taxes. Also, U.S. Government export controls could restrict or prohibit the exportation of products with defense applications. Because all of our foreign sales are denominated in U.S. dollars, our sales are subject to variability as prices become less competitive in countries with currencies that are low or are declining in value against the U.S. dollar and more competitive in countries with currencies that are high or increasing in value against the U.S. dollar.

If we fail to evaluate and implement 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 Semiconductor Corporation. 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 the acquired business, and difficulty in integrating the acquired business’s operations, personnel and financial and operating systems into our current business. We may not be able to successfully 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 and financial condition.

 

36


Table of Contents

Litigation could adversely affect our operating results and financial condition.

We are defendants in pending litigation as described in “Part II, Item 1. Legal Proceedings” of this report that alleges, among other things, violations of securities laws and patent infringement. Defending against existing and potential litigation will likely require significant attention and resources and, regardless of the outcome, result in significant legal expenses, which will adversely affect our results unless covered by insurance or recovered from third parties. If our defenses are ultimately unsuccessful, or if we are unable to achieve a favorable resolution, we could be liable for damage awards that could materially adversely affect our results of operations and financial condition.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The following table lists all repurchases during the first quarter of fiscal 2007 of any of our securities registered under Section 12 of the Exchange Act, by or on behalf of us or any affiliated purchaser.

Issuer Purchases of Equity Securities

 

Period

   Total
Number of
Shares
Purchased
   Average
Price
Paid Per
Share
   Total Number of
Shares Purchased as
Part of Publicly
Announced
Programs (1)
   Maximum Number
of Shares that May
Yet Be Purchased
Under the Programs

June 26 - July 23, 2006

   —      $ —      —      5,450,000

July 24 - August 20, 2006

   —      $ —      —      5,450,000

August 21 - September 24, 2006

   300,000    $ 18.14    300,000    5,150,000
                     

Total

   300,000    $ 18.14    300,000    5,150,000
                     

(1) On January 18, 2001, we announced the authorization by our Board of Directors of a program to repurchase shares of our outstanding common stock. Several times since then, the Board has renewed the program and increased the number of shares that we can repurchase under the program. On June 20, 2006 the Board approved the extension of our stock repurchase program through June 24, 2007. As of September 24, 2006 there were an aggregate 12.1 million shares of our common stock that have been approved for repurchase under the program, of which an aggregate of approximately 5.2 million shares remain authorized for future repurchase.

 

37


Table of Contents

Item 6. Exhibits

The following exhibits are being filed herewith and are numbered in accordance with Item 601 of Regulation S-K:

 

10.1   Fiscal 2007 Management Incentive Compensation Plan (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, dated August 21, 2006, as filed with the Securities and Exchange Commission on August 25, 2006)
10.2   Offer Letter Agreement, dated September 1, 2006, between Cree, Inc. and John T. Kurtzweil (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, dated September 1, 2006, as filed with the Securities and Exchange Commission on September 8, 2006)
10.3   Severance Agreement, dated September 29, 2006, between Cree, Inc. and John T. Kurtzweil
10.4   Form of Master Stock Option Award Agreement for Grants of Nonqualified Stock Options
10.5   Form of Master Restricted Stock Award Agreement
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

 

38


Table of Contents

SIGNATURE

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: November 2, 2006

/s/ John T. Kurtzweil

John T. Kurtzweil
Chief Financial Officer and Treasurer
(Authorized Officer and Chief Financial and Accounting Officer)

 

39


Table of Contents

EXHIBIT INDEX

 

Exhibit No.  

Description

10.1   Fiscal 2007 Management Incentive Compensation Plan (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, dated August 21, 2006, as filed with the Securities and Exchange Commission on August 25, 2006)
10.2   Offer Letter Agreement, dated September 1, 2006, between Cree, Inc. and John T. Kurtzweil (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, dated September 1, 2006, as filed with the Securities and Exchange Commission on September 8, 2006)
10.3   Severance Agreement, dated September 29, 2006, between Cree, Inc. and John T. Kurtzweil
10.4   Form of Master Stock Option Award Agreement for Grants of Nonqualified Stock Options
10.5   Form of Master Restricted Stock Award Agreement
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

 

40

Exhibit 10.3

CREE, INC.

SEVERANCE AGREEMENT

This Severance Agreement (the “Agreement”) is entered into as of September 29, 2006 (the “Effective Date”) by and between Cree, Inc. (the “Company”) and John T. Kurtzweil (“Executive”).

1. Background . As of the Effective Date, Executive has been employed by the Company as its Executive Vice President-Finance, Chief Financial Officer and Treasurer. The period during which Executive is employed by the Company is referred to in this Agreement as the “Employment Term.” The Company and Executive are entering into this Agreement to provide Executive severance benefits, as set forth herein, in connection with termination of Executive’s employment following any Change in Control that may occur during the Employment Term and in certain other circumstances.

2. At-Will Employment . Executive and the Company agree that Executive’s employment with the Company constitutes “at-will” employment. Executive and the Company acknowledge that this employment relationship may be terminated at any time, upon written notice to the other party, with or without good cause or for any or no cause, at the option either of the Company or Executive. However, as described in this Agreement, Executive may be entitled to severance benefits depending upon the circumstances of Executive’s termination of employment. Executive agrees to resign from all positions held with the Company and its affiliates immediately following the termination of his employment if the Company’s Board of Directors (the “Board”) so requests.

3. Term of Agreement . This Agreement will have an initial term of one year commencing on the Effective Date. On the first anniversary of the Effective Date and on each anniversary of the Effective Date thereafter, this Agreement automatically will renew for an additional one-year term unless either party provides the other party with written notice of non-renewal at least 120 days prior to the date of automatic renewal or unless Executive’s employment terminates for any reason prior to the anniversary date. Notwithstanding any contrary provision in this Section 3, in the event of a Change in Control during the Employment Term, this Agreement will continue for twelve months after the effective date of the Change in Control.

4. Severance .

(a) Termination Without Cause or Resignation for Good Reason not in connection with a Change in Control . If Executive’s employment is terminated by the Company without Cause or by Executive for Good Reason, and the termination is not in Connection with a Change in Control, then, subject to Section 4(d)(i) and Section 5 below, Executive will receive: (i) continued payment of base salary for twelve (12) months following the termination of Executive’s employment in accordance with the Company’s regular payroll cycle, and (ii) reimbursement of premiums through the Company’s payroll system as explained below for continuation of medical benefits for Executive, Executive’s spouse, and Executive’s eligible dependents under the Company’s Benefit Plans under the Consolidated Omnibus Budget Reconciliation Act of 1986, as amended (“COBRA”) for twelve (12) months following


Executive’s termination of employment; provided Executive validly elects to continue coverage under COBRA, continues coverage in accordance with applicable law, and pays the applicable premiums to the Company’s COBRA administrator when due. When applicable, COBRA premiums will be reimbursed as follows: the monthly COBRA premium in effect at the time of termination will be multiplied by twelve and the product will be divided by the number of pay periods remaining in the twelve (12) months following the termination of Executive’s employment, and an amount equal to the result (i.e., the quotient rounded to the nearest whole cent) will be included in Executive’s compensation each of the remaining pay periods, so long as Executive remains eligible for reimbursement of COBRA premiums under the terms of this Agreement.

(b) Termination Without Cause or Resignation for Good Reason in connection with a Change in Control . If Executive’s employment is terminated by the Company without Cause or by Executive for Good Reason, and the termination is in Connection with a Change in Control, then, subject to Section 4(d)(i) and Section 5 below, Executive will receive: (i) continued payment of base salary for twelve (12) months following the termination of Executive’s employment in accordance with the Company’s regular payroll cycle, (ii) reimbursement of premiums through the Company’s payroll system as explained above for continuation of medical benefits for Executive, Executive’s spouse, and Executive’s eligible dependents under the Company’s Benefit Plans under the Consolidated Omnibus Budget Reconciliation Act of 1986, as amended (“COBRA”) for twelve (12) months following Executive’s termination of employment; provided Executive validly elects to continue coverage under COBRA, continues coverage in accordance with applicable law, and pays the applicable premiums to the Company’s COBRA administrator when due, and (iii) accelerated vesting of all of Executive’s then outstanding, unvested equity awards.

(c) Sole Right to Severance . Any severance payment will be paid pursuant to and in accordance with the Company’s Severance Program. This Agreement is intended to represent Executive’s sole entitlement to severance payments and benefits in connection with the termination of his employment, except for such payments and benefits to which Executive would be entitled as an employee of the Company in the absence of this Agreement.

(d) Section 409A .

(i) Notwithstanding anything to the contrary in this Agreement, if the Company determines, in its good faith judgment, that the Executive is a “specified employee” within the meaning of Section 409A of the Internal Revenue Code of 1986, as amended, and the regulations thereunder (the “Code”), the Company will restructure payment of the severance benefits so that the severance benefits will accrue during the first six (6) months after the Executive’s termination, and the accrued amount will be paid in a lump sum payment on the first regular payroll payment date after expiration of the 6-month period, with all subsequent payments, if any, made in accordance with the Company’s regular payroll cycle as otherwise provided in this Agreement.

 

2


(ii) The Executive agrees to work in good faith with the Company to consider amendments to this Agreement which are necessary or appropriate to avoid imposition of any additional tax or income recognition under Section 409A of the Code prior to the actual payment to the Executive of payments or benefits under this Agreement.

5. Conditions to Receipt of Severance; No Duty to Mitigate .

(a) Separation Agreement and Release of Claims . The receipt of any severance pursuant to Section 4 will be subject to Executive signing and not revoking a release of claims in substantially the form attached as Exhibit A , but with any appropriate modifications, reflecting changes in applicable law, as is necessary or appropriate to provide the Company with the protection it would have if the release were executed as of the Effective Date. No severance will be paid or provided until the separation agreement and release of claims become effective.

(b) Nondisparagement . During the Employment Term and for twelve (12) months thereafter, Executive will not knowingly disparage, criticize, or otherwise make any derogatory statements regarding the Company, its directors, or its officers. The foregoing restrictions will not apply to any statements that are made truthfully in response to a subpoena or other compulsory legal process.

(c) Other Requirements . Executive’s receipt of continued severance payments will be subject to Executive continuing to comply with the terms of the Confidential Information Agreement.

(d) No Duty to Mitigate . Executive will not be required to mitigate the amount of any payment contemplated by this Agreement, nor will any earnings that Executive may receive from any other source reduce any such payment.

6. Definitions .

(a) Benefit Plans . For purposes of this Agreement, “Benefit Plans” means plans, policies, or arrangements that the Company sponsors (or participates in) and that immediately prior to Executive’s termination of employment provide Executive, Executive’s spouse, and/or Executive’s eligible dependents with medical, dental, or vision benefits. Benefit Plans do not include any other type of benefit (including, but not by way of limitation, financial counseling, disability, life insurance, or retirement benefits).

(b) Cause . For purposes of this Agreement only, “Cause” means Executive’s: (i) gross negligence or willful misconduct in the performance of his duties to the Company after one written warning detailing the concerns and offering the Executive the opportunity to cure; (ii) material and willful violation of any federal or state law; (iii) commission of any act of fraud with respect to the Company; (iv) conviction of, plea of nolo contendre to, or grant of prayer of judgment continued with respect to, a felony or any crime that the Chief Executive Officer or the Board reasonably believes has had or will have a material detrimental effect on the Company’s reputation or business; (v) material breach of his Confidential Information Agreement, which breach is (if capable of cure) not cured within thirty (30) days after the Company delivers written notice to Executive of the breach; (vi) death; or (vii) the Executive has been disabled within the meaning of the Company’s long-term disability insurance program for a period of six months and is unable to return to work after such six-month period, with or without reasonable accommodation.

 

3


(c) Change in Control . For purposes of this Agreement, “Change in Control” will have the same meaning as in Section 7.1 of the Company’s Equity Compensation Plan (as amended and restated August 5, 2002 and without regard to any subsequent amendments).

(d) Confidential Information Agreement . For purposes of this Agreement, “Confidential Information Agreement” means the Company’s standard form of Employee Agreement Regarding Confidential Information, Intellectual Property, and Non-Competition executed by Executive in favor of the Company concurrently with the execution of this Agreement, as such Confidential Information Agreement may be amended from time to time by mutual written agreement of the parties.

(e) Good Reason . For purposes of this Agreement, “Good Reason” means any act of the Company, without Executive’s consent, that materially and adversely diminishes the Executive’s duties or responsibilities; provided that, in the event of the happening of such act, the Executive must notify the Board in writing of the act and the basis for his belief that it constitutes Good Reason. The Company will have thirty (30) days from its receipt of such notice to remedy any act giving rise to a claim of Good Reason before Executive may take further action hereunder on the basis of such act. Executive’s actions approving any change, reduction, requirement, or occurrence in his role as Executive Vice President-Finance, Chief Financial Officer or Treasurer (that otherwise may be considered Good Reason) will be considered consent for the purposes of this Good Reason definition.

(f) In Connection with a Change in Control . For purposes of this Agreement, a termination of Executive’s employment with the Company is “in Connection with a Change in Control” if Executive’s employment is terminated within twelve (12) months following a Change in Control.

7. Indemnification . Subject to applicable law, Executive will be provided indemnification to the maximum extent permitted by the Company’s bylaws and Articles of Incorporation, with such indemnification to be on terms determined by the Board or any of its committees, but on terms no less favorable than provided to any other Company executive officer or director and subject to the terms of any separate written indemnification agreement.

8. Assignment . This Agreement will be binding upon and inure to the benefit of (a) the heirs, executors, and legal representatives of Executive upon Executive’s death, and (b) any successor of the Company. Any such successor of the Company will be deemed substituted for the Company under the terms of this Agreement for all purposes. For this purpose, “successor” means any person, firm, corporation, or other business entity which at any time, whether by purchase, merger, or otherwise, directly or indirectly acquires all or substantially all of the assets or business of the Company. None of the rights of Executive to receive any form of compensation payable pursuant to this Agreement may be assigned or transferred except by will or the laws of descent and distribution. Any other attempted assignment, transfer, conveyance, or other disposition of Executive’s right to compensation or other benefits will be null and void.

9. Notices . All notices, requests, demands, and other communications called for hereunder will be in writing and will be deemed given (a) on the date of delivery if delivered personally, (b) one day after being sent overnight by a well established commercial overnight service, or (c) four days after being mailed by registered or certified mail, return receipt

 

4


requested, prepaid and addressed to the parties or their successors at the following addresses, or at such other addresses as the parties may later designate in writing:

If to the Company:

Attn : Vice President, Administration

Cree, Inc.

4600 Silicon Drive

Durham, NC 27703

If to Executive:

at the last residential address known by the Company.

10. Severability . If any provision hereof becomes or is declared by a court of competent jurisdiction to be illegal, unenforceable, or void, this Agreement will continue in full force and effect without said provision.

11. Arbitration . The Parties agree that any and all disputes arising out of the terms of this Agreement, Executive’s employment by the Company, Executive’s service as an officer or director of the Company, or Executive’s compensation and benefits, their interpretation, and any of the matters herein released, will be subject to binding arbitration in Durham, North Carolina before the American Arbitration Association under its National Rules for the Resolution of Employment Disputes, supplemented by the North Carolina Rules of Civil Procedure. The Parties agree that the prevailing party in any arbitration will be entitled to injunctive relief in any court of competent jurisdiction to enforce the arbitration award. The Parties hereby agree to waive their right to have any dispute between them resolved in a court of law by a judge or jury. This paragraph will not prevent either party from seeking injunctive relief (or any other provisional remedy) from any court having jurisdiction over the Parties and the subject matter of their dispute relating to Executive’s obligations under this Agreement and the Confidential Information Agreement.

12. Expenses of Enforcement . In the event of a dispute relating to any provision of this Agreement, the Company will reimburse Executive’s fees and expenses as incurred quarterly, including reasonable attorneys’ fees, in connection with such dispute, provided Executive prevails on at least one material issue in such dispute, or provided an arbitrator does not determine that Executive’s legal positions were frivolous or without legal foundation. In the event Executive does not so prevail or in the event of such determination, Executive will repay to the Company any amounts previously reimbursed by it, and Executive will reimburse the Company for its fees and expenses, including reasonable attorneys’ fees, incurred in connection with the dispute.

 

5


13. Integration . This Agreement, together with the letter agreement between the parties dated September 1, 2006, the Confidential Information Agreement, and the standard equity plan documents governing Executive’s outstanding equity awards, represent the entire agreement and understanding between the parties as to the subject matter herein and supersedes all prior or contemporaneous agreements whether written or oral. No waiver, alteration, or modification of any of the provisions of this Agreement will be binding unless in a writing and is signed by duly authorized representatives of the parties hereto.

14. Waiver of Breach . The waiver of a breach of any term or provision of this Agreement, which must be in writing, will not operate as or be construed to be a waiver of any other previous or subsequent breach of this Agreement.

15. Survival . The Confidential Information Agreement, the Company’s and Executive’s responsibilities under Sections 4 and 5, Sections 7, 8, 11 and 12, and all other provisions that expressly or by their nature survive, will survive the termination or expiration of this Agreement.

16. Headings . All captions and Section headings used in this Agreement are for convenient reference only and do not form a part of this Agreement.

17. Tax Withholding . All payments made pursuant to this Agreement will be subject to withholding of applicable taxes.

18. Governing Law . This Agreement will be governed by the laws of the State of North Carolina as if executed and to be performed wholly within such State.

19. Acknowledgment . Executive acknowledges that he has had the opportunity to discuss this matter with and obtain advice from his private attorney, has had sufficient time to, and has carefully read and fully understands all the provisions of this Agreement, and is knowingly and voluntarily entering into this Agreement.

20. Counterparts . This Agreement may be executed in counterparts, and each counterpart will have the same force and effect as an original and will constitute an effective, binding agreement on the part of each of the undersigned.

[Next Page is Signature Page]

 

6


IN WITNESS WHEREOF, each of the parties has executed this Agreement, in the case of the Company by a duly authorized officer, as of the day and year written below.

COMPANY:

CREE, INC.

 

By:

 

/s/ Brenda F. Castonguay

    Date: October 16, 2006
  Brenda F. Castonguay    
  Vice President, Administration    
  EXECUTIVE:    
 

/s/ John T. Kurtzweil

John T. Kurtzweil

    Date: October 16, 2006

 

7

Exhibit 10.4

LOGO

MASTER STOCK OPTION AWARD AGREEMENT

TERMS AND CONDITIONS

(For Grants of Nonqualified Stock Options)

This Master Stock Option Award Agreement (this “Agreement”) is entered into between you (the “Participant” named below) and Cree, Inc., a corporation formed under the laws of the State of North Carolina (the “Company”).

This Agreement states the terms and conditions that govern nonqualified stock options (each an “Option”) the Company may from time to time award granting you the right to purchase shares (the “Shares”) of the Common Stock of Cree, Inc. (the “Common Stock”). This Agreement governs only grants of options made under the Company’s 2004 Long-Term Incentive Compensation Plan (the “Plan”). The number of Shares, vesting schedule and per share purchase price applicable to each Option will be stated in a Notice of Grant issued by the Company. A Notice of Grant, together with the terms and conditions set forth in this Agreement and the Plan, constitute the entire agreement between you and the Company with respect to the Option described in the Notice of Grant.

Unless otherwise specified in a Notice of Grant or agreed to in writing by you and the Company, this Agreement will apply to all Options granted to you under the Plan on and after the effective date stated below. This Agreement is subject to and will be construed in accordance with the Plan. Unless otherwise defined in this Agreement or a Notice of Grant, capitalized terms used in this Agreement and defined in the Plan will have the same meaning as defined in the Plan.

Please indicate that you have read and agree to the terms and conditions of this Agreement by signing below and returning the signed copy to the Company at its principal offices in Durham, North Carolina. By your signature below, you agree to be bound by the provisions of this Agreement and the Plan and Notices of Grant applicable to the Options to which this Agreement applies.

Effective Date 1 :                         

 

CREE, INC.    PARTICIPANT:
By:  

 

  

 

[Name]      Signature
[Title] 2      Print Name:

1 Grant date of first award subject to Agreement.
2 To be executed by the CEO except that if the CEO is the Participant the Agreement shall be signed by the Chairman of the Compensation Committee.

 

8


Cree, Inc. Master Stock Option Award

Agreement Terms and Conditions

Page 2 of 6

 

1. Grants of Options . Subject to the terms and conditions contained in this Agreement, the Notice of Grant applicable to the Award and the Plan, the Company may, from time to time in its discretion, grant you Options to purchase shares of Common Stock.

 

2. Term of Options . Unless sooner terminated in accordance with the Plan or this Agreement or as otherwise provided in the Notice of Grant, each Option will expire and cease to be exercisable upon the first to occur of the following:

 

  (a) the expiration of ninety (90) calendar days following your Termination of Service, except where the termination results from your death or Disability or where your death occurs following the termination but while the Option is otherwise still exercisable;

 

  (b) the expiration of one (1) year following your Termination of Service if the termination results from your death,

 

  (c) the expiration of one (1) year following your Termination of Service if the termination results from your Disability, except where your death occurs after the termination but while the Option is otherwise still exercisable;

 

  (d) the expiration of one (1) year following your death if your death occurs after your Termination of Service but while the Option is otherwise still exercisable; or

 

  (e) the seventh (7th) anniversary of the Grant Date of the Option, at 11:59 P.M., local time, Durham, North Carolina.

Upon expiration or termination of an Option, the Option will have no further effect and cannot thereafter be exercised to purchase any Shares.

 

3 . Vesting . Each Option will vest and become exercisable in accordance with the schedule set out on the corresponding Notice of Grant or such other vesting provisions expressly provided therein. All Options will become fully vested and exercisable to purchase all Shares subject to the Option, to the extent not already vested and exercisable, upon your Termination of Service on account of your death or Disability, unless otherwise provided in the Notice of Grant.

 

4 . Forfeiture upon Termination of Service. Except as otherwise provided in this Agreement or the Plan, upon your Termination of Service you will forfeit the Option with respect to any Shares as to which the Option has not vested as of the date of your Termination of Service.

 

5 . Tolling in the Event of Delayed Disability Determinations . If at the time of your Termination of Service, a determination as to whether the Termination of Service is on account of your Disability is outstanding, the forfeiture of Options with respect to Shares which are not then vested will be tolled for the period beginning on the date of your Termination of Service and ending on the earlier of the date that it is determined that your Termination of Service is on account of your Disability or the date of expiration or exhaustion of your right to appeal a decision that your Termination of Service was not on account of your Disability. If it is determined that your Termination of Service occurred on account of your Disability, you will become fully vested in the Options with respect to such Shares on the date of such determination. If it is determined that your Termination of Service did not occur on account of your Disability, then the Options will be forfeited with respect to such unvested Shares on the date of expiration or exhaustion of your right to appeal such decision.

 

6 . Exercise of Option . To exercise an Option, you must complete, execute and deliver to the Company of a notice of exercise in the form supplied by the Company and pay to the Company the purchase price for the number of Shares specified in the notice together with all taxes or other amounts the Company is required to withhold or collect pursuant to this Agreement. Exercise of the Option will be effective only when the notice and required payments are actually received by the Company. If the exercise is facilitated through a “broker-assisted exercise” or “cashless exercise” transaction by a brokerage firm you have designated, you agree that the

 

9


Cree, Inc. Master Stock Option Award

Agreement Terms and Conditions

Page 3 of 6

brokerage firm is acting as your agent in the transaction and that the Company may rely upon notices, instructions and information given by such firm in connection with the exercise, as if the same were given by you. The Company will deliver a certificate or certificates for the purchased Shares to you, or to such other person as you designate in writing, or make the Shares available for electronic delivery in the U.S. to an account you designate in writing, within three (3) business days after the Company receives the notice of exercise and required payments.

 

7 . Withholding Taxes . The Company’s obligation to issue Shares upon exercise of an Option is subject to the condition that you pay to the Company, in addition to the purchase price of the Shares purchased, all taxes and any other amounts the Company is required by law or regulation of any governmental authority, whether federal, state or local, domestic or foreign, to withhold or collect in connection with the Option exercise, if any.

 

8 . Transfer of Option. Neither an Option nor any rights under an Option may be assigned, pledged as collateral or otherwise transferred, except as permitted by the Plan, nor may an Option or such rights be subject to attachment, execution or other judicial process. In the event of any attempt to assign, pledge or otherwise dispose of an Option or any rights under an Option, except as permitted by the Plan, or in the event of the levy of any attachment, execution or similar judicial process upon the rights or interests conferred by an Option, the Committee may in its discretion terminate the Option upon notice to you.

 

9 . Rights Prior to Exercise . You will have no rights as a shareholder with respect to any Shares until such Shares have been duly issued by the Company or its transfer agent pursuant to exercise of an Option.

 

10 . Termination of Service . Unless otherwise provided in the Notice of Grant, for purposes of this Agreement “Termination of Service” means the discontinuance of your relationship with the Company as an employee of the Company or other Employer under the Plan or as a member of the Board of Directors of Cree, Inc. Except as determined otherwise by the Committee, you will not be deemed to have incurred a Termination of Service if the capacity in which you provide services to the Company changes (for example, you change from being a non-employee director to being an employee) or if you transfer employment among the various entities constituting the Employer, so long as there is no interruption in your provision of services to the Company or other Employer as an employee or as a non-employee member of the Board of Directors of Cree, Inc. The Committee, in its discretion, will determine whether you have incurred a Termination of Service. You will not be deemed to have incurred a Termination of Service during a period for which you are on military leave, sick leave, or other leave of absence approved by the Employer.

 

11 . Provisions of the Plan . The provisions of the Plan are incorporated by reference in this Agreement as if set out in full in this Agreement. To the extent that any conflict may exist between any other provision of this Agreement and a provision of the Plan, the Plan provision will control. All decisions of the Committee with respect to the interpretation, construction and application of the Plan or this Agreement shall be final, conclusive and binding upon you and the Company.

 

12 . Detrimental Activity. The Committee in its sole discretion may cancel, terminate, suspend or otherwise limit or restrict exercise of the unexercised portion of an Option if you engage in any “Detrimental Activity” (as defined below). In addition, if you engage in any Detrimental Activity prior to or within one (1) year after your Termination of Service, the Committee in its sole discretion may require you to pay to the Company the amount of all gain you realized from any exercise of the Option beginning six (6) months prior to your Termination of Service, provided that the Committee gives you notice of such requirement within one (1) year after your Termination of Service. In that event, the Company will be entitled to setoff such amount against any amount the Company owes to you, in addition to any other rights the Company may have. For purposes of this section:

 

  (a) “Company” includes Cree, Inc. and all other Employers under the Plan.

 

  (b) “Detrimental Activity” means any of the following conduct, as determined by the Committee in good faith:

 

10


Cree, Inc. Master Stock Option Award

Agreement Terms and Conditions

Page 4 of 6

 

  (1) the performance of services for any Competing Business (as defined below), whether as an employee, officer, director, consultant, agent, contractor or in any other capacity, except to the extent expressly permitted by any written agreement between you and the Company;

 

  (2) the unauthorized disclosure or use of any trade secrets or other confidential information of the Company;

 

  (3) any attempt to induce an employee to leave employment with the Company to perform services elsewhere, or any attempt to cause a customer or supplier of the Company to curtail or cancel its business with the Company;

 

  (4) breach of any confidentiality, noncompetition, nonsolicitation or nondisparagement obligations, or any obligations relating to the disclosure, assignment or protection of inventions, undertaken by you in any written agreement between you and the Company; or

 

  (5) any act of fraud, misappropriation, embezzlement, or tortious or criminal behavior that adversely impacts the Company.

 

  (c) “Competing Business” means any corporation, partnership, university, government agency or other entity or person (other than the Company) that is conducting research directed to, developing, manufacturing, marketing, distributing, or selling any product, service, or technology that is competitive with any part of the Company’s Business (as defined below). “Company’s Business” means the development, manufacture, marketing, distribution, or sale of, or the conduct of research directed to, any product, service, or technology that the Company is developing, manufacturing, marketing, distributing, selling, or conducting research directed to, at any time during your employment or other relationship with the Company, except that following your Termination of Service the Company’s Business will be determined as of the time of such termination. As of the effective date of this Agreement, the Company’s Business includes but is not limited to the conduct of research directed to, development, manufacture, marketing, distribution, and/or sale of the following products, services, and technologies: (1) silicon carbide (SiC) materials for electronic applications; (2) SiC materials for gemstone applications; (3) A III nitride materials for electronic applications; (4) light-emitting diode (LED) devices and components; (5) power semiconductor devices made using SiC and/or A III nitride materials and components incorporating such devices; (6) radio frequency (RF) and microwave devices made using SiC and/or A III nitride materials and components and modules incorporating such devices; (7) LED backlights for liquid crystal displays (LCDs); and (8) other semiconductor devices made using SiC and/or A III nitride materials and components incorporating such devices. You acknowledge that during your employment or other relationship with the Company the Company’s Business may expand or change and you agree that any such expansions and changes shall expand or contract the definition of the Company’s Business accordingly.

 

13. Data Privacy. By signing this Agreement, you consent to the collection, use and transfer, in electronic or other form, of your personal data as described below by and among, as applicable, your Employer, the Company and its subsidiaries and affiliates for the exclusive purpose of implementing, administering and managing your participation in the Plan.

You understand that the Employer holds or may hold certain personal information about you, including, but not limited to, your name, home address and telephone number, date of birth, social insurance number or other identification number, salary, nationality, position title, any shares of stock or directorships held in the Company, details of all options or any other entitlement to Shares of stock awarded, canceled, exercised, vested, unvested or outstanding in your favor, for the purpose of implementing, administering and managing the Plan (“Data”). You understand that Data may be transferred to any third parties assisting in the implementation, administration and management of the Plan, that these recipients may be located in your country or elsewhere, and that the recipient’s country may have different data privacy laws and protections than your country. You understand that you may request a list with the names and addresses of any potential recipients of the Data by contacting the Company’s Stock Plan Administrator. You authorize the recipients to receive, possess, use, retain and transfer the Data, in electronic or other form, for the purposes of implementing, administering and

 

11


Cree, Inc. Master Stock Option Award

Agreement Terms and Conditions

Page 5 of 6

managing your participation in the Plan, including any requisite transfer of such Data as may be required to a broker or other third party with whom you may elect to deposit any Shares of stock acquired pursuant to this Agreement. You understand that Data will be held pursuant to this Agreement only as long as is necessary to implement, administer and manage your participation in the Plan. You understand that you may, at any time, view Data, request additional information about the storage and processing of Data, require any necessary amendments to Data or refuse or withdraw the consents above, in any case without cost, by contacting in writing the Company’s Stock Plan Administrator. You acknowledge, however, that refusing or withdrawing your consent may affect your ability to participate in the Plan.

 

14. Language. If you have received this Agreement or any other document related to the Plan translated into a language other than English and the translated version is different than the English version, the English version will control.

 

15. Electronic Delivery. The Company may, in its sole discretion, deliver any documents related to Options granted under this Agreement by electronic means or request your consent to participate in the Plan by electronic means. By signing this Agreement, you consent to receive such documents by electronic delivery and, if requested, to agree to participate in the Plan through an on-line or electronic system established and maintained by the Company or another third party designated by Company.

 

16 . General.

 

  (a) Nothing in this Agreement will be construed as constituting a commitment, agreement or understanding of any kind that the Company or any other Employer will continue your employment or other relationship with the Company nor to limit or restrict either party’s right to terminate the relationship.

 

  (b) This Agreement shall be binding upon and inure to the benefit of the parties and their respective successors and permitted assigns. You may not assign any rights under this Agreement without the written consent of the Company, which it may withhold in its sole discretion; any such attempted assignment without the Company’s written consent shall be void. The Company may assign its rights under this Agreement at any time upon notice to you.

 

  (c) Notices under this Agreement must be in writing and delivered either by hand or by certified mail (return receipt requested and first-class postage prepaid), in the case of the Company, addressed to its principal executive offices to the attention of the Stock Plan Administrator, and, in your case, to your address as shown on the Employer’s records.

 

  (d) This Agreement shall be governed by and construed in accordance with the laws of the State of North Carolina as if made and to be performed wholly within such State.

 

  (e) No amendment or modification of this Agreement shall be valid unless the same is in writing and signed by you and by an authorized representative of the Company. If any provision of this Agreement is held to be invalid or unenforceable, such determination shall not affect the other provisions of the Agreement and the Agreement shall be construed as if the invalid or unenforceable provision were omitted and a valid and enforceable provision, as nearly comparable as possible, substituted in its place.

 

  (f) This Agreement, together with the corresponding Notice(s) of Grant and the Plan, set forth all of the promises, agreements and understandings between you and Company relating to each Option evidenced by this Agreement. This Agreement, together with the corresponding Notice(s) of Grant and the Plan, supersede any and all prior agreements or understandings, whether oral or written, with respect to each Option evidenced by this Agreement and such Notice, unless otherwise specified in the corresponding Notice of Grant.

 

  (g) Shares issued upon exercise of an Option may be subject to such stop transfer orders and other restrictions as the Committee may deem advisable under applicable law or the rules and regulations of the U.S. Securities and Exchange Commission or any stock exchange or trading system upon which the common

 

12


Cree, Inc. Master Stock Option Award

Agreement Terms and Conditions

Page 6 of 6

stock of the Company is listed, and the Committee may cause a legend or legends to be placed on any such certificates or the stock records of the Company to make appropriate reference to such restrictions.

 

  (h) You agree that each Option evidenced by this Agreement serves as additional, valuable consideration for your obligations, if any, undertaken in any existing agreement between you and the Company and/or other Employer regarding confidential information, noncompetition, nonsolicitation or similar covenants.

 

  (i) You acknowledge, represent and warrant to the Company, and agree with the Company, that (i) except for information provided in the Company’s filings with the U.S. Securities and Exchange Commission and in the Company’s current prospectus relating to the Plan, you have not relied and will not rely upon the Committee, the Company, an Employer or any employee or agent of the Company or an Employer in determining whether to accept or exercise an Option, or in connection with any disposition of Shares purchased upon exercise of an Option, or with respect to any tax consequences related to the grant or exercise of an Option or the disposition of Shares purchased pursuant to exercise of an Option; and (ii) you will seek from your own professional advisors such investment, tax and other advice as you believe necessary.

 

  (j) You acknowledge that you may incur a substantial tax liability as a result of exercise of an Option. You assume full responsibility for all such consequences and the filing of all tax returns and related elections you may be required or find desirable to file. If you are required to make any valuation of an Option or Shares purchased pursuant to exercise of the Option under any federal, state or other applicable tax law, and if the valuation affects any tax return or election of the Company or the Employer or affects the Company’s financial statement reporting, you agree that the Company may determine the value and that you will observe any determination so made by the Company in all tax returns and elections filed by you.

 

  (k) You acknowledge that copies of the Plan and Plan prospectus are available upon written or telephonic request to the Company’s Stock Plan Administrator.

 

17 . Severability. The provisions of this Agreement are severable and if any one or more provisions is determined to be illegal or otherwise unenforceable, in whole or in part, the remaining provisions shall nevertheless be binding and enforceable.

 

13


LOGO   

NOTICE OF GRANT

(Stock Option Award)

 

Company:    Participant:    _____________________________________
Cree, Inc.    Award Number:    ___________________________
4600 Silicon Drive    Plan:    2004 Long-Term Incentive Compensation Plan
Durham, NC 27703    Award Type:    Nonqualified Stock Option
Tax I.D. 56-1572719    Grant Date:    _________________________
   Number Shares:    _________________________
   Exercise Price:    _________________________
   Vesting Schedule:                 installment(s) beginning                     
   Expiration Date:    11:59 p.m. local time in Durham, NC on the 7 th Anniversary of the Grant Date

Dear Participant:

This Notice of Grant confirms that Cree, Inc. (the “Company”) has awarded you an option to purchase              shares (the “Shares”) of the common stock of the Company at a purchase price of $              per share, effective              , the Grant Date of the award. The option is subject to and governed by the Cree, Inc. 2004 Long-Term Incentive Compensation Plan (the “Plan”), the terms of the applicable Master Stock Option Award Agreement between you and the Company (the “Master Agreement”), and this Notice of Grant.

You may exercise the option to purchase up to the number of Shares for which it has vested unless and until the option expires or is earlier terminated. In accordance with the Master Agreement and the Plan, upon any Termination of Service (as defined in the Master Agreement), the option will be forfeited as to all Shares not then vested and will terminate thereafter as to vested Shares. If not previously terminated or expired, the option will vest in installments as follows, provided that on the indicated vesting date you are an employee of the Company or another Employer under the Plan [or are serving as a member of the Board of Directors of Cree, Inc.] 1 :

                     Shares on                  2 ;

                     additional Shares on                      ; and

                     additional Shares on                      .

This award and any other award(s) granted under the Plan on the Grant Date are intended to fulfill any and all agreements, obligations or promises, whether legally binding or not, previously made by the Company or another Employer under the Plan to grant you options or other rights to common stock of the Company. By signing below, you accept such awards, along with all prior awards received by you, in full satisfaction of any such agreement, obligation or promise.

 

FOR CREE, INC.    ACCEPTED AND AGREED TO:

 

[Name]

  

 

[Participant’s Name]

[Title] 3   

1 Bracketed language to be included only in grants to members of the Board of Directors of Cree, Inc.
2 Insert additional lines and terms as required for vesting schedule.
3 To be executed by the CEO except that if the CEO is the Participant the Notice of Grant shall be signed by the Chairman of the Compensation Committee.

 

14

Exhibit 10.5

LOGO

MASTER RESTRICTED STOCK AWARD AGREEMENT

TERMS AND CONDITIONS

(For Grants of Restricted Stock)

This Master Restricted Stock Award Agreement (this “Agreement”) is entered into between you (the “Participant” named below) and Cree, Inc., a corporation formed under the laws of the State of North Carolina (the “Company”).

This Agreement states the terms and conditions that govern shares of common stock of the Company (“Shares”) that the Company may from time to time grant to you subject to a risk of forfeiture and related restrictions for a specified period of time (“Restricted Stock”). This Agreement will only govern grants of Restricted Stock made under the Company’s 2004 Long-Term Incentive Compensation Plan (the “Plan”). The number of Shares and the vesting schedule applicable to each Restricted Stock Award will be stated in a Notice of Grant issued by the Company. A Notice of Grant, together with the terms and conditions set forth in this Agreement and the Plan, constitute the entire agreement between you and the Company with respect to the Restricted Stock described in the Notice of Grant.

Unless otherwise specified in a Notice of Grant or agreed to in writing by you and the Company, this Agreement will apply to all Restricted Stock granted to you under the Plan on and after the effective date stated below. This Agreement is subject to and will be construed in accordance with the Plan. Unless otherwise defined in this Agreement or a Notice of Grant, capitalized terms used in this Agreement and defined in the Plan will have the same meaning as defined in the Plan.

Please indicate that you have read and agree to the terms and conditions of this Agreement by signing below and returning the signed copy to the Company at its principal offices in Durham, North Carolina. By your signature below, you agree to be bound by the provisions of this Agreement and the Plan and Notices of Grant applicable to Awards of Restricted Stock to which this Agreement applies.

Effective Date 1 :                             

 

CREE, INC.    PARTICIPANT:
By:  

 

  

 

[Name]      Signature
[Title] 2      Print Name:

1 Grant date of first award subject to Agreement.
2 To be executed by the CEO except that if the CEO is the Participant the Agreement shall be signed by the Chairman of the Compensation Committee.

 

15


Cree, Inc. Master Restricted Stock Award

Agreement Terms and Conditions

Page 2 of 7

 

1. Grants of Restricted Stock. Subject to the terms and conditions contained in this Agreement, the Notice of Grant applicable to the Award and the Plan, the Company may, from time to time in its discretion, grant you Restricted Stock. The Shares issued pursuant to an Award of Restricted Stock will be registered in your name. The Shares will be evidenced by one or more certificates delivered to and deposited with the Secretary of the Company as escrow agent or, at the discretion of the Company, may be held in a restricted book entry account in lieu of issuing a certificate or certificates. Such certificates or such book entry shares are to be held by the escrow agent until the Restricted Stock vests, at which time the escrow agent will release the vested Shares; provided, however, that a portion of the Shares may be surrendered in payment of required withholding taxes in accordance with Section 8(b) below, unless alternative procedures for the payment of required withholding taxes are established by the Company.

 

2 . Vesting . Restricted Stock will vest in accordance with the schedule set out on the corresponding Notice of Grant or such other vesting provisions expressly referenced therein. All Restricted Stock will become fully vested, to the extent not already vested, upon your Termination of Service on account of your death or Disability, unless otherwise provided in the Notice of Grant.

 

3. Forfeiture of Restricted Stock upon Termination of Service . Except as otherwise provided in this Agreement or the Plan, upon your Termination of Service you will forfeit all Restricted Stock that is not vested as of the date of your Termination of Service.

 

4 . Forfeiture of Restricted Stock upon Section 83(b) Election . As permitted under Section 15.6 of the Plan, each grant of Restricted Stock is conditioned upon and subject to your not making an election under Section 83(b) of the Code with respect to such Restricted Stock. If you make an election under Section 83(b) of the Code with respect to any Restricted Stock, you will forfeit such Restricted Stock.

 

5 . Forfeiture of Restricted Stock for Awards Not Timely Accepted . Each grant of Restricted Stock is conditioned upon and subject to your accepting the Award by signing and delivering to the Company the corresponding Notice of Grant not later than the date specified in such Notice or, if no date is specified, not later than the first date Shares are scheduled to vest pursuant to the Award. If the Company issues Restricted Stock pursuant to an Award prior to your acceptance of the Award, and if you fail to accept the Award by signing and delivering to the Company the corresponding Notice of Grant within the time described above, you will forfeit such Restricted Stock.

 

6 . Tolling in the Event of Delayed Disability Determinations . If at the time of your Termination of Service, a determination as to whether the Termination of Service is on account of your Disability is outstanding, the forfeiture of Shares of Restricted Stock which are not then vested will be tolled for the period beginning on the date of your Termination of Service and ending on the earlier of the date that it is determined that your Termination of Service is on account of your Disability or the date of expiration or exhaustion of your right to appeal a decision that your Termination of Service was not on account of your Disability. If it is determined that your Termination of Service occurred on account of your Disability, you will become fully vested in such Restricted Stock on the date of such determination. If it is determined that your Termination of Service did not occur on account of your Disability, then such unvested Restricted Stock will be forfeited on the date of expiration or exhaustion of your right to appeal such decision.

 

7. Settlement of Restricted Stock . As soon as administratively practicable following the vesting of a portion of a Restricted Stock Award, the Company shall deliver to you (or, in the event of your death, to your estate or, if the Committee establishes a beneficiary designation procedure pursuant to Section 11 of the Plan, to any beneficiary that you have designated pursuant to such procedure) one or more certificates for the vested Shares or in the Company’s discretion may cause the vested Shares to be deposited in an account designated by you in writing.

 

16


Cree, Inc. Master Restricted Stock Award

Agreement Terms and Conditions

Page 3 of 7

 

8. Responsibility for Taxes.

 

  (a) For purposes of this Agreement, “Tax-Related Items” means any or all income tax, social insurance tax, payroll tax, payment on account or other tax-related withholding that may be applicable to Awards under this Agreement by law or regulation of any governmental authority, whether federal, state or local, domestic or foreign. Regardless of any action the Company takes with respect to Tax-Related Items, you acknowledge that the ultimate liability for reporting and/or payment of all Tax-Related Items legally due by or from you is and remains your responsibility and that the Company: (1) makes no representations or undertakings regarding the treatment of any Tax-Related Items in connection with any aspect of any Restricted Stock, including the grant, vesting or release of any Restricted Stock, the subsequent sale of Shares and the receipt of any dividends pursuant to Shares; and (2) does not commit to structure the terms of the grant or any aspect of Restricted Stock to reduce or eliminate your liability for Tax-Related Items.

 

  (b) Prior to vesting of Restricted Stock, you agree to pay or make adequate arrangements satisfactory to the Company to satisfy all withholding and payment on account obligations of the Company related to such vesting. If permissible under applicable law, the Company, in its discretion, may satisfy this condition pursuant to the withholding of Shares consistent with the “Share Withholding” provisions under Section 13.2 of the Plan. The Company, in its discretion, may authorize alternative arrangements, including, if permissible under applicable law, the Company’s selling or arranging for sale Shares that you acquire under the Plan or allowing you to deliver to the Company already vested and owned Shares having a fair market value equal to the minimum amount required to be withheld. In any event, to the extent this condition is not otherwise satisfied, you authorize your Employer under the Plan to withhold all applicable Tax-Related Items legally payable by you from your wages or other cash compensation paid to you by the Employer and you agree to pay to your Employer the amount of any Tax-Related Items the Employer is required to withhold as a result of Restricted Stock awarded to you under the Plan that cannot be satisfied by the other means described above.

 

  (c) The Company may refuse to honor the vesting of Restricted Stock and refuse to release restrictions on the Shares if you fail to comply with your obligations in connection with the Tax-Related Items as described in this section.

 

9. Transfer of Restricted Stock. Restricted Stock and any rights under Restricted Stock may not be assigned, pledged as collateral or otherwise transferred, except as permitted by the Plan, nor may Restricted Stock or such rights be subject to attachment, execution or other judicial process until the Restricted Stock becomes vested pursuant to Section 2 above and the corresponding Notice of Grant. In the event of any attempt to assign, pledge or otherwise dispose of Restricted Stock which is not then vested, or any rights under such Restricted Stock, except as permitted by the Plan, or in the event of the levy of any attachment, execution or similar judicial process upon the rights or interests with respect to Restricted Stock which is not then vested, the Committee may in its discretion, upon notice to you, cause you to forfeit such Restricted Stock.

 

10. Rights Prior to Vesting of Shares of Restricted Stock .

 

  (a) You will have at all times all rights as a shareholder with respect to your Restricted Stock, including, but not limited to, voting rights and rights to receive dividends, except for the right to transfer the Restricted Stock as set forth in Section 9 above; provided, however, that any dividends on such Restricted Stock will be automatically deferred and reinvested in additional Restricted Stock subject to the same restrictions as the underlying Restricted Stock.

 

  (b) In the event of a change in capitalization within the meaning of Section 4.3 of the Plan, the number and class of Shares or other securities that you are entitled to pursuant to this Agreement and a Notice of Grant shall be appropriately adjusted or changed as determined by the Committee to reflect the change in capitalization, provided that any such additional Shares or additional or different shares of securities shall remain subject to the restrictions in this Agreement and the applicable Notice of Grant.

 

17


Cree, Inc. Master Restricted Stock Award

Agreement Terms and Conditions

Page 4 of 7

 

11. Termination of Service . Unless otherwise provided in the Notice of Grant, for purposes of this Agreement “Termination of Service” means the discontinuance of your relationship with the Company as an employee of the Company or other Employer under the Plan or as a member of the Board of Directors of Cree, Inc. Except as determined otherwise by the Committee, you will not be deemed to have incurred a Termination of Service if the capacity in which you provide services to the Company changes (for example, you change from being a non-employee director to being an employee) or if you transfer employment among the various entities constituting the Employer, so long as there is no interruption in your provision of services to the Company or other Employer as an employee or as a non-employee member of the Board of Directors of Cree, Inc. The Committee, in its discretion, will determine whether you have incurred a Termination of Service. You will not be deemed to have incurred a Termination of Service during a period for which you are on military leave, sick leave, or other leave of absence approved by the Employer.

 

12 . Provisions of the Plan . The provisions of the Plan are incorporated by reference in this Agreement as if set out in full in this Agreement. To the extent that any conflict may exist between any other provision of this Agreement and a provision of the Plan, the Plan provision will control. All decisions of the Committee with respect to the interpretation, construction and application of the Plan or this Agreement shall be final, conclusive and binding upon you and the Company.

 

13 . Detrimental Activity. The Committee in its sole discretion may cancel and cause to be forfeited any Shares of Restricted Stock not previously vested or released from escrow under this Agreement if you engage in any “Detrimental Activity” (as defined below). In addition, if you engage in any Detrimental Activity prior to within one (1) year after your Termination of Service, the Committee in its sole discretion may require you to pay to the Company the amount of all gain you realized from any vesting of Shares of Restricted Stock beginning six (6) months prior to your Termination of Service, provided that the Committee gives you notice of such requirement within one (1) year after your Termination of Service. In that event, the Company will be entitled to setoff such amount against any amount the Company owes to you, in addition to any other rights the Company may have. For purposes of this section:

 

  (a) “Company” includes Cree, Inc. and all other Employers under the Plan.

 

  (b) “Detrimental Activity” means any of the following conduct, as determined by the Committee in good faith:

 

  (1) the performance of services for any Competing Business (as defined below), whether as an employee, officer, director, consultant, agent, contractor or in any other capacity, except to the extent expressly permitted by any written agreement between you and the Company;

 

  (2) the unauthorized disclosure or use of any trade secrets or other confidential information of the Company;

 

  (3) any attempt to induce an employee to leave employment with the Company to perform services elsewhere, or any attempt to cause a customer or supplier of the Company to curtail or cancel its business with the Company;

 

  (4) breach of any confidentiality, noncompetition, nonsolicitation or nondisparagement obligations, or any obligations relating to the disclosure, assignment or protection of inventions, undertaken by you in any written agreement between you and the Company; or

 

  (5) any act of fraud, misappropriation, embezzlement, or tortious or criminal behavior that adversely impacts the Company.

 

  (c) “Competing Business” means any corporation, partnership, university, government agency or other entity or person (other than the Company) that is conducting research directed to, developing, manufacturing, marketing, distributing, or selling any product, service, or technology that is competitive with any part of

 

18


Cree, Inc. Master Restricted Stock Award

Agreement Terms and Conditions

Page 5 of 7

the Company’s Business (as defined below). “Company’s Business” means the development, manufacture, marketing, distribution, or sale of, or the conduct of research directed to, any product, service, or technology that the Company is developing, manufacturing, marketing, distributing, selling, or conducting research directed to, at any time during your employment or other relationship with the Company, except that following your Termination of Service the Company’s Business will be determined as of the time of such termination. As of the effective date of this Agreement, the Company’s Business includes but is not limited to the conduct of research directed to, development, manufacture, marketing, distribution, and/or sale of the following products, services, and technologies: (1) silicon carbide (SiC) materials for electronic applications; (2) SiC materials for gemstone applications; (3) A III nitride materials for electronic applications; (4) light-emitting diode (LED) devices and components; (5) power semiconductor devices made using SiC and/or A III nitride materials and components incorporating such devices; (6) radio frequency (RF) and microwave devices made using SiC and/or A III nitride materials and components and modules incorporating such devices; (7) LED backlights for liquid crystal displays (LCDs); and (8) other semiconductor devices made using SiC and/or A III nitride materials and components incorporating such devices. You acknowledge that during your employment or other relationship with the Company the Company’s Business may expand or change and you agree that any such expansions and changes shall expand or contract the definition of the Company’s Business accordingly.

 

14 . Data Privacy. By signing this Agreement, you consent to the collection, use and transfer, in electronic or other form, of your personal data as described below by and among, as applicable, your Employer, the Company and its subsidiaries and affiliates for the exclusive purpose of implementing, administering and managing your participation in the Plan.

You understand that the Employer holds or may hold certain personal information about you, including, but not limited to, your name, home address and telephone number, date of birth, social insurance number or other identification number, salary, nationality, position title, any shares of stock or directorships held in the Company, details of all Restricted Stock or any other entitlement to Shares of stock awarded, canceled, exercised, vested, unvested or outstanding in your favor, for the purpose of implementing, administering and managing the Plan (“Data”). You understand that Data may be transferred to any third parties assisting in the implementation, administration and management of the Plan, that these recipients may be located in your country or elsewhere, and that the recipient’s country may have different data privacy laws and protections than your country. You understand that you may request a list with the names and addresses of any potential recipients of the Data by contacting the Company’s Stock Plan Administrator. You authorize the recipients to receive, possess, use, retain and transfer the Data, in electronic or other form, for the purposes of implementing, administering and managing your participation in the Plan, including any requisite transfer of such Data as may be required to a broker or other third party with whom you may elect to deposit any Shares of stock acquired pursuant to this Agreement. You understand that Data will be held pursuant to this Agreement only as long as is necessary to implement, administer and manage your participation in the Plan. You understand that you may, at any time, view Data, request additional information about the storage and processing of Data, require any necessary amendments to Data or refuse or withdraw the consents above, in any case without cost, by contacting in writing the Company’s Stock Plan Administrator. You acknowledge, however, that refusing or withdrawing your consent may affect your ability to participate in the Plan.

 

15. Language. If you have received this Agreement or any other document related to the Plan translated into a language other than English and the translated version is different than the English version, the English version will control.

 

16. Electronic Delivery. The Company may, in its sole discretion, decide to deliver any documents related to the Restricted Stock granted under this Agreement by electronic means or to request your consent to participate in the Plan by electronic means. By signing this Agreement, you consent to receive such documents by electronic delivery and, if requested, to agree to participate in the Plan through an on-line or electronic system established and maintained by the Company or another third party designated by Company.

 

19


Cree, Inc. Master Restricted Stock Award

Agreement Terms and Conditions

Page 6 of 7

 

17 . General.

 

  (a) Nothing in this Agreement will be construed as constituting a commitment, agreement or understanding of any kind that the Company or any other Employer will continue your employment or other relationship with the Company nor to limit or restrict either party’s right to terminate the service relationship.

 

  (b) This Agreement shall be binding upon and inure to the benefit of the parties and their respective successors and permitted assigns. You may not assign any rights under this Agreement without the written consent of the Company, which it may withhold in its sole discretion; any such attempted assignment without the Company’s written consent shall be void. The Company may assign its rights under this Agreement at any time upon notice to you.

 

  (c) Notices under this Agreement must be in writing and delivered either by hand or by certified mail (return receipt requested and first-class postage prepaid), in the case of the Company, addressed to its principal executive offices to the attention of the Stock Plan Administrator, and, in your case, to your address as shown on the Employer’s records.

 

  (d) This Agreement shall be governed by and construed in accordance with the laws of the State of North Carolina as if made and to be performed wholly within such State.

 

  (e) No amendment or modification of this Agreement shall be valid unless the same is in writing and signed by you and by an authorized representative of the Company. If any provision of this Agreement is held to be invalid or unenforceable, such determination shall not affect the other provisions of the Agreement and the Agreement shall be construed as if the invalid or unenforceable provision were omitted and a valid and enforceable provision, as nearly comparable as possible, substituted in its place.

 

  (f) This Agreement, together with the corresponding Notice(s) of Grant and the Plan, set forth all of the promises, agreements and understandings between you and Company relating to Restricted Stock Awards evidenced by this Agreement. This Agreement, together with the corresponding Notice(s) of Grant and the Plan, supersede any and all prior agreements or understandings, whether oral or written, with respect to the Restricted Stock Award evidenced by this Agreement and such Notice, unless otherwise specified in the corresponding Notice of Grant.

 

  (g) Shares issued pursuant to an Award of Restricted Stock may be subject to such stop transfer orders and other restrictions as the Committee may deem advisable under applicable law or the rules and regulations of the U.S. Securities and Exchange Commission or any stock exchange or trading system upon which the common stock of the Company is listed, and the Committee may cause a legend or legends to be placed on any such certificates or the stock records of the Company to make appropriate reference to such restrictions.

 

  (h) You agree that any and all Restricted Stock issued to you pursuant to the Plan, even if later forfeited, serves as additional, valuable consideration for your obligations, if any, undertaken in any existing agreement between you and the Company and/or other Employer regarding confidential information, noncompetition, nonsolicitation or similar covenants.

 

  (i) You acknowledge, represent and warrant to the Company, and agree with the Company, that (i) except for information provided in the Company’s filings with the U.S. Securities and Exchange Commission and in the Company’s current prospectus relating to the Plan, you have not relied and will not rely upon the Committee, the Company, an Employer or any employee or agent of the Company or an Employer in determining whether to accept Restricted Stock, or in connection with any disposition of Shares obtained pursuant to a Restricted Stock Award, or with respect to any tax consequences related to the grant of Restricted Stock or the disposition of Shares obtained pursuant to a Restricted Stock Award; and (ii) you
 

 

20


Cree, Inc. Master Restricted Stock Award

Agreement Terms and Conditions

Page 7 of 7

will seek from your own professional advisors such investment, tax and other advice as you believe necessary.

 

  (j) You acknowledge that you may incur a substantial tax liability as a result of vesting of Restricted Stock. You assume full responsibility for all such consequences and the filing of all tax returns and related elections you may be required or find desirable to file. If you are required to make any valuation of Shares obtained pursuant to a Restricted Stock Award under any federal, state or other applicable tax law, and if the valuation affects any tax return or election of the Company or the Employer or affects the Company’s financial statement reporting, you agree that the Company may determine the value and that you will observe any determination so made by the Company in all tax returns and elections filed by you.

 

  (k) You acknowledge that copies of the Plan and Plan prospectus are available upon written or telephonic request to the Company’s Stock Plan Administrator.

 

18. Severability . The provisions of this Agreement are severable and if any one or more provisions is determined to be illegal or otherwise unenforceable, in whole or in part, the remaining provisions shall nevertheless be binding and enforceable.

 

21


LOGO   

N OTICE OF GRANT

(Restricted Stock Award)

 

Company:    Participant:    ______________________________________
Cree, Inc.    Award Number:    __________________________
4600 Silicon Drive    Plan:    2004 Long-Term Incentive Compensation Plan
Durham, NC 27703    Award Type:    Restricted Stock
Tax I.D. 56-1572719    Grant Date:    __________________
   Number Shares:    __________________
   Purchase Price:    – $0 –
   Restriction Period:    Grant Date through                                 
   Vesting Schedule:                  installment(s) beginning                         

Dear Participant:

This Notice of Grant confirms that Cree, Inc. (the “Company”) has awarded you              shares (the “Shares”) of restricted stock pursuant to the Cree, Inc. 2004 Long-Term Incentive Compensation Plan (the “Plan”), effective              , the Grant Date of the award. The award is subject to and governed by the Plan, the terms of the applicable Master Restricted Stock Award Agreement between you and the Company (the “Master Agreement”), and this Notice of Grant.

The Shares will be held in escrow by the Company until vested or forfeited. Upon any Termination of Service (as defined in the Master Agreement) before the end of the Restriction Period, except as otherwise provided in the Master Agreement or the Plan, you will forfeit all Shares of Restricted Stock that are not then vested. If not previously vested or forfeited, the Restricted Stock will vest in installments as follows, provided that on the indicated vesting date you are an employee of the Company or another Employer under the Plan [or are serving as a member of the Board of Directors of Cree, Inc.] 1 :

                     Shares on              2 ;

                     additional Shares on                      ; and

                     additional Shares on                      .

This award and any other award(s) granted under the Plan on the Grant Date are intended to fulfill any and all agreements, obligations or promises, whether legally binding or not, previously made by the Company or another Employer under the Plan to grant you options or other rights to common stock of the Company. By signing below, you accept such awards, along with all prior awards received by you, in full satisfaction of any such agreement, obligation or promise.

 

FOR CREE, INC.    ACCEPTED AND AGREED TO:

 

[Name]

  

 

[Participant’s Name]

[Title] 2   

1 Bracketed language to be included only in grants to members of the Board of Directors of Cree, Inc.
2 Insert additional lines and terms as required for vesting schedule.
3 To be executed by the CEO except that if the CEO is the Participant the Notice of Grant shall be signed by the Chairman of the Compensation Committee.

 

22

Exhibit 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

I, Charles M. Swoboda, certify that:

 

  1. I have reviewed this quarterly report on Form 10-Q of Cree, Inc.;

 

  2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

  3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

  4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

  (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

  (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  (c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  (d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and


  5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

  (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 2, 2006

 

/s/ Charles M. Swoboda

Charles M. Swoboda
Chairman, President and Chief Executive Officer

Exhibit 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

I, John T. Kurtzweil, certify that:

 

  1. I have reviewed this quarterly report on Form 10-Q of Cree, Inc.;

 

  2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

  3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

  4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

  (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

  (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  (c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  (d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and


  5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

  (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 2, 2006

 

/s/ John T. Kurtzweil

John T. Kurtzweil
Chief Financial Officer

Exhibit 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

In connection with the Quarterly Report of Cree, Inc. (the “Company”) on Form 10-Q for the quarterly period ended September 24, 2006 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Charles M. Swoboda, Chairman, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, to my knowledge, that:

 

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

 

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

/s/ Charles M. Swoboda

Charles M. Swoboda
Chairman, President and Chief Executive Officer
November 2, 2006

This Certification is being furnished solely to accompany the Report pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, and shall not be deemed “filed” by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and shall not be incorporated by reference into any filing of the Company under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Report, irrespective of any general incorporation language contained in such filing.

A signed original of this written statement required by Section 906 of the Sarbanes-Oxley Act of 2002 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.

Exhibit 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

In connection with the Quarterly Report of Cree, Inc. (the “Company”) on Form 10-Q for the quarterly period ended September 24, 2006 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, John T. Kurtzweil, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, to my knowledge, that:

 

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

 

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

/s/ John T. Kurtzweil

John T. Kurtzweil
Chief Financial Officer
November 2, 2006

This Certification is being furnished solely to accompany the Report pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, and shall not be deemed “filed” by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and shall not be incorporated by reference into any filing of the Company under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Report, irrespective of any general incorporation language contained in such filing.

A signed original of this written statement required by Section 906 of the Sarbanes-Oxley Act of 2002 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.