| CREE INC 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 10 ______________________________________________________________________ [32]Table of Contents 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; • 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 |
| 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 11 ______________________________________________________________________ [33]Table of Contents 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 introduced in the third quarter of fiscal 2006, 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 increase our capacity too quickly, our business and results of operations could be adversely impacted |
| For example, we are currently expanding our manufacturing capacity, including the build out of the fabrication facility in Research Triangle Park, North Carolina, that we acquired from a third party in the third quarter of fiscal 2005 |
| Delays in bringing that facility on line could impact our ability to meet future demands for high-power products and contract revenue targets could be impacted |
| If our expansion initiative is delayed, costs more than we anticipate or requires long transition or qualification periods, our business and financial results could be harmed |
| If our business does not grow fast enough to use this new capacity, our financial results could decline |
| 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 12 ______________________________________________________________________ [34]Table of Contents 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 fiscal 2006, approximately 56prca 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; • 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 13 ______________________________________________________________________ [35]Table of Contents 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 |
| 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 |
| 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; 14 ______________________________________________________________________ [36]Table of Contents • 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 |
| 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 US 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 |
| We face significant challenges managing our growth |
| We have experienced a period of significant growth that has challenged our management and other resources |
| To manage our growth 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; 15 ______________________________________________________________________ [37]Table of Contents • 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 support |
| If we cannot attract qualified people or manage growth effectively, our business, operating results and financial condition could be adversely affected |
| For example, we are currently trying to build a worldwide team of sales, marketing, development, and application support employees for our LED and high-power businesses |
| If we are not successful in recruiting personnel, our actual growth may be lower than our forecasts |
| Conversely, if the product demand from our customers does not expand as we anticipate, our margins may decrease in part due to higher costs associated with the recently added capacity that would not be used |
| 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 |
| 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 |
| 16 ______________________________________________________________________ [38]Table of Contents 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 |
| 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 |
| 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 |
| 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, US Government export controls could restrict or prohibit the exportation of products with defense applications |
| Because all of our foreign sales are denominated in US 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 US dollar and more competitive in countries with currencies that are high or increasing in value against the US 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 the assets and liabilities of 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 17 ______________________________________________________________________ [39]Table of Contents 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 |
| Litigation could adversely affect our operating results and financial condition |