CREE INC - 10-K Annual Report

Back to GetFilings.com

1

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended June 24, 2001

CREE, INC.
(Exact name of registrant as specified in its charter)

NORTH CAROLINA 0-21154 56-1572719
(State or other jurisdiction (Commission File No.) (I.R.S. Employer
of incorporation) Identification Number)

4600 SILICON DRIVE, DURHAM, NORTH CAROLINA 27703
(Address of principal executive offices)

(919) 313-5300
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $0.00125 PAR VALUE
(Title of Class)

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

The aggregate market value of common stock held by non-affiliates of the
registrant as of August 10, 2001 was approximately $1,624,564,008 (based on the
closing sale price of $22.92 per share).

The number of shares of the registrant's Common Stock, $0.00125 par value per
share, outstanding as of August 10, 2001 was 72,940,483.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement to be delivered to shareholders in
connection with the Annual Meeting of Shareholders to be held October 23, 2001
are incorporated by reference into Part III.

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
2

CREE, INC.
FORM 10-K
FOR THE FISCAL YEAR ENDED JUNE 24, 2001

INDEX

2
3

PART I

ITEM 1. BUSINESS

INTRODUCTION

Cree, Inc., a North Carolina corporation, was established in 1987 to
commercialize silicon carbide, or SiC, semiconductor wafers and devices. Today,
we are the world-leader in developing and manufacturing compound semiconductor
materials and electronic devices made from SiC and gallium nitride, or GaN. We
have also acquired technology expertise in the area of silicon-based bipolar and
laterally diffused metal oxide semiconductors, or LDMOS, products that are used
in wireless infrastructure. We operate our business in two segments, the Cree
segment, which consists of our SiC based products, and the UltraRF segment,
which consists of radio frequency, or RF, transistors and amplifiers on a
silicon platform.

SiC-based devices offer significant advantages over competing products made from
silicon, gallium arsenide, sapphire and other materials for certain electronic
applications. We use our compound semiconductor technology to make enabling
products such as blue and green light emitting diodes, or LEDs. We sell our LEDs
to customers who package them for use in applications such as backlighting for
automotive dashboards and automotive interior lighting, wireless handsets and
other consumer products. Other applications for our LEDs include indoor and
outdoor full color displays, such as video boards in indoor arenas and outdoor
stadiums or billboards and message signs. Our LEDs are also used in traffic
signals, indicator lights for consumer or industrial equipment and miniature
white lights used for illumination applications. We have developed several
generations of LED products, including our MegaBright(TM) and UltraBright(TM)
LEDs, both released during fiscal 2001, which offer increased brightness over
our previous diodes and small chip products which consume less power. Our SiC
and GaN based blue and green LEDs offer benefits to our customers over competing
products, including an industry standard chip structure, improved resistance to
electrostatic discharge, small size and low unit price. We recently introduced
an ultraviolet, or UV, LED product that when combined with a red, green, blue
phosphor coating, may enable a higher quality emission of white light than
alternative methods using a blue LED combined with yellow phosphors. We also
manufacture SiC material products, including SiC wafers that we sell for use in
manufacturing and for research directed to optoelectronics, microwave and power
applications.

In December 2000, we acquired substantially all of the assets and liabilities of
UltraRF, Inc., or UltraRF, which was previously a division of the Spectrian
Corporation, or Spectrian. UltraRF operates its own wafer fabrication facility
that utilizes a silicon substrate together with bipolar and LDMOS technologies
to produce high-power, high performance RF power semiconductors for use in the
design and manufacture of wireless infrastructure equipment. We have product
initiatives for RF and microwave transistors using SiC and GaN technology. We
believe that these products may be useful in a variety of applications,
including power amplifiers for next generation wireless infrastructure,
home-based multi-channel, multi-point subscriber units, wireless local loop
applications, digital broadcast and solid state radar.

We have new product initiatives aimed at developing LEDs with higher luminous
efficiency to expand our existing family of optoelectronic devices. We believe
that if certain significant milestones are achieved, the LED chips currently in
development may enable our customers to produce white lamps designed to compete
in the conventional lighting market. In addition, we are developing and sampling
high power devices for power conversion and switching uses, which we believe,
will allow for more efficient use of energy in certain applications over
alternative silicon based semiconductor solutions. We are also developing blue
laser diodes for use in high-density digital versatile disk, or DVD, and other
optical storage applications.

BACKGROUND

Most semiconductor devices are fabricated on wafers made from silicon crystals.
Silicon evolved as the dominant semiconductor material because it is relatively
easy to grow into large, single crystals and is suitable for fabricating many
electronic devices. Alternative materials, such as gallium arsenide, or GaAs,
have emerged to enable the fabrication of new devices with characteristics that
could not be obtained using silicon,

3
4

including certain RF, microwave, LED, laser and other solid state devices.
However, GaAs, silicon and other commercially available semiconductor materials
have certain physical and electronic characteristics that limit their usefulness
in certain applications. For example, silicon and GaAs-based semiconductors have
not demonstrated the ability to fabricate short wavelength optoelectronic
devices. In addition, the power handling capabilities of silicon and GaAs-based
microwave transistors can limit the power and performance of microwave systems
used in certain commercial and military applications. SiC can deliver five times
more power per single device than silicon or GaAs based devices, therefore, SiC
based wireless systems may use fewer transistors per base station with less
complex circuitry, which may result in a lower system cost. Furthermore, few
silicon or GaAs devices can operate effectively at temperatures above
400(degree) Fahrenheit. This is a significant limitation for applications such
as advanced electronic systems for high power electric motors, jet engines and
satellites.

Substantial research and development efforts have been undertaken to explore the
properties of other potential semiconductor materials. These efforts have
identified few candidate materials that are capable of being grown as low defect
single crystals, a requirement in the production of most semiconductors. Of the
few potential candidates, SiC possesses physical and electronic properties that
meaningfully increase device performance over products fabricated from other
semiconductor materials in general use. The properties of SiC also make it an
excellent material for extending existing semiconductor device technology where
high power, high temperature or short wavelengths are important for performance.

SIC OVERVIEW

SiC has many physical characteristics that make it difficult to produce. For
example, in a typical semiconductor manufacturing process, the semiconductor
material is grown in single crystal form and sliced into wafers. The wafers are
then polished and chemically etched, coated with thin crystalline films
containing controlled levels of impurities and fabricated into devices. Because
SiC can form many different atomic arrangements and must be grown at process
temperatures above 3,500(degree) Fahrenheit, it is difficult to grow large
single crystals that are homogeneous in structure. In addition, the high
temperatures required to grow SiC make the control of impurity levels in SiC
crystals and thin films difficult. "Micropipes", or small diameter holes, may
appear in the crystals during their growth, affecting the electrical integrity
of the wafer and reducing the usability of portions of the wafer for certain
applications. Slicing and polishing SiC wafers is also hindered by the intrinsic
hardness of the material. Similarly, its inherent chemical resistance makes SiC
a difficult material to etch. The characteristics discussed below distinguish
SiC from conventional silicon and GaAs-based semiconductor materials, resulting
in significant advantages if production hurdles can be overcome:

WIDE ENERGY BANDGAP. Bandgap is the amount of energy required to ionize an
electron from the valence band to the conduction band. SiC is classified as a
"wide bandgap" semiconductor material, meaning that more energy is required for
ionization. Electronic devices made from this material can operate more
efficiently and at much higher temperatures than devices made from other common
semiconductor materials.

HIGH BREAKDOWN ELECTRIC FIELD. The "breakdown electric field" is the amount of
voltage per unit distance that a material can withstand and still effectively
operate as a semiconductor device. SiC has a much higher breakdown electric
field than silicon or GaAs. This characteristic allows SiC devices to operate at
much higher voltage levels. Additionally, it allows SiC power devices to be
significantly smaller while carrying the same as or greater power levels than
comparable silicon and GaAs-based devices.

HIGH THERMAL CONDUCTIVITY. SiC is an excellent thermal conductor compared to
other commercially available semiconductor materials. This feature enables
SiC-based devices to operate at high power levels and still dissipate the excess
heat generated.

HIGH SATURATED ELECTRON DRIFT VELOCITY. SiC has a "saturated electron drift
velocity" higher than that of silicon or GaAs. The saturated electron drift
velocity is the maximum speed at which electrons can travel through a material.
This characteristic, combined with a high breakdown electric field, allows the
fabrication of SiC-based microwave transistors that operate at significantly
higher power levels than current silicon and GaAs-based devices.
4
5

ROBUST MATERIAL. SiC has an extremely high melting point and is one of the
hardest known materials in the world. As a result, SiC can withstand much higher
electrical pulses and is much more radiation-resistant than silicon or GaAs. SiC
is also extremely resistant to chemical breakdown and can operate in harsh
environments.

THE CREE SOLUTION

Some of the same physical characteristics that make SiC an excellent material
for certain semiconductor applications also make the material very difficult to
produce. Through our 14 years of development and manufacturing experience, we
have succeeded in overcoming many of the difficulties involved in processing SiC
for commercial use. We introduced our first LED product in October 1989 and
believe we are currently the leading volume producer of SiC wafers and SiC and
GaN-based blue and green LED products in the world. We believe that our
proprietary process techniques and the inherent attributes of SiC give our
products significant advantages over competing products for certain electronic
applications. These advantages include:

BLUE AND GREEN LIGHT EMISSION. We produce high efficiency blue and green LEDs
using GaN and other nitrides grown on SiC substrates. Other manufacturers of
nitride-based LEDs currently use sapphire substrates. The conductive properties
of SiC enable us to fabricate a less complex LED chip that is smaller than LEDs
grown on competing sapphire substrates. Our chips made with SiC are the same
size as red, green and amber LED chips made from other materials that are widely
used in industry. We believe the standard size of our chip affords our customers
more flexibility in gaining design wins and our smaller chip size enables our
product to be offered for a lower cost per chip in comparison to sapphire-based
products currently available.

We have also demonstrated in the laboratory and are continuing development of
nitride-based blue laser diodes grown on SiC. The principal advantages of SiC
over other substrate materials for blue laser diodes are the high electrical and
thermal conductivity attributes of the material and the ability for the material
to be cleaved, providing an excellent surface for laser light emission.

ENABLING SUBSTRATE PROPERTIES. The inherent attributes of SiC as a substrate
enable researchers to work on developing new optoelectronic, microwave and power
devices that offer significant advantages over competing products and which
could not be produced as effectively on other substrate materials. We
manufacture SiC wafers for both internal use and for sale to external
development programs to further new product development. In October 1999, we
introduced a larger three-inch wafer to production for research purposes and
have recently released new three-inch wafer products capable of meeting higher
performance needs of power and microwave devices. We have also demonstrated a
four-inch prototype wafer.

HIGH POWER RF AND MICROWAVE OPERATIONS. We have demonstrated SiC RF and
microwave transistors that can operate at much higher voltages than silicon or
GaAs because of SiC's high breakdown electric field, allowing much higher power
operation at high frequencies. These same advantages exist for microwave devices
made using GaN on SiC substrates, which can also operate at much higher
frequencies than SiC-only devices. We began shipping limited quantities of SiC
RF devices that can be used in wireless infrastructure applications. As the
performance of silicon based LDMOS products became enhanced, we determined that
near-term wireless infrastructure power amplifiers were likely to be
manufactured with these products rather than our SiC based devices. As a result,
we acquired UltraRF in December 2000 to participate in the power amplifier
market in the near term. We believe our SiC devices will likely be more
efficient in higher frequency devices such as wireless local loop, or WLL,
multi-channel multi-point distribution systems, or MMDS, and future generation
base stations. In addition, we continue to develop GaN based devices for high
frequency wireless infrastructure and other commercial and defense related
applications.

HIGH POWER, HIGH VOLTAGE OPERATION. We are developing SiC power diodes and
switches that are able to operate at higher power densities than other
semiconductor materials used currently because of the much higher breakdown
electric field of SiC. In addition, we believe that our SiC power devices will
be able to operate with lower resistive losses and lower switching losses than
those made with silicon or GaAs.

5
6

PRODUCTS

We operate our business in two segments, the Cree segment, which consists of our
SiC based products, and the UltraRF segment, which consists of RF transistors
and amplifiers on a silicon platform. The following chart illustrates our
existing products and existing and potential applications for these products by
our customers and their end users:

THE CREE SEGMENT:

BLUE AND GREEN LEDs

LEDs are solid-state chips used in miniature lamps in everyday applications such
as indicator lights on printers, computers and other equipment. LEDs generally
offer substantial advantages over small incandescent bulbs, including longer
life, lower maintenance cost and energy consumption, and smaller space
requirements. Groups of LEDs can make up single or multicolor electronic
displays. Since the introduction of our first blue SiC-only LED product in 1989,
we have developed several generations of LED products. These products include
blue and green LEDs using nitride materials on SiC substrates, a more robust
conductive buffer chip that is easier to build into lamps, a small size low
power diode and several generations of higher brightness products. Prior to the
release of our blue MegaBright(TM) LED device in May 2001, sapphire-based
products offered by our competitors had a higher brightness than our LED
products. We believe that the brightness output of the MegaBright(TM) chip
equals the highest performing sapphire chips available in the market in the blue
color range. With the release of the UltraBright(TM) and MegaBright(TM) products
during fiscal year 2001, we have increased the brightness of our products by
four times in less than one year. In July 2001, we announced the release of a
MegaBright(TM) UV LED chip that is designed to be packaged with a phosphor
coating developed by our customers. We believe that this packaged chip can be
used as a white light source for consumer product backlighting and in
illumination applications such as a replacement to miniature incandescent bulbs,
and decorative and architectural lighting. We believe that the MegaBright(TM)
products offer the highest level of brightness that is comparable with any
nitride LED available in the world. The blue product is offered at 10 milliwatts
of power, while the UV device generates 12 milliwatts of power. We believe these
products are priced lower than competing nitride products based on sapphire. We
will continue to work to improve the brightness of our UV chip with higher
performance than currently available. Over the next five

6
7

to ten years, we believe these yet to be developed products could be used to
produce white lamps to compete with conventional lighting products for certain
applications. In addition, we are working on a new higher brightness green LED
device that we believe will allow us to better compete in the outdoor signage
and traffic signal markets. We believe that LEDs made from SiC substrates offer
important benefits over those made from sapphire substrates including:

- an industry standard vertical chip structure requiring a single wire bond
that permits faster LED assembly and reduced cost;

- a small chip size;

- improved resistance to electrostatic discharge, or ESD, which reduces the
cost, engineering effort and time to qualify LEDs at customer production
sites and;

- a low-priced product as compared to sapphire based devices.

Presently, our LED chips are used for backlighting purposes in applications such
as automotive dashboards, interior automotive lighting, and liquid crystal
displays or LCDs, including wireless handsets and other consumer products. In
addition, they are used in consumer products and office equipment as indicator
lighting, full color video display technology, such as arena video boards,
billboards and moving message advertising and informational signs. Our standard
brightness LED products, offered in blue wavelengths only, are primarily used in
automotive or indoor display applications or as indicator lights. Our recently
released MegaBright(TM) blue and UV LEDs, that are currently available in
limited commercial quantities, in addition to our previous generation blue
products, are designed for use in manufacturing solid-state LED components that
emit white light. By passing blue or near UV LED output through certain
conversion materials such as phosphors, blue or UV light may be converted into
white light. We currently sell blue LED chips to customers who produce packaged
components that emit white light. Current commercial products incorporating our
chips for white light conversion include backlighting applications for
automobile dashboards and instrumentation and LCD backlighting for wireless
handsets.

We are focusing current development efforts on further improving the brightness
as well as lowering our cost to manufacture our LEDs. We believe that increased
brightness will continue to be necessary to effectively compete against LEDs
fabricated on sapphire substrates, and may eventually lead to products marketed
for commercial lighting applications. LED products represented 65%, 63%, and 49%
of our revenue for the fiscal years ended June 24, 2001, June 25, 2000, and June
27, 1999, respectively.

MATERIALS PRODUCTS

We manufacture SiC wafers for sale to corporate, government and university
programs that use SiC as the basis for research in optoelectronic, microwave and
high power devices. Each order may be sold as a bare wafer or customized by
adding epitaxial films, depending upon the nature of the customer's development
program. For the past several years, we have worked to improve the quality of
our wafers while increasing their size. In October 1999, we introduced our first
three-inch wafer for sale to the research community and we have recently
expanded our product line of three-inch wafers that are better suited for the
manufacture of power and microwave devices. We also sell some wafers to Osram
OS, or Osram and Infineon Technologies, or Infineon, for the production of LED
and power products, respectively.

Single crystalline SiC has characteristics that are similar to diamond,
including properties relating to hardness and brilliance. Through a proprietary
process, we manufacture SiC crystals in near colorless form for use in gemstone
applications. We sell SiC crystals directly to Charles & Colvard, or C&C, a
company founded to develop gemstone products from SiC crystals. C&C cuts and
facets the SiC crystals to fabricate diamond-like gemstones targeted at
customers who desire affordable high quality jewelry. Sales of gemstone crystals
declined from 15% of revenue in fiscal 2000 to only 3% of revenue in fiscal
2001. Future demand for this product is dependent on C&C's ability to cut, facet
and effectively market its gemstone products. Wafer and other material products
represented 14%, 26% and 37% of our revenue for the fiscal years ended June 24,
2001, June 25, 2000, and June 27, 1999, respectively.

7
8

POWER DEVICES

In July 2001, we announced the first of a planned line of SiC based power
devices. Samples of this product were shipped beginning in the third quarter of
fiscal 2001. This product is a 600 Volt Schottky diode device. We believe that
these products can be employed in applications involving power conditioning as
well as power switching. SiC-based power devices have the potential to handle
significantly higher power densities than existing silicon-based devices and
operate at significantly higher temperatures and voltages with superior
switching capabilities, yielding power savings due to higher efficiency.
Potential applications include power drive components for electric vehicles,
lighting ballast components and industrial motor controls. At this time, we are
shipping only limited quantities of these products. Revenue growth from sales of
these devices is dependent on the results of customer evaluations of the
Schottky diode device and whether the products are designed into customer
applications.

RF AND MICROWAVE TRANSISTORS

During fiscal year 2000, we began to offer the first 10-watt transistor products
made from SiC to customers in limited quantities. We believe that these products
can be used in a variety of power amplifier applications, including wireless
infrastructure, home-based subscriber units, cable TV and digital broadcast
applications. At this time we are shipping only limited quantities of these
products. Revenue growth from sales of these devices is dependent on the results
of customer evaluations of the first SiC RF products and whether the products
are designed into customer applications.

THE ULTRARF SEGMENT:

RF AND MICROWAVE TRANSISTORS

In December 2000, we acquired UltraRF, a division of Spectrian, based in
Sunnyvale, California. UltraRF produces bipolar and LDMOS devices made from
silicon. We believe that silicon bipolar and LDMOS technology is complimentary
to our SiC and GaN based microwave devices. These products enable us to provide
an array of power amplifier semiconductor devices designed to meet the full
spectrum of the wireless infrastructure market now and in the future. By
acquiring UltraRF, we have access to technology that we believe will likely be
used in the roll out of second and third generation wireless solutions, in
addition to lower frequency applications. UltraRF products are currently
qualified for use in Advanced Mobile Phone Services, or AMPS, Time Division
Multiple Access, or TDMA, Code Division Multiple Access, or CDMA, Global System
for Mobile Communications, or GSM, and Universal Mobile Telephone Service, or
UMTS, based systems. UltraRF is the only independent LDMOS fabricator in the
world and one of only four major manufacturers of these devices.

The market for cellular communications services has grown substantially during
the past decade due to decreasing prices for wireless handsets, increasing
competition among service providers and a greater availability of high quality
services. In addition, several developing countries are installing wireless
telephone networks as an alternative to installing, expanding or upgrading
traditional wireline networks. A typical wireless communication system comprises
a geographic region containing a number of cells, each of which contains a base
station, which are networked to form a service provider's coverage area. Each
base station houses the equipment that sends telephone calls to and from the
switching office of the local wireline telephone company and transmits and
receives calls to the wireless users within the cell. Base stations may be
configured as single carrier or multi-carrier designs.

Traditional cellular systems based on analog technology operate in the frequency
range of 800 MHz to 1,000 MHz and are capable of carrying only one call per
channel in the allocated spectrum. Analog systems are being replaced with
digital systems, which convert voice transmission into bits of electronic
information that enable data transmission among other things. The three dominant
digital transmission modulation formats for cellular networks include GSM, TDMA
and CDMA systems and operate in frequency ranges from 1800 MHz to 2400 MHz.
These systems have a call capacity of three to eight times that of first
generation networks. The implementation of these digital networks has resulted
in an increased demand for network infrastructure equipment. By acquiring
UltraRF, we are now able to produce both bipolar and LDMOS

8
9

products that are used in the manufacture of power amplifiers used in both
analog and digital base stations. UltraRF produces the semiconductor content of
a power amplifier, which is used in a base station to boost the power of a
signal so that it can reach a wireless phone or other device within a designated
geography.

Radio frequency and microwave products represented 11% of our revenue for the
fiscal year ended June 24, 2001.

PRODUCTS UNDER DEVELOPMENT

The following chart illustrates the potential user applications for each area of
current product development:

THE CREE SEGMENT:

LEDs WITH HIGHER LUMINOUS EFFICIENCY

In May 2000, we acquired Nitres, Inc., (now a wholly owned subsidiary known as
Cree Lighting Company or Cree Lighting) with operations based in Goleta,
California. Cree Lighting is engaged in the development of new LED device and
manufacturing technology, with the goal of developing higher efficiency LED
technology that will permit LEDs to compete with incandescent and fluorescent
lighting technology for conventional lighting markets. During fiscal 2001, we
increased the brightness of our LED products by four times with the introduction
of our UltraBright(TM) and then our MegaBright(TM) products. In order to compete
with incandescent and fluorescent lighting technology for conventional lighting
markets, the brightness of our products will need to increase by approximately
four times over the brightness of our products available today. We do not
anticipate that our products can achieve this level of brightness over the next
few years, however, we believe we can achieve a greater level of brightness to
permit for interim step illumination applications, such as miniature
incandescent lighting replacements. We also continue to work on brighter green
products that we are targeting for release in fiscal 2002. We are currently
developing new large chip LED devices for use in backlighting. The development
of these products is in early stage and will not likely be released in the near
term.

9
10

POWER DEVICES

We are developing additional prototype high power devices that we believe have
many potential uses. Such devices could be employed in applications involving
power conditioning as well as power switching. In fiscal 1999, we entered into a
three-year project with Kansai Electric Power Company, one of the largest power
companies in the world, for development of SiC based devices for use in power
transmission networks. We have successfully demonstrated a high efficiency
rectifier capable of operating above 19 kV. This record blocking voltage exceeds
the highest blocking voltage of any other known semiconductor. We continue to
work on higher power devices such as Schottky and PIN diodes as well as power
switches. However; we do not expect a product release of these devices in the
near term.

BLUE AND NEAR ULTRAVIOLET LASER DIODES

We continue to focus on the development of blue and near ultraviolet laser
diodes. SiC's inherent attributes, including its natural cleavability and high
thermal conductivity, make it an excellent substrate material for development of
such short wavelength laser diodes. The storage capacity of optical disk drives
can be increased significantly by utilizing a laser diode capable of emitting
shorter wavelength light. We have made prototypes of blue laser diodes,
fabricated from nitride materials deposited on SiC substrates, which has a
shorter wavelength than that of the red or infrared lasers used in applications
today. We believe that the shorter wavelength of blue light could potentially
result in storage capacity for optical disk drives that is significantly greater
than the capacity permitted by red light. We also believe that blue laser
technology will enable more compact sized electronics. We continue to work on
increasing the lifetimes of our lasers and are targeting our first product to be
released for sampling during fiscal 2002.

RF AND MICROWAVE DEVICES

We are currently developing SiC-based high power transistors that operate at
radio and microwave frequencies. We believe these devices will have applications
in future generation wireless base stations, high power solid-state broadcast
systems for television and radio and radar search and detection equipment. These
SiC-based devices are targeted for frequencies from 30 megahertz to 4 gigahertz.
We believe that future SiC transistors in development, with higher output power
per transistor than current silicon and GaAs-based devices, may allow wireless
systems to use fewer transistors per base station, resulting in less complex
circuitry, higher linearity and lower cost.

We are also developing GaN-based microwave transistors on SiC substrates at Cree
as well as Cree Lighting, that are targeted for higher frequency applications
(10 to 30 gigahertz) such as solid state radar systems. We previously reported
the demonstration of GaN on SiC transistors that operated with an output power
of 50 watts at 10 gigahertz, which we believe to be the highest publicly
reported power output for a single device at this frequency. We also reported a
record high power density of 10 watts per millimeter at 10 gigahertz at Cree
Lighting. At our Durham, North Carolina facility, we have developed GaN
monolithic microwave integrated circuits, or MMICs, that have demonstrated 24
watts of power at 16 gigahertz. This power density is higher than that achieved
with equivalent silicon or GaAs-based devices. We do not anticipate that a
commercial device capable of emitting power at this level will be available in
the near term.

THE ULTRARF SEGMENT:

RF AND MICROWAVE DEVICES

We continue to enhance the capabilities of our silicon based LDMOS products and
are working towards the release of a next generation device that we believe will
allow for more linearity and increased power and match the best in class
products of our competitors. We are targeting this product to be available in
fiscal 2002. In addition, we are also developing an LDMOS module device that is
easier to assemble in a power amplifier than our current device. We believe that
this product will deliver a lower system cost to our customer due to less costly
packaging, a smaller design and easy manufacture. We target this product to be
released in fiscal 2002.

10
11

FINANCIAL INFORMATION ABOUT SEGMENTS

For financial information about business segments, please see Note 2, "Summary
of Significant Accounting Policies and Other Matters" to our consolidated
financial statements included in Item 8 of this report.

GOVERNMENT CONTRACT FUNDING

We derive a portion of our revenue with funding from research contracts with the
U.S. Government. For the fiscal years ended June 24, 2001, June 25, 2000 and
June 27, 1999, government funding represented 10%, 11% and 14% of total revenue,
respectively. These contracts typically cover work performed over several months
up to three years. These contracts may be modified or terminated at the
convenience of the government. The contracts generally provide that we may elect
to obtain title to inventions made in the course of research, with the
government retaining a nonexclusive license to practice such inventions for
government purposes.

RESEARCH AND DEVELOPMENT

We invest significant resources in research and development aimed at improving
our semiconductor materials and developing new device and production technology.
Our core SiC materials research is directed to improving the quality and
diameter of our SiC substrates. We are also working to improve the quality of
the SiC and nitride epitaxial materials we grow to produce devices and to
improve device yields by reducing variability in our processes. These efforts
are in addition to the on going projects that are focused on brighter LEDs,
higher power RF and microwave devices, blue laser devices and higher power
conditioning diodes discussed above.

We spent $38.4 million in fiscal 2001, $20.0 million in fiscal 2000 and $12.1
million in fiscal 1999 for direct expenditures relating to research and
development activities. Off-setting these expenditures were $19.0 million in
fiscal 2001, $12.7 million in fiscal 2000 and $9.0 million in fiscal 1999 of
U.S. Government funding for direct and indirect research and development
expenses. In addition, certain customers have also sponsored research activities
related to the development of new products. Customers contributed $11.9 million
in fiscal 2001, $5.5 million in fiscal 2000 and $ 4.5 million in fiscal 1999
towards our product research and development activities.

SALES AND MARKETING

We actively market our wafer and optoelectronic products through targeted
mailings, telemarketing, select advertising and attendance at trade shows. We
generally use an executive sales approach, relying predominantly on the efforts
of senior management and a small direct sales staff for worldwide product sales.
We believe that this approach is preferable in view of our current customer base
and product mix, particularly since the production of lamp and display products
incorporating LED chips is concentrated among a relatively small number of
manufacturers. However, we depart from this approach for sales to certain Asian
countries. In Japan, we market our LED products and SiC wafers through our
distributors Sumitomo Corporation, or Sumitomo, and Shin-Etsu Handotai Co. Ltd.,
or Shin-Etsu. We also use sales representatives to market our LED products in
Hong Kong, China, Taiwan and South Korea. We sell SiC crystal materials for use
in gemstone applications directly to C&C under an exclusive supply agreement. We
are using both direct sales and sales representative arrangements to market RF
products for UltraRF.

CUSTOMERS

During fiscal 2001, revenues from three customers, Siemens AG, or Siemens,
Sumitomo Corporation, or Sumitomo and Spectrian, each accounted for more than
10% of total revenue. Spectrian is a customer of the UltraRF segment. For the
year ended June 25, 2000 revenue from Siemens, Sumitomo, C&C and the U.S.
Government each accounted for more than 10% of total revenue. For the year ended
June 27, 1999, revenue from Siemens, C&C and the U.S. Government each accounted
for more that 10% of total revenue. For financial information about foreign and
domestic sales, please see Note 2, "Summary of Significant Accounting Policies
and Other Matters" to our consolidated financial statements included in Item 8
of this report.
11
12

BACKLOG

As of June 24, 2001, we had a firm backlog of approximately $86.5 million
consisting of approximately $69.9 million of product orders and $16.6 million
under research contracts signed with the U.S. Government, a portion which have
not yet been appropriated. This compares to a firm backlog level of $76.5
million as of June 25, 2000, which consisted of approximately $55.1 million of
product orders and approximately $21.4 million of research contracts signed with
the U.S. Government. We believe the entire backlog could be filled during fiscal
2002, with the exception of approximately $13.1 million of product orders and
$4.3 million in U.S. government funded contracts.

MANUFACTURING

Our SiC products are manufactured in a six-part process, which includes: SiC
crystal growth, wafer slicing, polishing, epitaxial deposition, fabrication, and
testing and packaging. SiC crystals are grown using a proprietary high
temperature process designed to produce uniform crystals in a single crystalline
form. Crystals used for moissanite gemstones exit the manufacturing process at
this stage. Crystals used for other products are then sliced into wafers. The
wafers are polished and then processed using our epitaxial deposition processes,
which require that we grow thin layers of SiC, GaN or other material on the
polished wafer, depending on the nature of the device under production. SiC
wafer products may leave the manufacturing process either after polishing or
epitaxy. Following epitaxy, LED and RF chips are fabricated in a clean room
environment. The final steps include testing and packaging for shipment to the
customer. In manufacturing our products we depend substantially on our
custom-manufactured equipment and systems, some of which are manufactured
internally and some of which we acquire from third parties and customize
ourselves.

UltraRF produces both silicon Bipolar Junction Transistor, or BJT, and silicon
LDMOS structures at its wafer fabrication facility in Sunnyvale, California.
Both product families use silicon wafers that are acquired from third parties
and the devices are fabricated in a clean room environment. The clean room steps
employ multiple stages of photolithography, diffusion, thin film metal
deposition and both wet and dry etch processes in the manufacturing cycle.
Finished wafers are electrically tested and may be shipped to customers at this
point. Transistor die from wafers which continue in the manufacturing process
are assembled into thermally conductive packages and tested prior to shipment to
customers.

SOURCES OF RAW MATERIALS

We depend on a limited number of suppliers for certain raw materials, components
and equipment used in our products, including certain key materials and
equipment used in our crystal growth, wafering, polishing, epitaxial deposition,
device fabrication and device assembly processes. We generally purchase these
limited source items pursuant to purchase orders and have no guaranteed supply
arrangements with our suppliers. In addition, the availability of these
materials, components and equipment to us is dependent in part on our ability to
provide our suppliers with accurate forecasts of our future requirements. We
endeavor to maintain ongoing communication with our suppliers to guard against
interruptions in supply and, to date, generally have been able to obtain
adequate supplies in a timely manner from our existing sources. However, any
interruption in the supply of these key materials, components or equipment could
have a significant adverse effect on our operations.

COMPETITION

The semiconductor industry is intensely competitive and is characterized by
rapid technological change, price erosion and intense foreign competition. We
believe that we currently enjoy a favorable position in the existing markets for
SiC-based products and materials. However, we face actual and potential
competition from a number of established domestic and international compound
semiconductor companies. Many of these companies have greater engineering,
manufacturing, marketing and financial resources than we have.

Our primary competition for blue and green LED products comes from Nichia
Corporation, or Nichia, Toyoda Gosei Co. Ltd. and Lumi Leds Lighting, a joint
venture between Agilent Technologies and Philips Lighting. These companies
currently market blue and green LED products using a sapphire substrate. In
12
13

addition, Uniroyal Technologies, Inc., American Xtal Technology, Lucky Goldstar
and other Asian based companies have announced intentions to begin production of
blue and green LEDs, all on sapphire substrates. Historically, some of our
existing competitors have been more successful in the market for outdoor display
applications because, prior to the release of our MegaBright(TM) product in May
2001, some sapphire devices were brighter than our SiC diodes. We believe our
new MegaBright(TM) devices will enable us to compete successfully in this market
because our LEDs often can be used in the same applications at a lower cost than
competing products. We are working on plans to improve the brightness of our
green LEDs to enhance our ability to compete in this market. We believe that our
approach to manufacturing blue and green LEDs from SiC substrates offers a more
cost-effective design and process than competitors, who use a sapphire
substrate. Our smaller chip design, which is possible because we use a
conductive substrate, permits more devices to be fabricated on each wafer
processed, which lowers our cost per unit. In addition, our industry standard
vertical chip structure allows manufacturers to package the LED on the same
production line as other green, amber and red LEDs, eliminating the need for
special equipment necessary for chips made from sapphire substrates.
Furthermore, our SiC-based devices can withstand a higher level of electro
static discharge, or ESD, than existing sapphire-based products and therefore
are more suitable for applications that require high ESD emission ratings, such
as automotive applications.

Osram is currently producing LEDs using technology licensed from us in 1995.
Shin-Etsu also licensed certain of our LED technology in 1996 but has not begun
production under this license. The market for SiC wafers also is becoming
competitive, as other companies in recent years have begun to offer SiC wafer
products or announced plans to do so.

UltraRF LDMOS and bipolar products are intensely competitive with products that
are manufactured by Motorola Incorporated, or Motorola, Telefonaktiebolaget LM
Ericsson, or Ericsson, and Royal Phillips Electronic NV, or Phillips. Currently,
Motorola dominates the marketplace for these devices due to superior quality and
pricing. UltraRF is targeting to release a new line of improved LDMOS products
during fiscal 2002 that is expected to match the performance of Motorola parts
for a competitive price.

PATENTS AND PROPRIETARY RIGHTS

We seek to protect our proprietary technology by applying for patents where
appropriate and in other cases by preserving the technology and related know-how
and information as trade secrets. We have also from time to time acquired,
through license grants or assignments, rights to patents on inventions
originally developed by others.

At June 24, 2001, we owned or held exclusive rights licensed under a total of
116 issued U.S. patents, subject in some cases to nonexclusive license rights
held by third parties. These patents expire between 2007 and 2019. Two of these
patents are jointly owned with a third party. In addition, we own or hold
exclusive license rights under corresponding patents and patent applications in
certain foreign countries.

Included in the patent licenses we hold is an exclusive license granted by North
Carolina State University, or NCSU, to 10 U.S. patents, and to corresponding
foreign patents and applications, that relate to SiC materials and device
technology, including a process to grow single crystal SiC. The license, granted
pursuant to an agreement executed with NCSU in 1987, is a worldwide, fully paid,
exclusive license to manufacture, use and sell products and processes covered by
the claims of patent applications filed by NCSU relating to the licensed
inventions. Ten U.S. patents were subsequently issued with respect to the
applications, with expiration dates between 2007 and 2009. Twelve of the foreign
applications have been issued with expiration dates from 2006 to 2013. The U.S.
government holds a non-exclusive license to practice the inventions covered by
the NCSU license for government purposes. We have also entered into other
license agreements with NCSU, and with the licensing agencies of other
universities, under which we have obtained rights to practice inventions claimed
in various patents and applications issued or pending in the U.S. and other
foreign countries.

For proprietary technology which is not patented or otherwise published, we seek
to protect the technology and related know-how and information as trade secrets
and to maintain it in confidence through appropriate non-disclosure agreements
with employees and others to whom the information is disclosed. There can be no
assurance that these agreements will provide meaningful protection against
unauthorized disclosure or use of
13
14

our confidential information or that our proprietary technology and know-how
will not otherwise become known or independently discovered by others. We also
rely upon other intellectual property rights such as copyright where
appropriate.

Because of rapid technological developments in the semiconductor industry, the
patent position of any semiconductor materials or device manufacturer, including
ours, is subject to uncertainties and may involve complex legal and factual
issues. Consequently, there can be no assurance that patents will be issued on
any of the pending applications owned or licensed to us or that claims allowed
in any patents issued or licensed to us will not be contested or invalidated. In
the past, the U.S. patent that we license from NCSU relating to growth of SiC
was subject to a reissue proceeding; however, that patent was successfully
reissued. Currently, a corresponding European patent is being opposed, which
means that we could lose patent protection in Europe for this particular method
or that the scope of our patent protection may be reduced. There is likewise no
assurance that patent rights owned or exclusively licensed to us will provide
significant commercial protection since issuance of a patent does not prevent
other companies from using alternative, non-infringing technology. Further, we
earn a material amount of our revenues in overseas markets. While we hold and
have applied for patent protection for certain of our technologies in these
markets, there can be no assurance that we will obtain protection in all
commercially significant foreign markets or that our intellectual property
rights will provide adequate protection in all such markets.

In December 1999, one of our distributors in Japan, Sumitomo, was named in a
lawsuit filed by Nichia in Tokyo District Court. As reported previously, the
complaint in this proceeding is directed to our standard brightness LED products
and alleged that these products infringe a Japanese patent owned by Nichia. The
suit sought a permanent injunction against further distribution of the products
in Japan. We intervened in the proceeding and filed a response denying the
allegations of infringement. On May 15, 2001, the Tokyo District Court ruled in
favor of Cree and Sumitomo and dismissed the lawsuit. Nichia has appealed the
ruling.

In April 2000, Nichia commenced two additional lawsuits against Sumitomo in
Tokyo District Court in which it alleges that our high brightness LED products
infringe a second Japanese patent owned by Nichia. The complaints in the new
proceedings seek provisional and permanent injunctive relief prohibiting
Sumitomo from further sales of these products in Japan. We have intervened in
the new proceedings and have filed responses denying the allegations of
infringement. No monetary damages for infringement have been sought in any of
the lawsuits brought by Nichia against Sumitomo. Management believes that the
infringement claims are without merit and that the lawsuits are motivated by
competitive factors. We intend to vigorously defend our products against these
claims.

On September 22, 2000, we and NCSU commenced a patent infringement lawsuit
against Nichia and Nichia America Corporation in the United States District
Court for the Eastern District of North Carolina. In their answer to the
complaint, Nichia and Nichia America Corporation denied infringement and
asserted counterclaims seeking a declaratory judgment that the subject patent is
invalid and not infringed. Nichia America Corporation also moved on December 11,
2000, for partial summary judgment seeking a determination that the subject
patent is invalid. Cree and NCSU have opposed the motion, which remains pending.

Nichia also asserted counterclaims alleging that we are infringing four U.S.
patents relating to nitride semiconductor technology and further asserting
misappropriation of trade secrets and related claims against us and a former
Nichia researcher now employed by one of our subsidiaries, Cree Lighting, on a
part-time basis. On February 20, 2001, we and our counterclaim codefendant moved
to dismiss the non-patent counterclaims on the grounds that Nichia failed to
allege a basis for subject matter jurisdiction and failed to state a claim upon
which relief may be granted. The motion also seeks dismissal of certain
counterclaims on forum non-conveniens grounds.

On February 20, 2001, we also replied to the patent infringement counterclaims,
denying any infringement and asserting a claim seeking a declaratory judgment
that the four patents at issue are invalid, unenforceable and not infringed. We
also added a claim for damages in which we alleged that Nichia's actions in
asserting the patent infringement counterclaims were not made for any legitimate
purpose and constitute unfair competition in violation of North Carolina law. On
April 2, 2001, Nichia moved for leave to file an amended answer and counterclaim
that seeks to address jurisdictional concerns. In addition, they moved to add
Cree Lighting
14
15

Company as a counterclaim defendant and to add federal statutory claims under
the Computer Fraud and Abuse Act against the Cree Lighting employee previously
added as a party. The motion for leave to file the amended answer and
counterclaim has been opposed and remains pending. The court has stayed
discovery as to damages and willful infringement issues pending ruling on a
motion filed by us and NCSU seeking to have the proceedings bifurcated into
separate liability and damages phases.

Although there can be no assurances of success, we believe the counterclaims
asserted in the North Carolina case are without merit and intend to defend
against them vigorously.

On May 3, 2001, Cree Lighting Company and the Trustees of Boston University, or
Boston University, commenced a patent infringement lawsuit against Nichia and
Nichia America Corporation in the United States District Court for the Northern
District of California. The lawsuit seeks enforcement of a patent relating to
gallium nitride-based semiconductor technology useful in manufacturing certain
light emitting diodes and other devices. The patent was issued to Boston
University in 1997 and is licensed to Cree Lighting under a March 2001 agreement
pursuant to which Cree Lighting obtained rights to a number of related patents.
In the complaint, Cree Lighting and Boston University allege that Nichia is
infringing the patent by, among other things, importing, selling and offering
for sale in the United States certain gallium nitride-based light emitting
devices covered by one or more claims of the patent. The lawsuit seeks damages
and an injunction against infringement. Boston University is a co-plaintiff in
the action.

Frequent claims and litigation involving patents and intellectual property
rights are common in the semiconductor industry. Litigation may be necessary in
the future to enforce our intellectual property rights or to defend us against
claims of infringement, and such litigation can be protracted and costly and
divert the attention of key personnel. There can be no assurance that third
parties will not attempt to assert infringement claims against us with respect
to our current or future products. We have been notified from time to time of
assertions that our products or processes may be infringing patents or other
intellectual property rights of others. We have investigated such claims and
determined the assertions were without merit or taken steps to obtain a license
or avoid the infringement. However, we cannot predict whether past or future
assertions of infringement may result in litigation or the extent to which such
assertions may require us to seek a license under the rights asserted or whether
a license would be available or available on acceptable terms. Likewise, we
cannot predict the occurrence of future assertions of infringement that may
prevent us from selling products, result in litigation or require us to pay
damage awards.

ENVIRONMENTAL REGULATION

The Company is subject to a variety of governmental regulations pertaining to
chemical and waste discharges and other aspects of our manufacturing process.
For example, we are responsible for the management of the hazardous materials we
use and dispose of hazardous waste resulting from our manufacturing process. The
proper handling and disposal of such hazardous material and waste requires us to
comply with certain government regulations. We believe we are in full compliance
with such regulations, but any failure to comply, whether intentional or
inadvertent, could have an adverse effect on our business.

EMPLOYEES

As of June 24, 2001, the Company (including its subsidiaries) employed 970
people, including 732 in manufacturing operations, 162 in research and
development, and 76 in sales and general administration. None of our employees
are represented by a labor union or subject to collective bargaining agreements.
We believe relations with our employees are strong.

15
16

CERTAIN BUSINESS RISKS AND UNCERTAINTIES

OUR OPERATING RESULTS AND MARGINS MAY FLUCTUATE SIGNIFICANTLY.

Although we have had significant revenue and earnings growth in recent 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. For example, historically, the prices of our LEDs have declined based on
market trends. We have attempted to maintain our margins by constantly
developing improved or new products, which command higher prices. 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 ability to expand our production capacity for our new LED products;

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

- demand for our products and our customers' products;

- declining average sales prices for our products;

- changes in the mix of products we sell; and

- changes in manufacturing capacity and variations in the utilization of
that capacity.

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 may decline.

IF WE EXPERIENCE POOR PRODUCTION YIELDS, OUR MARGINS COULD DECLINE AND OUR
OPERATING RESULTS MAY SUFFER.

Our SiC material products and our LED and RF device products are manufactured
using technologies that are highly complex. We manufacture our SiC wafer
products from bulk SiC crystals, and we use these SiC wafers to manufacture our
LED products and our SiC-based RF power semiconductors. Our UltraRF subsidiary
manufactures its RF semiconductors on silicon wafers purchased from others.
During manufacturing, each wafer is processed to contain numerous "die," which
are the individual semiconductor devices, and the RF power devices are further
processed by incorporating them into a package for sale as a packaged component.
The number of usable crystals, wafers, die and packaged components that result
from our production processes can fluctuate as a result of many factors,
including but not limited to the following:

- impurities in the materials used;

- contamination of the manufacturing environment;

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

- losses from broken wafers or other human error; and

- defects in packaging.

We refer to the proportion of usable product produced at each manufacturing step
relative to the gross number that could be constructed from the materials used
as our manufacturing "yield." Since many of our manufacturing costs are fixed,
if our yields decrease, our margins could decline and our operating results
would be adversely affected. In the past, we have experienced difficulties in
achieving acceptable yields on new products, which has adversely affected our
operating results. We may experience similar problems in the

16
17

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 significantly affect our future margins and operating
results.

OUR BUSINESS AND OUR ABILITY TO PRODUCE OUR PRODUCTS MAY BE IMPAIRED BY CLAIMS
WE INFRINGE INTELLECTUAL PROPERTY OF OTHERS.

The semiconductor industry is characterized by vigorous protection and pursuit
of intellectual property rights. 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.

Where we consider it necessary or desirable, we may seek licenses under patents
or other intellectual property rights. However, we cannot be certain that
licenses will be available or that we would find the terms of licenses offered
acceptable or commercially reasonable. Failure to obtain a necessary license
could cause us to incur substantial liabilities and costs and to suspend the
manufacture of products. In addition, if adverse results in litigation made it
necessary for us to seek a license or to develop non-infringing products or
processes, there is no assurance we would be successful in developing such
products or processes or in negotiating licenses upon reasonable terms or at
all. Our results of operations, financial condition and business could be harmed
if such problems were not resolved in a timely manner.

Our distributor in Japan is presently a party to patent litigation in Japan
brought by Nichia, in which the plaintiff claims that certain of our LED
products infringe two Japanese patents it owns. The complaints in the
proceedings seek injunctive relief that would prohibit our distributor from
further sales of these products in Japan. The court has ruled in our favor on
the suit directed towards our standard brightness product; however Nichia has
appealed the ruling. An adverse result in these cases would impair our ability
to sell both our standard brightness and high brightness LED products in Japan
and could cause customers not to purchase other LED products from us. Subject to
contractual limitations, we have an obligation to indemnify our distributor for
patent infringement claims.

We have also initiated patent infringement litigation in the United States
against Nichia and one of its subsidiaries, asserting patent infringement with
respect to certain Nichia nitride semiconductor products, including laser diode
products. Nichia has responded with counterclaims alleging, among other things,
patent infringement claims against us based on four U.S. patents directed to
nitride semiconductor technology. In addition, they allege trade secret
misappropriation and related claims against Cree and a former Nichia researcher
who is now employed by one of our subsidiaries on a part-time basis. An adverse
result under Nichia's counterclaims would impair our ability to sell our LED
products and could include a substantial damage award against us.

Our Cree Lighting subsidiary has also initiated litigation in the United States
against Nichia and one of its subsidiaries asserting patent infringement with
respect to gallium nitride-based semiconductor technology useful in
manufacturing certain LEDs and other devices. The lawsuit seeks damages and an
injunction against infringement.

17
18

We believe the claims asserted against our products in the Japanese cases and
the counterclaims asserted against us by the defendants in the initial U.S. case
are without merit, and we intend to vigorously defend against the charges.
However, we cannot be certain that we will be successful, and litigation may
require us to spend a substantial amount of time and money and could distract
management from our day-to-day operations. Litigation costs to date in these
cases have been substantial, and variability in these costs could adversely
affect our financial results. If any of these cases were decided against us, the
result would have a material adverse effect on our operations and financial
condition.

THERE ARE LIMITATIONS ON OUR ABILITY TO PROTECT OUR INTELLECTUAL PROPERTY.

Our intellectual property position is based in part on patents owned by us and
patents exclusively licensed to us by NCSU 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, but we cannot be sure that patents
will be issued on such applications or that our existing or future patents will
not be successfully contested. 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.

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 with
confidentiality agreements with our employees and other parties. We cannot be
sure that these agreements will not be breached, that we would have adequate
remedies for any breach or that our trade secrets and proprietary know-how will
not otherwise become known or independently discovered by others.

Where necessary, we may initiate litigation to enforce our patent or other
intellectual property rights, but there is not assurance that we will be
successful in any such litigation. Moreover, litigation may require us to spend
a substantial amount of time and money and could distract management from our
day-to-day operations.

IF WE ARE UNABLE TO PRODUCE ADEQUATE QUANTITIES OF OUR ULTRABRIGHT(TM) AND
MEGABRIGHT(TM) LEDs WITH IMPROVED YIELDS, OUR OPERATING RESULTS MAY SUFFER.

We believe that higher volume production and lower production costs for our
UltraBright(TM) blue and green LEDs and our MegaBright(TM) blue and UV LEDs 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
to meet the competition and satisfy prior contractual commitments. Achieving
greater volumes and lower costs requires improved production yields for these
products. In addition, in the case of our MegaBright(TM) LED products, we only
recently began manufacturing these products in volume and may encounter delays
and manufacturing difficulties as we ramp up our capacity to make these
products. Failure to produce adequate quantities and improve the yields of our
UltraBright(TM) and MegaBright(TM) LED 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 CORE SIC TECHNOLOGY.

Our future success will depend on our ability to develop new SiC solutions for
existing and new markets. We must introduce new products in a timely and
cost-effective manner, and we must secure production orders from our customers.
The development of new SiC products is a highly complex process, and we have
historically experienced delays in completing the development and introduction
of new products. Products currently under development include high power RF and
microwave devices, power devices, blue laser diodes and higher brightness LED
products. The successful development and introduction of these products depends
on a number of factors, including the following:

- achievement of technology breakthroughs required to make commercially
viable devices;

- the accuracy of our predictions of market requirements and evolving
standards;

18
19

- acceptance of our new product designs;

- 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 for commercial sales;

- our customers' ability to develop applications 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.

WE DEPEND ON A FEW LARGE CUSTOMERS.

Historically, a substantial portion of our revenue has come from large purchases
by a small number of customers. We expect that trend to continue. For example,
for fiscal 2001 our top five customers accounted for 72% of our total revenue.
Accordingly, our future operating results depend on the success of our largest
customers and on our success in selling large quantities of our products to
them. The concentration of our revenues with a few large customers makes us
particularly dependent on factors affecting those customers. For example, if
demand for their products decreases, they may stop purchasing our products and
our operating results will suffer. If we lose a large customer and fail to add
new customers to replace lost revenue, our operating results may not recover.

THE MARKETS IN WHICH WE OPERATE ARE HIGHLY COMPETITIVE.

The markets for our LED and RF and microwave power semiconductor products are
highly competitive. Our competitors currently sell LEDs made from sapphire
wafers that are brighter than the high brightness LEDs we currently produce and
similar in brightness to our UltraBright(TM) and MegaBright(TM) LED products. In
addition, new firms have begun offering or announced plans to offer blue and
green LEDs. In the RF power semiconductor field, the products manufactured by
UltraRF compete with products offered by substantially larger competitors. The
market for SiC wafers is also becoming competitive as other firms have in recent
years begun offering SiC wafer products or announced plans to do so. We also
expect significant competition for products we are currently developing, such as
those for use in microwave communications.

We expect competition to increase. This could mean lower prices for our
products, reduced demand for our products and a corresponding reduction in our
ability to recover development, engineering and manufacturing costs. Any of
these developments could have an adverse effect on our business, results of
operations and financial condition.

WE FACE SIGNIFICANT CHALLENGES MANAGING OUR GROWTH.

We have experienced a period of significant growth that has strained our
management and other resources. We have grown from 248 employees on June 28,
1998 to 970 employees on June 24, 2001 and from revenues of $44.0 million for
the fiscal year ended June 28, 1998 to $177.2 million for the fiscal year ended
June 24, 2001. To manage our growth effectively, we must continue to:

- implement and improve operating systems;

- maintain adequate manufacturing facilities and equipment to meet customer
demand;

- add experienced senior level managers; and

- attract and retain qualified people with experience in engineering,
design, technical marketing support.

We will spend substantial amounts of money in supporting our growth and may have
additional unexpected costs. Our systems, procedures or controls may not be
adequate to support our operations, and we may not be

19
20

able to expand quickly enough to exploit potential market opportunities. Our
future operating results will also depend on expanding sales and marketing,
research and development, and administrative support. If we cannot attract
qualified people or manage growth effectively, our business operating results
and financial condition could be adversely affected.

PERFORMANCE OF OUR INVESTMENTS IN OTHER COMPANIES COULD NEGATIVELY AFFECT OUR
FINANCIAL CONDITION.

From time to time, we have made investments in public and private companies that
engage in complementary businesses. Should these investments be deemed to be
impaired, the related write-down in value could have a material adverse effect
on our financial condition. Each of these investments is subject to the risks
inherent in the related company's business. Our private company investments are
subject to additional risks relating to the limitations on transferability of
our interests due to the lack of a public market and other transfer
restrictions. Our public company investments are subject to market risks and
also can be subject to contractual limitations on transferability. 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 OPERATING RESULTS COULD BE ADVERSELY AFFECTED IF WE ENCOUNTER PROBLEMS
TRANSITIONING PRODUCTION TO A LARGER WAFER SIZE.

We currently plan to begin gradually shifting production of some products from
two-inch wafers to three-inch wafers in fiscal 2002. We must first qualify our
production processes on systems designed to accommodate the larger wafer size,
and some of our existing production equipment must be refitted for the larger
wafer size. Delays in this process could have an adverse effect on our business,
particularly on our ability to sell some of our RF and power products at a
competitive price. In addition, in the past we have experienced lower yields for
a period of time following a transition to a larger wafer size until use of the
larger wafer is fully integrated in production and we begin to achieve
production efficiency. We anticipate that we will experience similar temporary
yield reductions during the transition to the three-inch wafers, and we have
factored this into our plan for production capacity. If this transition phase
takes longer than we expect or if we are unable to attain expected yield
improvements, our operating results may be adversely affected.

WE RELY ON A FEW KEY SUPPLIERS.

We depend on a limited number of suppliers for certain raw materials, components
and equipment used in manufacturing our products, including key materials and
equipment used in critical stages of our manufacturing processes. We generally
purchase these limited source items with purchase orders, and we have no
guaranteed supply arrangements with such suppliers. If we were to lose such key
suppliers, our manufacturing efforts could be hampered significantly. Although
we believe our relationship with our suppliers is good, we cannot assure you
that we will continue to maintain good relationships with such suppliers or that
such suppliers will continue to exist.

IF GOVERNMENT AGENCIES OR OTHER CUSTOMERS DISCONTINUE THEIR FUNDING FOR OUR
RESEARCH AND DEVELOPMENT OF SIC TECHNOLOGY, OUR BUSINESS MAY SUFFER.

In the past, government agencies and other customers have funded a significant
portion of our research and development activities. If this support is
discontinued or reduced, our ability to develop or enhance products could be
limited and our business, results of operations and financial condition could be
adversely affected.

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 that

20
21

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; or

- experience increased product returns.

WE ARE SUBJECT TO RISKS FROM INTERNATIONAL SALES.

Sales to customers located outside the U.S. accounted for about 69%, 69% and 59%
of our revenue in fiscal 2001, 2000 and 1999, respectively. We expect that
revenue from international sales will continue to be a significant part of our
total revenue. International sales are subject to a variety of risks, including
risks arising from currency fluctuations, trends in use of the Euro, trading
restrictions, tariffs, trade barriers and taxes. Also, U.S. Government or
military export restrictions could limit or prohibit sales to customers in
certain countries because of their uses in military or surveillance
applications. Because all of our foreign sales are denominated in U.S. dollars,
our products become less price competitive in countries with currencies that are
low or are declining in value against the U.S. dollar. Also, we cannot be sure
that our international customers will continue to place orders denominated in
U.S. dollars. If they do not, our reported revenue and earnings will be subject
to foreign exchange fluctuations.

IF WE FAIL TO INTEGRATE ACQUISITIONS SUCCESSFULLY, OUR BUSINESS WILL BE HARMED.

We completed two strategic acquisitions during calendar year 2000. We will
continue to evaluate strategic opportunities available to us, and we may pursue
other product, technology or business acquisitions. Such acquisitions can
present many types of risks, including the following:

- we may fail to successfully integrate the operations and personnel of
newly acquired companies with our existing business;

- we may experience difficulties integrating our financial and operating
systems;

- our ongoing business may be disrupted or receive insufficient management
attention;

- we may not cost-effectively and rapidly incorporate acquired technology;

- we may not be able to recognize cost savings or other financial benefits
we anticipated;

- acquired businesses may fail to meet our performance expectations;

- we may lose key employees of acquired businesses;

- we may not be able to retain the existing customers of newly acquired
operations;

- our corporate culture may clash with that of the acquired businesses; and

- we may incur undiscovered liabilities associated with acquired businesses
that are not covered by indemnification we may obtain from the seller.

We may not successfully address these risks or other problems that arise from
our recent or future acquisitions. In addition, in connection with future
acquisitions, we may issue equity securities that could dilute the percentage
ownership of our existing shareholders, we may incur debt and we may be required
to amortize expenses related to intangible assets that may negatively affect our
results of operations.

ITEM 2. PROPERTIES

We operate our own facilities in Durham, North Carolina. Direct control over SiC
crystal growth, wafering, epitaxial deposition, device fabrication and test
operations allows us to shorten our product design and production cycles and to
protect our proprietary technology and processes. In November 1997, we acquired
21
22

our present manufacturing facility, a 30-acre industrial site in Durham, North
Carolina, consisting of a 139,000 square foot production facility and 33,000
square feet of service and warehouse buildings. In fiscal 2000, we completed a
42,000 square foot expansion of this facility and we are currently completing
construction activities relating to a 147,000 square foot expansion on the main
facility. During fiscal 2000, we purchased a 120,000 square foot shell building
on 17.5 acres of land near the existing production site that we plan to use for
administrative offices and as an employee services center.

We lease approximately 21,900 square feet in Durham, North Carolina for support
of our manufacturing and administrative activities. This lease expires in
December 2001 and will not be renewed. We also lease approximately 13,200 square
feet in a separate building in Durham, North Carolina that is used for RF
production and microwave research and development. This lease expires in August
2002 and will not be renewed.

The UltraRF facility is approximately 49,600 square feet of administrative and
manufacturing space that is leased in Sunnyvale, California. Spectrian leased
the facility in November 1996 for a 15-year term (with three options to extend
the lease for up to an additional fifteen years). In connection with the
acquisition of the assets of the business, Spectrian and Cree's subsidiary,
UltraRF, also entered into a sublease agreement with respect to the UltraRF
facility. Under the sublease, if Spectrian exercises its option to extend the
term of its master lease with its landlord, UltraRF may also exercise an option
to extend its sublease of the UltraRF facility. Cree has guaranteed the
obligations of its subsidiary under the sublease.

Cree Lighting leases two facilities in Goleta, California. One facility, which
covers 35,840 square feet, has a five-year lease that was signed in August 2000
with an option to extend the lease for another five-year period. This facility
is used for research and development and administration. Cree Lighting has
sub-leased 10,217 square feet of this facility to a third party. This two-year
sub-lease agreement was entered into in October 2000. Cree Lighting also leases
an additional facility that comprises 2,887 square feet on a month to month
basis that is used for research and development.

ITEM 3. LEGAL PROCEEDINGS

In December 1999, one of our distributors in Japan, Sumitomo, was named in a
lawsuit filed by Nichia in Tokyo District Court. As previously reported, the
complaint in this proceeding was directed to our standard brightness LED
products and alleged that these products infringe a Japanese patent owned by
Nichia. The suit sought a permanent injunction against further distribution of
the products in Japan. We intervened in the proceeding and filed a response
denying the allegations of infringement. On May 15, 2001, the Tokyo District
Court ruled in favor of Cree and Sumitomo and dismissed the lawsuit. Nichia has
appealed the ruling.

In April 2000, Nichia commenced two additional lawsuits against Sumitomo in
Tokyo District Court in which it alleges that our high brightness LED products
infringe a second Japanese patent owned by Nichia. The complaints in the new
proceedings seek provisional and permanent injunctive relief prohibiting
Sumitomo from further sales of these products in Japan. We have intervened in
the new proceedings and have filed responses denying the allegations of
infringement. No monetary damages for infringement have been sought in any of
the lawsuits brought by Nichia against Sumitomo. Management believes that the
infringement claims are without merit and that the lawsuits are motivated by
competitive factors. We intend to vigorously defend our products against these
claims.

On September 22, 2000, NCSU, and Cree commenced a patent infringement lawsuit
against Nichia and Nichia America Corporation in the United States District
Court for the Eastern District of North Carolina. In their answer to the
complaint, Nichia and Nichia America Corporation denied infringement and
asserted counterclaims seeking a declaratory judgment that the subject patent is
invalid and not infringed. Nichia America Corporation also moved on December 11,
2000, for partial summary judgment seeking a determination that the subject
patent is invalid. Cree and NCSU have opposed the motion, which remains pending.

Nichia also asserted counterclaims alleging that we are infringing four U.S.
patents relating to nitride semiconductor technology and further asserting
misappropriation of trade secrets and related claims against us and a former
Nichia researcher now employed by one of our subsidiaries, Cree Lighting, on a
part-time basis.

22
23

On February 20, 2001, we and our counterclaim codefendant moved to dismiss the
non-patent counterclaims on the grounds that Nichia failed to allege a basis for
subject matter jurisdiction and failed to state a claim upon which relief may be
granted. The motion also seeks dismissal of certain counterclaims on forum non-
conveniens grounds.

On February 20, 2001, we also replied to the patent infringement counterclaims,
denying any infringement and asserting a claim seeking a declaratory judgment
that the four patents at issue are invalid, unenforceable and not infringed. We
also added a claim for damages in which we alleged that Nichia's actions in
asserting the patent infringement counterclaims were not made for any legitimate
purpose and constitute unfair competition in violation of North Carolina law. On
April 2, 2001, Nichia moved for leave to file an amended answer and counterclaim
that seeks to address jurisdictional concerns. In addition, they moved to add
Cree Lighting as a counterclaim defendant and to add federal statutory claims
under the Computer Fraud and Abuse Act against the Cree Lighting employee
previously added as a party. The motion for leave to file the amended answer and
counterclaim has been opposed and remains pending. The court has stayed
discovery as to damages and willful infringement issues pending ruling on a
motion filed by us and NCSU seeking to have the proceedings bifurcated into
separate liability and damages phases.

Although there can be no assurances of success, we believe the counterclaims
asserted in the North Carolina case are without merit and we intend to defend
against them vigorously.

On May 3, 2001, Cree Lighting and Boston University commenced a patent
infringement lawsuit against Nichia and Nichia America Corporation in the United
States District Court for the Northern District of California. The lawsuit seeks
enforcement of a patent relating to gallium nitride-based semiconductor
technology useful in manufacturing certain light emitting diodes and other
devices. The patent was issued to Boston University in 1997 and is licensed to
Cree Lighting under a March, 2001 agreement pursuant to which Cree Lighting
obtained rights to a number of related patents. In the complaint, Cree Lighting
and Boston University allege that Nichia is infringing the patent by, among
other things, importing, selling and offering for sale in the United States
certain gallium nitride-based light emitting devices covered by one or more
claims of the patent. The lawsuit seeks damages and an injunction against
infringement. Boston University is a co-plaintiff in the action.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fourth
quarter of fiscal 2001.

23
24

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Common Stock Market Information. The Company's common stock is traded in the
NASDAQ National Market and is quoted under the symbol "CREE". The following
table sets forth, for the quarters indicated, the high and low bid prices as
reported by NASDAQ. Quotations represent interdealer prices without an
adjustment for retail markups, markdowns or commissions and may not represent
actual transactions.

- ---------------

* As adjusted for the two-for-one split effective on December 1, 2000.

Holders and Dividends. There were approximately 697 holders of record of the
Company's common stock as of August 10, 2001.

The Company has never paid cash dividends on its Common Stock and does not
anticipate that it will do so in the foreseeable future. There are no
contractual restrictions in place that currently materially limit, or are likely
in the future to materially limit, the Company from paying dividends on its
common stock, but applicable state law may limit the payment of dividends. The
present policy of the Company is to retain earnings, if any, to provide funds
for the operation and expansion of its business.

24
25

ITEM 6. SELECTED FINANCIAL DATA

The consolidated statement of operations data set forth below with respect to
the years ended June 24, 2001, June 25, 2000 and June 27, 1999, and the
consolidated balance sheet data at June 24, 2001 and June 25, 2000 are derived
from, and are qualified by reference to, the audited consolidated financial
statements included elsewhere in this report and should be read in conjunction
with those financial statements and notes thereto. The consolidated statement of
operations data for the years ended June 28, 1998 and June 30, 1997 and the
consolidated balance sheet data at June 27, 1999, and June 28, 1998 and June 30,
1997 are derived from audited consolidated financial statements not included
herein. All consolidated statement of operations and consolidated balance sheet
data shown below are adjusted to reflect the acquisition of Nitres, Inc.
effective May 1, 2000. This transaction was accounted for under the pooling of
interests method. The Company acquired UltraRF in December 2000. This
transaction was accounted for under the purchase method. All share amounts have
been restated to reflect the Company's two-for-one stock splits effective July
26, 1999 and December 1, 2000.

SELECTED CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)

25
26

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

All statements, trend analysis and other information contained in the following
discussion relative to markets for our products and trends in revenue, gross
margins, and anticipated expense levels, as well as other statements, including
words such as "may," "will," "anticipate," "believe," "plan," "estimate,"
"expect," and "intend" and other similar expressions constitute forward-looking
statements. These forward-looking statements are subject to business and
economic risks and uncertainties, and our actual results of operations may
differ materially from those contained in the forward-looking statements.
Factors that could cause or contribute to such differences include, but are not
limited to, those discussed in "Certain Business Risks and Uncertainties" in
Item 1 of this report, as well as other risks and uncertainties referenced in
this report.

OVERVIEW

We are the world leader in developing and manufacturing semiconductor materials
and electronic devices made from SiC and GaN. We recognize product revenue at
the time of shipment or in accordance with the terms of the relevant contract.
We derive the largest portion of our revenue from the sale of blue and green LED
products. We offer LEDs at four-brightness levels- MegaBright(TM) blue and UV
products, UltraBright(TM) blue and green devices, high brightness blue and green
products and standard brightness blue products. Our LED devices are utilized by
end users for automotive dashboard lighting, LCD backlighting, including
wireless handsets and other consumer products, indicator lamps, miniature white
lights, indoor sign and arena displays, outdoor full color displays, traffic
signals and other lighting applications. LED products represented 65% of our
revenue in fiscal 2001 and 63% in fiscal 2000.

We introduced our new MegaBright(TM) LED line in May 2001 and began to ramp
production of the initial blue product in the month of June. We believe that
this product offers two times the brightness of our UltraBright(TM) device and
is one of the brightest blue LEDs commercially available in the world. During
our fourth quarter, the MegaBright(TM) product made up 4% of LED revenue. In
addition, in July 2001 we also announced the introduction of our blue
MegaBright(TM) UV product. We believe that this device is the brightest nitride
LED currently available in the market at 12 milliwatts of power. This product is
currently available in limited quantities and we target volume production to
begin in the first half of fiscal 2002. We believe that the MegaBright(TM)
product line is extremely important for our revenue stream for fiscal 2002 and
will likely replace some demand for our older products over time. These devices
also offer a dual path to white light. Some customers prefer a blue LED covered
with a yellow phosphor to create a white light emission, others believe a UV LED
with a red, green, blue phosphor will emit the purest form of white light. We
believe that Cree is the only company to offer both solutions at this time,
although UV products are currently available for limited distribution only. We
anticipate that the MegaBright(TM) products will likely benefit customers who
provide outdoor displays, automotive designs, cell phones and other consumer
products that require a white light source and applications targeted for solid
state illumination.

During the fourth quarter of fiscal 2001, our UltraBright(TM) chips comprised
35% of LED sales. This concentration was reduced from 39% of LED revenue
reported in our third quarter as some customers have switched the
UltraBright(TM) device for MegaBright(TM) chips. The UltraBright(TM) products
target applications including outdoor signs and traffic signals. Our high
brightness chip demand remains strong as it is supported by on-going design wins
including automotive, cellular phone and indoor display applications, however,
during the fourth quarter of fiscal 2001, these products had the biggest
percentage decline in revenue. During the fourth quarter of fiscal 2001, we
noted an increase in demand for our small chip products that are typically used
in cell phones and other designs. Revenue from our standard brightness device
remained stable as a percentage of LED revenue as it is supported by automotive
and indicator light designs.

For the twelve months ended June 2001, average sales prices for LEDs declined
18% from the prior year twelve month average, while LED volume more than doubled
over the prior year at a growth rate of 104%. For fiscal year 2002, we target
that LED volume will remain relatively stable during the first half of the year
due to market conditions and ramp up during the second half of the year as a
result of anticipated new design wins for our MegaBright(TM) products. Cree
continues to add new higher priced LED products to its portfolio. As a

26
27

result, we believe that average sales price declines for fiscal 2002 may be
reduced from fiscal 2001, depending on customer acceptance of the products and
market conditions.

We acquired UltraRF in December 2000. Revenue from UltraRF was $9.9 million
during the fourth quarter of fiscal 2001. For the six months ended June 2001,
57% of revenue was attributed to bipolar devices, 41% was generated by LDMOS
demand and 2% was related to other products. Over 90% of this revenue shipped to
Spectrian. The biggest challenge for UltraRF during fiscal 2002 will be to
diversify our Spectrian concentrated business. We believe the LDMOS product line
will enable growth of our products to customers other than Spectrian and we
target the UltraRF business to remain relatively stable during fiscal 2002 at
approximately 20-30% of total revenue. RF and microwave business was 11% of
total revenue during fiscal 2001.

We also derive revenue from the sale of advanced materials made from SiC that
are used for manufacturing LEDs and power devices by our customers or for
research and development for new semiconductor applications. During fiscal 2001,
wafer volume grew 107% over the prior year. Strong demand from corporate and
research communities are driving this growth. We also sell SiC crystals to C&C,
which incorporates them in gemstone applications. Overall, for fiscal 2001,
materials revenue declined 10% over the prior year due to a 63% reduction in
gemstone sales, which was nearly offset by a 71% increase in wafer sales. Sales
of SiC materials products and SiC crystals represented 14% of our revenue in
fiscal 2001 and approximately 26% during fiscal 2000.

The balance of our revenue, 10% for fiscal 2001 and 11% for fiscal 2000, is
derived from government and customer contract funding. Under various programs,
U.S. Government entities further the development of our technology by funding
our research and development efforts. All resulting technology remains our
property after the completion of the contract, subject to certain license rights
retained by the government. Contract revenue includes funding of direct research
and development costs and a portion of our general and administrative expenses
and other operating expenses for contracts under which we expect funding to
exceed direct costs over the life of the contract. For contracts under which we
anticipate that direct costs will exceed amounts to be funded over the life of
the contract, we report direct costs as research and development expenses with
related reimbursements recorded as an offset to those expenses.

We continue to focus on cost reduction and process yield improvements as some of
our highest priorities. During the past twelve months, we maximized our capacity
and have invested in additional plant and equipment and other infrastructure
that has increased our overall cost base. We anticipate that we will use much of
this equipment and infrastructure in the near term to perform research and
development work to support the commercialization and growth of future products.
We believe that a successful cost reduction program will be critical to meet our
profit objectives over the next several quarters. During the fourth quarter of
fiscal 2001, our gross margins declined to 43% of revenue. This was caused
primarily by reduced revenue combined with higher fixed costs and lower
throughput as production levels declined due to demand and inventory
optimization. Since a significant portion of our factory cost is fixed, our
greatest opportunity to improve margins would be in yield improvements and the
achievement of greater throughput levels. During fiscal 2002, we target to
increase our throughput each sequential quarter, subject to the acceptance of
our products by our customers and market conditions. As volume throughput rises,
our cost of LED chips and wafers per unit are anticipated to decline as fixed
costs are spread over more units.

27
28

The following table shows our statement of operations data expressed as a
percentage of total revenue for the periods indicated:

FISCAL YEARS ENDED JUNE 24, 2001 AND JUNE 25, 2000

Revenue

Revenue grew 63% to $177.2 million in fiscal 2001 from $108.6 million in fiscal
2000. This increase was attributable to higher product revenue, which rose 65%
to $159.5 million in fiscal 2001 from $96.7 million in fiscal 2000. Without the
acquisition of UltraRF in December 2000, revenue for fiscal 2001 would have
increased 46% over the prior year comparative results. Much of the increase in
revenue from our traditional business resulted from demand for our LED and SiC
wafer products. LED chip volume increased 104% over units delivered in the prior
year. The largest increase occurred as a result of the introduction of our
UltraBright(TM) product line in fiscal 2001. The MegaBright(TM) product,
introduced in the fourth quarter of fiscal 2001, offers two times the brightness
of our UltraBright(TM) device, while the UltraBright(TM) chips provide two times
the brightness of our high brightness products. During fiscal 2000 only our high
brightness and standard brightness product lines were available for sale. Our
standard brightness products also increased 65% in terms of units shipped over
the prior year due to strong demand for automotive and indicator light
applications. Average LED sales prices declined 18% for the twelve months ended
June 2001 compared to the prior year average due to expected contractual volume
discounts given to customers.

SiC wafer sales increased 71% over the prior year due to demand from corporate
and research communities, including certain customers using our wafers for
commercial production. Wafer units sold increased 107%, while average sales
prices declined 16% due to a higher mix of volume sales related to wafers used
in commercial production. Sales of gemstone products declined 63% during fiscal
year 2001 as compared to fiscal 2000 due to on going inventory reduction efforts
at C&C. We anticipate little to no revenue from this customer over the next
several quarters.

28
29

Revenue from UltraRF was $19.2 million for fiscal 2001. This represents six
months of sales for the unit as it was acquired in December 2000 under the
purchase method of accounting. UltraRF continues to ramp its production of LDMOS
products currently being shipped for next generation wireless base station
applications while working on new customer design wins. Since we acquired
UltraRF in December 2000, there were no sales for this unit in fiscal 2000.

Contract revenue received from U.S. Government agencies and non-governmental
customers increased 50% during fiscal 2001 compared to fiscal 2000, due to
additional contract awards. During fiscal 2001, we received seven new contract
awards.

Gross Profit

Gross profit increased 56% to $87.5 million in fiscal 2001 from $56.2 million in
fiscal 2000. Compared to the prior year, gross margins declined from 52% to 49%
of revenue. Lower margins resulted from a combination of reduced profitability
for LED devices and the acquisition of UltraRF. LED margins declined due to
average sales prices decreasing at a faster rate than average costs. During
fiscal 2001 average LED costs declined 11% while average sales prices were
reduced 18%. LED costs did not drop as quickly as revenue due to lower yields
than anticipated as a result of the new product introductions and chip
modification made to our products in the second half of the year that we believe
will improve our competitive advantage for new design wins. In addition, factory
throughput was reduced during the fourth quarter of fiscal 2001, which resulted
in higher costs per chip than anticipated. The margins for UltraRF's business
average in the mid 40's as a percentage of revenue due to the competitive
environment for LDMOS chips. UltraRF's business was 11% of total revenue in
fiscal 2001. In addition, during fiscal 2001, one-time adjustments were made to
UltraRF's cost of sales due to recording acquired inventory at fair value in
accordance with the purchase method of accounting.

Research and Development

Research and development expenses increased 84% in fiscal 2001 to $13.0 million
from $7.1 million in fiscal 2000. Much of this increase resulted from the
acquisition of UltraRF, as well as greater investment made for research in the
RF and microwave, power and optoelectronic programs. Without the acquisition of
UltraRF, research and development expenses would have increased 62% over the
prior year. We believe that internal funding for the development of new products
will continue to grow during fiscal 2002 as we have several new products that we
target to release to production during fiscal 2002.

Sales, General and Administrative

Sales, general and administrative expenses increased 63% in fiscal 2001 to $18.1
million from $11.1 million in fiscal 2000. This increase in expenses is due to
the acquisition of UltraRF and greater spending to support the overall growth of
the business, as well as costs associated with ongoing intellectual property
litigation. Without the acquisition of UltraRF, sales, general and
administrative expenses would have increased 44% over the prior year. In future
periods, we believe that total sales, general and administrative costs will
continue to increase in connection with the growth of our business and depending
on the outcomes of our ongoing patent litigation.

Intangible Asset Amortization and In-Process Research and Development Costs

The purchase of UltraRF generated goodwill and other intangible assets, which
will be amortized over periods ranging from five to 10 years. In addition, as a
result of the acquisition of UltraRF, we recorded a one-time charge of $17.4
million in the third quarter of fiscal 2001 associated with acquired in-process
research and development costs.

29
30

Other Expense

Other expense decreased 95% to $62,000 during fiscal 2001 from $1.3 million in
fiscal 2000. The decrease was attributable to fewer losses on fixed asset
disposals.

Other Non-Operating Income (Net)

Other non-operating income decreased 88% to $82,000 in fiscal 2001 from $656,000
in fiscal 2000. This decrease was attributable to a $4.6 million write down
taken in the fourth quarter of fiscal 2001 to establish a reserve for
investments made in private companies that was considered to be an other than
temporary impairment to value. In addition, the Company made a one-time
charitable contribution of $1.2 million to the University of California at Santa
Barbara to endow a Cree chair in solid state lighting and displays in the first
quarter of fiscal 2001. Finally, a $100,000 charge was recorded related to
one-time charges for expenses incurred for the acquisition of Nitres, Inc. These
charges were offset by a $6.0 million gain on the sale of investment securities
during the year. During fiscal 2000, a $4.1 million gain was recognized on the
sale of securities. This gain combined with one-time proceed