Cree, Inc.
CREE INC (Form: 10-Q, Received: 01/19/2012 06:01:04)
Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 25, 2011
or
[    ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission file number 0-21154
CREE, INC.
(Exact name of registrant as specified in its charter)
 
North Carolina
  
56-1572719
(State or other jurisdiction of incorporation or
organization)
  
(I.R.S. Employer Identification No.)
 
 
 
4600 Silicon Drive
Durham, North Carolina
  
27703
(Address of principal executive offices)
  
(Zip Code)
(919) 407-5300
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [ X ] No [    ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes [ X ] No [    ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer [X]
  
Accelerated filer [    ]
Non-accelerated filer [    ]  (Do not check if a smaller reporting company)
  
Smaller reporting company [    ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [   ] No[ X]
The number of shares outstanding of the registrant’s common stock, par value $0.00125 per share, as of January 11, 2012 , was 116,099,017 .



Table of Contents

CREE, INC.
FORM 10-Q
For the Quarterly Period Ended December 25, 2011
INDEX
 
Description
Page No.
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.
 
 

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Table of Contents

PART I - FINANCIAL INFORMATION
Item 1.    Financial Statements
CREE, INC.
CONSOLIDATED BALANCE SHEETS
 
December 25,
2011
 
June 26,
2011
 
(unaudited)
 
 
(Thousands, except par value)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
171,651

 
$
390,598

Short-term investments
515,595

 
695,199

Total cash, cash equivalents, and short-term investments
687,246

 
1,085,797

Accounts receivable, net
156,385

 
118,469

Income tax receivable
1,829

 
6,796

Inventories
187,373

 
176,482

Deferred income taxes
18,907

 
17,857

Prepaid expenses and other current assets
52,806

 
51,494

Total current assets
1,104,546

 
1,456,895

Property and equipment, net
605,504

 
555,929

Intangible assets, net
385,484

 
102,860

Goodwill
617,936

 
326,178

Other assets
5,990

 
4,860

Total assets
$
2,719,460

 
$
2,446,722

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

Current liabilities:

 

Accounts payable, trade
$
81,493

 
$
76,593

Accrued salaries and wages
25,957

 
18,491

Income taxes payable
2,209

 
15,493

Other current liabilities
39,505

 
29,739

Total current liabilities
149,164

 
140,316

Long-term liabilities:

 

Deferred income taxes
21,902

 
21,902

Other long-term liabilities
26,121

 
22,940

Total long-term liabilities
48,023

 
44,842

Commitments and contingencies (Note 11)

 

Shareholders’ equity:

 

Preferred stock, par value $0.01; 3,000 shares authorized at December 25, 2011 and June 26, 2011; none issued and outstanding

 

Common stock, par value $0.00125; 200,000 shares authorized at December 25, 2011 and June 26, 2011; 116,097 and 109,607 shares issued and outstanding at December 25, 2011 and June 26, 2011, respectively
144

 
136

Additional paid-in-capital
1,831,909

 
1,593,530

Accumulated other comprehensive income, net of taxes
10,516

 
13,091

Retained earnings
679,704

 
654,807

Total shareholders’ equity
2,522,273

 
2,261,564

Total liabilities and shareholders’ equity
$
2,719,460

 
$
2,446,722

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

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Table of Contents

CREE, INC.
(UNAUDITED)
CONSOLIDATED STATEMENTS OF INCOME
 
 
Three Months Ended
 
Six Months Ended
 
December 25,
2011
 
December 26,
2010
 
December 25,
2011
 
December 26,
2010
 
(Thousands, except per share amounts)
Revenue, net
$
304,118

 
$
256,983

 
$
573,098

 
$
525,420

Cost of revenue, net
199,000

 
135,837

 
369,952

 
273,745

Gross profit
105,118

 
121,146

 
203,146

 
251,675

Operating expenses:
 
 
 
 

 

Research and development
35,886

 
29,233

 
70,288

 
53,965

Sales, general and administrative
49,176

 
33,366

 
94,715

 
62,568

Amortization of acquisition related intangibles
7,367

 
2,706

 
11,292

 
5,412

Loss on disposal or impairment of long-lived assets
497

 
429

 
1,272

 
901

Total operating expenses
92,926

 
65,734

 
177,567

 
122,846

Operating income
12,192

 
55,412

 
25,579

 
128,829

Non-operating income:
 
 
 
 

 

Other non-operating (loss) income, net
(111
)
 
63

 
863

 
1

Interest income, net
1,800

 
2,170

 
3,769

 
4,186

Income from operations before income taxes
13,881

 
57,645

 
30,211

 
133,016

Income tax expense
1,803

 
7,870

 
5,314

 
25,205

Net income
$
12,078

 
$
49,775

 
$
24,897

 
$
107,811

Earnings per share:
 
 
 
 

 

Basic net income per share
$
0.10

 
$
0.46

 
$
0.22

 
$
1.00

Diluted net income per share
$
0.10

 
$
0.45

 
$
0.22

 
$
0.98

Shares used in per share calculation:
 
 
 
 

 

Basic
115,536

 
108,364

 
113,701

 
108,032

Diluted
115,883

 
109,976

 
114,239

 
109,817

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

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Table of Contents

CREE, INC.
(UNAUDITED)
CONSOLIDATED STATEMENTS OF CASH FLOW
 
Six Months Ended
 
December 25,
2011
 
December 26,
2010
 

 
 
Cash flows from operating activities:
 
 
 
Net income
$
24,897

 
$
107,811

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
68,303

 
50,318

Stock-based compensation
22,635

 
17,981

Excess tax benefit from share-based payment arrangements
(201
)
 
(9,277
)
Loss on disposal or impairment of long-lived assets
1,272

 
901

Amortization of premium/discount on investments
4,017

 
7,617

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(12,973
)
 
(16,928
)
Inventories
28,572

 
(32,871
)
Prepaid expenses and other assets
8,755

 
1,991

Accounts payable, trade
(14,923
)
 
22,516

Accrued salaries and wages and other liabilities
(8,117
)
 
(4,303
)
Net cash provided by operating activities
122,237

 
145,756

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(53,038
)
 
(126,387
)
Purchases of investments
(145,802
)
 
(194,872
)
Proceeds from maturities of investments
66,040

 
147,502

Proceeds from sale of property and equipment
2

 
1

Proceeds from sale of available-for-sale investments
252,152

 
61,833

Purchase of Ruud Lighting, net of cash acquired
(456,008
)
 

Purchases of patent and licensing rights
(8,043
)
 
(5,199
)
Net cash used in investing activities
(344,697
)
 
(117,122
)
Cash flows from financing activities:
 
 
 
Net proceeds from issuance of common stock
2,648

 
29,977

Excess tax benefit from share-based payment arrangements
201

 
9,277

Net cash provided by financing activities
2,849

 
39,254

Effects of foreign exchange changes on cash and cash equivalents
664

 
238

Net (decrease) increase in cash and cash equivalents
(218,947
)
 
68,126

Cash and cash equivalents:
 
 
 
Beginning of period
390,598

 
397,431

End of period
$
171,651

 
$
465,557

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

5

Table of Contents

CREE, INC.
(UNAUDITED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


Note 1.    Basis of Presentation and Changes in Significant Accounting Policies
Overview

Cree, Inc. (the "Company") is a leading innovator of lighting-class light emitting diode (LED) products, lighting products and semiconductor products for power and radio-frequency (RF) applications. The Company's products are targeted for applications such as general illumination, video displays, automotive, electronic signs and signals, power supplies and solar inverters.

The Company develops and manufactures semiconductor materials and devices primarily based on silicon carbide (SiC), gallium nitride (GaN) and related compounds. The physical and electronic properties of SiC and GaN offer technical advantages over traditional silicon, gallium arsenide (GaAs), sapphire and other materials used for electronic and opto-electronic applications.

The Company's LED products consist of LED components, LED chips, and SiC wafers. As the Company develops and improves its LED technology and the market continues to focus on energy efficiency, the Company believes the potential market for LED lighting will continue to expand. The Company's success in selling LED products depends upon its ability to drive adoption and offer innovative products and solutions that enable its customers to succeed in the market. By driving adoption, the Company believes it can influence the growth of the market and open more opportunities for LEDs.

The Company's lighting products consist of both LED and traditional lighting systems. The Company designs, manufactures and sells lighting systems for indoor and outdoor applications, with its primary focus on LED lighting systems for the commercial and industrial markets. The Company also uses its LED systems expertise to accelerate LED adoption and expand the market for its LED components.

In addition, the Company develops, manufactures and sells power and RF devices. The Company's power products are made from SiC and provide faster switching speeds than comparable silicon-based power devices. The Company's RF devices are made from SiC or GaN and produce higher power densities as compared to silicon or gallium arsenide.

The majority of the Company's products are manufactured at production facilities located in North Carolina, Wisconsin and China. The Company also uses contract manufacturers for certain aspects of its product fabrication, packaging and assembly. The Company operates research and development facilities in North Carolina, California, Wisconsin and China.

The Company currently operates its business as one reportable segment.
Basis of Presentation
The consolidated balance sheet at December 25, 2011 and the consolidated statements of income for the three and six months ended December 25, 2011 and December 26, 2010 , and the consolidated statements of cash flows for the six months ended December 25, 2011 and December 26, 2010 (“consolidated financial statements”) have been prepared by the Company and have not been audited. In the opinion of management, all normal and recurring adjustments necessary to present fairly the consolidated financial position, results of operations and cash flows at December 25, 2011 , and for all periods presented, have been made. The consolidated balance sheet at June 26, 2011 has been derived from the audited financial statements as of that date.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been condensed or omitted. It is suggested that these financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 26, 2011 (“fiscal 2011 ”). The results of operations for the period ended December 25, 2011 are not necessarily indicative of the operating results that may be attained for the entire fiscal year ending June 24, 2012 (“fiscal 2012 ”).
Certain fiscal 2011 amounts in the accompanying consolidated financial statements have been reclassified to conform to the fiscal 2012 presentation. These reclassifications had no effect on previously reported consolidated net income or shareholders’ equity.

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Table of Contents

Recently Adopted Accounting Pronouncements
Fair Value Disclosures
In January 2010, the Financial Accounting Standards Board (the "FASB") issued amended standards requiring additional fair value disclosures. The amended standards require disclosures of transfers in and out of Levels 1 and 2 of the fair value hierarchy, as well as requiring gross basis disclosures for purchases, sales, issuances and settlements within the Level 3 reconciliation. Additionally, the update clarifies the requirement to determine the level of disaggregation for fair value measurement disclosures and to disclose valuation techniques and inputs used for both recurring and nonrecurring fair value measurements in either Level 2 or Level 3. The Company adopted the new guidance in the third quarter of fiscal 2010, except for the disclosures related to purchases, sales, issuance and settlements, which was effective for the Company beginning in the first quarter of fiscal 2012. Because these new standards are related primarily to disclosures, their adoption has not had a significant impact on the Company's consolidated financial statements.
Goodwill Impairment Testing
On September 15, 2011, the FASB issued updated guidance concerning the testing of goodwill for impairment.  This guidance modifies goodwill impairment testing by allowing the inclusion of qualitative factors in the assessment of whether a two-step goodwill impairment test is necessary.   Thus, entities are no longer required to calculate the fair value of a reporting unit unless they conclude through an assessment of qualitative factors that it is more likely than not that the unit's carrying value is greater than its fair value.  When an entity's qualitative assessment reveals that goodwill impairment is more likely than not, the entity must perform the two-step goodwill impairment test.   This guidance became effective for the Company in the second quarter of fiscal 2012.  The Company's adoption of this guidance has not had a significant impact on its consolidated financial statements.
Recently Issued Accounting Pronouncements
Presentation of Comprehensive Income
In June 2010, the FASB issued new guidance concerning the presentation of total comprehensive income and its components. Under this guidance an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in single continuous statement of comprehensive income or in two separate but consecutive statements. This guidance, as amended in December 2011, will become effective for the Company beginning in the third quarter of fiscal 2012. The Company's adoption of the new accounting guidance is not expected to have a significant impact on its consolidated financial statements.

Note 2.    Acquisitions
Acquisition of Ruud Lighting, Inc.
On August 17, 2011 , the Company entered into a Stock Purchase Agreement with all of the shareholders of Ruud Lighting, Inc. ("Ruud Lighting"). Pursuant to the terms of the Stock Purchase Agreement and concurrently with the execution of the Stock Purchase Agreement, the Company acquired all of the outstanding share capital of Ruud Lighting in exchange for consideration consisting of 6.1 million shares of the Company's common stock and $372.2 million cash, subject to certain post-closing adjustments. Prior to the Company completing its acquisition of Ruud Lighting, Ruud Lighting completed the re-acquisition of its e-conolight business by purchasing all of the membership interests of E-conolight LLC ("E-conolight"). Ruud Lighting previously sold its e-conolight business in March 2010 and had been providing operational services to E-conolight since that date. In connection with the stock purchase transaction with Ruud Lighting, the Company funded Ruud Lighting's re-acquisition of E-conolight and paid off Ruud Lighting's outstanding debt in the aggregate amount of approximately $85.0 million . The acquisition allows the Company to expand its product portfolio into outdoor LED lighting.
The acquisitions of Ruud Lighting and E-conolight have been accounted for as business combinations in accordance with ASC 805 Business Combinations and, as such, the Ruud Lighting and E-conolight assets acquired and liabilities assumed have been recorded at their respective fair values. The determination of fair value for the identifiable tangible and intangible assets acquired and liabilities assumed requires extensive use of estimates and judgments. Significant estimates and assumptions include, but are not limited to: estimating future cash flows and determining the appropriate discount rate.

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The total purchase price for this acquisition is as follows (in thousands):
Cash consideration paid to stockholders
$
372,235

Fair value of common stock issued by the Company (1)
211,040

Fair value of debt paid on behalf of stockholders
84,991

Total purchase price
$
668,266

(1) Represents 6,074,833 shares of the Company's common stock at $34.74 per share, the closing share price on August 17, 2011 . The shares are subject to certain transfer restrictions under the Stock Purchase Agreement that will generally lapse with respect to 25% of the shares held (i) at the completion of the consecutive six-month period following the date of the closing of the transaction; and, (ii) at the completion of each of the following three successive six-month periods, such that all restrictions will lapse by the second anniversary of the closing.

The Company incurred total transaction costs related to the acquisition of approximately $3.6 million , of which, $3.1 million were expensed in the first quarter of fiscal 2012 in accordance with U.S. GAAP.

The purchase price for this acquisition has been preliminarily allocated to the assets acquired and liabilities assumed based on their estimated fair values as follows (in thousands):

 
August 17, 2011 (As initially reported)

Measurement Period Adjustments

August 17, 2011 (As adjusted)

Tangible assets:
 
 
 
Cash and cash equivalents
$
3,081

$

$
3,081

Accounts receivable
25,698

(375
)
25,323

Inventories
39,330

(461
)
38,869

Property and equipment
45,946

(233
)
45,713

Other assets
4,727

217

4,944

Total tangible assets
$
118,782

$
(852
)
$
117,930

Intangible assets:
 
 

Developed technology
$
96,300

$

$
96,300

Customer relationships
84,820


84,820

Trade names
82,950


82,950

In-process research & development
15,050


15,050

Non-compete agreements
9,800


9,800

Goodwill
287,431

4,326

291,757

Total intangible assets
$
576,351

$
4,326

$
580,677

Liabilities assumed:
 
 

Accounts payable
$
12,943

$

$
12,943

Accrued expenses and liabilities
10,116

451

10,567

Warranty liabilities
2,600

3,023

5,623

Other long-term liabilities
1,208


1,208

Total liabilities assumed
$
26,867

$
3,474

$
30,341

Net assets acquired
$
668,266

$

$
668,266


The above estimated fair values of assets acquired and liabilities assumed are based on the information that was available through the balance sheet date and are provisional. The Company believes that this information provides a reasonable basis for estimating the fair values but is waiting for certain additional information necessary to finalize those amounts, which includes certain post-closing working capital and related adjustments, certain litigation, potential uncertain tax positions, certain foreign taxes payable, certain product warranties and certain reviews at the foreign subsidiary locations. Thus, the provisional measurements of fair value reflected are subject to change.


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Acquired finished goods and work-in-process inventory was valued at its estimated selling price less the sum of costs of disposal and a reasonable profit allowance for the Company's selling effort and, with respect to work-in-process inventory, estimated costs to complete. This resulted in a fair value adjustment that increased finished goods inventory approximately $1.5 million . Raw material inventory has been valued at current replacement cost, resulting in a write down of approximately $0.7 million . As the Company sells the acquired inventory, its costs of revenue will reflect the increased valuation of the inventory, which will reduce the Company's gross margins until such inventory is sold.

The identifiable intangible assets acquired as a result of the acquisition will be amortized over their respective estimated useful lives as follows (in thousands, except for years):

Asset Amount
 
Estimated Life in Years
Developed technology
$
96,300

 
7 to 10
Customer relationships
84,820

 
7 to 20
Trade names (indefinite lived)
82,880

 
-
Trade names (definite lived)
70

 
3
In-process research and development  (1)
15,050

 
6 to 7
Non-compete agreements
9,800

 
5
Total identifiable intangible assets
$
288,920

 
 
(1) Initially, in-process research and development ("IPR&D") is classified as indefinite-lived assets until completion or abandonment. Therefore, amortization of IPR&D does not begin until the technological and market risk(s) no longer exist. During the interim, IPR&D intangibles are subject to annual testing for impairment or when there are indicators of impairment.

The fair value of the developed technology, IPR&D and customer relationship assets were estimated using an income approach. Under this method, an intangible asset's fair value is equal to the present value of the incremental after-tax cash flows (excess earnings) attributable solely to the intangible asset over its remaining useful life. To calculate fair value, the Company used cash flows discounted at rates considered appropriate given the inherent risks associated with each type of asset. The Company believes that the level and timing of cash flows appropriately reflect market participant assumptions. The fair value of the Ruud Lighting and e-conolight trade names were estimated using an income approach, specifically known as the relief from royalty method. The relief from royalty method is based on a hypothetical royalty stream that would be paid if the Company did not own the Ruud Lighting “BetaLED” brand and had to license the Ruud Lighting and e-conolight trade names. The Company derived the hypothetical royalty income from the projected revenues of Ruud Lighting and e-conolight products.  Cash flows were assumed to extend through the remaining economic useful life of each class of intangible asset.

Goodwill largely consists of geographic expansion of product sales, manufacturing and other synergies of the combined companies, and the value of the assembled workforce.

As a result of the Company's U.S. tax election under Internal Revenue Code section 338(h)(10), the acquisition did not result in the recording of an opening net deferred tax position as the deferred tax asset resulting from excess tax deductible goodwill equally offsets the deferred tax liability resulting from excess book over tax basis in the underlying assets acquired.

The assets, liabilities, and operating results of Ruud Lighting have been included in the Company's consolidated financial statements from the date of acquisition. The results of Ruud Lighting reflected in the Company's Consolidated Statements of Income from the date of acquisition ( August 17, 2011 ) to December 25, 2011 are as follows (in thousands, except per share data):

 
Three Months Ended
 
Six Months Ended
 
December 25, 2011
 
December 25, 2011
Revenue
$
61,148

 
$
83,491

Operating Income
1,647

 
1,125

Net Income
1,319

 
655

Basic net income per share
$
0.01

 
$
0.01

Diluted net income per share
$
0.01

 
$
0.01


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Amortization expense related to identifiable intangible assets associated with the Ruud Lighting acquisition, included in the table above, was $5.2 million and $6.9 million for the three and six months ended December 25, 2011 , respectively.
The following supplemental pro forma information (in thousands, except per share data) presents the financial results as if the Ruud Lighting transaction had occurred at the beginning of the 2011 fiscal year for the six months ended December 25, 2011 and the three and six months ended December 26, 2010. Financial results for the three months ended December 25, 2011, which are included in the Consolidated Statements of Income, are actual results and therefore have not been presented in the table below.

 
Three Months Ended
 
Six Months Ended

 
December 26,
2010
 
December 25,
2011
 
December 26,
2010
Revenue
 
$
313,220

 
$
603,430

 
$
623,516

Operating Income
 
55,625

 
23,872

 
124,048

Net income
 
50,290

 
23,117

 
105,433

Earnings per share, basic
 
$
0.44

 
$
0.20

 
$
0.92

Earnings per share, diluted
 
$
0.43

 
$
0.20

 
$
0.91


The total revenue for Ruud Lighting included in the pro forma table above was $60.1 million for the three months ended December 26, 2010 . The total revenue for Ruud Lighting included in the pro forma table above was $115.0 million and $107.4 million for the six months ended December 25, 2011 and December 26, 2010 , respectively. These amounts have been calculated after applying the Company’s accounting policies and adjusting the results of Ruud Lighting to give effect to events that are directly attributable to the Ruud Lighting transactions, including the elimination of sales to Ruud Lighting prior to acquisition, additional depreciation and amortization that would have been charged assuming the fair value adjustments primarily to property and equipment and intangible assets, had been applied at the beginning of the 2011 fiscal year, together with the consequential tax effects. Excluded from the pro forma net income and the earnings per share amounts for the six months ended December 25, 2011 are one-time acquisition costs of $3.1 million attributable to the Ruud Lighting transaction. This supplemental pro forma information has been prepared for comparative purposes and does not purport to be indicative of what would have occurred had the acquisition been made at the beginning of the 2011 fiscal year, nor is it indicative of any future results.

Acquisition of LED Lighting Fixtures, Inc.
On February 29, 2008 the Company acquired LED Lighting Fixtures, Inc. (“LLF”) through a wholly owned subsidiary that merged into Cree, Inc. on June 27, 2010. The Company acquired all of the outstanding share capital of LLF in exchange for total upfront consideration of $80.8 million , consisting of (1)  $16.5 million in cash, (2) approximately 1.9 million shares of the Company’s common stock valued at $58.8 million , and (3) the assumption of fully vested LLF employee stock options valued at $4.5 million . The Company incurred transaction costs of approximately $1.0 million consisting primarily of professional fees incurred relating to attorneys, accountants and valuation advisors. Under the acquisition terms, additional consideration of up to $26.4 million would become payable to the former shareholders of LLF if defined product development targets and key employee retention measures were achieved over the three calendar years following the acquisition.
LLF met the conditions necessary for the earn-out payment for the calendar years ended December 31, 2008, 2009 and 2010. As a result, the Company made a cash payment in the amount of $4.4 million to the former shareholders of LLF in the third quarter of fiscal 2009, a cash payment in the amount of $8.8 million to the former shareholders of LLF in the third quarter of fiscal 2010, and a final cash payment in the amount of $13.2 million to the former shareholders of LLF in the third quarter of fiscal 2011. These incremental payments were treated as additional purchase price and resulted in an increase to goodwill in the Company’s consolidated financial statements.
The assets, liabilities, and operating results of LLF have been included in the Company’s consolidated financial statements from the date of acquisition and are reflected in all periods presented in the accompanying financial statements.


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Note 3.    Financial Statement Details
Accounts Receivable, net
The following is a summary of the components of accounts receivable, net (in thousands):
 
 
December 25,
2011
 
June 26,
2011
Billed trade receivables
$
170,929

 
$
137,799

Unbilled contract receivables
1,623

 
1,038


172,552

 
138,837

Allowance for sales returns, discounts, and other incentives
(14,739
)
 
(19,615
)
Allowance for bad debts
(1,428
)
 
(753
)
Total accounts receivable, net
$
156,385

 
$
118,469

Inventories
The following is a summary of the components of inventories (in thousands):
 
 
December 25,
2011
 
June 26,
2011
Raw material
$
56,318

 
$
38,781

Work-in-progress
70,296

 
74,816

Finished goods
60,759

 
62,885

Total inventories
$
187,373

 
$
176,482

Revenues, net
Revenues were comprised of the following product groups (in thousands, except percentages):

 
Three Months Ended
 
Six Months Ended
 
December 25,
2011
 
December 26,
2010
 
December 25,
2011
 
December 26,
2010
LED products
$
194,162

 
$
209,984

 
$
390,940

 
$
438,749

Percent of revenue
64
%
 
81
%
 
68
%
 
83
%
Lighting products
$
95,736

 
$
19,715

 
$
147,409

 
$
35,316

Percent of revenue
31
%
 
8
%
 
26
%
 
7
%
Power and RF products
$
14,220

 
$
27,284

 
$
34,749

 
$
51,355

Percent of revenue
5
%
 
11
%
 
6
%
 
10
%
Total revenue
$
304,118

 
$
256,983

 
$
573,098

 
$
525,420


Note 4.    Investments
Short-term investments consist of high grade municipal and corporate bonds and other debt securities. The Company classifies its marketable securities as available-for-sale. This is based upon management’s determination that the underlying cash invested in these securities is available for operations as necessary.


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Table of Contents

The following table provides a summary of marketable investments by type (in thousands):
 
 
December 25, 2011
 
 
Amortized    
Cost
 
Gross Unrealized    
Gains
 
Gross
Unrealized    
Losses
 
 Estimated Fair 
Value
Municipal bonds
 
$
196,688

 
$
2,657

 
$
(4
)
 
$
199,341

Corporate bonds
 
168,732

 
1,374

 
(614
)
 
169,492

Certificates of deposit
 
68,002

 
5

 
(3
)
 
68,004

Municipal variable rate demand notes
 
2,795

 

 

 
2,795

Commercial paper
 
2,149

 

 

 
2,149

U.S. agency securities
 
72,446

 
476

 
(119
)
 
72,803

Non-U.S. government securities
 
1,013

 

 
(2
)
 
1,011

Total
 
$
511,825

 
$
4,512

 
$
(742
)
 
$
515,595

 
 
 
 
 
 
 
 
 
 
 
June 26, 2011
 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated Fair
Value
Municipal bonds
 
$
391,465

 
$
3,943

 
$
(10
)
 
$
395,398

Corporate bonds
 
207,241

 
2,312

 
(115
)
 
209,438

Certificates of deposit
 
10,003

 
12

 

 
10,015

Municipal variable rate demand notes
 
295

 

 

 
295

Commercial paper
 
4,999

 

 

 
4,999

U.S. agency securities
 
67,244

 
807

 
(2
)
 
68,049

Non-U.S. government securities
 
6,986

 
19

 

 
7,005

Total
 
$
688,233

 
$
7,093

 
$
(127
)
 
$
695,199



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The following table presents the gross unrealized losses and estimated fair value of the Company's investment securities, aggregated by investment type and length of time that individual investments securities have been in a continuous unrealized loss position (in thousands):
 
 
December 25, 2011
 
 
Less than 12 Months
 
Greater than 12 Months
 
Total
 
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
Municipal bonds
 
$
11,984

 
$
(4
)
 
$

 
$

 
$
11,984

 
$
(4
)
Corporate bonds
 
39,280

 
(614
)
 

 

 
39,280

 
(614
)
Certificates of deposit
 
2,998

 
(3
)
 

 

 
2,998

 
(3
)
U.S. agency securities
 
28,816

 
(119
)
 

 

 
28,816

 
(119
)
Non-U.S. government securities
 
1,012

 
(2
)
 

 

 
1,012

 
(2
)
Total
 
$
84,090

 
$
(742
)
 
$

 
$

 
$
84,090

 
$
(742
)
Number of securities with an unrealized loss
 
 
 
38

 
 
 

 
 
 
38

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
June 26, 2011
 
 
Less than 12 Months
 
Greater than 12 Months
 
Total
 
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
Municipal bonds
 
$
14,348

 
$
(10
)
 
$

 
$

 
$
14,348

 
$
(10
)
Corporate bonds
 
20,484

 
(115
)
 

 

 
20,484

 
(115
)
U.S. agency securities
 
6,518

 
(2
)
 

 

 
6,518

 
(2
)
Total
 
$
41,350

 
$
(127
)
 
$

 
$

 
$
41,350

 
$
(127
)
Number of securities with an unrealized loss
 
 
 
20

 
 
 

 
 
 
20


The contractual maturities of marketable investments at December 25, 2011 were as follows (in thousands):
 
 
December 25, 2011
 
    Within One    
Year
 
After One,
    Within Five    
Years
 
After Five,
    Within Ten    
Years
 
    After Ten    
Years
 
Total
Municipal bonds
$
89,687

 
$
109,654

 
$

 
$

 
$
199,341

Corporate bonds
64,957

 
104,535

 

 

 
169,492

Certificates of deposit
63,001

 
5,003

 

 

 
68,004

Municipal variable rate demand notes

 

 

 
2,795

 
2,795

Commercial paper
2,149

 

 

 

 
2,149

U.S. agency securities
10,235

 
62,568

 

 

 
72,803

Non-U.S. government securities

 
1,011

 

 

 
1,011

Total
$
230,029

 
$
282,771

 
$

 
$
2,795

 
$
515,595


Note 5.    Fair Value of Financial Instruments
Under U.S. GAAP, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., “the exit price”) in an orderly transaction between market participants at the measurement date. In determining fair value, the Company uses various valuation approaches, including quoted market prices and discounted cash flows. U.S. GAAP also establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available.


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Table of Contents

Observable inputs are obtained from independent sources and can be validated by a third party, whereas, unobservable inputs reflect assumptions regarding what a third party would use in pricing an asset or liability. The fair value hierarchy is broken down into three levels based on the reliability of inputs as follows:
Level 1 - Valuations based on quoted prices in active markets for identical instruments that the Company is able to access. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.
Level 2 - Valuations based on quoted prices in active markets for instruments that are similar, or quoted prices in markets that are not active for identical or similar instruments, and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.
Level 3 - Valuations based on inputs that are unobservable and significant to the overall fair value measurement.

The financial assets for which the Company performs recurring fair value remeasurements are cash equivalents and short-term investments. As of December 25, 2011 , financial assets utilizing Level 1 inputs included money market funds and investments traded on active securities exchanges. Financial assets utilizing Level 2 inputs included certificates of deposit, corporate bonds, commercial paper, municipal bonds and variable rate demand notes, and U.S. agency securities and non-U.S. government securities. Level 2 assets are valued using a third-party pricing services consensus price which is a weighted average price based on multiple sources. These sources determine prices utilizing market income models which factor in, where applicable, transactions of similar assets in active markets, transactions of identical assets in infrequent markets, interest rates, bond or credit default swap spreads and volatility. The Company does not have any significant financial assets requiring the use of Level 3 inputs. There were no transfers between Level 1 and Level 2 during the six months ended December 25, 2011 .
The following table sets forth financial instruments carried at fair value within the U.S. GAAP hierarchy and using the lowest level of input (in thousands):
 
 
December 25, 2011
 
June 26, 2011
 
 Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash equivalents
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
$
5,711

 
$

 
$

 
$
5,711

 
$
7,386

 
$

 
$

 
$
7,386

Total cash equivalents
5,711

 

 

 
5,711

 
7,386

 

 

 
7,386

Short-term investments
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Municipal bonds

 
199,341

 

 
199,341

 

 
395,398

 

 
395,398

Corporate bonds

 
169,492

 

 
169,492

 

 
209,438

 

 
209,438

Municipal variable rate demand notes

 
2,795

 

 
2,795

 

 
295

 

 
295

Certificates of deposit

 
68,004

 

 
68,004

 

 
10,015

 

 
10,015

Commercial paper

 
2,149

 

 
2,149

 

 
4,999

 

 
4,999

U.S. agency securities

 
72,803

 

 
72,803

 

 
68,049

 

 
68,049

Non-U.S. government securities

 
1,011

 

 
1,011

 

 
7,005

 

 
7,005

Total short-term investments

 
515,595

 

 
515,595

 

 
695,199

 

 
695,199

Total assets
$
5,711

 
$
515,595

 
$

 
$
521,306

 
$
7,386

 
$
695,199

 
$

 
$
702,585

The Company utilizes specific identification in computing realized gains and losses on the sale of investments. Realized gains from the sale of investments for the six months ended December 25, 2011 of approximately $1.0 million are included in “Other non-operating (loss) income, net” and unrealized gains and losses are included as a separate component of equity, net of tax, unless the loss is determined to be “other-than-temporary.”
The Company evaluates its investments for possible impairment or a decline in fair value below cost basis that is deemed to be “other-than-temporary” on a periodic basis. It considers such factors as the length of time and extent to which fair value has been below cost basis, the financial condition of the investee, and its ability and intent to hold the investment for a period of time that may be sufficient for an anticipated recovery in market value.


14

Table of Contents

Note 6.    Intangible Assets
Intangible Assets, net
The following table reflects the components of intangible assets, net (in thousands):
 
 
December 25,
2011
 
June 26,
2011
Customer relationships
$
137,440

 
$
52,620

Developed technology
148,160

 
51,860

In-process research and development
15,050

 

Non-compete agreements
9,800

 

Patent and license rights
174,454

 
83,884


$
484,904

 
$
188,364

Accumulated amortization
(99,420
)
 
(85,504
)
Intangible assets, net
$
385,484

 
$
102,860

Total amortization expense, including the amortization of acquisition related intangibles, patents and license rights, recognized during the three and six months ended December 25, 2011 was $8.8 and $14.1 million , respectively. For the three and six months ended December 26, 2010 , total amortization expense, including amortization of acquisition related intangibles, patents and license rights was $3.8 and $7.6 million , respectively.
Total annual amortization expense of intangible assets is estimated to be as follows (in thousands):
Fiscal Year Ending
 
June 24, 2012
$
31,452

June 30, 2013
33,955

June 29, 2014
31,802

June 28, 2015
28,715

June 26, 2016
28,533

Goodwill
Goodwill increased by $291.8 million during the six months ended December 25, 2011 due to the acquisition of Ruud Lighting. Refer to “Note 2. Acquisitions” for the calculation of total goodwill recognized on the purchase.

Note 7.    Shareholders’ Equity
In connection with the acquisition of Ruud Lighting, the Company issued 6.1 million shares of common stock valued at approximately $211.0 million . The shares are subject to certain transfer restrictions under the Stock Purchase Agreement that will generally lapse with respect to 25% of the shares held (i) at the completion of the consecutive six-month period following the date of the closing of the transaction; and, (ii) at the completion of each of the following three successive six-month periods, such that all restrictions will lapse by the second anniversary of the closing.
As of December 25, 2011 , the Company is authorized to repurchase shares of its common stock having an aggregate purchase price not exceeding $200.0 million for all purchases from June 16, 2011 through the expiration of the program, as authorized by the Board of Directors and extended through June 24, 2012 . During the six months ended December 25, 2011 , the Company did not repurchase any shares under the repurchase program.

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Table of Contents

The following presents a summary of activity in comprehensive income, net (in thousands):  
 
Three Months Ended
 
Six Months Ended
 
December 25,
2011
 
December 26,
2010
 
December 25,
2011
 
December 26,
2010
Net income
$
12,078

 
$
49,775

 
$
24,897

 
$
107,811

Other comprehensive income:
 
 
 
 

 

Net unrealized loss on available-for-sale securities, net of tax benefit of $544, $1,177, $1,206 and $611 respectively
(899
)
 
(1,945
)
 
(1,991
)
 
(1,010
)
Currency Translation Loss
(1,103
)
 

 
(583
)
 

Comprehensive income
$
10,076

 
$
47,830

 
$
22,323

 
$
106,801


For the six months ended December 25, 2011 approximately $1.0 million of unrealized gains were reclassified out of accumulated other comprehensive income into earnings for the period, and are included in "Other non-operating (loss) income, net" in the Consolidated Statements of Income.

Note 8.    Earnings Per Share
The following presents the computation of basic earnings per share (in thousands, except per share data):
 
Three Months Ended
 
Six Months Ended
 
December 25,
2011
 
December 26,
2010
 
December 25,
2011
 
December 26,
2010
Basic:
 
 
 
 
 
Net income
$
12,078

 
$
49,775

 
$
24,897

 
$
107,811

Weighted average common shares
115,536

 
108,364

 
113,701

 
108,032

Basic earnings per share
$
0.10

 
$
0.46

 
$
0.22

 
$
1.00

The following computation reconciles the differences between the basic and diluted earnings per share presentations (in thousands, except per share data):  
 
Three Months Ended
 
Six Months Ended
 
December 25,
2011
 
December 26,
2010
 
December 25,
2011
 
December 26,
2010
Diluted:
 
 
 
 
 
 
 
Net income
$
12,078

 
$
49,775

 
$
24,897

 
$
107,811

Weighted average common shares - basic
115,536

 
108,364

 
113,701

 
108,032

Dilutive effect of stock options, unvested shares and ESPP purchase rights
347

 
1,612

 
538

 
1,785

Weighted average common shares - diluted
115,883

 
109,976

 
114,239

 
109,817

Diluted earnings per share
$
0.10

 
$
0.45

 
$
0.22

 
$
0.98

Potential common shares that would have the effect of increasing diluted earnings per share are considered to be antidilutive. In accordance with U.S. GAAP, these shares were not included in calculating diluted earnings per share. For the three and six months ended December 25, 2011 , there were 8.1 and 6.6 million shares, respectively, not included in calculating diluted earnings per share because their effect was antidilutive. For three and six months ended December 26, 2010 , there were 2.3 and 1.6 million shares, respectively, not included in calculating diluted earnings per share because their effect was antidilutive.

Note 9.  Stock-Based Compensation
The Company currently has one equity-based compensation plan from which stock-based compensation awards can be granted to employees and directors. In addition, the Company has plans that have been terminated as to future grants, but under which options are currently outstanding. The Company also has an Employee Stock Purchase Plan ("ESPP") that provides employees with the opportunity to purchase the Company’s common stock at a discount. The ESPP was amended in the second quarter of fiscal 2012 to increase the six-month participation period to a twelve-month participation period, divided into two equal six-month purchase periods and provide for a look-back feature. At the end of each six-month period, employees purchase the

16

Table of Contents

Company's common stock through the ESPP at 15% less than the fair market value of the common stock on the first day of the twelve-month participation period or the purchase date, whichever is lower. The plan amendment also provides for an automatic reset feature to start participants on a new twelve-month participation period if the share value declines during the first six-month purchase period.
Stock Option Awards
The following table summarizes outstanding option awards as of December 25, 2011 , and changes during the six months then ended (shares in thousands):  
 
Number of Shares
 
Weighted-Average Exercise Price
Outstanding at June 26, 2011
6,467

 
$
39.56

Granted
2,920

 
30.74

Exercised
(112
)
 
23.64

Forfeited or expired
(311
)
 
39.83

Outstanding at December 25, 2011
8,964

 
$
36.88

Restricted Stock and Stock Unit Awards
A summary of nonvested shares of restricted stock and stock unit awards outstanding under the Company’s 2004 Long-Term Incentive Compensation Plan as of December 25, 2011 , and changes during the six months then ended, follows (shares in thousands):
 
Number of
  Shares/Units  
 
Weighted-
Average Grant-
Date Fair
Value
Nonvested at June 26, 2011
509

 
$
40.87

Granted
227

 
30.97

Vested
(177
)
 
38.29

Forfeited
(28
)
 
35.37

Nonvested at December 25, 2011
531

 
$
37.79

Stock-Based Compensation Valuation and Expense

The Company accounts for its employee stock-based compensation plan using the fair value method. The fair value method requires the Company to estimate the grant date fair value of its stock-based awards and amortize this fair value to compensation expense over the requisite service period or vesting term.

To estimate the fair value of the Company's stock option awards the Company currently uses the Black-Scholes option-pricing model. The determination of the fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by the Company's stock price as well as assumptions regarding a number of complex and subjective variables. These variables include the expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends. Due to the inherent limitations of option-valuation models available today, including future events that are unpredictable and the estimation process utilized in determining the valuation of the stock-based awards, the ultimate value realized by award holders may vary significantly from the amounts expensed in the Company's financial statements.

For restricted stock and stock unit awards, grant date fair value is based upon the market price of the Company's common stock on the date of the grant. This fair value is then amortized to compensation expense over the requisite service period or vesting term.


17

Table of Contents

Stock-based compensation expense is recorded net of estimated forfeitures such that expense is recorded only for those stock-based awards that are expected to vest. A forfeiture rate is estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from initial estimates.Total stock-based compensation expense was as follows (in thousands):
 
Three Months Ended
 
Six Months Ended
Income Statement Classification
December 25,
2011
 
December 26,
2010
 
December 25,
2011
 
December 26,
2010
Cost of goods sold
$
1,615

 
$
1,351

 
$
3,329

 
$
2,483

Research and development
2,603

 
2,183

 
5,031

 
3,998

Sales, general and administrative
6,977

 
6,443

 
14,275

 
11,500

Total operating expenses
9,580

 
8,626

 
19,306

 
15,498

Total
$
11,195

 
$
9,977

 
$
22,635

 
$
17,981


Note 10.  Income Taxes
The variation between the Company’s effective income tax rate and the U.S. statutory rate of 35 percent is primarily due to the consolidation of its foreign operations, which are subject to income taxes at lower statutory rates. A change in the mix of pretax income from these various tax jurisdictions can have a significant impact on the Company’s periodic effective tax rate.

Under U.S. GAAP, a two-step approach is followed to recognize and measure uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is cumulatively more than 50 percent likely to be realized upon ultimate settlement.
At June 26, 2011 , the Company had recorded $7.0 million of unrecognized tax benefits. During the six months ended December 25, 2011 , there were no changes to that amount of recognized tax benefits. As a result, the total amount of unrecognized tax benefits as of December 25, 2011 is $7.0 million . If any portion of this $7.0 million is recognized, the Company will then include that portion in the computation of its effective tax rate. Although the ultimate timing of the resolution and/or closure of audits is highly uncertain, the Company believes it is reasonably possible that approximately $2.6 million of gross unrecognized tax benefits will change in the next 12 months.
The Company’s policy is to include interest and penalties related to unrecognized tax benefits within the income tax expense line item in the consolidated statements of income. As of December 25, 2011 , the Company had accrued $58 thousand of interest and penalties.
The Company files U.S. federal, U.S. state, and foreign tax returns. For U.S. federal purposes, the Company is generally no longer subject to tax examinations for fiscal years ended June 29, 2008 and prior. For foreign purposes, the Company is generally no longer subject to examination for tax periods 2001 and prior. Certain carryforward tax attributes generated in prior years remain subject to examination and adjustment. For U.S. state tax returns, the Company is generally no longer subject to tax examinations for fiscal years prior to 2008 . The Company is currently under examination by the Internal Revenue Service for fiscal 2009. The Company is also currently under inquiry by the Hong Kong Inland Revenue Department for fiscal 2008 and fiscal 2010 .

Note 11.    Commitments and Contingencies
Warranties
The following table summarizes the changes in the Company's product warranty liabilities (in thousands):
Balance at September 25, 2011
$
3,860

Measurement period acquisition related warranty (See Note 2)
3,023

Warranties accrued in current period
323

Changes in estimates for pre-existing warranties
(400
)
Expenditures
(958
)
Balance at December 25, 2011
$
5,848


18

Table of Contents

Product warranties are provided for at the time the Company recognizes revenue. The warranty periods range from ninety days to ten years. The Company estimates these warranty liabilities as a percentage of revenue, based on historical knowledge of warranty costs and expected future warranty costs. If actual product failure rates materially differ from these estimates, revisions to the estimated warranty liability would be required. The Company evaluates its warranty reserve on a quarterly basis.

Litigation

The Company is a party to various legal proceedings. Information regarding material legal proceedings is contained in our Annual Report on Form 10-K for the year ended June 26, 2011 , and updates to that disclosure, including with respect to the proceedings discussed below, are contained in our Quarterly Report on Form 10-Q for the quarter ended September 25, 2011 . The following is provided as an update to the Company's legal proceedings as contained in those reports. Unless otherwise indicated, the potential losses for claims against the Company in these matters are not reasonably estimable.

Dow Corning Litigation
As previously reported, Dow Corning Compound Semiconductor Solutions, LLC filed a complaint against the Company in the U.S. District Court for the Eastern District of Michigan on September 27, 2011. The complaint, as subsequently amended, seeks a declaratory judgment that the plaintiff does not infringe three U.S. patents owned by the Company relating to high quality silicon carbide materials and that the patents are invalid. The Company has moved the court to dismiss the action for lack of subject matter jurisdiction on the grounds that at the time the complaint was filed there was no substantial or immediate controversy between the parties regarding the patents-in-suit.

Osram Sylvania and Lighting Science Group Litigation
As previously reported, Ruud Lighting, Inc. filed a complaint for patent infringement against Osram Sylvania, Inc. in the U.S. District Court for the Eastern District of Wisconsin on April 2, 2010 and Lighting Science Group Corporation intervened as a co-defendant in the action. In November 2011, the action was voluntarily dismissed without prejudice pursuant to a joint stipulation of the parties.

Cooper Lighting Litigation
As previously reported, Illumination Management Solutions, Inc., a subsidiary of Cooper Lighting, LLC, filed a complaint for patent infringement against Ruud Lighting in the U.S. District Court for the Eastern District of Texas on June 7, 2010. The action was later transferred to the U.S. District Court for the Eastern District of Wisconsin. As amended in January 2012, the complaint alleges that Ruud Lighting is infringing two U.S. patents owned by Illumination Management Solutions, No. 7,674,018 and No. 7,993,036, each entitled "LED Device for Wide Beam Generation." It also alleges that Ruud Lighting and its then president, Alan Ruud, who served on the plaintiff's board of directors in 2006 and 2007 when Ruud Lighting was a shareholder of the plaintiff, conspired to misuse confidential information obtained from the plaintiff to file patent applications and to obtain patents assigned to Ruud Lighting. The complaint seeks injunctive relief, damages and ownership of any interest in the patent applications and patents alleged to have been wrongfully filed and obtained.

As also previously reported, Ruud Lighting is a defendant in an action commenced by Illumination Management Solutions in the U.S. District Court for the Central District of California on June 8, 2010 and later transferred to the U.S. District Court for the Eastern District of Wisconsin. As amended in December 2011, the complaint names as defendants Ruud Lighting and two of its employees, Alan Ruud and Christopher Ruud, and asserts that the defendants engaged in wrongful acts arising out of the relationship between the plaintiff and Ruud Lighting in 2006 and 2007 when Ruud Lighting was a shareholder of the plaintiff and Alan Ruud served on the plaintiff's board of directors. The complaint alleges that the defendants breached fiduciary duties and otherwise acted improperly by pursuing a plan to compete with the plaintiff and that the defendants misused trade secrets and other information obtained from the plaintiff as fiduciaries and subject to a non-disclosure agreement. These allegedly wrongful acts included filing patent applications and obtaining patents assigned to Ruud Lighting on inventions claimed by the plaintiff. The complaint also alleges that Ruud Lighting: (a) marketed its LED products without reference to certain optical technology claimed by the plaintiff, thereby breaching a marketing agreement with the plaintiff and engaging in unfair competition and false advertising; (b) breached the marketing agreement by failing to give the plaintiff a right of first refusal to integrate the plaintiff's optical technology into Ruud Lighting LED products; and (c) committed fraud by entering into the marketing agreement without any intention to perform it. The complaint further alleges that the plaintiff is entitled to a correction of the inventors named in one or more patents to add a founder of the plaintiff as an inventor. The complaint seeks to recover damages, all profits and other gains realized by defendants as a result of the acts complained of, attorneys' fees, ownership of any interest in the patent applications and patents alleged to have been wrongfully filed and obtained, and correction of the named inventors on one or more patents.

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Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations
Information set forth in this Quarterly Report on Form 10-Q contains various “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All information contained in this report relative to future markets for our products and trends in and anticipated levels of revenue, gross margins and expenses, as well as other statements containing words such as “believe,” “project,” “may,” “will,” “anticipate,” “target,” “plan,” “estimate,” “expect” and “intend” and other similar expressions constitute forward-looking statements. These forward-looking statements are subject to business, economic and other risks and uncertainties, both known and unknown, and actual results may differ materially from those contained in the forward-looking statements. Any forward-looking statements we make are as of the date made and we have no duty to update them if our views later change. These forward-looking statements should not be relied upon as representing our views as of any date subsequent to the date of this Quarterly Report. Examples of risks and uncertainties that could cause actual results to differ materially from historical performance and any forward-looking statements include, but are not limited to, those described in “Risk Factors” in Part II, Item 1A of this Quarterly Report.
The following discussion is designed to provide a better understanding of our unaudited consolidated financial statements, including a brief discussion of our business and products, key factors that impacted our performance, and a summary of our operating results. The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q, and the consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended June 26, 2011 . Historical results and percentage relationships among any amounts in the financial statements are not necessarily indicative of trends in operating results for any future periods.

Overview

Cree, Inc. (Cree, we, our, or us) is a leading innovator of lighting-class light emitting diode (LED) products, lighting products and semiconductor products for power and radio-frequency (RF) applications. Our products are targeted for applications such as general illumination, video displays, automotive, electronic signs and signals, power supplies and solar inverters.

We develop and manufacture semiconductor materials and devices primarily based on silicon carbide (SiC), gallium nitride (GaN) and related compounds. The physical and electronic properties of SiC and GaN offer technical advantages over traditional silicon, gallium arsenide (GaAs), sapphire and other materials used for electronic and opto-electronic applications.

Our LED products consist of LED components, LED chips, and SiC wafers. As we develop and improve our LED technology and the market continues to focus on energy efficiency, we believe the potential market for LED lighting will continue to expand. Our success in selling LED products depends upon our ability to drive adoption and offer innovative products and solutions that enable our customers to succeed in the market. By driving adoption we believe we can influence the growth of the market and open more opportunities for LEDs.

Our lighting products consist of both LED and traditional lighting systems. We design, manufacture and sell lighting systems for indoor and outdoor applications, with our primary focus on LED lighting systems for the commercial and industrial markets. We also use our LED systems expertise to accelerate LED adoption and expand the market for our LED components.

In addition, we develop, manufacture and sell power and RF devices. Our power products are made from SiC and provide faster switching speeds than comparable silicon-based power devices. Our RF devices are made from SiC or GaN and produce higher power densities as compared to silicon or gallium arsenide devices.

The majority of our products are manufactured at our production facilities located in North Carolina, Wisconsin and China. We also use contract manufacturers for certain aspects of our products fabrication, packaging and assembly. We operate research and development facilities in North Carolina, California, Wisconsin and China.

We currently operate our business as one reportable segment.

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Industry Dynamics and Trends
There are a number of industry factors that affect our business which include, among others:
Overall Demand for Products and Applications using LEDs. Our potential for growth depends significantly on the adoption of LEDs within the general lighting market and our ability to affect this rate of adoption. Although LED lighting has grown in recent years, adoption of LEDs for general lighting is relatively new and faces

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significant challenges before widespread adoption. Demand also fluctuates based on various market cycles, a continuously evolving LED industry supply chain, and demand dynamics in the market. These uncertainties make demand difficult to forecast for us and our customers.
Intense and Constantly Evolving Competitive Environment. Competition in the industry is intense and new companies have entered and are entering the LED market, with many companies making significant investments in LED production equipment. Product pricing pressures exist as market participants often undertake pricing strategies to gain or protect market share and to increase the utilization of their production capacity. Currently, many LED suppliers are reporting excess or underutilized factory capacity which generally leads to a more aggressive pricing environment. To remain competitive, market participants must continuously increase product performance and reduce costs to offset lower average sales prices. To address this pricing pressure, we have invested in cost reduction activities including lower cost product designs, yield and productivity improvements, and the development of 150mm wafer production, which is intended to reduce our costs of producing LED chips. The effectiveness of these activities will vary based on overall factory utilization rates, which are driven primarily by market demand.
Technological Innovation and Advancement. Innovations and advancements in LED technology continue to expand the potential commercial application of LEDs particularly in the general illumination market. However, new technologies or standards could emerge, or improvements could be made in existing technologies, that reduce or limit the demand for LEDs in certain markets.
Regulatory Actions Concerning Energy Efficiency. Many countries have already instituted or have announced plans to institute government regulations and programs designed to encourage or mandate increased energy efficiency, even in some cases banning forms of incandescent lighting, which are advancing the adoption of more energy efficient lighting solutions such as LEDs. While this trend is generally positive, there have been some political efforts in the United States to change or limit the effectiveness of these new regulations.
Intellectual Property Issues. Market participants rely on patented and non-patented proprietary information relating to product development, manufacturing capabilities and other core competencies of their business. Protection of intellectual property is critical. Therefore, steps such as additional patent applications, confidentiality and non-disclosure agreements, as well as other security measures are generally taken. To enforce or protect intellectual property rights, litigation or threatened litigation commonly occurs.

Highlights of the Second Quarter Fiscal 2012
The following is a summary of our financial results for the three months ended December 25, 2011 :
Our year over year revenues increased to $304.1 million from $257.0 million .
Operating income was $12.2 million in the second quarter of fiscal 2012 compared to $55.4 million in the second quarter of fiscal 2011 . Net income per diluted share was $0.10 compared to $0.45 for the second quarter of fiscal 2011 ;
Inventory decreased to $187.4 million at December 25, 2011 compared to $203.6 million at September 25, 2011 ;
We spent $53.0 million on capital expenditures during the six months ended December 25, 2011 compared to $126.4 million during the six months ended December 26, 2010 ; and
Combined cash, cash equivalents and marketable investments increased to $687.2 million at December 25, 2011  compared to $632.2 million at September 25, 2011 .

Business Outlook

We project that the markets for our products will remain highly competitive during the remainder of fiscal 2012 . We anticipate focusing on the following key areas in response to this competitive environment:
Build on our market leadership and drive adoption of LED lighting. We are focused on developing innovative new LED lighting systems to drive adoption, and new LED components that enable our customers to deliver a more competitive payback versus traditional lighting. In August 2011, we acquired Ruud Lighting, a leading innovator of LED lighting products, which we believe gives us a stronger product portfolio to drive LED adoption and expand the market for LED lighting. We plan to continue to invest in both our LED lighting and LED component product lines to increase performance, enable lower lighting system costs with shorter paybacks and find new ways to drive the market and o

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bsolete old, energy-wasting lighting technology.
A ccelerate cost reductions and drive operational improvements to increase the profitability of our business. We target lower LED costs from new lower cost product designs, yield and productivity improvements and the conversion

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to 150mm wafers. In the near term, cost reductions may be offset by the aggressive pricing environment and low factory utilization. It will take time and increased volume to fully realize the benefit of many of these improvements. We are also delaying the rate of conversion to 150mm wafer production to take advantage of existing 100mm capacity to optimize the current factory to deliver the lowest cost in the near term. We are continuing work to enable the full conversion as business needs warrant over the next three to six quarters. We plan to lower LED lighting system costs with new product designs that are under development and we target improved operating leverage over time from higher revenues across our LED lighting systems and component product lines.
Expand the power and RF product line beyond niche applications. SiC power devices can deliver better performance and increased payback against silicon (Si) based power devices in applications where efficiency and reliability is an important criteria. We target continued investment in R&D for new diode and switch products focused on more mainstream and higher volume power switching applications. We are managing the product line through a slowdown in solar inverter demand. We target the combination of new products, improved market demand and expanded sales coverage to drive growth in the product line.
Results of Operations
The following table sets forth certain consolidated statement of income data for the periods indicated:
 
 
Three Months Ended
 
Six Months Ended
 
December 25,
2011
 
December 26,
2010
 
December 25,
2011
 
December 26,
2010
(in thousands, except per share amounts and percentages)
Dollars
 
% of Revenue
 
Dollars
 
% of Revenue
 
Dollars
 
% of Revenue
 
Dollars
 
% of Revenue
Revenue, net
$
304,118

 
100
 %
 
$
256,983

 
100
%
 
$
573,098

 
100
%
 
$
525,420

 
100
%
Cost of revenue, net
199,000

 
65
 %
 
135,837

 
53
%
 
369,952

 
65
%
 
273,745

 
52
%
Gross profit
105,118

 
35
 %
 
121,146

 
47
%
 
203,146

 
35
%
 
251,675

 
48
%
Research and development
35,886

 
12
 %
 
29,233

 
11
%
 
70,288

 
12
%
 
53,965

 
10
%
Sales, general and administrative
49,176

 
16
 %
 
33,366

 
13
%
 
94,715

 
17
%
 
62,568

 
12
%
Amortization of acquisition related intangibles
7,367

 
2
 %
 
2,706

 
1
%
 
11,292

 
2
%
 
5,412

 
1
%
Loss on disposal or impairment of long-lived assets
497

 
 %
 
429

 
%
 
1,272

 
%
 
901

 
%
Operating income
12,192

 
4
 %
 
55,412

 
22
%
 
25,579

 
4
%
 
128,829

 
25
%
Other non-operating (loss) income, net
(111
)
 
 %
 
63

 
%
 
863

 
%
 
1

 
%
Interest income, net
1,800

 
1
 %
 
2,170

 
1
%
 
3,769

 
1
%
 
4,186

 
1
%
Income from operations before income taxes
13,881

 
5
 %
 
57,645

 
22
%
 
30,211

 
5
%
 
133,016

 
25
%
Income tax expense
1,803

 
1
 %
 
7,870

 
3
%
 
5,314

 
1
%
 
25,205

 
5
%
Net income
12,078

 
4
 %
 
49,775

 
19
%
 
24,897

 
4
%
 
107,811

 
21
%
Diluted earnings per share
$
0.10

 
 
 
$
0.45

 
 
 
$
0.22

 
 
 
$
0.98

 
 

Revenues

Our revenues are presented below in the following categories: LED products, lighting products and power and RF products, which represents a change from our prior presentation. Revenues for the three and six months ended December 25, 2011 and December 26, 2010 were comprised of the following (in thousands, except percentages):
 

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Three Months Ended
 
Six Months Ended
 
December 25,
2011
 
December 26,
2010
 
Change
 
December 25,
2011
 
December 26,
2010
 
Change
LED products
$
194,162

 
$
209,984

 
$
(15,822
)
 
(8
)%
 
$
390,940

 
$
438,749

 
$
(47,809
)
 
(11
)%
Percent of revenues
64
%
 
81
%
 


 


 
68
%
 
83
%
 

 

Lighting products
95,736

 
19,715

 
76,021

 
386
 %
 
147,409

 
35,316

 
112,093

 
317
 %
Percent of revenues
31
%
 
8
%
 


 


 
26
%
 
7
%
 

 

Power and RF products
14,220

 
27,284

 
(13,064
)
 
(48
)%
 
34,749

 
51,355

 
(16,606
)
 
(32
)%
Percent of revenues
5
%
 
11
%
 


 


 
6
%
 
10
%
 

 

Total revenues
$
304,118

 
$
256,983

 
$
47,135

 
18
 %
 
$
573,098

 
$
525,420

 
$
47,678

 
9
 %
LED Products
We derive the largest portion of our revenue from the sale of our LED products which comprised approximately 64% and 81% of our total revenues for the second quarter of fiscal 2012 and fiscal 2011 , respectively.
    
Revenue from LED products decreased approximately 8% to $194.2 million in the second quarter of fiscal 2012 from $210.0 million in the second quarter of fiscal 2011 . For the six months ended December 25, 2011 , revenue from our LED products decreased approximately 11% to $390.9 million from $438.7 million for the six months ended December 26, 2010 . These decreases were primarily due to generally weaker demand and downward pricing pressure. Although the blended average selling price (ASP) for our LED chips decreased, the ASP for our LED products overall increased by 22.4% in the second quarter of fiscal 2012 compared to the second quarter of fiscal 2011 . This increase was primarily due to a higher product mix of LED components, which have a higher ASP.
Lighting Products
Revenues from lighting products comprised approximately 31% and 8% of our total revenues for the second quarter of fiscal 2012 and fiscal 2011 , respectively.

Revenue from lighting products increased approximately 386% to $95.7 million in the second quarter of fiscal 2012 from $19.7 million in the second quarter of fiscal 2011 . For the six months ended December 25, 2011 , revenue from our lighting products increased approximately 317% to $147.4 million from $35.3 million for the six months ended December 26, 2010 . These increases were due to an increase in the sales of our existing products and sales of product offerings acquired from Ruud Lighting. The ASP for our lighting products increased by 24.9% in the second quarter of fiscal 2012 compared to the second quarter of fiscal 2011 .
Power and RF Products
Revenues from power and RF products comprised approximately 5% and 11% of our total revenues for the second quarter of fiscal 2012 and fiscal 2011 , respectively.

Revenue from power and RF decreased approximately 48% to $14.2 million in the second quarter of fiscal 2012 from $27.3 million in the second quarter of fiscal 2011 . For the six months ended December 25, 2011 , revenue from our power and RF products decreased approximately 32% to $34.7 million from $51.4 million for the six months ended December 26, 2010 . The decreases in our power and RF products revenue were primarily due to a lower demand in the solar inverter markets and the delay of RF orders related to military programs. The ASP for our power and RF products decreased by 7.6% in the second quarter of fiscal 2012 compared to the second quarter of fiscal 2011 .

Gross Profit
Cost of revenue includes materials, labor and overhead costs incurred internally or paid to contract manufacturers to produce our products. Gross profit in dollars and gross margin were as follows (in thousands, except percentages):
 
 
Three Months Ended
 
Six Months Ended
 
December 25,
2011
 
December 26,
2010