Cree, Inc.
CREE INC (Form: 10-Q, Received: 04/23/2014 16:19:52)
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 March 30, 2014
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 April 16, 2014 , was 121,938,248 .


Table of Contents

CREE, INC.
FORM 10-Q
For the Quarterly Period Ended March 30, 2014
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.
 
 

2

Table of Contents


PART I - FINANCIAL INFORMATION
Item 1.    Financial Statements
CREE, INC.
CONSOLIDATED BALANCE SHEETS
 
March 30,
2014
 
June 30,
2013
 
(unaudited)
 
 
(In thousands, except par value)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents

$268,838

 

$190,069

Short-term investments
954,573

 
833,846

Total cash, cash equivalents and short-term investments
1,223,411

 
1,023,915

Accounts receivable, net
222,333

 
192,507

Inventories
251,234

 
197,001

Deferred income taxes
25,740

 
26,125

Prepaid expenses and other current assets
59,352

 
76,218

Total current assets
1,782,070

 
1,515,766

Property and equipment, net
575,945

 
542,833

Intangible assets, net
343,647

 
357,525

Goodwill
616,345

 
616,345

Other assets
45,041

 
19,941

Total assets

$3,363,048

 

$3,052,410

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

Current liabilities:

 

Accounts payable, trade

$159,230

 

$121,441

Accrued salaries and wages
44,030

 
41,407

Income taxes payable
16,060

 
1,315

Other current liabilities
44,400

 
43,248

Total current liabilities
263,720

 
207,411

Long-term liabilities:

 

Deferred income taxes
27,249

 
25,504

Other long-term liabilities
40,691

 
12,843

Total long-term liabilities
67,940

 
38,347

Commitments and contingencies (Note 11)

 

Shareholders’ equity:

 

Preferred stock, par value $0.01; 3,000 shares authorized at March 30, 2014 and June 30, 2013; none issued and outstanding

 

Common stock, par value $0.00125; 200,000 shares authorized at March 30, 2014 and June 30, 2013; 121,930 and 119,623 shares issued and outstanding at March 30, 2014 and June 30, 2013, respectively
151

 
148

Additional paid-in-capital
2,162,798

 
2,025,764

Accumulated other comprehensive income, net of taxes
10,117

 
8,244

Retained earnings
858,322

 
772,496

Total shareholders’ equity
3,031,388

 
2,806,652

Total liabilities and shareholders’ equity

$3,363,048

 

$3,052,410

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

3

Table of Contents

CREE, INC.
(UNAUDITED)
CONSOLIDATED STATEMENTS OF INCOME
 
 
Three Months Ended
 
Nine Months Ended
 
March 30,
2014
 
March 31,
2013
 
March 30,
2014
 
March 31,
2013
 
(In thousands, except per share amounts)
Revenue, net

$405,259

 

$348,934

 

$1,211,351

 

$1,010,973

Cost of revenue, net
255,265

 
215,924

 
754,822

 
628,438

Gross profit
149,994

 
133,010

 
456,529

 
382,535

Operating expenses:
 
 
 
 

 

Research and development
46,626

 
39,036

 
132,805

 
116,524

Sales, general and administrative
65,368

 
62,140

 
197,589

 
174,885

Amortization of acquisition-related intangibles
7,257

 
7,719

 
21,800

 
23,108

Loss on disposal or impairment of long-lived assets
364

 
863

 
1,781

 
2,385

Total operating expenses
119,615

 
109,758

 
353,975

 
316,902

Operating income
30,379

 
23,252

 
102,554

 
65,633

Non-operating income, net
3,152

 
2,512

 
9,373

 
8,378

Income before income taxes
33,531

 
25,764

 
111,927

 
74,011

Income tax expense
5,367

 
3,607

 
17,585

 
15,328

Net income

$28,164

 

$22,157

 

$94,342

 

$58,683

Earnings per share:
 
 
 
 

 

Basic

$0.23

 

$0.19

 

$0.78

 

$0.51

Diluted

$0.23

 

$0.19

 

$0.77

 

$0.50

Weighted average shares used in per share calculation:
 
 
 
 

 

Basic
121,535

 
116,682

 
120,677

 
116,059

Diluted
123,695

 
118,608

 
123,140

 
116,768

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

4

Table of Contents

CREE, INC.
(UNAUDITED)
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 
Three Months Ended
 
Nine Months Ended
 
March 30,
2014
 
March 31,
2013
 
March 30,
2014
 
March 31,
2013
 
(In thousands)
Net income

$28,164

 

$22,157

 

$94,342

 

$58,683

Other comprehensive income:
 
 
 
 
 
 
 
Currency translation (loss) gain, net of tax benefit (expense) of $0, $90, $0 and ($1), respectively
(163
)
 
(145
)
 
(28
)
 
5

Net unrealized gain (loss) on available-for-sale securities, net of tax (expense) of ($126), ($75), ($1,191) and ($22), respectively
191

 
67

 
1,901

 
(17
)
Other comprehensive income (loss)
28

 
(78
)
 
1,873

 
(12
)
Comprehensive income

$28,192

 

$22,079

 

$96,215

 

$58,671

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


5

Table of Contents

CREE, INC.
(UNAUDITED)
CONSOLIDATED STATEMENTS OF CASH FLOWS

 
Nine Months Ended
 
March 30,
2014
 
March 31,
2013
 
(In thousands)
Cash flows from operating activities:
 
 
 
Net income

$94,342

 

$58,683

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
120,219

 
114,370

Stock-based compensation
46,261

 
40,945

Excess tax benefit from share-based payment arrangements
(18,396
)
 
(3,636
)
Loss on disposal or impairment of long-lived assets
1,781

 
2,385

Amortization of premium/discount on investments
7,674

 
7,075

Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net
(29,829
)
 
(29,624
)
Inventories
(53,511
)
 
(6,866
)
Prepaid expenses and other assets
13,008

 
(6,472
)
Accounts payable, trade
29,016

 
33,495

Accrued salaries and wages and other liabilities
17,605

 
13,715

Net cash provided by operating activities
228,170

 
224,070

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(119,614
)
 
(55,406
)
Purchases of available-for-sale investments
(510,401
)
 
(533,884
)
Proceeds from maturities of available-for-sale investments
365,005

 
297,740

Proceeds from sale of property and equipment
117

 
301

Proceeds from sale of available-for-sale investments
22,387

 
36,089

Purchases of patent and licensing rights
(14,755
)
 
(15,794
)
Net cash used in investing activities
(257,261
)
 
(270,954
)
Cash flows from financing activities:
 
 
 
Net proceeds from issuance of common stock
89,476

 
43,352

Excess tax benefit from share-based payment arrangements
18,396

 
3,636

Repurchases of common stock
(107
)
 
(638
)
Net cash provided by financing activities
107,765

 
46,350

Effects of foreign exchange changes on cash and cash equivalents
95

 
87

Net increase (decrease) in cash and cash equivalents
78,769

 
(447
)
Cash and cash equivalents:
 
 
 
Beginning of period
190,069

 
178,885

End of period

$268,838

 

$178,438

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

6

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 indoor and outdoor lighting, video displays, transportation, electronic signs and signals, power supplies, inverters and wireless systems.
The Company develops and manufactures semiconductor materials and devices primarily based on silicon carbide (SiC), gallium nitride (GaN) and related compounds. In many cases, the properties of SiC and GaN offer technical advantages over traditional silicon, gallium arsenide (GaAs) and other materials used for electronic applications.
The Company's LED products consist of LED components, LED chips and SiC materials. The Company's success in selling LED products depends upon its ability to offer innovative products and to enable its customers to develop and market LED-based products that successfully compete against other LED-based products and drive LED adoption against traditional lighting products.
The Company's lighting products primarily consist of LED lighting systems. The Company designs, manufactures and sells lighting fixtures and lamps for the commercial, industrial and consumer markets.
In addition, the Company develops, manufactures and sells power and RF devices. The Company's power products are made from SiC and provide increased efficiency, faster switching speeds and reduced system size and weight over comparable silicon-based power devices. The Company's RF devices are made from GaN and provide improved efficiency, bandwidth and frequency of operation as compared to silicon or GaAs.
The majority of the Company's products are manufactured at its production facilities located in North Carolina, Wisconsin and China. The Company also uses contract manufacturers for certain aspects of product fabrication, assembly and packaging. The Company operates research and development facilities in North Carolina, California, Wisconsin, India and China (including Hong Kong).

Cree, Inc. is a North Carolina corporation established in 1987 and is headquartered in Durham, North Carolina.
As of March 30, 2014 , the Company has three reportable segments:
LED Products
Lighting Products
Power and RF Products

For financial results by reportable segment, please refer to Note 12 "Reportable Segments."
Basis of Presentation
The consolidated balance sheet at March 30, 2014 , the consolidated statements of income for the three and nine months ended March 30, 2014 and March 31, 2013 , the consolidated statements of comprehensive income for the three and nine months ended March 30, 2014 and March 31, 2013 , and the consolidated statements of cash flows for the nine months ended March 30, 2014 and March 31, 2013 (collectively, the 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 March 30, 2014 , and for all periods presented, have been made. All intercompany accounts and transactions have been eliminated. The consolidated balance sheet at June 30, 2013 has been derived from the audited financial statements as of that date. The nine month period ended March 30, 2014 includes one less week as compared to the nine month period ended March 31, 2013 .
Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) have been condensed or omitted pursuant to such rules and regulations. These financial statements should 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 30, 2013 (fiscal 2013 ).

7


The results of operations for the three and nine months ended March 30, 2014 are not necessarily indicative of the operating results that may be attained for the entire fiscal year ending June 29, 2014 (fiscal 2014 ).
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities. Actual amounts could differ materially from those estimates.
Certain fiscal 2013 amounts in the accompanying consolidated financial statements have been reclassified to conform to the fiscal 2014 presentation. These reclassifications had no effect on previously reported consolidated net income or shareholders’ equity.

New Accounting Standards

Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward or Tax Credit Carryforward Exists

In July 2013, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward or Tax Credit Carryforward Exists. The ASU provides guidance regarding the presentation in the statement of financial position of an unrecognized tax benefit when a net operating loss carryforward or a tax credit carryfoward exists. The ASU generally provides that an entity's unrecognized tax benefit, or a portion of its unrecognized tax benefit, should be presented in its financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. The ASU applies prospectively to all entities that have unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists at the reporting date, and is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The Company early adopted this guidance beginning with the first quarter of fiscal 2014. The Company's adoption of this guidance did not have a significant impact on its consolidated financial statements.
Note 2.    Acquisitions
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 valued at approximately $211.0 million and $372.2 million cash, subject to certain post-closing adjustments. Following the acquisition, the Company recorded certain post-closing purchase price adjustments resulting in a $2.3 million reduction to the purchase price and a total purchase price of approximately $666.0 million . See Note 11 “Commitments and Contingencies” for a discussion of the amounts received from the Stock Purchase Agreement escrow funds. The acquisition allowed the Company to expand its product portfolio into outdoor LED lighting.
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 repaid Ruud Lighting's outstanding debt in the aggregate amount of approximately $85.0 million .
The assets, liabilities and operating results of Ruud Lighting have been included in the Lighting Products segment of the Company’s consolidated financial statements from the date of acquisition and are reflected in all periods presented in the accompanying unaudited consolidated financial statements.

8


Note 3.    Financial Statement Details
Accounts receivable, net
The following table summarizes the components of accounts receivable, net (in thousands):
 
March 30, 2014
 
June 30, 2013
Billed trade receivables

$254,274

 

$220,307

Unbilled contract receivables
1,427

 
1,171


255,701

 
221,478

Allowance for sales returns, discounts and other incentives
(31,111
)
 
(26,500
)
Allowance for bad debts
(2,257
)
 
(2,471
)
Total accounts receivable, net

$222,333

 

$192,507

Inventories
The following table summarizes the components of inventories (in thousands):
 
March 30, 2014
 
June 30, 2013
Raw material

$84,302

 

$62,253

Work-in-progress
81,846

 
68,146

Finished goods
85,086

 
66,602

Total inventories

$251,234

 

$197,001

Other current liabilities
The following table summarizes the components of other current liabilities (in thousands):
 
March 30, 2014
 
June 30, 2013
Accrued taxes

$17,812

 

$21,436

Accrued professional fees
7,390

 
4,493

Accrued warranty
5,602

 
5,259

Accrued other
13,596

 
12,060

Total other current liabilities

$44,400

 

$43,248

Accumulated other comprehensive income, net of taxes
The following table summarizes the components of accumulated other comprehensive income, net of taxes (in thousands):
 
March 30, 2014
 
June 30, 2013
Currency translation gain

$8,464

 

$8,492

Net unrealized gain (loss) on available-for-sale securities
1,653

 
(248
)
Total accumulated other comprehensive income, net of taxes

$10,117

 

$8,244


9


Non-operating income, net
The following table summarizes the components of non-operating income, net (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
March 30, 2014
 
March 31, 2013
 
March 30, 2014
 
March 31, 2013
Foreign currency (loss) gain, net

($368
)
 

$296

 

$109

 

$424

Gain on sale of investments, net
15

 
48

 
25

 
84

Interest income, net
3,415

 
2,018

 
8,562

 
5,756

Other, net
90

 
150

 
677

 
2,114

Total non-operating income, net

$3,152

 

$2,512

 

$9,373

 

$8,378

Reclassifications out of accumulated other comprehensive income
The following table summarizes the amounts reclassified out of accumulated other comprehensive income (in thousands):
Accumulated Other Comprehensive Income Component
 
Amount Reclassified from Accumulated Other Comprehensive Income
 
Affected Line Item in the Statement of Income
 
 
Three Months Ended
 
Nine Months Ended
 
 
 
 
March 30, 2014
 
March 31, 2013
 
March 30, 2014
 
March 31, 2013
 
 
Net unrealized gain on available-for-sale securities, net of tax expense
 

$15

 

$43

 

$25

 

$80

 
Non-operating income, net
 
 
15

 
43

 
25

 
80

 
Income before income taxes
 
 
2

 
6

 
4

 
17

 
Income tax expense
 
 

$13

 

$37

 

$21

 

$63

 
Net income
Note 4.    Investments
Short-term investments consist of municipal bonds, corporate bonds, U.S. agency securities, non-U.S. certificates of deposit and non-U.S. government securities. All marketable investments are classified as available-for-sale.

10


The following tables summarize marketable investments (in thousands):
 
 
March 30, 2014
 
 
Amortized    
Cost
 
Gross Unrealized    
Gains
 
Gross
Unrealized    
Losses
 
 Estimated Fair 
Value
Municipal bonds
 

$306,484

 

$1,598

 

($289
)
 

$307,793

Corporate bonds
 
227,500

 
1,742

 
(574
)
 
228,668

U.S. agency securities
 
27,095

 
189

 

 
27,284

Non-U.S. certificates of deposit
 
383,758

 

 

 
383,758

Non-U.S. government securities
 
7,045

 
25

 

 
7,070

Total
 

$951,882

 

$3,554

 

($863
)
 

$954,573

 
 
 
 
 
 
 
 
 
 
 
June 30, 2013
 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated Fair
Value
Municipal bonds
 

$250,206

 

$817

 

($1,314
)
 

$249,709

Corporate bonds
 
192,147

 
1,678

 
(1,765
)
 
192,060

U.S. agency securities
 
39,288

 
186

 

 
39,474

Non-U.S. certificates of deposit
 
345,000

 

 

 
345,000

Non-U.S. government securities
 
7,608

 
14

 
(19
)
 
7,603

Total
 

$834,249

 

$2,695

 

($3,098
)
 

$833,846

The following tables present the gross unrealized losses and estimated fair value of the Company's investment securities, aggregated by investment type and the length of time that individual investment securities have been in a continuous unrealized loss position (in thousands, except numbers of securities):
 
 
March 30, 2014
 
 
Less than 12 Months
 
Greater than 12 Months
 
Total
 
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
Municipal bonds
 

$61,656

 

($289
)
 

$—

 

$—

 

$61,656

 

($289
)
Corporate bonds
 
82,888

 
(536
)
 
1,979

 
(38
)
 
84,867

 
(574
)
Non-U.S. government securities
 

 

 

 

 

 

Total
 

$144,544

 

($825
)
 

$1,979

 

($38
)
 

$146,523

 

($863
)
Number of securities with an unrealized loss
 
 
 
71

 
 
 
1

 
 
 
72

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
June 30, 2013
 
 
Less than 12 Months
 
Greater than 12 Months
 
Total
 
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
Municipal bonds
 

$126,926

 

($1,314
)
 

$—

 

$—

 

$126,926

 

($1,314
)
Corporate bonds
 
102,010

 
(1,765
)
 

 

 
102,010

 
(1,765
)
Non-U.S. government securities
 
5,534

 
(19
)
 

 

 
5,534

 
(19
)
Total
 

$234,470

 

($3,098
)
 

$—

 

$—

 

$234,470

 

($3,098
)
Number of securities with an unrealized loss
 
 
 
123

 
 
 

 
 
 
123

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 nine months ended March 30, 2014 of $25 thousand were included in " Non-operating income,

11


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 the fair value has been below the 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 full recovery in market value. Accordingly, the Company considers declines in its securities to be temporary in nature, and does not consider its securities to be impaired as of March 30, 2014 and June 30, 2013 .
The contractual maturities of marketable investments as of March 30, 2014 were as follows (in thousands):
 
 
Within One    
Year
 
After One,
Within Five    
Years
 
After Five,
Within Ten    
Years
 
After Ten    
Years
 
Total
Municipal bonds

$70,398

 

$213,400

 

$23,995

 

$—

 

$307,793

Corporate bonds
33,506

 
176,288

 
18,874

 

 
228,668

U.S. agency securities
8,083

 
19,201

 

 

 
27,284

Non-U.S. certificates of deposit
383,758

 

 

 

 
383,758

Non-U.S. government securities
4,054

 
3,016

 

 

 
7,070

Total

$499,799

 

$411,905

 

$42,869

 

$—

 

$954,573

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. U.S. GAAP also establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are obtained from independent sources and can be validated by a third party, whereas unobservable inputs reflect assumptions regarding what a third party would use in pricing an asset or liability. The fair value hierarchy is categorized 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 March 30, 2014 , financial assets utilizing Level 1 inputs included money market funds. Financial assets utilizing Level 2 inputs included municipal bonds, corporate bonds, U.S. agency securities, non-U.S. certificates of deposit 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 financial assets requiring the use of Level 3 inputs. There were no transfers between Level 1 and Level 2 during the nine months ended March 30, 2014 .

12


The following table sets forth financial instruments carried at fair value within the U.S. GAAP hierarchy (in thousands):
 
March 30, 2014
 
June 30, 2013
 
 Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-U.S. certificates of deposit
$

 
$
12,163

 
$

 
$
12,163

 
$

 
$

 
$

 
$

Municipal bonds

 

 

 

 

 
2,009

 

 
2,009

Money market funds
67,553

 

 

 
67,553

 
12,589

 

 

 
12,589

Total cash equivalents
67,553

 
12,163

 

 
79,716

 
12,589

 
2,009

 

 
14,598

Short-term investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Municipal bonds

 
307,793

 

 
307,793

 

 
249,709

 

 
249,709

Corporate bonds

 
228,668

 

 
228,668

 

 
192,060

 

 
192,060

U.S. agency securities

 
27,284

 

 
27,284

 

 
39,474

 

 
39,474

Non-U.S. certificates of deposit

 
383,758

 

 
383,758

 

 
345,000

 

 
345,000

Non-U.S. government securities

 
7,070

 

 
7,070

 

 
7,603

 

 
7,603

Total short-term investments

 
954,573

 

 
954,573

 

 
833,846

 

 
833,846

Total assets

$67,553

 

$966,736

 

$—

 

$1,034,289

 

$12,589

 

$835,855

 

$—

 

$848,444


Note 6.    Intangible Assets
The following table presents the components of intangible assets, net (in thousands):
 
March 30, 2014
 
June 30, 2013
 
Gross
 
Accumulated Amortization
 
Net
 
Gross
 
Accumulated Amortization
 
Net
Intangible assets with finite lives:
 
 
 
 
 
 
 
 
 
 
 
Customer relationships

$137,440

 

($65,131
)
 

$72,309

 

$137,440

 

($59,611
)
 

$77,829

Developed technology
162,760

 
(68,260
)
 
94,500

 
162,760

 
(53,476
)
 
109,284

Non-compete agreements
10,244

 
(5,507
)
 
4,737

 
10,244

 
(4,037
)
 
6,207

Trade names, finite-lived
520

 
(510
)
 
10

 
520

 
(493
)
 
27

Patent and licensing rights
129,599

 
(40,388
)
 
89,211

 
116,147

 
(34,849
)
 
81,298

Total intangible assets with finite lives
440,563

 
(179,796
)
 
260,767

 
427,111

 
(152,466
)
 
274,645

Trade names, indefinite-lived
82,880

 


 
82,880

 
82,880

 


 
82,880

Total intangible assets

$523,443

 

($179,796
)
 

$343,647

 

$509,991

 

($152,466
)
 

$357,525

Total amortization of intangible assets recognized during the three and nine months ended March 30, 2014 was $9.5 million and $28.3 million , respectively. For the three and nine months ended March 31, 2013 , total amortization of intangible assets recognized was $9.4 million and $28.2 million , respectively.

13


Total future amortization expense of finite-lived intangible assets is estimated to be as follows (in thousands):
Fiscal Year Ending
 
June 29, 2014 (remainder of fiscal 2014)

$9,035

June 28, 2015
33,973

June 26, 2016
33,686

June 25, 2017
31,702

June 24, 2018
30,534

Thereafter
121,837

Total

$260,767

Note 7.    Shareholders’ Equity
As of March 30, 2014 , pursuant to an extension of the stock repurchase program authorized by the Board of Directors, the Company is authorized to repurchase shares of its common stock having an aggregate purchase price not exceeding $200 million for all purchases from June 20, 2013 through the expiration of the program on June 29, 2014 . During the nine months ended March 30, 2014 , there were no repurchases of common stock by the Company under the share repurchase program.
Note 8.    Earnings Per Share
The following table presents the computation of basic earnings per share (in thousands, except per share amounts):
 
Three Months Ended
 
Nine Months Ended
 
March 30,
2014
 
March 31,
2013
 
March 30,
2014
 
March 31,
2013
Net income

$28,164

 

$22,157

 

$94,342

 

$58,683

Weighted average common shares
121,535

 
116,682

 
120,677

 
116,059

Basic earnings per share
$0.23

 

$0.19

 
$0.78

 

$0.51

The following computation reconciles the differences between the basic and diluted earnings per share presentations (in thousands, except per share amounts):  
 
Three Months Ended
 
Nine Months Ended
 
March 30,
2014
 
March 31,
2013
 
March 30,
2014
 
March 31,
2013
Net income

$28,164

 

$22,157

 

$94,342

 

$58,683

Weighted average common shares - basic
121,535

 
116,682

 
120,677

 
116,059

Dilutive effect of stock options, nonvested shares and ESPP purchase rights
2,160

 
1,926

 
2,463

 
709

Weighted average common shares - diluted
123,695

 
118,608

 
123,140

 
116,768

Diluted earnings per share
$0.23

 

$0.19

 
$0.77

 

$0.50

Potential common shares that would have the effect of increasing diluted earnings per share are considered to be anti-dilutive and as such, these shares are not included in calculating diluted earnings per share. For the three and nine months ended March 30, 2014 , there were 3.1 million and 2.4 million , respectively, of potential common shares not included in the calculation of diluted earnings per share because their effect was anti-dilutive. For the three and nine months March 31, 2013 , there were 2.2 million and 8.7 million , respectively, of potential common shares not included in the calculation of diluted earnings per share because their effect was anti-dilutive.
Note 9.   Stock-Based Compensation
Prior to the second quarter of fiscal 2014, the Company had one equity-based compensation plan, the 2004 Long-Term Incentive Compensation Plan (2004 LTIP), from which stock-based compensation awards could be granted to employees and directors. The Company’s 2013 Long-Term Incentive Compensation Plan (2013 LTIP) became effective in the second quarter of fiscal 2014,

14


and replaced the 2004 LTIP as the sole plan for providing stock-based compensation awards to employees and directors on January 1, 2014. The 2004 LTIP has been terminated as to future grants although outstanding awards under the 2004 LTIP will continue to be governed by that plan. In addition, the Company has other equity-based compensation plans that have been terminated so that no future grants can be made under those plans, but under which options are currently outstanding.
Prior to fiscal 2013, the Company’s stock-based awards had been service-based only.  Beginning in fiscal 2013, the Company issued grants of awards that also contain performance-based conditions.  Performance-based conditions are generally tied to future financial and/or operating performance of the Company. The compensation expense with respect to performance-based grants is recognized if the Company believes it is probable that the performance condition will be achieved. The Company reassesses the probability of the achievement of the performance condition at each reporting period, and adjusts the compensation expense for subsequent changes in the estimate or actual outcome.
The Company also has an Employee Stock Purchase Plan (ESPP) that provides employees with the opportunity to purchase common stock at a discount. The ESPP limits employee contributions to 15% of each employee’s compensation (as defined in the plan). The ESPP allows employees to purchase shares at a 15% discount to the fair market value of common stock on the purchase date during the twelve-month participation period, divided into two equal six-month purchase periods, and provides a look-back feature. At the end of each six-month period in April and October, employees participating in the plan purchase the Company's common stock through the ESPP at a 15% discount to 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 also provides for an automatic reset feature to start participants on a new twelve-month participation period if the stock price declines during the first six-month purchase period.
Stock Option Awards
The following table summarizes option activity during the nine months ended March 30, 2014 (in thousands, except per share data):  
 
Number of Shares
 
Weighted Average Exercise Price
Outstanding at June 30, 2013
8,657

 

$35.67

Granted
2,969

 
55.21

Exercised
(2,260
)
 
36.28

Forfeited or expired
(300
)
 
40.20

Outstanding at March 30, 2014
9,066

 

$41.77

Restricted Stock Awards and Units
A summary of nonvested restricted stock awards (RSAs) and restricted stock unit awards (RSUs) outstanding as of March 30, 2014 , and changes during the nine months then ended, are as follows (in thousands, except per share data):  
 
Number of
  RSAs/RSUs  
 
Weighted Average 
Grant-Date Fair Value
Nonvested at June 30, 2013
647

 

$33.80

Granted
527

 
54.76

Vested
(252
)
 
33.09

Forfeited
(22
)
 
40.37

Nonvested at March 30, 2014
900

 

$46.11

Stock-Based Compensation Valuation and Expense
The Company accounts for its employee stock-based compensation plans 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.
The Company currently uses the Black-Scholes option-pricing model to estimate the fair value of the Company's stock option and ESPP awards. 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

15


exercise behaviors, the risk-free interest rate and expected dividends. Due to the inherent limitations of option-valuation models, 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 RSAs and RSUs, the 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.
Stock-based compensation expense is recognized net of estimated forfeitures such that expense is recognized 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
 
Nine Months Ended
 
March 30,
2014
 
March 31,
2013
 
March 30,
2014
 
March 31,
2013
Income Statement Classification:
 
 
 
 
 
 
 
Cost of goods sold

$3,129

 

$2,334

 

$8,357

 

$6,875

Research and development
3,912

 
3,441

 
11,453

 
10,445

Sales, general and administrative
8,970

 
8,140

 
26,451

 
23,625

Total

$16,011

 

$13,915

 

$46,261

 

$40,945

Note 10.   Income Taxes
The variation between the Company's effective income tax rate and the U.S. statutory rate of 35% is due to a percentage of the Company's projected income for the full year being derived from international locations with lower tax rates than the U.S. and the impact of tax credits available in the current year. A change in the mix of pretax income of the Company's various tax jurisdictions can have a material impact on the Company's periodic effective tax rate.
During the second quarter of fiscal 2014, the Company was notified by the Internal Revenue Service that it had been allocated up to $30 million of federal tax credits as part of the American Recovery and Reinvestment Act of 2009 - Phase II (Internal Revenue Code Section 48C). This $30 million allocation is in addition to the $39 million previously allocated to the Company in the third quarter of fiscal 2010. The $30 million allocation was based upon the Company's plan to place into service approximately $100 million of qualified equipment at its U.S. manufacturing locations from fiscal 2013 through fiscal 2017. Property placed into service during fiscal 2013 generated $15 million of the potential $30 million Internal Revenue Code Section 48C credit. The remaining $15 million of Internal Revenue Code Section 48C credit was generated during the first three quarters of fiscal 2014. The tax benefit (net of related basis adjustments) will be amortized into income over the useful life ( five years ) of the underlying equipment that was placed in service to generate these credits. In fiscal 2014, the Company anticipates it will recognize an income tax benefit of approximately $5.2 million related to this award; of this amount, $0.7 million and $4.4 million have been recorded as tax benefits in the three and nine months ended March 30, 2014 , respectively.
U.S. GAAP requires a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is cumulatively more than 50% likely to be realized upon ultimate settlement.
As of June 30, 2013 , the Company's liability for unrecognized tax benefits was $2.7 million . The Company recognized an $18.0 million increase to the liability for unrecognized tax benefits due to uncertainty regarding a change in tax depreciation methodology adopted in the first quarter of fiscal 2014. In addition, there was a $2.3 million decrease to the amount of unrecognized tax benefits following the settlement of prior year tax audits and statute expirations. As a result, the total liability for unrecognized tax benefits as of March 30, 2014 was $18.4 million . If any portion of this $18.4 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 $0.2 million of gross unrecognized tax benefits will change in the next 12 months as a result of pending audit settlements or statute requirements.
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 prior to 2011. For U.S. state tax returns, the Company is generally no longer subject to tax examinations for fiscal years prior to 2010. For foreign purposes, the Company is generally no longer subject to examination

16


for tax periods 2003 and prior. Certain carryforward tax attributes generated in prior years remain subject to examination and adjustment. During the third quarter of fiscal 2014, the Company settled its examination with the German Federal Central Tax Office for the fiscal year ended June 29, 2008 through the fiscal year ended June 27, 2010, resulting in an immaterial amount of additional tax expense.
Note 11.    Commitments and Contingencies
Warranties
The following table summarizes the changes in the Company's product warranty liabilities (in thousands):
 
Nine Months Ended
 
March 30, 2014
Balance at beginning of period

$6,171

Warranties accrued in current period
3,019

Changes in estimates for pre-existing warranties
907

Expenditures
(3,449
)
Balance at end of period

$6,648

Product warranties are estimated and recognized at the time the Company recognizes revenue. The warranty periods range from 90 days to 10 years. The Company accrues warranty liabilities at the time of sale, based on historical and projected incident rates and expected future warranty costs. The warranty reserves, which are primarily related to Lighting Products, are evaluated on a quarterly basis based on various factors including historical warranty claims, assumptions about the frequency of warranty claims, and assumptions about the frequency of product failures derived from quality testing, field monitoring and the Company's reliability estimates. As of March 30, 2014 , $1.0 million of the Company's product warranty liabilities were classified as long-term.
Litigation
The Company is currently a party to various legal proceedings, including those described in the Company's Annual Report on Form 10-K for fiscal 2013. The following is provided as an update to the Company's legal proceedings as contained in that report. Unless otherwise indicated, the potential losses for claims against the Company in these matters are not reasonably estimable.
Cooper Lighting Litigation
Ruud Lighting, Inc. filed a complaint for patent infringement against Cooper Lighting, LLC in the U.S. District Court for the Eastern District of Wisconsin on April 2, 2010. The complaint as amended seeks injunctive relief and damages for infringement of two U.S. patents owned by Ruud Lighting: No. 7,686,469, entitled "LED Lighting Fixture"; and No. 7,891,835, entitled “Light-Directed Apparatus with Protected Reflector-Shield and Lighting Fixture Utilizing Same.” On May 23, 2012, Ruud Lighting filed a second complaint for patent infringement against Cooper Lighting, LLC in the U.S. District Court for the Eastern District of Wisconsin. The complaint seeks injunctive relief and damages for infringement of a third U.S. patent owned by Ruud Lighting, No. 7,952,262, entitled “Modular LED Unit Incorporating Interconnected Heat Sinks Configured To Mount and Hold Adjacent LED Modules." In each of these actions Cooper Lighting has filed an answer and counterclaims in which it denies any infringement and seeks a declaratory judgment that the asserted claims of the patents are invalid. On February 19, 2013, the Company, as successor-in-interest to Ruud Lighting, Inc., filed a third complaint for patent infringement against Cooper Lighting in the U.S. District Court for the Eastern District of Wisconsin. The complaint seeks injunctive relief and damages for infringement of two U.S. patents owned by the Company, No. 8,282,239, entitled “Light-Directing Apparatus with Protected Reflector-Shield and Lighting Fixture Utilizing Same” and No. 8,070,306, entitled “LED Lighting Fixture.”
Cooper Lighting, LLC filed a complaint for patent infringement against the Company and Ruud Lighting, Inc. in the U.S. District Court for the Northern District of Georgia on September 7, 2012. The complaint seeks injunctive relief and damages for infringement of one U.S. patent owned by Cooper Lighting, LLC: No. 8,210,722, entitled "LED Device for Wide Beam Generation." The Company has filed an answer in which it denies any infringement and asserts that the patent is invalid as well as other defenses.
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 alleged 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 alleged 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.

17


The complaint sought injunctive relief, damages and ownership of the patent applications and patents alleged to have been wrongfully filed and obtained. The court in October 2012 granted partial summary judgment in favor of Ruud Lighting, finding that most of the accused products did not infringe either of the asserted patents. The court in February 2013 entered final judgment in which the court 1) dismissed the claims relating to most of the accused products, finding that they did not infringe either of the asserted patents; 2) dismissed with prejudice and with the consent of the parties the claims with respect to the remaining accused products; 3) severed the conspiracy claim, which was subsequently voluntarily dismissed; and 4) dismissed the remaining claims and counterclaims without prejudice. In March 2013, the plaintiffs filed a notice of appeal from this judgment to the U.S. Court of Appeals for the Federal Circuit.
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 January 2013, 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 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: 1) 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; and 2) 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. 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.
In September 2013, the Company and the Cooper Lighting and Illumination Management Solutions parties reached a binding term sheet agreement to settle all six cases. This non-cash settlement agreement provided for a royalty-free cross license of all of the patents-in-suit in the six cases for the life of the patents; a royalty-free cross license of each of the Company’s and Cooper Lighting’s LED luminaire patent portfolios for seven years (with carve-outs of the Company’s LED chip, LED component and LED replacement lamp patents from the cross license, as well as carve-outs for certain LED luminaires of Cooper Lighting that are not for general illumination); and a supply agreement, with no minimum purchase commitment and with a seven year term, whereby the Company may sell Cooper Lighting LED components and modules. The Company recorded a $17.4 million non-cash litigation settlement charge and related obligation in the first quarter of fiscal 2014, representing the current estimated fair value of the patent licenses to be provided to the Cooper Lighting and Illumination Management Solutions parties in excess of the fair value patent license rights to be received by the Company under the terms of the cross license agreement. This $17.4 million obligation will be amortized into income over the remainder of the seven year license period. The parties executed the definitive agreements to effect this binding agreement in February 2014, and the six cases have been dismissed with prejudice by the parties.
In conjunction with the September 2013 settlement with the Cooper Lighting and Illumination Management Solutions parties, the Company also recorded a $17.4 million offset to the non-cash litigation charge to reflect the amount receivable by the Company from the Stock Purchase Agreement escrow funds, including cash and common stock consideration, pursuant to a letter agreement approved by the Audit Committee, which the Company entered into during September 2013 with Christopher Ruud, acting as the Seller Representative for the former Ruud Lighting shareholders. The escrow consideration was provided to the Company during the third quarter of fiscal 2014 upon the execution of the final settlement agreement with the Cooper Lighting and Illumination Management Solutions parties.
Lighting Science Group Litigation
Lighting Science Group Corporation (“LSG”) filed a complaint for patent infringement against the Company in the U.S. District Court for the Middle District of Florida on April 10, 2013.  The complaint sought injunctive relief and damages for alleged infringement of U.S. patent No. 8.201,968, entitled “Low Profile Light." In March 2014, the Company and LSG executed a settlement agreement, which settlement permitted LSG to return certain LED component parts that LSG had purchased from the Company for partial credit, and provided the Company with a worldwide, non-exclusive, non-transferable, fully paid-up license under the patent-in-suit, and any and all parents, continuations, continuations-in-part, divisions, substitutions, extensions, reissues, and reexaminations thereof, and any and all foreign counterparts of the patent-in-suit. This settlement agreement ended the litigation between the parties.

18


Note 12. Reportable Segments

The Company's operating and reportable segments are:
LED Products
Lighting Products
Power and RF Products
Reportable Segments Description
The Company's LED Products segment includes LED chips, LED components a nd SiC materials. The Company's Lighting Products segment primarily consists of LED lighting systems. The Company's Power and RF Pro ducts segment includes power devices and RF devices.
Financial Results by Reportable Segment
The table below reflects the results of the Company's reportable segments as reviewed by the Chief Operating Decision Maker (CODM) for the three and nine months ended March 30, 2014 and March 31, 2013 . The Company's CODM is the Chief Executive Officer. The Company uses substantially the same accounting policies to derive the segment results reported below as those used in the Company's consolidated financial statements.
The Company's CODM does not review inter-segment revenue when evaluating segment performance and allocating resources to each segment. Thus, inter-segment revenue is not included in the segment revenues presented in the table below. As such, total segment revenue in the table below is equal to the Company's consolidated revenue.
The Company's CODM reviews gross profit as the lowest and only level of segment profit. As such, all items below gross profit in the consolidated statements of income must be included to reconcile the consolidated gross profit presented in the table below to the Company's consolidated income before income taxes.
In order to determine gross profit for each reportable segment, the Company allocates direct costs and indirect costs to each segment's cost of revenue. The Company allocates indirect costs, such as employee benefits for manufacturing employees, shared facilities services, information technology, purchasing, and customer service, when the costs are identifiable and beneficial to the reportable segment. The Company allocates these indirect costs based on a reasonable measure of utilization that considers the specific facts and circumstances of the costs being allocated.
Unallocated costs in the table below consist primarily of manufacturing employees' stock-based compensation, expenses for profit sharing and quarterly or annual incentive plans, matching contributions under the Company's 401(k) plan and acquisition related costs. These costs are not allocated to the reportable segments’ gross profit because the Company’s CODM does not review them regularly when evaluating segment performance and allocating resources.

19


Revenues, gross profit and gross margin for each of the Company's segments were as follows (in thousands, except percentages):
 
Three Months Ended
 
Nine Months Ended
 
March 30,
2014
 
March 31,
2013
 
March 30,
2014
 
March 31,
2013
Revenues:
 
 
 
 
 
 
 
LED Products

$201,119

 

$195,561

 

$634,164

 

$584,070

Lighting Products
176,691

 
130,659

 
498,265

 
361,446

Power and RF Products
27,449

 
22,714

 
78,922

 
65,457

Total revenue

$405,259

 

$348,934

 

$1,211,351

 

$1,010,973

 
 
 
 
 
 
 
 
Gross Profit and Gross Margin:
 
 
 
 
 
 
 
LED Products gross profit

$91,634

 

$85,728

 

$290,931

 

$245,381

LED Products gross margin
45.6
%
 
43.8
%
 
45.9
%
 
42.0
%
Lighting Products gross profit
48,487

 
39,966

 
136,731

 
115,449

Lighting Products gross margin
27.4
%
 
30.6
%
 
27.4
%
 
31.9
%
Power and RF Products gross profit
15,675

 
12,033

 
44,452

 
35,253

Power and RF Products gross margin
57.1
%
 
53.0
%
 
56.3
%
 
53.9
%
Total segment gross profit
155,796

 
137,727

 
472,114

 
396,083

Unallocated costs
(5,802
)
 
(4,717
)
 
(15,585
)
 
(13,548
)
Consolidated gross profit

$149,994

 

$133,010

 

$456,529

 

$382,535

Consolidated gross margin
37.0
%
 
38.1
%
 
37.7
%
 
37.8
%

Assets by Reportable Segment
Inventories are the only assets reviewed by the Company's CODM when evaluating segment performance and allocating resources to the segments. The following table sets forth the Company's inventories by reportable segment at March 30, 2014 and June 30, 2013 .
Unallocated inventories in the table below consist primarily of manufacturing employees' stock-based compensation, expenses for profit sharing and quarterly or annual incentive plans and matching contributions under the Company's 401(k) plan. These costs are not allocated to the reportable segments’ inventories because the Company’s CODM does not review them regularly when evaluating segment performance and allocating resources.
The Company does not allocate assets other than inventories to the reportable segments because the Company's CODM does not review them when assessing segment performance and allocating resources. The CODM reviews all of the Company's assets other than inventories on a consolidated basis.
Inventories for each of the Company's segments are as follows (in thousands):
 
March 30,
2014
 
June 30,
2013
LED Products
$
107,392

 
$
99,835

Lighting Products
133,067

 
87,546

Power and RF Products
6,997

 
6,593

Total segment inventories
247,456

 
193,974

Unallocated inventories
3,778

 
3,027

Consolidated inventories
$
251,234

 
$
197,001



20


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 except as required under the U.S. federal securities laws and the rules and regulations of the Securities and Exchange Commission (the SEC), 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 30, 2013 . 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 indoor and outdoor lighting, video displays, transportation, electronic signs and signals, power supplies, inverters and wireless systems.
We develop and manufacture semiconductor materials and devices primarily based on silicon carbide (SiC), gallium nitride (GaN) and related compounds. In many cases, the properties of SiC and GaN offer technical advantages over traditional silicon, gallium arsenide (GaAs) and other materials used for electronic applications.
Our LED products consist of LED components, LED chips and SiC materials. Our success in selling LED products depends upon our ability to offer innovative products and to enable our customers to develop and market LED-based products that successfully compete against other LED-based products and drive LED adoption against traditional lighting products.
Our lighting products primarily consist of LED lighting systems. We design, manufacture and sell lighting fixtures and lamps for the commercial, industrial and consumer markets.
In addition, we develop, manufacture and sell power and RF devices. Our power products are made from SiC and provide increased efficiency, faster switching speeds and reduced system size and weight over comparable silicon-based power devices. Our RF devices are made from GaN and provide improved efficiency, bandwidth and frequency of operation as compared to silicon or GaAs.
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 product fabrication, assembly and packaging. We operate research and development facilities in North Carolina, California, Wisconsin, India and China (including Hong Kong).
Cree, Inc. is a North Carolina corporation established in 1987, and our headquarters are in Durham, North Carolina.
Reportable Segments
As of March 30, 2014 , we have three reportable segments:
LED Products
Lighting Products
Power and RF Products
For further information about our reportable segments, please refer to Note 12 "Reportable Segments" in our consolidated financial statements included in Item 1 of this Quarterly Report.

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Table of Contents

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 the market for LED lighting has grown in recent years, adoption of LEDs for general lighting is relatively low and faces 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 LED and lighting industry is intense. Many companies have made significant investments in LED development and production equipment. Traditional lighting companies and new entrants are investing in LED-based lighting products as LED adoption has gained momentum. Traditional lighting companies have taken steps to try and limit access to their sales channels, including lighting agents and distributors. Product pricing pressures exist as market participants often undertake pricing strategies to gain or protect market share, increase the utilization of their production capacity and open new applications to LED-based solutions. To remain competitive, market participants must continuously increase product performance and reduce costs. To address these competitive pressures, we have invested in R&D activities to support new product development to deliver higher levels of performance and lower costs to differentiate our products in the market.
Technological Innovation and Advancement. Innovations and advancements in LED, power and RF technologies continue to expand the potential commercial application for our products, particularly in the general illumination, power electronics and wireless markets. However, new technologies or standards could emerge, or improvements could be made in existing technologies, that could reduce or limit the demand for our products 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. Government agencies are also involved in setting standards for LED lighting, which can affect market acceptance and the availability of rebates from government agencies or third parties such as utilities. While this trend is generally positive, these regulations are affected by changing political priorities and evolving technical standards which can modify 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.
Financial Results
The following is a summary of our financial results for the nine months ended March 30, 2014 :

Revenues increased to $1.2 billion for the nine months ended March 30, 2014 from $1.0 billion for the nine months ended March 31, 2013 .
For the nine months ended March 30, 2014 , gross margins remained consistent at 37.7% compared to 37.8% for the nine months ended March 31, 2013 . For the nine months ended March 30, 2014 , gross profit increased to $456.5 million from $382.5 million for the nine months ended March 31, 2013 .
Operating income increased to $102.6 million for the nine months ended March 30, 2014 from $65.6 million for the nine months ended March 31, 2013 . Net income per diluted share increased to $0.77 for the nine months ended March 30, 2014 from $0.50 for the nine months ended March 31, 2013 .

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Table of Contents

Combined cash, cash equivalents and short-term investments increased to $1.2 billion at March 30, 2014  compared to $1.0 billion at June 30, 2013 . Cash provided by operating activities was $228.2 million for the nine months ended March 30, 2014 , compared to $224.1 million for the nine months ended March 31, 2013 .
Inventories increased to $251.2 million at March 30, 2014 compared to $197.0 million at June 30, 2013 .
Business Outlook
We project that the markets for our products will remain highly competitive during fiscal 2014 . We anticipate focusing on the following key areas, among others, in response to this competitive environment:
Lead with innovation and drive to cost parity. We continue to work on developing new LEDs, LED lighting systems, and Power and RF devices to deliver improved value that approaches cost parity with existing technology and solutions. We believe that as our technology approaches cost parity, the market for these products will expand significantly.

Build the Cree brand. We are working to build the Cree brand in both the commercial and consumer lighting segments by expanding our product offerings and continuing to invest in marketing the value of the Cree LED bulb and LED lighting directly to the end user. The level of investment will vary from quarter to quarter to optimize new product introductions, utility rebates, channel opportunities and seasonal trends.

Focus on select market segments to drive LED adoption. In addition to our broad sales strategies, we are focused on a number of market segments where we can upgrade existing lighting and drive LED adoption with a combination of new product offerings, short payback, expanded services and innovative channel approaches.

Translate product innovation into revenue and profit growth. We target revenue growth from new products and increased LED adoption and profit growth from the combination of higher sales, lower cost products and operating expense leverage.

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Table of Contents

Results of Operations
The following table sets forth certain consolidated statement of income data for the periods indicated (in thousands, except per share amounts and percentages):
 
 
Three Months Ended
 
Nine Months Ended
 
March 30,
2014
 
March 31,
2013
 
March 30,
2014
 
March 31,
2013
 
Dollars
 
% of Revenue
 
Dollars
 
% of Revenue
 
Dollars
 
% of Revenue
 
Dollars
 
% of Revenue
Revenue, net

$405,259

 
100
%
 

$348,934

 
100
%
 

$1,211,351

 
100
%
 

$1,010,973

 
100
%
Cost of revenue, net
255,265

 
63
%
 
215,924

 
62
%
 
754,822

 
62
%
 
628,438

 
62
%
Gross profit
149,994

 
37
%
 
133,010

 
38
%
 
456,529

 
38
%
 
382,535

 
38
%
Research and development
46,626

 
12
%
 
39,036

 
11
%
 
132,805

 
11
%
 
116,524

 
12
%
Sales, general and administrative
65,368

 
16
%
 
62,140

 
18
%
 
197,589

 
16
%
 
174,885

 
17
%
Amortization of acquisition-related intangibles
7,257

 
2
%
 
7,719

 
2
%
 
21,800

 
2
%
 
23,108

 
2
%
Loss on disposal or impairment of long-lived assets
364

 
%
 
863

 
%
 
1,781

 
%
 
2,385

 
%
Operating income
30,379

 
7
%
 
23,252

 
7
%
 
102,554

 
8
%
 
65,633

 
6
%
Non-operating income, net
3,152

 
1
%
 
2,512

 
1
%
 
9,373

 
1
%
 
8,378

 
1
%
Income before income taxes
33,531

 
8
%
 
25,764

 
7
%
 
111,927

 
9
%
 
74,011

 
7
%
Income tax expense
5,367

 
1
%
 
3,607

 
1
%
 
17,585

 
1
%
 
15,328

 
2
%
Net income

$28,164

 
7
%
 

$22,157

 
6
%
 

$94,342

 
8
%
 

$58,683

 
6
%
Basic earnings per share
$0.23

 
 
 

$0.19

 
 
 
$0.78

 
 
 

$0.51

 
 
Diluted earnings per share
$0.23

 
 
 

$0.19

 
 
 
$0.77

 
 
 

$0.50

 
 

Revenues

Revenues for the three and nine months ended March 30, 2014 and March 31, 2013 were comprised of the following (in thousands, except percentages):
 
Three Months Ended
 
 
 
 
 
Nine Months Ended
 
 
 
 
 
March 30,
2014
 
March 31,
2013
 
Change
 
March 30,
2014
 
March 31,
2013
 
Change
LED Products

$201,119

 

$195,561

 

$5,558

 
3
%
 

$634,164

 

$584,070

 

$50,094

 
9
%
Percent of revenue
49
%
 
56
%
 
 
 
 
 
52
%
 
58
%
 
 
 
 
Lighting Products
176,691

 
130,659

 
46,032

 
35
%
 
498,265

 
361,446

 
136,819

 
38
%
Percent of revenue
44
%
 
37
%
 
 
 
 
 
41
%
 
36
%
 
 
 
 
Power and RF Products
27,449

 
22,714

 
4,735

 
21
%
 
78,922

 
65,457

 
13,465

 
21
%
Percent of revenue
7
%
 
7
%
 
 
 
 
 
7
%
 
6
%
 
 
 
 
Total revenue

$405,259

 

$348,934

 

$56,325

 
16
%
 

$1,211,351

 

$1,010,973

 

$200,378

 
20
%
Our consolidated revenue increased 16% to $405.3 million for the three months ended March 30, 2014 from $348.9 million for the three months ended March 31, 2013 . For the nine months ended March 30, 2014 , our consolidated revenue increased 20% to $1.2 billion from $1.0 billion for the nine months ended March 31, 2013 . The year-over-year increase was due to higher sales across all three of our business segments, but driven primarily by strong sales in the Lighting Products segment.

24