Cree, Inc.
CREE INC (Form: 10-Q, Received: 10/22/2014 17:11:29)
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 September 28, 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 October 15, 2014 , was 119,445,374 .


Table of Contents

CREE, INC.
FORM 10-Q
For the Quarterly Period Ended September 28, 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
 
September 28,
2014
 
June 29,
2014
 
(unaudited)
 
 
(In thousands, except par value)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents

$196,300

 

$286,824

Short-term investments
908,543

 
875,642

Total cash, cash equivalents and short-term investments
1,104,843

 
1,162,466

Accounts receivable, net
236,992

 
225,160

Inventories
310,780

 
284,780

Deferred income taxes
29,695

 
29,414

Prepaid expenses and other current assets
74,371

 
72,071

Total current assets
1,756,681

 
1,773,891

Property and equipment, net
635,341

 
605,713

Goodwill
616,345

 
616,345

Intangible assets, net
332,123

 
336,423

Other assets
12,162

 
11,997

Total assets

$3,352,652

 

$3,344,369

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

Current liabilities:

 

Accounts payable, trade

$198,631

 

$202,294

Accrued salaries and wages
43,268

 
50,527

Income taxes payable
11,850

 
14,848

Other current liabilities
39,129

 
38,986

Total current liabilities
292,878

 
306,655

Long-term liabilities:

 

Long-term debt
45,000

 

Deferred income taxes
15,828

 
12,173

Other long-term liabilities
29,082

 
35,395

Total long-term liabilities
89,910

 
47,568

Commitments and contingencies (Note 11)

 

Shareholders’ equity:

 

Preferred stock, par value $0.01; 3,000 shares authorized at September 28, 2014 and June 29, 2014; none issued and outstanding

 

Common stock, par value $0.00125; 200,000 shares authorized at September 28, 2014 and June 29, 2014; 119,421 and 120,114 shares issued and outstanding at September 28, 2014 and June 29, 2014, respectively
148

 
149

Additional paid-in-capital
2,214,601

 
2,190,011

Accumulated other comprehensive income, net of taxes
9,727

 
11,405

Retained earnings
745,388

 
788,581

Total shareholders’ equity
2,969,864

 
2,990,146

Total liabilities and shareholders’ equity

$3,352,652

 

$3,344,369

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
 
September 28,
2014
 
September 29,
2013
 
(In thousands, except per share amounts)
Revenue, net

$427,672

 

$391,006

Cost of revenue, net
291,852

 
240,249

Gross profit
135,820

 
150,757

Operating expenses:
 
 
 
Research and development
46,725

 
41,743

Sales, general and administrative
69,692

 
64,278

Amortization or impairment of acquisition-related intangibles
6,499

 
7,287

Loss on disposal or impairment of long-lived assets
1,447

 
657

Total operating expenses
124,363

 
113,965

Operating income
11,457

 
36,792

Non-operating income, net
2,904

 
2,818

Income before income taxes
14,361

 
39,610

Income tax expense
3,231

 
9,113

Net income

$11,130

 

$30,497

Earnings per share:
 
 
 
Basic
$0.09

 

$0.26

Diluted
$0.09

 

$0.25

Weighted average shares used in per share calculation:
 
 
 
Basic
119,605

 
119,564

Diluted
121,143

 
122,364

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
 
September 28,
2014
 
September 29,
2013
 
(In thousands)
Net income

$11,130

 

$30,497

Other comprehensive income:
 
 
 
Currency translation (loss) gain
(1,167
)
 
259

Net unrealized (loss)/gain on available-for-sale securities, net of tax benefit/(expense) of $339 and $(782), respectively
(511
)
 
1,263

Other comprehensive (loss) income
(1,678
)
 
1,522

Comprehensive income

$9,452

 

$32,019

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


5

Table of Contents

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

 
Three Months Ended
 
September 28,
2014
 
September 29,
2013
 
(In thousands)
Cash flows from operating activities:
 
 
 
Net income

$11,130

 

$30,497

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
43,335

 
39,481

Stock-based compensation
16,759

 
14,578

Excess tax benefit from stock-based payment arrangements
(1,448
)
 
(5,666
)
Loss on disposal or impairment of long-lived assets
1,447

 
657

Amortization of premium/discount on investments
2,412

 
2,435

Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net
(12,018
)
 
(16,613
)
Inventories
(25,674
)
 
(19,782
)
Prepaid expenses and other assets
(3,176
)
 
(36,998
)
Accounts payable, trade
(2,164
)
 
22,960

Accrued salaries and wages and other liabilities
(17,319
)
 
37,687

Net cash provided by operating activities
13,284

 
69,236

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(63,446
)
 
(33,680
)
Purchases of short-term investments
(171,067
)
 
(196,312
)
Proceeds from maturities of short-term investments
126,958

 
116,510

Proceeds from sale of property and equipment
43

 

Proceeds from sale of short-term investments
4,667

 
12,295

Purchases of patent and licensing rights
(4,806
)
 
(4,769
)
Net cash used in investing activities
(107,651
)
 
(105,956
)
Cash flows from financing activities:
 
 
 
Proceeds from long-term debt borrowings
60,000

 

Payments on long-term debt borrowings
(15,000
)
 

Net proceeds from issuance of common stock
12,109

 
28,741

Excess tax benefit from stock-based payment arrangements
1,448

 
5,666

Repurchases of common stock
(54,325
)
 

Net cash provided by financing activities
4,232

 
34,407

Effects of foreign exchange changes on cash and cash equivalents
(389
)
 
126

Net decrease in cash and cash equivalents
(90,524
)
 
(2,187
)
Cash and cash equivalents:
 
 
 
Beginning of period
286,824

 
190,069

End of period

$196,300

 

$187,882

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
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's LED products consist of LED components, LED chips and silicon carbide (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 and bulbs. 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 gallium nitride (GaN) and provide improved efficiency, bandwidth and frequency of operation as compared to silicon or gallium arsenide (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.
The Company's three reportable segments are:
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 September 28, 2014 , the consolidated statements of income for the three months ended September 28, 2014 and September 29, 2013 , the consolidated statements of comprehensive income for the three months ended September 28, 2014 and September 29, 2013 , and the consolidated statements of cash flows for the three months ended September 28, 2014 and September 29, 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 September 28, 2014 , and for all periods presented, have been made. All intercompany accounts and transactions have been eliminated. The consolidated balance sheet at June 29, 2014 has been derived from the audited financial statements as of that date.

These financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) for interim information and with the instructions to Form 10-Q and Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for annual financial statements. 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 29, 2014 (fiscal 2014 ). The results of operations for the three months ended September 28, 2014 are not necessarily indicative of the operating results that may be attained for the entire fiscal year ending June 28, 2015 (fiscal 2015 ).

7


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, revenue and expenses, and the disclosure of contingent assets and liabilities. Actual amounts could differ materially from those estimates.
Certain fiscal 2014 amounts in the accompanying consolidated financial statements have been reclassified to conform to the fiscal 2015 presentation. These reclassifications had no effect on previously reported consolidated net income or shareholders’ equity.
New Accounting Standards
Revenue from Contracts with Customers

In May 2014, the FASB issued Accounting Standards Update (ASU) No. 2014-09: Revenue from Contracts with Customers (Topic 606). The ASU establishes a principles-based approach for accounting for revenue arising from contracts with customers and supersedes existing revenue recognition guidance. The ASU provides that an entity should apply a five-step approach for recognizing revenue, including (1) identify the contract with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when, or as, the entity satisfies a performance obligation. Also, the entity must provide various disclosures concerning the nature, amount and timing of revenue and cash flows arising from contracts with customers. The effective date will be the first quarter of the Company's fiscal year ending June 24, 2018, using one of two retrospective application methods. The Company is currently analyzing the impact of this new accounting guidance.
Note 2 – Financial Statement Details
Accounts Receivable, net
The following table summarizes the components of accounts receivable, net (in thousands):
 
September 28, 2014
 
June 29, 2014
Billed trade receivables

$271,459

 

$255,374

Unbilled contract receivables
1,727

 
1,557


273,186

 
256,931

Allowance for sales returns, discounts and other incentives
(33,473
)
 
(29,010
)
Allowance for bad debts
(2,721
)
 
(2,761
)
Accounts receivable, net

$236,992

 

$225,160

Inventories
The following table summarizes the components of inventories (in thousands):
 
September 28, 2014
 
June 29, 2014
Raw material

$93,883

 

$95,594

Work-in-progress
104,969

 
92,889

Finished goods
111,928

 
96,297

Inventories

$310,780

 

$284,780


8


Other Current Liabilities
The following table summarizes the components of other current liabilities (in thousands):
 
September 28, 2014
 
June 29, 2014
Accrued taxes

$19,256

 

$19,835

Accrued professional fees
6,496

 
5,373

Accrued warranty
6,397

 
5,842

Accrued other
6,980

 
7,936

Other current liabilities

$39,129

 

$38,986

Accumulated Other Comprehensive Income, net of taxes
The following table summarizes the components of accumulated other comprehensive income, net of taxes (in thousands):
 
September 28, 2014
 
June 29, 2014
Currency translation gain

$7,382

 

$8,549

Net unrealized gain on available-for-sale securities
2,345

 
2,856

Accumulated other comprehensive income, net of taxes

$9,727

 

$11,405

Non-Operating Income, net
The following table summarizes the components of non-operating income, net (in thousands):
 
Three Months Ended
 
September 28, 2014
 
September 29, 2013
Foreign currency (loss) gain, net

($231
)
 

$264

Gain on sale of investments, net
2

 
10

Interest income, net
3,032

 
2,341

Other, net
101

 
203

Non-operating income, net

$2,904

 

$2,818

Reclassifications Out of Accumulated Other Comprehensive Income, net of taxes
The following table summarizes the amounts reclassified out of accumulated other comprehensive income, net of taxes (in thousands):
Accumulated Other Comprehensive Income Component
 
Amount Reclassified from Accumulated Other Comprehensive Income
Affected Line Item in the Consolidated Statements of Income
 
 
Three Months Ended
 
 
 
 
September 28, 2014
 
September 29, 2013
 
 
Net unrealized gain on available-for-sale securities, net of taxes
 

$2

 

$10

 
Non-operating income, net
 
 
2

 
10

 
Income before income taxes
 
 

 
2

 
Income tax expense
 
 

$2

 

$8

 
Net income
Note 3 – Investments
Investments consist of municipal bonds, corporate bonds, U.S. agency securities, non-U.S. certificates of deposit and non-U.S. government securities . All investments are short-term and classified as available-for-sale.

9


The following tables summarize short-term investments (in thousands):
 
 
September 28, 2014
 
 
Amortized    
Cost
 
Gross Unrealized    
Gains
 
Gross
Unrealized    
Losses
 
 Estimated Fair 
Value
Municipal bonds
 

$295,437

 

$2,405

 

($24
)
 

$297,818

Corporate bonds
 
214,055

 
1,690

 
(419
)
 
215,326

U.S. agency securities
 
18,950

 
129

 

 
19,079

Non-U.S. certificates of deposit
 
373,303

 

 

 
373,303

Non-U.S. government securities
 
2,999

 
18

 

 
3,017

Total short-term investments
 

$904,744

 

$4,242

 

($443
)
 

$908,543

 
 
 
 
 
 
 
 
 
 
 
June 29, 2014
 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated Fair
Value
Municipal bonds
 

$291,869

 

$2,323

 

($12
)
 

$294,180

Corporate bonds
 
200,177

 
2,283

 
(114
)
 
202,346

U.S. agency securities
 
18,994

 
141

 

 
19,135

Non-U.S. certificates of deposit
 
352,928

 

 

 
352,928

Non-U.S. government securities
 
7,025

 
28

 

 
7,053

Total short-term investments
 

$870,993

 

$4,775

 

($126
)
 

$875,642


10


The following tables present the gross unrealized losses and estimated fair value of the Company's short-term investments, aggregated by investment type and the length of time that individual securities have been in a continuous unrealized loss position (in thousands, except numbers of securities):
 
 
September 28, 2014
 
 
Less than 12 Months
 
Greater than 12 Months
 
Total
 
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
Municipal bonds
 

$10,125

 

($21
)
 

$1,516

 

($3
)
 

$11,641

 

($24
)
Corporate bonds
 
49,004

 
(265
)
 
12,935

 
(154
)
 
61,939

 
(419
)
U.S. agency securities
 

 

 

 

 

 

Non-U.S. certificates of deposit
 

 

 

 

 

 

Non-U.S. government securities
 

 

 

 

 

 

Total
 

$59,129

 

($286
)
 

$14,451

 

($157
)
 

$73,580

 

($443
)
Number of securities with an unrealized loss
 
 
 
32

 
 
 
7

 
 
 
39

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
June 29, 2014
 
 
Less than 12 Months
 
Greater than 12 Months
 
Total
 
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
Municipal bonds
 

$7,906

 

($8
)
 

$1,520

 

($4
)
 

$9,426

 

($12
)
Corporate bonds
 
15,696

 
(31
)
 
13,049

 
(83
)
 
28,745

 
(114
)
U.S. agency securities
 

 

 

 

 

 

Non-U.S. certificates of deposit
 

 

 

 

 

 

Non-U.S. government securities
 

 

 

 

 

 

Total
 

$23,602

 

($39
)
 

$14,569

 

($87
)
 

$38,171

 

($126
)
Number of securities with an unrealized loss
 
 
 
13

 
 
 
7

 
 
 
20

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 three months ended September 28, 2014 of $2 thousand were included in Non-operating income, net in the Consolidated Statements of Income 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 considered declines in its investments to be temporary in nature, and did not consider its securities to be impaired as of September 28, 2014 and June 29, 2014 .
The contractual maturities of short-term investments as of September 28, 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

$58,114

 

$210,550

 

$29,154

 

$—

 

$297,818

Corporate bonds
21,052

 
156,156

 
38,118

 

 
215,326

U.S. agency securities
6,571

 
12,508

 

 

 
19,079

Non-U.S. certificates of deposit
373,303

 

 

 

 
373,303

Non-U.S. government securities

 
3,017

 

 

 
3,017

Total short-term investments

$459,040

 

$382,231

 

$67,272

 

$—

 

$908,543


11


Note 4 – 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. 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 September 28, 2014 , financial assets utilizing Level 1 inputs included money market funds, and 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 service's 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 did not have any financial assets requiring the use of Level 3 inputs as of September 28, 2014 . There were no transfers between Level 1 and Level 2 during the three months ended September 28, 2014 .
The following table sets forth financial instruments carried at fair value within the U.S. GAAP hierarchy (in thousands):
 
September 28, 2014
 
June 29, 2014
 
 Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-U.S. certificates of deposit

$—

 

$165

 

$—

 

$165

 

$—

 

$—

 

$—

 

$—

Money market funds
18,714

 

 

 
18,714

 
40,031

 

 

 
40,031

Total cash equivalents
18,714

 
165

 

 
18,879

 
40,031

 

 

 
40,031

Short-term investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Municipal bonds

 
297,818

 

 
297,818

 

 
294,180

 

 
294,180

Corporate bonds

 
215,326

 

 
215,326

 

 
202,346

 

 
202,346

U.S. agency securities

 
19,079

 

 
19,079

 

 
19,135

 

 
19,135

Non-U.S. certificates of deposit

 
373,303

 

 
373,303

 

 
352,928

 

 
352,928

Non-U.S. government securities

 
3,017

 

 
3,017

 

 
7,053

 

 
7,053

Total short-term investments

 
908,543

 

 
908,543

 

 
875,642

 

 
875,642

Total assets

$18,714

 

$908,708

 

$—

 

$927,422

 

$40,031

 

$875,642

 

$—

 

$915,673


12


Note 5 – Intangible Assets
The following table presents the components of intangible assets, net (in thousands):
 
September 28, 2014
 
June 29, 2014
 
Gross
 
Accumulated Amortization
 
Net
 
Gross
 
Accumulated Amortization
 
Net
Intangible assets with finite lives:
 
 
 
 
 
 
 
 
 
 
 
Customer relationships

$137,440

 

($68,315
)
 

$69,125

 

$137,440

 

($66,970
)
 

$70,470

Developed technology
162,760

 
(77,581
)
 
85,179

 
162,760

 
(72,921
)
 
89,839

Non-compete agreements
10,244

 
(6,487
)
 
3,757

 
10,244

 
(5,997
)
 
4,247

Trade names, finite-lived
520

 
(520
)
 

 
520

 
(516
)
 
4

Patent and licensing rights
139,070

 
(44,688
)
 
94,382

 
134,607

 
(42,424
)
 
92,183

Total intangible assets with finite lives
450,034

 
(197,591
)
 
252,443

 
445,571

 
(188,828
)
 
256,743

Trade names, indefinite-lived
79,680

 


 
79,680

 
79,680

 


 
79,680

Total intangible assets

$529,714

 

($197,591
)
 

$332,123

 

$525,251

 

($188,828
)
 

$336,423

Total amortization of finite-lived intangible assets was $8.9 million and $9.4 million during the three months ended September 28, 2014 and September 29, 2013 , respectively.
Total future amortization expense of finite-lived intangible assets is estimated to be as follows (in thousands):
Fiscal Year Ending
 
June 28, 2015 (remainder of fiscal 2015)

$26,021

June 26, 2016
34,466

June 25, 2017
32,463

June 24, 2018
31,278

June 30, 2019
18,730

Thereafter
109,485

Total future amortization expense

$252,443


Note 6 – Long-term Debt
The Company has a $150 million unsecured revolving line of credit under which the Company may borrow, repay and reborrow loans from time to time prior to its scheduled maturity date of August 12, 2017.
The Company classifies balances outstanding under this agreement as Long-term debt in the Consolidated Balance Sheets. At September 28, 2014, the Company had $45.0 million outstanding under the line of credit and $105.0 million available for borrowing. The average interest rate and the commitment fee percentage for the three months ended September 28, 2014 were 0.85% and 0.08% , respectively. The Company was in compliance with all covenants in the line of credit at September 28, 2014.
Note 7 – Shareholders’ Equity
As of September 28, 2014 , pursuant to an approval by the Board of Directors to an increase in the amount of the stock repurchase program, the Company is authorized to repurchase shares of its common stock having an aggregate purchase price not exceeding $300 million for all purchases from June 20, 2013 through the expiration of the program on June 28, 2015 . During the three months ended September 28, 2014 , the Company repurchased $54.3 million of common stock under the stock repurchase program.

13


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
 
September 28,
2014
 
September 29,
2013
Basic:
 
 
 
Net income

$11,130

 

$30,497

Weighted average common shares
119,605

 
119,564

Basic earnings per share

$0.09

 

$0.26

The following computation reconciles the differences between the basic and diluted earnings per share presentations (in thousands, except per share amounts):  
 
Three Months Ended
 
September 28,
2014
 
September 29,
2013
Diluted:
 
 
 
Net income

$11,130

 

$30,497

Weighted average common shares - basic
119,605

 
119,564

Dilutive effect of stock options, nonvested shares and Employee Stock Purchase Plan purchase rights
1,538

 
2,800

Weighted average common shares - diluted
121,143

 
122,364

Diluted earnings per share

$0.09

 

$0.25

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 months ended September 28, 2014 and September 29, 2013 , there were 5.2 million and 1.1 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
Overview of Employee Stock-Based Compensation Plans
The Company currently has one equity-based compensation plan, the 2013 Long-Term Incentive Compensation Plan (2013 LTIP), from which stock-based compensation awards can be granted to employees and directors. The 2013 LTIP provides for awards in the form of incentive stock options, non-qualified stock options, stock appreciation rights, restricted stock, restricted stock units, performance shares, performance units and other awards. 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, restricted stock and restricted stock units are currently outstanding.
Prior to fiscal 2013, the Company’s stock-based awards had been service-based only.  Beginning in fiscal 2013, the Company began issuing 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. As with non-performance based awards, compensation expense is recognized over the vesting period. The vesting period runs from the date of grant to the expected date that the performance objective is likely to be achieved.
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) and originally allowed employees to purchase shares at a 15% discount to the fair market value of common stock on the purchase date two times per year. 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 to provide for 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

14


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 amendment also provides for an automatic reset feature to start participants on a new twelve-month participation period if the fair market value of common stock declines during the first six-month purchase period.
Stock Option Awards
The following table summarizes option activity as of September 28, 2014 and changes during the three months then ended (number of shares in thousands):  
 
Number of Shares
 
Weighted Average Exercise Price
Outstanding at June 29, 2014
8,922

 

$41.85

Granted
3,171

 
45.29

Exercised
(421
)
 
29.18

Forfeited or expired
(103
)
 
51.19

Outstanding at September 28, 2014
11,569

 

$43.17

Restricted Stock Awards and Units
A summary of nonvested restricted stock awards (RSAs) and restricted stock unit awards (RSUs) outstanding as of September 28, 2014 , and changes during the three months then ended is as follows (number of awards and units in thousands):  
 
Number of
  RSAs/RSUs  
 
Weighted Average 
Grant-Date Fair Value
Nonvested at June 29, 2014
860

 

$46.81

Granted
417

 
45.38

Vested
(346
)
 
46.11

Forfeited
(4
)
 
59.47

Nonvested at September 28, 2014
927

 

$46.37

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 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.

15


Total stock-based compensation expense was as follows (in thousands):
 
Three Months Ended
 
September 28,
2014
 
September 29,
2013
Income Statement Classification:
 
 
 
Cost of revenue, net

$2,905

 

$2,379

Research and development
4,471

 
3,712

Sales, general and administrative
9,383

 
8,487

Total stock-based compensation expense

$16,759

 

$14,578

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.
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 29, 2014 , the Company's liability for unrecognized tax benefits was $18.4 million . During the three months ended September 28, 2014 , there were no changes to the amount of unrecognized tax benefits. As a result, the total liability for unrecognized tax benefits as of September 28, 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 tax examinations for tax periods 2004 and prior. Certain carryforward tax attributes generated in prior years remain subject to examination and adjustment. The Company is currently under audit by the French Tax Administration for the fiscal year ended June 26, 2011 (fiscal 2011) through the fiscal year ended June 29, 2014 (fiscal 2014).
Note 11 – Commitments and Contingencies
Warranties
The following table summarizes the changes in the Company's product warranty liabilities (in thousands):
Balance at June 29, 2014

$6,822

Warranties accrued in current period
1,952

Expenditures
(1,574
)
Balance at September 28, 2014

$7,200

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 September 28, 2014 , $0.8 million of the Company's product warranty liabilities were classified as long-term.

16


Litigation
The Company is currently a party to various legal proceedings.  While management presently believes that the ultimate outcome of such proceedings, individually and in the aggregate, will not materially harm the Company’s financial position, cash flows, or overall trends in results of operations, legal proceedings are subject to inherent uncertainties, and unfavorable rulings could occur.  An unfavorable ruling could include money damages or, in matters for which injunctive relief or other conduct remedies may be sought, an injunction prohibiting the Company from selling one or more products at all or in particular ways.  Were unfavorable final outcomes to occur, there exists the possibility of a material adverse impact on the Company’s business, results of operation, financial position and overall trends.  The outcomes in these matters are not reasonably estimable.
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 and SiC materials. The Company's Lighting Products segment primarily consists of LED lighting systems and bulbs. The Company's Power and RF Products 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 months ended September 28, 2014 and September 29, 2013 . The Company's CODM is the Chief Executive Officer. The Company used 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 transactions when evaluating segment performance and allocating resources to each segment, and inter-segment transactions are not included in the segment revenue 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 and matching contributions under the Company's 401(k) plan. These costs were 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.

17


Revenue, gross profit and gross margin for each of the Company's segments were as follows (in thousands, except percentages):
 
Three Months Ended
 
September 28,
2014
 
September 29,
2013
Revenue:
 
 
 
LED Products revenue

$173,590

 

$218,023

Lighting Products revenue
223,086

 
147,918

Power and RF Products revenue
30,996

 
25,065

Total revenue

$427,672

 

$391,006

 
 
 
 
Gross Profit and Gross Margin:
 
 
 
LED Products gross profit

$67,624

 

$101,653

LED Products gross margin
39.0
%
 
46.6
%
Lighting Products gross profit
55,592

 
39,818

Lighting Products gross margin
24.9
%
 
26.9
%
Power and RF Products gross profit
17,857

 
13,456

Power and RF Products gross margin
57.6
%
 
53.7
%
Total segment gross profit
141,073

 
154,927

Unallocated costs
(5,253
)
 
(4,170
)
Consolidated gross profit

$135,820

 

$150,757

Consolidated gross margin
31.8
%
 
38.6
%

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.
Unallocated inventories in the table below were not allocated to the reportable segments because the Company’s CODM does not review them when evaluating performance and allocating resources to each segment. Unallocated inventories consisted primarily of manufacturing employees’ stock-based compensation, profit sharing and quarterly or annual incentive compensation and matching contributions under the Company’s 401(k) plan.
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):
 
September 28,
2014
 
June 29,
2014
LED Products
$
149,654

 
$
123,249

Lighting Products
147,982

 
148,757

Power and RF Products
8,732

 
8,019

Total segment inventories
306,368

 
280,025

Unallocated inventories
4,412

 
4,755

Consolidated inventories
$
310,780

 
$
284,780



18


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.

Executive Summary
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 fiscal year ended June 29, 2014 . 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.
Our LED products consist of LED components, LED chips and silicon carbide (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 gallium nitride (GaN) and provide improved efficiency, bandwidth and frequency of operation as compared to silicon or gallium arsenide (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. For further information about our consolidated revenue and earnings, please see our consolidated financial statements included in Item 1 of this Quarterly Report.
Reportable Segments
Our three reportable segments are:
LED Products
Lighting Products
Power and RF Products

19

Table of Contents

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.
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 research and development activities to support new product development and 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, in some cases even 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 is common.
Overview of the Three Months Ended September 28, 2014
The following is a summary of our financial results for the three months ended September 28, 2014 :

Revenue increased to $428 million for the three months ended September 28, 2014 from $391 million for the three months ended September 29, 2013 .
Gross profit decreased to $136 million for the three months ended September 28, 2014 from $151 million for the three months ended September 29, 2013 . Gross margin declined to 32% for the three months ended September 28, 2014 from 39% for the three months ended September 29, 2013 .
Operating income decreased to $11 million for the three months ended September 28, 2014 from $37 million for the three months ended September 29, 2013 . Net income per diluted share decreased to $0.09 for the three months ended September 28, 2014 from $0.25 for the three months ended September 29, 2013 .

20

Table of Contents

Cash, cash equivalents and short-term investments decreased to $1.1 billion at September 28, 2014  compared to $1.2 billion at June 29, 2014 . Cash provided by operating activities was $13 million for the three months ended September 28, 2014 , compared to $69 million for the three months ended September 29, 2013 .
Inventories increased to $311 million at September 28, 2014 compared to $285 million at June 29, 2014 .
Purchases of property and equipment were $63 million for the three months ended September 28, 2014 compared to $34 million for the three months ended September 29, 2013 .
Business Outlook
We project that the markets for our products will remain highly competitive during fiscal 2015 . We anticipate focusing on the following key areas, among others, in response to this competitive environment:

Build financial momentum. We target generating incremental operating margin over time through revenue growth and incremental operating leverage across the business. In fiscal 2015, we target revenue growth in Lighting Products and Power and RF Products, while LED Products revenue is currently targeted to be lower for the fiscal year. We have been developing a new LED technology platform that is targeted to drive new design wins for our market leading high power LED products later in fiscal 2015. As a result, we currently target incremental operating leverage in the second half of fiscal 2015 as compared with the first half of fiscal 2015.

Drive innovation to lower upfront customer cost and further improve payback. The LED lighting market has been enabled with tremendous innovation over the last decade with technology improvements in LEDs and LED lighting systems. We believe we can further accelerate LED lighting adoption by continuing to innovate in LEDs and LED lighting systems to lower the upfront cost and make the payback even more compelling. The approach also applies to our Power and RF product lines, where today our technology has tremendous technical benefits but a higher upfront cost. We are focused on developing the next generation devices that improve payback and expand the market for these products.

Drive LED lighting growth and build the Cree brand. We target growth in both the LED fixture and LED bulb product lines, driven by the new products we released over the last year and continued innovation in the year ahead. We plan to continue to drive awareness of the Cree brand and LED lighting in both the consumer and commercial markets.

Expand our work with third party manufacturers to enable growth in LEDs and LED Lighting. We work with third party manufacturers for the production of LEDs and LED lighting products. Our internal team is focused primarily on the high-performance, high-power LEDs that differentiate Cree in the market. We work with external manufacturers on mid-power LEDs. As demand increases, we plan to expand production at both our manufacturing partners and our own factories over time to support our targeted growth, optimize our factory utilization and focus our capital spending on higher value products.


21

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
 
September 28,
2014
 
September 29,
2013
 
Dollars
 
% of Revenue
 
Dollars
 
% of Revenue
Revenue, net

$427,672

 
100
%
 

$391,006

 
100
%
Cost of revenue, net
291,852

 
68
%
 
240,249

 
61
%
Gross profit
135,820

 
32
%
 
150,757

 
39
%
Research and development
46,725

 
11
%
 
41,743

 
11
%
Sales, general and administrative
69,692

 
16
%
 
64,278

 
16
%
Amortization or impairment of acquisition-related intangibles
6,499

 
2
%
 
7,287

 
2
%
Loss on disposal or impairment of long-lived assets
1,447

 
%
 
657

 
%
Operating income
11,457

 
3
%
 
36,792

 
9
%
Non-operating income, net
2,904

 
1
%
 
2,818

 
1
%
Income before income taxes
14,361

 
3
%
 
39,610

 
10
%
Income tax expense
3,231

 
1
%
 
9,113

 
2
%
Net income

$11,130

 
3
%
 

$30,497

 
8
%
Basic earnings per share

$0.09

 
 
 

$0.26

 
 
Diluted earnings per share

$0.09

 
 
 

$0.25

 
 

Revenue

Revenue was comprised of the following (in thousands, except percentages):
 
Three Months Ended
 
 
 
 
 
September 28,
2014
 
September 29,
2013
 
Change
LED Products revenue

$173,590

 

$218,023

 

($44,433
)
 
(20
)%
Percent of revenue
41
%
 
56
%
 
 
 
 
Lighting Products revenue
223,086

 
147,918

 
75,168

 
51
 %
Percent of revenue
52
%
 
38
%
 
 
 
 
Power and RF Products revenue
30,996

 
25,065

 
5,931

 
24
 %
Percent of revenue
7
%
 
6
%
 
 
 
 
Total revenue

$427,672

 

$391,006

 

$36,666

 
9
 %
Our consolidated revenue increased 9% to $427.7 million for the three months ended September 28, 2014 from $391.0 million for the three months ended September 29, 2013 . The increase was driven primarily by the 51% increase in Lighting Products revenue, offset by the 20% decrease in LED Products revenue.
LED Products Segment Revenue
LED Products revenue represented 41% and 56% of our total revenue for the three months ended September 28, 2014 and September 29, 2013 , respectively.    
LED Products revenue decreased 20% to $173.6 million for the three months ended September 28, 2014 from $218.0 million for the three months ended September 29, 2013 . This decrease was the result of an overall decrease in the number of units sold and lower pricing, due to weaker global demand for LED Products.

22

Table of Contents

Lighting Products Segment Revenue
Lighting Products revenue represented approximately 52% and 38% of our total revenue for the three months ended September 28, 2014 and September 29, 2013 , respectively.
Lighting Products revenue increased 51% to $223.1 million for the three months ended September 28, 2014 from $147.9 million for the three months ended September 29, 2013 . This increase was the result of an overall increase in the number of units sold, partially offset by a reduction in ASP primarily due to a higher mix of lower priced LED bulb products.
Power and RF Products Segment Revenue
Power and RF Products revenue represented approximately 7% and 6% of our total revenue for the three months ended September 28, 2014 and September 29, 2013 , respectively.
Power and RF Products revenue increased 24% to $31.0 million for the three months ended September 28, 2014 from $25.1 million for the three months ended September 29, 2013 . This increase was the result of an overall increase in the number of units sold, which was partially offset by a reduction in ASP.
Gross Profit and Gross Margin
Gross profit and gross margin were as follows (in thousands, except percentages):
 
Three Months Ended
 
 
 
 
 
September 28,
2014
 
September 29,
2013
 
Change
LED Products gross profit

$67,624

 

$101,653

 

($34,029
)
 
(33
)%
LED Products gross margin
39.0
%
 
46.6
%
 
 
 
 
Lighting Products gross profit
55,592

 
39,818

 
15,774

 
40
 %
Lighting Products gross margin
24.9
%
 
26.9
%
 
 
 
 
Power and RF Products gross profit
17,857

 
13,456

 
4,401

 
33
 %
Power and RF Products gross margin
57.6
%
 
53.7
%
 
 
 
 
Unallocated costs
(5,253
)
 
(4,170
)
 
(1,083
)
 
26
 %
Consolidated gross profit

$135,820

 

$150,757

 

($14,937
)
 
(10
)%
Consolidated gross margin
31.8
%
 
38.6
%
 
 
 
 
Our consolidated gross profit decreased 10% to $135.8 million for the three months ended September 28, 2014 from $150.8 million for the three months ended September 29, 2013 . Our consolidated gross margin decreased to 31.8% for the three months ended September 28, 2014 from 38.6% for the three months ended September 29, 2013 .
LED Products Segment Gross Profit and Gross Margin
LED Products gross profit decreased 33% to $67.6 million for the three months ended September 28, 2014 from $101.7 million for the three months ended September 29, 2013 . LED Products gross margin decreased to 39.0% for the three months ended September 28, 2014 from 46.6% for the three months ended September 29, 2013 . LED Products gross profit and gross margin decreases were due to lower units sold and lower pricing, as a result of weaker global demand.
Lighting Products Segment Gross Profit and Gross Margin
Lighting Products gross profit increased 40% to $55.6 million for the three months ended September 28, 2014 from $39.8 million for the three months ended September 29, 2013 . Lighting Products gross margin decreased to 24.9% for the three months ended September 28, 2014 from 26.9% for the three months ended September 29, 2013 . Lighting Products gross profit increased for the three months ended September 28, 2014 as compared to the three months ended September 29, 2013 due to growth in LED lighting products sales. Lighting Products gross margin decreased for the three months ended September 28, 2014 as compared to the three months ended September 29, 2013 due to changes in product mix driven primarily by higher sales of LED bulbs, which have lower gross margins.

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Power and RF Products Segment Gross Profit and Gross Margin
Power and RF Products gross profit increased 33% to $17.9 million for the three months ended September 28, 2014 from $13.5 million for the three months ended September 29, 2013 . Power and RF Products gross margin increased to 57.6% for the three months ended September 28, 2014 from 53.7% for the three months ended September 29, 2013 . Power and RF Products gross profit and gross margin increases were due primarily to higher revenue, factory cost reductions and increased factory utilization . These benefits more than offset the decline in the ASP for the three months ended September 28, 2014 as compared to the three months ended September 29, 2013 .
Unallocated Costs
Unallocated costs were $5.3 million and $4.2 million for the three months ended September 28, 2014 and September 29, 2013 , respectively. These costs consisted primarily of manufacturing employees' stock-based compensation, expenses for profit sharing and quarterly or annual incentive plans and matching contributions under our 401(k) plan. These costs were not allocated to the reportable segments' gross profit because our CODM does not review them regularly when evaluating segment performance and allocating resources. The increase of $1.1 million for the three months ended September 28, 2014 as compared to the three months ended September 29, 2013 was primarily attributable to higher incentive compensation, as well as higher stock-based compensation, resulting from an increase in historical grant date stock prices.
Research and Development
Research and development expenses include costs associated with the development of new products, enhancements of existing products and general technology research. These costs consisted primarily of employee salaries and related compensation costs, occupancy costs, consulting costs and the cost of development equipment and supplies.
The following sets forth our research and development expenses in dollars and as a percentage of revenue (in thousands, except percentages):
 
Three Months Ended
 
 
 
 
 
September 28,
2014
 
September 29,
2013
 
Change
Research and development

$46,725

 

$41,743

 

$4,982

 
12
%
Percent of revenue
11
%
 
11
%
 
 
 
 
Research and development expenses for the three months ended September 28, 2014 increased 12% to $46.7 million from $41.7 million for the three months ended September 29, 2013 . This increase was primarily due to increased spending on research and development activities focused on new higher performance and lower cost products in all our product lines. Our research and development expenses vary significantly from quarter to quarter based on a number of factors, including the timing of new product introductions and the number and nature of our ongoing research and development activities. We anticipate that in general our research and development expenses will continue to increase over time to support future growth.

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Table of Contents

Sales, General and Administrative
Sales, general and administrative expenses were comprised primarily of costs associated with our sales and marketing personnel and our executive and administrative personnel (for example, finance, human resources, information technology and legal) and consisted of salaries and related compensation costs; consulting and other professional services (such as litigation and other outside legal counsel fees, audit and other compliance costs); marketing and advertising expenses; facilities and insurance costs; and travel and other costs. The following table sets forth our sales, general and administrative expenses in dollars and as a percentage of revenue (in thousands, except percentages):   
 
Three Months Ended
 
 
 
 
 
September 28,
2014
 
September 29,
2013
 
Change
Sales, general and administrative

$69,692

 

$64,278

 

$5,414

 
8
%
Percent of revenue
16
%
 
16
%
 
 
 
 
Sales, general and administrative expenses for the three months ended September 28, 2014 increased 8% to $69.7 million from $64.3 million for the three months ended September 29, 2013 . This increase was primarily due to an increase in spending on sales and marketing for lighting products, including commissions and advertising, as we continue to expand our direct sales resources and channels and invest in building and promoting the Cree brand.
Amortization or Impairment of Acquisition-Related Intangibles
As a result of our acquisitions, we have recognized various amortizable intangible assets, including customer relationships, developed technology, non-compete agreements and trade names. Amortization of intangible assets related to our acquisitions was as follows (in thousands, except percentages):
 
Three Months Ended
 
 
 
 
 
September 28,
2014
 
September 29,
2013
 
Change
Customer relationships

$1,345

 

$1,843

 

($498
)
 
(27
)%
Developed technology
4,660

 
4,948

 
(288
)
 
(6
)%
Non-compete agreements
490

 
490

 

 
 %
Trade names, finite-lived
4

 
6

 
(2
)
 
(33
)%
Total amortization

$6,499

 

$7,287

 

($788
)
 
(11
)%
Loss on Disposal or Impairment of Long-Lived Assets
We operate a capital intensive business. As such, we dispose of a certain level of our equipment in the normal course of business as our production processes change due to production improvement initiatives or product mix changes. Due to the risk of technological obsolescence or changes in our production process, we regularly review our equipment and capitalized patent costs for possible impairment.
The following table sets forth our loss on disposal or impairment of long-lived assets (in thousands, except percentages):  
 
Three Months Ended
 
 
 
 
 
September 28,
2014
 
September 29,
2013
 
Change
Loss on disposal or impairment of long-lived assets

$1,447

 

$657

 

$790

 
120
%
We recognized a net loss of $1.4 million and $0.7 million on the disposal of long-lived assets for the three months ended September 28, 2014 and the three months ended September 29, 2013 , respectively. These net losses were primarily the result of disposals of equipment due to changes in various manufacturing processes, the abandonment of certain patent assets as a result of technological obsolescence and dispositions of building improvements as we expand our manufacturing facilities to support future growth.

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Non-Operating Income, net
The following table sets forth our non-operating income, net (in thousands, except percentages):
 
Three Months Ended
 
 
 
 
 
September 28, 2014
 
September 29, 2013
 
Change
Foreign currency (loss) gain, net

($231
)
 

$264

 

($495
)
 
(188
)%
Gain on sale of investments, net
2

 
10

 
(8
)
 
(80
)%
Interest income, net
3,032

 
2,341

 
691

 
30
 %
Other, net
101

 
203

 
(102
)
 
(50
)%
Non-operating income, net

$2,904

 

$2,818

 

$86

 
3
 %
Foreign currency (loss) gain, net . Foreign currency (loss) gain, net consisted primarily of remeasurement adjustments resulting from consolidating our international subsidiaries. The foreign currency loss for the three months ended September 28, 2014 was primarily due to fluctuations in the exchange rate between the EURO and the United States Dollar. The foreign currency gain for the three months ended September 29, 2013 was primarily due to fluctuations in the exchange rate between the Chinese Yuan and the United States Dollar.
Gain on sale of investments, net . Gain on sale of investments, net was $2 thousand for the three months ended September 28, 2014 compared to $10 thousand for the three months ended September 29, 2013 .
Interest income, net . Interest income, net was $3.0 million for the three months ended September 28, 2014 compared to $2.3 million for the three months ended September 29, 2013 . The increase in interest income, net for the three months ended September 28, 2014 was primarily due to earning higher investment yields and higher invested balances as compared to the three months ended September 29, 2013 .
Other, net . Other, net was $0.1 million for the three months ended September 28, 2014 compared to $0.2 million for the three months ended September 29, 2013 .
Income Tax Expense
The following table sets forth our income tax expense in dollars and our effective tax rate (in thousands, except percentages):  
 
Three Months Ended
 
 
 
 
 
September 28, 2014
 
September 29, 2013
 
Change
Income tax expense

$3,231

 

$9,113

 

($5,882
)
 
(65
)%
Effective tax rate
22.5
%
 
23.0
%
 
 
 
 

The variation between our effective income tax rate and the U.S. statutory rate of 35 percent is due to a percentage of our 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 our various tax jurisdictions can have a material impact on our periodic effective tax rate.
We recognized income tax expense of $3.2 million for an effective tax rate of 22.5% for the three months ended September 28, 2014 as compared to income tax expense of $9.1 million for an effective tax rate of 23.0% for the three months ended September 29, 2013 . This decrease in income tax expense was primarily due to lower pretax income.
Liquidity and Capital Resources
Overview
We require cash to fund our operating expenses and working capital requirements, including outlays for research and development, capital expenditures, strategic acquisitions and investments. Our principal sources of liquidity are cash on hand, marketable securities, cash generated from operations and availability under our line of credit. Our ability to generate cash from operations has been one of our fundamental strengths and has provided us with substantial flexibility in meeting our operating, financing and investing needs.

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Based on past performance and current expectations, we believe our current working capital, availability under our line of credit and anticipated cash flows from operations will be adequate to meet our cash needs for our daily operations and capital expenditures for at least the next 12 months. We may use a portion of our available cash and cash equivalents, line of credit or funds underlying our marketable securities to repurchase shares of our common stock pursuant to repurchase programs authorized by our Board of Directors. With our strong working capital position, we believe that we have the ability to continue to invest in further development of our products and, when necessary or appropriate, make selective acquisitions or other strategic investments to strengthen our product portfolio, secure key intellectual properties or expand our production capacity.
From time to time, we evaluate strategic opportunities, including potential acquisitions, divestitures or investments in complementary businesses, and we anticipate continuing to make such evaluations. We may also access capital markets through the issuance of debt or additional shares of common stock in connection with the acquisition of complementary businesses or other significant assets or for other strategic opportunities.
Liquidity
Our liquidity and capital resources primarily depend on our cash flows from operations and our working capital. The significant components of our working capital are liquid assets such as cash and cash equivalents, short-term investments, accounts receivable and inventories reduced by trade accounts payable.
The following table presents the components of our cash conversion cycle:
 
Three Months Ended
 
 
 
September 28,
2014
 
June 29,
2014
 
Change
Days of sales outstanding (a)
50
 
46
 
4

Days of supply in inventory (b)
96
 
94
 
2

Days in accounts payable (c)
(61)
 
(66)
 
5

Cash conversion cycle
85
 
74
 
11

a)
Days of sales outstanding (DSO) measures the average collection period of our receivables. DSO is based on the ending net trade receivables and the revenue, net for the quarter then ended. DSO is calculated by dividing ending accounts receivable, net of applicable allowances and reserves, by the average net revenue per day for the respective 90 day period.
b)
Days of supply in inventory (DSI) measures the average number of days from procurement to sale of our product. DSI is based on ending inventory and cost of revenue, net for the quarter then ended. DSI is calculated by dividing ending inventory by average cost of revenue, net per day for the respective 90 day period.
c)
Days in accounts payable (DPO) measures the average number of days our payables remain outstanding before payment. DPO is based on ending accounts payable and cost of revenue, net for the quarter then ended. DPO is calculated by dividing ending accounts payable by the average cost of revenue, net per day for the respective 90 day period.
The increase in the cash conversion cycle was primarily driven by an increase in days sales outstanding and a decrease in days in accounts payable.
As of September 28, 2014 , we had unrealized losses on our investments of $0.4 million . All of our investments had investment grade ratings, and any such investments that were in an unrealized loss position at September 28, 2014 were in such position due to interest rate changes, sector credit rating changes or company-specific rating changes. As we intend and believe that we have the ability to hold such investments for a period of time that will be sufficient for anticipated recovery in market value, we currently expect to receive the full principal or recover our cost basis in these securities. The declines in value of the securities in our portfolio are considered to be temporary in nature and, accordingly, we do not believe these securities are impaired as of September 28, 2014 .

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Cash Flows
In summary, our cash flows were as follows (in thousands, except percentages):
 
Three Months Ended
 
 
 
 
 
September 28, 2014
 
September 29, 2013
 
Change
Net cash provided by operating activities

$13,284

 

$69,236

 

($55,952