Cree, Inc.
CREE INC (Form: 10-Q, Received: 10/18/2017 16:15:14)
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 24, 2017
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
LOGO042115A19.GIF
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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer,” “smaller reporting company,” and "emerging growth 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 [    ]
 
 
 
 
Emerging growth company [    ]

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Securities Act . [   ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [   ] No[ X]


Table of Contents

The number of shares outstanding of the registrant’s common stock, par value $0.00125 per share, as of October 13, 2017 , was 98,135,192 .


Table of Contents

CREE, INC.
FORM 10-Q
For the Quarterly Period Ended September 24, 2017
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.
UNAUDITED CONSOLIDATED BALANCE SHEETS
 
September 24,
2017
 
June 25,
2017
 
(In thousands, except par value)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents

$152,058

 

$132,597

Short-term investments
472,796

 
478,341

Total cash, cash equivalents and short-term investments
624,854

 
610,938

Accounts receivable, net
154,854

 
148,392

Income tax receivable
7,639

 
8,040

Inventories, net
277,944

 
284,385

Prepaid expenses
23,572

 
23,305

Other current assets
15,352

 
23,390

Current assets held for sale
2,254

 
2,180

Total current assets
1,106,469

 
1,100,630

Property and equipment, net
594,698

 
581,263

Goodwill
618,828

 
618,828

Intangible assets, net
267,066

 
274,315

Other long-term investments
47,298

 
50,366

Deferred income taxes
11,137

 
11,763

Other assets
12,491

 
12,702

Total assets

$2,657,987

 

$2,649,867

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

Current liabilities:

 

Accounts payable, trade

$146,578

 

$133,185

Accrued salaries and wages
39,766

 
41,860

Other current liabilities
43,024

 
36,978

Total current liabilities
229,368

 
212,023

Long-term liabilities:

 

Long-term debt
141,000

 
145,000

Deferred income taxes
52,895

 
49,860

Other long-term liabilities
18,743

 
20,179

Total long-term liabilities
212,638

 
215,039

Commitments and contingencies (Note 13)

 

Shareholders’ equity:

 

Preferred stock, par value $0.01; 3,000 shares authorized at September 24, 2017 and June 25, 2017; none issued and outstanding

 

Common stock, par value $0.00125; 200,000 shares authorized at September 24, 2017 and June 25, 2017; 98,045 issued and 98,039 outstanding at September 24, 2017 and 97,674 shares issued and outstanding at June 25, 2017
121

 
121

Additional paid-in-capital
2,426,063

 
2,419,517

Accumulated other comprehensive income, net of taxes
7,512

 
5,909

Accumulated deficit
(222,599
)
 
(202,742
)
Total shareholders’ equity
2,211,097

 
2,222,805

Noncontrolling interest
4,884

 

Total liabilities and equity

$2,657,987

 

$2,649,867

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

3


CREE, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF (LOSS) INCOME
 
 
Three Months Ended
 
 
September 24,
2017
 
September 25,
2016
 
 
(In thousands, except per share amounts)
Revenue, net

$360,398

 

$371,231

 
Cost of revenue, net
260,066

 
261,302

 
Gross profit
100,332

 
109,929

 
Operating expenses:
 
 
 
 
Research and development
41,859

 
39,948

 
Sales, general and administrative
62,964

 
68,458

 
Amortization or impairment of acquisition-related intangibles
6,792

 
6,408

 
Loss on disposal or impairment of long-lived assets
2,825

 
324

 
Total operating expenses
114,440

 
115,138

 
Operating loss
(14,108
)
 
(5,209
)
 
Non-operating expense, net
(1,068
)
 
(158
)
 
Loss before income taxes
(15,176
)
 
(5,367
)
 
Income tax expense (benefit)
4,697

 
(5,933
)
 
Net (loss) income

($19,873
)
 

$566

 
Net loss attributable to noncontrolling interest
(16
)
 

 
Net (loss) income attributable to controlling interest

($19,857
)
 

$566

 
(Loss) earnings per share:
 
 
 
 
Basic

($0.20
)
 

$0.01

 
Diluted

($0.20
)
 

$0.01

 
Weighted average shares used in per share calculation:
 
 
 
 
Basic
97,811

 
100,559

 
Diluted
97,811

 
100,559

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

4


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

 
Three Months Ended
 
 
September 24,
2017
 
September 25,
2016
 
 
(In thousands)
Net (loss) income

($19,857
)
 

$566

 
Other comprehensive (loss) income:
 
 
 
 
Currency translation gain
1,642

 
29

 
Net unrealized loss on available-for-sale securities, net of tax benefit of $0 and $199, respectively
(39
)
 
(320
)
 
Other comprehensive (loss) income
1,603

 
(291
)
 
Comprehensive (loss) income

($18,254
)
 

$275

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


5


CREE, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
Three Months Ended
 
September 24,
2017
 
September 25,
2016
 
(In thousands)
Cash flows from operating activities:
 
 
 
Net (loss) income

($19,873
)
 

$566

Adjustments to reconcile net (loss) income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
37,400

 
35,939

Stock-based compensation
10,135

 
14,650

Excess tax benefit from stock-based payment arrangements

 
(12
)
Loss on disposal or impairment of long-lived assets
2,824

 
325

Amortization of premium/discount on investments
1,310

 
1,382

Loss on equity investment
3,267

 
2,487

Foreign exchange gain on equity investment
(199
)
 
(1,373
)
Deferred income taxes
3,133

 
54

Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net
(5,996
)
 
(9,227
)
Inventories
6,960

 
(10,808
)
Prepaid expenses and other assets
9,323

 
(1,922
)
Accounts payable, trade
6,442

 
(2,111
)
Accrued salaries and wages and other liabilities
(603
)
 
(11,852
)
Net cash provided by operating activities
54,123

 
18,098

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(36,450
)
 
(19,337
)
Purchases of patent and licensing rights
(2,476
)
 
(2,252
)
Proceeds from sale of property and equipment
327

 
165

Purchases of short-term investments
(117,607
)
 
(106,749
)
Proceeds from maturities of short-term investments
119,928

 
77,645

Proceeds from sale of short-term investments
1,974

 
5,148

Net cash used in investing activities
(34,304
)
 
(45,380
)
Cash flows from financing activities:
 
 
 
Proceeds from issuing shares to non-controlling interest
4,900

 

Payment of acquisition-related contingent consideration
(1,850
)
 
(2,775
)
Proceeds from long-term debt borrowings
95,000

 
110,000

Payments on long-term debt borrowings
(99,000
)
 
(83,000
)
Net proceeds from issuance of common stock
119

 
406

Excess tax benefit from stock-based payment arrangements

 
12

Repurchases of common stock

 
(35,663
)
Net cash used in financing activities
(831
)
 
(11,020
)
Effects of foreign exchange changes on cash and cash equivalents
473

 
(11
)
Net increase (decrease) in cash and cash equivalents
19,461

 
(38,313
)
Cash and cash equivalents:
 
 
 
Beginning of period
132,597

 
166,154

End of period

$152,058

 

$127,841

Supplemental disclosure of cash flow information:
 
 
 
Significant non-cash transactions:
 
 
 
Accrued property and equipment

$18,909

 

$3,103

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

6


CREE, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – Basis of Presentation and New Accounting Standards
Overview
Cree, Inc. (the Company) is a leading innovator of lighting-class light emitting diode (LED) products, lighting products and wide bandgap 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 lighting products primarily consist of LED lighting systems and lamps. The Company designs, manufactures and sells lighting fixtures and lamps for the commercial, industrial and consumer markets.
The Company's LED products consist of LED chips and LED components. The Company's LED products enable its customers to develop and market LED-based products for lighting, video screens, automotive and other industrial applications.

The Company’s Wolfspeed business consists of silicon carbide (SiC) materials, power devices and RF devices based on wide bandgap semiconductor materials such as SiC and gallium nitride (GaN). The Company’s materials products and power devices are used in solar, electric vehicles, motor drives, power supplies and transportation applications. The Company’s RF devices are used in military communications, radar, satellite and telecommunication applications.
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 products and aspects of product fabrication, assembly and packaging. The Company operates research and development facilities in North Carolina, Arkansas, California, Wisconsin, India, Italy 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:
Lighting Products
LED Products
Wolfspeed
For financial results by reportable segment, please refer to Note 14, "Reportable Segments."
Basis of Presentation
The consolidated balance sheet at September 24, 2017 , the consolidated statements of (loss) income for the three months ended September 24, 2017 and September 25, 2016 , the consolidated statements of comprehensive (loss) income for the three months ended September 24, 2017 and September 25, 2016 , and the consolidated statements of cash flows for the three months ended September 24, 2017 and September 25, 2016 (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 fairly state the consolidated financial position, results of operations, comprehensive income and cash flows at September 24, 2017 , and for all periods presented, have been made. All intercompany accounts and transactions have been eliminated. The consolidated balance sheet at June 25, 2017 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 25, 2017 (fiscal 2017 ). The results of operations for the three months ended September 24, 2017 are not necessarily indicative of the operating results that may be attained for the entire fiscal year ending June 24, 2018 (fiscal 2018 ).

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 2017 amounts related to the Wolfspeed business in the accompanying consolidated financial statements have been reclassified to continuing operations to conform to the fiscal 2018 presentation. These reclassifications had no effect on previously reported consolidated net income or shareholders’ equity.
Recently Issued Accounting Pronouncements
Revenue from Contracts with Customers
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09: Revenue from Contracts with Customers (Topic 606). The FASB has subsequently issued multiple ASUs which amend and clarify the guidance in 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 Company’s evaluation of ASU 2014-09 is ongoing and not complete; however, the Company anticipates the primary changes to revenue recognition to be related to certain patent license arrangements. The FASB has issued and may issue in the future, interpretive guidance, which may cause our evaluation to change. The effective date will be the first quarter of the Company's fiscal year ending June 30, 2019 and the Company currently expects to use the modified retrospective method.
Leases
In February 2016, the FASB issued ASU No. 2016-02: Leases (Topic 842). The ASU requires that a lessee recognize in its statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. The asset will be based on the liability, subject to adjustment, such as for initial direct costs. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. For income statement purposes, leases are still required to be classified as either operating or finance. Operating leases will result in straight-line expense while finance leases will result in a front-loaded expense pattern. The effective date will be the first quarter of the Company's fiscal year ending June 28, 2020, using a modified retrospective approach. The Company is currently analyzing the impact of this new pronouncement.
Stock Compensation
In March 2016, the FASB issued ASU No. 2016-09: Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting.  The ASU simplifies the current stock compensation guidance for tax consequences. The ASU requires an entity to recognize all excess tax benefits and tax deficiencies as income tax expense or benefit in its income statement. The ASU also eliminates the requirement to defer recognition of an excess tax benefit until the benefit is realized through a reduction to taxes payable. For cash flows statement purposes, excess tax benefits should be classified as an operating activity and cash payments made to taxing authorities on the employee’s behalf for withheld shares should be classified as financing activity. The ASU grants an entity the right to withhold up to the employee’s maximum statutory tax rate in the applicable jurisdiction without triggering liability accounting. The effective date was the first quarter of the Company's fiscal year ending June 24, 2018.
The Company's adoption of this ASU did not have a material impact on its consolidated financial statements. All excess tax benefits and deficiencies in the current and future periods will be recognized as income tax expense in the Company’s income statement in the reporting period in which they occur. This could result in increased volatility in the Company’s effective tax rate. For the three months ended September 24, 2017, the Company did not recognize a discrete event related to the excess tax benefits from stock-based compensation due to a full U.S. valuation allowance on the impact. The Company plans to continue its existing practice of estimating expected forfeitures in determining compensation cost.
Goodwill Impairment Testing
In January 2017, the FASB issued ASU No. 2017-04: Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The ASU simplifies the manner in which an entity is required to test for goodwill impairment by eliminating Step 2 from the goodwill impairment test. Additionally, the ASU removes the requirement for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails such qualitative test, to continue to perform Step 1 of

8


the goodwill impairment test. The effective date will be the first quarter of the Company's fiscal year ending June 27, 2021. The Company’s adoption of this guidance is not expected to have a significant impact on its consolidated financial statements.
Note 2 – Joint Venture
Effective July 17, 2017, we entered into a Shareholders Agreement with San’an Optoelectronics Co., Ltd. (San’an) and Cree Venture LED Company Limited. (Cree Venture LED) pursuant to which we and San’an funded our contributions to Cree Venture LED and agreed upon the management and operation of Cree Venture LED.  We contributed $5.1 million of cash for a 51% ownership interest and San’an contributed $4.9 million of cash for a 49% ownership interest.  Cree Venture LED has a five-member board of directors, three of which were designated by Cree and two of which were designated by San’an. As a result of our majority voting interest, we consolidate the operations of Cree Venture LED and report its revenue and gross profit within our LED Products segment. We classify the 49% ownership interest held by San'an as "Noncontrolling interest" on the consolidated balance sheet.
In connection with forming Cree Venture LED and entering into the Shareholders Agreement, Cree Venture LED and San’an also entered into a manufacturing agreement pursuant to which San’an will supply Cree Venture LED with mid-power LED products, and we and Cree Venture LED entered into a sales agency agreement pursuant to which we will be the independent sales representative of Cree Venture LED in the exclusive markets, among certain other ancillary agreements related to the transaction.
Cree Venture LED will produce and deliver to market high performing, mid-power lighting class LEDs in an exclusive arrangement to serve the expanding markets of North and South America, Europe and Japan, and serve China and the rest of the world on a non-exclusive basis. Cree Venture LED recorded its first sales to customers during the first quarter of fiscal 2018.
Note 3 – Acquisition
On July 8, 2015, the Company closed on the acquisition of Arkansas Power Electronics International, Inc. (APEI), a global leader in power modules and power electronics applications, pursuant to a merger agreement with APEI and certain shareholders of APEI, whereby the Company acquired all of the outstanding share capital of APEI in exchange for a base purchase price of $13.8 million , subject to certain adjustments. In addition, if certain goals were achieved over the subsequent two years, additional cash payments totaling up to $4.6 million were to be made to the former APEI shareholders. Payments totaling $2.8 million were made to the former APEI shareholders in July 2016 based on achievement of the first year goals. The final payment of $1.9 million was made in July 2017 based on achievement of the second year goals. In connection with this acquisition, APEI became a wholly owned subsidiary of the Company, renamed Cree Fayetteville, Inc. (Cree Fayetteville). Cree Fayetteville is not considered a significant subsidiary of the Company and its results from operations are reported as part of the Company's Wolfspeed segment.
Note 4 – Financial Statement Details
Accounts Receivable, net
The following table summarizes the components of accounts receivable, net (in thousands):
 
September 24, 2017
 
June 25, 2017
Billed trade receivables

$213,345

 

$205,516

Unbilled contract receivables
1,294

 
912


214,639

 
206,428

Allowance for sales returns, discounts and other incentives
(51,076
)
 
(49,425
)
Allowance for bad debts
(8,709
)
 
(8,611
)
Accounts receivable, net

$154,854

 

$148,392

Inventories
The following table summarizes the components of inventories (in thousands):

9


 
September 24, 2017
 
June 25, 2017
Raw material

$77,097

 

$73,410

Work-in-progress
95,720

 
100,402

Finished goods
105,127

 
110,573

Inventories

$277,944

 

$284,385

Other Current Liabilities
The following table summarizes the components of other current liabilities (in thousands):
 
September 24, 2017
 
June 25, 2017
Accrued taxes

$12,561

 

$11,148

Accrued professional fees
6,625

 
5,545

Accrued warranty
16,627

 
13,631

Accrued other
7,211

 
6,654

Other current liabilities

$43,024

 

$36,978

Accumulated Other Comprehensive Income, net of taxes
The following table summarizes the components of accumulated other comprehensive income, net of taxes (in thousands):
 
September 24, 2017
 
June 25, 2017
Currency translation gain

$6,114

 

$4,471

Net unrealized gain on available-for-sale securities
1,398

 
1,438

Accumulated other comprehensive income, net of taxes

$7,512

 

$5,909

Non-Operating Expense, net
The following table summarizes the components of non-operating expense, net (in thousands):
 
Three Months Ended
 
September 24, 2017
 
September 25, 2016
Foreign currency gain, net

$767

 

$1,361

Gain on sale of investments, net
45

 
12

Loss on equity investment
(3,267
)
 
(2,487
)
Interest income, net
1,151

 
887

Other, net
236

 
69

Non-operating expense, net

($1,068
)
 

($158
)

10


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 Out of Accumulated Other Comprehensive Income
 
Affected Line Item in the Consolidated Statements of (Loss) Income
 
Three Months Ended
 
 
 
September 24, 2017
 
September 25, 2016
 
 
Net unrealized gain on available-for-sale securities, net of taxes

$45

 

$12

 
Non-operating expense, net
 
45

 
12

 
(Loss) income before income taxes
 

 
9

 
Income tax expense (benefit)
 

$45

 

$3

 

Note 5 – Investments
Investments consist of municipal bonds, corporate bonds, commercial paper and certificates of deposit. All short-term investments are classified as available-for-sale. Other long-term investments consist of the Company's ownership interest in Lextar Electronics Corporation.
The following tables summarize short-term investments (in thousands):
 
 
September 24, 2017
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
Municipal bonds
 

$183,070

 

$2,247

 

($77
)
 

$185,240

Corporate bonds
 
171,326

 
1,830

 
(189
)
 
172,967

Non-U.S. certificates of deposit
 
112,478

 
31

 

 
112,509

Commercial paper
 
2,080

 

 

 
2,080

Total short-term investments
 

$468,954

 

$4,108

 

($266
)
 

$472,796

 
 
 
 
 
 
 
 
 
 
 
June 25, 2017
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
Municipal bonds
 

$177,890

 

$2,219

 

($68
)
 

$180,041

Corporate bonds
 
175,991

 
1,925

 
(195
)
 
177,721

Non-U.S. certificates of deposit
 
120,379

 

 

 
120,379

Commercial paper
 
200

 

 

 
200

Total short-term investments
 

$474,460

 

$4,144

 

($263
)
 

$478,341


11


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 24, 2017
 
 
Less than 12 Months
 
Greater than 12 Months
 
Total
 
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
Municipal bonds
 

$22,844

 

($40
)
 

$3,795

 

($22
)
 

$26,639

 

($62
)
Corporate bonds
 
45,214

 
(159
)
 
5,572

 
(45
)
 
50,786

 
(204
)
Total
 

$68,058

 

($199
)
 

$9,367

 

($67
)
 

$77,425

 

($266
)
Number of securities with an unrealized loss
 
 
 
53

 
 
 
11
 
 
 
64

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
June 25, 2017
 
 
Less than 12 Months
 
Greater than 12 Months
 
Total
 
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
Municipal bonds
 

$26,816

 

($68
)
 

$—

 

$—

 

$26,816

 

($68
)
Corporate bonds
 
57,404

 
(195
)
 

 

 
57,404

 
(195
)
Total
 

$84,220

 

($263
)
 

$—

 

$—

 

$84,220

 

($263
)
Number of securities with an unrealized loss
 
 
 
67

 
 
 

 
 
 
67

The Company utilizes specific identification in computing realized gains and losses on the sale of investments. Realized gains and losses from the sale of investments are included in Non-operating expense, net in the consolidated statements of (loss) 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 24, 2017 and June 25, 2017 .
The contractual maturities of short-term investments as of September 24, 2017 were as follows (in thousands):
 
 
Within One Year
 
After One, Within Five Years
 
After Five, Within Ten Years
 
After Ten
Years
 
Total
Municipal bonds

$45,350

 

$116,758

 

$23,132

 

$—

 

$185,240

Corporate bonds
33,399

 
107,050

 
32,518

 

 
172,967

Non-U.S. certificates of deposit
107,788

 
4,721

 

 

 
112,509

Commercial paper
2,080

 

 

 

 
2,080

Total short-term investments

$188,617

 

$228,529

 

$55,650

 

$—

 

$472,796


12


Note 6 – 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, short-term investments and long-term investments. As of September 24, 2017 , financial assets utilizing Level 1 inputs included money market funds and certificates of deposit, and financial assets utilizing Level 2 inputs included municipal bonds, corporate bonds, certificates of deposit, commercial paper and common stock of non-U.S. corporations. Level 2 assets are valued based on quoted prices in active markets for instruments that are similar or 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 24, 2017 . There were no transfers between Level 1 and Level 2 during the three months ended September 24, 2017 .

13


The following table sets forth financial instruments carried at fair value within the U.S. GAAP hierarchy (in thousands):
 
September 24, 2017
 
June 25, 2017
 
 Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Municipal bonds

$—

 

$—

 

$—

 

$—

 

$—

 

$1,802

 

$—

 

$1,802

Non-U.S. certificates of deposit

 
86,161

 

 
86,161

 

 
736

 

 
736

Money market funds
861

 

 

 
861

 
1,184

 

 

 
1,184

Total cash equivalents
861

 
86,161

 

 
87,022

 
1,184

 
2,538

 

 
3,722

Short-term investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Municipal bonds

 
185,240

 

 
185,240

 

 
180,041

 

 
180,041

Corporate bonds

 
172,967

 

 
172,967

 

 
177,721

 

 
177,721

Commercial paper

 
2,080

 

 
2,080

 

 
200

 

 
200

Non-U.S. certificates of deposit

 
112,509

 

 
112,509

 

 
120,379

 

 
120,379

Total short-term investments

 
472,796

 

 
472,796

 

 
478,341

 

 
478,341

Other long-term investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common stock of non-U.S. corporations

 
47,298

 

 
47,298

 

 
50,366

 

 
50,366

Total other long-term investments

 
47,298

 

 
47,298

 

 
50,366

 

 
50,366

Total assets

$861

 

$606,255

 

$—

 

$607,116

 

$1,184

 

$531,245

 

$—

 

$532,429

Note 7– Intangible Assets
Intangible Assets, net
The following table presents the components of intangible assets, net (in thousands):
 
September 24, 2017
 
June 25, 2017
 
Gross
 
Accumulated Amortization
 
Net
 
Gross
 
Accumulated Amortization
 
Net
Intangible assets with finite lives:
 
 
 
 
 
 
 
 
 
 
 
Customer relationships

$141,420

 

($86,232
)
 

$55,188

 

$141,420

 

($84,673
)
 

$56,747

Developed technology
181,728

 
(137,963
)
 
43,765

 
181,728

 
(132,747
)
 
48,981

Non-compete agreements
10,475

 
(10,417
)
 
58

 
10,475

 
(10,398
)
 
77

Trade names, finite-lived
520

 
(520
)
 

 
520

 
(520
)
 

Patent and licensing rights
153,893

 
(65,518
)
 
88,375

 
151,985

 
(63,155
)
 
88,830

Total intangible assets with finite lives
488,036

 
(300,650
)
 
187,386

 
486,128

 
(291,493
)
 
194,635

Trade names, indefinite-lived
79,680

 

 
79,680

 
79,680

 

 
79,680

Total intangible assets

$567,716

 

($300,650
)
 

$267,066

 

$565,808

 

($291,493
)
 

$274,315

For the three months ended September 24, 2017 , total amortization of finite-lived intangible assets was $9.9 million . For the three months ended September 25, 2016 , total amortization of finite-lived intangible assets was $9.4 million .

14


Total future amortization expense of finite-lived intangible assets is estimated to be as follows (in thousands):
Fiscal Year Ending
 
June 24, 2018 (remainder of fiscal 2018)

$28,618

June 30, 2019
25,225

June 28, 2020
19,821

June 27, 2021
18,444

June 26, 2022
16,323

Thereafter
78,955

Total future amortization expense

$187,386

Note 8 – Long-term Debt
As of September 24, 2017 , the Company had a $500 million secured revolving line of credit under which the Company can borrow, repay and reborrow loans from time to time prior to its scheduled maturity date of January 9, 2020 .
The Company classifies balances outstanding under its line of credit as long-term debt in the consolidated balance sheets. At September 24, 2017 , the Company had $141 million outstanding under the line of credit and $359 million available for borrowing. For the three months ended September 24, 2017 , the average interest rate was 1.78% . For the three months ended September 24, 2017 the average commitment fee percentage was 0.09% . The Company was in compliance with all covenants in the line of credit at September 24, 2017 .
Note 9 – Shareholders’ Equity
As of September 24, 2017 , pursuant to an approval 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 26, 2017 through the expiration of the program on June 24, 2018 . During the three months ended September 24, 2017 , the Company repurchased no shares of common stock under the stock repurchase program.
Note 10– (Loss) Earnings Per Share
The following table presents the computation of basic (loss) earnings per share (in thousands, except per share amounts):
 
Three Months Ended
 
September 24,
2017
 
September 25,
2016
Net (loss) income

($19,857
)
 

$566

Weighted average common shares
97,811

 
100,559

Basic (loss) earnings per share

($0.20
)
 

$0.01

The following computation reconciles the differences between the basic and diluted (loss) earnings per share presentations (in thousands, except per share amounts):  
 
Three Months Ended
 
September 24,
2017
 
September 25,
2016
Net (loss) income

($19,857
)
 

$566

Weighted average common shares - basic
97,811

 
100,559

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

 

Weighted average common shares - diluted
97,811

 
100,559

Diluted (loss) earnings per share

($0.20
)
 

$0.01


15


Potential common shares that would have the effect of increasing diluted earnings per share or decreasing diluted loss 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 24, 2017 , there were 10.1 million of potential common shares not included in the calculation of diluted (loss) earnings per share because their effect was anti-dilutive. For the three months ended September 25, 2016 , there were 11.4 million of potential common shares not included in the calculation of diluted (loss) earnings per share because their effect was anti-dilutive.
Note 11 – 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 stock options, restricted stock and restricted stock units are currently outstanding.
The Company’s stock-based awards can be either service-based or performance-based.  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 allows 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 provides for a twelve-month participation period, divided into two equal six-month purchase periods, and also provides for a look-back feature. At the end of each six-month period in April and October, participants 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 fair market value of common stock declines during the first six-month purchase period.

16


Stock Option Awards
The following table summarizes stock option awards outstanding as of September 24, 2017 and changes during the three months then ended (numbers of shares in thousands):  
 
Number of Shares
 
Weighted Average Exercise Price
Outstanding at June 25, 2017
10,604

 
$38.27

Granted
53

 
$24.66

Exercised
(5
)
 
$25.13

Forfeited or expired
(1,133
)
 
$50.88

Outstanding at September 24, 2017
9,519

 
$36.70

Restricted Stock Awards and Units
A summary of nonvested restricted stock awards (RSAs) and restricted stock unit awards (RSUs) outstanding as of September 24, 2017 , and changes during the three months then ended is as follows (numbers of awards and units in thousands):  
 
Number of
  RSAs/RSUs  
 
Weighted Average 
Grant-Date Fair Value
Nonvested at June 25, 2017
2,412

 
$26.74

Granted
1,705

 
$24.44

Vested
(523
)
 
$29.91

Forfeited
(191
)
 
$25.20

Nonvested at September 24, 2017
3,403

 
$25.18

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 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.

17


Total stock-based compensation expense was as follows (in thousands):
 
Three Months Ended
 
September 24,
2017
 
September 25,
2016
Income Statement Classification:
 
 
 
Cost of revenue, net
$1,775

 

$2,805

Research and development
2,457

 
3,439

Sales, general and administrative
5,903

 
8,406

Total stock-based compensation expense

$10,135

 

$14,650

Note 12 – Income Taxes
The variation between the Company's effective income tax rate and the U.S. statutory rate of 35% is primarily due to: (i) changes in the Company’s valuation allowances against deferred tax assets in the U.S. and Luxembourg, (ii) projected income for the full year derived from international locations with lower tax rates than the U.S. and (iii) projected tax credits generated.
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 25, 2017 , the Company's liability for unrecognized tax benefits was $13.3 million . During the three months ended September 24, 2017 , the Company did not record any material movement in its unrecognized tax benefits. As a result, the total liability for unrecognized tax benefits as of September 24, 2017 was $13.3 million . If any portion of this $13.3 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 $0.2 million of gross unrecognized tax benefits will change in the next 12 months as a result of 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 2014. For U.S. state tax returns, the Company is generally no longer subject to tax examinations for fiscal years prior to 2013. For foreign purposes, the Company is generally no longer subject to tax examinations for tax periods 2007 and prior. Certain carryforward tax attributes generated in prior years remain subject to examination, adjustment and recapture.
The Company assesses all available positive and negative evidence to estimate if sufficient future taxable income will be generated to utilize the existing deferred tax assets by jurisdiction. The Company has concluded that it is necessary to recognize a full valuation allowance against its U.S. and Luxembourg deferred tax assets.
Note 13 – Commitments and Contingencies
Warranties
The following table summarizes the changes in the Company's product warranty liabilities (in thousands):
Balance at June 25, 2017

$27,919

Warranties accrued in current period
7,142

Expenditures
(4,890
)
Balance at September 24, 2017

$30,171

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 Company accrues estimated costs related to product recalls based on a formal campaign soliciting repair or return of that product when they are deemed probable and reasonably estimable. The warranty reserves, which are primarily related to Lighting Products, are evaluated quarterly 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 24, 2017 , $13.5 million of the Company's product warranty liabilities were classified as long-term.

18


The Company has voluntarily recalled its linear LED T8 replacement lamps due to the hazard of overheating and melting. The Company expects the majority of the costs of the recall to be recoverable from insurance proceeds resulting in an immaterial impact to the Company’s financial results.
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 14 – Reportable Segments

The Company's operating and reportable segments are:
Lighting Products
LED Products
Wolfspeed
Reportable Segments Description
The Company's Lighting Products segment primarily consists of LED lighting systems and bulbs. The Company's LED Products segment includes LED chips and LED components. The Company's Wolfspeed segment includes power devices, RF devices, and SiC materials.
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 24, 2017 . 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 (loss) income must be included to reconcile the consolidated gross profit presented in the table below to the Company's consolidated loss from continuing operations 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 consisted 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.

19


Revenue, gross profit and gross margin for each of the Company's segments were as follows (in thousands, except percentages):
 
Three Months Ended
 
September 24,
2017
 
September 25,
2016
Revenue:
 
 
 
Lighting Products revenue

$149,724

 

$183,836

LED Products revenue
144,520

 
137,493

Wolfspeed revenue
66,154

 
49,902

Total revenue

$360,398

 

$371,231

 
 
 
 
Gross Profit and Gross Margin:
 
 
 
Lighting Products gross profit

$31,883

 

$49,290

Lighting Products gross margin
21.3
%
 
26.8
%
LED Products gross profit
38,810

 
41,770

LED Products gross margin
26.9
%
 
30.4
%
Wolfspeed gross profit
32,398

 
23,460

Wolfspeed gross margin
49.0
%
 
47.0
%
Total segment gross profit
103,091

 
114,520

Unallocated costs
(2,759
)
 
(4,591
)
Consolidated gross profit

$100,332

 

$109,929

Consolidated gross margin
27.8
%
 
29.6
%

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. The CODM reviews all of the Company's assets other than inventories on a consolidated basis.
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 .
Inventories for each of the Company's segments were as follows (in thousands):
 
September 24,
2017
 
June 25,
2017
Lighting Products

$141,544

 

$145,710

LED Products
105,799

 
108,297

Wolfspeed
26,172

 
26,453

Total segment inventories
273,515

 
280,460

Unallocated inventories
4,429

 
3,925

Consolidated inventories

$277,944

 

$284,385

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

20

Table of Contents

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 25, 2017 . 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 wide bandgap 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 lighting products primarily consist of LED lighting systems and lamps. We design, manufacture and sell lighting fixtures and lamps for the commercial, industrial and consumer markets.
Our LED products consist of LED chips and LED components. Our LED products enable our customers to develop and market LED-based products for lighting, video screens, automotive and other industrial applications.
Our Wolfspeed business consists of silicon carbide (SiC) and gallium nitride (GaN) materials, power devices and RF devices based on wide bandgap semiconductor materials. Our materials products and power devices are used in solar, electric vehicles, motor drives, power supplies and transportation applications. Our materials products and RF devices are used in military communications, radar, satellite and telecommunication applications.
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 products and aspects of product fabrication, assembly and packaging. We operate research and development facilities in North Carolina, Arkansas, California, Wisconsin, India, Italy 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:
Lighting Products
LED Products
Wolfspeed
For further information about our reportable segments, please refer to Note 14, "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, SiC power devices and GaN RF devices . Our potential for growth depends significantly on the continued adoption of LEDs, the adoption of SiC and GaN materials and device products in the power and RF markets, and our ability to win new designs for these applications. Demand also fluctuates based on various market cycles, continuously evolving industry supply chains, and evolving competitive dynamics in each of the respective markets. These uncertainties make demand difficult to forecast for us and our customers.
Intense and Constantly Evolving Competitive Environment. Competition in the industries we serve is intense. Many companies have made significant investments in product development and production equipment. 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 the LED, lighting, power and RF markets we serve. To remain competitive, market participants must continuously increase product performance, reduce costs and develop improved ways to serve their customers. To address these competitive pressures, we have invested in research and development activities to support new product development, lower product costs and deliver higher levels of performance to differentiate our products in the market. In addition, we invest in systems, people and new processes to improve our ability to deliver a better overall experience for our customers.
Lighting Sales Channel Development. Commercial lighting is usually sold through lighting agents and distributors in the North American lighting market. The lighting agents typically have exclusive sales rights for a defined territory and are typically aligned with one large lighting company for a large percentage of their product sales. The size, quality and capability of the lighting agent has a significant effect on winning new projects and sales in a given geographic market. While these agents sell other lighting products, the large traditional lighting companies have taken steps to prevent their channel partners from selling competing product lines. We are constantly working to improve the capabilities of our existing channel partners and increase our share of their sales as well as develop new partners to improve our sales effectiveness in each geographic market.
Technological Innovation and Advancement. Innovations and advancements in LEDs, lighting and power and RF technologies continue to expand the potential commercial application for our products. 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.
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 24, 2017
The following is a summary of our financial results for the three months ended September 24, 2017 :

Revenue decreased to $360 million for the three months ended September 24, 2017 from $371 million for the three months ended September 25, 2016 .
Gross profit decreased to $100 million for the three months ended September 24, 2017 from $110 million for the three months ended September 25, 2016 . Gross margin was 28% for the three months ended September 24, 2017 and 30% for the three months ended September 25, 2016 .
Operating loss was $14 million for the three months ended September 24, 2017 and $5 million for the three months ended September 25, 2016 . Net loss per diluted share was $0.20 for the three months ended September 24, 2017 compared to net earnings per diluted share of $0.01 for the three months ended September 25, 2016 .
Cash, cash equivalents and short-term investments were $0.6 billion at September 24, 2017  and $0.6 billion at June 25, 2017 . Cash provided by operating activities was $54 million for the three months ended September 24, 2017 compared to $18 million for the three months ended September 25, 2016 .
Inventories decreased to $278 million at September 24, 2017 compared to $284 million at June 25, 2017 .
Purchases of property and equipment were $36 million for the three months ended September 24, 2017 compared to $19 million for the three months ended September 25, 2016 .

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Business Outlook
We continue to focus on growing the Wolfspeed business, as our customers have further realized the value of our technology. The strength of our balance sheet and improving operating cash flow provides us the ability to invest in Wolfspeed, while continuing to pursue our LED and Lighting growth plans.

We are uniquely positioned as a market leading innovator in all three business segments and target growth in all three businesses over the next several years. These businesses are in different phases of their growth plans and generally operate on different market cycles. This is targeted to provide better business diversity and less cyclical results over time.
We are focused on the following priorities to support our goals of delivering higher revenue and profits over time:
Invest in the Wolfspeed business to increase capacity and further develop the technology to support longer term growth opportunities in SiC materials, SiC power devices and modules, and GaN RF devices.
Grow Lighting Products revenue and improve margins by investing in our channel relationships, improving execution, and continuing to deliver innovative lighting solutions.
Grow the LED Products business by expanding our product offering with new products that leverage our market leadership to serve a larger share of existing customers’ LED demand, while also opening new applications for our technology.
Improve the customer experience and service levels in all of our businesses.
Results of Operations
The following table sets forth certain consolidated statement of (loss) income data for the periods indicated (in thousands, except per share amounts and percentages):
 
 
Three Months Ended
 
September 24,
2017
 
September 25,
2016
 
Dollars
 
% of Revenue
 
Dollars
 
% of Revenue
Revenue, net

$360,398

 
100
 %
 

$371,231

 
100
 %
Cost of revenue, net
260,066

 
72
 %
 
261,302

 
70
 %
Gross profit
100,332

 
28
 %
 
109,929

 
30
 %
Research and development
41,859

 
12
 %
 
39,948

 
11
 %
Sales, general and administrative
62,964

 
17
 %
 
68,458

 
18
 %
Amortization or impairment of acquisition-related intangibles
6,792

 
2
 %
 
6,408

 
2
 %
Loss on disposal or impairment of long-lived assets
2,825

 
1
 %
 
324

 
 %
Operating loss
(14,108
)
 
(4
)%
 
(5,209
)
 
(1
)%
Non-operating expense, net
(1,068
)
 
 %
 
(158
)
 
 %
Loss before income taxes
(15,176
)
 
(4
)%
 
(5,367
)
 
(1
)%
Income tax expense (benefit)
4,697

 
1
 %
 
(5,933
)
 
(2
)%
Net (loss) income
(19,873
)
 
(6
)%
 

$566

 
 %
Net loss attributable to noncontrolling interest
(16
)
 
 %
 

 
 %
Net (loss) income attributable to controlling interest

($19,857
)
 
(6
)%
 

$566

 
 %
Basic (loss) earnings per share

($0.20
)
 
 
 

$0.01

 
 
Diluted (loss) earnings per share

($0.20
)
 

 

$0.01

 




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Revenue

Revenue was comprised of the following (in thousands, except percentages):
 
Three Months Ended
 
 
 
 
 
September 24,
2017
 
September 25,
2016
 
Change
Lighting Products revenue

$149,724

 

$183,836

 

($34,112
)
 
(19
)%
Percent of revenue
42
%
 
50
%
 
 
 
 
LED Products revenue
144,520

 
137,493

 
7,027

 
5
 %
Percent of revenue
40
%
 
37
%
 
 
 
 
Wolfspeed revenue
66,154

 
49,902

 
16,252

 
33
 %
Percent of revenue
18
%
 
13
%
 
 
 
 
Total revenue

$360,398

 

$371,231

 

($10,833
)
 
(3
)%
Our consolidated revenue decreased 3% to $360.4 million for the three months ended September 24, 2017 from $371.2 million for the three months ended September 25, 2016 . This decrease was driven by the 19% reduction in Lighting Products revenue, which was partially offset by the 33% and 5% increase in Wolfspeed and LED Products revenue, respectively.
Lighting Products Segment Revenue
Lighting Products revenue represented approximately 42% and 50% of our total revenue for the three months ended September 24, 2017 and September 25, 2016 , respectively.
Lighting Products revenue decreased 19% to $149.7 million for the three months ended September 24, 2017 from $183.8 million for the three months ended September 25, 2016 . The decrease in revenue for the three months ended September 24, 2017 compared to the three months ended September 25, 2016 was due to a 52% decrease in the number of overall units sold, which was partially offset by a 68% increase in average selling prices (ASP). The decrease in units sold for the period was due to weakness in the North American commercial market, the lingering effects related primarily to driver quality holds which have lowered project win rates and lower consumer sales due to lower demand.
LED Products Segment Revenue
LED Products revenue represented 40% and 37% of our total revenue for the three months ended September 24, 2017 and September 25, 2016 , respectively.    
LED Products revenue increased 5% to $144.5 million for the three months ended September 24, 2017 from $137.5 million for the three months ended September 25, 2016 . The increase in revenue for the three months ended September 24, 2017 compared to the three months ended September 25, 2016 was due primarily to a 17% increase in the number of units sold partially offset by a 11% decrease in ASP. The decrease in ASP for the respective period was due primarily to competitive pricing pressures.
Wolfspeed Segment Revenue
Wolfspeed revenue represented approximately 18% and 13% of our total revenue for the three months ended September 24, 2017 and September 25, 2016 , respectively.
Wolfspeed revenue increased 33% to $66.2 million for the three months ended September 24, 2017 from $49.9 million for the three months ended September 25, 2016 . The increase in revenue for the three months ended September 24, 2017 as compared to the three months ended September 25, 2016 was due to a 17% increase in the number of units sold as well as a 22% increase in ASP. The increase in ASP was due to a greater mix of higher priced products.

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Gross Profit and Gross Margin
Gross profit and gross margin were as follows (in thousands, except percentages):
 
Three Months Ended
 
 
 
 
 
September 24,
2017
 
September 25,
2016
 
Change
Lighting Products gross profit

$31,883

 

$49,290

 

($17,407
)
 
(35
)%
Lighting Products gross margin
21
%
 
27
%
 
 
 
 
LED Products gross profit
38,810

 
41,770

 
(2,960
)
 
(7
)%
LED Products gross margin
27
%
 
30
%
 
 
 
 
Wolfspeed gross profit
32,398

 
23,460

 
8,938

 
38
 %
Wolfspeed gross margin
49
%
 
47
%
 
 
 
 
Unallocated costs
(2,759
)
 
(4,591
)
 
1,832

 
(40
)%
Consolidated gross profit

$100,332

 

$109,929

 

($9,597
)
 
(9
)%
Consolidated gross margin
28
%
 
30
%
 
 
 
 
Our consolidated gross profit decreased 9% to $100.3 million for the three months ended September 24, 2017 from $109.9 million for the three months ended September 25, 2016 . Our consolidated gross margin decreased to 27.8% for the three months ended September 24, 2017 from 29.6% for the three months ended September 25, 2016 .
Lighting Products Segment Gross Profit and Gross Margin
Lighting Products gross profit decreased 35% to $31.9 million for the three months ended September 24, 2017 from $49.3 million for the three months ended September 25, 2016 . Lighting Products gross margin decreased to 21.3% for the three months ended September 24, 2017 from 26.8% for the three months ended September 25, 2016 . The decrease in Lighting Products gross profit and gross margin for the three months ended September 24, 2017 was primarily due to lower commercial lighting fixture sales, lower commercial factory utilization and higher commercial lighting product warranty reserves.
LED Products Segment Gross Profit and Gross Margin
LED Products gross profit decreased 7% to $38.8 million for the three months ended September 24, 2017 from $41.8 million for the three months ended September 25, 2016 . LED Products gross margin decreased to 26.9% for the three months ended September 24, 2017 from 30.4% for the three months ended September 25, 2016 . The decreases in gross profit and gross margin are due primarily to lower pricing resulting from the global competition for LED products and a less favorable mix of LED products sold.
Wolfspeed Segment Gross Profit and Gross Margin
Wolfspeed gross profit increased 38% to $32.4 million for the three months ended September 24, 2017 from $23.5 million for the three months ended September 25, 2016 . Wolfspeed gross margin increased to 49.0% for the three months ended September 24, 2017 from 47.0% for the three months ended September 25, 2016 . The increases in gross profit and gross margin are primarily due to a more favorable product sales mix, higher factory utilization and improved production yields.
Unallocated Costs
Unallocated costs were $2.8 million and $4.6 million for the three months ended September 24, 2017 and September 25, 2016 , 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 Chief Operating Decision Maker does not review them regularly when evaluating segment performance and allocating resources. The decrease for the three months ended September 24, 2017 as compared to the three months ended September 25, 2016 was primarily attributable to lower stock-based and incentive compensation.

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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 table sets forth our research and development expenses in dollars and as a percentage of revenue (in thousands, except percentages):
 
Three Months Ended
 
 
 
 
 
September 24,
2017
 
September 25,
2016
 
Change
Research and development

$41,859

 

$39,948

 

$1,911

 
5
%
Percent of revenue
12
%
 
11
%
 
 
 
 
Research and development expenses for the three months ended September 24, 2017 increased 5% to $41.9 million from $39.9 million for the three months ended September 25, 2016 . These increases were primarily due to an increase in Wolfspeed research and development, to accelerate 150mm development along with next generation power and RF device research and development. 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.
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 24,
2017
 
September 25,
2016
 
Change
Sales, general and administrative

$62,964

 

$68,458

 

($5,494
)
 
(8
)%
Percent of revenue
17
%
 
18
%
 
 
 
 
Sales, general and administrative expenses of $63.0 million for the three months ended September 24, 2017 decreased 8% from $68.5 million for the three months ended September 25, 2016 . The decrease for the three months ended September 24, 2017 was primarily due to lower variable commercial lighting sales expense resulting from the decrease in lighting revenue, lower stock compensation expense and the non-recurrence of fiscal 2017 costs associated with the former Wolfspeed transaction.
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 24,
2017
 
September 25,
2016
 
Change
Customer relationships

$1,558

 

$1,324

 

$234

 
18
 %
Developed technology
5,214

 
4,845

 
369

 
8
 %
Non-compete agreements
20

 
239

 
(219
)
 
(92
)%
Total amortization

$6,792

 

$6,408

 

$384

 
6
 %
Amortization of acquisition-related intangibles was $6.8 million for the three months ended September 24, 2017 compared to $6.4 million for the three months ended September 25, 2016 .

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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 24,
2017
 
September 25,
2016
 
Change
Loss on disposal or impairment of long-lived assets

$2,825

 

$324

 

$2,501

 
772
%
We recognized a net loss of $2.8 million and a net loss of $0.3 million on the disposal of long-lived assets for the three months ended September 24, 2017 and September 25, 2016 , respectively. The increase in net loss for the three months ended  September 24, 2017 as compared to the three months ended  September 25, 2016  was primarily due to demolition and move costs associated with our current Wolfspeed manufacturing capacity expansion.
Non-Operating Expense, net
The following table sets forth our non-operating income (expense), net (in thousands, except percentages):
 
Three Months Ended
 
 
 
 
 
September 24, 2017
 
September 25, 2016
 
Change
Gain on sale of investments, net

$45

 

$12

 

$33

 
275
 %
Loss on equity investment
(3,267
)
 
(2,487
)
 
(780
)
 
31
 %
Foreign currency gain, net
767

 
1,361

 
(594
)
 
(44
)%
Interest income, net
1,151

 
887

 
264

 
30
 %
Other, net
236

 
69

 
167

 
242
 %
Non-operating expense, net

($1,068
)
 

($158
)
 

($910
)
 
576
 %
Gain on sale of investments, net . Gain on sale of investments, net was $45 thousand for the three months ended September 24, 2017 compared to $12 thousand for the three months ended September 25, 2016 .
Loss on equity investment . Loss on our equity investment in Lextar Electronics Corporation (Lextar), which we account for utilizing the fair value option, was $3.3 million for the three months ended September 24, 2017 compared to a loss on equity investment of $2.5 million for the three months ended September 25, 2016 . Lextar’s stock is publicly traded on the Taiwan Stock Exchange and its share price declined from 18.40 New Taiwanese Dollars (TWD) at June 25, 2017 to 17.20 TWD at September 24, 2017. This volatile stock price trend may continue in the future given the risks inherent in Lextar’s business and trends affecting the Taiwan and global equity markets. Any future stock price changes will be recorded as further gains or losses on equity investment based on the increase or decrease, respectively, in the fair value of the investment during the applicable fiscal period. Further losses could have a material adverse effect on our results of operations .
Foreign currency gain, net . Foreign currency gain, net consisted primarily of remeasurement adjustments resulting from our investment in Lextar and consolidating our international subsidiaries. The foreign currency gain for the three months ended September 24, 2017 was primarily due to favorable fluctuations in the exchange rates between both the Chinese Yuan and the Euro and the United States Dollar. The foreign currency gain for the three months ended September 25, 2016 was primarily due to favorable fluctuation in the exchange rate between the TWD and the United States Dollar related to our Lextar investment.
Interest income, net . Interest income, net was $1.2 million for the three months ended September 24, 2017 compared to $0.9 million for the three months ended September 25, 2016 . The increase in interest income, net for the three months ended September 24, 2017 was primarily due to higher invested balances in China and Hong Kong which was offset with a higher interest expense due to higher borrowing rates associated with our line of credit as compared to the three months ended September 25, 2016 .
Other, net . Other, net was income of $0.2 million for the three months ended September 24, 2017 compared to income of $0.1 million for the three months ended September 25, 2016 .

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Income Tax Expense (Benefit)
The following table sets forth our income tax expense (benefit) in dollars and our effective tax rate (in thousands, except percentages):  
 
Three Months Ended
 
 
 
 
 
September 24, 2017
 
September 25, 2016
 
Change
Income tax expense (benefit)

$4,697

 

($5,933
)
 

$10,630

 
(179
)%
Effective tax rate
(31.0
)%
 
110.5
%
 
 
 
 

The variation between our effective income tax rate and the U.S. statutory rate of 35% is due to: (i) changes in our valuation allowances against deferred tax assets in the U.S. and Luxembourg, (ii) projected income for the full year derived from international locations with lower tax rates than the U.S., and (iii) projected tax credits generated.
We recognized an income tax expense of $4.7 million for an effective tax rate of (31.0)% for the three months ended September 24, 2017 as compared to income tax benefit of $5.9 million for an effective tax rate of 110.5% for the three months ended September 25, 2016 . The decrease in our effective tax rate for the three months ended September 24, 2017 was primarily due to the change in the valuation allowance against our U.S. deferred tax assets.
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. We have a $500 million line of credit as discussed in Note 8, “Long-term Debt,” in our consolidated financial statements included in Part I, Item 1 of this Quarterly Report. The purpose of this facility is to provide short-term flexibility to optimize returns on our cash and investment portfolio while funding share repurchases, capital expenditures and other general business needs.
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, joint ventures, 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.

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The following table presents the components of our cash conversion cycle:
 
Three Months Ended
 
 
 
September 24,
2017
 
June 25,
2017
 
Change
Days of sales outstanding (a)
39
 
37
 
2

Days of supply in inventory (b)
96
 
98
 
(2
)
Days in accounts payable (c)
(51)