Edgar Filing: CREE INC

CREE-10Q Q2 FY12

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 25, 2011

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 0-21154

CREE, INC.

(Exact name of registrant as specified in its charter)



North Carolina		56-1572719
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

4600 Silicon Drive Durham, North Carolina		27703
(Address of principal executive offices)		(Zip Code)

(919) 407-5300

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [ X ] No [ ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes [ X ] No [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.



Large accelerated filer [X]				Accelerated filer [ ]
Non-accelerated filer [ ] (Do not check if a smaller reporting company)				Smaller reporting company [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes [ ] No[ X]

The number of shares outstanding of the registrant’s common stock, par value $0.00125 per share, as of January 11, 2012, was 116,099,017.

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CREE, INC.

FORM 10-Q

For the Quarterly Period Ended December 25, 2011

INDEX



Description		Page No.

PART I - FINANCIAL INFORMATION

Item 1.	Financial Statements	3

	Consolidated Balance Sheets as of December 25, 2011 (unaudited) and June 26, 2011	3

	Consolidated Statements of Income for the three and six months ended December 25, 2011 (unaudited) and December 26, 2010 (unaudited)	4

	Consolidated Statements of Cash Flow for the six months ended December 25, 2011 (unaudited) and December 26, 2010 (unaudited)	5

	Notes to Consolidated Financial Statements (unaudited)	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	35

Item 4.	Controls and Procedures	35

PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	37

Item 1A.	Risk Factors	37

Item 2.	Unregistered Sale of Equity Securities and Use of Proceeds	47

Item 3.	Defaults Upon Senior Securities	47

Item 4.	(Removed and Reserved)	47

Item 5.	Other Information	47

Item 6.	Exhibits	47

SIGNATURE		48

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PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

CREE, INC.

CONSOLIDATED BALANCE SHEETS



	December 25, 2011		June 26, 2011
	(unaudited)
	(Thousands, except par value)
ASSETS
Current assets:
Cash and cash equivalents	$	171,651	$	390,598
Short-term investments	515,595		695,199
Total cash, cash equivalents, and short-term investments	687,246		1,085,797
Accounts receivable, net	156,385		118,469
Income tax receivable	1,829		6,796
Inventories	187,373		176,482
Deferred income taxes	18,907		17,857
Prepaid expenses and other current assets	52,806		51,494
Total current assets	1,104,546		1,456,895
Property and equipment, net	605,504		555,929
Intangible assets, net	385,484		102,860
Goodwill	617,936		326,178
Other assets	5,990		4,860
Total assets	$	2,719,460	$	2,446,722
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable, trade	$	81,493	$	76,593
Accrued salaries and wages	25,957		18,491
Income taxes payable	2,209		15,493
Other current liabilities	39,505		29,739
Total current liabilities	149,164		140,316
Long-term liabilities:
Deferred income taxes	21,902		21,902
Other long-term liabilities	26,121		22,940
Total long-term liabilities	48,023		44,842
Commitments and contingencies (Note 11)
Shareholders’ equity:
Preferred stock, par value $0.01; 3,000 shares authorized at December 25, 2011 and June 26, 2011; none issued and outstanding	—		—
Common stock, par value $0.00125; 200,000 shares authorized at December 25, 2011 and June 26, 2011; 116,097 and 109,607 shares issued and outstanding at December 25, 2011 and June 26, 2011, respectively	144		136
Additional paid-in-capital	1,831,909		1,593,530
Accumulated other comprehensive income, net of taxes	10,516		13,091
Retained earnings	679,704		654,807
Total shareholders’ equity	2,522,273		2,261,564
Total liabilities and shareholders’ equity	$	2,719,460	$	2,446,722

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

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CREE, INC.

(UNAUDITED)

CONSOLIDATED STATEMENTS OF INCOME



	Three Months Ended					Six Months Ended
	December 25, 2011			December 26, 2010		December 25, 2011		December 26, 2010
	(Thousands, except per share amounts)
Revenue, net	$	304,118		$	256,983	$	573,098	$	525,420
Cost of revenue, net	199,000			135,837		369,952		273,745
Gross profit	105,118			121,146		203,146		251,675
Operating expenses:
Research and development	35,886			29,233		70,288		53,965
Sales, general and administrative	49,176			33,366		94,715		62,568
Amortization of acquisition related intangibles	7,367			2,706		11,292		5,412
Loss on disposal or impairment of long-lived assets	497			429		1,272		901
Total operating expenses	92,926			65,734		177,567		122,846
Operating income	12,192			55,412		25,579		128,829
Non-operating income:
Other non-operating (loss) income, net	(111		)	63		863		1
Interest income, net	1,800			2,170		3,769		4,186
Income from operations before income taxes	13,881			57,645		30,211		133,016
Income tax expense	1,803			7,870		5,314		25,205
Net income	$	12,078		$	49,775	$	24,897	$	107,811
Earnings per share:
Basic net income per share	$	0.10		$	0.46	$	0.22	$	1.00
Diluted net income per share	$	0.10		$	0.45	$	0.22	$	0.98
Shares used in per share calculation:
Basic	115,536			108,364		113,701		108,032
Diluted	115,883			109,976		114,239		109,817

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

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CREE, INC.

(UNAUDITED)

CONSOLIDATED STATEMENTS OF CASH FLOW



	Six Months Ended
	December 25, 2011			December 26, 2010

Cash flows from operating activities:
Net income	$	24,897		$	107,811
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	68,303			50,318
Stock-based compensation	22,635			17,981
Excess tax benefit from share-based payment arrangements	(201		)	(9,277		)
Loss on disposal or impairment of long-lived assets	1,272			901
Amortization of premium/discount on investments	4,017			7,617
Changes in operating assets and liabilities:
Accounts receivable	(12,973		)	(16,928		)
Inventories	28,572			(32,871		)
Prepaid expenses and other assets	8,755			1,991
Accounts payable, trade	(14,923		)	22,516
Accrued salaries and wages and other liabilities	(8,117		)	(4,303		)
Net cash provided by operating activities	122,237			145,756
Cash flows from investing activities:
Purchases of property and equipment	(53,038		)	(126,387		)
Purchases of investments	(145,802		)	(194,872		)
Proceeds from maturities of investments	66,040			147,502
Proceeds from sale of property and equipment	2			1
Proceeds from sale of available-for-sale investments	252,152			61,833
Purchase of Ruud Lighting, net of cash acquired	(456,008		)	—
Purchases of patent and licensing rights	(8,043		)	(5,199		)
Net cash used in investing activities	(344,697		)	(117,122		)
Cash flows from financing activities:
Net proceeds from issuance of common stock	2,648			29,977
Excess tax benefit from share-based payment arrangements	201			9,277
Net cash provided by financing activities	2,849			39,254
Effects of foreign exchange changes on cash and cash equivalents	664			238
Net (decrease) increase in cash and cash equivalents	(218,947		)	68,126
Cash and cash equivalents:
Beginning of period	390,598			397,431
End of period	$	171,651		$	465,557

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

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CREE, INC.

(UNAUDITED)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

Overview

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

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

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

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

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

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

The Company currently operates its business as one reportable segment.

Basis of Presentation

The consolidated balance sheet at December 25, 2011 and the consolidated statements of income for the three and six months ended December 25, 2011 and December 26, 2010, and the consolidated statements of cash flows for the six months ended December 25, 2011 and December 26, 2010 (“consolidated financial statements”) have been prepared by the Company and have not been audited. In the opinion of management, all normal and recurring adjustments necessary to present fairly the consolidated financial position, results of operations and cash flows at December 25, 2011, and for all periods presented, have been made. The consolidated balance sheet at June 26, 2011 has been derived from the audited financial statements as of that date.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been condensed or omitted. It is suggested that these financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 26, 2011 (“fiscal 2011”). The results of operations for the period ended December 25, 2011 are not necessarily indicative of the operating results that may be attained for the entire fiscal year ending June 24, 2012 (“fiscal 2012”).

Certain fiscal 2011 amounts in the accompanying consolidated financial statements have been reclassified to conform to the fiscal 2012 presentation. These reclassifications had no effect on previously reported consolidated net income or shareholders’ equity.

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Recently Adopted Accounting Pronouncements

Fair Value Disclosures

In January 2010, the Financial Accounting Standards Board (the "FASB") issued amended standards requiring additional fair value disclosures. The amended standards require disclosures of transfers in and out of Levels 1 and 2 of the fair value hierarchy, as well as requiring gross basis disclosures for purchases, sales, issuances and settlements within the Level 3 reconciliation. Additionally, the update clarifies the requirement to determine the level of disaggregation for fair value measurement disclosures and to disclose valuation techniques and inputs used for both recurring and nonrecurring fair value measurements in either Level 2 or Level 3. The Company adopted the new guidance in the third quarter of fiscal 2010, except for the disclosures related to purchases, sales, issuance and settlements, which was effective for the Company beginning in the first quarter of fiscal 2012. Because these new standards are related primarily to disclosures, their adoption has not had a significant impact on the Company's consolidated financial statements.

Goodwill Impairment Testing

On September 15, 2011, the FASB issued updated guidance concerning the testing of goodwill for impairment. This guidance modifies goodwill impairment testing by allowing the inclusion of qualitative factors in the assessment of whether a two-step goodwill impairment test is necessary. Thus, entities are no longer required to calculate the fair value of a reporting unit unless they conclude through an assessment of qualitative factors that it is more likely than not that the unit's carrying value is greater than its fair value. When an entity's qualitative assessment reveals that goodwill impairment is more likely than not, the entity must perform the two-step goodwill impairment test. This guidance became effective for the Company in the second quarter of fiscal 2012. The Company's adoption of this guidance has not had a significant impact on its consolidated financial statements.

Recently Issued Accounting Pronouncements

Presentation of Comprehensive Income

In June 2010, the FASB issued new guidance concerning the presentation of total comprehensive income and its components. Under this guidance an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in single continuous statement of comprehensive income or in two separate but consecutive statements. This guidance, as amended in December 2011, will become effective for the Company beginning in the third quarter of fiscal 2012. The Company's adoption of the new accounting guidance is not expected to have a significant impact on its consolidated financial statements.

Note 2. Acquisitions

Acquisition of Ruud Lighting, Inc.

On August 17, 2011, the Company entered into a Stock Purchase Agreement with all of the shareholders of Ruud Lighting, Inc. ("Ruud Lighting"). Pursuant to the terms of the Stock Purchase Agreement and concurrently with the execution of the Stock Purchase Agreement, the Company acquired all of the outstanding share capital of Ruud Lighting in exchange for consideration consisting of 6.1 million shares of the Company's common stock and $372.2 million cash, subject to certain post-closing adjustments. Prior to the Company completing its acquisition of Ruud Lighting, Ruud Lighting completed the re-acquisition of its e-conolight business by purchasing all of the membership interests of E-conolight LLC ("E-conolight"). Ruud Lighting previously sold its e-conolight business in March 2010 and had been providing operational services to E-conolight since that date. In connection with the stock purchase transaction with Ruud Lighting, the Company funded Ruud Lighting's re-acquisition of E-conolight and paid off Ruud Lighting's outstanding debt in the aggregate amount of approximately $85.0 million. The acquisition allows the Company to expand its product portfolio into outdoor LED lighting.

The acquisitions of Ruud Lighting and E-conolight have been accounted for as business combinations in accordance with ASC 805 Business Combinations and, as such, the Ruud Lighting and E-conolight assets acquired and liabilities assumed have been recorded at their respective fair values. The determination of fair value for the identifiable tangible and intangible assets acquired and liabilities assumed requires extensive use of estimates and judgments. Significant estimates and assumptions include, but are not limited to: estimating future cash flows and determining the appropriate discount rate.

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The total purchase price for this acquisition is as follows (in thousands):



Cash consideration paid to stockholders	$	372,235
Fair value of common stock issued by the Company ⁽¹⁾	211,040
Fair value of debt paid on behalf of stockholders	84,991
Total purchase price	$	668,266

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

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

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



	August 17, 2011 (As initially reported)		Measurement Period Adjustments			August 17, 2011 (As adjusted)
Tangible assets:
Cash and cash equivalents	$	3,081	$	—		$	3,081
Accounts receivable	25,698		(375		)	25,323
Inventories	39,330		(461		)	38,869
Property and equipment	45,946		(233		)	45,713
Other assets	4,727		217			4,944
Total tangible assets	$	118,782	$	(852	)	$	117,930
Intangible assets:
Developed technology	$	96,300	$	—		$	96,300
Customer relationships	84,820		—			84,820
Trade names	82,950		—			82,950
In-process research & development	15,050		—			15,050
Non-compete agreements	9,800		—			9,800
Goodwill	287,431		4,326			291,757
Total intangible assets	$	576,351	$	4,326		$	580,677
Liabilities assumed:
Accounts payable	$	12,943	$	—		$	12,943
Accrued expenses and liabilities	10,116		451			10,567
Warranty liabilities	2,600		3,023			5,623
Other long-term liabilities	1,208		—			1,208
Total liabilities assumed	$	26,867	$	3,474		$	30,341
Net assets acquired	$	668,266	$	—		$	668,266

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

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

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



	Asset Amount		Estimated Life in Years
Developed technology	$	96,300	7 to 10
Customer relationships	84,820		7 to 20
Trade names (indefinite lived)	82,880		-
Trade names (definite lived)	70		3
In-process research and development⁽¹⁾	15,050		6 to 7
Non-compete agreements	9,800		5
Total identifiable intangible assets	$	288,920

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

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

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

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

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



	Three Months Ended		Six Months Ended
	December 25, 2011		December 25, 2011
Revenue	$	61,148	$	83,491
Operating Income	1,647		1,125
Net Income	1,319		655
Basic net income per share	$	0.01	$	0.01
Diluted net income per share	$	0.01	$	0.01

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Amortization expense related to identifiable intangible assets associated with the Ruud Lighting acquisition, included in the table above, was $5.2 million and $6.9 million for the three and six months ended December 25, 2011, respectively.

The following supplemental pro forma information (in thousands, except per share data) presents the financial results as if the Ruud Lighting transaction had occurred at the beginning of the 2011 fiscal year for the six months ended December 25, 2011 and the three and six months ended December 26, 2010. Financial results for the three months ended December 25, 2011, which are included in the Consolidated Statements of Income, are actual results and therefore have not been presented in the table below.



	Three Months Ended		Six Months Ended
	December 26, 2010		December 25, 2011		December 26, 2010
Revenue	$	313,220	$	603,430	$	623,516
Operating Income	55,625		23,872		124,048
Net income	50,290		23,117		105,433
Earnings per share, basic	$	0.44	$	0.20	$	0.92
Earnings per share, diluted	$	0.43	$	0.20	$	0.91

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

Acquisition of LED Lighting Fixtures, Inc.

On February 29, 2008 the Company acquired LED Lighting Fixtures, Inc. (“LLF”) through a wholly owned subsidiary that merged into Cree, Inc. on June 27, 2010. The Company acquired all of the outstanding share capital of LLF in exchange for total upfront consideration of $80.8 million, consisting of (1) $16.5 million in cash, (2) approximately 1.9 million shares of the Company’s common stock valued at $58.8 million, and (3) the assumption of fully vested LLF employee stock options valued at $4.5 million. The Company incurred transaction costs of approximately $1.0 million consisting primarily of professional fees incurred relating to attorneys, accountants and valuation advisors. Under the acquisition terms, additional consideration of up to $26.4 million would become payable to the former shareholders of LLF if defined product development targets and key employee retention measures were achieved over the three calendar years following the acquisition.

LLF met the conditions necessary for the earn-out payment for the calendar years ended December 31, 2008, 2009 and 2010. As a result, the Company made a cash payment in the amount of $4.4 million to the former shareholders of LLF in the third quarter of fiscal 2009, a cash payment in the amount of $8.8 million to the former shareholders of LLF in the third quarter of fiscal 2010, and a final cash payment in the amount of $13.2 million to the former shareholders of LLF in the third quarter of fiscal 2011. These incremental payments were treated as additional purchase price and resulted in an increase to goodwill in the Company’s consolidated financial statements.

The assets, liabilities, and operating results of LLF have been included in the Company’s consolidated financial statements from the date of acquisition and are reflected in all periods presented in the accompanying financial statements.

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Note 3. Financial Statement Details

Accounts Receivable, net

The following is a summary of the components of accounts receivable, net (in thousands):



	December 25, 2011			June 26, 2011
Billed trade receivables	$	170,929		$	137,799
Unbilled contract receivables	1,623			1,038
	172,552			138,837
Allowance for sales returns, discounts, and other incentives	(14,739		)	(19,615		)
Allowance for bad debts	(1,428		)	(753		)
Total accounts receivable, net	$	156,385		$	118,469

Inventories

The following is a summary of the components of inventories (in thousands):



	December 25, 2011		June 26, 2011
Raw material	$	56,318	$	38,781
Work-in-progress	70,296		74,816
Finished goods	60,759		62,885
Total inventories	$	187,373	$	176,482

Revenues, net

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



	Three Months Ended						Six Months Ended
	December 25, 2011			December 26, 2010			December 25, 2011			December 26, 2010
LED products	$	194,162		$	209,984		$	390,940		$	438,749
Percent of revenue	64		%	81		%	68		%	83		%
Lighting products	$	95,736		$	19,715		$	147,409		$	35,316
Percent of revenue	31		%	8		%	26		%	7		%
Power and RF products	$	14,220		$	27,284		$	34,749		$	51,355
Percent of revenue	5		%	11		%	6		%	10		%
Total revenue	$	304,118		$	256,983		$	573,098		$	525,420

Note 4. Investments

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

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The following table provides a summary of marketable investments by type (in thousands):



	December 25, 2011
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Municipal bonds	$	196,688	$	2,657	$	(4	)	$	199,341
Corporate bonds	168,732		1,374		(614		)	169,492
Certificates of deposit	68,002		5		(3		)	68,004
Municipal variable rate demand notes	2,795		—		—			2,795
Commercial paper	2,149		—		—			2,149
U.S. agency securities	72,446		476		(119		)	72,803
Non-U.S. government securities	1,013		—		(2		)	1,011
Total	$	511,825	$	4,512	$	(742	)	$	515,595

	June 26, 2011
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Municipal bonds	$	391,465	$	3,943	$	(10	)	$	395,398
Corporate bonds	207,241		2,312		(115		)	209,438
Certificates of deposit	10,003		12		—			10,015
Municipal variable rate demand notes	295		—		—			295
Commercial paper	4,999		—		—			4,999
U.S. agency securities	67,244		807		(2		)	68,049
Non-U.S. government securities	6,986		19		—			7,005
Total	$	688,233	$	7,093	$	(127	)	$	695,199

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The following table presents the gross unrealized losses and estimated fair value of the Company's investment securities, aggregated by investment type and length of time that individual investments securities have been in a continuous unrealized loss position (in thousands):



	December 25, 2011
	Less than 12 Months					Greater than 12 Months				Total
	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
Municipal bonds	$	11,984	$	(4	)	$	—	$	—	$	11,984	$	(4	)
Corporate bonds	39,280		(614		)	—		—		39,280		(614		)
Certificates of deposit	2,998		(3		)	—		—		2,998		(3		)
U.S. agency securities	28,816		(119		)	—		—		28,816		(119		)
Non-U.S. government securities	1,012		(2		)	—		—		1,012		(2		)
Total	$	84,090	$	(742	)	$	—	$	—	$	84,090	$	(742	)
Number of securities with an unrealized loss			38					—				38

	June 26, 2011
	Less than 12 Months					Greater than 12 Months				Total
	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
Municipal bonds	$	14,348	$	(10	)	$	—	$	—	$	14,348	$	(10	)
Corporate bonds	20,484		(115		)	—		—		20,484		(115		)
U.S. agency securities	6,518		(2		)	—		—		6,518		(2		)
Total	$	41,350	$	(127	)	$	—	$	—	$	41,350	$	(127	)
Number of securities with an unrealized loss			20					—				20

The contractual maturities of marketable investments at December 25, 2011 were as follows (in thousands):



	December 25, 2011
	Within One Year		After One, Within Five Years		After Five, Within Ten Years		After Ten Years		Total
Municipal bonds	$	89,687	$	109,654	$	—	$	—	$	199,341
Corporate bonds	64,957		104,535		—		—		169,492
Certificates of deposit	63,001		5,003		—		—		68,004
Municipal variable rate demand notes	—		—		—		2,795		2,795
Commercial paper	2,149		—		—		—		2,149
U.S. agency securities	10,235		62,568		—		—		72,803
Non-U.S. government securities	—		1,011		—		—		1,011
Total	$	230,029	$	282,771	$	—	$	2,795	$	515,595

Note 5. Fair Value of Financial Instruments

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

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Observable inputs are obtained from independent sources and can be validated by a third party, whereas, unobservable inputs reflect assumptions regarding what a third party would use in pricing an asset or liability. The fair value hierarchy is broken down into three levels based on the reliability of inputs as follows:


•	Level 1 - Valuations based on quoted prices in active markets for identical instruments that the Company is able to access. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.


•	Level 2 - Valuations based on quoted prices in active markets for instruments that are similar, or quoted prices in markets that are not active for identical or similar instruments, and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.


•	Level 3 - Valuations based on inputs that are unobservable and significant to the overall fair value measurement.

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

The following table sets forth financial instruments carried at fair value within the U.S. GAAP hierarchy and using the lowest level of input (in thousands):



	December 25, 2011								June 26, 2011
	Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
Assets:
Cash equivalents
Money market funds	$	5,711	$	—	$	—	$	5,711	$	7,386	$	—	$	—	$	7,386
Total cash equivalents	5,711		—		—		5,711		7,386		—		—		7,386
Short-term investments
Municipal bonds	—		199,341		—		199,341		—		395,398		—		395,398
Corporate bonds	—		169,492		—		169,492		—		209,438		—		209,438
Municipal variable rate demand notes	—		2,795		—		2,795		—		295		—		295
Certificates of deposit	—		68,004		—		68,004		—		10,015		—		10,015
Commercial paper	—		2,149		—		2,149		—		4,999		—		4,999
U.S. agency securities	—		72,803		—		72,803		—		68,049		—		68,049
Non-U.S. government securities	—		1,011		—		1,011		—		7,005		—		7,005
Total short-term investments	—		515,595		—		515,595		—		695,199		—		695,199
Total assets	$	5,711	$	515,595	$	—	$	521,306	$	7,386	$	695,199	$	—	$	702,585

The Company utilizes specific identification in computing realized gains and losses on the sale of investments. Realized gains from the sale of investments for the six months ended December 25, 2011 of approximately $1.0 million are included in “Other non-operating (loss) income, net” and unrealized gains and losses are included as a separate component of equity, net of tax, unless the loss is determined to be “other-than-temporary.”

The Company evaluates its investments for possible impairment or a decline in fair value below cost basis that is deemed to be “other-than-temporary” on a periodic basis. It considers such factors as the length of time and extent to which fair value has been below cost basis, the financial condition of the investee, and its ability and intent to hold the investment for a period of time that may be sufficient for an anticipated recovery in market value.

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Note 6. Intangible Assets

Intangible Assets, net

The following table reflects the components of intangible assets, net (in thousands):



	December 25, 2011			June 26, 2011
Customer relationships	$	137,440		$	52,620
Developed technology	148,160			51,860
In-process research and development	15,050			—
Non-compete agreements	9,800			—
Patent and license rights	174,454			83,884
	$	484,904		$	188,364
Accumulated amortization	(99,420		)	(85,504		)
Intangible assets, net	$	385,484		$	102,860

Total amortization expense, including the amortization of acquisition related intangibles, patents and license rights, recognized during the three and six months ended December 25, 2011 was $8.8 and $14.1 million, respectively. For the three and six months ended December 26, 2010, total amortization expense, including amortization of acquisition related intangibles, patents and license rights was $3.8 and $7.6 million, respectively.

Total annual amortization expense of intangible assets is estimated to be as follows (in thousands):



Fiscal Year Ending
June 24, 2012	$	31,452
June 30, 2013	33,955
June 29, 2014	31,802
June 28, 2015	28,715
June 26, 2016	28,533

Goodwill

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

Note 7. Shareholders’ Equity

In connection with the acquisition of Ruud Lighting, the Company issued 6.1 million shares of common stock valued at approximately $211.0 million. The shares are subject to certain transfer restrictions under the Stock Purchase Agreement that will generally lapse with respect to 25% of the shares held (i) at the completion of the consecutive six-month period following the date of the closing of the transaction; and, (ii) at the completion of each of the following three successive six-month periods, such that all restrictions will lapse by the second anniversary of the closing.

As of December 25, 2011, the Company is authorized to repurchase shares of its common stock having an aggregate purchase price not exceeding $200.0 million for all purchases from June 16, 2011 through the expiration of the program, as authorized by the Board of Directors and extended through June 24, 2012. During the six months ended December 25, 2011, the Company did not repurchase any shares under the repurchase program.

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The following presents a summary of activity in comprehensive income, net (in thousands):



	Three Months Ended						Six Months Ended
	December 25, 2011			December 26, 2010			December 25, 2011			December 26, 2010
Net income	$	12,078		$	49,775		$	24,897		$	107,811
Other comprehensive income:
Net unrealized loss on available-for-sale securities, net of tax benefit of $544, $1,177, $1,206 and $611 respectively	(899		)	(1,945		)	(1,991		)	(1,010		)
Currency Translation Loss	(1,103		)	—			(583		)	—
Comprehensive income	$	10,076		$	47,830		$	22,323		$	106,801

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

Note 8. Earnings Per Share

The following presents the computation of basic earnings per share (in thousands, except per share data):



	Three Months Ended				Six Months Ended
	December 25, 2011		December 26, 2010		December 25, 2011		December 26, 2010
Basic:
Net income	$	12,078	$	49,775	$	24,897	$	107,811
Weighted average common shares	115,536		108,364		113,701		108,032
Basic earnings per share	$	0.10	$	0.46	$	0.22	$	1.00

The following computation reconciles the differences between the basic and diluted earnings per share presentations (in thousands, except per share data):



	Three Months Ended				Six Months Ended
	December 25, 2011		December 26, 2010		December 25, 2011		December 26, 2010
Diluted:
Net income	$	12,078	$	49,775	$	24,897	$	107,811
Weighted average common shares - basic	115,536		108,364		113,701		108,032
Dilutive effect of stock options, unvested shares and ESPP purchase rights	347		1,612		538		1,785
Weighted average common shares - diluted	115,883		109,976		114,239		109,817
Diluted earnings per share	$	0.10	$	0.45	$	0.22	$	0.98

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

Note 9. Stock-Based Compensation

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

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Company's common stock through the ESPP at 15% less than the fair market value of the common stock on the first day of the twelve-month participation period or the purchase date, whichever is lower. The plan amendment also provides for an automatic reset feature to start participants on a new twelve-month participation period if the share value declines during the first six-month purchase period.

Stock Option Awards

The following table summarizes outstanding option awards as of December 25, 2011, and changes during the six months then ended (shares in thousands):



	Number of Shares		Weighted-Average Exercise Price
Outstanding at June 26, 2011	6,467		$	39.56
Granted	2,920		30.74
Exercised	(112	)	23.64
Forfeited or expired	(311	)	39.83
Outstanding at December 25, 2011	8,964		$	36.88

Restricted Stock and Stock Unit Awards

A summary of nonvested shares of restricted stock and stock unit awards outstanding under the Company’s 2004 Long-Term Incentive Compensation Plan as of December 25, 2011, and changes during the six months then ended, follows (shares in thousands):



	Number of Shares/Units		Weighted- Average Grant- Date Fair Value
Nonvested at June 26, 2011	509		$	40.87
Granted	227		30.97
Vested	(177	)	38.29
Forfeited	(28	)	35.37
Nonvested at December 25, 2011	531		$	37.79

Stock-Based Compensation Valuation and Expense

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

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

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

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Stock-based compensation expense is recorded net of estimated forfeitures such that expense is recorded only for those stock-based awards that are expected to vest. A forfeiture rate is estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from initial estimates.Total stock-based compensation expense was as follows (in thousands):



	Three Months Ended				Six Months Ended
Income Statement Classification	December 25, 2011		December 26, 2010		December 25, 2011		December 26, 2010
Cost of goods sold	$	1,615	$	1,351	$	3,329	$	2,483
Research and development	2,603		2,183		5,031		3,998
Sales, general and administrative	6,977		6,443		14,275		11,500
Total operating expenses	9,580		8,626		19,306		15,498
Total	$	11,195	$	9,977	$	22,635	$	17,981

Note 10. Income Taxes

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

Under U.S. GAAP, a two-step approach is followed to recognize and measure uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is cumulatively more than 50 percent likely to be realized upon ultimate settlement.

At June 26, 2011, the Company had recorded $7.0 million of unrecognized tax benefits. During the six months ended December 25, 2011, there were no changes to that amount of recognized tax benefits. As a result, the total amount of unrecognized tax benefits as of December 25, 2011 is $7.0 million. If any portion of this $7.0 million is recognized, the Company will then include that portion in the computation of its effective tax rate. Although the ultimate timing of the resolution and/or closure of audits is highly uncertain, the Company believes it is reasonably possible that approximately $2.6 million of gross unrecognized tax benefits will change in the next 12 months.

The Company’s policy is to include interest and penalties related to unrecognized tax benefits within the income tax expense line item in the consolidated statements of income. As of December 25, 2011, the Company had accrued $58 thousand of interest and penalties.

The Company files U.S. federal, U.S. state, and foreign tax returns. For U.S. federal purposes, the Company is generally no longer subject to tax examinations for fiscal years ended June 29, 2008 and prior. For foreign purposes, the Company is generally no longer subject to examination for tax periods 2001 and prior. Certain carryforward tax attributes generated in prior years remain subject to examination and adjustment. For U.S. state tax returns, the Company is generally no longer subject to tax examinations for fiscal years prior to 2008. The Company is currently under examination by the Internal Revenue Service for fiscal 2009. The Company is also currently under inquiry by the Hong Kong Inland Revenue Department for fiscal 2008 and fiscal 2010.

Note 11. Commitments and Contingencies

Warranties

The following table summarizes the changes in the Company's product warranty liabilities (in thousands):



Balance at September 25, 2011	$	3,860
Measurement period acquisition related warranty (See Note 2)	3,023
Warranties accrued in current period	323
Changes in estimates for pre-existing warranties	(400		)
Expenditures	(958		)
Balance at December 25, 2011	$	5,848

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

Litigation

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

Dow Corning Litigation

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

Osram Sylvania and Lighting Science Group Litigation

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

Cooper Lighting Litigation

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

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

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Information set forth in this Quarterly Report on Form 10-Q contains various “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All information contained in this report relative to future markets for our products and trends in and anticipated levels of revenue, gross margins and expenses, as well as other statements containing words such as “believe,” “project,” “may,” “will,” “anticipate,” “target,” “plan,” “estimate,” “expect” and “intend” and other similar expressions constitute forward-looking statements. These forward-looking statements are subject to business, economic and other risks and uncertainties, both known and unknown, and actual results may differ materially from those contained in the forward-looking statements. Any forward-looking statements we make are as of the date made and we have no duty to update them if our views later change. These forward-looking statements should not be relied upon as representing our views as of any date subsequent to the date of this Quarterly Report. Examples of risks and uncertainties that could cause actual results to differ materially from historical performance and any forward-looking statements include, but are not limited to, those described in “Risk Factors” in Part II, Item 1A of this Quarterly Report.

The following discussion is designed to provide a better understanding of our unaudited consolidated financial statements, including a brief discussion of our business and products, key factors that impacted our performance, and a summary of our operating results. The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q, and the consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended June 26, 2011. Historical results and percentage relationships among any amounts in the financial statements are not necessarily indicative of trends in operating results for any future periods.

Overview

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

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

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

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

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

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

We currently operate our business as one reportable segment.

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Industry Dynamics and Trends

There are a number of industry factors that affect our business which include, among others:


•	Overall Demand for Products and Applications using LEDs. Our potential for growth depends significantly on the adoption of LEDs within the general lighting market and our ability to affect this rate of adoption. Although LED lighting has grown in recent years, adoption of LEDs for general lighting is relatively new and faces

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significant challenges before widespread adoption. Demand also fluctuates based on various market cycles, a continuously evolving LED industry supply chain, and demand dynamics in the market. These uncertainties make demand difficult to forecast for us and our customers.

•

Intense and Constantly Evolving Competitive Environment. Competition in the industry is intense and new companies have entered and are entering the LED market, with many companies making significant investments in LED production equipment. Product pricing pressures exist as market participants often undertake pricing strategies to gain or protect market share and to increase the utilization of their production capacity. Currently, many LED suppliers are reporting excess or underutilized factory capacity which generally leads to a more aggressive pricing environment. To remain competitive, market participants must continuously increase product performance and reduce costs to offset lower average sales prices. To address this pricing pressure, we have invested in cost reduction activities including lower cost product designs, yield and productivity improvements, and the development of 150mm wafer production, which is intended to reduce our costs of producing LED chips. The effectiveness of these activities will vary based on overall factory utilization rates, which are driven primarily by market demand.


•	Technological Innovation and Advancement. Innovations and advancements in LED technology continue to expand the potential commercial application of LEDs particularly in the general illumination market. However, new technologies or standards could emerge, or improvements could be made in existing technologies, that reduce or limit the demand for LEDs in certain markets.

•

Regulatory Actions Concerning Energy Efficiency. Many countries have already instituted or have announced plans to institute government regulations and programs designed to encourage or mandate increased energy efficiency, even in some cases banning forms of incandescent lighting, which are advancing the adoption of more energy efficient lighting solutions such as LEDs. While this trend is generally positive, there have been some political efforts in the United States to change or limit the effectiveness of these new regulations.

•

Intellectual Property Issues. Market participants rely on patented and non-patented proprietary information relating to product development, manufacturing capabilities and other core competencies of their business. Protection of intellectual property is critical. Therefore, steps such as additional patent applications, confidentiality and non-disclosure agreements, as well as other security measures are generally taken. To enforce or protect intellectual property rights, litigation or threatened litigation commonly occurs.

Highlights of the Second Quarter Fiscal 2012

The following is a summary of our financial results for the three months ended December 25, 2011:


•	Our year over year revenues increased to $304.1 million from $257.0 million.


•	Operating income was $12.2 million in the second quarter of fiscal 2012 compared to $55.4 million in the second quarter of fiscal 2011. Net income per diluted share was $0.10 compared to $0.45 for the second quarter of fiscal 2011;


•	Inventory decreased to $187.4 million at December 25, 2011 compared to $203.6 million at September 25, 2011;


•	We spent $53.0 million on capital expenditures during the six months ended December 25, 2011 compared to $126.4 million during the six months ended December 26, 2010; and


•	Combined cash, cash equivalents and marketable investments increased to $687.2 million at December 25, 2011 compared to $632.2 million at September 25, 2011.

Business Outlook

We project that the markets for our products will remain highly competitive during the remainder of fiscal 2012. We anticipate focusing on the following key areas in response to this competitive environment:

•

Build on our market leadership and drive adoption of LED lighting. We are focused on developing innovative new LED lighting systems to drive adoption, and new LED components that enable our customers to deliver a more competitive payback versus traditional lighting. In August 2011, we acquired Ruud Lighting, a leading innovator of LED lighting products, which we believe gives us a stronger product portfolio to drive LED adoption and expand the market for LED lighting. We plan to continue to invest in both our LED lighting and LED component product lines to increase performance, enable lower lighting system costs with shorter paybacks and find new ways to drive the market and o

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bsolete old, energy-wasting lighting technology.


•	Accelerate cost reductions and drive operational improvements to increase the profitability of our business. We target lower LED costs from new lower cost product designs, yield and productivity improvements and the conversion

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to 150mm wafers. In the near term, cost reductions may be offset by the aggressive pricing environment and low factory utilization. It will take time and increased volume to fully realize the benefit of many of these improvements. We are also delaying the rate of conversion to 150mm wafer production to take advantage of existing 100mm capacity to optimize the current factory to deliver the lowest cost in the near term. We are continuing work to enable the full conversion as business needs warrant over the next three to six quarters. We plan to lower LED lighting system costs with new product designs that are under development and we target improved operating leverage over time from higher revenues across our LED lighting systems and component product lines.

•

Expand the power and RF product line beyond niche applications. SiC power devices can deliver better performance and increased payback against silicon (Si) based power devices in applications where efficiency and reliability is an important criteria. We target continued investment in R&D for new diode and switch products focused on more mainstream and higher volume power switching applications. We are managing the product line through a slowdown in solar inverter demand. We target the combination of new products, improved market demand and expanded sales coverage to drive growth in the product line.

Results of Operations

The following table sets forth certain consolidated statement of income data for the periods indicated:



	Three Months Ended									Six Months Ended
	December 25, 2011					December 26, 2010				December 25, 2011				December 26, 2010
(in thousands, except per share amounts and percentages)	Dollars			% of Revenue		Dollars		% of Revenue		Dollars		% of Revenue		Dollars		% of Revenue
Revenue, net	$	304,118		100	%	$	256,983	100	%	$	573,098	100	%	$	525,420	100	%
Cost of revenue, net	199,000			65	%	135,837		53	%	369,952		65	%	273,745		52	%
Gross profit	105,118			35	%	121,146		47	%	203,146		35	%	251,675		48	%
Research and development	35,886			12	%	29,233		11	%	70,288		12	%	53,965		10	%
Sales, general and administrative	49,176			16	%	33,366		13	%	94,715		17	%	62,568		12	%
Amortization of acquisition related intangibles	7,367			2	%	2,706		1	%	11,292		2	%	5,412		1	%
Loss on disposal or impairment of long-lived assets	497			—	%	429		—	%	1,272		—	%	901		—	%
Operating income	12,192			4	%	55,412		22	%	25,579		4	%	128,829		25	%
Other non-operating (loss) income, net	(111		)	—	%	63		—	%	863		—	%	1		—	%
Interest income, net	1,800			1	%	2,170		1	%	3,769		1	%	4,186		1	%
Income from operations before income taxes	13,881			5	%	57,645		22	%	30,211		5	%	133,016		25	%
Income tax expense	1,803			1	%	7,870		3	%	5,314		1	%	25,205		5	%
Net income	12,078			4	%	49,775		19	%	24,897		4	%	107,811		21	%
Diluted earnings per share	$	0.10				$	0.45			$	0.22			$	0.98

Revenues

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

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	Three Months Ended											Six Months Ended
	December 25, 2011			December 26, 2010			Change					December 25, 2011			December 26, 2010			Change
LED products	$	194,162		$	209,984		$	(15,822	)	(8	)%	$	390,940		$	438,749		$	(47,809	)	(11	)%
Percent of revenues	64		%	81		%						68		%	83		%
Lighting products	95,736			19,715			76,021			386	%	147,409			35,316			112,093			317	%
Percent of revenues	31		%	8		%						26		%	7		%
Power and RF products	14,220			27,284			(13,064		)	(48	)%	34,749			51,355			(16,606		)	(32	)%
Percent of revenues	5		%	11		%						6		%	10		%
Total revenues	$	304,118		$	256,983		$	47,135		18	%	$	573,098		$	525,420		$	47,678		9	%

LED Products

We derive the largest portion of our revenue from the sale of our LED products which comprised approximately 64% and 81% of our total revenues for the second quarter of fiscal 2012 and fiscal 2011, respectively.

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

Lighting Products

Revenues from lighting products comprised approximately 31% and 8% of our total revenues for the second quarter of fiscal 2012 and fiscal 2011, respectively.

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

Power and RF Products

Revenues from power and RF products comprised approximately 5% and 11% of our total revenues for the second quarter of fiscal 2012 and fiscal 2011, respectively.

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

Gross Profit

Cost of revenue includes materials, labor and overhead costs incurred internally or paid to contract manufacturers to produce our products. Gross profit in dollars and gross margin were as follows (in thousands, except percentages):



	Three Months Ended											Six Months Ended
	December 25, 2011			December 26, 2010			Change					December 25, 2011			December 26, 2010			Change
Total gross profit	$	105,118		$	121,146		$	(16,028	)	(13	)%	$	203,146		$	251,675		$	(48,529	)	(19	)%
Gross margin	35		%	47		%						35		%	48		%

Gross profit in the second quarter of fiscal 2012 decreased approximately 13% to $105.1 million from $121.1 million in the

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second quarter of fiscal 2011. For the six months ended December 25, 2011, gross profit decreased approximately 19% to $203.1 million from $251.7 million for the six months ended December 26, 2010. Additionally, for the second quarter of fiscal

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2012 our gross margin decreased to 35% from 47% in the second quarter of fiscal 2011. For the six months ended December 25, 2011, our gross margin decreased to 35% from 48% for the six months ended December 26, 2010. Factors contributing to the decrease in gross profit and gross margin were an aggressive pricing environment for LED chips and components and overall lower factory utilization.

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 consist primarily of employee compensation and benefits, 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 revenues (in thousands, except percentages):



	Three Months Ended										Six Months Ended
	December 25, 2011			December 26, 2010			Change				December 25, 2011			December 26, 2010			Change
Research and development	$	35,886		$	29,233		$	6,653	23	%	$	70,288		$	53,965		$	16,323	30	%
Percent of revenues	12		%	11		%					12		%	10		%

Research and development expenses in the second quarter of fiscal 2012 increased 23% to $35.9 million from $29.2 million in the second quarter of fiscal 2011. For the six months ended December 25, 2011, research and development expenses increased 30% to $70.3 million from $54.0 million for the six months ended December 26, 2010. These increases were primarily due to increased spending on research and development activities focused on new LED chips, LED components, LED lighting products, power products and the incremental research and development expense incurred from the acquisition of Ruud Lighting. Our research and development expenses vary significantly from quarter to quarter based on a number of factors, including: the timing of new product introductions, timing of expenditures and the number and nature of our ongoing research and development activities. However, we anticipate that in general our research and development expenses will continue to increase over time to support future growth.

Sales, General and Administrative

Sales, general and administrative expenses are composed primarily of costs associated with our sales and marketing personnel and our executive and administrative personnel (for example, legal, finance, information technology and human resources personnel) and consist of 1) salaries and related compensation costs, 2) consulting and other professional services (such as litigation and other outside legal counsel fees, audit and other compliance costs), 3) facilities and insurance costs, and 4) travel and other costs. The following table sets forth our sales, general and administrative expenses in dollars and as a percentage of revenues (in thousands, except percentages):



	Three Months Ended										Six Months Ended
	December 25, 2011			December 26, 2010			Change				December 25, 2011			December 26, 2010			Change
Sales, general and administrative	$	49,176		$	33,366		$	15,810	47	%	$	94,715		$	62,568		$	32,147	51	%
Percent of revenues	16		%	13		%					17		%	12		%

Sales, general and administrative expenses in the second quarter of fiscal 2012 increased 47% to $49.2 million from $33.4 million in the second quarter of fiscal 2011. For the six months ended December 25, 2011, sales, general and administrative expenses increased 51% to $94.7 million from $62.6 million for the six months ended December 26, 2010. The increase in the second quarter of fiscal 2012 from fiscal 2011 is primarily due to an increase in spending on sales and marketing for lighting products as we continue to expand our direct sales resources and channels and invest in building and promoting the Cree brand, as well as the incremental sales, general and administrative expenses associated with Ruud Lighting. Additionally, we incurred increased legal costs associated with patent litigation and transaction costs associated with the acquisition of Ruud Lighting.

Amortization of Acquisition Related Intangibles

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As a result of our acquisitions, we have recorded various intangible assets that require amortization, including customer relationships and developed technologies. During fiscal 2007, we acquired INTRINSIC Semiconductor Corporation and

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COTCO Luminant Device Limited (now Cree Hong Kong Limited) (COTCO), resulting in $63.7 million of amortizable intangible assets principally composed of customer relationships and developed technology. In fiscal 2008, we acquired LLF, resulting in an additional $41.2 million of amortizable intangible assets. These intangible assets are principally composed of developed technology that specifically relates to technologies underlying the development of LED lighting products for the general illumination market. During fiscal 2012, we acquired Ruud Lighting, resulting in $206.0 million of amortizable intangible assets consisting of developed technology, customer relationships, trade names, in-process research and development, and non-compete agreements. Amortization of intangible assets related to our acquisitions is as follows (in thousands, except percentages):



	Three Months Ended								Six Months Ended
	December 25, 2011		December 26, 2010		Change				December 25, 2011		December 26, 2010	Change
INTRINSIC	$	186	$	186	$	—	—	%	$	372