Document
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 25, 2016
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
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CREE, INC.
(Exact name of registrant as specified in its charter)
 
North Carolina
  
56-1572719
(State or other jurisdiction of incorporation or
organization)
  
(I.R.S. Employer Identification No.)
 
 
 
4600 Silicon Drive
Durham, North Carolina
  
27703
(Address of principal executive offices)
  
(Zip Code)
(919) 407-5300
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [ X ] No [    ]

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [   ] No[ X]
The number of shares outstanding of the registrant’s common stock, par value $0.00125 per share, as of October 14, 2016, was 99,704,078.

Table of Contents

CREE, INC.
FORM 10-Q
For the Quarterly Period Ended September 25, 2016
INDEX
 
Description
Page No.
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.
 
 

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PART I - FINANCIAL INFORMATION
Item 1.    Financial Statements
CREE, INC.
UNAUDITED CONSOLIDATED BALANCE SHEETS
 
September 25,
2016
 
June 26,
2016
 
(In thousands, except par value)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents

$127,841

 

$166,154

Short-term investments
461,207

 
439,151

Total cash, cash equivalents and short-term investments
589,048

 
605,305

Accounts receivable, net
146,067

 
138,772

Income tax receivable
9,855

 
6,304

Inventories
291,533

 
281,671

Prepaid expenses
23,344

 
25,728

Other current assets
41,584

 
44,501

Current assets held for sale
421,094

 
54,426

Total current assets
1,522,525

 
1,156,707

Property and equipment, net
373,211

 
387,167

Goodwill
518,059

 
518,059

Intangible assets, net
252,568

 
259,400

Other long-term investments
39,049

 
40,179

Deferred income taxes
38,708

 
38,564

Long-term assets held for sale
—

 
356,735

Other assets
8,635

 
9,249

Total assets

$2,752,755

 

$2,766,060

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

Current liabilities:

 

Accounts payable, trade

$114,302

 

$122,808

Accrued salaries and wages
36,250

 
40,128

Other current liabilities
41,940

 
45,101

Current liabilities held for sale
18,383

 
14,962

Total current liabilities
210,875

 
222,999

Long-term liabilities:

 

Long-term debt
187,000

 
160,000

Deferred income taxes
945

 
943

Long-term liabilities held for sale
—

 
1,850

Other long-term liabilities
11,676

 
12,444

Total long-term liabilities
199,621

 
175,237

Commitments and contingencies (Note 13)

 

Shareholders’ equity:

 

Preferred stock, par value $0.01; 3,000 shares authorized at September 25, 2016 and June 26, 2016; none issued and outstanding
—

 
—

Common stock, par value $0.00125; 200,000 shares authorized at September 25, 2016 and June 26, 2016; 99,689 and 100,829 shares issued and outstanding at September 25, 2016 and June 26, 2016, respectively
124

 
125

Additional paid-in-capital
2,369,408

 
2,359,584

Accumulated other comprehensive income, net of taxes
8,437

 
8,728

Accumulated deficit
(35,710
)
 
(613
)
Total shareholders’ equity
2,342,259

 
2,367,824

Total liabilities and shareholders’ equity

$2,752,755

 

$2,766,060

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

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CREE, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME (LOSS)
 
 
Three Months Ended
 
 
September 25,
2016
 
September 27,
2015
 
 
(In thousands, except per share amounts)
Revenue, net

$321,329

 

$381,549

 
Cost of revenue, net
234,988

 
274,357

 
Gross profit
86,341

 
107,192

 
Operating expenses:
 
 
 
 
Research and development
28,531

 
32,731

 
Sales, general and administrative
61,371

 
70,172

 
Amortization or impairment of acquisition-related intangibles
6,266

 
6,469

 
Loss on disposal or impairment of long-lived assets
316

 
9,565

 
Total operating expenses
96,484

 
118,937

 
Operating loss
(10,143
)
 
(11,745
)
 
Non-operating expense
(158
)
 
(22,803
)
 
Loss from continuing operations before income taxes
(10,301
)
 
(34,548
)
 
Income tax benefit
(7,443
)
 
(8,812
)
 
Loss from continuing operations
(2,858
)
 
(25,736
)
 
Income from discontinued operations, net of tax
3,424


1,247

 
Net income (loss)

$566



($24,489
)
 
Earnings (loss) per share-basic
 
 
 
 
Continuing operations

($0.03
)
 

($0.25
)
 
Discontinued operations
0.03

 
0.01

 
Earnings (loss) per share-basic

$—



($0.24
)
 
 

 

 
Earnings (loss) per share-diluted

 

 
Continuing operations

($0.03
)
 

($0.25
)
 
Discontinued operations
0.03

 
0.01

 
Earnings (loss) per share-diluted

$—



($0.24
)
 
 
 
 
 
 
Weighted average shares used in per share calculation:
 
 
 
 
Basic
100,559

 
103,473

 
Diluted
100,559

 
103,473

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

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

 
Three Months Ended
 
 
September 25,
2016
 
 
September 27,
2015
 
 
(In thousands)
Net income (loss)

$566

 
 

($24,489
)
 
Other comprehensive (loss) income:
 
 
 
 
 
Currency translation gain (loss)
29

 
 
(359
)
 
Net unrealized (loss) gain on available-for-sale securities, net of tax benefit (expense) of $199 and ($490), respectively
(320
)
 
 
792

 
Other comprehensive (loss) income
(291
)
 
 
433

 
Comprehensive income (loss)

$275

 
 

($24,056
)
 
The accompanying notes are an integral part of the consolidated financial statements.


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CREE, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
Three Months Ended
 
September 25,
2016
 
September 27,
2015
 
(In thousands)
Cash flows from operating activities:
 
 
 
Net income (loss)

$566

 

($24,489
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Depreciation and amortization
35,939

 
41,360

Stock-based compensation
14,650

 
15,074

Excess tax benefit from stock-based payment arrangements
(12
)
 
(3
)
Loss on disposal or impairment of long-lived assets
325

 
14,573

Amortization of premium/discount on investments
1,382

 
1,361

Loss on equity investment
2,487

 
19,948

Foreign exchange loss on equity investment
(1,373
)
 
3,036

Deferred income taxes
54

 
979

Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net
(9,227
)
 
(6,406
)
Inventories
(10,808
)
 
(8,428
)
Prepaid expenses and other assets
(1,922
)
 
(772
)
Accounts payable, trade
(2,111
)
 
(459
)
Accrued salaries and wages and other liabilities
(11,852
)
 
(8,940
)
Net cash provided by operating activities
18,098

 
46,834

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(19,337
)
 
(49,883
)
Purchases of patent and licensing rights
(2,252
)
 
(4,314
)
Proceeds from sale of property and equipment
165

 
3

Purchases of short-term investments
(106,749
)
 
(121,628
)
Proceeds from maturities of short-term investments
77,645

 
137,121

Proceeds from sale of short-term investments
5,148

 
8,643

Purchase of acquired business, net of cash acquired
(2,775
)
 
(12,513
)
Net cash used in investing activities
(48,155
)
 
(42,571
)
Cash flows from financing activities:
 
 
 
Proceeds from long-term debt borrowings
110,000

 
195,000

Payments on long-term debt borrowings
(83,000
)
 
(188,000
)
Net proceeds from issuance of common stock
406

 
2,801

Excess tax benefit from stock-based payment arrangements
12

 
3

Repurchases of common stock
(35,663
)
 
(69,604
)
Net cash used in financing activities
(8,245
)
 
(59,800
)
Effects of foreign exchange changes on cash and cash equivalents
(11
)
 
(804
)
Net decrease in cash and cash equivalents
(38,313
)
 
(56,341
)
Cash and cash equivalents:
 
 
 
Beginning of period
166,154

 
139,710

End of period

$127,841

 

$83,369

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

$3,103

 

$17,672

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

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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 bulbs. 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 components and LED chips. The Company's LED products enable its customers to develop and market LED-based products for lighting, video screens and other industrial applications.
In addition, the Company develops, manufactures and sells 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 SiC materials products are sold to customers developing power and RF products as well as gemstones. These SiC materials products had previously been included within the LED Products segment. The Company's power products are made from SiC and provide increased efficiency, faster switching speeds and reduced system size and weight over comparable silicon-based power devices. The Company's RF devices are made from GaN and provide improved efficiency, bandwidth and frequency of operation as compared to silicon or gallium arsenide (GaAs). Collectively, the Company refers to these product lines as the Wolfspeed business. As discussed more fully below in Note 2, “Discontinued Operations,” on July 13, 2016, the Company executed a definitive agreement to sell its Wolfspeed business to Infineon Technologies AG (Infineon). As a result, the Company has classified the results of the Wolfspeed business as discontinued operations in its consolidated statements of income (loss) for all periods presented. Additionally, the related assets and liabilities associated with the discontinued operations are classified as held for sale in the consolidated balance sheets. Unless otherwise noted, discussion within these notes to the consolidated financial statements relates to the Company's continuing operations.
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, 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 two reportable segments are:
•
Lighting Products
•
LED Products
For financial results by reportable segment, please refer to Note 14, "Reportable Segments."
Basis of Presentation
The consolidated balance sheet at September 25, 2016, the consolidated statements of income (loss) for the three months ended September 25, 2016 and September 27, 2015, the consolidated statements of comprehensive income (loss) for the three months ended September 25, 2016 and September 27, 2015, and the consolidated statements of cash flows for the three months ended September 25, 2016 and September 27, 2015 (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 25, 2016, and for all periods presented, have been made. All intercompany accounts and transactions have been eliminated. The consolidated balance sheet at June 26, 2016 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

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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 26, 2016 (fiscal 2016). The results of operations for the three months ended September 25, 2016 are not necessarily indicative of the operating results that may be attained for the entire fiscal year ending June 25, 2017 (fiscal 2017).
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 2016 amounts in the accompanying consolidated financial statements have been reclassified to conform to the fiscal 2017 presentation. These reclassifications had no effect on previously reported consolidated net income or shareholders’ equity.
Revision of Prior Period Financial Statements
During the third quarter of fiscal 2016, the Company identified errors in its previously reported financial statements in which amortization expense was understated as certain patents were being amortized over a life longer than the life of the underlying patent right.
The Company assessed the materiality of these errors on prior periods’ financial statements in accordance with the United States Securities and Exchange Commission (SEC) Staff Accounting Bulletin (SAB) No. 99, Materiality, codified in the Accounting Standards Codification (ASC) 250, Presentation of Financial Statements, and concluded that they were not material individually or in the aggregate to any prior annual or interim periods.  However, through the second quarter of fiscal 2016 the aggregate amount of the prior period errors of $6.8 million before income taxes would have been material to the Company's interim Consolidated Statements of Income (Loss) for the third quarter of fiscal 2016.  Consequently, in accordance with ASC 250, the Company corrected these errors, and other immaterial errors, for all prior periods presented by revising the consolidated financial statements and other financial information included herein. Periods not presented herein will be revised, as applicable in future filings.
The following table summarizes the effects of the revision on the consolidated statements of income (loss) (in thousands):
 
Three Months Ended September 27, 2015
 
 
As Reported
 
Revision Adjustments
 
As Revised
 
Cost of revenue, net

$273,256

 

$1,101

 

$274,357

 
Gross profit
108,293

 
(1,101
)
 
107,192

 
Operating loss
(10,644
)
 
(1,101
)
 
(11,745
)
 
Loss from continuing operations before income taxes
(33,447
)
 
(1,101
)
 
(34,548
)
 
Income tax benefit
(8,528
)
 
(284
)
 
(8,812
)
 
Loss from continuing operations
(24,919
)
 
(817
)
 
(25,736
)
 
Income (loss) from discontinued operations, net of tax
1,296

 
(49
)
 
1,247

 
Net income (loss)

($23,623
)
 

($866
)
 

($24,489
)
 
(Loss) earnings per share-basic
 
 
 
 
 
 
Continuing operations

($0.24
)
 

($0.01
)
 

($0.25
)
 
Discontinued operations
0.01

 
—

 
0.01

 
(Loss) earnings per share-basic

($0.23
)
 

($0.01
)
 

($0.24
)
 
 
 
 
 
 
 
 
(Loss) earnings per share-diluted
 
 
 
 
 
 
Continuing operations

($0.24
)
 

($0.01
)
 

($0.25
)
 
Discontinued operations
0.01

 
—

 
0.01

 
(Loss) earnings per share-diluted

($0.23
)
 

($0.01
)
 

($0.24
)
 
The revision had no net impact on the Company’s net cash provided by operating activities.

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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 effective date will be the first quarter of the Company's fiscal year ending June 30, 2019, using one of two retrospective application methods. The Company is currently analyzing the impact of this new accounting guidance.
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 is effective for public companies for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years.  The Company is currently analyzing the impact of this new pronouncement.
Note 2 – Discontinued Operations

On July 13, 2016, the Company executed an Asset Purchase Agreement (the APA) with Infineon. The transaction, which was approved by both the Company’s Board of Directors and Infineon’s Supervisory Board, is expected to close by the end of calendar year 2016, subject to customary closing conditions and governmental approvals.

Pursuant to the APA, the Company will sell to Infineon, and Infineon will (i) purchase from the Company (a) the assets comprising the Company’s Power and RF Products segment, including manufacturing facilities and equipment, inventory, intellectual property rights, contracts, real estate, and the outstanding equity interests of Cree Fayetteville, Inc, one of the Company’s wholly-owned subsidiaries, and (b) certain related portions of the Company’s SiC materials and gemstones business previously included within the LED Products segment and (ii) assume certain liabilities related to the Wolfspeed business. The Company will retain certain liabilities associated with the Wolfspeed business arising prior to the closing of the transaction. Infineon is expected to hire most of the Company’s approximately 564 Wolfspeed employees either at the closing of the transaction or following a transition period.

The purchase price for the Wolfspeed business will be $850 million in cash, which is subject to certain adjustments. In connection with the transaction, the Company and Infineon will also enter into certain ancillary and related agreements, including (i) an intellectual property assignment and license agreement, which will assign to Infineon certain intellectual property owned by the Company and license to Infineon certain additional intellectual property owned by the Company, (ii) a transition services agreement, which is designed to ensure a smooth transition of the Wolfspeed business to Infineon, and (iii) a wafer supply agreement, pursuant to which the Company will supply Infineon with silicon carbide wafers and silicon carbide boules for a transitional period of time.


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The APA contains customary representations, warranties and covenants, including covenants to cooperate in seeking regulatory approvals, as well as the Company’s agreement to not compete with the Wolfspeed business for five years following the closing of the transaction and to indemnify Infineon for certain damages that Infineon may suffer following the closing of the transaction.

Infineon's obligation to purchase the Wolfspeed business is subject to the satisfaction or waiver of a number of conditions set forth in the APA, including regulatory approval under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 and certain similar non-U.S. regulations, the approval of the Committee on Foreign Investment in the United States and other customary closing conditions. The APA provides for customary termination rights of the parties and also provides that in the event the APA is terminated for certain specified regulatory-related circumstances, Infineon may be required to pay the Company a termination fee ranging from $12.5 million to $42.5 million.

The Company has classified the results of the Wolfspeed business as discontinued operations in the Company’s consolidated statements of income (loss) for all periods presented. The Company ceased recording depreciation and amortization of long-lived assets of the Wolfspeed business upon classification as discontinued operations in July 2016. Additionally, the related assets and liabilities associated with the discontinued operations are classified as held for sale in the consolidated balance sheets. The assets and liabilities held for sale as of September 25, 2016 are classified as current in the consolidated balance sheet as the Company expects the transaction to close within one year.

The following table presents the financial results of the Wolfspeed business as income from discontinued operations, net of income taxes in the Company's consolidated statements of income (loss) (in thousands):

Three Months Ended

September 25, 2016


September 27, 2015

Revenue, net

$49,902



$43,939

Cost of revenue, net
26,314


20,548

Gross profit
23,588


23,391

Total operating expenses
18,654


21,514

Income from discontinued operations before income taxes
4,934


1,877

Income tax expense
1,510


630

Income from discontinued operations, net of income taxes

$3,424



$1,247


The following table presents the assets and liabilities related to the Wolfspeed business held for sale (in thousands):

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September 25, 2016

 
June 26, 2016

Assets Held For Sale


 


Accounts receivable, net

$28,794

 

$26,839

Prepaid and other Current Assets
1,491

 
1,369

Inventories
19,005

 
21,871

Property and equipment, net
224,773

 
214,934

Intangible assets, net
44,352

 
43,409

Goodwill
100,769

 
100,769

Total Assets Held for Sale*

$419,184

 

$409,191




 


Liabilities Held for Sale


 


Accounts payable

$12,470

 

$9,477

Accrued salaries and wages
3,740

 
4,514

Other accrued liabilities
2,173

 
971

Other long term liabilities
—

 
1,850

Total Liabilities Held for Sale*

$18,383

 

$16,812

*Amounts in the June 26th, 2016 column are classified as current and long-term in the consolidated balance sheet.

The following table presents the cash flow of the Wolfspeed business (in thousands):

 
Three Months Ended

September 25, 2016

 
September 27, 2015

Net cash provided by discontinued operating activities

$9,138

 

$12,868

Net cash used in discontinued investing activities

$12,507

 

$53,049


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 are achieved over the subsequent two years, additional cash payments totaling up to $4.6 million may 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 Company expects that the second year goals will also be achieved. 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 were reported as part of the Company's Power and RF Products segment prior to the classification of the Wolfspeed business as discontinued operations and is discussed more fully in Note 2, "Discontinued Operations."

The total purchase price for this acquisition was as follows (in thousands):
Cash consideration paid to shareholders

$13,797

Post-closing adjustments
181

Contingent consideration
4,625

Total purchase price

$18,603


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

$1,284

Accounts receivable
1,006

Inventories
143

Property and equipment
935

Other assets
270

Total tangible assets
3,638

Intangible assets:
 
Patents
40

Customer relationships
4,500

Developed technology
11,403

In-process research and development
7,565

Non-compete agreements
231

Goodwill
2,483

Total intangible assets
26,222

Liabilities assumed:
 
Accounts payable
55

Accrued expenses and liabilities
1,911

Other long-term liabilities
9,291

Total liabilities assumed
11,257

Net assets acquired

$18,603

Prior to the classification of the Wolfspeed business as discontinued operations, the identifiable intangible assets acquired as a result of the acquisition were being amortized over their respective estimated useful lives as follows (in thousands, except for years):
 
Asset Amount
 
Estimated Life in Years
Patents

$40

 
20
Customer relationships
4,500

 
4
Developed technology
11,403

 
10
In-process research and development1
7,565

 
7
Non-compete agreements
231

 
3
Total identifiable intangible assets

$23,739

 
 
(1) In-process research and development (IPR&D) is initially classified as indefinite-lived assets and tested for impairment at least annually or when indications of potential impairment exist. The IPR&D was completed in January 2016.
Goodwill largely consists of expansion of product offerings of power modules and power electronics applications, manufacturing and other synergies of the combined companies, and the value of the assembled workforce.
The assets, liabilities, and operating results of APEI have been included in the Company's consolidated financial statements from the date of acquisition and are not significant to the Company as a whole.

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Note 4 – Financial Statement Details
Accounts Receivable, net
The following table summarizes the components of accounts receivable, net (in thousands):
 
September 25, 2016
 
June 26, 2016
Billed trade receivables

$194,218

 

$188,672

Unbilled contract receivables
192

 
59


194,410

 
188,731

Allowance for sales returns, discounts and other incentives
(42,802
)
 
(44,543
)
Allowance for bad debts
(5,541
)
 
(5,416
)
Accounts receivable, net

$146,067

 

$138,772

Inventories
The following table summarizes the components of inventories (in thousands):
 
September 25, 2016
 
June 26, 2016
Raw material

$74,159

 

$79,957

Work-in-progress
87,552

 
84,459

Finished goods
129,822

 
117,255

Inventories

$291,533

 

$281,671

Other Current Liabilities
The following table summarizes the components of other current liabilities (in thousands):
 
September 25, 2016
 
June 26, 2016
Accrued taxes

$11,887

 

$12,023

Accrued professional fees
6,411

 
7,959

Accrued warranty
18,495

 
20,102

Accrued other
5,147

 
5,017

Other current liabilities

$41,940

 

$45,101

Accumulated Other Comprehensive Income, net of taxes
The following table summarizes the components of accumulated other comprehensive income, net of taxes (in thousands):
 
September 25, 2016
 
June 26, 2016
Currency translation gain

$4,653

 

$4,624

Net unrealized gain on available-for-sale securities
3,784

 
4,104

Accumulated other comprehensive income, net of taxes

$8,437

 

$8,728


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Table of Contents

Non-Operating Expense, net
The following table summarizes the components of non-operating expense, net (in thousands):
 
Three Months Ended
 
 
September 25, 2016
 
September 27, 2015
 
Foreign currency gain (loss), net

$1,361

 

($4,294
)
 
Gain on sale of investments, net
12

 
2

 
Loss on equity investment
(2,487
)
 
(19,948
)
 
Interest income, net
887

 
1,297

 
Other, net
69

 
140

 
Non-operating expense, net

($158
)
 

($22,803
)
 
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 Income (Loss)
 
 
Three Months Ended
 
 
 
 
September 25, 2016
 
September 27, 2015
 
 
Net unrealized gain on available-for-sale securities, net of taxes
 

$12

 

$2

 
Non-operating expense
 
 
12

 
2

 
Loss from continuing operations before income taxes
 
 
9

 
1

 
Income tax benefit
 
 

$3

 

$1

 
Loss from continuing operations
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.

14
Table of Contents

The following tables summarize short-term investments (in thousands):
 
 
September 25, 2016
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
Municipal bonds
 

$183,585

 

$2,775

 

($50
)
 

$186,310

Corporate bonds
 
165,897

 
3,347

 
(43
)
 
169,201

Non-U.S. certificates of deposit
 
93,103

 
—

 
—

 
93,103

U.S. certificates of deposit
 
8,791

 
—

 
—

 
8,791

Commercial paper
 

$3,802

 

$—

 

$—

 
3,802

Total short-term investments
 

$455,178

 

$6,122

 

($93
)
 

$461,207

 
 
 
 
 
 
 
 
 
 
 
June 26, 2016
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
Municipal bonds
 

$186,893

 

$3,562

 

($15
)
 

$190,440

Corporate bonds
 
165,766

 
3,074

 
(73
)
 
168,767

Non-U.S. certificates of deposit
 
73,127

 
—

 
—

 
73,127

U.S. certificates of deposit
 
3,500

 
—

 
—

 
3,500

Commercial paper
 
3,317

 
—

 
—

 
3,317

Total short-term investments
 

$432,603

 

$6,636

 

($88
)
 

$439,151

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 25, 2016
 
 
Less than 12 Months
 
Greater than 12 Months
 
Total
 
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
Municipal bonds
 

$17,003

 

($41
)
 

$1,620

 

($9
)
 

$18,623

 

($50
)
Corporate bonds
 
12,632

 
(30
)
 
2,487

 
(13
)
 
15,119

 
(43
)
Total
 

$29,635

 

($71
)
 

$4,107

 

($22
)
 

$33,742

 

($93
)
Number of securities with an unrealized loss
 
 
 
30

 
 
 
3

 
 
 
33

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
June 26, 2016
 
 
Less than 12 Months
 
Greater than 12 Months
 
Total
 
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
Municipal bonds
 

$2,936

 

($9
)
 

$3,535

 

($6
)
 

$6,471

 

($15
)
Corporate bonds
 
27,578

 
(73
)
 
—

 
—

 
27,578

 
(73
)
Total
 

$30,514

 

($82
)
 

$3,535

 

($6
)
 

$34,049

 

($88
)
Number of securities with an unrealized loss
 
 
 
22

 
 
 
3

 
 
 
25

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 in the consolidated statements of income (loss) 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.

15
Table of Contents

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 25, 2016 and June 26, 2016.
The contractual maturities of short-term investments as of September 25, 2016 were as follows (in thousands):
 
 
Within One Year
 
After One, Within Five Years
 
After Five, Within Ten Years
 
After Ten Years
 
Total
Municipal bonds

$43,513

 

$110,598

 

$32,199

 

$—

 

$186,310

Corporate bonds
22,617

 
108,207

 
38,377

 
—

 
169,201

Non-U.S. certificates of deposit
93,103

 
—

 
—

 
—

 
93,103

U.S. certificates of deposit
5,791

 
3,000

 
—

 
—

 
8,791

Commercial paper

$3,802

 

$—

 

$—

 

$—

 
3,802

Total short-term investments

$168,826

 

$221,805

 

$70,576

 

$—

 

$461,207

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 25, 2016, financial assets utilizing Level 1 inputs included money market funds, and financial assets utilizing Level 2 inputs included municipal bonds, corporate bonds, certificates of deposit, 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 25, 2016. There were no transfers between Level 1 and Level 2 during the three months ended September 25, 2016.

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Table of Contents

The following table sets forth financial instruments carried at fair value within the U.S. GAAP hierarchy (in thousands):
 
September 25, 2016
 
June 26, 2016
 
 Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. agency securities

$—

 

$—

 

$—

 

$—

 

$—

 

$—

 

$—

 

$—

Non-U.S. certificates of deposit
—

 
137

 
—

 
137

 
—

 
137

 
—

 
137

Money market funds
1,360

 
—

 
—

 
1,360

 
576

 
—

 
—

 
576

Total cash equivalents
1,360

 
137

 
—

 
1,497

 
576

 
137

 
—

 
713

Short-term investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Municipal bonds
—

 
186,310

 
—

 
186,310

 
—

 
190,440

 
—

 
190,440

Corporate bonds
—

 
169,201

 
—

 
169,201

 
—

 
168,767

 
—

 
168,767

U.S. certificates of deposit
—

 
8,791

 
—

 
8,791

 
—

 
3,500

 
—

 
3,500

Commercial paper
—

 
3,802

 
—

 
3,802

 
—

 
3,317

 
—

 
3,317

Non-U.S. certificates of deposit
—

 
93,103

 
—

 
93,103

 
—

 
73,127

 
—

 
73,127

Total short-term investments
—

 
461,207

 
—

 
461,207

 
—

 
439,151

 
—

 
439,151

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

 
39,049

 
—

 
39,049

 
—

 
40,179

 
—

 
40,179

Total other long-term investments
—

 
39,049

 
—

 
39,049

 
—

 
40,179

 
—

 
40,179

Total assets

$1,360

 

$500,393

 

$—

 

$501,753

 

$576

 

$479,467

 

$—

 

$480,043

Note 7– Intangible Assets
Intangible Assets, net
The following table presents the components of intangible assets, net (in thousands):
 
September 25, 2016
 
June 26, 2016
 
Gross
 
Accumulated Amortization
 
Net
 
Gross
 
Accumulated Amortization
 
Net
Intangible assets with finite lives:
 
 
 
 
 
 
 
 
 
 
 
Customer relationships

$136,920

 

($78,591
)
 

$58,329

 

$136,920

 

($77,313
)
 

$59,607

Developed technology
162,760

 
(114,864
)
 
47,896

 
162,760

 
(110,204
)
 
52,556

Non-compete agreements
10,244

 
(10,244
)
 
—

 
10,244

 
(9,917
)
 
327

Trade names, finite-lived
520

 
(520
)
 
—

 
520

 
(520
)
 
—

Patent and licensing rights
106,273

 
(39,610
)
 
66,663

 
105,035

 
(37,805
)
 
67,230

Total intangible assets with finite lives
416,717

 
(243,829
)
 
172,888

 
415,479

 
(235,759
)
 
179,720

Trade names, indefinite-lived
79,680

 
—

 
79,680

 
79,680

 
—

 
79,680

Total intangible assets

$496,397

 

($243,829
)
 

$252,568

 

$495,159

 

($235,759
)
 

$259,400

For the three months ended September 25, 2016, total amortization of finite-lived intangible assets was $9.4 million. For the three months ended September 27, 2015, total amortization of finite-lived intangible assets was $9.2 million.

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Table of Contents

Total future amortization expense of finite-lived intangible assets is estimated to be as follows (in thousands):
Fiscal Year Ending
 
June 25, 2017 (remainder of fiscal 2017)

$24,096

June 24, 2018
31,319

June 30, 2019
18,683

June 28, 2020
14,680

June 27, 2021
13,430

Thereafter
70,680

Total future amortization expense

$172,888


Note 8 – Long-term Debt
As of September 25, 2016, 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 25, 2016, the Company had $187 million outstanding under the line of credit and $313 million available for borrowing. For the three months ended September 25, 2016, the average interest rate was 1.41%. For the three months ended September 25, 2016 the average commitment fee percentage was 0.09%. The Company was in compliance with all covenants in the line of credit at September 25, 2016.
Note 9 – Shareholders’ Equity
As of September 25, 2016, 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 $300 million for all purchases from August 24, 2016 through the expiration of the program on June 25, 2017. During the three months ended September 25, 2016, the Company repurchased 1.5 million shares of common stock for $35.7 million under the stock repurchase program.
Note 10– Earnings (Loss) Per Share
The following table presents the computation of basic earnings (loss) per share (in thousands, except per share amounts):
 
Three Months Ended
 
 
September 25,
2016
 
September 27,
2015
 
Loss from continuing operations

($2,858
)
 

($25,736
)
 
Income from discontinued operations, net of tax
3,424

 
1,247

 
Net income (loss)

$566



($24,489
)
 
Weighted average common shares
100,559

 
103,473

 
Basic loss per share from continuing operations

($0.03
)
 

($0.25
)
 
Basic earnings per share from discontinued operations
0.03

 
0.01

 
Earnings (loss) per share-basic

$—

 

($0.24
)
 

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Table of Contents

The following computation reconciles the differences between the basic and diluted earnings (loss) per share presentations (in thousands, except per share amounts): 
 
Three Months Ended
 
 
September 25,
2016
 
September 27,
2015
 
Loss from continuing operations

($2,858
)
 

($25,736
)
 
Income from discontinued operations, net of tax
3,424

 
1,247

 
Net income (loss)

$566

 

($24,489
)
 
Weighted average common shares - basic
100,559

 
103,473

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

 
—

 
Weighted average common shares - diluted
100,559

 
103,473

 
Diluted earnings (loss) per share from continuing operations

($0.03
)
 

($0.25
)
 
Diluted earnings (loss) per share from discontinued operations
0.03

 
0.01

 
Earnings (loss) per share-diluted

$—

 

($0.24
)
 
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 25, 2016, there were 11.4 million of potential common shares not included in the calculation of diluted earnings (loss) per share because their effect was anti-dilutive. For the three months ended September 27, 2015, there were 7.7 million of potential common shares not included in the calculation of diluted earnings (loss) 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.

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Table of Contents

Stock Option Awards
The following table summarizes stock option awards outstanding as of September 25, 2016 and changes during the three months then ended (numbers of shares in thousands): 
 
Number of Shares
 
Weighted Average Exercise Price
Outstanding at June 26, 2016
11,247

 

$40.42

Granted
1,651

 

$24.42

Exercised
(16
)
 

$25.90

Forfeited or expired
(666
)
 

$37.53

Outstanding at September 25, 2016
12,216

 

$38.43

Restricted Stock Awards and Units
A summary of nonvested restricted stock awards (RSAs) and restricted stock unit awards (RSUs) outstanding as of September 25, 2016, 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 26, 2016
1,631

 

$31.66

Granted
1,091

 

$24.40

Vested
(536
)
 

$34.38

Forfeited
(18
)
 

$27.43

Nonvested at September 25, 2016
2,168

 

$27.37

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

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Table of Contents

Total stock-based compensation expense was as follows (in thousands):
 
Three Months Ended
 
September 25,
2016
 
September 27,
2015
Income Statement Classification:
 
 
 
Cost of revenue, net

$2,779

 

$2,622

Research and development
2,606

 
2,631

Sales, general and administrative
7,635

 
7,712

Income from discontinued operations, net of tax
1,630

 
2,109

Total stock-based compensation expense

$14,650

 

$15,074

Note 12 – Income Taxes
The variation between the Company's effective income tax rate and the U.S. statutory rate of 35% is due to the impact of the Company’s pre-tax income or loss relative to favorable tax rate impacts associated predominantly with the Company’s: (i) projected income for the full year derived from international locations with lower tax rates than the U.S. and (ii) projected tax credits generated. Tax credits and other deductions have the impact of increasing the tax rate above the statutory rate of 35% in periods in which the Company reports pre-tax losses as they provide a benefit that is recoverable in future periods.
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 26, 2016, the Company's liability for unrecognized tax benefits was $17.7 million. During the three months ended September 25, 2016, 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 25, 2016 was $17.7 million. If any portion of this $17.7 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 $4.3 million of gross unrecognized tax benefits will change in the next 12 months as a result of audit closures and 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 2013. For U.S. state tax returns, the Company is generally no longer subject to tax examinations for fiscal years prior to 2012. For foreign purposes, the Company is generally no longer subject to tax examinations for tax periods 2006 and prior. Certain carryforward tax attributes generated in prior years remain subject to examination, adjustment and recapture. The Company is currently under audit by the Italian Revenue Agency for the fiscal year ended June 30, 2013.
During the fourth quarter of fiscal 2016, the Company concluded it is likely that sufficient future taxable income needed to fully utilize net operating loss carryovers in Luxembourg will not be generated due to additional losses on the Company’s equity investment held there. The Company recorded a $9.5 million valuation allowance against the related deferred tax asset, representing the $32.4 million net operating loss carryover net of tax. During the three months ended September 25, 2016, the Company recorded an additional $0.3 million valuation allowance against the loss carryover deferred tax asset as a result of the $1.1 million year-to-date loss on the equity investment held in Luxembourg.


21
Table of Contents

Note 13 – Commitments and Contingencies
Warranties
The following table summarizes the changes in the Company's product warranty liabilities (in thousands):
Balance at June 26, 2016

$21,426

Warranties accrued in current period
5,520

Recall costs accrued in current period
—

Expenditures
(7,093
)
Balance at September 25, 2016

$19,853

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 25, 2016, $1.4 million of the Company's product warranty liabilities were classified as long-term.
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

As discussed more fully in Note 2, “Discontinued Operations,” on July 13, 2016, the Company executed a definitive agreement to sell the Wolfspeed business to Infineon. As a result, the Company has classified the results of the Wolfspeed business as discontinued operations in its consolidated statements of income (loss) for all periods presented. For comparative purposes, the prior segment results have been revised to conform to the current segment presentation.
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.
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 25, 2016 and September 27, 2015. 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,

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total segment revenue in the table below is equal to the Company's consolidated revenue.
The Company's CODM reviews gross profit as the lowest and only level of segment profit. As such, all items below gross profit in the consolidated statements of income (loss) 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.
Revenue, gross profit and gross margin for each of the Company's segments were as follows (in thousands, except percentages):
 
Three Months Ended
 
 
September 25,
2016
 
September 27,
2015
 
Revenue:
 
 
 
 
Lighting Products revenue

$183,836

 

$248,031

 
LED Products revenue
137,493

 
133,518

 
Total revenue

$321,329

 

$381,549

 
 
 
 
 
 
Gross Profit and Gross Margin:
 
 
 
 
Lighting Products gross profit

$49,290

 

$69,081

 
Lighting Products gross margin
26.8
%
 
27.9
%
 
LED Products gross profit
41,770

 
41,869

 
LED Products gross margin
30.4
%
 
31.4
%
 
Total segment gross profit
91,060

 
110,950

 
Unallocated costs
(4,719
)
 
(3,758
)
 
Consolidated gross profit

$86,341

 

$107,192

 
Consolidated gross margin
26.9
%
 
28.1
%
 

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 25,
2016
 
June 26,
2016
Lighting Products

$183,529

 

$172,261

LED Products
103,540

 
104,544

Total segment inventories
287,069

 
276,805

Unallocated inventories
4,464

 
4,866

Consolidated inventories

$291,533

 

$281,671


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Note 15 - Costs Associated with LED Business Restructuring
In June 2015, the Company’s Board of Directors approved a plan to restructure the LED Products business. The restructuring reduced excess capacity and overhead in order to improve the cost structure moving forward. The primary components of the restructuring include the planned sale or abandonment of certain manufacturing equipment, facility consolidation and the elimination of certain positions. The restructuring activity ended in the second quarter of fiscal 2016.
The Company incurred a total of $102.4 million, of which $4.9 million related to discontinued operations, pursuant to this restructuring plan. See Note 18, "Costs Associated with LED Business Restructuring" in Part II, Item 8 of the Company's Form 10K for the fiscal year ended June 26, 2016 for additional information. The following table summarizes the actual charges incurred for the three months ended September 27, 2015 (in thousands):
Capacity and Overhead Cost Reductions

Amounts incurred for the three months ended September 27, 2015

Affected Line Item in the Consolidated Statements of Income (Loss)
Loss on disposal or impairment of long-lived assets
 

$9,005

 
Loss on disposal or impairment of long-lived assets
Loss on disposal or impairment of long-lived assets
 
4,873

 
Income from discontinued operations, net of tax
Severance expense
 
300

 
Sales, general and administrative expenses
Lease termination and facility consolidation costs
 
1,735

 
Sales, general and administrative expenses
  Total restructuring charges
 

$15,913

 
 


Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations
Information set forth in this Quarterly Report on Form 10-Q contains various “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). All information contained in this report relative to future markets for our products and trends in and anticipated levels of revenue, gross margins and expenses, as well as other statements containing words such as “believe,” “project,” “may,” “will,” “anticipate,” “target,” “plan,” “estimate,” “expect” and “intend” and other similar expressions constitute forward-looking statements. These forward-looking statements are subject to business, economic and other risks and uncertainties, both known and unknown, and actual results may differ materially from those contained in the forward-looking statements. Any forward-looking statements we make are as of the date made, and except as required under the U.S. federal securities laws and the rules and regulations of the Securities and Exchange Commission (the SEC), we have no duty to update them if our views later change. These forward-looking statements should not be relied upon as representing our views as of any date subsequent to the date of this Quarterly Report. Examples of risks and uncertainties that could cause actual results to differ materially from historical performance and any forward-looking statements include, but are not limited to, those described in “Risk Factors” in Part II, Item 1A of this Quarterly Report.
Executive Summary
The following discussion is designed to provide a better understanding of our unaudited consolidated financial statements, including a brief discussion of our business and products, key factors that impacted our performance and a summary of our operating results. The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q, and the consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the fiscal year ended June 26, 2016. 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.

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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 bulbs. We design, manufacture and sell lighting fixtures and lamps for the commercial, industrial and consumer markets.
Our LED products consist of LED components and LED chips. Our LED products enable our customers to develop and market LED-based products for lighting, video screens and other industrial applications.
In addition, we develop, manufacture and sell silicon carbide (SiC) materials, power devices and RF devices based on wide bandgap semiconductor materials such as SiC and gallium nitride (GaN). Our SiC materials products are sold to customers developing power and RF products as well as gemstones. These SiC materials products had previously been included within our LED Products segment. Our power products are made from SiC and provide increased efficiency, faster switching speeds and reduced system size and weight over comparable silicon-based power devices. Our RF devices are made from GaN and provide improved efficiency, bandwidth and frequency of operation as compared to silicon or gallium arsenide (GaAs). Collectively, we refer to these product lines as the Wolfspeed business. As discussed more fully in Note 2, “Discontinued Operations,” in our consolidated financial statements included in Item 1 of this quarterly report, on July 13, 2016, we executed a definitive agreement to sell the Wolfspeed business to Infineon Technologies AG (Infineon). As a result, we have classified the results of the Wolfspeed business as discontinued operations in our consolidated statements of income (loss) for all periods presented. Additionally, the related assets and liabilities associated with the discontinued operations are classified as held for sale in the consolidated balance sheets. Unless otherwise noted, discussion within this Management's Discussion and Analysis relates to our continuing operations.
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, 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 two reportable segments are:
•
Lighting Products
•
LED Products
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.
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 continued adoption of LEDs within the general lighting market and our ability to affect this rate of adoption. Demand also fluctuates based on various market cycles, a continuously evolving LED industry supply chain, and evolving competitive dynamics in the market. These uncertainties make demand difficult to forecast for us and our customers.
•
Intense and Constantly Evolving Competitive Environment. Competition in the LED and lighting industries is intense. Many companies have made significant investments in LED 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 LED-based solutions. To remain competitive, market participants must continuously increase product performance and reduce costs. To address these competitive pressures, we have invested in research and development activities to support new product development and to deliver higher levels of performance and lower costs to differentiate our products in the market.
•
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, qu

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ality and capability of the lighting agent has a significant effect on winning new projects and sales in a given geographic market. While these agents or distributors can 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 as well as develop new partners to improve our sales effectiveness in each geographic market.
•
Technological Innovation and Advancement. Innovations and advancements in LEDs and lighting 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 25, 2016
The following is a summary of our financial results for the three months ended September 25, 2016:

•
Revenue decreased to $321 million for the three months ended September 25, 2016 from $382 million for the three months ended September 27, 2015.
•
Gross profit decreased to $86 million for the three months ended September 25, 2016 from $107 million for the three months ended September 27, 2015. Gross margin declined to 27% for the three months ended September 25, 2016 from 28% for the three months ended September 27, 2015.
•
Operating loss was $10 million for the three months ended September 25, 2016 compared to operating loss of $12 million for the three months ended September 27, 2015. Net loss per diluted share was $0.00 for the three months ended September 25, 2016 compared to net loss per diluted share of $0.24 for the three months ended September 27, 2015.
•
Cash, cash equivalents and short-term investments were consistent at $0.6 billion at September 25, 2016 and June 26, 2016. Cash provided by operating activities was $18 million for the three months ended September 25, 2016 compared to $47 million for the three months ended September 27, 2015.
•
Inventories increased to $292 million at September 25, 2016 compared to $282 million at June 26, 2016.
•
Purchases of property and equipment were $19 million for the three months ended September 25, 2016 compared to $50 million for the three months ended September 27, 2015.
Business Outlook
We announced Cree 3.0 during fiscal 2016 and updated our strategy to become a more focused LED lighting technology company. As part of this strategy, we outlined a plan to separate the Wolfspeed business through an initial public offering (IPO). The decision to sell the Wolfspeed business to Infineon, instead of continuing down the IPO path, speeds our transition to an LED lighting company while providing significant resources to accelerate our growth. Divesting the Wolfspeed business is expected to reduce short-term profits, but at the same time increase free cash flow. We believe this transaction will increase management focus on the core growth business and provide capital to support our mission to build a more valuable company.
We project that the markets for commercial LED lighting products will expand in fiscal 2017, while the consumer LED bulb and LED components market will remain highly competitive.
We are focused on the following goals to further support our transition to a more focused LED lighting company:
•
Complete the sale of our Wolfspeed business to Infineon.
•
Grow company revenue.
◦
Grow commercial lighting revenue with the market, potentially adding to that growth through product line expansion and/or strategic acquisitions, and maintain consumer lighting revenue in a similar range while transitioning to a new generation LED bulb family.
◦
Maintain LED revenue in a similar range through new product design wins to offset the competitive environment.

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•
Improve operating margin.
◦
Increase lighting margins through a combination of lower costs and higher value new products.
◦
Maintain LED margins in a similar range by reducing product costs and increasing performance levels.
◦
Manage company operating expenses to grow slower than revenue.
•
Continue to innovate in all of our businesses to differentiate our products in the market.
•
Improve the customer experience and service levels in all of our businesses.


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Results of Operations
The following table sets forth certain consolidated statement of income (loss) data for the periods indicated (in thousands, except per share amounts and percentages):
 
 
Three Months Ended
 
 
September 25,
2016
 
September 27,
2015
 
 
Dollars
 
% of Revenue
 
Dollars
 
% of Revenue
 
Revenue, net

$321,329

 
100
 %
 

$381,549

 
100
 %
 
Cost of revenue, net
234,988

 
73
 %
 
274,357

 
72
 %
 
Gross profit
86,341

 
27
 %
 
107,192

 
28
 %
 
Research and development
28,531

 
9
 %
 
32,731

 
9
 %
 
Sales, general and administrative
61,371

 
19
 %
 
70,172

 
18
 %
 
Amortization or impairment of acquisition-related intangibles
6,266

 
2
 %
 
6,469

 
2
 %
 
Loss on disposal or impairment of long-lived assets
316

 
—
 %
 
9,565

 
3
 %
 
Operating loss
(10,143
)
 
(3
)%
 
(11,745
)
 
(3
)%
 
Non-operating expense
(158
)
 
—
 %
 
(22,803
)
 
(6
)%
 
Loss from continuing operations before income taxes
(10,301
)
 
(3
)%
 
(34,548
)
 
(9
)%
 
Income tax benefit
(7,443
)
 
(2
)%
 
(8,812
)
 
(2
)%
 
Loss from continuing operations

($2,858
)
 
(1
)%
 

($25,736
)
 
(7
)%
 
Income from discontinued operations, net of tax
3,424

 
1
 %
 
1,247

 
—
 %
 
Net income (loss)

$566

 
—
 %
 

($24,489
)
 
(6
)%
 
 
 
 
 
 
 
 
 
 
Earnings (loss) per share-basic
 
 

 
 
 


 
Continuing operations

($0.03
)
 

 

($0.25
)
 


 
Discontinued operations
0.03

 

 
0.01

 


 
Earnings (loss) per share-basic

$—

 

 

($0.24
)
 


 
 
 
 
 
 
 
 
 
 
Earnings (loss) per share-diluted
 
 
 
 
 
 
 
 
Continuing operations

($0.03
)
 
 
 

($0.25
)
 
 
 
Discontinued operations
0.03

 
 
 
0.01

 
 
 
Earnings (loss) per share-diluted

$—

 
 
 

($0.24
)
 
 
 
LED Business Restructuring
In June 2015, our Board of Directors approved a plan to restructure the LED Products business. The restructuring reduced excess capacity and overhead in order to improve the cost structure moving forward. The primary components of the restructuring include the planned sale or abandonment of certain manufacturing equipment, facility consolidation and the elimination of certain positions. The restructuring activity ended in the second quarter of fiscal 2016.

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We incurred a total of $102.4 million, of which $4.9 million related to discontinued operations, pursuant to this restructuring plan. The following table summarizes the actual charges incurred for the three months ended September 27, 2015 (in thousands):

Capacity and Overhead Cost Reductions
 
Amounts incurred for the three months ended September 27, 2015
 
Affected Line Item in the Consolidated Statements of Income (Loss)
Loss on disposal or impairment of long-lived assets
 

$9,005

 
Loss on disposal or impairment of long-lived assets
Loss on disposal or impairment of long-lived assets
 
4,873

 
Income from discontinued operations, net of tax
Severance expense
 
300

 
Sales, general and administrative expenses
Lease termination and facility consolidation costs
 
1,735

 
Sales, general and administrative expenses
  Total restructuring charges
 

$15,913

 
 
Revenue

Revenue was comprised of the following (in thousands, except percentages):
 
Three Months Ended
 
 
 
 
 
 
September 25,
2016
 
September 27,
2015
 
Change
 
Lighting Products revenue

$183,836

 

$248,031

 

($64,195
)
 
(26
)%
 
Percent of revenue
57
%
 
65
%
 
 
 
 
 
LED Products revenue
137,493

 
133,518

 
3,975

 
3
 %
 
Percent of revenue
43
%
 
35
%
 
 
 
 
 
Total revenue

$321,329

 

$381,549

 

($60,220
)
 
(16
)%
 
Our consolidated revenue decreased 16% to $321.3 million for the three months ended September 25, 2016 from $381.5 million for the three months ended September 27, 2015. This decrease was driven by the 26% decrease in Lighting Products revenue partially offset by the 3% increase in LED Products revenue.
Lighting Products Segment Revenue
Lighting Products revenue represented approximately 57% and 65% of our total revenue for the three months ended September 25, 2016 and September 27, 2015, respectively.