Document
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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 March 26, 2017
or
[    ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission file number 0-21154
logo042115a19.gif
CREE, INC.
(Exact name of registrant as specified in its charter)
 
North Carolina
  
56-1572719
(State or other jurisdiction of incorporation or
organization)
  
(I.R.S. Employer Identification No.)
 
 
 
4600 Silicon Drive
Durham, North Carolina
  
27703
(Address of principal executive offices)
  
(Zip Code)
(919) 407-5300
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [ X ] No [    ]

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

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

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

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The number of shares outstanding of the registrant’s common stock, par value $0.00125 per share, as of April 21, 2017, was 97,288,271.

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CREE, INC.
FORM 10-Q
For the Quarterly Period Ended March 26, 2017
INDEX
 
Description
Page No.
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.
 
 

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PART I - FINANCIAL INFORMATION
Item 1.    Financial Statements
CREE, INC.
UNAUDITED CONSOLIDATED BALANCE SHEETS
 
March 26,
2017
 
June 26,
2016
 
(In thousands, except par value)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents

$117,094

 

$166,154

Short-term investments
474,783

 
439,151

Total cash, cash equivalents and short-term investments
591,877

 
605,305

Accounts receivable, net
149,508

 
165,611

Income tax receivable
7,453

 
6,304

Inventories
291,133

 
303,542

Prepaid expenses
23,200

 
26,810

Other current assets
32,138

 
44,788

Current assets held for sale
4,062

 
4,347

Total current assets
1,099,371

 
1,156,707

Property and equipment, net
574,275

 
599,723

Goodwill
618,828

 
618,828

Intangible assets, net
281,535

 
302,810

Other long-term investments
42,759

 
40,179

Deferred income taxes
12,140

 
38,564

Other assets
8,266

 
9,249

Total assets

$2,637,174

 

$2,766,060

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

Current liabilities:

 

Accounts payable, trade

$124,968

 

$132,286

Accrued salaries and wages
41,818

 
44,642

Other current liabilities
40,615

 
46,071

Total current liabilities
207,401

 
222,999

Long-term liabilities:

 

Long-term debt
153,000

 
160,000

Deferred income taxes
46,699

 
943

Other long-term liabilities
19,827

 
14,294

Total long-term liabilities
219,526

 
175,237

Commitments and contingencies (Note 13)

 

Shareholders’ equity:

 

Preferred stock, par value $0.01; 3,000 shares authorized at March 26, 2017 and June 26, 2016; none issued and outstanding
—

 
—

Common stock, par value $0.00125; 200,000 shares authorized at March 26, 2017 and June 26, 2016; 97,283 and 100,829 shares issued and outstanding at March 26, 2017 and June 26, 2016, respectively
120

 
125

Additional paid-in-capital
2,403,741

 
2,359,584

Accumulated other comprehensive income, net of taxes
3,240

 
8,728

Accumulated deficit
(196,854
)
 
(613
)
Total shareholders’ equity
2,210,247

 
2,367,824

Total liabilities and shareholders’ equity

$2,637,174

 

$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 (LOSS) INCOME
 
 
Three Months Ended
 
Nine Months Ended
 
March 26,
2017
 
March 27,
2016
 
March 26,
2017
 
March 27,
2016
 
(In thousands, except per share amounts)
Revenue, net

$341,505

 

$366,919

 

$1,114,064

 

$1,228,214

Cost of revenue, net
255,429

 
257,886

 
777,490

 
854,163

Gross profit
86,076

 
109,033

 
336,574

 
374,051

Operating expenses:
 
 
 
 

 

Research and development
41,451

 
41,871

 
119,292

 
127,363

Sales, general and administrative
68,165

 
64,489

 
213,136

 
214,443

Amortization or impairment of acquisition-related intangibles
8,362

 
7,318

 
20,707

 
21,442

Loss (gain) on disposal or impairment of long-lived assets
500

 
(104
)
 
1,541

 
16,483

Wolfspeed transaction termination fee
(12,500
)
 
—

 
(12,500
)
 
—

Total operating expenses
105,978

 
113,574

 
342,176

 
379,731

Operating loss
(19,902
)
 
(4,541
)
 
(5,602
)
 
(5,680
)
Non-operating income (expense), net
9,865

 
717

 
4,946

 
(14,075
)
Loss before income taxes
(10,037
)
 
(3,824
)
 
(656
)
 
(19,755
)
Income tax expense (benefit)
88,976

 
(3,976
)
 
91,574

 
(8,860
)
Net (loss) income

($99,013
)
 

$152

 

($92,230
)
 

($10,895
)
(Loss) earnings per share:
 
 
 
 

 

Basic

($1.02
)
 

$—

 

($0.93
)
 

($0.11
)
Diluted
(1.02
)
 
—

 
(0.93
)
 
(0.11
)
Weighted average shares used in per share calculation:
 
 
 
 
 
 
 
Basic
97,346

 
100,606

 
98,791

 
102,157

Diluted
97,346

 
101,221

 
98,791

 
102,157

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

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

 
Three Months Ended
 
Nine Months Ended
 
March 26,
2017
 
March 27,
2016
 
March 26,
2017
 
March 27,
2016
 
(In thousands)
Net (loss) income

($99,013
)
 

$152

 

($92,230
)
 

($10,895
)
Other comprehensive (loss) income:
 
 
 
 
 
 
 
Currency translation gain (loss)
550

 
432

 
(765
)
 
(357
)
Net unrealized (loss) gain on available-for-sale securities, net of tax benefit (expense) of $1,948 and ($716), ($4,723) and ($1,092), respectively
(608
)
 
1,152

 
(4,723
)
 
1,765

Other comprehensive (loss) income
(58
)
 
1,584

 
(5,488
)
 
1,408

Comprehensive (loss) income

($99,071
)
 

$1,736

 

($97,718
)
 

($9,487
)
The accompanying notes are an integral part of the consolidated financial statements.


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CREE, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
Nine Months Ended
 
March 26,
2017
 
March 27,
2016
 
(In thousands)
Cash flows from operating activities:
 
 
 
Net (loss) income

($92,230
)
 

($10,895
)
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
113,459

 
119,920

Stock-based compensation
38,417

 
44,318

Excess tax benefit from stock-based payment arrangements
(1
)
 
(12
)
Loss on disposal or impairment of long-lived assets
1,345

 
16,483

Amortization of premium/discount on investments
4,150

 
4,100

(Gain) Loss on equity investment
(144
)
 
13,712

Foreign exchange (gain) loss on equity investment
(2,436
)
 
2,220

Deferred income taxes
71,342

 
537

Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net
16,080

 
8,594

Inventories
12,064

 
(17,517
)
Prepaid expenses and other assets
11,478

 
(14,792
)
Accounts payable, trade
(10,891
)
 
(18,279
)
Accrued salaries and wages and other liabilities
521

 
(9,626
)
Net cash provided by operating activities
163,154

 
138,763

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(56,895
)
 
(99,692
)
Purchases of patent and licensing rights
(8,876
)
 
(11,034
)
Proceeds from sale of property and equipment
1,111

 
5,199

Purchases of short-term investments
(169,414
)
 
(192,728
)
Proceeds from maturities of short-term investments
112,307

 
228,774

Proceeds from sale of short-term investments
13,613

 
31,262

Purchase of acquired business, net of cash acquired
—

 
(12,513
)
Net cash used in investing activities
(108,154
)
 
(50,732
)
Cash flows from financing activities:
 
 
 
Payment of acquisition-related contingent consideration
(2,775
)
 
—

Proceeds from long-term debt borrowings
373,000

 
538,000

Payments on long-term debt borrowings
(380,000
)
 
(513,000
)
Net proceeds from issuance of common stock
10,160

 
13,321

Excess tax benefit from stock-based payment arrangements
1

 
12

Repurchases of common stock
(104,014
)
 
(149,555
)
Net cash used in financing activities
(103,628
)
 
(111,222
)
Effects of foreign exchange changes on cash and cash equivalents
(432
)
 
(957
)
Net decrease in cash and cash equivalents
(49,060
)
 
(24,148
)
Cash and cash equivalents:
 
 
 
Beginning of period
166,154

 
139,710

End of period

$117,094

 

$115,562

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

$7,243

 

$7,317

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.
The Company's Wolfspeed business consists of silicon carbide (SiC) materials, power devices and RF devices based on wide bandgap semiconductor materials such as SiC and gallium nitride (GaN). The Company's SiC materials products consist of crystals, bare and epitaxial wafers. The Company's materials products enable devices that power renewable energy, base stations and telecom, traction, industrial motor control, power management, automotive and gemstone applications. The Company's power products consist of SiC Schottky diodes, metal oxide semiconductor field effect transistors (MOSFETs), power modules and gate driver boards. The Company's power devices are used in solar, electric vehicle charging, motor drives, industrial power supplies, IT power supplies, traction and transportation applications. The Company's RF devices consist of GaN die, high-electron mobility transistors (HEMT) and monolithic microwave integrated circuits (MMIC). The Company's RF devices are used in military communications, radar, satellite communications, point to point radio, telecom, data link and broadband amplifier applications.
As discussed more fully below in Note 2, “Termination of Wolfspeed Sale Transaction,” on July 13, 2016, the Company executed a definitive agreement to sell its Wolfspeed business to Infineon Technologies AG (Infineon), which agreement was subsequently terminated on March 6, 2017. As a result of the termination of the agreement, the Company has reclassified the results of the Wolfspeed business as continuing operations in its consolidated statements of (loss) income, and presented it as a separate reportable segment for all periods presented. Additionally, the related assets and liabilities associated with the discontinued operations were reclassified as held and used in the consolidated balance sheets for all periods presented.
The majority of the Company's products are manufactured at its production facilities located in North Carolina, Wisconsin and China. The Company also uses contract manufacturers for certain products and aspects of product fabrication, assembly and packaging. The Company operates research and development facilities in North Carolina, Arkansas, California, Wisconsin, India, Italy and China (including Hong Kong).
Cree, Inc. is a North Carolina corporation established in 1987 and is headquartered in Durham, North Carolina.
The Company's three reportable segments are:
•
Lighting Products
•
LED Products
•
Wolfspeed
For financial results by reportable segment, please refer to Note 14, "Reportable Segments."
Basis of Presentation
The consolidated balance sheet at March 26, 2017, the consolidated statements of (loss) income for the three and nine months ended March 26, 2017 and March 27, 2016, the consolidated statements of comprehensive (loss) income for the three and nine months ended March 26, 2017 and March 27, 2016, and the consolidated statements of cash flows for the nine months ended March 26, 2017 and March 27, 2016 (collectively, the consolidated financial statements) have been prepared by the Company and have not been audited. In the opinion of management, all normal and recurring adjustments necessary to fairly state the consolidated financial position, results of operations, comprehensive income and cash flows at March 26, 2017, and for all periods presented,

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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 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 and nine months ended March 26, 2017 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.
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 pronouncement.
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 effective date will be the first quarter of the Company's fiscal year ending June 30, 2018.  The Company is currently analyzing the impact of this new pronouncement.
Goodwill Impairment Testing

In January 2017, the FASB issued ASU No. 2017-04: Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The ASU simplifies the manner in which an entity is required to test for goodwill impairment by eliminating Step 2 from the goodwill impairment test. Additionally, the ASU removes the requirement for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails such qualitative test, to perform Step 2 of the goodwill

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impairment test. The effective date will be the first quarter of the Company's fiscal year ending June 27, 2021. The Company’s adoption of this guidance is not expected to have a significant impact on its consolidated financial statements.
Note 2 – Termination of Wolfspeed Sale Transaction

On July 13, 2016, the Company executed an Asset Purchase Agreement (the APA) with Infineon, which was approved by both the Company’s Board of Directors and Infineon’s Supervisory Board. Pursuant to the APA, the Company agreed to sell to Infineon, and Infineon agreed to (i) purchase from the Company (a) the assets comprising the Company’s power and RF product lines (formerly 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.

Beginning in July 2016, the Company classified the results of the Wolfspeed business as discontinued operations in the Company’s consolidated statements of (loss) income for all periods presented. The Company also 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 were classified as held for sale in the consolidated balance sheets.

On February 16, 2017, the Company announced that the APA would be terminated because the Company and Infineon were unable to identify alternatives to modify the transaction to address the national security concerns of, and obtain approval from, the Committee on Foreign Investment in the United States, one of the closing conditions under the APA. On March 6, 2017, the Company and Infineon entered into a Termination Agreement pursuant to which the APA was terminated. Pursuant to the APA and the Termination Agreement, Infineon paid the Company a termination fee of $12.5 million in cash on March 10, 2017, which is included in Wolfspeed transaction termination fee in the Company’s consolidated statements of (loss) income and in net cash provided by operating activities in the Company’s consolidated statements of cash flows.

As a result of the announcement of the termination of the APA and the Company’s decision to continue operating the Wolfspeed business, as of February 16, 2017, the Company reclassified the results of the Wolfspeed business as continuing operations in the Company’s consolidated statements of (loss) income, and presented it as a separate reportable segment for all periods presented. Additionally, the related assets and liabilities of the Wolfspeed business were reclassified as held and used in the consolidated balance sheets for all periods presented. The long-lived assets were measured at the lower of their carrying amount before being classified as held for sale, adjusted for any depreciation and amortization expense that would have been recognized had the assets been continuously classified as held and used, or their fair value at the date of the subsequent decision not to sell.

The following table presents the adjustment recognized during the three months ended March 26, 2017 for depreciation and amortization that would have been recognized had the assets been continuously classified as held and used (in thousands):



Inventories

$4,067

Cost of Revenue, net
4,601

Research and development
2,801

Sales, general and administrative
1,161

Amortization or impairment of acquisition-related intangibles
1,569

Total depreciation and amortization adjustment

$14,199

As a result of this adjustment, the depreciation and amortization for the nine months ended March 26, 2017 equals the depreciation and amortization that would have been recognized had the assets been continuously classified as held and used.

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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 are reported as part of the Company's Wolfspeed segment.

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

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


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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
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.
Note 4 – Financial Statement Details
Accounts Receivable, net
The following table summarizes the components of accounts receivable, net (in thousands):
 
March 26, 2017
 
June 26, 2016
Billed trade receivables

$203,645

 

$217,691

Unbilled contract receivables
1,761

 
2,135


205,406

 
219,826

Allowance for sales returns, discounts and other incentives
(49,048
)
 
(48,710
)
Allowance for bad debts
(6,850
)
 
(5,505
)
Accounts receivable, net

$149,508

 

$165,611

Inventories
The following table summarizes the components of inventories (in thousands):
 
March 26, 2017
 
June 26, 2016
Raw material

$72,455

 

$83,299

Work-in-progress
102,799

 
96,779

Finished goods
115,879

 
123,464

Inventories

$291,133

 

$303,542


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Other Current Liabilities
The following table summarizes the components of other current liabilities (in thousands):
 
March 26, 2017
 
June 26, 2016
Accrued taxes

$12,286

 

$12,720

Accrued professional fees
9,153

 
7,980

Accrued warranty
11,918

 
20,207

Accrued other
7,258

 
5,164

Other current liabilities

$40,615

 

$46,071

Accumulated Other Comprehensive Income, net of taxes
The following table summarizes the components of accumulated other comprehensive income, net of taxes (in thousands):
 
March 26, 2017
 
June 26, 2016
Currency translation gain

$3,860

 

$4,624

Net unrealized (loss) gain on available-for-sale securities
(620
)
 
4,104

Accumulated other comprehensive income, net of taxes

$3,240

 

$8,728

Non-Operating Income (Expense), net
The following table summarizes the components of non-operating income (expense) income, net (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
March 26, 2017
 
March 27, 2016
 
March 26, 2017
 
March 27, 2016
Foreign currency gain (loss), net

$2,434

 

$348

 

$1,939

 

($4,331
)
Gain on sale of investments, net
1

 
47

 
13

 
63

Gain (loss) on equity investment
6,443

 
(790
)
 
160

 
(13,712
)
Interest income, net
927

 
1,024

 
2,714

 
3,541

Other, net
60

 
88

 
120

 
364

Non-operating income (expense), net

$9,865

 

$717

 

$4,946

 

($14,075
)

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Reclassifications Out of Accumulated Other Comprehensive Income, net of taxes
The following table summarizes the amounts reclassified out of accumulated other comprehensive income, net of taxes (in thousands):
Accumulated Other Comprehensive Income Component
 
Amount Reclassified Out of Accumulated Other Comprehensive Income
 
Affected Line Item in the Consolidated Statements of (Loss) Income
 
 
Three Months Ended
 
Nine Months Ended
 
 
 
 
March 26, 2017
 
March 27, 2016
 
March 26, 2017
 
March 27, 2016
 
 
Net unrealized gain on available-for-sale securities, net of taxes
 

$1

 

$47

 

$13

 

$63

 
Non-operating income (expense), net
 
 
1

 
47

 
13

 
63

 
(Loss) income before income taxes
 
 
—

 
49

 
—

 
28

 
Income tax expense (benefit)
 
 

$1

 

($2
)
 

$13

 

$35

 

Note 5 – Investments
Investments consist of municipal bonds, corporate bonds, commercial paper and certificates of deposit. All short-term investments are classified as available-for-sale. Other long-term investments consist of the Company's ownership interest in Lextar Electronics Corporation.
The following tables summarize short-term investments (in thousands):
 
 
March 26, 2017
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
Municipal bonds
 

$182,500

 

$1,266

 

($218
)
 

$183,548

Corporate bonds
 
168,792

 
1,254

 
(477
)
 
169,569

Non-U.S. certificates of deposit
 
109,901

 
—

 
—

 
109,901

U.S. certificates of deposit
 
11,087

 
—

 
—

 
11,087

Commercial paper
 
678

 
—

 
—

 
678

Total short-term investments
 

$472,958

 

$2,520

 

($695
)
 

$474,783

 
 
 
 
 
 
 
 
 
 
 
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


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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):
 
 
March 26, 2017
 
 
Less than 12 Months
 
Greater than 12 Months
 
Total
 
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
Municipal bonds
 

$51,923

 

($218
)
 

$—

 

$—

 

$51,923

 

($218
)
Corporate bonds
 
65,492

 
(477
)
 
—

 
—

 
65,492

 
(477
)
Total
 

$117,415

 

($695
)
 

$—

 

$—

 

$117,415

 

($695
)
Number of securities with an unrealized loss
 
 
 
85

 
 
 
0
 
 
 
85

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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 income (expense), net in the consolidated statements of (loss) income and unrealized gains and losses are included as a separate component of equity, net of tax, unless the loss is determined to be other-than-temporary.
The Company evaluates its investments for possible impairment or a decline in fair value below cost basis that is deemed to be other-than-temporary on a periodic basis. It considers such factors as the length of time and extent to which the fair value has been below the cost basis, the financial condition of the investee, and its ability and intent to hold the investment for a period of time that may be sufficient for an anticipated full recovery in market value. Accordingly, the Company considered declines in its investments to be temporary in nature, and did not consider its securities to be impaired as of March 26, 2017 and June 26, 2016.
The contractual maturities of short-term investments as of March 26, 2017 were as follows (in thousands):
 
 
Within One Year
 
After One, Within Five Years
 
After Five, Within Ten Years
 
After Ten
Years
 
Total
Municipal bonds

$46,459

 

$108,079

 

$29,010

 

$—

 

$183,548

Corporate bonds
50,835

 
83,479

 
35,255

 
—

 
169,569

Non-U.S. certificates of deposit
109,901

 
—

 
—

 
—

 
109,901

U.S. certificates of deposit
6,365

 
4,722

 
—

 
—

 
11,087

Commercial paper
678

 
—

 
—

 
—

 
678

Total short-term investments

$214,238

 

$196,280

 

$64,265

 

$—

 

$474,783


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Table of Contents

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 March 26, 2017, 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 March 26, 2017. There were no transfers between Level 1 and Level 2 during the nine months ended March 26, 2017.

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The following table sets forth financial instruments carried at fair value within the U.S. GAAP hierarchy (in thousands):
 
March 26, 2017
 
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

Money market funds
3,522

 
—

 
—

 
3,522

 
576

 
—

 
—

 
576

Total cash equivalents
3,522

 
—

 
—

 
3,522

 
576

 
137

 
—

 
713

Short-term investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Municipal bonds
—

 
183,548

 
—

 
183,548

 
—

 
190,440

 
—

 
190,440

Corporate bonds
—

 
169,569

 
—

 
169,569

 
—

 
168,767

 
—

 
168,767

U.S. certificates of deposit
—

 
11,087

 
—

 
11,087

 
—

 
3,500

 
—

 
3,500

Commercial paper
—

 
678

 
—

 
678

 
—

 
3,317

 
—

 
3,317

Non-U.S. certificates of deposit
—

 
109,901

 
—

 
109,901

 
—

 
73,127

 
—

 
73,127

Total short-term investments
—

 
474,783

 
—

 
474,783

 
—

 
439,151

 
—

 
439,151

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

 
42,759

 
—

 
42,759

 
—

 
40,179

 
—

 
40,179

Total other long-term investments
—

 
42,759

 
—

 
42,759

 
—

 
40,179

 
—

 
40,179

Total assets

$3,522

 

$517,542

 

$—

 

$521,064

 

$576

 

$479,467

 

$—

 

$480,043

Note 7– Intangible Assets
Intangible Assets, net
The following table presents the components of intangible assets, net (in thousands):
 
March 26, 2017
 
June 26, 2016
 
Gross
 
Accumulated Amortization
 
Net
 
Gross
 
Accumulated Amortization
 
Net
Intangible assets with finite lives:
 
 
 
 
 
 
 
 
 
 
 
Customer relationships

$141,420

 

($83,115
)
 

$58,305

 

$141,420

 

($78,438
)
 

$62,982

Developed technology
181,728

 
(127,532
)
 
54,196

 
181,728

 
(111,884
)
 
69,844

Non-compete agreements
10,475

 
(10,379
)
 
96

 
10,475

 
(9,994
)
 
481

Trade names, finite-lived
520

 
(520
)
 
—

 
520

 
(520
)
 
—

Patent and licensing rights
150,378

 
(61,120
)
 
89,258

 
145,780

 
(55,957
)
 
89,823

Total intangible assets with finite lives
484,521

 
(282,666
)
 
201,855

 
479,923

 
(256,793
)
 
223,130

Trade names, indefinite-lived
79,680

 
—

 
79,680

 
79,680

 
—

 
79,680

Total intangible assets

$564,201

 

($282,666
)
 

$281,535

 

$559,603

 

($256,793
)
 

$302,810

For the three and nine months ended March 26, 2017, total amortization of finite-lived intangible assets was $13.0 million and $29.9 million, respectively. Additionally, as discussed more fully in Note 2, “Termination of Wolfspeed Sale Transaction,” for the three and nine months ended March 26, 2017, total amortization of finite-lived intangible assets includes $3.2 million for

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amortization that would have been recognized had the Wolfspeed assets been continuously classified as held and used. For the three and nine months ended March 27, 2016, total amortization of finite-lived intangible assets was $10.2 million and $29.9 million, respectively.
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)

$14,165

June 24, 2018
31,611

June 30, 2019
18,965

June 28, 2020
14,948

June 27, 2021
13,681

Thereafter
108,485

Total future amortization expense

$201,855


Note 8 – Long-term Debt
As of March 26, 2017, the Company had a $500 million secured revolving line of credit under which the Company can borrow, repay and reborrow loans from time to time prior to its scheduled maturity date of January 9, 2020.
The Company classifies balances outstanding under its line of credit as long-term debt in the consolidated balance sheets. At March 26, 2017, the Company had $153 million outstanding under the line of credit and $347 million available for borrowing. For the three and nine months ended March 26, 2017, the average interest rate was 1.58% and 1.46%, respectively. For the three and nine months ended March 26, 2017 the average commitment fee percentage was 0.09%. The Company was in compliance with all covenants in the line of credit at March 26, 2017.
Note 9 – Shareholders’ Equity
As of March 26, 2017, pursuant to an approval by the Board of Directors, the Company is authorized to repurchase shares of its common stock having an aggregate purchase price not exceeding $300 million for all purchases from August 24, 2016 through the expiration of the program on June 25, 2017. During the nine months ended March 26, 2017, the Company repurchased 4.4 million shares of common stock for $104.1 million under the stock repurchase program.
Note 10– (Loss) Earnings Per Share
The following table presents the computation of basic (loss) earnings per share (in thousands, except per share amounts):
 
Three Months Ended
 
Nine Months Ended
 
March 26,
2017
 
March 27,
2016
 
March 26,
2017
 
March 27,
2016
Net (loss) income

($99,013
)
 

$152

 

($92,230
)
 

($10,895
)
Weighted average common shares
97,346

 
100,606

 
98,791

 
102,157

Basic (loss) earnings per share

($1.02
)
 

$—

 

($0.93
)
 

($0.11
)

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Table of Contents

The following computation reconciles the differences between the basic and diluted (loss) earnings per share presentations (in thousands, except per share amounts): 
 
Three Months Ended
 
Nine Months Ended
 
March 26,
2017
 
March 27,
2016
 
March 26,
2017
 
March 27,
2016
Net (loss) income

($99,013
)
 

$152

 

($92,230
)
 

($10,895
)
Weighted average common shares - basic
97,346

 
100,606

 
98,791

 
102,157

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

 
615

 
—

 
—

Weighted average common shares - diluted
97,346

 
101,221

 
98,791

 
102,157

Diluted (loss) earnings per share

($1.02
)
 

$—

 

($0.93
)
 

($0.11
)
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 and nine months ended March 26, 2017, there were 11.3 million and 11.5 million, respectively, of potential common shares not included in the calculation of diluted (loss) earnings per share because their effect was anti-dilutive. For the three and nine months ended March 27, 2016, there were 10.2 million and 11.5 million, respectively, of potential common shares not included in the calculation of diluted (loss) earnings per share because their effect was anti-dilutive.
Note 11 – Stock-Based Compensation
Overview of Employee Stock-Based Compensation Plans
The Company currently has one equity-based compensation plan, the 2013 Long-Term Incentive Compensation Plan (2013 LTIP), from which stock-based compensation awards can be granted to employees and directors. The 2013 LTIP provides for awards in the form of incentive stock options, non-qualified stock options, stock appreciation rights, restricted stock, restricted stock units, performance shares, performance units and other awards. The Company has other equity-based compensation plans that have been terminated so that no future grants can be made under those plans, but under which stock options, restricted stock and restricted stock units are currently outstanding.
The Company’s stock-based awards can be either service-based or performance-based.  Performance-based conditions are generally tied to future financial and/or operating performance of the Company. The compensation expense with respect to performance-based grants is recognized if the Company believes it is probable that the performance condition will be achieved. The Company reassesses the probability of the achievement of the performance condition at each reporting period, and adjusts the compensation expense for subsequent changes in the estimate or actual outcome. As with non-performance based awards, compensation expense is recognized over the vesting period. The vesting period runs from the date of grant to the expected date that the performance objective is likely to be achieved.
The Company also has an Employee Stock Purchase Plan (ESPP) that provides employees with the opportunity to purchase common stock at a discount. The ESPP limits employee contributions to 15% of each employee’s compensation (as defined in the plan) and allows employees to purchase shares at a 15% discount to the fair market value of common stock on the purchase date two times per year. The ESPP provides for a twelve-month participation period, divided into two equal six-month purchase periods, and also provides for a look-back feature. At the end of each six-month period in April and October, participants purchase the Company’s common stock through the ESPP at a 15% discount to the fair market value of the common stock on the first day of the twelve-month participation period or the purchase date, whichever is lower. The plan also provides for an automatic reset feature to start participants on a new twelve-month participation period if the fair market value of common stock declines during the first six-month purchase period.

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Table of Contents

Stock Option Awards
The following table summarizes stock option awards outstanding as of March 26, 2017 and changes during the nine 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
1,761

 

$24.52

Exercised
(114
)
 

$26.47

Forfeited or expired
(1,785
)
 

$38.70

Outstanding at March 26, 2017
11,109

 

$38.32

Restricted Stock Awards and Units
A summary of nonvested restricted stock awards (RSAs) and restricted stock unit awards (RSUs) outstanding as of March 26, 2017, and changes during the nine 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
1,528

 

$24.62

Vested
(565
)
 

$34.72

Forfeited
(138
)
 

$29.73

Nonvested at March 26, 2017
2,456

 

$26.78

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
 
Nine Months Ended
 
March 26,
2017
 
March 27,
2016
 
March 26,
2017
 
March 27,
2016
Income Statement Classification:
 
 
 
 
 
 
 
Cost of revenue, net

$2,229

 

$3,078

 

$8,012

 

$9,221

Research and development
2,542

 
3,694

 
8,468

 
10,554

Sales, general and administrative
6,790

 
8,084

 
21,937

 
24,539

Total stock-based compensation expense

$11,561

 

$14,856

 

$38,417

 

$44,314

Note 12 – Income Taxes
The variation between the Company's effective income tax rate and the U.S. statutory rate of 35% is primarily due to: (i) changes in the Company’s valuation allowances against deferred tax assets in the U.S. and Luxembourg, (ii) projected income for the full year derived from international locations with lower tax rates than the U.S. and (iii) projected tax credits generated.
  
U.S. GAAP requires a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is cumulatively more than 50% likely to be realized upon ultimate settlement.
As of June 26, 2016, the Company's liability for unrecognized tax benefits was $17.7 million. During the nine months ended March 26, 2017, the Company released $4.3 million of its unrecognized tax benefits; $3.7 million following statute expirations, and $0.6 million related to settlement of the audit by the Italian Revenue Agency. As a result, the total liability for unrecognized tax benefits as of March 26, 2017 was $13.4 million. If any portion of this $13.4 million is recognized, the Company will then include that portion in the computation of its effective tax rate. Although the ultimate timing of the resolution and/or closure of audits is highly uncertain, the Company believes it is reasonably possible that $0.2 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 2014. For U.S. state tax returns, the Company is generally no longer subject to tax examinations for fiscal years prior to 2013. For foreign purposes, the Company is generally no longer subject to tax examinations for tax periods 2006 and prior. Certain carryforward tax attributes generated in prior years remain subject to examination, adjustment and recapture. On January 20, 2017, the Company settled an ongoing audit by the Italian Revenue Agency for the fiscal year ended June 30, 2013, resulting in immaterial impact on tax expense.
The Company assesses all available positive and negative evidence to estimate if sufficient future taxable income will be generated to utilize the existing deferred tax assets by jurisdiction. During the third quarter of fiscal 2017, the Company concluded that it was necessary to recognize a full valuation allowance against its U.S. deferred tax assets and other deferred charges primarily due to the Company’s three-year cumulative pre-tax loss position in the U.S. and the termination of the Wolfspeed sale transaction, which was anticipated to generate U.S. taxable income upon the closing of the sale. Based on this evaluation, during the three months ended March 26, 2017, the Company recorded a valuation allowance of $67.6 million against its U.S. deferred tax assets. In addition, the company recognized a related deferred tax charge of $17.9 million.
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. As a result, 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 nine months ended March 26, 2017, the Company recorded an additional $0.9 million valuation allowance against the loss carryover deferred tax asset as a result of the $3.2 million year-to-date loss in Luxembourg.


20
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

$21,531

Warranties accrued in current period
24,571

Expenditures
(20,904
)
Balance at March 26, 2017

$25,198

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 March 26, 2017, $13.3 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
•
Wolfspeed

As discussed more fully in Note 2, “Termination of Wolfspeed Sale Transaction,” on July 13, 2016, the Company executed a definitive agreement to sell the Wolfspeed business to Infineon, which agreement was subsequently terminated on March 6, 2017. As a result of the termination of the agreement, the Company has reclassified the results of the Wolfspeed business as continuing operations in its consolidated statements of (loss) income, and presented it as a separate reportable segment, for all periods presented. For comparative purposes, the prior segment results have been recast 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. The Company's Wolfspeed segment includes power devices, RF devices, and SiC materials.
Financial Results by Reportable Segment
The table below reflects the results of the Company's reportable segments as reviewed by the Chief Operating Decision Maker (CODM) for the three and nine months ended March 26, 2017 and March 27, 2016. 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.

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Table of Contents

The Company's CODM does not review inter-segment transactions when evaluating segment performance and allocating resources to each segment, and inter-segment transactions are not included in the segment revenue presented in the table below. As such, total segment revenue in the table below is equal to the Company's consolidated revenue.
The Company's CODM reviews gross profit as the lowest and only level of segment profit. As such, all items below gross profit in the consolidated statements of (loss) income must be included to reconcile the consolidated gross profit presented in the table below to the Company's consolidated loss from continuing operations before income taxes.
In order to determine gross profit for each reportable segment, the Company allocates direct costs and indirect costs to each segment's cost of revenue. The Company allocates indirect costs, such as employee benefits for manufacturing employees, shared facilities services, information technology, purchasing, and customer service, when the costs are identifiable and beneficial to the reportable segment. The Company allocates these indirect costs based on a reasonable measure of utilization that considers the specific facts and circumstances of the costs being allocated.
Unallocated costs in the table below consisted primarily of manufacturing employees’ stock-based compensation, expenses for profit sharing and quarterly or annual incentive plans and matching contributions under the Company’s 401(k) plan. These costs were not allocated to the reportable segments’ gross profit because the Company’s CODM does not review them regularly when evaluating segment performance and allocating resources.
The depreciation and amortization adjustment in the table below represents the depreciation and amortization that would have been recognized had the Wolfspeed assets been continuously classified as held and used, as discussed more fully in Note 2, “Termination of Wolfspeed Sale Transaction.” These costs were not allocated to the reportable segments’ gross profit for the three months ended March 26, 2017 because they represent an adjustment which does not provide comparability to the corresponding prior period and therefore were not reviewed by the Company’s CODM when evaluating segment performance and allocating resources. These costs were allocated to the Wolfspeed segment’s gross profit for the nine months ended March 26, 2017 because they provide comparability to the corresponding prior period and were reviewed by the Company’s CODM 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
 
Nine Months Ended
 
March 26,
2017
 
March 27,
2016
 
March 26,
2017

March 27,
2016
Revenue:
 
 
 
 
 
 
 
Lighting Products revenue

$154,045

 

$187,714

 

$546,805

 

$690,715

LED Products revenue
131,327

 
135,552

 
406,858

 
407,873

Wolfspeed revenue
56,133

 
43,653

 
160,401

 
129,626

Total revenue

$341,505

 

$366,919

 

$1,114,064

 

$1,228,214

 
 
 
 
 
 
 
 
Gross Profit and Gross Margin:
 
 
 
 
 
 
 
Lighting Products gross profit

$35,355

 

$48,808

 

$159,415

 

$190,531

Lighting Products gross margin
23.0
%
 
26.0
%
 
29.2
%
 
27.6
%
LED Products gross profit
32,385

 
42,829

 
115,499

 
127,645

LED Products gross margin
24.7
%
 
31.6
%
 
28.4
%
 
31.3
%
Wolfspeed gross profit
26,396

 
22,750

 
74,737

 
70,990

Wolfspeed gross margin
47.0
%
 
52.1
%
 
46.6
%
 
54.8
%
Total segment gross profit
94,136

 
114,387

 
349,651

 
389,166

Unallocated costs
(3,459
)
 
(5,354
)
 
(13,077
)
 
(15,115
)
Depreciation and amortization adjustment
(4,601
)
 
—

 
—

 
—

Consolidated gross profit

$86,076

 

$109,033

 

$336,574

 

$374,051

Consolidated gross margin
25.2
%
 
29.7
%
 
30.2
%
 
30.5
%


Assets by Reportable Segment

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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):
 
March 26,
2017
 
June 26,
2016
Lighting Products

$151,698

 

$172,261

LED Products
111,308

 
104,544

Wolfspeed
24,041

 
21,871

Total segment inventories
287,047

 
298,676

Unallocated inventories
4,086

 
4,866

Consolidated inventories

$291,133

 

$303,542


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Table of Contents

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. While no charges were incurred for the three months ended March 27, 2016, the Company did realize a gain on the sale of long-lived assets related to the restructuring which were sold for a value in excess of their estimated net realizable value.
The Company incurred a total of $102.4 million pursuant to this restructuring plan. See Note 18, "Costs Associated with LED Business Restructuring" in Part II, Item 8 of the Company's Annual Report on Form 10K for the fiscal year ended June 26, 2016 for additional information. The following table summarizes the actual charges incurred for the three and nine months ended March 27, 2016 (in thousands):
Capacity and Overhead Cost Reductions

Amounts incurred for
the three
months ended
March 27, 2016

Amounts incurred for
the nine
months ended
March 27, 2016

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

$—

 

$15,519

 
Loss on disposal or impairment of long-lived assets
Severance expense
 
—

 
264

 
Sales, general and administrative expenses
Lease termination and facility consolidation costs
 
—

 
2,933

 
Sales, general and administrative expenses
  Total restructuring charges
 

$—

 

$18,716

 
 



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Table of Contents

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.
Overview
Cree, Inc. (Cree, we, our, or us) is a leading innovator of lighting-class light emitting diode (LED) products, lighting products and wide bandgap semiconductor products for power and radio-frequency (RF) applications. Our products are targeted for applications such as indoor and outdoor lighting, video displays, transportation, electronic signs and signals, power supplies, inverters and wireless systems.
Our lighting products primarily consist of LED lighting systems and lamps. We design, manufacture and sell lighting fixtures and lamps for the commercial, industrial and consumer markets.
Our LED products consist of LED 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.
Our Wolfspeed business consists of silicon carbide (SiC) materials, power devices and RF devices based on wide bandgap semiconductor materials such as SiC and gallium nitride (GaN). Our SiC materials products consist of crystals, bare and epitaxial wafers. Our materials products enable devices that power renewable energy, base stations and telecom, traction, industrial motor control, power management, automotive and gemstone applications. Our power products consist of SiC Schottky diodes, metal oxide semiconductor field effect transistors (MOSFETs), power modules and gate driver boards. Our power devices are used in solar, electric vehicle charging, motor drives, industrial power supplies, IT power supplies, traction and transportation applications. Our RF devices consist of GaN die, high-electron mobility transistors (HEMT) and monolithic microwave integrated circuits (MMIC). Our RF devices are used in military communications, radar, satellite communications, point to point radio, telecom, data link and broadband amplifier applications.
As discussed more fully in Note 2, “Termination of Wolfspeed Sale Transaction,” 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), which agreement was subsequently terminated on March 6, 2017. As a result of the termination of the agreement, we have reclassified the results of the Wolfspeed business as continuing operations in our consolidated statements of (loss) income, and presented it as a separate reportable segment, for all periods presented. Additionally, the related assets and liabilities associated with the discontinued operations were reclassified as held and used in the consolidated balance sheets for all periods presented.
The majority of our products are manufactured at our production facilities located in North Carolina, Wisconsin, and China. We also use contract manufacturers for certain products and aspects of product fabrication, assembly and packaging. We operate research and development facilities in North Carolina, Arkansas, California, Wisconsin, India, Italy and China (including Hong Kong).

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Table of Contents

Cree, Inc. is a North Carolina corporation established in 1987, and our headquarters are in Durham, North Carolina. For further information about our consolidated revenue and earnings, please see our consolidated financial statements included in Item 1 of this Quarterly Report.
Reportable Segments
Our three reportable segments are:
•
Lighting Products
•
LED Products
•
Wolfspeed
For further information about our reportable segments, please refer to Note 14, "Reportable Segments," in our consolidated financial statements included in Item 1 of this Quarterly Report.
Industry Dynamics and Trends
There are a number of industry factors that affect our business which include, among others:
•
Overall Demand for Products and Applications using LEDs, SiC power devices and GaN RF devices. Our potential for growth depends significantly on the continued adoption of LEDs within the general lighting markets, the adoption of SiC and GaN substrate and device products in the Power and RF markets, and our ability to win new designs for these applications. Demand also fluctuates based on various market cycles, continuously evolving industry supply chains, and evolving competitive dynamics in each of the respective markets. These uncertainties make demand difficult to forecast for us and our customers.
•
Intense and Constantly Evolving Competitive Environment. Competition in the industries we serve is intense. Many companies have made significant investments in product development and production equipment. Product pricing pressures exist as market participants often undertake pricing strategies to gain or protect market share, increase the utilization of their production capacity and open new applications to the LED, lighting, power and RF markets we serve. To remain competitive, market participants must continuously increase product performance, reduce costs and develop improved ways to serve their customers. To address these competitive pressures, we have invested in research and development activities to support new product development, lower product costs and deliver higher levels of performance to differentiate our products in the market. In addition, we are investing in systems, people and new processes to improve our ability to deliver a better overall experience for our customers.
•
Lighting Sales Channel Development. Commercial lighting is usually sold through lighting agents and distributors in the North American lighting market. The lighting agents typically have exclusive sales rights for a defined territory and are typically aligned with one large lighting company for a large percentage of their product sales. The size, quality and capability of the lighting agent has a significant effect on winning new projects and sales in a given geographic market. While these agents or distributors sell other lighting products, the large traditional lighting companies have taken steps to prevent their channel partners from selling competing product lines. We are constantly working to improve the capabilities of our existing channel partners and increase our share of their sales as well as develop new partners to improve our sales effectiveness in each geographic market.
•
Technological Innovation and Advancement. Innovations and advancements in LEDs, lighting and power and RF technologies continue to expand the potential commercial application for our products. However, new technologies or standards could emerge or improvements could be made in existing technologies that could reduce or limit the demand for our products in certain markets.
•
Intellectual Property Issues. Market participants rely on patented and non-patented proprietary information relating to product development, manufacturing capabilities and other core competencies of their business. Protection of intellectual property is critical. Therefore, steps such as additional patent applications, confidentiality and non-disclosure agreements, as well as other security measures are generally taken. To enforce or protect intellectual property rights, litigation or threatened litigation is common.
Overview of the Nine Months Ended March 26, 2017
The following is a summary of our financial results for the nine months ended March 26, 2017:

•
Revenue decreased to $1.1 billion for the nine months ended March 26, 2017 from $1.2 billion for the nine months ended March 27, 2016.

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Table of Contents

•
Gross profit decreased to $337 million for the nine months ended March 26, 2017 from $374 million for the nine months ended March 27, 2016. Gross margin was 30% for the nine months ended March 26, 2017 and for the nine months ended March 27, 2016.
•
Operating loss was $6 million for the nine months ended March 26, 2017 and for the nine months ended March 27, 2016. Net loss per diluted share was $0.93 for the nine months ended March 26, 2017 compared to net loss per diluted share of $0.11 for the nine months ended March 27, 2016. The increase in net loss per diluted share was primarily due to a depreciation and amortization adjustment, which represents the depreciation and amortization that would have been recognized had the Wolfspeed assets been continuously classified as held and used, and the recognition of a full valuation allowance against our U.S. deferred tax assets and other deferred charges as discussed in Note 2, "Termination of Wolfspeed Sale Transaction" and in Note 12, "Income Taxes," respectively, in our consolidated financial statements included in Item 1 of this Quarterly Report.
•
Cash, cash equivalents and short-term investments were $0.6 billion at March 26, 2017 and June 26, 2016. Cash provided by operating activities was $163 million for the nine months ended March 26, 2017 compared to $139 million for the nine months ended March 27, 2016.
•
Inventories decreased to $291 million at March 26, 2017 compared to $304 million at June 26, 2016.
•
Purchases of property and equipment were $57 million for the nine months ended March 26, 2017 compared to $100 million for the nine months ended March 27, 2016.
Business Outlook
As a result of the termination of the proposed sale of Wolfspeed to Infineon, we continue to focus on growing this business. The Wolfspeed business has performed well this year as our customers have further realized the value of our unique technology. The strength of our balance sheet and improving operating cash flow provides us the ability to invest in Wolfspeed, while continuing to pursue our LED and Lighting growth plans.

We are uniquely positioned as a market leading innovator in all three business segments and target growth in all three businesses over the next several years. These businesses are in different phases of their growth plans and generally operate on different market cycles. This is targeted to provide better business diversity and less cyclical results over time.
We are focused on the following priorities to support our goals of delivering higher revenue and profits over time:
•
Invest in the Wolfspeed business to increase capacity and further develop the technology to support longer term growth opportunities in SiC materials, SiC power devices and modules, and GaN RF devices.
•
Grow Lighting Products revenue and improve margins by investing in our channel relationships, improving execution, and continuing to deliver innovative lighting solutions.
•
Grow the LED Products business by expanding our product offering with new products that leverage our market leadership to serve a larger share of existing customers’ LED demand, while also opening new applications for our technology.
•
Improve the customer experience and service levels in all of our businesses.


27
Table of Contents

Results of Operations
The following table sets forth certain consolidated statement of (loss) income data for the periods indicated (in thousands, except per share amounts and percentages):
 
 
Three Months Ended
 
Nine Months Ended
 
March 26,
2017
 
March 27,
2016
 
March 26,
2017
 
March 27,
2016
 
 
 
% of Revenue
 
 
 
% of Revenue
 
 
 
% of Revenue
 
 
 
% of Revenue
Revenue, net

$341,505

 
100
 %
 

$366,919

 
100
 %
 

$1,114,064

 
100
 %
 

$1,228,214

 
100
 %
Cost of revenue, net
255,429

 
75
 %
 
257,886

 
70
 %
 
777,490

 
70
 %
 
854,163

 
70
 %
Gross profit
86,076

 
25
 %
 
109,033

 
30
 %
 
336,574

 
30
 %
 
374,051

 
30
 %
Research and development
41,451

 
12
 %
 
41,871

 
11
 %
 
119,292

 
11
 %
 
127,363

 
10
 %
Sales, general and administrative
68,165

 
20
 %
 
64,489

 
18
 %
 
213,136

 
19
 %
 
214,443

 
17
 %
Amortization or impairment of acquisition-related intangibles
8,362

 
2
 %
 
7,318

 
2
 %
 
20,707

 
2
 %
 
21,442

 
2
 %
Loss (gain) on disposal or impairment of long-lived assets
500

 
—
 %
 
(104
)
 
—
 %
 
1,541

 
—
 %
 
16,483

 
1
 %
Wolfspeed transaction termination fee
(12,500
)
 
(4
)%
 
—

 
—
 %
 
(12,500
)
 
(1
)%
 
—

 
—
 %
Operating loss
(19,902
)
 
(6
)%
 
(4,541
)
 
(1
)%
 
(5,602
)
 
(1
)%
 
(5,680
)
 
—
 %
Non-operating income (expense), net
9,865

 
3
 %
 
717

 
—
 %
 
4,946

 
—
 %
 
(14,075
)
 
(1
)%
Loss before income taxes
(10,037
)
 
(3
)%
 
(3,824
)
 
(1
)%
 
(656
)
 
—
 %
 
(19,755
)
 
(2
)%
Income tax expense (benefit)
88,976

 
26
 %
 
(3,976
)
 
(1
)%
 
91,574

 
8
 %
 
(8,860
)
 
(1
)%
Net (loss) income

($99,013
)
 
(29
)%
 

$152

 
—
 %
 

($92,230
)
 
(8
)%
 

($10,895
)
 
(1
)%
Basic (loss) earnings per share

($1.02
)
 
 
 

$—

 
 
 

($0.93
)
 
 
 

($0.11
)
 
 
Diluted (loss) earnings per share

($1.02
)
 

 

$—

 


 

($0.93
)
 
 
 

($0.11
)
 
 

Depreciation and Amortization Adjustment

As discussed more fully in Note 2, “Termination of Wolfspeed Sale Transaction,” in our consolidated financial statements included in Item 1 of this Quarterly Report, as a result of the termination of the agreement to sell the Wolfspeed business to Infineon, we have reclassified the results of the Wolfspeed business as continuing operations in our consolidated statements of (loss) income for all periods presented. Additionally, the related assets and liabilities associated with the discontinued operations were reclassified as held and used in the consolidated balance sheets for all periods presented. The long-lived assets were measured at the lower of their carrying amount before being classified as held for sale, adjusted for any depreciation and amortization expense that would have been recognized had the assets been continuously classified as held and used or their fair value at the date of the subsequent decision not to sell.

The following table presents the adjustment recognized for the three months ended March 26, 2017 for depreciation and amortization that would have been recognized had the assets been continuously classified as held and used (in thousands):




Inventories

$4,067

Cost of Revenue, net
4,601

Research and development
2,801

Sales, general and administrative
1,161

Amortization or impairment of acquisition-related intangibles
1,569

Total depreciation and amortization adjustment

$14,199


As a result of this adjustment, the depreciation and amortization for the nine months ended March 26, 2017 equals the depreciation and amortization that would have been recognized had the assets been continuously classified as held and used.


28
Table of Contents

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. While no charges were incurred for the three months ended March 27, 2016, the Company did realize a gain on the sale of long-lived assets related to the restructuring which were sold for a value in excess of their estimated net realizable value.
We incurred a total of $102.4 million pursuant to this restructuring plan. The following table summarizes the actual charges incurred for the three and nine months ended March 27, 2016 (in thousands):
Capacity and Overhead Cost Reductions
 
Amounts incurred for
the three
months ended
March 27, 2016
 
Amounts incurred for
the nine
months ended
March 27, 2016
 
Affected Line Item in the Consolidated Statements of (Loss) Income
Loss on disposal or impairment of long-lived assets
 

$—

 

$15,519

 
Loss on disposal or impairment of long-lived assets
Severance expense
 
—

 
264

 
Sales, general and administrative expenses
Lease termination and facility consolidation costs
 
—

 
2,933

 
Sales, general and administrative expenses
  Total restructuring charges
 

$—

 

$18,716

 
 
Revenue

Revenue was comprised of the following (in thousands, except percentages):
 
Three Months Ended
 
 
 
 
 
Nine Months Ended
 
 
 
 
 
March 26,
2017
 
March 27,
2016
 
Change