CREE, INC. - FORM 10-Q - January 24, 2018

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EX-32.2 - EXHIBIT 32.2 - CREE, INC.ex3222qfy2018.htm
EX-32.1 - EXHIBIT 32.1 - CREE, INC.ex3212qfy2018.htm
EX-31.2 - EXHIBIT 31.2 - CREE, INC.ex3122qfy2018.htm
EX-31.1 - EXHIBIT 31.1 - CREE, INC.ex3112qfy2018.htm
EX-10.6 - EXHIBIT 10.6 - CREE, INC.ex1062qfy2018.htm
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EX-4.1 - EXHIBIT 4.1 - CREE, INC.ex412qfy2018.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 24, 2017
or
[    ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission file number 0-21154
logo042115a19.gif
CREE, INC.
(Exact name of registrant as specified in its charter)
 
North Carolina
 
56-1572719
(State or other jurisdiction of incorporation or
organization)
 
(I.R.S. Employer Identification No.)
 
 
 
4600 Silicon Drive
Durham, North Carolina
 
27703
(Address of principal executive offices)
 
(Zip Code)
(919) 407-5300
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [ X ] No [    ]

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

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

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


The number of shares outstanding of the registrant’s common stock, par value $0.00125 per share, as of January 19, 2018, was 99,960,179.


CREE, INC.
FORM 10-Q
For the Quarterly Period Ended December 24, 2017
INDEX
 
Description
Page No.
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.
 
 

2

PART I - FINANCIAL INFORMATION
Item 1.    Financial Statements
CREE, INC.
UNAUDITED CONSOLIDATED BALANCE SHEETS
 
December 24,
2017
 
June 25,
2017
 
(In thousands, except par value)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents

$169,688

 

$132,597

Short-term investments
480,221

 
478,341

Total cash, cash equivalents and short-term investments
649,909

 
610,938

Accounts receivable, net
153,014

 
148,392

Income tax receivable
2,809

 
8,040

Inventories, net
273,211

 
284,385

Prepaid expenses
22,933

 
23,305

Other current assets
19,450

 
23,390

Current assets held for sale
6,913

 
2,180

Total current assets
1,128,239

 
1,100,630

Property and equipment, net
612,131

 
581,263

Goodwill
618,828

 
618,828

Intangible assets, net
259,607

 
274,315

Other long-term investments
72,517

 
50,366

Deferred income taxes
10,399

 
11,763

Other assets
12,564

 
12,702

Total assets

$2,714,285

 

$2,649,867

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

Current liabilities:

 

Accounts payable, trade

$158,291

 

$133,185

Accrued salaries and wages
46,906

 
41,860

Other current liabilities
40,525

 
36,978

Total current liabilities
245,722

 
212,023

Long-term liabilities:

 

Long-term debt
124,000

 
145,000

Deferred income taxes
37,404

 
49,860

Other long-term liabilities
24,147

 
20,179

Total long-term liabilities
185,551

 
215,039

Commitments and contingencies (Note 13)

 

Shareholders’ equity:

 

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

 
—

Common stock, par value $0.00125; 200,000 shares authorized at December 24, 2017 and June 25, 2017; 99,888 issued and outstanding at December 24, 2017 and 97,674 shares issued and outstanding at June 25, 2017
123

 
121

Additional paid-in-capital
2,483,424

 
2,419,517

Accumulated other comprehensive income, net of taxes
3,427

 
5,909

Accumulated deficit
(208,878
)
 
(202,742
)
Total shareholders’ equity
2,278,096

 
2,222,805

Noncontrolling interest
4,916

 
—

Total liabilities and equity

$2,714,285

 

$2,649,867

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

3

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

$367,870

 

$401,326

 

$728,268

 

$772,559

Cost of revenue, net
275,267

 
260,759

 
535,333

 
522,061

Gross profit
92,603

 
140,567

 
192,935

 
250,498

Operating expenses:
 
 
 
 
 
 

Research and development
39,776

 
37,893

 
81,635

 
77,841

Sales, general and administrative
68,076

 
76,513

 
131,040

 
144,971

Amortization or impairment of acquisition-related intangibles
6,792

 
5,937

 
13,584

 
12,345

Loss on disposal or impairment of long-lived assets
4,262

 
717

 
7,087

 
1,041

Total operating expenses
118,906

 
121,060

 
233,346

 
236,198

Operating (loss) income
(26,303
)
 
19,507

 
(40,411
)
 
14,300

Non-operating income (expense), net
26,729

 
(4,760
)
 
25,662

 
(4,919
)
Income (loss) before income taxes
426

 
14,747

 
(14,749
)
 
9,381

Income tax (benefit) expense
(13,326
)
 
8,531

 
(8,629
)
 
2,598

Net income (loss)

$13,752

 

$6,216

 

($6,120
)
 

$6,783

Net income attributable to noncontrolling interest
31

 
—

 
16

 
—

Net income (loss) attributable to controlling interest

$13,721

 

$6,216

 

($6,136
)
 

$6,783

Earnings (loss) per share:
 
 
 
 
 
 

Basic

$0.14

 

$0.06

 

($0.06
)
 

$0.07

Diluted

$0.14

 

$0.06

 

($0.06
)
 

$0.07

Weighted average shares used in per share calculation:
 
 
 
 
 
 
 
Basic
99,184

 
98,467

 
98,499

 
99,513

Diluted
100,763

 
98,730

 
98,499

 
99,994

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

4

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

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

$13,721

 

$6,216

 

($6,136
)
 

$6,783

Other comprehensive loss:
 
 
 
 
 
 
 
Currency translation (loss) gain
(424
)
 
(1,343
)
 
1,218

 
(1,314
)
Net unrealized loss on available-for-sale securities, net of tax benefit of $0 and $2,357 and $0 and $2,556 respectively
(3,660
)
 
(3,795
)
 
(3,700
)
 
(4,115
)
Other comprehensive loss:
(4,084
)
 
(5,138
)
 
(2,482
)
 
(5,429
)
Comprehensive income (loss)

$9,637

 

$1,078

 

($8,618
)
 

$1,354

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


5

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

($6,120
)
 

$6,783

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
74,634

 
62,574

Stock-based compensation
22,162

 
26,856

Excess tax benefit from stock-based payment arrangements
—

 
(1
)
Loss on disposal or impairment of long-lived assets
7,087

 
845

Amortization of premium/discount on investments
2,631

 
2,749

(Gain) loss on equity investment
(21,479
)
 
6,298

Foreign exchange gain on equity investment
(672
)
 
(434
)
Deferred income taxes
(11,801
)
 
44

Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net
(4,203
)
 
13,647

Inventories
11,339

 
1,290

Prepaid expenses and other assets
5,014

 
2,735

Accounts payable, trade
17,925

 
(13,834
)
Accrued salaries and wages and other liabilities
9,295

 
10,164

Net cash provided by operating activities
105,812

 
119,716

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(85,222
)
 
(35,211
)
Purchases of patent and licensing rights
(4,932
)
 
(5,836
)
Proceeds from sale of property and equipment
380

 
236

Purchases of short-term investments
(158,327
)
 
(125,022
)
Proceeds from maturities of short-term investments
138,435

 
93,312

Proceeds from sale of short-term investments
11,938

 
7,619

Net cash used in investing activities
(97,728
)
 
(64,902
)
Cash flows from financing activities:
 
 
 
Proceeds from issuing shares to noncontrolling interest
4,900

 
—

Payment of acquisition-related contingent consideration
(1,850
)
 
(2,775
)
Proceeds from long-term debt borrowings
160,000

 
245,000

Payments on long-term debt borrowings
(181,000
)
 
(235,000
)
Net proceeds from issuance of common stock
46,550

 
8,021

Excess tax benefit from stock-based payment arrangements
—

 
1

Repurchases of common stock
—

 
(98,431
)
Net cash provided by (used in) financing activities
28,600

 
(83,184
)
Effects of foreign exchange changes on cash and cash equivalents
407

 
(691
)
Net increase (decrease) in cash and cash equivalents
37,091

 
(29,061
)
Cash and cash equivalents:
 
 
 
Beginning of period
132,597

 
166,154

End of period

$169,688

 

$137,093

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

$19,039

 

$8,240

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

6

CREE, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – Basis of Presentation and New Accounting Standards
Overview
Cree, Inc. (the Company) is an innovator of lighting-class light emitting diode (LED) products, lighting products and wide bandgap semiconductor products for power and radio-frequency (RF) applications. The Company's products are targeted for applications such as indoor and outdoor lighting, video displays, transportation, electronic signs and signals, power supplies, inverters and wireless systems.
The Company's lighting products primarily consist of LED lighting systems and lamps. The Company designs, manufactures and sells lighting fixtures and lamps for the commercial, industrial and consumer markets.
The Company's LED products consist of LED chips and LED components. The Company's LED products enable its customers to develop and market LED-based products for lighting, video screens, automotive and other industrial applications.

The Company’s Wolfspeed business consists of silicon carbide (SiC) materials, power devices and RF devices based on wide bandgap semiconductor materials such as SiC and gallium nitride (GaN). The Company’s materials products and power devices are used in solar, electric vehicles, motor drives, power supplies and transportation applications. The Company’s RF devices are used in military communications, radar, satellite and telecommunication applications.
The majority of the Company's products are manufactured at its production facilities located in North Carolina, Wisconsin and China. The Company also uses contract manufacturers for certain products and aspects of product fabrication, assembly and packaging. The Company operates research and development facilities in North Carolina, Arkansas, California, Wisconsin, India, Italy and China (including Hong Kong).
Cree, Inc. is a North Carolina corporation established in 1987 and is headquartered in Durham, North Carolina.
The Company's three reportable segments are:
•
Lighting Products
•
LED Products
•
Wolfspeed
For financial results by reportable segment, please refer to Note 14, "Reportable Segments."
Basis of Presentation
The consolidated balance sheet at December 24, 2017, the consolidated statements of income (loss) for the three and six months ended December 24, 2017 and December 25, 2016, the consolidated statements of comprehensive income (loss) for the three and six months ended December 24, 2017 and December 25, 2016, and the consolidated statements of cash flows for the six months ended December 24, 2017 and December 25, 2016 (collectively, the consolidated financial statements) have been prepared by the Company and have not been audited. In the opinion of management, all normal and recurring adjustments necessary to fairly state the consolidated financial position, results of operations, comprehensive income and cash flows at December 24, 2017, and for all periods presented, have been made. All intercompany accounts and transactions have been eliminated. The consolidated balance sheet at June 25, 2017 has been derived from the audited financial statements as of that date.
These financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) for interim information and with the instructions to Form 10-Q and Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for annual financial statements. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 25, 2017 (fiscal 2017). The results of operations for the three and six months ended December 24, 2017 are not necessarily indicative of the operating results that may be attained for the entire fiscal year ending June 24, 2018 (fiscal 2018).

7

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and the disclosure of contingent assets and liabilities. Actual amounts could differ materially from those estimates.
Certain fiscal 2017 amounts related to the Wolfspeed business in the accompanying consolidated financial statements have been reclassified to continuing operations to conform to the fiscal 2018 presentation. These reclassifications had no effect on previously reported consolidated net income or shareholders’ equity.
Recently Issued Accounting Pronouncements
Revenue from Contracts with Customers
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09: Revenue from Contracts with Customers (Topic 606). The FASB has subsequently issued multiple ASUs which amend and clarify the guidance in Topic 606. The ASU establishes a principles-based approach for accounting for revenue arising from contracts with customers and supersedes existing revenue recognition guidance. The ASU provides that an entity should apply a five-step approach for recognizing revenue, including (1) identify the contract with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when, or as, the entity satisfies a performance obligation. Also, the entity must provide various disclosures concerning the nature, amount and timing of revenue and cash flows arising from contracts with customers. The Company’s evaluation of ASU 2014-09 is ongoing and not complete; however, the Company anticipates the primary changes to revenue recognition to be related to certain patent license arrangements. The FASB has issued and may issue in the future, interpretive guidance, which may cause our evaluation to change. The effective date will be the first quarter of the Company's fiscal year ending June 30, 2019 and the Company currently expects to use the modified retrospective method.
Leases
In February 2016, the FASB issued ASU No. 2016-02: Leases (Topic 842). The ASU requires that a lessee recognize in its statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. The asset will be based on the liability, subject to adjustment, such as for initial direct costs. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. For income statement purposes, leases are still required to be classified as either operating or finance. Operating leases will result in straight-line expense while finance leases will result in a front-loaded expense pattern. The effective date will be the first quarter of the Company's fiscal year ending June 28, 2020, using a modified retrospective approach. The Company is currently analyzing the impact of this new pronouncement.
Stock Compensation
In March 2016, the FASB issued ASU No. 2016-09: Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting.  The ASU simplifies the current stock compensation guidance for tax consequences. The ASU requires an entity to recognize all excess tax benefits and tax deficiencies as income tax expense or benefit in its income statement. The ASU also eliminates the requirement to defer recognition of an excess tax benefit until the benefit is realized through a reduction to taxes payable. For cash flows statement purposes, excess tax benefits should be classified as an operating activity and cash payments made to taxing authorities on the employee’s behalf for withheld shares should be classified as financing activity. The ASU grants an entity the right to withhold up to the employee’s maximum statutory tax rate in the applicable jurisdiction without triggering liability accounting. The effective date was the first quarter of the Company's fiscal year ending June 24, 2018.
The Company's adoption of this ASU did not have a material impact on its consolidated financial statements. All excess tax benefits and deficiencies in the current and future periods will be recognized as income tax expense in the Company’s income statement in the reporting period in which they occur. This could result in increased volatility in the Company’s effective tax rate. For the six months ended December 24, 2017, the Company did not recognize a discrete event related to the excess tax benefits from stock-based compensation due to a full U.S. valuation allowance on the impact. The Company plans to continue its existing practice of estimating expected forfeitures in determining compensation cost.
Goodwill Impairment Testing
In January 2017, the FASB issued ASU No. 2017-04: Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The ASU simplifies the manner in which an entity is required to test for goodwill impairment by eliminating Step 2 from the goodwill impairment test. Additionally, the ASU removes the requirement for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails such qualitative test, to continue to perform Step 1 of

8

the goodwill impairment test. The effective date will be the first quarter of the Company's fiscal year ending June 27, 2021. The Company’s adoption of this guidance is not expected to have a significant impact on its consolidated financial statements.
Note 2 – Joint Venture
Effective July 17, 2017, the Company entered into a Shareholders Agreement with San’an Optoelectronics Co., Ltd. (San’an) and Cree Venture LED Company Limited (Cree Venture LED) pursuant to which the Company and San’an funded their contributions to Cree Venture LED and agreed upon the management and operation of Cree Venture LED.  The Company contributed $5.1 million of cash for a 51% ownership interest and San’an contributed $4.9 million of cash for a 49% ownership interest.  Cree Venture LED has a five-member board of directors, three of which were designated by the Company and two of which were designated by San’an. As a result of the Company's majority voting interest, the Company consolidates the operations of Cree Venture LED and reports its revenue and gross profit within the Company's LED Products segment. The Company classifies the 49% ownership interest held by San'an as "Noncontrolling interest" on the consolidated balance sheet. During the six months ended December 24, 2017, the noncontrolling interest increased by $16 thousand for its share of net income from Cree Venture LED. There were no other changes in the noncontrolling interest.
In connection with forming Cree Venture LED and entering into the Shareholders Agreement, Cree Venture LED and San’an also entered into a manufacturing agreement pursuant to which San'an will supply Cree Venture LED with mid-power LED products, and the Company and Cree Venture LED entered into a sales agency agreement pursuant to which the Company will be the independent sales representative of Cree Venture LED in the exclusive markets, among certain other ancillary agreements related to the transaction. Cree Venture LED will produce and deliver to market high performing, mid-power lighting class LEDs in an exclusive arrangement to serve the expanding markets of North and South America, Europe and Japan, and serve China and the rest of the world on a non-exclusive basis. Cree Venture LED recorded its first sales to customers during the first quarter of fiscal 2018.
Note 3 – Acquisition
On July 8, 2015, the Company closed on the acquisition of Arkansas Power Electronics International, Inc. (APEI), a global leader in power modules and power electronics applications, pursuant to a merger agreement with APEI and certain shareholders of APEI, whereby the Company acquired all of the outstanding share capital of APEI in exchange for a base purchase price of $13.8 million, subject to certain adjustments. In addition, if certain goals were achieved over the subsequent two years, additional cash payments totaling up to $4.6 million were to be made to the former APEI shareholders. Payments totaling $2.8 million were made to the former APEI shareholders in July 2016 based on achievement of the first year goals. The final payment of $1.9 million was made in July 2017 based on achievement of the second year goals. In connection with this acquisition, APEI became a wholly owned subsidiary of the Company, renamed Cree Fayetteville, Inc. (Cree Fayetteville). Cree Fayetteville is not considered a significant subsidiary of the Company and its results from operations are reported as part of the Company's Wolfspeed segment.
Note 4 – Financial Statement Details
Accounts Receivable, net

9

The following table summarizes the components of accounts receivable, net (in thousands):
 
December 24, 2017
 
June 25, 2017
Billed trade receivables

$214,266

 

$205,516

Unbilled contract receivables
987

 
912


215,253

 
206,428

Allowance for sales returns, discounts and other incentives
(53,528
)
 
(49,425
)
Allowance for bad debts
(8,711
)
 
(8,611
)
Accounts receivable, net

$153,014

 

$148,392

Inventories
The following table summarizes the components of inventories, net (in thousands):
 
December 24, 2017
 
June 25, 2017
Raw material

$84,429

 

$73,410

Work-in-progress
89,501

 
100,402

Finished goods
99,281

 
110,573

Inventories, net

$273,211

 

$284,385

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

$13,181

 

$11,148

Accrued professional fees
4,713

 
5,545

Accrued warranty
15,151

 
13,631

Accrued other
7,480

 
6,654

Other current liabilities

$40,525

 

$36,978

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

$5,689

 

$4,471

Net unrealized (loss) gain on available-for-sale securities
(2,262
)
 
1,438

Accumulated other comprehensive income, net of taxes

$3,427

 

$5,909


10

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

$462

 

($1,856
)
 

$1,228

 

($495
)
Gain on sale of investments, net
1

 
—

 
47

 
12

Gain (loss) on equity investment, net
24,746

 
(3,796
)
 
21,479

 
(6,283
)
Interest income, net
1,467

 
900

 
2,617

 
1,787

Other, net
53

 
(8
)
 
291

 
60

Non-operating income (expense), net

$26,729

 

($4,760
)
 

$25,662

 

($4,919
)
The change in Gain (loss) on equity investment is due to the increase in the Lextar Electronics Corporation (Lextar) stock price.
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
 
Six Months Ended
 
 
 
 
December 24, 2017
 
December 25, 2016
 
December 24, 2017
 
December 25, 2016
 
 
Net unrealized gain on available-for-sale securities, net of taxes
 

$1

 

$—

 

$47

 

$12

 
Non-operating income (expense), net
 
 
1

 
—

 
47

 
12

 
Income (loss) before income taxes
 
 
—

 
—

 
—

 
5

 
Income tax (benefit) expense
 
 

$1

 

$—

 

$47

 

$7

 

Note 5 – Investments
Investments consist of municipal bonds, corporate bonds, U.S. agency securities, 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.

11

The following tables summarize short-term investments (in thousands):
 
 
December 24, 2017
 
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
Municipal bonds
 

$178,985

 

$815

 

($1,025
)
 

$178,775

Corporate bonds
 
172,410

 
1,161

 
(761
)
 
172,810

U.S. agency securities
 
3,921

 
—

 
(7
)
 
3,914

Non-U.S. certificates of deposit
 
122,634

 
—

 
—

 
122,634

Commercial paper
 
2,088

 
—

 
—

 
2,088

Total short-term investments
 

$480,038

 

$1,976

 

($1,793
)
 

$480,221

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

$177,890

 

$2,219

 

($68
)
 

$180,041

Corporate bonds
 
175,991

 
1,925

 
(195
)
 
177,721

U.S. agency securities
 
—

 
—

 
—

 
—

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

 
—

 
—

 
120,379

Commercial paper
 
200

 
—

 
—

 
200

Total short-term investments
 

$474,460

 

$4,144

 

($263
)
 

$478,341

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

$115,005

 

($897
)
 

$7,821

 

($90
)
 

$122,826

 

($987
)
Corporate bonds
 
100,236

 
(563
)
 
12,808

 
(237
)
 
113,044

 
(800
)
U.S. agency securities
 
3,914

 
(7
)
 
—

 
—

 
3,914

 
(7
)
Total
 

$219,155

 

($1,467
)
 

$20,629

 

($327
)
 

$239,784

 

($1,794
)
Number of securities with an unrealized loss
 
 
 
148

 
 
 
23
 
 
 
171

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

$26,816

 

($68
)
 

$—

 

$—

 

$26,816

 

($68
)
Corporate bonds
 
57,404

 
(195
)
 
—

 
—

 
57,404

 
(195
)
U.S. agency securities
 
—

 
—

 
—

 
—

 
—

 
—

Total
 

$84,220

 

($263
)
 

$—

 

$—

 

$84,220

 

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

 
 
 
—

 
 
 
67


12

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 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.
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 December 24, 2017 and June 25, 2017.
The contractual maturities of short-term investments as of December 24, 2017 were as follows (in thousands):
 
 
Within One Year
 
After One, Within Five Years
 
After Five, Within Ten Years
 
After Ten
Years
 
Total
Municipal bonds

$1,526

 

$130,557

 

$35,186

 

$11,506

 

$178,775

Corporate bonds
4,759

 
97,126

 
62,274

 
8,651

 
172,810

U.S. agency securities
—

 
3,914

 
—

 
—

 
3,914

Non-U.S. certificates of deposit
114,911

 
7,723

 
—

 
—

 
122,634

Commercial paper
2,088

 
—

 
—

 
—

 
2,088

Total short-term investments

$123,284

 

$239,320

 

$97,460

 

$20,157

 

$480,221

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 December 24, 2017, financial assets utilizing Level 1 inputs included money market funds and certificates of deposit, and financial assets utilizing Level 2 inputs included municipal bonds, corporate bonds, U.S. agency securities, certificates of deposit, commercial paper and common stock of non-U.S. corporations. Level 2 assets are valued based on quoted prices in active markets for instruments that are similar or using a third-party pricing service's consensus price, which is a weighted average price based on multiple sources. These sources determine prices utilizing market income models which factor in, where applicable, transactions of similar assets in active markets, transactions of identical assets in infrequent markets, interest rates, bond or credit default swap spreads and volatility. The Company did not have any financial assets requiring the use of Level 3 inputs as of December 24, 2017. There were no transfers between Level 1 and Level 2 during the six months ended December 24, 2017.

13

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

$—

 

$—

 

$—

 

$—

 

$—

 

$1,802

 

$—

 

$1,802

Non-U.S. certificates of deposit
—

 
85,259

 
—

 
85,259

 
—

 
736

 
—

 
736

Money market funds
1,191

 
—

 
—

 
1,191

 
1,184

 
—

 
—

 
1,184

Total cash equivalents
1,191

 
85,259

 
—

 
86,450

 
1,184

 
2,538

 
—

 
3,722

Short-term investments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Municipal bonds
—

 
178,775

 
—

 
178,775

 
—

 
180,041

 
—

 
180,041

Corporate bonds
—

 
172,810

 
—

 
172,810

 
—

 
177,721

 
—

 
177,721

U.S. agency securities
3,914

 
—

 
—

 
3,914

 
—

 
—

 
—

 
—

Commercial paper
—

 
2,088

 
—

 
2,088

 
—

 
200

 
—

 
200

Non-U.S. certificates of deposit
—

 
122,634

 
—

 
122,634

 
—

 
120,379

 
—

 
120,379

Total short-term investments
3,914

 
476,307

 
—

 
480,221

 
—

 
478,341

 
—

 
478,341

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

 
72,517

 
—

 
72,517

 
—

 
50,366

 
—

 
50,366

Total other long-term investments
—

 
72,517

 
—

 
72,517

 
—

 
50,366

 
—

 
50,366

Total assets

$5,105

 

$634,083

 

$—

 

$639,188

 

$1,184

 

$531,245

 

$—

 

$532,429

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

$141,420

 

($87,790
)
 

$53,630

 

$141,420

 

($84,673
)
 

$56,747

Developed technology
181,728

 
(143,179
)
 
38,549

 
181,728

 
(132,747
)
 
48,981

Non-compete agreements
10,475

 
(10,436
)
 
39

 
10,475

 
(10,398
)
 
77

Trade names, finite-lived
520

 
(520
)
 
—

 
520

 
(520
)
 
—

Patent and licensing rights
155,523

 
(67,814
)
 
87,709

 
151,985

 
(63,155
)
 
88,830

Total intangible assets with finite lives
489,666

 
(309,739
)
 
179,927

 
486,128

 
(291,493
)
 
194,635

Trade names, indefinite-lived
79,680

 
—

 
79,680

 
79,680

 
—

 
79,680

Total intangible assets

$569,346

 

($309,739
)
 

$259,607

 

$565,808

 

($291,493
)
 

$274,315

For the three and six months ended December 24, 2017, total amortization of finite-lived intangible assets was $9.9 million and $19.8 million, respectively. For the three and six months ended December 25, 2016, total amortization of finite-lived intangible assets was $9.0 million and $18.4 million, respectively.

14

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

$13,925

June 30, 2019
25,459

June 28, 2020
20,042

June 27, 2021
18,631

June 26, 2022
16,307

Thereafter
85,563

Total future amortization expense

$179,927

Note 8 – Long-term Debt
As of December 24, 2017, the Company had a $500 million secured revolving line of credit under which the Company can borrow, repay and reborrow loans from time to time prior to its scheduled maturity date of January 9, 2022.
The Company classifies balances outstanding under its line of credit as long-term debt in the consolidated balance sheets. At December 24, 2017, the Company had $124 million outstanding under the line of credit and $376 million available for borrowing. For the three and six months ended December 24, 2017, the average interest rate was 1.75% and 1.76% for each period, respectively. For the three and six months ended December 24, 2017 the average commitment fee percentage was 0.10%. The Company was in compliance with all covenants in the line of credit at December 24, 2017.
Note 9 – Shareholders’ Equity
As of December 24, 2017, pursuant to an approval by the Board of Directors, the Company is authorized to repurchase shares of its common stock having an aggregate purchase price not exceeding $200 million for all purchases from June 26, 2017 through the expiration of the program on June 24, 2018. During the six months ended December 24, 2017, the Company repurchased no shares of common stock 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
 
Six Months Ended
 
December 24,
2017
 
December 25,
2016
 
December 24,
2017
 
December 25,
2016
Net income (loss)

$13,721

 

$6,216

 

($6,136
)
 

$6,783

Weighted average common shares
99,184

 
98,467

 
98,499

 
99,513

Basic earnings (loss) per share

$0.14

 

$0.06

 

($0.06
)
 

$0.07


15

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
 
Six Months Ended
 
December 24,
2017
 
December 25,
2016
 
December 24,
2017
 
December 25,
2016
Net income (loss)

$13,721

 

$6,216

 

($6,136
)
 

$6,783

Weighted average common shares - basic
99,184

 
98,467

 
98,499

 
99,513

Dilutive effect of stock options, nonvested shares and Employee Stock Purchase Plan purchase rights
1,579

 
263

 
—

 
481

Weighted average common shares - diluted
100,763

 
98,730

 
98,499

 
99,994

Diluted earnings (loss) per share

$0.14

 

$0.06

 

($0.06
)
 

$0.07

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 six months ended December 24, 2017, there were 4.1 million and 5.8 million, respectively, of potential common shares not included in the calculation of diluted earnings (loss) per share because their effect was anti-dilutive. For the three and six months ended December 25, 2016, there were 12.1 million and 11.5 million, respectively, 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.

16

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

 

$38.27

Granted
53

 

$24.66

Exercised
(1,448
)
 

$27.56

Forfeited or expired
(1,371
)
 

$49.48

Outstanding at December 24, 2017
7,838

 

$38.20

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

 

$26.74

Granted
2,211

 

$25.91

Vested
(584
)
 

$29.44

Forfeited
(478
)
 

$24.52

Nonvested at December 24, 2017
3,561

 

$26.08

Stock-Based Compensation Valuation and Expense
The Company accounts for its employee stock-based compensation plans using the fair value method. The fair value method requires the Company to estimate the grant-date fair value of its stock-based awards and amortize this fair value to compensation expense over the requisite service period or vesting term.
The Company uses the Black-Scholes option-pricing model to estimate the fair value of the Company’s stock option and ESPP awards. The determination of the fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of complex and subjective variables. These variables include the expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, the risk-free interest rate and expected dividends. Due to the inherent limitations of option-valuation models, future events that are unpredictable and the estimation process utilized in determining the valuation of the stock-based awards, the ultimate value realized by award holders may vary significantly from the amounts expensed in the Company’s financial statements.
For RSAs and RSUs, the grant-date fair value is based upon the market price of the Company’s common stock on the date of the grant. This fair value is then amortized to compensation expense over the requisite service period or vesting term.
Stock-based compensation expense is recognized net of estimated forfeitures such that expense is recognized only for those stock-based awards that are expected to vest. A forfeiture rate is estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from initial estimates.

17

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

$1,898

 

$2,978

 

$3,673

 

$5,783

Research and development
1,999

 
2,486

 
4,456

 
5,925

Sales, general and administrative
8,129

 
6,742

 
14,031

 
15,148

Total stock-based compensation expense

$12,026

 

$12,206

 

$22,160

 

$26,856

Note 12 – Income Taxes
The variation between the Company's effective income tax rate and the U.S. statutory rate of 28.3% 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.
The Tax Cuts and Jobs Act of 2017 (Tax Legislation), enacted on December 22, 2017, contains significant changes to U.S. tax law, including lowering the U.S. corporate income tax rate to 21%, implementing a territorial tax system, and imposing a one-time tax on deemed repatriated earnings of foreign subsidiaries.
The Tax Legislation reduces the U.S. statutory tax rate from 35% to 21%, effective January 1, 2018. U.S. tax law requires that taxpayers with a fiscal year that begins before and ends after the effective date of a rate change calculate a blended tax rate based on the pro rata number of days in the fiscal year before and after the effective date. As a result, for the fiscal year ending June 24, 2018, the Company’s statutory income tax rate will be 28.3%. For the fiscal year ending June 30, 2019, the Company’s statutory income tax rate will be 21%. During the three months ended December 24, 2017, the Company recorded an $18.8 million discrete tax benefit representing the benefit of remeasuring its U.S. deferred tax liabilities at the lower 21% statutory tax rate.
The Tax Legislation also implements a territorial tax system. Under the territorial tax system, in general, the Company’s foreign earnings will no longer be subject to tax in the U.S. As part of transitioning to the territorial tax system the Tax Legislation includes a mandatory deemed repatriation of all undistributed foreign earnings that are subject to a U.S. income tax. The Company estimates that the deemed repatriation will result in $15.7 million of additional U.S. income tax which the Company expects to fully offset through the utilization of tax credits. This preliminary estimate may be impacted by a number of additional considerations, including, but not limited to, the issuance of final regulations, the Company's ongoing analysis of the new law and the Company's actual earnings for the fiscal year ending June 24, 2018.
As of December 24, 2017, the Company has approximately $280.3 million of undistributed earnings for certain non-U.S. subsidiaries. These undistributed earnings are subject to the one-time deemed repatriation tax, but could be subject to additional foreign and state income taxes if they are repatriated. The Company has historically asserted its intent to reinvest these earnings in foreign operations indefinitely. The Company has reevaluated its historical assertion considering the enactment of the Tax Legislation and determined that $220.8 million of the undistributed foreign earnings are expected to be repatriated in the foreseeable future. During the three months ended December 24, 2017, the Company recorded a $3.0 million discrete tax expense representing the deferred tax liability for foreign income taxes expected to be withheld upon repatriation of the foreign earnings. As of December 24, 2017, the Company has not provided income taxes on the remaining undistributed foreign earnings as the Company continues to maintain its intention to reinvest these earnings in foreign operations indefinitely. If, at a later date, these earnings were repatriated to the U.S., the Company would be required to pay approximately $3.0 million in taxes on these amounts.
The Company assesses all available positive and negative evidence to estimate if sufficient future taxable income will be generated to utilize the existing deferred tax assets by jurisdiction. The Company has concluded that it is necessary to recognize a full valuation allowance against its U.S. and Luxembourg deferred tax assets. The Company reassessed the need for a full valuation allowance against its U.S. deferred tax assets due to the Tax Legislation and concluded that a full valuation allowance is still necessary. As of June 25, 2017, the U.S. valuation allowance was $101.8 million. During the six months ended December 24, 2017, the Company reduced the U.S. valuation allowance by $20.0 million as a result of remeasuring its U.S. deferred tax assets at the 21% statutory rate and, as a result, the U.S. valuation allowance is $81.8 million as of December 24, 2017. As of June 25, 2017, the Luxembourg valuation allowance was $5.8 million. During the six months ended December 24, 2017, the Company reduced this valuation allowance by $4.8 million as a result of the $18.4 million year-to-date income in Luxembourg.

18

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 available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is cumulatively more than 50% likely to be realized upon ultimate settlement.
As of June 25, 2017, the Company's liability for unrecognized tax benefits was $13.3 million. During the six months ended December 24, 2017, the Company recorded a $4.7 million decrease to the liability for unrecognized tax benefits due to the U.S. statutory rate reduction. In addition, there was a $0.6 million increase in the unrecognized tax benefits due to uncertainty regarding state depreciation deductions. As a result, the total liability for unrecognized tax benefits as of December 24, 2017 was $9.2 million. If any portion of this $9.2 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 $0.4 million of gross unrecognized tax benefits will change in the next 12 months as a result of statute requirements.
The Company files U.S. federal, U.S. state and foreign tax returns. For U.S. federal purposes, the Company is generally no longer subject to tax examinations for fiscal years prior to 2014. For U.S. state tax returns, the Company is generally no longer subject to tax examinations for fiscal years prior to 2013. For foreign purposes, the Company is generally no longer subject to tax examinations for tax periods prior to 2007. Certain carryforward tax attributes generated in prior years remain subject to examination, adjustment and recapture.
Note 13 – Commitments and Contingencies
Warranties
The following table summarizes the changes in the Company's product warranty liabilities (in thousands):
Balance at June 25, 2017

$27,919

Warranties accrued in current period
15,853

Expenditures
(9,171
)
Balance at December 24, 2017

$34,601

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 December 24, 2017, $19.5 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

19

Reportable Segments Description
The Company's Lighting Products segment primarily consists of LED lighting systems and lamps. 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 six months ended December 24, 2017. The Company's CODM is the Chief Executive Officer. The Company used the same accounting policies to derive the segment results reported below as those used in the Company's consolidated financial statements.
The Company's CODM does not review inter-segment transactions when evaluating segment performance and allocating resources to each segment, and inter-segment transactions are not included in the segment revenue presented in the table below. As such, total segment revenue in the table below is equal to the Company's consolidated revenue.
The Company's CODM reviews gross profit as the lowest and only level of segment profit. As such, all items below gross profit in the consolidated statements of income (loss) must be included to reconcile the consolidated gross profit presented in the table below to the Company's consolidated income (loss) 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.
For the three and six months ended December 25, 2016, the Wolfspeed segment was presented as discontinued operations. 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. These costs were allocated to the Wolfspeed segment's gross profit for the three and six months ended December 25, 2016 because they represent an adjustment which provides comparability to the current period.

20

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

December 25,
2016
Revenue:
 
 
 
 
 
 
 
Lighting Products revenue

$144,616

 

$208,924

 

$294,340

 

$392,760

LED Products revenue
152,682

 
138,038

 
297,202

 
275,531

Wolfspeed revenue
70,572

 
54,364

 
136,726

 
104,268

Total revenue

$367,870

 

$401,326

 

$728,268

 

$772,559

 
 
 
 
 
 
 
 
Gross Profit and Gross Margin:
 
 
 
 
 
 
 
Lighting Products gross profit

$22,964

 

$74,770

 

$54,847

 

$124,060

Lighting Products gross margin
15.9
%
 
35.8
%
 
18.6
%
 
31.6
%
LED Products gross profit
38,606

 
40,314

 
77,416

 
82,084

LED Products gross margin
25.3
%
 
29.2
%
 
26.0
%
 
29.8
%
Wolfspeed gross profit
34,133

 
25,911

 
66,531

 
49,371

Wolfspeed gross margin
48.4
%
 
47.7
%
 
48.7
%
 
47.4
%
Total segment gross profit
95,703

 
140,995

 
198,794

 
255,515

Unallocated costs
(3,100
)
 
(4,859
)
 
(5,859
)
 
(9,618
)
Depreciation and amortization adjustment
—

 
4,431

 
—

 
4,601

Consolidated gross profit

$92,603

 

$140,567

 

$192,935

 

$250,498

Consolidated gross margin
25.2
%
 
35.0
%
 
26.5
%
 
32.4
%

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):
 
December 24,
2017
 
June 25,
2017
Lighting Products

$140,657

 

$145,710

LED Products
100,411

 
108,297

Wolfspeed
28,047

 
26,453

Total segment inventories, net
269,115

 
280,460

Unallocated inventories
4,096

 
3,925

Consolidated inventories, net

$273,211

 

$284,385

Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations
Information set forth in this Quarterly Report on Form 10-Q contains various “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). All information contained in this report relative to future markets for our products and trends in and anticipated levels of revenue, gross margins and expenses, as well as other statements containing words such as “believe,” “project,” “may,” “will,” “anticipate,” “target,” “plan,” “estimate,” “expect” and “intend” and other similar expressions constitute forward-looking statements. These forward-looking statements are subject to business, economic and other risks and uncertainties, both known and unknown, and actual results may differ materially from those contained in the forward-

21

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 25, 2017. Historical results and percentage relationships among any amounts in the financial statements are not necessarily indicative of trends in operating results for any future periods.
Overview
Cree, Inc. (Cree, we, our, or us) is an innovator of lighting-class light emitting diode (LED) products, lighting products and wide bandgap semiconductor products for power and radio-frequency (RF) applications. Our products are targeted for applications such as indoor and outdoor lighting, video displays, transportation, electronic signs and signals, power supplies, inverters and wireless systems.
Our lighting products primarily consist of LED lighting systems and lamps. We design, manufacture and sell lighting fixtures and lamps for the commercial, industrial and consumer markets.
Our LED products consist of LED chips and LED components. Our LED products enable our customers to develop and market LED-based products for lighting, video screens, automotive and other industrial applications.
Our Wolfspeed business consists of silicon carbide (SiC) and gallium nitride (GaN) materials, power devices and RF devices based on wide bandgap semiconductor materials. Our materials products and power devices are used in solar, electric vehicles, motor drives, power supplies and transportation applications. Our materials products and RF devices are used in military communications, radar, satellite and telecommunication applications.
The majority of our products are manufactured at our production facilities located in North Carolina, Wisconsin and China. We also use contract manufacturers for certain products and aspects of product fabrication, assembly and packaging. We operate research and development facilities in North Carolina, Arkansas, California, Wisconsin, India, Italy and China (including Hong Kong).
Cree, Inc. is a North Carolina corporation established in 1987, and our headquarters are in Durham, North Carolina. For further information about our consolidated revenue and earnings, please see our consolidated financial statements included in Item 1 of this Quarterly Report.
Reportable Segments
Our three reportable segments are:
•
Lighting Products
•
LED Products
•
Wolfspeed
For further information about our reportable segments, please refer to Note 14, "Reportable Segments," in our consolidated financial statements included in Item 1 of this Quarterly Report.

22

Industry Dynamics and Trends
There are a number of industry factors that affect our business which include, among others:
•
Overall Demand for Products and Applications using LEDs, SiC power devices and GaN RF devices. Our potential for growth depends significantly on the continued adoption of LEDs, the adoption of SiC and GaN materials and device products in the power and RF markets, and our ability to win new designs for these applications. Demand also fluctuates based on various market cycles, continuously evolving industry supply chains, and evolving competitive dynamics in each of the respective markets. These uncertainties make demand difficult to forecast for us and our customers.
•
Intense and Constantly Evolving Competitive Environment. Competition in the industries we serve is intense. Many companies have made significant investments in product development and production equipment. Product pricing pressures exist as market participants often undertake pricing strategies to gain or protect market share, increase the utilization of their production capacity and open new applications to the LED, lighting, power and RF markets we serve. To remain competitive, market participants must continuously increase product performance, reduce costs and develop improved ways to serve their customers. To address these competitive pressures, we have invested in research and development activities to support new product development, lower product costs and deliver higher levels of performance to differentiate our products in the market. In addition, we invest in systems, people and new processes to improve our ability to deliver a better overall experience for our customers.
•
Lighting Sales Channel Development. Commercial lighting is usually sold through lighting agents and distributors in the North American lighting market. The lighting agents typically have exclusive sales rights for a defined territory and are typically aligned with one large lighting company for a large percentage of their product sales. The size, quality and capability of the lighting agent has a significant effect on winning new projects and sales in a given geographic market. While these agents sell other lighting products, the large traditional lighting companies have taken steps to prevent their channel partners from selling competing product lines. We are constantly working to improve the capabilities of our existing channel partners and increase our share of their sales as well as develop new partners to improve our sales effectiveness in each geographic market.
•
Technological Innovation and Advancement. Innovations and advancements in LEDs, lighting and power and RF technologies continue to expand the potential commercial application for our products. However, new technologies or standards could emerge or improvements could be made in existing technologies that could reduce or limit the demand for our products in certain markets.
•
Intellectual Property Issues. Market participants rely on patented and non-patented proprietary information relating to product development, manufacturing capabilities and other core competencies of their business. Protection of intellectual property is critical. Therefore, steps such as additional patent applications, confidentiality and non-disclosure agreements, as well as other security measures are generally taken. To enforce or protect intellectual property rights, litigation or threatened litigation is common.
Overview of the Six Months Ended December 24, 2017
The following is a summary of our financial results for the six months ended December 24, 2017:

•
Revenue decreased to $728 million for the six months ended December 24, 2017 from $773 million for the six months ended December 25, 2016.
•
Gross profit decreased to $193 million for the six months ended December 24, 2017 from $250 million for the six months ended December 25, 2016. Gross margin was 26% for the six months ended December 24, 2017 and 32% for the six months ended December 25, 2016.
•
Operating loss was $40 million for the six months ended December 24, 2017 compared to operating income of $14 million for the six months ended December 25, 2016. Net loss per diluted share was $(0.06) for the six months ended December 24, 2017 compared to net earnings per diluted share of $0.07 for the six months ended December 25, 2016.
•
Cash, cash equivalents and short-term investments were $650 million at December 24, 2017 and $611 million at June 25, 2017. Cash provided by operating activities was $106 million for the six months ended December 24, 2017 compared to $120 million for the six months ended December 25, 2016.
•
Inventories decreased to $273 million at December 24, 2017 compared to $284 million at June 25, 2017.
•
Purchases of property and equipment were $85 million for the six months ended December 24, 2017 compared to $35 million for the six months ended December 25, 2016.

23

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

$367,870

 
100
 %
 

$401,326

 
100
 %
 

$728,268

 
100
 %
 

$772,559

 
100
 %
Cost of revenue, net
275,267

 
75
 %
 
260,759

 
65
 %
 
535,333

 
74
 %
 
522,061

 
68
 %
Gross profit
92,603

 
25
 %
 
140,567

 
35
 %
 
192,935

 
26
 %
 
250,498

 
32
 %
Research and development
39,776

 
11
 %
 
37,893

 
9
 %
 
81,635

 
11
 %
 
77,841

 
10
 %
Sales, general and administrative
68,076

 
19
 %
 
76,513

 
19
 %
 
131,040

 
18
 %
 
144,971

 
19
 %
Amortization or impairment of acquisition-related intangibles
6,792

 
2
 %
 
5,937

 
1
 %
 
13,584

 
2
 %
 
12,345

 
2
 %
Loss on disposal or impairment of long-lived assets
4,262

 
1
 %
 
717

 
—
 %
 
7,087

 
1
 %
 
1,041

 
—
 %
Operating (loss) income
(26,303
)
 
(7
)%
 
19,507

 
5
 %
 
(40,411
)
 
(6
)%
 
14,300

 
2
 %
Non-operating income (expense), net
26,729

 
7
 %
 
(4,760
)
 
(1
)%
 
25,662

 
4
 %
 
(4,919
)
 
(1
)%
Income (loss) before income taxes
426

 
—
 %
 
14,747

 
4
 %
 
(14,749
)
 
(2
)%
 
9,381

 
1
 %
Income tax (benefit) expense
(13,326
)
 
(4
)%
 
8,531

 
2
 %
 
(8,629
)
 
(1
)%
 
2,598

 
—
 %
Net income (loss)
13,752

 
4
 %
 

$6,216

 
2
 %
 

($6,120
)
 
(1
)%
 

$6,783

 
1
 %
Net income attributable to noncontrolling interest
31

 
—
 %
 
—

 
—
 %
 
16

 
—
 %
 
—

 
—
 %
Net income (loss) attributable to controlling interest

$13,721

 
4
 %
 

$6,216

 
2
 %
 

($6,136
)
 
(1
)%
 

$6,783

 
1
 %
Basic earnings (loss) per share

$0.14

 
 
 

$0.06

 
 
 

($0.06
)
 
 
 

$0.07

 
 
Diluted earnings (loss) per share

$0.14

 

 

$0.06

 


 

($0.06
)
 
 
 

$0.07

 
 


24

Revenue

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

$144,616

 

$208,924

 

($64,308
)
 
(31
)%
 

$294,340

 

$392,760

 

($98,420
)
 
(25
)%
Percent of revenue
39
%
 
52
%
 
 
 
 
 
40
%
 
51
%
 
 
 
 
LED Products revenue
152,682

 
138,038

 
14,644

 
11
 %
 
297,202

 
275,531

 
21,671