[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 25, 2012
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
CREE, INC.
(Exact name of registrant as specified in its charter)
North Carolina
56-1572719
(State or other jurisdiction of incorporation or
organization)
(I.R.S. Employer Identification No.)
4600 Silicon Drive
Durham, North Carolina
27703
(Address of principal executive offices)
(Zip Code)
(919) 407-5300
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [ X ] No [ ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes [ X ] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer [X]
Accelerated filer [ ]
Non-accelerated filer [ ] (Do not check if a smaller reporting company)
Smaller reporting company [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No[ X]
The number of shares outstanding of the registrant’s common stock, par value $0.00125 per share, as of April 11, 2012, was 116,152,940.
Total cash, cash equivalents, and short-term investments
710,094
1,085,797
Accounts receivable, net
168,208
118,469
Income tax receivable
1,201
6,796
Inventories
196,835
176,482
Deferred income taxes
18,854
17,857
Prepaid expenses and other current assets
56,340
51,494
Total current assets
1,151,532
1,456,895
Property and equipment, net
594,468
555,929
Intangible assets, net
380,356
102,860
Goodwill
616,982
326,178
Other assets
7,670
4,860
Total assets
$
2,751,008
$
2,446,722
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable, trade
$
90,556
$
76,593
Accrued salaries and wages
34,196
18,491
Income taxes payable
1,955
15,493
Other current liabilities
33,142
29,739
Total current liabilities
159,849
140,316
Long-term liabilities:
Deferred income taxes
21,902
21,902
Other long-term liabilities
24,509
22,940
Total long-term liabilities
46,411
44,842
Commitments and contingencies (Note 11)
Shareholders’ equity:
Preferred stock, par value $0.01; 3,000 shares authorized at March 25, 2012 and June 26, 2011; none issued and outstanding
—
—
Common stock, par value $0.00125; 200,000 shares authorized at March 25, 2012 and June 26, 2011; 116,165 and 109,607 shares issued and outstanding at March 25, 2012 and June 26, 2011, respectively
144
136
Additional paid-in-capital
1,843,975
1,593,530
Accumulated other comprehensive income, net of taxes
11,436
13,091
Retained earnings
689,193
654,807
Total shareholders’ equity
2,544,748
2,261,564
Total liabilities and shareholders’ equity
$
2,751,008
$
2,446,722
The accompanying notes are an integral part of the consolidated financial statements.
Note 1. Basis of Presentation and Changes in Significant Accounting Policies
Overview
Cree, Inc. (the "Company") is a leading innovator of lighting-class light emitting diode (LED) products, lighting products and semiconductor products for power and radio-frequency (RF) applications. The Company's products are targeted for applications such as general illumination, video displays, automotive, electronic signs and signals, power supplies and solar inverters.
The Company develops and manufactures semiconductor materials and devices primarily based on silicon carbide (SiC), gallium nitride (GaN) and related compounds. The physical and electronic properties of SiC and GaN offer technical advantages over traditional silicon, gallium arsenide (GaAs), sapphire and other materials used for electronic and opto-electronic applications.
The Company's LED products consist of LED components, LED chips, and SiC wafers. As LED technology improves, the Company believes the potential market for LED lighting will continue to expand. The Company's success in selling LED products depends upon its ability to drive adoption and offer innovative products and solutions that enable its customers to develop and market LED based products that successfully compete against traditional lighting products.
The Company's lighting products consist of both LED and traditional lighting systems. The Company designs, manufactures and sells lighting systems for indoor and outdoor applications, with its primary focus on LED lighting systems for the commercial and industrial markets. The Company also uses its LED systems expertise to accelerate LED lighting adoption and expand the market for its LED components.
In addition, the Company develops, manufactures and sells power and RF devices. The Company's power products are made from SiC and provide faster switching speeds than comparable silicon-based power devices. The Company's RF devices are made from SiC or GaN and produce higher power densities as compared to silicon or gallium arsenide.
The majority of the Company's products are manufactured at production facilities located in North Carolina, Wisconsin and China. The Company also uses contract manufacturers for certain aspects of its product fabrication, packaging and assembly. The Company operates research and development facilities in North Carolina, California, Wisconsin and China.
The Company currently operates its business as one reportable segment.
Basis of Presentation
The consolidated balance sheet at March 25, 2012 and the consolidated statements of income for the three and nine months ended March 25, 2012 and March 27, 2011, and the consolidated statements of cash flows for the nine months ended March 25, 2012 and March 27, 2011 (“consolidated financial statements”) have been prepared by the Company and have not been audited. In the opinion of management, all normal and recurring adjustments necessary to present fairly the consolidated financial position, results of operations and cash flows at March 25, 2012, and for all periods presented, have been made. The consolidated balance sheet at June 26, 2011 has been derived from the audited financial statements as of that date.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been condensed or omitted. It is suggested that these financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 26, 2011 (“fiscal 2011”). The results of operations for the three and nine months ended March 25, 2012 are not necessarily indicative of the operating results that may be attained for the entire fiscal year ending June 24, 2012 (“fiscal 2012”).
Certain fiscal 2011 amounts in the accompanying consolidated financial statements have been reclassified to conform to the fiscal 2012 presentation. These reclassifications had no effect on previously reported consolidated net income or shareholders’ equity.
In January 2010, the Financial Accounting Standards Board (the "FASB") issued amended standards requiring additional fair value disclosures. The amended standards require disclosures of transfers in and out of Levels 1 and 2 of the fair value hierarchy, as well as requiring gross basis disclosures for purchases, sales, issuances and settlements within the Level 3 reconciliation. Additionally, the update clarifies the requirement to determine the level of disaggregation for fair value measurement disclosures and to disclose valuation techniques and inputs used for both recurring and nonrecurring fair value measurements in either Level 2 or Level 3. The Company adopted the new guidance in the third quarter of fiscal 2010, except for the disclosures related to purchases, sales, issuance and settlements, which was effective for the Company beginning in the first quarter of fiscal 2012. Because these new standards are related primarily to disclosures, their adoption has not had a significant impact on the Company's consolidated financial statements.
Goodwill Impairment Testing
On September 15, 2011, the FASB issued updated guidance concerning the testing of goodwill for impairment. This guidance modifies goodwill impairment testing by allowing the inclusion of qualitative factors in the assessment of whether a two-step goodwill impairment test is necessary. Thus, entities are no longer required to calculate the fair value of a reporting unit unless they conclude through an assessment of qualitative factors that it is more likely than not that the unit's carrying value is greater than its fair value. When an entity's qualitative assessment reveals that goodwill impairment is more likely than not, the entity must perform the two-step goodwill impairment test. This guidance became effective for the Company in the second quarter of fiscal 2012. The Company's adoption of this guidance has not had a significant impact on its consolidated financial statements.
Recently Issued Accounting Pronouncements
Presentation of Comprehensive Income
In June 2011, the FASB issued new guidance concerning the presentation of total comprehensive income and its components. Under this guidance an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in single continuous statement of comprehensive income or in two separate but consecutive statements. This guidance also requires an entity to present on the face of the financial statements reclassification adjustments from other comprehensive income to net income. In December 2011, the FASB issued an accounting standards update that defers the presentation requirement for other comprehensive income reclassifications on the face of the financial statements. This guidance, as amended, will become effective for the Company beginning in the first quarter of the fiscal year ending June 30, 2013. The Company's adoption of the new accounting guidance is not expected to have a significant impact on its consolidated financial statements.
Note 2. Acquisitions
Acquisition of Ruud Lighting, Inc.
On August 17, 2011, the Company entered into a Stock Purchase Agreement with all of the shareholders of Ruud Lighting, Inc. ("Ruud Lighting"). Pursuant to the terms of the Stock Purchase Agreement and concurrently with the execution of the Stock Purchase Agreement, the Company acquired all of the outstanding share capital of Ruud Lighting in exchange for consideration consisting of 6.1 million shares of the Company's common stock and $372.2 million cash, subject to certain post-closing adjustments. In the third quarter of fiscal 2012 the Company finalized certain post-closing working capital adjustments with the former shareholders of Ruud Lighting, resulting in a $1.6 million reduction in the purchase price. This adjustment to the purchase price has been reflected as a reduction of goodwill. The acquisition allows the Company to expand its product portfolio into outdoor LED lighting.
Prior to the Company completing its acquisition of Ruud Lighting, Ruud Lighting completed the re-acquisition of its e-conolight business by purchasing all of the membership interests of E-conolight LLC ("E-conolight"). Ruud Lighting previously sold its e-conolight business in March 2010 and had been providing operational services to E-conolight since that date. In connection with the stock purchase transaction with Ruud Lighting, the Company funded Ruud Lighting's re-acquisition of E-conolight and paid off Ruud Lighting's outstanding debt in the aggregate amount of approximately $85.0 million.
The acquisitions of Ruud Lighting and E-conolight have been accounted for as business combinations in accordance with ASC 805 Business Combinations and, as such, the Ruud Lighting and E-conolight assets acquired and liabilities assumed have been recorded at their respective fair values. The determination of fair value for the identifiable tangible and intangible assets acquired and liabilities assumed requires extensive use of estimates and judgments. Significant estimates and assumptions include, but are not limited to: estimating future cash flows and determining the appropriate discount rate.
The total purchase price for this acquisition is as follows (in thousands):
Cash consideration paid to stockholders
$
372,235
Fair value of common stock issued by the Company (1)
211,040
Fair value of debt paid on behalf of stockholders
84,991
Post-closing working capital adjustment (2)
(1,623
)
Total purchase price
$
666,643
(1) Represents 6,074,833 shares of the Company's common stock at $34.74 per share, the closing share price on August 17, 2011. The shares are subject to certain transfer restrictions under the Stock Purchase Agreement that will generally lapse with respect to 25% of the shares held (i) at the completion of the consecutive six-month period following the date of the closing of the transaction; and, (ii) at the completion of each of the following three successive six-month periods, such that all restrictions will lapse by the second anniversary of the closing.
(2) In accordance with the stock purchase agreement, the post-closing working capital adjustment was composed of approximately $1.0 million in cash and the return of 15,895 shares of the Company's common stock, each of which were received in the fourth quarter of fiscal 2012.
The Company incurred total transaction costs related to the acquisition of approximately $3.6 million, of which, $3.1 million were expensed in the first quarter of fiscal 2012 in accordance with U.S. GAAP.
The following table presents the allocation of the purchase price for this acquisition to the assets acquired and liabilities assumed based on their estimated fair values and resulting residual goodwill (in thousands):
August 17, 2011 (As initially reported)
Measurement Period Adjustments
August 17, 2011 (As adjusted)
Tangible assets:
Cash and cash equivalents
$
3,081
$
—
$
3,081
Accounts receivable
25,698
(375
)
25,323
Inventories
39,330
(461
)
38,869
Property and equipment
45,946
(233
)
45,713
Other assets
4,727
—
4,727
Total tangible assets
$
118,782
$
(1,069
)
$
117,713
Intangible assets:
Developed technology
$
96,300
$
—
$
96,300
Customer relationships
84,820
—
84,820
Trade names
82,950
—
82,950
In-process research & development
15,050
—
15,050
Non-compete agreements
9,800
—
9,800
Goodwill
287,431
3,371
290,802
Total intangible assets
$
576,351
$
3,371
$
579,722
Liabilities assumed:
Accounts payable
$
12,943
$
—
$
12,943
Accrued expenses and liabilities
10,116
902
11,018
Warranty liabilities
2,600
3,023
5,623
Other long-term liabilities
1,208
—
1,208
Total liabilities assumed
$
26,867
$
3,925
$
30,792
Net assets acquired
$
668,266
$
(1,623
)
$
666,643
The above estimated fair values of assets acquired and liabilities assumed are based on the information that was available through the balance sheet date and are provisional. The Company believes that this information provides a reasonable basis for estimating the fair values but is waiting for certain additional information necessary to finalize those amounts, including certain
litigation and taxes. Thus, the provisional measurements of fair value reflected are subject to change.
Acquired finished goods and work-in-process inventory was valued at its estimated selling price less the sum of costs of disposal and a reasonable profit allowance for the Company's selling effort and, with respect to work-in-process inventory, estimated costs to complete. This resulted in a fair value adjustment that increased finished goods inventory approximately $1.5 million. Raw material inventory has been valued at current replacement cost, resulting in a write down of approximately $0.7 million. As of March 25, 2012, the Company has recognized the net step up of $0.8 million in its cost of revenue.
The identifiable intangible assets acquired as a result of the acquisition will be amortized over their respective estimated useful lives as follows (in thousands, except for years):
Asset Amount
Estimated Life in Years
Developed technology
$
96,300
7 to 10
Customer relationships
84,820
7 to 20
Trade names (indefinite lived)
82,880
-
Trade names (definite lived)
70
3
In-process research and development (1)
15,050
6 to 7
Non-compete agreements
9,800
5
Total identifiable intangible assets
$
288,920
(1) Initially, in-process research and development ("IPR&D") is classified as indefinite-lived assets until completion or abandonment. Therefore, amortization of IPR&D does not begin until the technological and market risk(s) no longer exist. During the interim, IPR&D intangibles are subject to annual testing for impairment or when there are indicators of impairment.
The fair value of the developed technology, IPR&D and customer relationship assets were estimated using an income approach. Under this method, an intangible asset's fair value is equal to the present value of the incremental after-tax cash flows (excess earnings) attributable solely to the intangible asset over its remaining useful life. To calculate fair value, the Company used cash flows discounted at rates considered appropriate given the inherent risks associated with each type of asset. The Company believes that the level and timing of cash flows appropriately reflect market participant assumptions. The fair value of the Ruud Lighting and e-conolight trade names were estimated using an income approach, specifically known as the relief from royalty method. The relief from royalty method is based on a hypothetical royalty stream that would be paid if the Company did not own the Ruud Lighting “BetaLED” brand and had to license the Ruud Lighting and e-conolight trade names. The Company derived the hypothetical royalty income from the projected revenues of Ruud Lighting and e-conolight products. Cash flows were assumed to extend through the remaining economic useful life of each class of intangible asset.
Goodwill largely consists of geographic expansion of product sales, manufacturing and other synergies of the combined companies, and the value of the assembled workforce.
As a result of the Company's U.S. tax election under Internal Revenue Code section 338(h)(10), the acquisition did not result in the recording of an opening net deferred tax position as the deferred tax asset resulting from excess tax deductible goodwill equally offsets the deferred tax liability resulting from excess book over tax basis in the underlying assets acquired.
The assets, liabilities, and operating results of Ruud Lighting have been included in the Company's consolidated financial statements from the date of acquisition. The results of Ruud Lighting reflected in the Company's Consolidated Statements of Income from the date of acquisition (August 17, 2011) to March 25, 2012 are as follows (in thousands, except per share data):
Amortization expense related to identifiable intangible assets associated with the Ruud Lighting acquisition, included in the table above, was $5.2 million and $12.1 million, for the three months ended March 25, 2012 and the period since acquisition date to March 25, 2012, respectively.
The following supplemental pro forma information (in thousands, except per share data) presents the financial results as if the Ruud Lighting transaction had occurred at the beginning of the 2011 fiscal year for the nine months ended March 25, 2012 and the three and nine months ended March 27, 2011. Financial results for the three months ended March 25, 2012, which are included in the Consolidated Statements of Income, are actual results and therefore have not been presented in the table below.
Three Months Ended
Nine Months Ended
March 27, 2011
March 25, 2012
March 27, 2011
Revenue
$
266,524
$
888,231
$
890,040
Operating Income
18,321
28,879
142,369
Net income
16,443
32,401
121,876
Earnings per share, basic
$
0.14
$
0.28
$
1.07
Earnings per share, diluted
$
0.14
$
0.28
$
1.05
The total revenue for Ruud Lighting included in the pro forma table above was $49.3 million for the three months ended March 27, 2011. The total revenue for Ruud Lighting included in the pro forma table above was $171.6 million and $156.7 million for the nine months ended March 25, 2012 and March 27, 2011, respectively. These amounts have been calculated after applying the Company’s accounting policies and adjusting the results of Ruud Lighting to give effect to events that are directly attributable to the Ruud Lighting transactions, including the elimination of sales to Ruud Lighting prior to acquisition, additional depreciation and amortization that would have been charged assuming the fair value adjustments primarily to property and equipment and intangible assets, had been applied at the beginning of the 2011 fiscal year, together with the consequential tax effects. Excluded from the pro forma net income and the earnings per share amounts for the nine months ended March 25, 2012 are one-time acquisition costs of $3.1 million attributable to the Ruud Lighting transaction. This supplemental pro forma information has been prepared for comparative purposes and does not purport to be indicative of what would have occurred had the acquisition been made at the beginning of the 2011 fiscal year, nor is it indicative of any future results.
Acquisition of LED Lighting Fixtures, Inc.
On February 29, 2008 the Company acquired LED Lighting Fixtures, Inc. (“LLF”) through a wholly owned subsidiary that merged into Cree, Inc. on June 27, 2010. The Company acquired all of the outstanding share capital of LLF in exchange for total upfront consideration of $80.8 million, consisting of (1) $16.5 million in cash, (2) approximately 1.9 million shares of the Company’s common stock valued at $58.8 million, and (3) the assumption of fully vested LLF employee stock options valued at $4.5 million. The Company incurred transaction costs of approximately $1.0 million consisting primarily of professional fees incurred relating to attorneys, accountants and valuation advisors. Under the acquisition terms, additional consideration of up to $26.4 million would become payable to the former shareholders of LLF if defined product development targets and key employee retention measures were achieved over the three calendar years following the acquisition.
LLF met the conditions necessary for the earn-out payment for the calendar years ended December 31, 2008, 2009 and 2010. As a result, the Company made a cash payment in the amount of $4.4 million to the former shareholders of LLF in the third quarter of fiscal 2009, a cash payment in the amount of $8.8 million to the former shareholders of LLF in the third quarter of fiscal 2010, and a final cash payment in the amount of $13.2 million to the former shareholders of LLF in the third quarter of fiscal 2011. These incremental payments were treated as additional purchase price and resulted in an increase to goodwill in the Company’s consolidated financial statements.
The assets, liabilities, and operating results of LLF have been included in the Company’s consolidated financial statements from the date of acquisition and are reflected in all periods presented in the accompanying financial statements.
The following is a summary of the components of accounts receivable, net (in thousands):
March 25, 2012
June 26, 2011
Billed trade receivables
$
182,508
$
137,799
Unbilled contract receivables
1,854
1,038
184,362
138,837
Allowance for sales returns, discounts, and other incentives
(14,391
)
(19,615
)
Allowance for bad debts
(1,763
)
(753
)
Total accounts receivable, net
$
168,208
$
118,469
Inventories
The following is a summary of the components of inventories (in thousands):
March 25, 2012
June 26, 2011
Raw material
$
61,486
$
38,781
Work-in-progress
76,461
74,816
Finished goods
58,888
62,885
Total inventories
$
196,835
$
176,482
Revenues, net
Revenues were comprised of the following product groups (in thousands, except percentages):
Three Months Ended
Nine Months Ended
March 25, 2012
March 27, 2011
March 25, 2012
March 27, 2011
LED products
$
180,944
$
172,439
$
571,884
$
611,188
Percent of revenue
64
%
79
%
67
%
82
%
Lighting products
$
86,527
$
21,829
$
233,936
$
57,145
Percent of revenue
30
%
10
%
27
%
8
%
Power and RF products
$
17,330
$
24,900
$
52,079
$
76,255
Percent of revenue
6
%
11
%
6
%
10
%
Total revenue
$
284,801
$
219,168
$
857,899
$
744,588
Note 4. Investments
Short-term investments consist of high grade municipal and corporate bonds and other debt securities. The Company classifies its marketable securities as available-for-sale. This is based upon management’s determination that the underlying cash invested in these securities is available for operations as necessary.
The following table provides a summary of marketable investments by type (in thousands):
The following table presents the gross unrealized losses and estimated fair value of the Company's investment securities, aggregated by investment type and length of time that individual investments securities have been in a continuous unrealized loss position (in thousands):
March 25, 2012
Less than 12 Months
Greater than 12 Months
Total
Fair Value
Unrealized Loss
Fair Value
Unrealized Loss
Fair Value
Unrealized Loss
Municipal bonds
$
21,888
$
(143
)
$
—
$
—
$
21,888
$
(143
)
Corporate bonds
25,936
(88
)
—
—
25,936
(88
)
U.S. agency securities
2,997
(2
)
—
—
2,997
(2
)
Non-U.S. government securities
3,111
(1
)
—
—
3,111
(1
)
Total
$
53,932
$
(234
)
$
—
$
—
$
53,932
$
(234
)
Number of securities with an unrealized loss
26
—
26
June 26, 2011
Less than 12 Months
Greater than 12 Months
Total
Fair Value
Unrealized Loss
Fair Value
Unrealized Loss
Fair Value
Unrealized Loss
Municipal bonds
$
14,348
$
(10
)
$
—
$
—
$
14,348
$
(10
)
Corporate bonds
20,484
(115
)
—
—
20,484
(115
)
U.S. agency securities
6,518
(2
)
—
—
6,518
(2
)
Total
$
41,350
$
(127
)
$
—
$
—
$
41,350
$
(127
)
Number of securities with an unrealized loss
20
—
20
The contractual maturities of marketable investments at March 25, 2012 were as follows (in thousands):
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 broken down into three levels based on the reliability of inputs as follows:
•
Level 1 - Valuations based on quoted prices in active markets for identical instruments that the Company is able to access. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.
•
Level 2 - Valuations based on quoted prices in active markets for instruments that are similar, or quoted prices in markets that are not active for identical or similar instruments, and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.
•
Level 3 - Valuations based on inputs that are unobservable and significant to the overall fair value measurement.
The financial assets for which the Company performs recurring fair value remeasurements are cash equivalents and short-term investments. As of March 25, 2012, financial assets utilizing Level 1 inputs included money market funds. Financial assets utilizing Level 2 inputs included certificates of deposit, corporate bonds and municipal bonds, U.S. agency securities and non-U.S. government securities. Level 2 assets are valued using a third-party pricing services consensus price which is a weighted average price based on multiple sources. These sources determine prices utilizing market income models which factor in, where applicable, transactions of similar assets in active markets, transactions of identical assets in infrequent markets, interest rates, bond or credit default swap spreads and volatility. The Company does not have any financial assets requiring the use of Level 3 inputs. There were no transfers between Level 1 and Level 2 during the nine months ended March 25, 2012.
The following table sets forth financial instruments carried at fair value within the U.S. GAAP hierarchy and using the lowest level of input (in thousands):
The Company utilizes specific identification in computing realized gains and losses on the sale of investments. Realized gains from the sale of investments for the nine months ended March 25, 2012 of approximately $1.0 million are included in “Other non-operating income, net” and unrealized gains and losses are included as a separate component of equity, net of tax, unless the loss is determined to be “other-than-temporary.”
The Company evaluates its investments for possible impairment or a decline in fair value below cost basis that is deemed to be “other-than-temporary” on a periodic basis. It considers such factors as the length of time and extent to which fair value has been below cost basis, the financial condition of the investee, and its ability and intent to hold the investment for a period of time that may be sufficient for an anticipated recovery in market value.
Note 6. Intangible Assets
The following table reflects the components of intangible assets, net (in thousands):
March 25, 2012
June 26, 2011
Customer relationships
$
137,440
$
52,620
Developed technology
148,160
51,860
In-process research and development
15,050
—
Non-compete agreements
10,240
—
Patent and license rights
176,087
83,884
$
486,977
$
188,364
Accumulated amortization
(106,621
)
(85,504
)
Intangible assets, net
$
380,356
$
102,860
Total amortization expense, including the amortization of acquisition related intangibles, patents and license rights, recognized during the three and nine months ended March 25, 2012 was $8.9 and $22.9 million, respectively. For the three and nine months ended March 27, 2011, total amortization expense, including amortization of acquisition related intangibles, patents and license rights was $3.9 and $11.6 million, respectively.
Total annual amortization expense of intangible assets is estimated to be as follows (in thousands):
Goodwill increased by $290.8 million during the nine months ended March 25, 2012 due to the acquisition of Ruud Lighting. Refer to “Note 2. Acquisitions” for the calculation of total goodwill recognized on the purchase.
Note 7. Shareholders’ Equity
In connection with the acquisition of Ruud Lighting, the Company issued 6.1 million shares of common stock valued at approximately $211.0 million. As discussed in "Note 2. Acquisitions", the post-closing working capital adjustment included the return of 15,895 shares of the Company's common stock, which were received in the fourth quarter of fiscal 2012.
The shares issued in connection with the acquisition are subject to certain transfer restrictions under the Stock Purchase Agreement that will generally lapse with respect to 25% of the shares held (i) at the completion of the consecutive six-month period following the date of the closing of the transaction; and, (ii) at the completion of each of the following three successive six-month periods, such that all restrictions will lapse by the second anniversary of the closing.
As of March 25, 2012, the Company is authorized to repurchase shares of its common stock having an aggregate purchase price not exceeding $200.0 million for all purchases from June 16, 2011 through the expiration of the program, as authorized by the Board of Directors and extended through June 24, 2012. During the nine months ended March 25, 2012, the Company did not repurchase any shares under the repurchase program.
The following presents a summary of activity in comprehensive income, net (in thousands):
Three Months Ended
Nine Months Ended
March 25, 2012
March 27, 2011
March 25, 2012
March 27, 2011
Net income
$
9,489
$
18,881
$
34,386
$
126,692
Other comprehensive income:
Net unrealized gain (loss) on available-for-sale securities, net of tax (expense) benefit of $(290), $(46), $915 and $566 respectively
480
77
(1,512
)
(935
)
Currency Translation Gain (Loss)
440
—
(144
)
—
Comprehensive income
$
10,409
$
18,958
$
32,730
$
125,757
For the nine months ended March 25, 2012 approximately $1.0 million of unrealized gains were reclassified out of accumulated other comprehensive income into earnings for the period, and are included in "Other non-operating income, net" in the Consolidated Statements of Income.
Note 8. Earnings Per Share
The following presents the computation of basic earnings per share (in thousands, except per share data):
The following computation reconciles the differences between the basic and diluted earnings per share presentations (in thousands, except per share data):
Three Months Ended
Nine Months Ended
March 25, 2012
March 27, 2011
March 25, 2012
March 27, 2011
Diluted:
Net income
$
9,489
$
18,881
$
34,386
$
126,692
Weighted average common shares - basic
115,641
108,948
114,348
108,338
Dilutive effect of stock options, unvested shares and ESPP purchase rights
433
1,375
531
1,669
Weighted average common shares - diluted
116,074
110,323
114,879
110,007
Diluted earnings per share
$
0.08
$
0.17
$
0.30
$
1.15
Potential common shares that would have the effect of increasing diluted earnings per share are considered to be antidilutive. In accordance with U.S. GAAP, these shares were not included in calculating diluted earnings per share. For the three and nine months ended March 25, 2012, there were 7.9 and 6.8 million shares, respectively, not included in calculating diluted earnings per share because their effect was antidilutive. For three and nine months ended March 27, 2011, there were 2.4 and 1.8 million shares, respectively, not included in calculating diluted earnings per share because their effect was antidilutive.
Note 9. Stock-Based Compensation
The Company currently has one equity-based compensation plan from which stock-based compensation awards can be granted to employees and directors. In addition, the Company has plans that have been terminated as to future grants, but under which options are currently outstanding. The Company also has an Employee Stock Purchase Plan ("ESPP") that provides employees with the opportunity to purchase the Company’s common stock at a discount. The ESPP was amended in the second quarter of fiscal 2012 to increase the six-month participation period to a twelve-month participation period, divided into two equal six-month purchase periods and provide for a look-back feature. At the end of each six-month period, employees purchase the Company's common stock through the ESPP at 15% less than the fair market value of the common stock on the first day of the twelve-month participation period or the purchase date, whichever is lower. The plan amendment also provides for an automatic reset feature to start participants on a new twelve-month participation period if the share value declines during the first six-month purchase period.
Stock Option Awards
The following table summarizes outstanding option awards as of March 25, 2012, and changes during the nine months then ended (shares in thousands):
Number of Shares
Weighted-Average Exercise Price
Outstanding at June 26, 2011
6,467
$
39.56
Granted
3,000
30.62
Exercised
(175
)
23.38
Forfeited or expired
(420
)
40.30
Outstanding at March 25, 2012
8,872
$
36.82
Restricted Stock and Stock Unit Awards
A summary of nonvested shares of restricted stock and stock unit awards outstanding under the Company’s 2004 Long-Term Incentive Compensation Plan as of March 25, 2012, and changes during the nine months then ended, follows (shares in thousands):
The Company accounts for its employee stock-based compensation plan using the fair value method. The fair value method requires the Company to estimate the grant date fair value of its stock-based awards and amortize this fair value to compensation expense over the requisite service period or vesting term.
To estimate the fair value of the Company's stock option awards the Company currently uses the Black-Scholes option-pricing model. The determination of the fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by the Company's stock price as well as assumptions regarding a number of complex and subjective variables. These variables include the expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends. Due to the inherent limitations of option-valuation models available today, including future events that are unpredictable and the estimation process utilized in determining the valuation of the stock-based awards, the ultimate value realized by award holders may vary significantly from the amounts expensed in the Company's financial statements.
For restricted stock and stock unit awards, grant date fair value is based upon the market price of the Company's common stock on the date of the grant. This fair value is then amortized to compensation expense over the requisite service period or vesting term.
Stock-based compensation expense is recorded net of estimated forfeitures such that expense is recorded only for those stock-based awards that are expected to vest. A forfeiture rate is estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from initial estimates.
Total stock-based compensation expense was as follows (in thousands):
Three Months Ended
Nine Months Ended
Income Statement Classification
March 25, 2012
March 27, 2011
March 25, 2012
March 27, 2011
Cost of goods sold
$
2,104
$
1,440
$
5,433
$
3,924
Research and development
2,738
2,259
7,769
6,256
Sales, general and administrative
7,407
6,612
21,682
18,113
Total operating expenses
10,145
8,871
29,451
24,369
Total
$
12,249
$
10,311
$
34,884
$
28,293
Note 10. Income Taxes
The variation between the Company's effective income tax rate and the U.S. statutory rate of 35 percent is due to (i) the net tax benefit related to the prior year audit settlement recorded during the third quarter of fiscal 2012, (ii) a higher percentage of the Company's projected income for the full year being derived from international locations with lower tax rates than the U.S., (iii) the cumulative effect of reducing the Company's full year estimated effective tax rate as a result of the items discussed in (i) and (ii), and (iv) the increased impact of tax credits relative to lower year over year pre-tax income.
Under U.S. GAAP, a two-step approach is followed to recognize and measure uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is cumulatively more than 50 percent likely to be realized
At June 26, 2011, the Company had recorded $7.0 million of unrecognized tax benefits. During the nine months ended March 25, 2012, there was a $2.0 million decrease to the amount of unrecognized tax benefits due to the settlement of prior year tax audits. As a result, the total amount of unrecognized tax benefits as of March 25, 2012 is $5.0 million. If any portion of this $5.0 million is recognized, the Company will then include that portion in the computation of its effective tax rate. Although the ultimate timing of the resolution and/or closure of audits is highly uncertain, the Company believes it is reasonably possible that approximately $600 thousand of gross unrecognized tax benefits will change in the next 12 months.
The Company’s policy is to include interest and penalties related to unrecognized tax benefits within the income tax expense line item in the consolidated statements of income. As of March 25, 2012, the Company had accrued $32 thousand of interest and penalties.
The Company files U.S. federal, U.S. state, and foreign tax returns. For U.S. federal purposes, the Company is generally no longer subject to tax examinations for fiscal years ended June 28, 2009 and prior. During the third quarter of fiscal 2012, the Company settled its federal examination with the Internal Revenue Service for fiscal 2009. For U.S. state tax returns, the Company is generally no longer subject to tax examinations for fiscal years prior to 2008. For foreign purposes, the Company is generally no longer subject to examination for tax periods 2001 and prior. Certain carryforward tax attributes generated in prior years remain subject to examination and adjustment. The Company is currently under inquiry by the Hong Kong Inland Revenue Department for fiscal 2008 through fiscal 2010.
Note 11. Commitments and Contingencies
Warranties
The following table summarizes the changes in the Company's product warranty liabilities (in thousands):
Balance at June 26, 2011
$
2,235
Acquisition related warranties (See Note 2)
5,623
Warranties accrued in current period
732
Changes in estimates for pre-existing warranties
(658
)
Expenditures
(2,121
)
Balance at March 25, 2012
$
5,811
Product warranties are provided for at the time the Company recognizes revenue. The warranty periods range from ninety days to ten years. The Company estimates these warranty liabilities as a percentage of revenue, based on historical knowledge of warranty costs and expected future warranty costs. If actual product failure rates materially differ from these estimates, revisions to the estimated warranty liability would be required. The Company evaluates its warranty reserve on a quarterly basis.
Litigation
The Company is a party to various legal proceedings. Information regarding material legal proceedings is contained in our Annual Report on Form 10-K for the year ended June 26, 2011, and updates to that disclosure, are contained in our Quarterly Report on Form 10-Q for the first and second quarters of fiscal 2012.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Information set forth in this Quarterly Report on Form 10-Q contains various “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All information contained in this report relative to future markets for our products and trends in and anticipated levels of revenue, gross margins and expenses, as well as other statements containing words such as “believe,” “project,” “may,” “will,” “anticipate,” “target,” “plan,” “estimate,” “expect” and “intend” and other similar expressions constitute forward-looking statements. These forward-looking statements are subject to business, economic and other risks and uncertainties, both known and unknown, and actual results may differ materially from those contained in the forward-looking statements. Any forward-looking statements we make are as of the date made and we have no duty to update them if our views later change. These forward-looking statements should not be relied upon as representing our views as of any date subsequent to the date of this Quarterly Report. Examples of risks and uncertainties that
could cause actual results to differ materially from historical performance and any forward-looking statements include, but are not limited to, those described in “Risk Factors” in Part II, Item 1A of this Quarterly Report.
The following discussion is designed to provide a better understanding of our unaudited consolidated financial statements, including a brief discussion of our business and products, key factors that impacted our performance, and a summary of our operating results. The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q, and the consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended June 26, 2011. Historical results and percentage relationships among any amounts in the financial statements are not necessarily indicative of trends in operating results for any future periods.
Overview
Cree, Inc. (Cree, we, our, or us) is a leading innovator of lighting-class light emitting diode (LED) products, lighting products and semiconductor products for power and radio-frequency (RF) applications. Our products are targeted for applications such as general illumination, video displays, automotive, electronic signs and signals, power supplies and solar inverters.
We develop and manufacture semiconductor materials and devices primarily based on silicon carbide (SiC), gallium nitride (GaN) and related compounds. The physical and electronic properties of SiC and GaN offer technical advantages over traditional silicon, gallium arsenide (GaAs), sapphire and other materials used for electronic and opto-electronic applications.
Our LED products consist of LED components, LED chips, and SiC wafers. As LED technology improves, we believe the potential market for LED lighting will continue to expand. Our success in selling LED products depends upon our ability to drive adoption and offer innovative products and solutions that enable our customers to develop and market LED based products that successfully compete against traditional lighting products.
Our lighting products consist of both LED and traditional lighting systems. We design, manufacture and sell lighting systems for indoor and outdoor applications, with our primary focus on LED lighting systems for the commercial and industrial markets. We also use our LED systems expertise to accelerate LED lighting adoption and expand the market for our LED components.
In addition, we develop, manufacture and sell power and RF devices. Our power products are made from SiC and provide faster switching speeds than comparable silicon-based power devices. Our RF devices are made from SiC or GaN and produce higher power densities as compared to silicon or gallium arsenide devices.
The majority of our products are manufactured at our production facilities located in North Carolina, Wisconsin and China. We also use contract manufacturers for certain aspects of our products fabrication, packaging and assembly. We operate research and development facilities in North Carolina, California, Wisconsin and China.
We currently operate our business as one reportable segment.
Industry Dynamics and Trends
There are a number of industry factors that affect our business which include, among others:
•
Overall Demand for Products and Applications using LEDs. Our potential for growth depends significantly on the adoption of LEDs within the general lighting market and our ability to affect this rate of adoption. Although LED lighting has grown in recent years, adoption of LEDs for general lighting is relatively new and faces significant challenges before widespread adoption. Demand also fluctuates based on various market cycles, a continuously evolving LED industry supply chain, and demand dynamics in the market. These uncertainties make demand difficult to forecast for us and our customers.
•
Intense and Constantly Evolving Competitive Environment. Competition in the industry is intense and new companies have entered and are entering the LED market, with many companies making significant investments in LED production equipment. Product pricing pressures exist as market participants often undertake pricing strategies to gain or protect market share and to increase the utilization of their production capacity. Currently, many LED suppliers are reporting excess or underutilized factory capacity which generally leads to a more aggressive pricing environment. To remain competitive, market participants must continuously increase product performance and reduce costs to offset lower average sales prices. To address this pricing pressure, we have invested in cost reduction activities including lower cost product designs, yield and productivity improvements,
and the development of 150mm wafer production, which is intended to reduce our costs of producing LED chips. The effectiveness of these activities will vary based on overall factory utilization rates, which are driven primarily by market demand.
•
Technological Innovation and Advancement. Innovations and advancements in LED technology continue to expand the potential commercial application of LEDs particularly in the general illumination market. However, new technologies or standards could emerge, or improvements could be made in existing technologies, that reduce or limit the demand for LEDs in certain markets.
•
Regulatory Actions Concerning Energy Efficiency. Many countries have already instituted or have announced plans to institute government regulations and programs designed to encourage or mandate increased energy efficiency, even in some cases banning forms of incandescent lighting, which are advancing the adoption of more energy efficient lighting solutions such as LEDs. While this trend is generally positive, there have been some political efforts in the United States to change or limit the effectiveness of these new regulations.
•
Intellectual Property Issues. Market participants rely on patented and non-patented proprietary information relating to product development, manufacturing capabilities and other core competencies of their business. Protection of intellectual property is critical. Therefore, steps such as additional patent applications, confidentiality and non-disclosure agreements, as well as other security measures are generally taken. To enforce or protect intellectual property rights, litigation or threatened litigation commonly occurs.
Financial Results of the Third Quarter Fiscal 2012
The following is a summary for the three months ended March 25, 2012:
•
Revenues decreased to $284.8 million in the third quarter of fiscal 2012 from $304.1 million in the second quarter.
•
Gross margins improved to 34.9% in the third quarter of fiscal 2012 from 34.6% in the second quarter.
•
Operating income was $5.0 million in the third quarter of fiscal 2012 compared to $12.2 million in the second quarter of fiscal 2012. Net income per diluted share was $0.08 compared to $0.10 for the second quarter of fiscal 2012.
•
Inventory increased to $196.8 million at March 25, 2012 compared to $187.4 million at December 25, 2011.
•
We spent $26.1 million on capital expenditures during the three months ended March 25, 2012 compared to $23.0 million during the three months ended December 25, 2011.
•
Combined cash, cash equivalents and marketable investments increased to $710.1 million at March 25, 2012 compared to $687.2 million at December 25, 2011.
Business Outlook
We project that the markets for our products will remain highly competitive during the remainder of fiscal 2012. We anticipate focusing on the following key areas in response to this competitive environment:
•
Build on our market leadership and drive adoption of LED lighting. We are focused on developing innovative new LED lighting systems to drive adoption, and new LED components that enable our customers to deliver a more competitive payback versus traditional lighting. In August 2011, we acquired Ruud Lighting, a leading innovator of LED lighting products, which we believe gives us a stronger product portfolio to drive LED adoption and expand the market for LED lighting. We plan to continue to invest in both our LED lighting and LED component product lines to increase performance, enable lower lighting system costs with shorter paybacks, and find new ways to drive the market and obsolete old, energy-wasting lighting technology.
•
Accelerate cost reductions and drive operational improvements to increase the profitability of our business. We target lower LED costs from new lower cost product designs, yield and productivity improvements and the conversion to 150mm wafers. In the near term, cost reductions may be offset by the aggressive pricing environment and lower factory utilization. It will take time and increased volume to fully realize the benefit of many of these improvements. We are also delaying the rate of conversion to 150mm wafer production to take advantage of existing 100mm capacity to optimize the current factory to deliver the lowest cost in the near term. We are continuing work to enable the full conversion as business needs warrant over the next three to six quarters. We plan to lower LED lighting system costs with new product designs that are under development and we target improved operating leverage over time from higher revenues across our LED lighting systems and component product lines.
•
Expand the power and RF product line beyond niche applications. SiC power devices can deliver better performance
and increased payback against silicon (Si) based power devices in applications where efficiency and reliability are important criteria. We target continued investment in R&D for new diode and switch products focused on more mainstream and higher volume power switching applications. We are managing the product line through a slowdown in solar inverter demand. We target the combination of new products, improved market demand and expanded sales coverage to drive growth in the product line.
Results of Operations
The following table sets forth certain consolidated statement of income data for the periods indicated:
Three Months Ended
Nine Months Ended
March 25, 2012
March 27, 2011
March 25, 2012
March 27, 2011
(in thousands, except per share amounts and percentages)
Dollars
% of Revenue
Dollars
% of Revenue
Dollars
% of Revenue
Dollars
% of Revenue
Revenue, net
$
284,801
100
%
$
219,168
100
%
$
857,899
100
%
$
744,588
100
%
Cost of revenue, net
185,388
65
%
127,773
58
%
555,340
65
%
401,518
54
%
Gross profit
99,413
35
%
91,395
42
%
302,559
35
%
343,070
46
%
Research and development
36,148
13
%
31,016
14
%
106,436
12
%
84,981
11
%
Sales, general and administrative
50,074
18
%
37,603
17
%
144,789
17
%
100,171
13
%
Amortization of acquisition-related intangibles
7,368
3
%
2,693
1
%
18,660
2
%
8,105
1
%
Loss on disposal or impairment of long-lived assets
816
—
%
405
—
%
2,088
—
%
1,306
—
%
Operating income
5,007
2
%
19,678
9
%
30,586
4
%
148,507
20
%
Other non-operating income, net
324
—
%
106
—
%
1,187
—
%
107
—
%
Interest income, net
1,859
1
%
2,170
1
%
5,628
1
%
6,356
1
%
Income from operations before income taxes
7,190
3
%
21,954
10
%
37,401
4
%
154,970
21
%
Income tax (benefit) expense
(2,299
)
(1
)%
3,073
1
%
3,015
—
%
28,278
4
%
Net income
9,489
3
%
18,881
9
%
34,386
4
%
126,692
17
%
Diluted earnings per share
$
0.08
$
0.17
$
0.30
$
1.15
Revenues
Our revenues are presented below in the following categories: LED products, lighting products and power and RF products, which represents a change from our prior presentation. Revenues for the three and nine months ended March 25, 2012 and March 27, 2011 were comprised of the following (in thousands, except percentages):
