10-K 1 cree-06292014x10k.htm 10-K CREE-06.29.2014-10K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 __________________________________________
FORM 10-K
(Mark One)
ý
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended June 29, 2014
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)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Common Stock, $0.00125 par value
 
The NASDAQ Stock Market LLC
Securities registered pursuant to Section 12(g) of the Act:
None
__________________________________________ 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ý    No  ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.    Yes  ¨    No  ý
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  ý    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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨
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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
ý
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 Act).    Yes  ¨    No  ý
The aggregate market value of common stock held by non-affiliates of the registrant as of December 27, 2013, the last business day of the registrant’s most recently completed second fiscal quarter, was $7,379,080,394 (based on the closing sale price of $61.49 per share).
The number of shares of the registrant’s Common Stock, $0.00125 par value per share, outstanding as of August 21, 2014 was 120,040,796.
__________________________________________ 
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement to be delivered to shareholders in connection with the Annual Meeting of Shareholders to be held October 28, 2014 are incorporated by reference into Part III.



CREE, INC.
FORM 10-K
For the Fiscal Year Ended June 29, 2014
INDEX
 
 
Page
Part I
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 1B.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Part II
 
 
Item 5.
 
 
 
Item 6.
 
 
 
Item 7.
 
 
 
Item 7A.
 
 
 
Item 8.
 
 
 
Item 9.
 
 
 
Item 9A.
 
 
 
Item 9B.
 
 
 
Part III
 
 
Item 10.
 
 
 
Item 11.
 
 
 
Item 12.
 
 
 
Item 13.
 
 
 
Item 14.
 
 
 
PART IV
 
 
Item 15.
 
 

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Forward-Looking Information
Information set forth in this Annual Report on Form 10-K contains various “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (Exchange Act). All information contained in this report relative to future markets for our products and trends in and anticipated levels of revenue, gross margins and expenses, as well as other statements containing words such as “believe,” “project,” “may,” “will,” “anticipate,” “target,” “plan,” “estimate,” “expect” and “intend” and other similar expressions constitute forward-looking statements. These forward-looking statements are subject to business, economic and other risks and uncertainties, both known and unknown, and actual results may differ materially from those contained in the forward-looking statements. Any forward-looking statements we make are as of the date made, and except as required under the U.S. federal securities laws and the rules and regulations of the Securities and Exchange Commission (SEC), we disclaim any obligation 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 Annual 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 Item 1A of this Annual Report.


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PART I

Item 1. Business

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 indoor and outdoor lighting, video displays, transportation, electronic signs and signals, power supplies, inverters and wireless systems.
Our LED products consist of LED components, LED chips and silicon carbide (SiC) materials. Our success in selling LED products depends upon our ability to offer innovative products and to enable our customers to develop and market LED-based products that successfully compete against other LED-based products and drive LED adoption against traditional lighting products.
Our lighting products primarily consist of LED lighting systems and bulbs. We design, manufacture and sell lighting fixtures and lamps for the commercial, industrial and consumer markets.
In addition, we develop, manufacture and sell power and RF devices. Our power products are made from SiC and provide increased efficiency, faster switching speeds and reduced system size and weight over comparable silicon-based power devices. Our RF devices are made from gallium nitride (GaN) and provide improved efficiency, bandwidth and frequency of operation as compared to silicon or gallium arsenide (GaAs).
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 product fabrication, assembly and packaging. We operate research and development facilities in North Carolina, California, Wisconsin, India and China (including Hong Kong).
Cree, Inc. is a North Carolina corporation established in 1987 and is headquartered in Durham, North Carolina. For further information about our consolidated revenue and earnings, please see our consolidated financial statements included in Item 8 of this Annual Report.

Reportable Segments
Our three reportable segments are:
LED Products
Lighting Products
Power and RF Products

Reportable segments are components of an entity that have separate financial data that the entity’s Chief Operating Decision Maker (CODM) regularly reviews when allocating resources and assessing performance. Our CODM is the Chief Executive Officer.

For financial results by reportable segment, please refer to Note 13, “Reportable Segments,” in our consolidated financial statements included in Item 8 of this Annual Report.

Products by Reportable Segment
LED Products Segment
LED Products revenue was $833.7 million, $801.5 million and $756.9 million representing 51%, 58%, and 65% of revenue for the fiscal years ended June 29, 2014June 30, 2013 and June 24, 2012, respectively. LED Products gross profit was $381.0 million, $344.6 million and $290.6 million and gross margin was 46%, 43% and 38% for the fiscal years 2014, 2013 and 2012, respectively.
Our LED Products segment includes LED chips, LED components and SiC materials.

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LED Chips
Our LED chip products include blue and green LED chips based on GaN and related materials. LED chips or die are solid state electronic components used in a number of applications and are currently available in a variety of brightness levels, wavelengths (colors) and sizes. We use our LED chips in the manufacturing of our LED components. Customers use our blue and green LED chips in a variety of applications including video screens, gaming displays, function indicator lights and automotive backlights, headlamps and directional indicators. Customers may also combine our blue LED chips with phosphors to create white LEDs, which are used in various applications for indoor and outdoor illumination and backlighting, full-color display screens, liquid crystal display (LCD) backlighting, white keypads and the camera flash function.
LED Components
Our LED components include a range of packaged LED products, from our XLamp® LED components and LED modules for lighting applications to our high-brightness LED components.
Our XLamp LED components and LED modules are lighting class packaged LED products designed to meet a broad range of market needs for lighting applications including general illumination (both indoor and outdoor applications), portable, architectural, signal and transportation lighting. We use our XLamp LED components in our own lighting products. We also sell XLamp LED components externally to customers and distributors for use in a variety of products, primarily for lighting applications.
Our high-brightness LED components consist of surface mount (SMD) and through-hole packaged LED products. Our SMD LED component products are available in a full range of colors designed to meet a broad range of market needs, including video, signage, general illumination, transportation, gaming and specialty lighting. Our through-hole packaged LED component products are available in a full range of colors primarily designed for the signage market and provide users with color and brightness consistency across a wide viewing area.
SiC Materials
Our SiC materials are targeted for customers who use them to manufacture products for RF, power switching, gemstones and other applications. Corporate, government and university customers also buy SiC materials for research and development directed at RF and high power devices. We sell our SiC materials in bulk form, as a bare wafer and with SiC or GaN epitaxial films.
Lighting Products Segment
Lighting Products revenue was $706.4 million, $495.1 million, and $334.7 million, representing 43%, 36%, and 29% of our revenue for the fiscal years ended June 29, 2014June 30, 2013 and June 24, 2012, respectively. Lighting Products gross profit was $197.3 million, $148.9 million and $103.4 million and gross margin was 28%, 30% and 31% for the fiscal years 2014, 2013 and 2012, respectively.
Our Lighting Products segment primarily consists of LED lighting systems and bulbs. We design, manufacture and sell lighting systems for indoor and outdoor applications, with our primary focus on LED lighting systems for the commercial, industrial and consumer markets. Lighting products are sold to distributors, retailers and direct to customers. Our portfolio of lighting products is designed for use in settings such as office and retail space, restaurants and hospitality, schools and universities, manufacturing, healthcare, airports, municipal, residential, street lighting and parking structures, among other applications.
Power and RF Products Segment
Power and RF Products revenue was $107.5 million, $89.4 million, and $73.0 million, representing 6%, 6% and 6% of our revenue for the fiscal years ended June 29, 2014June 30, 2013 and June 24, 2012, respectively. Power and RF Products gross profit was $60.7 million, $48.1 million and $32.1 million and gross margin was 56%, 54% and 44% for the fiscal years 2014, 2013 and 2012, respectively.
Our Power and RF Products segment includes power devices and RF devices.
Power Devices
Our SiC-based power products include Schottky diodes, SiC metal semiconductor field-effect transistors (MOSFETs), and SiC power modules at various voltages. Our power products provide increased efficiency, faster switching speeds and reduced system size and weight over comparable silicon-based power devices. Power products are sold primarily to customers and distributors for use in power supplies used in computer servers, solar inverters, uninterruptible power supplies, industrial power supplies and other applications. We are working to develop additional and improved SiC-based power device solutions to expand the potential uses and applications for our products.

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RF Devices
Our RF products include a variety of GaN high electron mobility transistors (HEMTs) and monolithic microwave integrated circuits (MMICs), which are optimized for military, telecom and other commercial applications. Our RF devices are made from SiC and GaN and provide improved efficiency, bandwidths and frequency of operation as compared to silicon or GaAs. We also provide foundry services for GaN HEMTs and MMICs. Our foundry service allows a customer to design its own custom RF circuits to be fabricated in our foundry, or have us design and fabricate custom products that meet their specific requirements.

Financial Information about Geographic Areas of Customers and Assets
We derive a significant portion of our revenue from product sales to international customers. For information concerning geographic areas of our customers and geographic information concerning our long-lived assets, please see Note 13, “Reportable Segments,” in our consolidated financial statements included in Item 8 of this Annual Report. International operations expose us to risks that are different from operating in the United States, including foreign currency translation and transaction risk, risk of changes in tax laws, application of import/export laws and regulations and other risks described further in Item 1A, “Risk Factors,” of this Annual Report.

Research and Development
We invest significant resources in research and development. Our research and development activity includes efforts to:
increase the quality, performance and diameter of our substrate and epitaxial materials;
continually improve our manufacturing processes;
develop brighter, more efficient and lower cost LED chip and component products;
create new, and improve existing LED components and LED lighting products; and
develop higher power diodes/switches and higher power/linearity RF devices.
When our customers participate in funding our research and development programs, we recognize the amount funded as a reduction of research and development expenses to the extent that our customers’ funding does not exceed our respective research and development costs. Research and development expenses were $181.4 million, $155.9 million and $143.4 million for the fiscal years ended June 29, 2014June 30, 2013 and June 24, 2012, respectively. For further information about these programs, see Note 2, “Basis of Presentation and Summary of Significant Accounting Policies,” in our consolidated financial statements included in Item 8 of this Annual Report. For further information about our research and development, see “Research and Development” in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations."

Sales and Marketing
We continue to make significant investments to expand our global sales, marketing, technical applications support, and distribution capabilities to sell our lighting products and further enable new and existing customers to implement LED and power technology into their products. We also continue to make investments to promote and build market awareness of the Cree brand. Our growing sales, marketing and technical applications teams include personnel throughout North America, Asia and Europe.

Customers
We have historically had a few key customers who represented more than 10% of our consolidated revenue. In fiscal 2014, revenue from Arrow Electronics, Inc. (Arrow) and The Home Depot, Inc. (Home Depot) accounted for 13% and 11% of our total consolidated revenue, respectively. In fiscal 2013, revenue from Arrow accounted for 16% of our total consolidated revenue. In fiscal 2012, revenue from Arrow and World Peace Industrial Co., Ltd. (World Peace) represented 18% and 10% of our total consolidated revenue, respectively. Arrow is a customer of our LED Products and Power and RF Products segments. Home Depot is a customer of our Lighting Products segment. World Peace is a customer of our LED Products segment. For further discussion regarding customer concentration, please see Note 14, “Concentrations of Risk,” in our consolidated financial statements included in Item 8 of this Annual Report. The loss of any large customer could have a material adverse effect on our business and results of operations.

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Distribution
A substantial portion of our products are sold to distributors. Distributors stock inventory and sell our products to their own customer base, which may include: value added resellers, manufacturers who incorporate our products into their own manufactured goods and ultimate end users of our products. We also utilize third-party sales representatives who generally do not maintain a product inventory; instead, their customers place orders directly with us or through distributors. We also sell an increasing portion of our products through retailers, which stock inventory and sell our products directly to consumers.

Seasonality
Our LED Products segment historically has experienced, and in the future may experience, seasonally lower sales during our fiscal third quarter due to the Chinese New Year holiday.  Our Lighting Products segment historically has experienced, and in the future may experience, seasonally lower lighting fixture sales due to winter weather, impacting our fiscal second and third quarters. In addition, the retail lighting industry has historically had seasonally lower sales of light bulbs in the summer, which has not yet but could impact our fiscal fourth and first quarters. Our Power and RF Products segment is not generally subject to seasonality.
Our sales also vary based on other factors such as customer demand and government regulation.
If anticipated sales or shipments do not occur when expected, our results of operations for that quarter, and potentially for future quarters, may be adversely affected.

Backlog
Our backlog at June 29, 2014, the last day of our 2014 fiscal year, was approximately $193.2 million, compared with a backlog of approximately $216.0 million at June 30, 2013, the last day of our 2013 fiscal year. Because of the generally short cycle time between order and shipment and occasional customer changes in delivery schedules or cancellation of orders (which at times may be made without significant penalty), we do not believe that our backlog, as of any particular date, is necessarily indicative of actual net revenue for any future period.  Additionally, our June 29, 2014 backlog figure contained $34.3 million of research contracts signed with the U.S. Government, for which approximately $26.0 million had not been appropriated as of the last day of fiscal 2014.  Our June 30, 2013 backlog figure contained $39.0 million of research contracts signed with the U.S. Government, for which approximately $30.5 million was not appropriated as of the last day of fiscal 2013. Our backlog could be adversely affected if the U.S. Government exercises its rights to terminate our government contracts or does not appropriate and allocate all of the funding contemplated by the contracts.

Sources of Raw Materials
We depend on a number of suppliers for certain raw materials, components and equipment used in manufacturing our products, including certain key materials and equipment used in critical stages of our manufacturing processes. We generally purchase these limited source items pursuant to purchase orders and have limited guaranteed supply arrangements with our suppliers. Our suppliers, located around the world, can be subject to many constraints limiting supply that are beyond our control. We believe our current supply of essential materials is sufficient to meet our needs. However, shortages have occurred from time to time and could occur again.

Competition by Reportable Segment
Our success depends on our ability to keep pace with the evolving technology standards of the industries we serve. These industries are characterized by rapid technological change, frequent introduction of new products, short product life cycles, changes in end user and customer requirements, and a competitive pricing environment. The evolving nature of these industries may render our existing or future products obsolete, noncompetitive or unmarketable. Any of these developments could have an adverse effect on our business, results of operations and financial condition.
LED Products Segment
Our LED Products segment’s primary competitors are Nichia Corporation (Nichia), OSRAM Opto Semiconductors GmbH (OSRAM), Koninklijke Philips Electronics N.V. (Philips), and Samsung LED Company (Samsung).

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LED Chips
The primary competition for our LED chip products comes from companies that manufacture and/or sell nitride-based LED chips. We consider Nichia to be a competitor because it sells LED chips to a select number of LED packaging companies and it sells packaged LEDs that most often compete directly with packaged LEDs made and sold by our chip customers. We believe, based on industry information, that Nichia currently has the largest market share for nitride-based LEDs.
There are many other LED chip producers who sell blue, green and white LED chip products, including OSRAM, Toyoda Gosei Co., Ltd., and Epistar Corporation. These competitors make products for a variety of applications in a range of performance levels that compete directly with our LED chip products.
Overall, we believe that performance, price and strength of intellectual property are the most significant factors to compete successfully in the nitride LED market. We believe our products are well positioned to meet the market performance requirements; however, there is significant pricing pressure from a number of competitors, including new companies based in China. We continually strive to improve our competitive position by developing brighter and higher performing LED chips while focusing on lowering costs.
LED Components
The market for lighting class LED components is concentrated primarily in indoor and outdoor commercial lighting; specialty lighting, including torch lamps (flashlights); color changing architectural lighting; signs and signals; and transportation. Nichia, OSRAM, Philips and Samsung are the main competitors in these markets. These companies sell LED components that compete indirectly with our target customers for LED chips and compete directly with our XLamp LED components and LED modules. There are a large number of other companies, primarily based in Asia, that offer products designed to compete both directly and indirectly with our LED components in lighting and other applications. We are positioning our XLamp LED components and LED modules to compete in this market based on performance, price and usability.
Our high-brightness LED components compete with a larger number of companies around the world in a variety of applications including signage, video, transportation, gaming and specialty lighting. We are positioning our high-brightness LED components to compete in this market based on performance, price, availability and usability.
SiC Materials
We have continued to maintain our well-established leadership position in the sale of SiC bulk material, SiC wafer and SiC and GaN epitaxy products. We are seeing increased competition in this market.

Lighting Products Segment
Our Lighting Products segment currently faces competition from traditional lighting fixture companies, lamp manufacturers and from non-traditional companies focused on LED lighting systems including fixtures and lamps. Lighting companies such as Acuity Brands, Inc., the Cooper Lighting division of Eaton Corporation plc, General Electric Company, Hubbell Incorporated, Philips and OSRAM are the main competitors in this market, but there are also many small and medium sized lighting competitors. Increasingly, other start-up companies are also beginning to emerge in the LED lighting markets in which we compete.
Our LED lighting products compete against traditional lighting products using incandescent, fluorescent, halogen, ceramic metal halide, high pressure sodium or other lighting technologies. Our LED lighting products compete against traditional lighting products based upon superior energy savings, extended life, improved lighting quality and lower total cost of ownership. Also, our LED lighting products have a reduced impact on the environment as compared to fluorescent and compact fluorescent technologies that contain mercury.
We also compete with LED-based products from traditional and non-traditional lamp and fixture companies, some of which are customers for our LED chips and LED components. Our products compete on the basis of color quality and consistency, superior light output, reduced energy consumption, brand, customer service and lower total cost of ownership.

Power and RF Products Segment
Power Devices
Our SiC-based power devices compete with similar devices offered by Infineon Technologies AG, STMicroelectronics, Inc. and Rohm Co., Ltd. There are also a number of other companies developing SiC-based power devices. In addition, our products compete with existing silicon-based power devices offered by a variety of manufacturers.

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RF Devices
Currently, Sumitomo Electric Device Innovations, Inc. is the main company offering products that compete directly with our GaN HEMT products, although several other companies such as RF Micro Devices, Inc. and Triquint Semiconductor, Inc. (who have announced their plans to merge) have products that compete with us as well. Our products also face competition from existing silicon and GaAs-based products.

Patents and Other Intellectual Property Rights
We believe it is important to protect our investment in technology by obtaining and enforcing intellectual property rights, including rights under patent, trademark, trade secret and copyright laws. We seek to protect inventions we consider significant by applying for patents in the United States and other countries when appropriate. We have also acquired, through license grants, purchases and assignments, rights to patents on inventions originally developed by others. As of June 29, 2014, we owned or were the exclusive licensee of 1,326 issued U.S. patents and approximately 2,340 foreign patents with various expiration dates extending up to 2039. We do not consider our business to be materially dependent upon any one patent, and we believe our business will not be materially adversely affected by the expiration of any one patent. For proprietary technology that is not patented, we generally seek to protect the technology and related know-how and information as trade secrets by keeping confidential the information that we believe provides us with a competitive advantage. We attempt to create strong brands for our products and promote our products through trademarks that distinguish them in the market. We may license our customers to use our trademarks in connection with the sale of our products, and we monitor for the proper and authorized use of our marks.
Licensing activities and lawsuits to enforce intellectual property rights, particularly patent rights, are a common aspect of the semiconductor, LED and lighting industries, and we attempt to ensure respect for our intellectual property rights through appropriate actions. The breadth of our intellectual property rights and the extent to which they can be successfully enforced varies across jurisdictions. We both make and receive inquiries regarding possible patent infringements and possible violations of other intellectual property rights in the normal course of business. Depending on the circumstances, we may seek to negotiate a license or other acceptable resolution. If we are unable to achieve a resolution by agreement, we may seek to enforce our rights or defend our position through litigation. Patent litigation in particular is expensive and the outcome is often uncertain. We believe that the strength of our portfolio of patent rights is important in helping us resolve or avoid such disputes with other companies in our industry.

Environmental Regulation
We are subject to a variety of federal, state and local provisions regulating the discharge of materials into the environment or otherwise relating to the protection of the environment. These include statutory and regulatory provisions under which we are responsible for the management of hazardous materials we use and the disposition of hazardous wastes resulting from our manufacturing processes. Failure to comply with such provisions could result in fines and other liabilities to the government or third parties, injunctions requiring us to suspend or curtail operations or other remedies, and could have a material adverse effect on our business.

Working Capital
For a discussion of our working capital practices, see “Liquidity and Capital Resources” in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations."

Employees
As of June 29, 2014, we employed 7,130 regular full and part-time employees. We also employ individuals on a temporary full-time basis and use the services of contractors as necessary. Certain of our employees in various countries outside of the United States are subject to laws providing representation rights. We consider relations with our employees to be good.

Available Information
Our website address is www.cree.com. We make available free of charge through our website our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, including Interactive Data Files, and Current Reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after we electronically file such material with, or furnish such material to, the SEC. These reports may be accessed from our website by following the links under “Investors,” then “SEC Filings.” The information

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found on our website is not part of this or any other report we file with or furnish to the SEC. We assume no obligation to update or revise any forward-looking statements in this Annual Report or in other reports filed with the SEC, whether as a result of new information, future events or otherwise, unless we are required to do so by law. A copy of this Annual Report and our other reports is available without charge upon written request to Investor Relations, Cree, Inc., 4600 Silicon Drive, Durham, North Carolina 27703.

Item 1A. Risk Factors
Described below are various risks and uncertainties that may affect our business. If any of the risks described below actually occurs, our business, financial condition or results of operations could be materially and adversely affected.
Our operating results are substantially dependent on the development and acceptance of new products.
Our future success may depend on our ability to develop new, higher performing and lower cost solutions for existing and new markets and for customers to accept those solutions. We must introduce new products in a timely and cost-effective manner, and we must secure production orders for those products from our customers. The development of new products is a highly complex process, and we have in some instances experienced delays in completing the development and introduction of new products. Our research and development efforts are aimed at solving increasingly complex problems, and we do not expect that all of our projects will be successful. The successful development, introduction and acceptance of new products depends on a number of factors, including the following:
achievement of technology breakthroughs required to make commercially viable devices;
the accuracy of our predictions for market requirements;
our ability to predict, influence and/or react to evolving standards;
acceptance of our new product designs;
acceptance of new technology in certain markets;
the availability of qualified research and development personnel;
our timely completion of product designs and development;
our ability to develop repeatable processes to manufacture new products in sufficient quantities, with the desired specifications and at competitive costs;
our ability to effectively transfer products and technology from development to manufacturing;
our customers’ ability to develop competitive products incorporating our products; and
market acceptance of our customers’ products.
If any of these or other similar factors becomes problematic, we may not be able to develop and introduce these new products in a timely or cost-effective manner.
If we are unable to effectively develop, manage and expand our sales channels for our products, our operating results may suffer.
We have expanded into business channels that are different from those in which we have historically operated as we grow our business and sell more LED and lighting products. Lighting sales agents have in the past and may in the future choose to drop our product lines from their portfolio to avoid losing access to our competitors’ lighting products, resulting in a disruption in the project pipeline and lower than targeted sales for our lighting products. We sell an increasing portion of our lighting products through retailers who may alter their promotional pricing or inventory strategies, which could impact our targeted sales of these products. If we are unable to effectively penetrate these channels or develop alternate channels to ensure our products are reaching the intended customer base, our financial results may be adversely impacted. In addition, if we successfully penetrate or develop these channels, we cannot guarantee that customers will accept our products or that we will be able to manufacture and deliver them in the timeline established by our customers.

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We sell a substantial portion of our products to distributors. We rely on distributors to develop and expand their customer base as well as anticipate demand from their customers. If they are not successful, our growth and profitability may be adversely impacted. Distributors must balance the need to have enough products in stock in order to meet their customers’ needs against their internal target inventory levels and the risk of potential inventory obsolescence. The risks of inventory obsolescence are especially relevant to technological products. The distributors’ internal target inventory levels vary depending on market cycles and a number of factors within each distributor over which we have very little, if any, control.
We typically recognize revenue on products sold to distributors when the item is shipped and title passes to the distributor (sell-in method). Certain distributors have limited rights to return inventory under stock rotation programs and have limited price protection rights for which we make estimates. We evaluate inventory levels in the distribution channel, current economic trends and other related factors in order to account for these factors in our judgments and estimates. As inventory levels and product return trends change, we may have to revise our estimates and incur additional costs, and our gross margins and operating results could be adversely impacted.
We face significant challenges managing our growth as the market adopts LEDs for general lighting.
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 the market for LED lighting has grown rapidly in recent years, adoption of LEDs for general lighting is relatively new, still limited and faces significant challenges before widespread adoption. In order to manage our growth and business strategy effectively in light of uncertainty related to the pace of adoption, we must continue to:
maintain, expand and purchase adequate manufacturing facilities and equipment to meet customer demand;
manage an increasingly complex supply chain that has the ability to scale to maintain a sufficient supply of raw materials;
expand research and development, sales and marketing, technical support, distribution capabilities and administrative functions;
manage organizational complexity and communication;
expand the skills and capabilities of our current management team;
add experienced senior level managers; and
attract and retain qualified employees.
While we intend to focus on managing our costs and expenses, over the long term we expect to invest substantially to support our growth and may have additional unexpected costs. For example, we have recently expanded our facilities in Wisconsin and North Carolina, and continue to do so to support our growth. Such investments take time to become fully operational, and we may not be able to expand quickly enough to exploit targeted market opportunities. There are also inherent execution risks in starting up a new factory or expanding production capacity that could increase costs and reduce our operating results, including design and construction cost overruns, poor production process yields and reduced quality control during the start-up phase.
We are also increasingly dependent on information technology to enable us to improve the effectiveness of our operations and to maintain financial accuracy and efficiency. If we do not allocate and effectively manage the resources necessary to build, implement, upgrade, integrate and sustain the proper technology infrastructure, we could be subject to transaction errors, processing inefficiencies, loss of customers, business disruptions or loss of or damage to intellectual property through security breach.
In connection with our efforts to cost-effectively manage our growth, we have increasingly relied on contractors for production capacity, logistics support and certain administrative functions including hosting of certain information technology software applications. If these service providers do not perform effectively, we may not be able to achieve the expected cost savings and may incur additional costs to correct errors or fulfill customer demand. Depending on the function involved, such errors may also lead to business disruption, processing inefficiencies, the loss of or damage to intellectual property through security breach, or an impact on employee morale. Our operations may also be negatively impacted if any of these service providers do not have the financial capability to meet our growing needs.
The markets in which we operate are highly competitive and have evolving technical requirements.
The markets for our products are highly competitive. In the LED market, we compete with companies that manufacture and sell LED chips and LED components. In the lighting market, we compete with companies that manufacture and sell traditional and LED lighting products, many of which have larger and more established sales channels. Competitors continue to offer new products

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with aggressive pricing and improved performance. Competitive pricing pressures may change and could accelerate the rate of decline of our average sales prices.
With the growth potential for LEDs, we will continue to face increased competition in the future. If the investment in new capacity exceeds the growth in demand, the LED market is likely to become more competitive with additional pricing pressures. Additionally, new technologies could emerge or improvements could be made in existing technologies that may also reduce the demand for LEDs in certain markets. There are also new technologies, such as organic LEDs (OLEDs), which could potentially have the same impact on LED demand for backlighting, which could impact the overall LED market.
As competition increases, in order to continue to grow our business, we need to continue to develop new products that meet or exceed the needs of our customers. Therefore, our ability to continually produce more efficient, higher brightness and lower cost LEDs and lighting products that meet the evolving needs of our customers will be critical to our success. Competitors may also try to align with some of our strategic customers. This could mean lower prices for our products, reduced demand for our products and a corresponding reduction in our ability to recover development, engineering and manufacturing costs. Any of these developments could have an adverse effect on our business, results of operations or financial condition.
We rely on a number of key sole source and limited source suppliers and are subject to high price volatility on certain commodity inputs, variations in parts quality, and raw material consistency and availability.
We depend on a number of sole source and limited source suppliers for certain raw materials, components, services and equipment used in manufacturing our products, including key materials and equipment used in critical stages of our manufacturing processes. Although alternative sources generally exist for these items, qualification of many of these alternative sources could take up to six months or longer. Where possible, we attempt to identify and qualify alternative sources for our sole and limited source suppliers.
We generally purchase these sole or limited source items with purchase orders, and we have limited guaranteed supply arrangements with such suppliers. Some of our sources can have variations in attributes and availability which can affect our ability to produce products in sufficient volume or quality. We do not control the time and resources that these suppliers devote to our business, and we cannot be sure that these suppliers will perform their obligations to us. Additionally, general shortages in the marketplace of certain raw materials or key components may adversely impact our business. In the past, we have experienced decreases in our production yields when suppliers have varied from previously agreed upon specifications or made other modifications we do not specify, which impacted our cost of revenue.
Additionally, the inability of our suppliers to access capital efficiently could cause disruptions in their businesses, thereby negatively impacting ours. This risk may increase if an economic downturn negatively affects key suppliers or a significant number of our other suppliers. Any delay in product delivery or other interruption or variation in supply from these suppliers could prevent us from meeting commercial demand for our products. If we were to lose key suppliers, if our key suppliers were unable to support our demand for any reason or if we were unable to identify and qualify alternative suppliers, our manufacturing operations could be interrupted or hampered significantly.
We rely on arrangements with independent shipping companies for the delivery of our products from vendors and to customers both in the United States and abroad. The failure or inability of these shipping companies to deliver products or the unavailability of shipping or port services, even temporarily, could have a material adverse effect on our business. We may also be adversely affected by an increase in freight surcharges due to rising fuel costs and added security.
In our fabrication process we consume a number of precious metals and other commodities, which are subject to high price volatility. Our operating margins could be significantly affected if we are not able to pass along price increases to our customers. In addition, production could be disrupted by the unavailability of the resources used in production such as water, silicon, electricity and gases. Future environmental regulations could restrict supply or increase the cost of certain of those materials.
We operate in an industry that is subject to significant fluctuation in supply and demand that affects our revenue and profitability.
The LED lighting industry is in the early stages of adoption and is characterized by constant and rapid technological change, rapid product obsolescence and price erosion, evolving standards, short product life-cycles and fluctuations in product supply and demand. The industry has experienced significant fluctuations, often in connection with, or in anticipation of, product cycles and changes in general economic conditions. As the markets for our products mature, additional fluctuations may result from variability and consolidations within the industry’s customer base. These fluctuations have been characterized by lower product demand, production overcapacity, higher inventory levels and increased pricing pressure. These fluctuations have also been characterized by higher demand for key components and equipment used in, or in the manufacture of, our products resulting in longer lead times, supply delays and production disruptions.

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We have experienced these conditions in our business in the past and may experience such conditions in the future, which could have a material negative impact on our business, results of operations or financial condition.
In addition, as we diversify our product offerings and as pricing differences in the average selling prices among our product lines widen, a change in the mix of sales among our product lines may increase volatility in our revenue and gross margin from period to period.
As a result of our continued expansion into new markets, we may compete with existing customers who may reduce their orders.
Through acquisitions and organic growth, we continue to expand into new markets and new market segments. Many of our existing customers who purchase our LED products develop and manufacture products using those chips and components that are offered into the same lighting markets. As a result, some of our current customers perceive us as a competitor in these market segments. In response, our customers may reduce or discontinue their orders for our LED products. This reduction in or discontinuation of orders could occur faster than our sales growth in these new markets, which could adversely affect our business, results of operations or financial condition.
We depend on a limited number of customers, including distributors and retailers, for a substantial portion of our revenue, and the loss of, or a significant reduction in purchases by, one or more of these customers could adversely affect our operating results.
We receive a significant amount of our revenue from a limited number of customers, including distributors and retailers, two of which represented greater than 10% of our consolidated revenue in fiscal 2014. Most of our customer orders are made on a purchase order basis, which does not generally require any long-term customer commitments. Therefore, these customers may alter their purchasing behavior with little or no notice to us for various reasons, including developing, or, in the case of our distributors, their customers developing, their own product solutions; choosing to purchase product from our competitors; incorrectly forecasting end market demand for their products; or experiencing a reduction in their market share in the markets for which they purchase our products. In the case of retailers, these customers may alter their promotional pricing; increase promotion of competitors' products over our products; or reduce their inventory levels; all of which could negatively impact our financial condition and results of operations. If our customers alter their purchasing behavior, if our customers’ purchasing behavior does not match our expectations or if we encounter any problems collecting amounts due from them, our financial condition and results of operations could be negatively impacted.
Our results of operations, financial condition and business could be harmed if we are unable to balance customer demand and capacity.
As customer demand for our products changes, we must be able to ramp up or adjust our production capacity to meet demand. We are continually taking steps to address our manufacturing capacity needs for our products. If we are not able to increase our production capacity at our targeted rate or if there are unforeseen costs associated with adjusting our capacity levels, we may not be able to achieve our financial targets.
Conversely, due to the proportionately high fixed cost nature of our business (such as facility costs), if demand does not increase at the rate forecasted, we may not be able to scale our manufacturing expenses or overhead costs to correspond to the demand.  This could result in lower margins and adversely impact our business and results of operations.  Additionally, if product demand decreases or we fail to forecast demand accurately, we may be required to recognize impairments on our long-lived assets or recognize excess inventory write-off charges. We have in the past and may in the future be required to recognize excess capacity charges, which would have a negative impact on our results of operations.
In addition, our efforts to improve quoted delivery lead-time performance may result in corresponding reductions in order backlog. A decline in backlog levels could result in more variability and less predictability in our quarter-to-quarter net revenue and operating results.
If our products fail to perform or fail to meet customer requirements or expectations, we could incur significant additional costs, including costs associated with the recall of those items.
The manufacture of our products involves highly complex processes. Our customers specify quality, performance and reliability standards that we must meet. If our products do not meet these standards, we may be required to replace or rework the products. In some cases, our products may contain undetected defects or flaws that only become evident after shipment. Even if our products meet standard specifications, our customers may attempt to use our products in applications for which they were not designed or in products that were not designed or manufactured properly, resulting in product failures and creating customer satisfaction issues.

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We have experienced product quality, performance or reliability problems from time to time and defects or failures may occur in the future. If failures or defects occur, we may need to recall our products. These recalls could result in significant losses due to:
costs associated with the removal, collection and destruction of the product recalled;
payments made to replace recalled product;
the write-down or destruction of existing inventory subject to the recall;
lost sales due to the unavailability of product for a period of time;
delays, cancellations or rescheduling of orders for our products; or
increased product returns.

A significant product recall could also result in adverse publicity, damage to our reputation and a loss of customer or consumer confidence in our products. We also may be the target of product liability lawsuits or regulatory proceedings by the Consumer Product Safety Commission (CPSC) and could suffer losses from a significant product liability judgment or adverse CPSC finding against us if the use of our products at issue is determined to have caused injury or contained a substantial product hazard.
We provide warranty periods ranging from 90 days to 10 years on our products. The standard warranty on nearly all of our new LED lighting products, which represent an increasing portion of our revenue, is 10 years. Although we believe our reserves are appropriate, we are making projections about the future reliability of new products and technologies, and we may experience increased variability in warranty claims. Increased warranty claims could result in significant losses due to a rise in warranty expense and costs associated with customer support.
Variations in our production yields could impact our ability to reduce costs and could cause our margins to decline and our operating results to suffer.
All of our products are manufactured using technologies that are highly complex. The number of usable items, or yield, from our production processes may fluctuate as a result of many factors, including but not limited to the following:
variability in our process repeatability and control;
contamination of the manufacturing environment;
equipment failure, power outages, information or other system failures or variations in the manufacturing process;
lack of consistency and adequate quality and quantity of piece parts, other raw materials and other bill of materials items;
inventory shrinkage or human errors;
defects in production processes (including system assembly) either within our facilities or at our suppliers; and
any transitions or changes in our production process, planned or unplanned.
In the past, we have experienced difficulties in achieving acceptable yields on certain products, which has adversely affected our operating results. We may experience similar problems in the future, and we cannot predict when they may occur or their severity.
In addition, our ability to convert volume manufacturing to larger diameter substrates can be an important factor in providing a more cost effective manufacturing process. If we are unable to make this transition in a timely or cost effective manner, our results could be negatively impacted.
In some instances, we may offer products for future delivery at prices based on planned yield improvements or increased cost efficiencies from other production advances. Failure to achieve these planned improvements or advances could have a significant impact on our margins and operating results.
Our results may be negatively impacted if customers do not maintain their favorable perception of our brand and products.
We have a developing brand with increasing value.  Maintaining and continually enhancing the value of this brand is critical to the success of our business.  Brand value is based in large part on customer perceptions.  Success in promoting and enhancing brand value depends in large part on our ability to provide high-quality products.  Brand value could diminish significantly due

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to a number of factors, including adverse publicity about our products (whether valid or not), a failure to maintain the quality of our products (whether perceived or real), the failure of our products to deliver consistently positive consumer experiences, the products becoming unavailable to consumers or consumer perception that we have acted in an irresponsible manner.  Damage to our brand, reputation or loss of customer confidence in our brand or products could result in decreased demand for our products and have a negative impact on our business, results of operations or financial condition.
Global economic conditions could materially adversely impact demand for our products and services.
Our operations and performance depend significantly on worldwide economic conditions. Uncertainty about global economic conditions could result in customers postponing purchases of our products and services in response to tighter credit, unemployment, negative financial news and/or declines in income or asset values and other macroeconomic factors, which could have a material negative effect on demand for our products and services and, accordingly, on our business, results of operations or financial condition.
If we fail to evaluate and execute strategic opportunities successfully, our business may suffer.
From time to time, we evaluate strategic opportunities available to us for product, technology or business transactions, such as business acquisitions, divestitures or investments. If we choose to enter into such transactions, we face certain risks, such as the failure of an acquired business to meet our performance expectations, diversion of management attention, identification of additional liabilities relating to the acquired business, loss of existing customers of our current and acquired businesses due to concerns that new product lines may be in competition with the customers’ existing product lines, and difficulty integrating an acquired business’s operations, personnel and financial and operating systems into our current business.
We may not be able to adequately address these risks or any other problems that arise from our prior or future acquisitions, divestitures or investments. Any failure to successfully evaluate strategic opportunities and address risks or other problems that arise related to any such business transaction could adversely affect our business, results of operations or financial condition.
Our revenue is highly dependent on our customers’ ability to produce, market and sell more integrated products.
Our revenue in our LED Products and Power and RF Products segments depends on getting our products designed into a larger number of our customers’ products and in turn, our customers’ ability to produce, market and sell their products. For example, we have current and prospective customers that create, or plan to create, lighting systems using our LED components. Even if our customers are able to develop and produce LED lighting products and products that incorporate our Power and RF products, there can be no assurance that our customers will be successful in marketing and selling these products in the marketplace.
The adoption of or changes in government and/or industry policies, standards or regulations relating to the efficiency, performance, use or other aspects of lighting could impact the demand for our products.
The adoption of or changes in government and/or industry policies, standards or regulations relating to the efficiency, performance or other aspects of LED lighting may impact the demand for our products. Demand for our products may also be impacted by changes in government and/or industry policies, standards or regulations that discourage the use of certain traditional lighting technologies. These constraints may be eliminated or delayed by legislative action, which could have a negative impact on demand for our products.
If governments, their agencies or utilities reduce their demand for our products or discontinue or curtail their funding, our business may suffer.
Changes in governmental budget priorities could adversely affect our business and results of operations.  U.S. and foreign government agencies have purchased products directly from us and products from our customers, and U.S. government agencies have historically funded a portion of our research and development activities.  When the government changes budget priorities, such as in times of war or financial crisis, our research and development funding and our product sales to government entities and government-funded customers are at risk.  For example, demand and payment for our products and our customers’ products may be affected by public sector budgetary cycles, funding authorizations or utility rebates. Funding reductions or delays could negatively impact demand for our products. If government or utility funding is discontinued or significantly reduced, our business and results of operations could be adversely affected. 

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Our operations in foreign countries expose us to certain risks inherent in doing business internationally, which may adversely affect our business, results of operations or financial condition.
We have operations, manufacturing facilities and contract manufacturing arrangements in foreign countries that expose us to certain risks. For example, fluctuations in exchange rates may affect our revenue, expenses and results of operations as well as the value of our assets and liabilities as reflected in our financial statements. We are also subject to other types of risks, including the following:
protection of intellectual property and trade secrets;
tariffs, customs and other barriers to importing/exporting materials and products in a cost effective and timely manner, or changes in applicable tariffs or custom rules;
timing and availability of export licenses;
rising labor costs;
disruptions in or inadequate infrastructure of the countries where we operate;
difficulties in collecting accounts receivable;
difficulties in staffing and managing international operations;
the burden of complying with foreign and international laws and treaties; and
the burden of complying with and changes in international taxation policies.
In some instances, we have received and may continue to receive incentives from foreign governments to encourage our investment in certain countries, regions or areas outside of the United States. In particular, we have received and may continue to receive such incentives in connection with our operations in Asia, as Asian national and local governments seek to encourage the development of the technology industry. Government incentives may include tax rebates, reduced tax rates, favorable lending policies and other measures, some or all of which may be available to us due to our foreign operations. Any of these incentives could be reduced or eliminated by governmental authorities at any time. Any reduction or elimination of incentives currently provided to our operations could adversely affect our business and results of operations. These same governments also may provide increased incentives to or require production processes that favor local companies, which could further negatively impact our business and results of operations.
Abrupt political change, terrorist activity and armed conflict pose a risk of general economic disruption in affected countries, which could also result in an adverse effect on our business and results of operations.
In order to compete, we must attract, motivate and retain key employees, and our failure to do so could harm our results of operations.
Hiring and retaining qualified executives, scientists, engineers, technical staff and sales personnel is critical to our business, and competition for experienced employees in our industry can be intense. As a global company, this issue is not limited to the United States, but includes our other locations such as Europe and China. For example, there is substantial competition in China for qualified and capable personnel, particularly experienced engineers and technical personnel, which may make it difficult for us to recruit and retain qualified employees. Also, within Huizhou, China, there are other large companies building manufacturing plants that will likely compete for qualified employees. If we are unable to staff sufficient and adequate personnel at our China facilities, we may experience lower revenue or increased manufacturing costs, which would adversely affect our results of operations.
To help attract, motivate and retain key employees, we use benefits such as stock-based compensation awards. If the value of such awards does not appreciate, as measured by the performance of the price of our common stock or if our stock-based compensation otherwise ceases to be viewed as a valuable benefit, our ability to attract, retain and motivate employees could be weakened, which could harm our business and results of operations.

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Litigation could adversely affect our operating results and financial condition.
We are often involved in litigation, primarily patent litigation. Defending against existing and potential litigation will likely require significant attention and resources and, regardless of the outcome, result in significant legal expenses, which could adversely affect our results unless covered by insurance or recovered from third parties. If our defenses are ultimately unsuccessful or if we are unable to achieve a favorable resolution, we could be liable for damage awards that could materially affect our results of operations and financial condition.
Where necessary, we may initiate litigation to enforce our patent or other intellectual property rights. Any such litigation may require us to spend a substantial amount of time and money and could distract management from our day-to-day operations. Moreover, there is no assurance that we will be successful in any such litigation.
Our business may be impaired by claims that we, or our customers, infringe the intellectual property rights of others.
Vigorous protection and pursuit of intellectual property rights characterize our industry. These traits have resulted in significant and often protracted and expensive litigation. Litigation to determine the validity of patents or claims by third parties of infringement of patents or other intellectual property rights could result in significant legal expense and divert the efforts of our technical personnel and management, even if the litigation results in a determination favorable to us. In the event of an adverse result in such litigation, we could be required to:
pay substantial damages;
indemnify our customers;
stop the manufacture, use and sale of products found to be infringing;
incur asset impairment charges;
discontinue the use of processes found to be infringing;
expend significant resources to develop non-infringing products or processes; or
obtain a license to use third party technology.
There can be no assurance that third parties will not attempt to assert infringement claims against us, or our customers, with respect to our products. In addition, our customers may face infringement claims directed to the customer’s products that incorporate our products, and an adverse result could impair the customer’s demand for our products. We have also promised certain of our customers that we will indemnify them in the event they are sued by our competitors for infringement claims directed to the products we supply. Under these indemnification obligations, we may be responsible for future payments to resolve infringement claims against them.
From time to time, we receive correspondence asserting that our products or processes are or may be infringing patents or other intellectual property rights of others. If we believe the assertions may have merit or in other appropriate circumstances, we may take steps to seek to obtain a license or to avoid the infringement. We cannot predict, however, whether a license will be available; that we would find the terms of any license offered acceptable; or that we would be able to develop an alternative solution. Failure to obtain a necessary license or develop an alternative solution could cause us to incur substantial liabilities and costs and to suspend the manufacture of affected products.
There are limitations on our ability to protect our intellectual property.
Our intellectual property position is based in part on patents owned by us and patents licensed to us. We intend to continue to file patent applications in the future, where appropriate, and to pursue such applications with U.S. and certain foreign patent authorities.
Our existing patents are subject to expiration and re-examination and we cannot be sure that additional patents will be issued on any new applications around the covered technology or that our existing or future patents will not be successfully contested by third parties. Also, since issuance of a valid patent does not prevent other companies from using alternative, non-infringing technology, we cannot be sure that any of our patents, or patents issued to others and licensed to us, will provide significant commercial protection, especially as new competitors enter the market.
We periodically discover products that are counterfeit reproductions of our products or that otherwise infringe on our intellectual property rights. The actions we take to establish and protect trademarks, patents and other intellectual property rights may not be adequate to prevent imitation of our products by others, and therefore, may adversely affect our sales and our brand and result in

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the shift of customer preference away from our products. Further, the actions we take to establish and protect trademarks, patents and other intellectual property rights could result in significant legal expense and divert the efforts of our technical personnel and management, even if the litigation or other action results in a determination favorable to us.
We also rely on trade secrets and other non-patented proprietary information relating to our product development and manufacturing activities. We try to protect this information through appropriate efforts to maintain its secrecy, including requiring employees and third parties to sign confidentiality agreements. We cannot be sure that these efforts will be successful or that the confidentiality agreements will not be breached. We also cannot be sure that we would have adequate remedies for any breach of such agreements or other misappropriation of our trade secrets, or that our trade secrets and proprietary know-how will not otherwise become known or be independently discovered by others.
We may be required to recognize a significant charge to earnings if our goodwill or other intangible assets become impaired.
Goodwill and purchased intangible assets with indefinite lives are not amortized, but are reviewed for impairment annually and more frequently when events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. We assess the recoverability of the unamortized balance of our finite-lived intangible assets when indicators of potential impairment are present. Factors that may indicate that the carrying value of our goodwill or other intangible assets may not be recoverable include a decline in our stock price and market capitalization and slower growth rates in our industry. The recognition of a significant charge to earnings in our consolidated financial statements resulting from any impairment of our goodwill or other intangible assets could adversely impact our results of operations.
We may be subject to confidential information theft or misuse, which could harm our business and results of operations.
We face attempts by others to gain unauthorized access to our information technology systems on which we maintain proprietary and other confidential information. Our security measures may be breached as the result of industrial or other espionage actions of outside parties, employee error, malfeasance or otherwise, and as a result, an unauthorized party may obtain access to our systems. Additionally, outside parties may attempt to access our confidential information through other means, for example by fraudulently inducing our employees to disclose confidential information. We actively seek to prevent, detect and investigate any unauthorized access, which sometimes occurs. We might be unaware of any such access or unable to determine its magnitude and effects. The theft and/or unauthorized use or publication of our trade secrets and other confidential business information as a result of such an incident could adversely affect our competitive position and the value of our investment in research and development could be reduced. Our business could be subject to significant disruption and we could suffer monetary or other losses.
We are subject to risks related to international sales and purchases.
We expect that revenue from international sales will continue to represent a significant portion of our total revenue. As such, a significant slowdown or instability in relevant foreign economies, including economic instability in Europe, or lower investments in new infrastructure could have a negative impact on our sales. We also purchase a portion of the materials included in our products from overseas sources.
Our international sales and purchases are subject to numerous U.S. and foreign laws and regulations, including, without limitation, tariffs, trade barriers, regulations relating to import-export control, technology transfer restrictions, the International Traffic in Arms Regulation promulgated under the Arms Export Control Act, the Foreign Corrupt Practices Act and the anti-boycott provisions of the U.S. Export Administration Act. If we fail to comply with these laws and regulations, we could be liable for administrative, civil or criminal liabilities, and, in the extreme case, we could be suspended or debarred from government contracts or have our export privileges suspended, which could have a material adverse effect on our business.
International sales and purchases are also subject to a variety of other risks, including risks arising from currency fluctuations, collection issues and taxes. Our international sales are subject to variability as our selling prices become less competitive in countries with currencies that are declining in value against the U.S. Dollar and more competitive in countries with currencies that are increasing in value against the U.S. Dollar. In addition, our international purchases can become more expensive if the U.S. Dollar weakens against the foreign currencies in which we are billed.
We have entered and may in the future enter into foreign currency derivative financial instruments in an effort to manage or hedge some of our foreign exchange rate risk. We may not be able to engage in hedging transactions in the future, and, even if we do, foreign currency fluctuations may still have a material adverse effect on our results of operations.

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Our business may be adversely affected by uncertainties in the global financial markets and our or our customers’ or suppliers’ ability to access the capital markets.
Global financial markets continue to reflect uncertainty about a sustained global economic recovery. Given these uncertainties, there could be future disruptions in the global economy, financial markets and consumer confidence. If economic conditions deteriorate unexpectedly, our business and results of operations could be materially and adversely affected. For example, our customers, including our distributors and their customers, may experience difficulty obtaining the working capital and other financing necessary to support historical or projected purchasing patterns, which could negatively affect our results of operations.
Although we believe we have adequate liquidity and capital resources to fund our operations internally, our inability to access the capital markets on favorable terms in the future, or at all, may adversely affect our financial performance. The inability to obtain adequate financing from debt or capital sources in the future could force us to self-fund strategic initiatives or even forego certain opportunities, which in turn could potentially harm our performance.
Changes in our effective tax rate may affect our results.
Our future effective tax rates may be affected by a number of factors including:
the jurisdiction in which profits are determined to be earned and taxed;
changes in government administrations, such as the Presidency and Congress of the U.S. as well as in the states and countries in which we operate;
changes in tax laws or interpretation of such tax laws and changes in generally accepted accounting principles;
the resolution of issues arising from tax audits with various authorities;
changes in the valuation of our deferred tax assets and liabilities;
adjustments to estimated taxes upon finalization of various tax returns;
increases in expenses not deductible for tax purposes, including write-offs of acquired in-process research and development and impairment of goodwill in connection with acquisitions;
changes in available tax credits;
the recognition and measurement of uncertain tax positions;
the lack of sufficient excess tax benefits (credits) in our additional paid-in-capital pool in situations where our realized tax deductions for certain stock-based compensation awards (such as non-qualified stock options and restricted stock) are less than those originally anticipated; and
the repatriation of non-U.S. earnings for which we have not previously provided for U.S. taxes or any changes in legislation that may result in these earnings being taxed within the U.S., regardless of our decision regarding repatriation of funds.
Any significant increase or decrease in our future effective tax rates could impact net income for future periods. In addition, the determination of our income tax provision requires complex estimations, significant judgments and significant knowledge and experience concerning the applicable tax laws. To the extent our income tax liability materially differs from our income tax provisions due to factors, including the above, which were not anticipated at the time we estimated our tax provision, our net income or cash flows could be affected.
Failure to comply with applicable environmental laws and regulations worldwide could harm our business and results of operations.
The manufacturing, assembling and testing of our products require the use of hazardous materials that are subject to a broad array of environmental, health and safety laws and regulations. Our failure to comply with any of these applicable laws or regulations could result in:
regulatory penalties, fines, legal liabilities and the forfeiture of certain tax benefits;
suspension of production;

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alteration of our fabrication, assembly and test processes; and
curtailment of our operations or sales.
In addition, our failure to manage the use, transportation, emission, discharge, storage, recycling or disposal of hazardous materials could subject us to increased costs or future liabilities. Existing and future environmental laws and regulations could also require us to acquire pollution abatement or remediation equipment, modify our product designs or incur other expenses, such as permit costs, associated with such laws and regulations. Many new materials that we are evaluating for use in our operations may be subject to regulation under existing or future environmental laws and regulations that may restrict our use of one or more of such materials in our manufacturing, assembly and test processes or products. Any of these restrictions could harm our business and results of operations by increasing our expenses or requiring us to alter our manufacturing processes.
Our results could vary as a result of the methods, estimates and judgments that we use in applying our accounting policies, including changes in the accounting standards to be applied.
The methods, estimates and judgments that we use in applying our accounting policies have a significant impact on our results (see “Critical Accounting Policies and Estimates” in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in Item 7 of this Annual Report). Such methods, estimates and judgments are, by their nature, subject to substantial risks, uncertainties and assumptions, and factors may arise over time that lead us to change our methods, estimates and judgments. Changes in those methods, estimates and judgments could significantly affect our results of operations or financial condition.
Likewise, our results may be impacted due to changes in the accounting standards to be applied, such as the increased use of fair value measurement standards and changes in revenue recognition requirements.
Catastrophic events may disrupt our business.
A disruption or failure of our systems or operations in the event of a natural disaster, health pandemic, such as an influenza outbreak within our workforce, or man-made catastrophic event could cause delays in completing sales, continuing production or performing other critical functions of our business, particularly if a catastrophic event occurred at our primary manufacturing locations or our subcontractors' locations. Any of these events could severely affect our ability to conduct normal business operations and, as a result, our operating results could be adversely affected. There may also be secondary impacts that are unforeseeable as well, such as impacts to our customers, which could cause delays in new orders, delays in completing sales or even order cancellations.
Our stock price may be volatile.
Historically, our common stock has experienced substantial price volatility, particularly as a result of significant fluctuations in our revenue, earnings and margins over the past few years, and variations between our actual financial results and the published expectations of analysts. For example, the closing price per share of our common stock on the NASDAQ Global Select Market ranged from a low of $44.99 to a high of $75.76 during fiscal 2014. If our future operating results or margins are below the expectations of stock market analysts or our investors, our stock price will likely decline.
Speculation and opinions in the press or investment community about our strategic position, financial condition, results of operations or significant transactions can also cause changes in our stock price. In particular, speculation around our market opportunities for energy efficient lighting may have a dramatic effect on our stock price, especially as various government agencies announce their planned investments in energy efficient technology, including lighting.
We are exposed to fluctuations in the market value of our investment portfolio and in interest rates, and therefore, impairment of our investments or lower investment income could harm our earnings.
We are exposed to market value and inherent interest rate risk related to our investment portfolio. We have historically invested portions of our available cash in fixed interest rate securities such as high-grade corporate debt, commercial paper, municipal bonds, non-U.S. certificates of deposit, government securities and other fixed interest rate investments. The primary objective of our investment policy is preservation of principal. However, our investments are generally not Federal Deposit Insurance Corporation insured and may lose value and/or become illiquid regardless of their credit rating.


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Regulations related to conflict-free minerals may force us to incur additional expenses.
The Dodd-Frank Wall Street Reform and Consumer Protection Act contains provisions to improve transparency and accountability concerning the supply of minerals originating from the conflict zones of the Democratic Republic of Congo (DRC) and adjoining countries. As a result, in August 2012 the SEC established new annual disclosure and reporting requirements for those companies who may use “conflict” minerals mined from the DRC and adjoining countries in their products. These requirements required us to undertake due diligence efforts beginning in the 2013 calendar year, with initial disclosures regarding our diligence to the SEC filed in June 2014. These requirements could affect the sourcing and availability of certain minerals used in the manufacture of our products. As a result, we may not be able to obtain the relevant minerals at competitive prices and there will likely be additional costs associated with complying with the due diligence procedures as required by the SEC. In addition, because our supply chain is complex, we may face reputational challenges with our customers and other stakeholders if we are unable to sufficiently verify the origins of all minerals used in our products through the due diligence procedures that we implement, and we may incur additional costs as a result of changes to product, processes or sources of supply as a consequence of these requirements.
Item 1B. Unresolved Staff Comments
Not applicable.

Item 2. Properties
The table below sets forth information with respect to our significant owned and leased facilities as of June 29, 2014. The sizes of the locations represent the approximate gross square footage of each site’s buildings.
 
 
 
Size (approximate gross square footage)
Location
Segment Utilization1
 
Total
 
Production
 
Facility
Services and
Warehousing
 
Administrative
Function
 
Housing /
Other
Owned Facilities
 
 
 
 
 
 
 
 
 
 
 
Durham, NC
All
 
916,600

 
500,720

 
106,000

 
309,880

 

Research Triangle Park, NC
1,3
 
163,121

 
68,884

 
42,599

 
51,638

 

Racine, WI
2
 
802,845

 
160,000

 
418,000

 
224,845

 

Huizhou, China
1
 
806,312

 
351,345

 
82,019

 
41,763

 
331,185

Total owned
 
 
2,688,878

 
1,080,949

 
648,618

 
628,126

 
331,185

 
 
 
 
 
 
 
 
 
 
 
 
Leased Facilities
 
 
 
 
 
 
 
 
 
 
 
Durham, NC
2
 
188,982

 
42,000

 
134,982

 
12,000

 

Morrisville, NC
2
 
27,050

 

 

 
27,050

 

Goleta, CA
All
 
25,623

 

 
1,882

 
23,741

 

Yorkville, WI
2
 
79,016

 

 
77,316

 
1,700

 

Florence, Italy
1,2
 
35,360

 
4,628

 
21,679

 
9,053

 

Hong Kong
All
 
36,090

 

 

 
29,955

 
6,135

Huizhou, China
1
 
375,702

 
260,014

 

 

 
115,688

Miscellaneous sales and support offices
All
 
67,675

 

 
9,976

 
54,470

 
3,229

Total leased
 
 
835,498

 
306,642

 
245,835

 
157,969

 
125,052

 
 
 
 
 
 
 
 
 
 
 
 
Total gross square footage
 
 
3,524,376

 
1,387,591

 
894,453

 
786,095

 
456,237

1 Segments listed in the “Segment Utilization” column above are identified as follows: 1) LED Products; 2) Lighting Products and 3) Power and RF Products.
In the United States, our corporate headquarters as well as our primary research and development and manufacturing operations are located at the Durham, North Carolina facilities that we own. These Durham facilities sit on 149 acres of land that we own. Our power and RF products are primarily produced at our owned manufacturing facility located in Research Triangle Park, North Carolina. This facility sits on 55 acres of land that we own. Domestically, our lighting products are primarily produced at our owned facility in Racine, Wisconsin which sits on 33 acres of land that we own and a leased facility in Durham, North Carolina.

21


In China, LED products are produced at our owned manufacturing facility and a leased facility, both located in Huizhou, Guangdong Province, China. The building we own sits on land that is leased from the Chinese government through two leases. One lease for eight acres expires in June 2057. The other lease for two acres expires in November 2060.
We also maintain sales and support offices, through our subsidiaries, in leased office premises in North America, Asia, and Europe. In addition, we lease a facility in Goleta, California that is used for research and development and administrative functions.

Item 3. Legal Proceedings
The information required by this item is set forth under Note 12, “Commitments and Contingencies,” in our consolidated financial statements included in Item 8 of this Annual Report, and is incorporated herein by reference.

Item 4. Mine Safety Disclosures
Not applicable.

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Common Stock Market Information
Our common stock is traded on the NASDAQ Global Select Market and is quoted under the symbol CREE. There were 360 holders of record of our common stock as of August 21, 2014. The following table sets forth, for the quarters indicated, the high and low closing sales prices as reported by NASDAQ.
 
 
Fiscal 2014
 
Fiscal 2013
 
High
 
Low
 
High
 
Low
First Quarter

$75.76

 

$53.90

 

$29.01

 

$22.78

Second Quarter
74.32

 
54.01

 
34.69

 
24.83

Third Quarter
67.33

 
55.01

 
55.28

 
31.44

Fourth Quarter
58.10

 
44.99

 
65.70

 
49.20

We have never paid cash dividends on our common stock and do not anticipate that we will do so in the foreseeable future. Our credit agreement with Wells Fargo Bank, National Association executed on August 12, 2014, contains certain dividend distribution restrictions. Applicable state laws may also limit the payment of dividends. Our present policy is to retain earnings, if any, to provide funds for the operation and expansion of our business.


22


Stock Performance Graph
The following information in this Item 5 of this Annual Report on Form 10-K is not deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C under the Exchange Act or to the liabilities of Section 18 of the Exchange Act, and will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent we specifically incorporate it by reference into such filing.
The following graph compares the cumulative total return on our common stock with the cumulative total returns of the NASDAQ Composite Index and the NASDAQ Electronic Components Index for the five-year period commencing June 28, 2009. The stock price performance shown on the graph below is not necessarily indicative of future price performance.

Comparison of Five-Year Cumulative Total Return*
Among Cree, Inc., the NASDAQ Composite Index and the NASDAQ Electronic Components Index
*
Assumes (1) $100 invested on June 28, 2009 in Cree, Inc. Common Stock, the NASDAQ Composite Index and the NASDAQ Electronic Components Index and (2) the immediate reinvestment of all dividends.
    
 
6/28/2009
 
6/27/2010
 
6/26/2011
 
6/24/2012
 
6/30/2013
 
6/29/2014
Cree, Inc.

$100.00

 

$217.45

 

$113.50

 

$81.72

 

$213.34

 

$162.03

NASDAQ Composite Index
100.00

 
122.04

 
146.97

 
161.98

 
193.36

 
253.01

NASDAQ Electronic Components Index
100.00

 
123.26

 
122.61

 
126.37

 
149.41

 
190.64


Sale of Unregistered Securities
There were no unregistered securities sold during fiscal 2014.

23


Stock Repurchase Program
The following table summarizes stock repurchase activity for the fourth quarter of fiscal 2014 (in thousands except price per share data):
Period
 
Total Number of Shares Purchased
 
Average Price Paid per Share
 
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
 
Approximate Dollar Value of Shares that May Yet be Purchased Under the Plans or Programs1
Shares repurchased under our Stock Repurchase Program
 
 
 
 
 
 
 
 
March 31, 2014 to April 27, 2014
 

 

$—

 

 

$200,000

April 28, 2014 to May 25, 2014
 
2,115

 
47.11

 
2,115

 
200,365

May 26, 2014 to June 29, 2014
 

 

 

 
200,365

Total
 
2,115

 

$47.11

 
2,115

 

$200,365

 
 
 
 
 
 
 
 
 
Shares repurchased outside our Stock Repurchase Program to satisfy tax withholding obligations on the vesting of shares of restricted stock
 
 
 
 
 
 
 
 
March 31, 2014 to April 27, 2014
 
15

 

$58.05

 
 
 
 
April 28, 2014 to May 25, 2014
 

 

 
 
 
 
May 26, 2014 to June 29, 2014
 

 

 
 
 
 
Total
 
15

 

$58.05

 
 
 
 
(1) On May 6, 2014, our Board of Directors approved an increase in the amount of our stock repurchase program. Pursuant to the program, we are now authorized to repurchase shares of our common stock having an aggregate purchase price not exceeding $300 million for all purchases from June 20, 2013 through the new expiration of the program on June 28, 2015.
Since the inception of our stock repurchase program in January 2001 through June 29, 2014, we have repurchased 12.4 million shares of our common stock at an average price of $24.57 per share with an aggregate value of $305.1 million. The repurchase program can be implemented through open market or privately negotiated transactions at the discretion of our management. 

Item 6. Selected Financial Data
The consolidated statement of income data set forth below with respect to the fiscal years ended June 29, 2014, June 30, 2013, and June 24, 2012 and the consolidated balance sheet data at June 29, 2014 and June 30, 2013 are derived from, and are qualified by reference to, the audited consolidated financial statements included in Item 8 of this Annual Report and should be read in conjunction with those financial statements and notes thereto. The consolidated statement of income data for the fiscal years ended June 26, 2011 and June 27, 2010 and the consolidated balance sheet data at June 24, 2012, June 26, 2011, and June 27, 2010 are derived from audited consolidated financial statements not included herein.

24



Selected Consolidated Financial Data
(In thousands, except per share data)
 
 
Fiscal Years Ended
 
June 29,
2014
 
June 30,
2013
 
June 24,
2012
 
June 26,
2011
 
June 27,
2010
Consolidated Statement of Income Data1
 
 
 
 
 
 
 
 
 
Revenue, net

$1,647,641

 

$1,385,982

 

$1,164,658

 

$987,615

 

$867,287

Operating income
134,275

 
96,494

 
39,258

 
168,706

 
197,778

Net income
124,191

 
86,925

 
44,412

 
146,500

 
152,290

Earnings per share:
 
 
 
 
 
 
 
 
 
Basic

$1.03

 

$0.75

 

$0.39

 

$1.35

 

$1.49

Diluted

$1.01

 

$0.74

 

$0.39

 

$1.33

 

$1.45

Weighted average shares used in per share calculation:
 
 
 
 
 
 
 
 
 
Basic
120,623

 
116,621

 
114,693

 
108,522

 
102,371

Diluted
122,914

 
117,979

 
115,225

 
110,035

 
104,698

 
 
 
 
June 29,
2014
 
June 30,
2013
 
June 24,
2012
 
June 26,
2011
 
June 27,
2010
Consolidated Balance Sheet Data1
 
 
 
 
 
 
 
 
 
Total cash, cash equivalents and short-term investments

$1,162,466

 

$1,023,915

 

$744,513

 

$1,085,797

 

$1,066,405

Working capital
1,467,236

 
1,308,355

 
1,015,104

 
1,316,579

 
1,235,072

Total assets
3,344,369

 
3,052,410

 
2,747,498

 
2,446,722

 
2,199,176

Total long-term liabilities
47,568

 
38,347

 
38,304

 
44,842

 
51,037

Total shareholders’ equity
2,990,146

 
2,806,652

 
2,560,017

 
2,261,564

 
2,028,048

1 Consolidated statement of income data and balance sheet data for fiscal year 2012 include Ruud Lighting from the date of its acquisition in the first quarter of fiscal 2012. See Note 3, “Acquisitions,” in our consolidated financial statements included in Item 8 of this Annual Report for more information about the impact of the acquisition on our consolidated financial statements.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Executive Summary
The following discussion is designed to provide a better understanding of our audited consolidated financial statements and notes thereto, 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 our consolidated financial statements included in Item 8 of this Annual Report. 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 indoor and outdoor lighting, video displays, transportation, electronic signs and signals, power supplies, inverters and wireless systems.


25


Our LED products consist of LED components, LED chips, and silicon carbide (SiC) materials. Our success in selling LED products depends upon our ability to offer innovative products and to enable our customers to develop and market LED-based products that successfully compete against other LED-based products and drive LED adoption against traditional lighting products.
Our lighting products primarily consist of LED lighting systems and bulbs. We design, manufacture and sell lighting fixtures and lamps for the commercial, industrial and consumer markets.
In addition, we develop, manufacture and sell power and RF devices. Our power products are made from SiC and provide increased efficiency, faster switching speeds and reduced system size and weight over comparable silicon-based power devices. Our RF devices are made from gallium nitride (GaN) and provide improved efficiency, bandwidth and frequency of operation as compared to silicon or gallium arsenide (GaAs).
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 product fabrication, assembly and packaging. We operate research and development facilities in North Carolina, California, Wisconsin, India, 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 8 of this Annual Report.

Reportable Segments
Our three reportable segments are:
LED Products
Lighting Products
Power and RF Products

Reportable segments are components of an entity that have separate financial data that the entity’s Chief Operating Decision Maker (CODM) regularly reviews when allocating resources and assessing performance. Our CODM is the Chief Executive Officer.
Our 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 our segment revenue disclosure. As such, total segment revenue is equal to our consolidated revenue.
Our 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 must be included to reconcile the consolidated gross profit to our consolidated income before income taxes.
For financial results by reportable segment, please refer to Note 13, “Reportable Segments,” in our consolidated financial statements included in Item 8 of this Annual Report.

Industry Dynamics and Trends
There are a number of industry factors that affect our business which include, among others:
Overall Demand for Products and Applications using LEDs. Our potential for growth depends significantly on the adoption of LEDs within the general lighting market and our ability to affect this rate of adoption. Although the market for LED lighting has grown in recent years, adoption of LEDs for general lighting is relatively low 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 LED and lighting industry is intense. Many companies have made significant investments in LED development and production equipment. Traditional lighting companies and new entrants are investing in LED-based lighting products as LED adoption has gained momentum. Traditional lighting companies have taken steps to try and limit access to their sales channels, including lighting agents and distributors. Product pricing pressures exist as market participants often undertake pricing strategies to gain or protect market share, increase the utilization of their production capacity and open new applications to LED-based solutions. To remain competitive, market participants must continuously increase product performance and reduce costs. To address these competitive pressures, we have invested in research and development

26


activities to support new product development and to deliver higher levels of performance and lower costs to differentiate our products in the market.
Technological Innovation and Advancement. Innovations and advancements in LED, power and RF technologies continue to expand the potential commercial application for our products, particularly in the general illumination, power electronics and wireless markets. 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.
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, in some cases even banning forms of incandescent lighting, which are advancing the adoption of more energy efficient lighting solutions such as LEDs. Government agencies are also involved in setting standards for LED lighting, which can affect market acceptance and the availability of rebates from government agencies or third parties such as utilities. While this trend is generally positive, these regulations are affected by changing political priorities and evolving technical standards which can modify 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 is common.

Fiscal 2014 Overview
The following is a summary of our financial results for the year ended June 29, 2014:
Our year-over-year revenue increased 19% to $1.6 billion.
Gross margin remained consistent at 38%. Gross profit increased by $96 million to $619 million.
Operating income was $134 million in fiscal 2014 compared to $96 million in fiscal 2013. Net income per diluted share was $1.01 in fiscal 2014 compared to $0.74 in fiscal 2013.
Combined cash, cash equivalents and short-term investments increased to $1.2 billion at June 29, 2014 compared to $1.0 billion at June 30, 2013. Cash provided by operating activities was $319 million in fiscal 2014, compared to $285 million in fiscal 2013.
Inventories increased to $285 million at June 29, 2014 compared to $197 million at June 30, 2013.
We spent $179 million on purchases of property and equipment in fiscal 2014 compared to $77 million in fiscal 2013.

Business Outlook
We project that the markets for our products will remain highly competitive during fiscal 2015. We anticipate focusing on the following key areas, among others, in response to this competitive environment:

Drive innovation to lower upfront customer cost and further improve payback. The LED lighting market has been enabled with tremendous innovation over the last decade with technology improvements in LEDs and LED lighting systems. We see many applications today where LED lighting offers a clear payback over conventional lighting products, whether it is for new construction or for lighting retrofits installed in existing buildings. We believe we can further accelerate adoption by continuing to innovate to lower the upfront cost and make the payback even more compelling. The approach also applies to our Power and RF product lines, where today our technology has tremendous technical benefits but a higher upfront cost. We are focused on developing the next generation devices that improve payback and expand the market for these products.

Drive LED lighting growth and build the Cree brand. We target strong growth in both the LED fixture and LED bulb product lines, driven by the new products we released over the last year and continued innovation in the year ahead. We plan to continue to drive awareness of the Cree brand and LED lighting in both the consumer and commercial markets.


27


Expand our work with third party manufacturers to enable growth in LEDs and LED Lighting. We work with third party manufacturers for the production of LEDs and LED lighting systems. Our internal team is focused on the high-performance, high-power LED chips that differentiate Cree LEDs in the market, and we work with external LED manufacturers on mid-power sapphire LED chips. We also have LED lighting manufacturing partners which are focused on building some of the higher volume products, which gives us the flexibility to utilize our own factories to support the new product ramps and shorten the time to market for new technologies. We plan to expand production at both our manufacturing partners and our own factories to support our targeted growth, optimize our factory utilization and focus our capital spending on higher value products.

Build financial momentum. We target generating incremental operating margin through revenue growth and incremental operating leverage across the business. We target revenue growth in all three product segments, with LED lighting being the biggest growth driver. While we plan to continue to invest in research and development, sales, marketing, general and administrative expenses to support our growth and other strategic initiatives, we target revenue to increase faster than operating expenses providing incremental operating margin growth for the year.

Results of Operations
The following table sets forth certain consolidated statement of income data for the periods indicated (in thousands, except per share amounts and percentages):

 
Fiscal Years Ended
 
June 29, 2014
 
June 30, 2013
 
June 24, 2012
 
Dollars
 
% of
Revenue
 
Dollars
 
% of
Revenue
 
Dollars
 
% of
Revenue
Revenue, net

$1,647,641

 
100
%
 

$1,385,982

 
100
%
 

$1,164,658

 
100
%
Cost of revenue, net
1,028,846

 
62
%
 
862,722

 
62
%
 
755,196

 
65
%
Gross profit
618,795

 
38
%
 
523,260

 
38
%
 
409,462

 
35
%
Research and development
181,382

 
11
%
 
155,889

 
11
%
 
143,357

 
12
%
Sales, general and administrative
268,460

 
16
%
 
236,581

 
17
%
 
197,092

 
17
%
Amortization or impairment of acquisition-related intangibles
31,988

 
2
%
 
30,823

 
2
%
 
26,274

 
2
%
Loss on disposal or impairment of long-lived assets
2,690

 
0
%
 
3,473

 
0
%
 
3,481

 
0
%
Operating income
134,275

 
8
%
 
96,494

 
7
%
 
39,258

 
3
%
Non-operating income, net
13,295

 
1
%
 
11,063

 
1
%
 
8,389

 
1
%
Income before income taxes
147,570

 
9
%
 
107,557

 
8
%
 
47,647

 
4
%
Income tax expense
23,379

 
1
%
 
20,632

 
1
%
 
3,235

 
%
Net income

$124,191

 
8
%
 

$86,925

 
6
%
 

$44,412

 
4
%
Basic earnings per share

$1.03

 
 
 

$0.75

 
 
 

$0.39

 
 
Diluted earnings per share

$1.01

 
 
 

$0.74

 
 
 

$0.39

 
 

28


Revenue
Revenue was comprised of the following (in thousands, except percentages):
 
 
Fiscal Years Ended
 
Year-Over-Year Change
 
June 29,
2014
 
June 30,
2013
 
June 24,
2012
 
2013 to 2014
 
2012 to 2013
LED Products

$833,684

 

$801,483

 

$756,924

 

$32,201

 
4
%
 

$44,559

 
6
%
Percent of revenue
51
%
 
58
%
 
65
%
 
 
 
 
 
 
 
 
Lighting Products
706,425

 
495,089

 
334,704

 
211,336

 
43
%
 
160,385

 
48
%
Percent of revenue
43
%
 
36
%
 
29
%
 
 
 
 
 
 
 
 
Power and RF Products
107,532

 
89,410

 
73,030

 
18,122

 
20
%
 
16,380

 
22
%
Percent of revenue
6
%
 
6
%
 
6
%
 
 
 
 
 
 
 
 
Total revenue

$1,647,641

 

$1,385,982

 

$1,164,658

 

$261,659

 
19
%
 

$221,324

 
19
%
Our consolidated revenue increased 19% to $1.6 billion in fiscal 2014 from $1.4 billion in fiscal 2013. This year-over-year increase was due to higher sales across all three of our reportable segments, but driven primarily by the 43% increase in Lighting Products. Lighting Products revenue increased due to an overall increase in the number of units sold, including new product introductions, partially offset by a reduction in the average selling prices, or ASP.
Our consolidated revenue increased 19% to $1.4 billion in fiscal 2013 from $1.2 billion in fiscal 2012. This year-over-year increase was due to higher sales across all three of our reportable segments, but driven primarily by the 48% increase in Lighting Products. Lighting Products revenue increased primarily due to an increase in sales of existing products, the sales of new and re-designed products introduced during the fiscal year, and the recognition of revenue from the Ruud Lighting acquisition for a full fiscal year.
LED Products Segment Revenue
LED Products revenue represented the largest portion of our revenue with approximately 51%, 58%, and 65% of our total revenue for fiscal 2014, 2013, and 2012, respectively. LED Products revenue was $833.7 million, $801.5 million, and $756.9 million for fiscal 2014, 2013, and 2012, respectively.
LED Products revenue increased 4% to $833.7 million in fiscal 2014 from $801.5 million in fiscal 2013. This increase was the result of an overall increase in the number of units sold, primarily from our newer products, partially offset by a decline in selling prices. The ASP for LED Products decreased by 13% in fiscal 2014 compared to fiscal 2013, due primarily to market downward pricing pressure.
LED Products revenue increased 6% to $801.5 million in fiscal 2013 from $756.9 million in fiscal 2012. This increase was the result of an overall increase in the number of units sold, primarily for our newer products, partially offset by a decline in selling prices. LED Products overall ASP decreased by 8% in fiscal 2013 compared to fiscal 2012 due primarily to a higher mix of new lower priced products and competitive pricing pressures.

Lighting Products Segment Revenue
Lighting Products revenue represented approximately 43%, 36%, and 29% of our total revenue for fiscal 2014, 2013 and 2012 respectively. Lighting Products revenue was $706.4 million, $495.1 million, and $334.7 million for fiscal 2014, 2013, and 2012 respectively.
Lighting Products revenue increased 43% to $706.4 million in fiscal 2014 from $495.1 million in fiscal 2013. This increase was the result of an overall increase in the number of units sold, partially offset by a reduction in selling prices. Lighting Products overall ASP decreased by 30% in fiscal 2014 compared to fiscal 2013 primarily due to a higher mix of new lower priced consumer lighting products.
Lighting Products revenue increased 48% to $495.1 million in fiscal 2013 from $334.7 million in fiscal 2012. This increase was the result of an overall increase in the number of units sold, including sales from new and re-designed products, as well as recognizing a full year of revenue in fiscal 2013 from the sale of Ruud Lighting products. Lighting Products overall ASP decreased by approximately 27% in fiscal 2013 compared to fiscal 2012 due to a change in product mix.


29


Power and RF Products Segment Revenue
Power and RF Products revenue represented approximately 6%, 6%, and 6% of our total revenue for fiscal 2014, 2013, and 2012, respectively. Power and RF Products revenue was $107.5 million, $89.4 million, and $73.0 million for fiscal 2014, 2013, and 2012, respectively.
Power and RF Products revenue increased 20% to $107.5 million in fiscal 2014 from $89.4 million in fiscal 2013. This increase was primarily the result of higher RF product unit sales in fiscal 2014. The increased volume was partially offset by a reduction in selling prices. Power and RF Products overall ASP decreased by 12% in fiscal 2014 compared to fiscal 2013 primarily due to a higher mix of new lower priced Power and RF products.
Power and RF Products revenue increased 22% to $89.4 million in fiscal 2013 from $73.0 million in fiscal 2012. This increase was primarily the result of higher RF product unit sales in fiscal 2013. The overall ASP for Power and RF Products decreased by 9% in fiscal 2013 compared to fiscal 2012 primarily due to a higher mix of new lower priced Power and RF products.

Gross Profit and Gross Margin
Gross profit and gross margin were as follows (in thousands, except percentages): 
 
Fiscal Years Ended
 
Year-Over-Year Change
 
June 29, 2014
 
June 30, 2013
 
June 24, 2012
 
2013 to 2014
 
2012 to 2013
LED Products gross profit

$381,003

 

$344,649

 

$290,642

 

$36,354

 
11
%
 

$54,007

 
19
%
LED Products gross margin
46
%
 
43
%
 
38
%
 
 
 
 
 
 
 
 
Lighting Products gross profit
197,304

 
148,947

 
103,396

 
48,357

 
32
%
 
45,551

 
44
%
Lighting Products gross margin
28
%
 
30
%
 
31
%
 
 
 
 
 
 
 
 
Power and RF Products gross profit
60,723

 
48,127

 
32,051

 
12,596

 
26
%
 
16,076

 
50
%
Power and RF Products gross margin
56
%
 
54
%
 
44
%
 
 
 
 
 
 
 
 
Unallocated costs
(20,235
)
 
(18,463
)
 
(16,627
)

(1,772
)
 
10
%
 
(1,836
)
 
11
%
Consolidated gross profit

$618,795

 

$523,260

 

$409,462

 

$95,535

 
18
%
 

$113,798

 
28
%
Consolidated gross margin
38
%
 
38
%
 
35
%
 
 
 
 
 
 
 
 
Our consolidated gross profit increased 18% to $618.8 million in fiscal 2014 from $523.3 million in fiscal 2013. Our consolidated gross margin remained consistent at 38% for fiscal 2014 and fiscal 2013. The consolidated gross profit increase was driven by increased revenue volumes across all reporting segments. The consolidated gross margin benefited from improvements in LED Products and Power and RF Products, primarily due to higher revenue, factory cost reductions, the introduction of new lower cost products, and higher factory utilization. These improvements were offset by lower margins in Lighting Products, primarily due to changes in product mix.
Our consolidated gross profit increased 28% to $523.3 million in fiscal 2013 from $409.5 million in fiscal 2012. Our consolidated gross margin increased to 38% in fiscal 2013 from 35% in fiscal 2012. These consolidated gross profit and gross margin increases were due to the improvements in LED Products and Power and RF Products, primarily due to higher volume of units sold, factory cost reductions, the introduction of new lower cost products, and higher factory utilization.

LED Products Segment Gross Profit and Gross Margin
Our LED Products gross profit was $381.0 million, $344.6 million, and $290.6 million for fiscal 2014, 2013, and 2012, respectively. LED Products gross margin was 46%, 43%, and 38% for fiscal 2014, 2013, and 2012, respectively.
LED Products gross profit increased 11% to $381.0 million in fiscal 2014 from $344.6 million in fiscal 2013, and LED Products gross margin increased to 46% in fiscal 2014 from 43% in fiscal 2013. LED Products gross profit and gross margin increased during fiscal 2014 due to higher revenue, factory cost reductions, the introduction of new lower cost products and higher factory utilization. These benefits more than offset the ASP decline in fiscal 2014 as compared to fiscal 2013.
LED Products gross profit increased 19% to $344.6 million in fiscal 2013 from $290.6 million in fiscal 2012, and LED Products gross margin increased to 43% in fiscal 2013 from 38% in fiscal 2012. LED Products gross profit and gross margin increased during fiscal 2013 due to factory cost reductions, the introduction of new lower cost products and higher factory utilization. These benefits more than offset the ASP decline in fiscal 2013 as compared to fiscal 2012.

30



Lighting Products Segment Gross Profit and Gross Margin
Lighting Products gross profit was $197.3 million, $148.9 million, and $103.4 million for fiscal 2014, 2013, and 2012, respectively. Lighting Products gross margin was 28%, 30%, and 31% for fiscal 2014, 2013, and 2012, respectively.
Lighting Products gross profit increased 32% to $197.3 million in fiscal 2014 from $148.9 million in fiscal 2013, due to growth in LED lighting products sales. Lighting Products gross margin decreased to 28% in fiscal 2014 from 30% in fiscal 2013, primarily due to changes in product mix driven primarily by higher sales of consumer lighting products, which have lower gross margins.
Lighting Products gross profit increased 44% to $148.9 million in fiscal 2013 from $103.4 million in fiscal 2012, primarily due to an increase in the number of overall units sold. Lighting Products gross margin decreased to 30% in fiscal 2013 from 31% in fiscal 2012, primarily due to a change in product mix.

Power and RF Products Segment Gross Profit and Gross Margin
Power and RF Products gross profit was $60.7 million, $48.1 million, and $32.1 million for fiscal 2014, 2013, and 2012, respectively. Power and RF Products gross margin was 56%, 54%, and 44% for fiscal 2014, 2013, and 2012, respectively.
Power and RF Products gross profit increased 26% to $60.7 million in fiscal 2014 from $48.1 million in fiscal 2013. Power and RF Products gross margin increased to 56% in fiscal 2014 from 54% in fiscal 2013. Power and RF Products gross profit and gross margin increases were due primarily to higher revenue, factory cost reductions, increased factory utilization, and introduction of new lower cost products. These benefits more than offset the ASP decline in fiscal 2014 as compared to fiscal 2013.
Power and RF Products gross profit increased 50% to $48.1 million in fiscal 2013 from $32.1 million in fiscal 2012. Power and RF Products gross margin increased to 54% in fiscal 2013 from 44% in fiscal 2012. Power and RF Products gross profit and gross margin increases were due primarily to factory cost reductions, increased factory utilization, and higher sales of new lower cost products. These benefits more than offset the ASP decline in fiscal 2013 as compared to fiscal 2012.

Unallocated Costs
Unallocated costs were $20.2 million, $18.5 million, and $16.6 million for fiscal 2014, 2013, and 2012, respectively. These costs consisted primarily of manufacturing employees’ stock-based compensation, expenses for profit sharing and quarterly or annual incentive plans and matching contributions under our 401(k) plan. These costs were not allocated to the reportable segments’ gross profit because our CODM does not review them regularly when evaluating segment performance and allocating resources.
Unallocated costs increased by $1.8 million in fiscal 2014 and by $1.9 million in fiscal 2013 as compared to fiscal 2013 and fiscal 2012, respectively, primarily attributable to higher incentive and stock-based compensation incurred as a result of improved business performance year over year.
For further information on the allocation of costs to segment gross profit, refer to Note 13, “Reportable Segments,” in our consolidated financial statements included in Item 8 of this Annual Report.

Research and Development
Research and development expenses include costs associated with the development of new products, enhancements of existing products and general technology research. These costs consisted primarily of employee salaries and related compensation costs, occupancy costs, consulting costs and the cost of development equipment and supplies.
The following sets forth our research and development expenses in dollars and as a percentage of revenue (in thousands, except percentages):
 
 
Fiscal Years Ended
 
Year-Over-Year Change
 
June 29, 2014
 
June 30, 2013
 
June 24, 2012
 
2013 to 2014
 
2012 to 2013
Research and development

$181,382

 

$155,889

 

$143,357

 

$25,493

 
16
%
 

$12,532

 
9
%
Percent of revenue
11
%
 
11
%
 
12
%
 
 
 
 
 
 
 
 
Research and development expenses increased 16% in fiscal 2014 to $181.4 million compared to $155.9 million in fiscal 2013, which was a 9% increase from $143.4 million in fiscal 2012. In both fiscal 2014 and fiscal 2013, the increases were primarily

31


due to increased spending on research and development activities focused on new higher performance and lower cost LED chips, LED components, LED lighting products and Power and RF products.
Our research and development expenses vary significantly from year to year based on a number of factors, including the timing of new product introductions and the number and nature of our ongoing research and development activities. We anticipate that in general our research and development expenses will continue to increase over time to support future growth.

Sales, General and Administrative
Sales, general and administrative expenses were comprised primarily of costs associated with our sales and marketing personnel and our executive and administrative personnel (for example, finance, human resources, information technology and legal) and consisted of salaries and related compensation costs; consulting and other professional services (such as litigation and other outside legal counsel fees, audit and other compliance costs); marketing and advertising expenses; facilities and insurance costs and travel and other costs. The following table sets forth our sales, general and administrative expenses in dollars and as a percentage of revenue (in thousands, except percentages): 
 
Fiscal Years Ended
 
Year-Over-Year Change
 
June 29, 2014
 
June 30, 2013
 
June 24, 2012
 
2013 to 2014
 
2012 to 2013
Sales, general and administrative

$268,460

 

$236,581

 

$197,092

 

$31,879

 
13
%
 

$39,489

 
20
%
Percent of revenue
16
%
 
17
%
 
17
%
 
 
 
 
 
 
 
 
Sales, general and administrative expenses in fiscal 2014 increased 13% to $268.5 million from $236.6 million in fiscal 2013, which was a 20% increase from $197.1 million in fiscal 2012. In both fiscal 2014 and fiscal 2013, the increases were primarily due to increases in spending on sales and marketing for lighting products, including commissions, trade shows and advertising, as we continue to expand our direct sales resources and channels and invest in building and promoting the Cree brand. Additionally, the increases included personnel additions during fiscal 2014 and fiscal 2013 to support our growth.

Amortization or Impairment of Acquisition-Related Intangibles
As a result of our acquisitions, we have recognized various amortizable intangible assets, including customer relationships, developed technology, non-compete agreements and trade names. During fiscal 2012, we acquired Ruud Lighting, resulting in $206.0 million of amortizable intangible assets, principally composed of customer relationships, developed technology and trade names.
Amortization of intangible assets related to our acquisitions is as follows (in thousands, except percentages): 
 
Fiscal Years Ended
 
Year-Over-Year Change
 
June 29,
2014
 
June 30,
2013
 
June 24,
2012
 
2013 to 2014
 
2012 to 2013
Customer relationships

$7,359

 

$8,509

 

$8,540

 

($1,150
)
 
(14
)%
 

($31
)
 
0
 %
Developed technology
19,446

 
20,331

 
16,081

 
(885
)
 
(4
)%
 
4,250

 
26
 %
Non-compete agreements
1,960

 
1,960

 
1,633

 

 
0
 %
 
327

 
20
 %
Trade names, finite-lived
23

 
23

 
20

 

 
0
 %
 
3

 
15
 %
Total

$28,788

 

$30,823

 

$26,274

 

($2,035
)
 
(7
)%
 

$4,549

 
17
 %
Amortization of acquisition-related intangibles decreased in fiscal 2014 compared to fiscal 2013, primarily due to less amortization expense for customer relationships and developed technology in fiscal 2014. For fiscal 2013 compared to fiscal 2012, amortization of acquisition-related intangibles increased primarily due to the completion of in-process research and development projects in fiscal 2013.
In the fourth quarter of fiscal 2014, we performed a qualitative impairment assessment on each of our indefinite-lived trade names.  We determined that, with the exception of the Ruud Lighting trade name, the fair value of each indefinite-lived trade name was more likely than not greater than its carrying value and therefore a quantitative impairment assessment was not required.  With respect to the Ruud Lighting trade name, we determined that this trade name has a finite useful life and therefore performed a quantitative impairment assessment.  As a result of the quantitative impairment assessment, we recognized a $3.2 million impairment of the Ruud Lighting trade name.

32


Loss on Disposal or Impairment of Long-Lived Assets
We operate a capital intensive business. As such, we dispose of a certain level of our equipment in the normal course of business as our production processes change due to production improvement initiatives or product mix changes. Due to the risk of technological obsolescence or changes in our production process, we regularly review our equipment and capitalized patent costs for possible impairment. The following table sets forth our loss on disposal or impairment of long-lived assets (in thousands, except percentages): 
 
Fiscal Years Ended
 
Year-Over-Year Change
 
June 29, 2014
 
June 30, 2013
 
June 24, 2012
 
2013 to 2014
 
2012 to 2013
Loss on disposal or impairment of long-lived assets, net

$2,690

 

$3,473

 

$3,481

 

($783
)
 
(23
)%
 

($8
)
 
0
 %
We recognized a net loss of $2.7 million, $3.5 million, and $3.5 million on the disposal of long-lived assets in fiscal years 2014, 2013, and 2012 respectively. These net losses were primarily the result of disposals of equipment due to changes in various manufacturing processes and the abandonment of certain patent assets as a result of technological obsolescence.

Non-Operating Income, net
The following table sets forth our non-operating income, net (in thousands, except percentages): 
 
Fiscal Years Ended
 
Year-Over-Year Change
 
June 29, 2014
 
June 30, 2013
 
June 24, 2012
 
2013 to 2014
 
2012 to 2013
Foreign currency gain, net

$45

 

$735

 

$171

 

($690
)
 
(94
)%
 

$564

 
330
 %
Gain on sale of investments, net
68

 
111

 
994

 
(43
)
 
(39
)%
 
(883
)
 
(89
)%
Interest income, net
11,932

 
7,882

 
7,457

 
4,050

 
51
 %
 
425

 
6
 %
Other, net
1,250

 
2,335

 
(233
)
 
(1,085
)
 
(46
)%
 
2,568

 
(1,102
)%
Non-operating income, net

$13,295

 

$11,063

 

$8,389

 

$2,232

 
20
 %
 

$2,674

 
32
 %
During fiscal 2014, 2013 and 2012, we had no debt and we were in a net interest income position. Our investments consisted of corporate bonds, municipal bonds, U.S. agency securities, non-U.S. certificates of deposit and non-U.S. government securities. The primary objective of our investment policy is preservation of principal.
Foreign currency gain, net. Foreign currency gain, net consisted primarily of remeasurement adjustments resulting from consolidating our international subsidiaries. The changes in foreign currency gain, net were primarily due to fluctuations in the exchange rate between the Chinese Yuan and the United States Dollar.
Gain on sale of investments, net. Gain on sale of investments, net was higher in fiscal 2012, primarily due to gains realized on sales of investments liquidated in fiscal 2012 in order to fund our acquisition of Ruud Lighting.
Interest income, net. Interest income was $11.9 million and $7.9 million in fiscal 2014 and fiscal 2013, respectively. The increase in interest income in fiscal 2014 was primarily due to earning higher investment yields and higher invested balances as compared to fiscal 2013. Interest income increased from $7.5 million in fiscal 2012 to $7.9 million in fiscal 2013 due to having higher invested cash and investment balances partially offset by lower interest rates.
Other, net. Other, net decreased in fiscal 2014 as compared to fiscal 2013, and increased in fiscal 2013 compared to fiscal 2012, primarily due to the one-time payment received in fiscal 2013 in connection with the SemiLEDs patent litigation settlement.

33


Income Tax Expense
The following table sets forth our income tax expense in dollars and our effective tax rate (in thousands, except percentages): 
 
Fiscal Years Ended
 
Year-Over-Year Change
 
June 29,
2014
 
June 30,
2013
 
June 24,
2012
 
2013 to 2014
 
2012 to 2013
Income tax expense

$23,379

 

$20,632

 

$3,235

 
2,747

 
13
%
 
17,397

 
538
%
Effective tax rate
16
%
 
19
%
 
7
%
 
 
 
 
 
 
 
 
We recognized income tax expense of $23.4 million in fiscal 2014 as compared to income tax expense of $20.6 million in fiscal 2013. The decrease in the effective tax rate from 19% in fiscal 2013 to 16% in fiscal 2014 was primarily due to the tax benefit related to the receipt of U.S. federal tax credits awarded on November 15, 2013 as part of Phase II of the American Recovery and Reinvestment Act of 2009 (Internal Revenue Code Section 48C). The increase in the effective tax rate from 7% in fiscal 2012 to 19% in fiscal 2013 was due to the decreased impact of tax credits relative to higher year-over-year pre-tax income, a higher percentage of our pre-tax income being derived from U.S. operations that were taxed at a higher tax rate than international locations and the inclusion of a tax benefit related to a prior year audit settlement in fiscal 2012. For further discussion of changes in our effective tax rate, please refer to Note 11, “Income Taxes,” in our consolidated financial statements included in Item 8 of this Annual Report.
The variation between our effective tax rate and the U.S. statutory rate of 35% was primarily due to the consolidation of our foreign operations, which are generally subject to income taxes at lower statutory rates. A change in the mix of pretax income from these various tax jurisdictions can have a significant impact on our periodic effective tax rate. In addition, our effective tax rate may be negatively impacted by the lack of sufficient excess tax benefits (credits) that accumulate in our equity as additional paid-in-capital (APIC) and referred to as the “APIC pool” of credits. In situations where our realized tax deductions for certain stock-based compensation awards, such as non-qualified stock options and restricted stock, are less than those originally anticipated, which accumulate in the APIC pool, accounting principles generally accepted in the United States (U.S. GAAP) requires that we recognize the difference as an increase to income tax expense.

Liquidity and Capital Resources
Overview
We require cash to fund our operating expenses and working capital requirements, including outlays for research and development, capital expenditures, strategic acquisitions and investments. Our principal sources of liquidity are cash on hand, marketable securities and cash generated from operations. Our ability to generate cash from operations has been one of our fundamental strengths and has provided us with substantial flexibility in meeting our operating, financing and investing needs. We have no debt or outstanding balances on our line of credit note and have minimal lease commitments. See Note 18, “Subsequent Event,” to our consolidated financial statements in Item 8 of this Annual Report for a description of the credit agreement and line of credit note entered into on August 12, 2014 with Wells Fargo Bank, National Association.
Based on past performance and current expectations, we believe our current working capital and anticipated cash flows from operations will be adequate to meet our cash needs for our daily operations and capital expenditures for at least the next 12 months. We may use a portion of our available cash and cash equivalents, or funds underlying our marketable securities, to repurchase shares of our common stock pursuant to repurchase programs authorized by our Board of Directors. With our strong working capital position, we believe that we have the ability to continue to invest in further development of our products and, when necessary or appropriate, make selective acquisitions or other strategic investments to strengthen our product portfolio, secure key intellectual properties or expand our production capacity.
From time to time, we evaluate strategic opportunities, including potential acquisitions, divestitures or investments in complementary businesses, and we anticipate continuing to make such evaluations. We may also access capital markets through the issuance of debt or additional shares of common stock in connection with the acquisition of complementary businesses or other significant assets or for other strategic opportunities.

34


Contractual Obligations
At June 29, 2014, payments to be made pursuant to significant contractual obligations are as follows (in thousands): 
 
 
 
Payments Due by Period
 
Total
 
Less than
One Year
 
One to
Three Years
 
Three to
Five Years
 
More Than
Five Years
Operating lease obligations

$14,150

 

$5,840

 

$6,442

 

$1,766

 

$102

Purchase obligations
245,226

 
236,143

 
6,925

 
905

 
1,253

Other long-term liabilities1

 

 

 

 

Total contractual obligations

$259,376

 

$241,983

 

$13,367

 

$2,671

 

$1,355

1 Other long-term liabilities as of June 29, 2014 included long-term tax contingencies and other tax liabilities of $20.5 million, deferred liabilities of $13.4 million and other long-term contingent liabilities (for example, warranties) of $1.5 million. These liabilities were not included in the table above as they will either not be settled in cash and/or the timing of any payments is uncertain.
Operating lease obligations include rental amounts due on leases of certain office and manufacturing space under the terms of non-cancelable operating leases. These leases expire at various times through May 2022. Most of the lease agreements provide for rental adjustments for increases in base rent, property taxes and general property maintenance that would be recognized as rent expense, if applicable.
Purchase obligations represent purchase commitments, including open purchase orders and contracts, and are generally related to the purchase of goods and services in the ordinary course of business such as raw materials, supplies and capital equipment.
 
Financial Condition
The following table sets forth our cash, cash equivalents and short-term investments (in thousands): 
 
June 29,
2014
 
June 30,
2013
 
Change
Cash and cash equivalents

$286,824

 

$190,069

 

$96,755

Short-term investments
875,642

 
833,846

 
41,796

Total cash, cash equivalents and short-term investments

$1,162,466

 

$1,023,915

 

$138,551

Our liquidity and capital resources depend on our cash flows from operations and our working capital. The significant components of our working capital are liquid assets such as cash and cash equivalents, short-term investments, accounts receivable and inventories reduced by trade accounts payable.
The following table presents the components of our cash conversion cycle: 
 
Three Months Ended
 
 
 
June 29,
2014
 
June 30,
2013
 
Change
Days of sales outstanding (a)
46

 
46

 

Days of supply in inventory (b)
94

 
76

 
18

Days in accounts payable (c)
(66
)
 
(47
)
 
(19
)
Cash conversion cycle
74

 
75

 
(1
)
a)
Days of sales outstanding (DSO) measures the average collection period of our receivables. DSO is based on the ending net trade receivables and the revenue, net for the quarter then ended. DSO is calculated by dividing ending accounts receivable, net of applicable allowances and reserves, by the average net revenue per day for the respective 90 day period.

35


b)
Days of supply in inventory (DSI) measures the average number of days from procurement to sale of our product. DSI is based on ending inventory and cost of revenue, net for the quarter then ended. DSI is calculated by dividing ending inventory by average cost of revenue, net per day for the respective 90 day period.
c)
Days in accounts payable (DPO) measures the average number of days our payables remain outstanding before payment. DPO is based on ending accounts payable and cost of revenue, net for the quarter then ended. DPO is calculated by dividing ending accounts payable by the average cost of revenue, net per day for the respective 90 day period.
The decrease in the cash conversion cycle was primarily driven by an increase in days in accounts payable, partially offset by an increase in days of supply in inventory.
As of June 29, 2014, we had unrealized losses on our investments of $0.1 million. All of our investments had investment grade ratings, and any such investments that were in an unrealized loss position at June 29, 2014 were in such position due to interest rate changes, sector credit rating changes or company-specific rating changes. As we intend and believe that we have the ability to hold such investments for a period of time that will be sufficient for anticipated recovery in market value, we currently expect to receive the full principal or recover our cost basis in these securities. The declines in value of the securities in our portfolio are considered to be temporary in nature and, accordingly, we do not believe these securities are impaired as of June 29, 2014.

Cash Flows
In summary, our cash flows were as follows (in thousands): 
 
Fiscal Years Ended
 
Year-Over-Year Change
 
June 29, 2014
 
June 30, 2013
 
June 24, 2012
 
2013 to 2014
 
2012 to 2013
Cash provided by operating activities

$319,308

 

$285,234

 

$242,280

 

$34,074

 

$42,954

Cash used in investing activities
(242,265
)
 
(380,307
)
 
(448,141
)
 
138,042

 
67,834

Cash provided by (used in) financing activities
19,542

 
105,952

 
(6,692
)
 
(86,410
)
 
112,644

Effect of foreign exchange changes
170

 
305

 
840

 
(135
)
 
(535
)
Net increase (decrease) in cash and cash equivalents

$96,755

 

$11,184

 

($211,713
)
 

$85,571

 

$222,897

The following is a discussion of our primary sources and uses of cash in our operating, investing and financing activities.
Cash Flows from Operating Activities
Net cash provided by operating activities increased to $319.3 million in fiscal 2014 from $285.2 million in fiscal 2013. The increase was primarily due to an increase in net income. Net cash provided by operating activities increased to $285.2 million in fiscal 2013 from $242.3 million in fiscal 2012, primarily due to an increase in net income.
Cash Flows from Investing Activities
Our investing activities primarily relate to transactions within our short-term investments, purchases of property and equipment and payments for patents and licensing rights. Net cash used in investing activities was $242.3 million for fiscal 2014 compared to $380.3 million for fiscal 2013. Our capital spending increased as we continued to make investments in manufacturing capacity to support our future growth. This increase was more than offset by lower net purchases of short-term investments during fiscal 2014.
Net cash used in investing activities was $380.3 million for fiscal 2013 compared to $448.1 million for fiscal 2012. This decrease was primarily the result of a reduction in cash used in business combinations, partially offset by an increase in the net purchases of short-term investments during fiscal 2013.
We continue to actively manage our capital spending. For fiscal 2015, we target committing approximately $200.0 million of capital investment to support our growth and strategic priorities.

36


Cash Flows from Financing Activities
Net cash provided by financing activities was $19.5 million in fiscal 2014 compared to $106.0 million in fiscal 2013. Our financing activities for fiscal 2014 primarily consisted of proceeds of $119.2 million from net issuances of common stock pursuant to the exercise of employee stock options and purchases under our employees stock purchase plan, including the excess tax benefit on those exercises, mostly offset by the repurchase of common stock worth approximately $99.7 million.
In fiscal 2013, net cash provided by financing activities was $106.0 million compared to net cash used in financing activities of $6.7 million in fiscal 2012. Our financing activities in fiscal 2013 consisted primarily of $107.6 million from net issuances of common stock pursuant to the exercise of employee stock options and purchases under our employees stock purchase plan, including the excess tax benefit on those exercises. Our financing activities in fiscal 2012 primarily related to the repurchase of 0.5 million shares of common stock worth approximately $12.0 million during the fourth quarter of fiscal 2012, partially offset by $5.3 million from net issuances of common stock pursuant to the exercise of employee stock options and purchases under our employees stock purchase plan, including the excess tax benefit on those exercises.
Pursuant to an extension of our stock repurchase program authorized by our Board of Directors, we are authorized to repurchase shares of our common stock having an aggregate purchase price not exceeding $300 million for all purchases from June 20, 2013 through the expiration of the program on June 28, 2015. Since the inception of our stock repurchase program in 2001, we have repurchased approximately 12.4 million shares of our common stock at an average price of $24.57 per share with an aggregate value of $305.1 million.
At the discretion of our management, the repurchase program can be implemented through open market or privately negotiated transactions. We will determine the time and extent of repurchases based on our evaluation of market conditions and other factors.

Fair Value
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, we use 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 we are 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 we perform recurring fair value remeasurements are cash equivalents and short-term investments. As of June 29, 2014, financial assets utilizing Level 1 inputs included money market funds. Financial assets utilizing Level 2 inputs included corporate bonds, municipal bonds, U.S. agency securities, non-U.S. certificates of deposit and non-U.S. government securities. Level 2 assets are valued 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. We do not have any financial assets requiring the use of Level 3 inputs. Please refer to Note 6, “Fair Value of Financial Instruments,” to the consolidated financial statements included in Item 8 of this Annual Report for further information.

Financial and Market Risks
We are exposed to financial and market risks, including changes in interest rates, currency exchange rates and commodities risk. We have entered and may in the future enter into foreign currency derivative financial instruments in an effort to manage or hedge some of our foreign exchange rate risk. We may not be able to engage in hedging transactions in the future, and even if we do, foreign currency fluctuations may still have a material adverse effect on our results of operations and financial performance. All of the potential changes noted below are based on sensitivity analyses performed on our financial positions at June 29, 2014 and June 30, 2013. Actual results may differ materially.

37



Interest Rates
We maintain an investment portfolio principally composed of money market funds, municipal bonds, corporate bonds, U.S. agency securities, non-U.S. certificates of deposit and non-U.S. government securities. In order to minimize risk, our cash management policy permits us to acquire investments rated “A” grade or better. As of June 29, 2014 our cash equivalents and short-term investments had a fair value of $915.7 million. If interest rates were to increase by 100 basis points, the fair value of our cash equivalents and short-term investments would decrease by $12.9 million. We do not believe that a 10% change in interest rates would have a significant impact on our financial position, results of operations or cash flows.

Currency Exchange Rates
Because we operate internationally and have transactions denominated in foreign currencies, including the Chinese Yuan and Euro, among others, we are exposed to currency exchange rate risks. As a result, fluctuations in exchange rates may adversely affect our expenses and results of operations as well as the value of our assets and liabilities. Our primary exposures relate to the exchange rates between the U.S. Dollar and the Chinese Yuan. The potential loss in fair value resulting from a hypothetical 10% increase in the value of the U.S. Dollar compared to the Chinese Yuan was approximately $3.8 million at June 29, 2014.

Commodities
We utilize significant amounts of precious metals, gases and other commodities in our manufacturing processes. General economic conditions, market specific changes or other factors outside of our control may affect the pricing of these commodities.  We do not use financial instruments to hedge commodity prices.

Off-Balance Sheet Arrangements
We do not use off-balance sheet arrangements with unconsolidated entities or related parties, nor do we use any other forms of off-balance sheet arrangements. Accordingly, our liquidity and capital resources are not subject to off-balance sheet risks from unconsolidated entities. As of June 29, 2014, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.
We have entered into operating leases primarily for certain of our U.S. and international facilities in the normal course of business. Future minimum lease payments under our operating leases as of June 29, 2014 are detailed above in “Liquidity and Capital Resources” in the section entitled “Contractual Obligations.”

Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with U.S. GAAP. In the application of U.S. GAAP, we are required to make estimates that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities in our consolidated financial statements. Changes in the accounting estimates from period to period are reasonably likely to occur. Accordingly, actual results could differ significantly from the estimates made by management. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation of our financial condition or results of operations may be affected.
We evaluate our estimates on an ongoing basis, including those related to revenue recognition, product warranty obligations, valuation of inventories, tax related contingencies, valuation of stock-based compensation, valuation of long-lived and intangible assets, other contingencies and litigation, among others. We base our estimates on historical experience and on various other assumptions, including expected trends that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.
Our significant accounting policies are discussed in Note 2, “Basis of Presentation and Summary of Significant Accounting Policies,” to the consolidated financial statements included in Item 8 of this Annual Report. We believe that the following are our most critical accounting policies and estimates, each of which is critical to the portrayal of our financial condition and results of operations and requires our most difficult, subjective and complex judgments. Our management has reviewed our critical accounting policies and the related disclosures with the Audit Committee of our Board of Directors.


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Revenue Recognition
We recognize product revenue when the earnings process is complete, as evidenced by persuasive evidence of an arrangement (typically in the form of a purchase order), when the sales price is fixed or determinable, collection of revenue is reasonably assured, and title and risk of loss have passed to the customer.
For the year ended June 29, 2014, 53% of our revenue was from sales to distributors. Distributors stock inventory and sell our products to their own customer base, which may include: value added resellers; manufacturers who incorporate our products into their own manufactured goods; or ultimate end users of our products. We recognize revenue upon shipment of our products to our distributors. This arrangement is often referred to as a “sell-in” or “point-of-purchase” model as opposed to a “sell-through” or “point-of-sale” model, where revenue is deferred and not recognized until the distributor sells the product through to their customer.
Our distributors may be provided limited rights that allow them to return a portion of inventory (product exchange rights or stock rotation rights) and receive credits for changes in selling prices (price protection rights) or customer pricing arrangements under our “ship and debit” program or other targeted sales incentives. When determining our net revenue, we make significant judgments and estimates corresponding with product shipments. We recognize a reserve for estimated future returns, changes in selling prices, and other targeted sales incentives when product ships. We also recognize an asset for the estimated value of product returns that we believe will be returned to inventory in the future and resold, and these estimates are based upon historical data, current economic trends, distributor inventory levels and other related factors. Our financial condition and operating results are dependent upon our ability to make reliable estimates. Actual results may vary and could have a significant impact on our operating results.
From time to time, we will issue a new price book for our products, and provide a credit to certain distributors for inventory quantities on hand if required by our agreement with the distributor. This practice is known as price protection. These credits are applied against the reserve that we establish upon initial shipment of product to the distributor.
Under the ship and debit program, products are sold to distributors at negotiated prices and the distributors are required to pay for the products purchased within our standard commercial terms. Subsequent to the initial product purchase, a distributor may request a price allowance for a particular part number(s) for certain target customers, prior to the distributor reselling the particular part to that customer. If we approve an allowance and the distributor resells the product to the target customer, we credit the distributor according to the allowance we approved. These credits are applied against a reserve we establish upon initial shipment of product to the distributor.
In addition, we run sales incentive programs with certain distributors and retailers, such as product rebates and cooperative advertising campaigns. We recognize these incentives at the time they are offered to customers and record a credit to their account with an offsetting expense as either a reduction to revenue, increase to cost of revenue, or marketing expense depending on the type of sales incentive.

Warranties
Product warranties are estimated and recognized at the time we recognize revenue. The warranty periods range from 90 days to 10 years. We estimate these warranty liabilities at the time of sale, based on historical and projected incident rates and expected future warranty costs. We evaluate our warranty reserves on a quarterly basis 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 our reliability estimates. Actual product failure rates that materially differ from our estimates could have a significant impact on our operating results.

Inventories
Inventories are stated at the lower of cost or market, with cost determined on a first-in, first-out (FIFO) method or an average cost method; and with market not to exceed net realizable value. We write-down our inventories for estimated obsolescence equal to the difference between the cost of the inventory and its estimated market value based upon an aging analysis of the inventory on hand, specifically known inventory-related risks (such as technological obsolescence), and assumptions about future demand. We also analyze sales levels by product type, including historical and estimated future customer demand for those products to determine if any additional reserves are appropriate. For example, we adjust for items that are considered obsolete based upon changes in customer demand, manufacturing process changes or new product introductions that may eliminate demand for the product. Any adjustment to our inventories as a result of an estimated obsolescence or net realizable condition is reflected as a component of our cost of revenue. At the point of the loss recognition, a new, lower-cost basis for that inventory is established, and any subsequent improvements in facts and circumstances do not result in the restoration or increase in that newly established lower-cost basis.

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In order to determine what costs can be included in the valuation of inventories, we determine normal capacity for our manufacturing facilities based on historical patterns. If our estimates regarding customer demand are inaccurate, or market conditions or technology change in ways that are less favorable than those projected by management, we may be required to take excess capacity charges in accordance with U.S. GAAP, which could have an adverse effect on our operating results.

Deferred Tax Asset Valuation Allowances
In assessing the adequacy of a recognized valuation allowance, we consider all positive and negative evidence and a variety of factors including historical and projected future taxable income and prudent and feasible tax planning strategies. When we establish or increase a valuation allowance, our income tax expense increases in the period such determination is made. If we decrease a valuation allowance, our income tax expense decreases in the period such a determination is made.

Tax Contingencies
We are subject to periodic audits of our income tax returns by federal, state, local and foreign agencies. These audits typically include questions regarding our tax filing positions, including the timing and amount of deductions and the allocation of income among various tax jurisdictions. In accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification Topic 740, “Income Taxes” (ASC 740), we regularly evaluate the exposures associated with our various tax filing positions. ASC 740 states that a tax benefit should not be recognized for financial statement purposes for an uncertain tax filing position where it is not more likely than not (likelihood of greater than 50%) for being sustained by the taxing authorities based on the technical merits of the position.
In accordance with the provisions of ASC 740, we have established unrecognized tax benefits (as a reduction to the deferred tax asset or as an increase to other liabilities) to reduce some or all of the tax benefit of any of our tax positions at the time we determine that the positions become uncertain based upon one of the following: the tax position is not “more likely than not” to be sustained; the tax position is “more likely than not” to be sustained, but for a lesser amount; or the tax position is “more likely than not” to be sustained, but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings and case law and their applicability to the facts and circumstances of the tax position; and each tax position is evaluated without consideration of the possibility of offset or aggregation with other tax positions taken. We adjust these unrecognized tax benefits, including any impact on the related interest and penalties, in light of changing facts and circumstances, such as the progress of a tax audit.
A number of years may elapse before a particular matter for which we have established an unrecognized tax benefit is audited and fully resolved. To the extent we prevail in matters for which we have established an unrecognized benefit or are required to pay amounts in excess of what we have recognized, our effective tax rate in a given financial statement period could be materially affected. An unfavorable tax settlement might require use of our cash and/or result in an increase in our effective tax rate in the year of resolution. A favorable tax settlement would be recognized as a reduction in our effective tax rate in the year of resolution.

Stock-Based Compensation
We account for awards of stock-based compensation under our employee stock-based compensation plans using the fair value method. Accordingly, we estimate the grant date fair value of our stock-based awards and amortize this fair value to compensation expense over the requisite service period or vesting term. We currently use the Black-Scholes option-pricing model to estimate the fair value of our stock option and Employee Stock Purchase Plan (ESPP) awards. The determination of the fair value of stock-based awards on the date of grant using an option-pricing model is affected by our then current 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 our financial statements. For restricted stock and stock unit awards, grant date fair value is based upon the market price of our 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.
We estimate expected forfeitures at the time of grant and revise this estimate, if necessary, in subsequent periods if actual forfeitures differ from initial estimates. Our determination of an estimated forfeiture rate is primarily based upon a review of historical experience but may also include consideration of other facts and circumstances we believe are indicative of future activity. The

40


assessment of an estimated forfeiture rate will not alter the total compensation expense to be recognized, only the timing of this recognition as compensation expense is adjusted to reflect instruments that actually vest.
If actual results are not consistent with our assumptions and judgments used in estimating key assumptions, we may be required to adjust compensation expense, which could be material to our results of operations.

Long-Lived Assets
We evaluate long-lived assets such as property, equipment and finite-lived intangible assets, such as patents, for impairment whenever events or circumstances indicate that the carrying value of the assets recognized in our financial statements may not be recoverable. Factors that we consider include whether there has been a significant decrease in the market value of an asset, a significant change in the way an asset is being used, or a significant change, delay or departure in our strategy for that asset. Our assessment of the recoverability of long-lived assets involves significant judgment and estimation. These assessments reflect our assumptions, which, we believe, are consistent with the assumptions hypothetical marketplace participants use. Factors that we must estimate when performing recoverability and impairment tests include, among others, the economic life of the asset, sales volumes, prices, cost of capital, tax rates, and capital spending. These factors are often interdependent and therefore do not change in isolation. If impairment is indicated, we first determine if the total estimated future cash flows on an undiscounted basis are less than the carrying amounts of the asset or assets. If so, an impairment loss is measured and recognized.
After an impairment loss is recognized, a new, lower cost basis for that long-lived asset is established. Subsequent changes in facts and circumstances do not result in the reversal of a previously recognized impairment loss.
Our impairment loss calculations require that we apply judgment in estimating future cash flows and asset fair values, including estimating useful lives of the assets. To make these judgments, we may use internal discounted cash flow estimates, quoted market prices when available and independent appraisals as appropriate to determine fair value.
If actual results are not consistent with our assumptions and judgments used in estimating future cash flows and asset fair values, we may be required to recognize additional impairment losses which could be material to our results of operations.

Goodwill
We test goodwill for impairment at least annually as of the first day of the fiscal fourth quarter, or when indications of potential impairment exist. We monitor for the existence of potential impairment indicators throughout the fiscal year. We conduct impairment testing for goodwill at the reporting unit level. Reporting units, as defined by FASB Accounting Standards Codification Topic 350, “Intangibles - Goodwill and Other” (ASC 350), may be operating segments as a whole or an operation one level below an operating segment, referred to as a component. We have determined that our reporting units are our three operating and reportable segments.
We may initiate goodwill impairment testing by considering qualitative factors to determine whether it is more likely than not that a reporting unit’s carrying value is greater than its fair value. Such factors may include the following, among others: a significant decline in the reporting unit’s expected future cash flows; a sustained, significant decline in our stock price and market capitalization; a significant adverse change in legal factors or in the business climate, unanticipated competition; and slower growth rates; as well as changes in management, key personnel, strategy, and customers. If our qualitative assessment indicates that goodwill impairment is more likely than not, we perform the two-step impairment test. Alternatively, we may bypass the qualitative test and initiate goodwill impairment testing with the first step of the two-step goodwill impairment test.
During the first step of the goodwill impairment test, we compare the fair value of the reporting unit to its carrying value, including goodwill. We derive a reporting units fair value through a combination of the market approach (a guideline transaction method) and the income approach (a discounted cash flow analysis). The income approach utilizes a discount rate from the capital asset pricing model. If all reporting units are analyzed during the first step of the goodwill impairment test, their respective fair values are reconciled back to our consolidated market capitalization.
If the fair value of a reporting unit exceeds its carrying value, then we conclude that no goodwill impairment has occurred. If the carrying value of the reporting unit exceeds its fair value, we perform the second step of the goodwill impairment test to measure possible goodwill impairment loss. During the second step, we hypothetically value the reporting units tangible and intangible assets and liabilities as if the reporting unit had been acquired in a business combination. Then, the implied fair value of the reporting units goodwill is compared to the carrying value of its goodwill. If the carrying value of the reporting units goodwill exceeds the implied fair value of the goodwill, we recognize an impairment loss in an amount equal to the excess, not to exceed the carrying value of the reporting units goodwill. Once an impairment loss is recognized, the adjusted carrying value of the goodwill becomes the new accounting basis of the goodwill for the reporting unit.


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Indefinite-Lived Intangible Assets
We test indefinite-lived intangible assets for impairment at least annually in the fiscal fourth quarter, or when indications of potential impairment exist. We monitor for the existence of potential impairment indicators throughout the fiscal year. Our impairment test may begin with a qualitative test to determine whether it is more likely than not that an indefinite-lived intangible assets carrying value is greater than its fair value. If our qualitative assessment indicates that asset impairment is more likely than not, we perform a quantitative impairment test by comparing the fair value of the indefinite-lived intangible asset to its carrying value. Alternatively, we may bypass the qualitative test and initiate impairment testing with the quantitative impairment test.
Determining the fair value of indefinite-lived intangible assets entails significant estimates and assumptions including, but not limited to, determining the timing and expected costs to complete development projects, estimating future cash flows from product revenue, developing appropriate discount rates, estimating probability rates for the successful completion of development projects, continuation of customer relationships and renewal of customer contracts, and approximating the useful lives of the intangible assets acquired.
If the fair value of the indefinite-lived intangible asset exceeds its carrying value, we conclude that no impairment has occurred. If the carrying value of the indefinite-lived intangible asset exceeds its fair value, we recognize an impairment loss in an amount equal to the excess, not to exceed the carrying value. Once an impairment loss is recognized, the adjusted carrying value becomes the new accounting basis of the indefinite-lived intangible asset.

Contingent Liabilities
We provide for contingent liabilities in accordance with U.S. GAAP, under which a loss contingency is charged to income when (1) it is probable that an asset has been impaired or a liability has been incurred at the date of the financial statements, and (2) the amount of the loss can be reasonably estimated.
Periodically, we review the status of each significant matter to assess the potential financial exposure. If a potential loss is considered probable and the amount can be reasonably estimated, we reflect the estimated loss in our results of operations. Significant judgment is required to determine the probability that a liability has been incurred or an asset impaired and whether such loss is reasonably estimable. Because of uncertainties related to these matters, accruals are based on the best information available at the time. Further, estimates of this nature are highly subjective, and the final outcome of these matters could vary significantly from the amounts that may have been included in the accompanying consolidated financial statements. In determining the probability of an unfavorable outcome of a particular contingent liability and whether such liability is reasonably estimable, we consider the individual facts and circumstances related to the liability, opinions of legal counsel and recent legal rulings by the appropriate regulatory bodies, among other factors.  As additional information becomes available, we reassess the potential liability related to our pending and threatened claims and litigation and may revise our estimates accordingly. Such revisions in the estimates of the potential liabilities could have a material impact on our results of operations and financial position. See also a discussion of specific contingencies in Note 12, “Commitments and Contingencies,” to our consolidated financial statements in Item 8 of this Annual Report.

Recent Accounting Pronouncements
See Note 2, “Basis of Presentation and Summary of Significant Accounting Policies,” to our consolidated financial statements in Item 8 of this Annual Report for a description of recent accounting pronouncements, including the expected dates of adoption and estimated effects, if any, on our consolidated financial statements.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk
See the section entitled “Financial and Market Risks” included in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 of this Annual Report.

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Item 8. Financial Statements and Supplementary Data

Index to Consolidated Financial Statements
 


43


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To Board of Directors and Shareholders of Cree, Inc.
In our opinion, the accompanying consolidated balance sheet and the related consolidated statement of income, comprehensive income, cash flows and shareholders’ equity present fairly, in all material respects, the financial position of Cree, Inc. and its subsidiaries at June 29, 2014, and the results of their operations and their cash flows for the year in the period ended June 29, 2014 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 29, 2014, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, appearing under Item 9A, Management's Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on these financial statements and on the Company's internal control over financial reporting based on our integrated audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 
/s/ PricewaterhouseCoopers LLP
Raleigh, North Carolina
 
August 26, 2014
 



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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders of Cree, Inc.
We have audited the accompanying consolidated balance sheet of Cree, Inc. as of June 30, 2013, and the related consolidated statements of income, comprehensive income, shareholders' equity, and cash flows for each of the two years in the period ended June 30, 2013.  These financial statements are the responsibility of the Company's management.  Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Cree, Inc. at June 30, 2013, and the consolidated results of its operations and its cash flows for each of the two years in the period ended June 30, 2013, in conformity with U.S. generally accepted accounting principles.

 
/s/ Ernst & Young LLP
Raleigh, North Carolina
 
August 27, 2013
 


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CREE, INC.
CONSOLIDATED BALANCE SHEETS
 
 
June 29,
2014
 
June 30,
2013
 
(In thousands, except par value)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents

$286,824

 

$190,069

Short-term investments
875,642

 
833,846

Total cash, cash equivalents and short-term investments
1,162,466

 
1,023,915

Accounts receivable, net
225,160

 
192,507

Inventories
284,780

 
197,001

Deferred income taxes
29,414

 
26,125

Prepaid expenses and other current assets
72,071

 
76,218

Total current assets
1,773,891

 
1,515,766

Property and equipment, net
605,713

 
542,833

Goodwill
616,345

 
616,345

Intangible assets, net
336,423

 
357,525

Other assets
11,997

 
19,941

Total assets

$3,344,369

 

$3,052,410

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current liabilities:

 

Accounts payable, trade

$202,294

 

$121,441

Accrued salaries and wages
50,527

 
41,407

Income taxes payable
14,848

 
1,315

Other current liabilities
38,986

 
43,248

Total current liabilities
306,655

 
207,411

Long-term liabilities:
 
 
 
Deferred income taxes
12,173

 
25,504

Other long-term liabilities
35,395

 
12,843

Total long-term liabilities
47,568

 
38,347

Commitments and contingencies (Note 12)

 

Shareholders’ equity:
 
 
 
Preferred stock, par value $0.01; 3,000 shares authorized at June 29, 2014 and June 30, 2013; none issued and outstanding

 

Common stock, par value $0.00125; 200,000 shares authorized at June 29, 2014 and June 30, 2013; 120,114 and 119,623 shares issued and outstanding at June 29, 2014 and June 30, 2013, respectively
149

 
148

Additional paid-in-capital
2,190,011

 
2,025,764

Accumulated other comprehensive income, net of taxes
11,405

 
8,244

Retained earnings
788,581

 
772,496

Total shareholders’ equity
2,990,146

 
2,806,652

Total liabilities and shareholders’ equity

$3,344,369

 

$3,052,410

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

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CREE, INC.
CONSOLIDATED STATEMENTS OF INCOME
 
 
Fiscal Years Ended
 
June 29,
2014
 
June 30,
2013
 
June 24,
2012
 
(In thousands, except per share data)
Revenue, net

$1,647,641

 

$1,385,982

 

$1,164,658

Cost of revenue, net
1,028,846

 
862,722

 
755,196

Gross profit
618,795

 
523,260

 
409,462