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CREE INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Information set forth in this Quarterly Report on Form 10-Q contains various "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended (the Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). All information contained in this report relative to future markets for our products and trends in and anticipated levels of revenue, gross margins and expenses, as well as other statements containing words such as "believe," "project," "may," "will," "anticipate," "target," "plan," "estimate," "expect" and "intend" and other similar expressions constitute forward-looking statements. These forward-looking statements are subject to business, economic and other risks and uncertainties, both known and unknown, and actual results may differ materially from those contained in the forward-looking statements. Any forward-looking statements we make are as of the date made, and except as required under the U.S. federal securities laws and the rules and regulations of the Securities and Exchange Commission (the SEC), we have no duty to update them if our views later change. These forward-looking statements should not be relied upon as representing our views as of any date subsequent to the date of this Quarterly Report. Examples of risks and uncertainties that could cause actual results to differ materially from historical performance and any forward-looking statements include, but are not limited to, those described in "Risk Factors" in Part II, Item 1A of this Quarterly Report. Executive Summary The following discussion is designed to provide a better understanding of our unaudited consolidated financial statements, including a brief discussion of our business and products, key factors that impacted our performance and a summary of our operating results. The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q, and the consolidated financial statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the fiscal year ended June 29, 2014. 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. 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. 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 1 of this Quarterly Report. Reportable Segments Our three reportable segments are: • LED Products • Lighting Products • Power and RF Products 19-------------------------------------------------------------------------------- Table of Contents For further information about our reportable segments, please refer to Note 12, "Reportable Segments," in our consolidated financial statements included in Item 1 of this Quarterly Report. Industry Dynamics and Trends There are a number of industry factors that affect our business which include, among others: • Overall Demand for Products and Applications using LEDs. Our potential for growth depends significantly on the 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 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. Overview of the Three Months Ended September 28, 2014 The following is a summary of our financial results for the three months ended September 28, 2014: • Revenue increased to $428 million for the three months ended September 28, 2014 from $391 million for the three months ended September 29, 2013. • Gross profit decreased to $136 million for the three months ended September 28, 2014 from $151 million for the three months ended September 29, 2013. Gross margin declined to 32% for the three months ended September 28, 2014 from 39% for the three months ended September 29, 2013. • Operating income decreased to $11 million for the three months ended September 28, 2014 from $37 million for the three months ended September 29, 2013. Net income per diluted share decreased to $0.09 for the three months ended September 28, 2014 from $0.25 for the three months ended September 29, 2013. 20-------------------------------------------------------------------------------- Table of Contents • Cash, cash equivalents and short-term investments decreased to $1.1 billion at September 28, 2014 compared to $1.2 billion at June 29, 2014. Cash provided by operating activities was $13 million for the three months ended September 28, 2014, compared to $69 million for the three months ended September 29, 2013. • Inventories increased to $311 million at September 28, 2014 compared to $285 million at June 29, 2014. • Purchases of property and equipment were $63 million for the three months ended September 28, 2014 compared to $34 million for the three months ended September 29, 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: • Build financial momentum. We target generating incremental operating margin over time through revenue growth and incremental operating leverage across the business. In fiscal 2015, we target revenue growth in Lighting Products and Power and RF Products, while LED Products revenue is currently targeted to be lower for the fiscal year. We have been developing a new LED technology platform that is targeted to drive new design wins for our market leading high power LED products later in fiscal 2015. As a result, we currently target incremental operating leverage in the second half of fiscal 2015 as compared with the first half of fiscal 2015. • 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 believe we can further accelerate LED lighting adoption by continuing to innovate in LEDs and LED lighting systems 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 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. • 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 products. Our internal team is focused primarily on the high-performance, high-power LEDs that differentiate Cree in the market. We work with external manufacturers on mid-power LEDs. As demand increases, we plan to expand production at both our manufacturing partners and our own factories over time to support our targeted growth, optimize our factory utilization and focus our capital spending on higher value products. 21-------------------------------------------------------------------------------- Table of Contents 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): Three Months Ended September 28, September 29, 2014 2013 Dollars % of Revenue Dollars % of Revenue Revenue, net $427,672 100 % $391,006 100 % Cost of revenue, net 291,852 68 % 240,249 61 % Gross profit 135,820 32 % 150,757 39 % Research and development 46,725 11 % 41,743 11 % Sales, general and administrative 69,692 16 % 64,278 16 % Amortization or impairment of acquisition-related intangibles 6,499 2 % 7,287 2 % Loss on disposal or impairment of long-lived assets 1,447 - % 657 - % Operating income 11,457 3 % 36,792 9 % Non-operating income, net 2,904 1 % 2,818 1 % Income before income taxes 14,361 3 % 39,610 10 % Income tax expense 3,231 1 % 9,113 2 % Net income $11,130 3 % $30,497 8 % Basic earnings per share $0.09 $0.26 Diluted earnings per share $0.09 $0.25 Revenue Revenue was comprised of the following (in thousands, except percentages): Three Months Ended September 28, September 29, 2014 2013 Change LED Products revenue $173,590 $218,023 ($44,433 ) (20 )% Percent of revenue 41 % 56 % Lighting Products revenue 223,086 147,918 75,168 51 % Percent of revenue 52 % 38 % Power and RF Products revenue 30,996 25,065 5,931 24 % Percent of revenue 7 % 6 % Total revenue $427,672 $391,006 $36,666 9 % Our consolidated revenue increased 9% to $427.7 million for the three months ended September 28, 2014 from $391.0 million for the three months ended September 29, 2013. The increase was driven primarily by the 51% increase in Lighting Products revenue, offset by the 20% decrease in LED Products revenue. LED Products Segment Revenue LED Products revenue represented 41% and 56% of our total revenue for the three months ended September 28, 2014 and September 29, 2013, respectively. LED Products revenue decreased 20% to $173.6 million for the three months ended September 28, 2014 from $218.0 million for the three months ended September 29, 2013. This decrease was the result of an overall decrease in the number of units sold and lower pricing, due to weaker global demand for LED Products. 22-------------------------------------------------------------------------------- Table of Contents Lighting Products Segment Revenue Lighting Products revenue represented approximately 52% and 38% of our total revenue for the three months ended September 28, 2014 and September 29, 2013, respectively. Lighting Products revenue increased 51% to $223.1 million for the three months ended September 28, 2014 from $147.9 million for the three months ended September 29, 2013. This increase was the result of an overall increase in the number of units sold, partially offset by a reduction in ASP primarily due to a higher mix of lower priced LED bulb products. Power and RF Products Segment Revenue Power and RF Products revenue represented approximately 7% and 6% of our total revenue for the three months ended September 28, 2014 and September 29, 2013, respectively. Power and RF Products revenue increased 24% to $31.0 million for the three months ended September 28, 2014 from $25.1 million for the three months ended September 29, 2013. This increase was the result of an overall increase in the number of units sold, which was partially offset by a reduction in ASP. Gross Profit and Gross Margin Gross profit and gross margin were as follows (in thousands, except percentages): Three Months Ended September 28, September 29, 2014 2013 Change LED Products gross profit $67,624 $101,653 ($34,029 ) (33 )% LED Products gross margin 39.0 % 46.6 % Lighting Products gross profit 55,592 39,818 15,774 40 % Lighting Products gross margin 24.9 % 26.9 % Power and RF Products gross profit 17,857 13,456 4,401 33 % Power and RF Products gross margin 57.6 % 53.7 % Unallocated costs (5,253 ) (4,170 ) (1,083 ) 26 % Consolidated gross profit $135,820 $150,757 ($14,937 ) (10 )% Consolidated gross margin 31.8 % 38.6 % Our consolidated gross profit decreased 10% to $135.8 million for the three months ended September 28, 2014 from $150.8 million for the three months ended September 29, 2013. Our consolidated gross margin decreased to 31.8% for the three months ended September 28, 2014 from 38.6% for the three months ended September 29, 2013. LED Products Segment Gross Profit and Gross Margin LED Products gross profit decreased 33% to $67.6 million for the three months ended September 28, 2014 from $101.7 million for the three months ended September 29, 2013. LED Products gross margin decreased to 39.0% for the three months ended September 28, 2014 from 46.6% for the three months ended September 29, 2013. LED Products gross profit and gross margin decreases were due to lower units sold and lower pricing, as a result of weaker global demand. Lighting Products Segment Gross Profit and Gross Margin Lighting Products gross profit increased 40% to $55.6 million for the three months ended September 28, 2014 from $39.8 million for the three months ended September 29, 2013. Lighting Products gross margin decreased to 24.9% for the three months ended September 28, 2014 from 26.9% for the three months ended September 29, 2013. Lighting Products gross profit increased for the three months ended September 28, 2014 as compared to the three months ended September 29, 2013 due to growth in LED lighting products sales. Lighting Products gross margin decreased for the three months ended September 28, 2014 as compared to the three months ended September 29, 2013 due to changes in product mix driven primarily by higher sales of LED bulbs, which have lower gross margins. 23-------------------------------------------------------------------------------- Table of Contents Power and RF Products Segment Gross Profit and Gross Margin Power and RF Products gross profit increased 33% to $17.9 million for the three months ended September 28, 2014 from $13.5 million for the three months ended September 29, 2013. Power and RF Products gross margin increased to 57.6% for the three months ended September 28, 2014 from 53.7% for the three months ended September 29, 2013. Power and RF Products gross profit and gross margin increases were due primarily to higher revenue, factory cost reductions and increased factory utilization . These benefits more than offset the decline in the ASP for the three months ended September 28, 2014 as compared to the three months ended September 29, 2013. Unallocated Costs Unallocated costs were $5.3 million and $4.2 million for the three months ended September 28, 2014 and September 29, 2013, 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. The increase of $1.1 million for the three months ended September 28, 2014 as compared to the three months ended September 29, 2013 was primarily attributable to higher incentive compensation, as well as higher stock-based compensation, resulting from an increase in historical grant date stock prices. 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): Three Months Ended September 28, September 29, 2014 2013 Change Research and development $46,725 $41,743 $4,982 12 % Percent of revenue 11 % 11 % Research and development expenses for the three months ended September 28, 2014 increased 12% to $46.7 million from $41.7 million for the three months ended September 29, 2013. This increase was primarily due to increased spending on research and development activities focused on new higher performance and lower cost products in all our product lines. Our research and development expenses vary significantly from quarter to quarter 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. 24-------------------------------------------------------------------------------- Table of Contents 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): Three Months Ended September 28, September 29, 2014 2013 Change Sales, general and administrative $69,692 $64,278 $5,414 8 % Percent of revenue 16 % 16 % Sales, general and administrative expenses for the three months ended September 28, 2014 increased 8% to $69.7 million from $64.3 million for the three months ended September 29, 2013. This increase was primarily due to an increase in spending on sales and marketing for lighting products, including commissions and advertising, as we continue to expand our direct sales resources and channels and invest in building and promoting the Cree brand. 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. Amortization of intangible assets related to our acquisitions was as follows (in thousands, except percentages): Three Months Ended September 28, September 29, 2014 2013 Change Customer relationships $1,345 $1,843 ($498 ) (27 )% Developed technology 4,660 4,948 (288 ) (6 )% Non-compete agreements 490 490 - - % Trade names, finite-lived 4 6 (2 ) (33 )% Total amortization $6,499 $7,287 ($788 ) (11 )% 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): Three Months Ended September 28, September 29, 2014 2013 Change Loss on disposal or impairment of long-lived assets $1,447 $657 $790 120 % We recognized a net loss of $1.4 million and $0.7 million on the disposal of long-lived assets for the three months ended September 28, 2014 and the three months ended September 29, 2013, respectively. These net losses were primarily the result of disposals of equipment due to changes in various manufacturing processes, the abandonment of certain patent assets as a result of technological obsolescence and dispositions of building improvements as we expand our manufacturing facilities to support future growth. 25-------------------------------------------------------------------------------- Table of Contents Non-Operating Income, net The following table sets forth our non-operating income, net (in thousands, except percentages): Three Months Ended September 28, 2014 September 29, 2013 Change Foreign currency (loss) gain, net ($231 ) $264 ($495 ) (188 )% Gain on sale of investments, net 2 10 (8 ) (80 )% Interest income, net 3,032 2,341 691 30 % Other, net 101 203 (102 ) (50 )% Non-operating income, net $2,904 $2,818 $86 3 % Foreign currency (loss) gain, net. Foreign currency (loss) gain, net consisted primarily of remeasurement adjustments resulting from consolidating our international subsidiaries. The foreign currency loss for the three months ended September 28, 2014 was primarily due to fluctuations in the exchange rate between the EURO and the United States Dollar. The foreign currency gain for the three months ended September 29, 2013 was 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 $2 thousand for the three months ended September 28, 2014 compared to $10 thousand for the three months ended September 29, 2013. Interest income, net. Interest income, net was $3.0 million for the three months ended September 28, 2014 compared to $2.3 million for the three months ended September 29, 2013. The increase in interest income, net for the three months ended September 28, 2014 was primarily due to earning higher investment yields and higher invested balances as compared to the three months ended September 29, 2013. Other, net. Other, net was $0.1 million for the three months ended September 28, 2014 compared to $0.2 million for the three months ended September 29, 2013. Income Tax Expense The following table sets forth our income tax expense in dollars and our effective tax rate (in thousands, except percentages): Three Months Ended September 28, 2014 September 29, 2013 Change Income tax expense $3,231 $9,113 ($5,882 ) (65 )% Effective tax rate 22.5 % 23.0 % The variation between our effective income tax rate and the U.S. statutory rate of 35 percent is due to a percentage of our projected income for the full year being derived from international locations with lower tax rates than the U.S. and the impact of tax credits available in the current year. A change in the mix of pretax income of our various tax jurisdictions can have a material impact on our periodic effective tax rate. We recognized income tax expense of $3.2 million for an effective tax rate of 22.5% for the three months ended September 28, 2014 as compared to income tax expense of $9.1 million for an effective tax rate of 23.0% for the three months ended September 29, 2013. This decrease in income tax expense was primarily due to lower pretax income. 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, cash generated from operations and availability under our line of credit. 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. 26-------------------------------------------------------------------------------- Table of Contents Based on past performance and current expectations, we believe our current working capital, availability under our line of credit 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, line of credit 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. Liquidity Our liquidity and capital resources primarily 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 September 28, June 29, 2014 2014 Change Days of sales outstanding(a) 50 46 4 Days of supply in inventory(b) 96 94 2 Days in accounts payable(c) (61) (66) 5 Cash conversion cycle 85 74 11 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. 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 increase in the cash conversion cycle was primarily driven by an increase in days sales outstanding and a decrease in days in accounts payable. As of September 28, 2014, we had unrealized losses on our investments of $0.4 million. All of our investments had investment grade ratings, and any such investments that were in an unrealized loss position at September 28, 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 September 28, 2014. 27-------------------------------------------------------------------------------- Table of Contents Cash Flows In summary, our cash flows were as follows (in thousands, except percentages): Three Months Ended September 28, 2014 September 29, 2013 Change Net cash provided by operating activities $13,284 $69,236 ($55,952 ) (81 )% Net cash used in investing activities (107,651 ) (105,956 ) (1,695 ) 2 % Net cash provided by financing activities 4,232 34,407 (30,175 ) (88 )% Effects of foreign exchange changes on cash and cash equivalents (389 ) 126 (515 ) (409 )% Net decrease in cash and cash equivalents ($90,524 ) ($2,187 ) ($88,337 ) 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 decreased to $13.3 million for the three months ended September 28, 2014 from $69.2 million for the three months ended September 29, 2013. This decrease was primarily due to a decrease in net income and an increase in our working capital. 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 $107.7 million for the three months ended September 28, 2014 compared to $106.0 million for the three months ended September 29, 2013. Our capital spending increased $29.8 million to make manufacturing capacity investments to support our future growth. This increase was partially offset by lower net purchases of short-term investments of $28.1 million for the three months ended September 28, 2014 compared to the three months ended September 29, 2013. We continue to actively manage our capital spending. For fiscal 2015, we target approximately $200.0 million of capital investment which is primarily related to infrastructure projects to support our longer term growth and strategic priorities. Cash Flows from Financing Activities Net cash provided by financing activities was $4.2 million for the three months ended September 28, 2014 and $34.4 million for the three months ended September 29, 2013. For the three months ended September 28, 2014, our financing activities primarily consisted of net borrowings on our line of credit of $45 million, proceeds of $13.6 million from net issuances of common stock pursuant to the exercise of employee stock options, including the excess tax benefit on those exercises, partially offset by the repurchase of common stock worth approximately $54.3 million. For the three months ended September 29, 2013, our financing activities primarily consisted of proceeds of $34.4 million from net issuances of common stock pursuant to the exercise of employee stock options, including the excess tax benefit on those exercises. 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 September 28, 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. Please refer to Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended June 29, 2014, in the section entitled "Contractual Obligations" for the future minimum lease payments due under our operating leases as of June 29, 2014. There have been no significant changes to the contractual obligations discussed therein, except for our new line of credit as discussed in Note 6, "Long-term Debt," in our consolidated financial statements included in Item 1 of this Quarterly Report. 28-------------------------------------------------------------------------------- Table of Contents Critical Accounting Policies and Estimates For information about our critical accounting policies and estimates, see the "Critical Accounting Policies and Estimates" section of "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the fiscal year ended June 29, 2014. New Accounting Standards Revenue from Contracts with Customers In May 2014, the FASB issued Accounting Standards Update (ASU) No. 2014-09: Revenue from Contracts with Customers (Topic 606). The ASU establishes a principles-based approach for accounting for revenue arising from contracts with customers and supersedes existing revenue recognition guidance. The ASU provides that an entity should apply a five-step approach for recognizing revenue, including (1) identify the contract with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when, or as, the entity satisfies a performance obligation. Also, the entity must provide various disclosures concerning the nature, amount and timing of revenue and cash flows arising from contracts with customers. The effective date will be the first quarter of our fiscal year ending June 24, 2018, using one of two retrospective application methods. The Company is currently analyzing the impact of this new accounting guidance. Item 3. Quantitative and Qualitative Disclosures About Market Risk For quantitative and qualitative disclosures about our market risks, see "Part II. Item 7A. Quantitative and Qualitative Disclosures About Market Risk" of our Annual Report on Form 10-K for the fiscal year ended June 29, 2014. There have been no material changes to the amounts presented therein, except as noted below. We maintain an unsecured revolving line of credit under which the Company may borrow, repay and reborrow loans from time to time prior to its scheduled maturity date of August 12, 2017. At September 28, 2014, we had $45.0 million outstanding under the line of credit. If interest rates were to increase by 100 basis points, the annual interest incurred under our line of credit would increase $0.5 million. Item 4. Controls and Procedures Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Form 10-Q. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this Form 10-Q, our disclosure controls and procedures are effective in that they provide reasonable assurances that the information we are required to disclose in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods required by the SEC's rules and forms and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. We routinely review our internal control over financial reporting and from time to time make changes intended to enhance the effectiveness of our internal control over financial reporting. We will continue to evaluate the effectiveness of our disclosure controls and procedures and internal control over financial reporting on an ongoing basis and will take action as appropriate. There have been no changes to our internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act, during the first quarter of fiscal 2015 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. |