UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended DecemberMarch 30, 20072008

or

For the transition period from            to            

Commission file number 0-21154

CREE, INC.

(Exact name of registrant as specified in its charter)

(919) 313-5300

(Registrant'sRegistrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a non-accelerated filer.smaller reporting company. See definitionthe definitions of “accelerated filer and large“large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  x    Accelerated filer  ¨    Non-accelerated filer  ¨

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

The number of shares outstanding of the registrant’s common stock, par value $0.00125 per share, as of January 15,April 22, 2008, was 85,610,550.89,669,120.

CREE, INC.

FORM 10-Q

For the Three and Six MonthsQuarterly Period Ended DecemberMarch 30, 20072008

INDEX

PART I - I—FINANCIAL INFORMATION

CREE, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share amounts)

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

CREE, INC.

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share amounts)

(Unaudited)

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

CREE, INC.

CONSOLIDATED STATEMENTS OF CASH FLOW

(In thousands)

(Unaudited)

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

CREE, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DecemberMarch 30, 20072008

(Unaudited)

1. Basis of Presentation

The consolidated balance sheet at DecemberMarch 30, 20072008 and the consolidated statements of income for the three and sixnine months ended DecemberMarch 30, 20072008 and December 24, 2006,March 25, 2007, and the consolidated statements of cash flows for the sixnine months ended DecemberMarch 30, 20072008 and December 24, 2006March 25, 2007 have been prepared by Cree, Inc. (collectively with its subsidiaries, the “Company”) and have not been audited. In the opinion of management, all normal and recurring adjustments necessary to present fairly the consolidated financial position, results of operations and cash flows at DecemberMarch 30, 2007,2008, and for all periods presented, have been made. The consolidated balance sheet at June 24, 2007 has been derived from the audited financial statements as of that date.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. It is suggested that these financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 24, 2007. The results of operations for the period ended DecemberMarch 30, 20072008 are not necessarily indicative of the operating results that may be attained for the entire fiscal year.

2. Significant Accounting Policies

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All material intercompany accounts and transactions have been eliminated in consolidation.

Fiscal Year

The Company’s fiscal year is a 52- or 53-week period ending on the last Sunday in the month of June. The Company’s 2008 fiscal year extends from June 25, 2007 through June 29, 2008 and is a 53-week fiscal year, with the additional week included in the Company’s fiscal second quarter. The Company’s 2007 fiscal year extended from June 26, 2006 through June 24, 2007 and was a 52-week fiscal year.

Use of Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to revenue recognition, provision for doubtful accounts and sales returns, provision for inventory obsolescence, fair value of investments, fair value of acquired intangible assets and goodwill, useful lives of intangible assets and property and equipment, income taxes, product warranty obligations, employee stock options, and contingencies and litigation, among others. The Company generally bases its estimates on historical experience and on various other assumptions 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. Actual amounts could differ from those estimates.

Accounting Changes

In the first quarter of fiscal 2008, the Company adopted Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109,” (“FIN 48”). See Note 10, “Income Taxes” below for a further discussion onof the Company’s adoption of FIN 48.

Reclassifications

Certain fiscal 2007 amounts in the accompanying consolidated financial statements have been reclassified to conform to the fiscal 2008 presentation. These reclassifications had no effect on previously reported consolidated net income or shareholders’ equity.

Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities, at December 30, 2007 and June 24, 2007, and the reported amounts of revenues and expenses during the three and six months ended December 30, 2007 and December 24, 2006. Actual amounts could differ from those estimates.

Revenue Recognition

The Company provides its customers with limited rights of return for non-conforming shipments. In addition, certain of the Company’s contractual sales arrangements provide for limited product exchanges and the potential for reimbursement of certain sales costs. As a result, the Company records an allowance, which is recorded as a reduction of product revenue in the consolidated statements of income and as a reduction to accounts receivable in the consolidated balance sheets.

The Company estimates its allowance in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 48, “Revenue Recognition When Right of Return Exists” (“SFAS 48”). Specifically, the Company reviews historical sales returns and other relevant data and matches returns or other credits to the quarter when the sales were originally recorded. Based on historical return percentages and other relevant factors, the Company estimates its potential future exposure on product sales that have been recorded. The allowance for sales returns at DecemberMarch 30, 20072008 and June 24, 2007 was $4.8$5.1 million and $4.6 million, respectively.

In accordance with SFAS 48, the Company also records an estimate for the value of product returns that it believes will be returned to inventory in the future and resold. As of DecemberMarch 30, 20072008 and June 24, 2007, the Company estimated the cost of future product returns at $1.6$1.9 million and $1.3 million, respectively, which is recorded in prepaid expenses and other current assets in the consolidated balance sheets.

Investments

Investments are accounted for in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS 115”). This statement requires certain securities to be classified into three categories:

Investments in marketable securities with maturities beyond one year may be classified as short term based on their highly liquid nature and because such marketable securities represent the investment of cash that is available for current operations.

In accordance with SFAS 115, the Company reassesses the appropriateness of the classification (i.e. held-to-maturity, trading securities, or available-for-sale) of its investments at the end of each reporting period. At March 30, 2008, the Company determined that its marketable securities previously classified as held-to-maturity, should be reclassified to available-for-sale. This was based upon management’s determination during the quarter ended March 30, 2008, that it no longer had the positive intent to hold

the securities to maturity, as the underlying cash invested in these securities would be made available for operations. As a result of this determination, investments with amortized cost of approximately $102.6 million were transferred to available-for-sale. These investments are required to be carried at fair value, which resulted in a net increase in the carrying value of these investments of $2.3 million with a corresponding increase in accumulated other comprehensive income net of the related tax effect.

Foreign Currency Translation

In accordance with SFAS No. 52, “Foreign Currency Translation” (“SFAS 52”), certain of the Company’s international operations use the local currency as their functional currency. For the Company’s international operations in which the functional currency is considered to be the local currency, the foreign currency is translated into the Company’s reporting currency, the U.S. Dollar, using exchange rates in effect at period end for assets and liabilities and average exchange rates during each reporting period for the results of operations. Adjustments resulting from the translation of these foreign subsidiaries’ financial statements are reported in accumulated other comprehensive income (loss). The foreign currency translation adjustment is not adjusted for income taxes since it relates to the Company’s indefinite investment in non-U.S. subsidiaries. Gains or losses on foreign currency transactions are recognized in current operations.

Reclassifications

Certain fiscal 2007 amounts in the accompanying consolidated financial statements have been reclassified to conform to the fiscal 2008 presentation. These reclassifications had no effect on previously reported consolidated net income or shareholders’ equity.

3. Acquisitions

The Company records the assets acquired and liabilities assumed in business combinations at their respective fair values at the date of acquisition, with any excess purchase price recorded as goodwill. Valuation of intangible assets and in-process research and development 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 sales, 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.

Acquisition of LED Lighting Fixtures, Inc.

On February 29, 2008 the Company acquired LED Lighting Fixtures, Inc. (now Cree LED Lighting Solutions, Inc.) (“LLF”) through a wholly owned subsidiary. The Company acquired all of the outstanding share capital of LLF in exchange for total upfront consideration of $80.8 million, consisting of i) $16.5 million in cash, ii) 1,852,335 shares of the Company’s common stock valued at $58.8 million, iii) the assumption of fully vested LLF employee stock options valued at $4.5 million, and iv) transaction costs of $1.0 million consisting primarily of professional fees incurred relating to attorneys, accountants and valuation advisors. Additional consideration of up to $26.4 million may be payable to the former shareholders of LLF if defined product development targets and key employee retention measures are achieved over the next three calendar years. If such contingent payments occur, these will be considered as additional purchase price and result in an increase in goodwill.

The total purchase price for this acquisition is as follows (amounts in 000’s):

The purchase price for this acquisition has been preliminarily allocated to the assets acquired and liabilities assumed based on their estimated fair values as follows (amounts in 000’s):

The goodwill associated with the acquisition of LLF is not deductible for tax purposes.

The assets, liabilities, and operating results of LLF have been included in the Company’s consolidated financial statements from the date of acquisition. Pro forma information giving effect to this acquisition has not been presented because the pro forma information would not differ materially from historical results.

Acquisition of COTCO Luminant Device Limited

On March 30, 2007, Cree, Inc., acquired COTCO Luminant Device Limited (now Cree Hong Kong Limited), a Hong Kong company (“COTCO”), from COTCO Holdings Limited (now United Luminous International (Holdings) Limited), a Hong Kong company (“Holdings”). The Company acquired all of the outstanding share capital of COTCO in exchange for consideration consisting of 7,604,785 shares of the

Company’s common stock and $77 million cash. Additional consideration of up to $125 million may be payable to Holdings or its designees in the event COTCO achieves specific EBITDA targets over the Company’s next two fiscal years. The Company may elect to pay the additional consideration, if any, in cash, shares of the Company’s common stock or a combination of cash and stock, so long as the total number of shares of the Company’s common stock issued to Holdings relating to the transaction is less than 9.99% of the Company’s then outstanding common stock.

This acquisition has been accounted for under the purchase method of accounting as prescribed by SFAS 141, “Business Combinations”. All related goodwill and other intangible assets have been accounted for in accordance with SFAS 142, “Goodwill and Other Intangible Assets.” The goodwill associated with the acquisition of COTCO is not expected to be tax deductible.

The total purchase price for this acquisition is as follows (amounts in 000’s):

The purchase price for this acquisition has been preliminarily allocated based on estimated fair values ofto the assets acquired and liabilities assumed. The allocation of the purchase price will be finalized within one year of the date of the acquisition. The Company’s preliminary purchase price allocation isassumed based on their estimated fair values as follows (amounts in 000’s):

The goodwill associated with the acquisition of COTCO is not deductible for tax purposes.

The following unaudited pro forma information presents a summary of the Company’s consolidated results of operations as if the COTCO transaction occurred at the beginning of the fiscal year for the period presented (amounts in 000’s, except per share data):

4.	Inventories

4. Inventories

Inventories are stated at the lower of cost or market, with cost determined using the first-in, first-out (“FIFO”) method for finished goods and work-in-progress accounts. The Company uses the average cost method to value raw materials. The Company records a reserve against inventory once it has been determined that conditions exist which may not allow the Company to sell the inventory for its intended purpose, the inventory’s value is determined to be less than cost or it is determined to be obsolete. The charge for the inventory reserves is recorded in cost of revenue in the consolidated statements of income. Reserves are adjusted quarterly to reflect inventory values in excess of forecasted sales, as well as overall inventory risk assessed by management. The following is a summary of inventory:

5. Investments

During the fourth quarter of fiscal 2007, Color Kinetics Incorporated (“Color Kinetics”) announced that it had been acquired. The transaction closed during the Company’s first fiscal quarter of 2008 ended September 23, 2007, and as a result the Company liquidated its remaining 500,000 shares of Color Kinetics stock. The Company no longer holds an equity investment in Color Kinetics. The Company received proceeds of $17.0 million and recognized a pre-tax gain of $14.1 million from this transaction in the consolidated statement of income during the quarter.its first fiscal quarter of 2008 ended September 23, 2007.

6. Intangible Assets and Goodwill

Intangible Assets

The following table reflects the components of intangible assets:

AmortizationTotal amortization expense, including the amortization of acquisition related intangibles, patents and license rights, recognized during the three and sixnine months ended DecemberMarch 30, 2007 and December 24, 20062008 was $4.9$5.0 million and $9.7$14.8 million, respectively. For the three and $1.0 millionnine months ended March 25, 2007, total amortization expense, including the amortization of acquisition related intangibles, patents and $1.7license rights, was $900,000 and $2.6 million, respectively.

Customer relationships are amortized over ten years. Developed technology istechnologies are amortized over periods ranging from seven to fourteen years. Patent and license rights are amortized over twenty years.

Goodwill

7.	Earnings Per Share

The changes in goodwill during the nine months ended March 30, 2008 are as follows:

7. Earnings Per Share

The following computation reconciles the differences between the basic and diluted earnings per share presentations:

Potential common shares that would have the effect of increasing diluted earnings per share are considered to be antidilutive. In accordance with SFAS No. 128, “Earnings per Share,” these shares were not included in calculating diluted earnings per share. For the three and sixnine months ended DecemberMarch 30, 20072008 there were 4.6 million and 4.24.3 million shares, respectively, not included in calculating diluted earnings per share because their effect was antidilutive. For the three and sixnine months ended December 24, 2006March 25, 2007 there were 8.09.5 million and 8.7 million shares, in both periods that wererespectively, not included in calculating diluted earnings per share because their effect was antidilutive.

8.	Shareholders’ Equity

8. Shareholders’ Equity

The following presents a summary of activity in shareholders’ equity for the sixnine months ended DecemberMarch 30, 20072008 (dollars and shares in thousands):

9. Stock-Based Compensation

The Company currently has one equity-based compensation plan from which stock-based compensation awards can be granted to employees and directors. In addition, the Company has five plans that have been terminated as to future grants, but under which options are currently outstanding. The Company also has an Employee Stock Purchase Plan (“ESPP”) that provides employees with the opportunity to purchase the Company’s common stock at 85% of the fair market value of the common stock at two designated times each year.

The Company recorded stock-based compensation expense of $3.9 million and $7.2 million for the three and six months ended December 30, 2007, respectively. The Company recorded stock-based compensation of $2.7 million and $6.4 million for the three and six months ended December 24, 2006, respectively. Approximately $429,000 and $699,000 of stock-based compensation has been recorded in inventory in the Company’s consolidated balance sheets as of December 30, 2007 and June 24, 2007, respectively.

The fair value of each award is estimated on the date of grant using the Black-Scholes-Merton option-pricing model using the following assumptions:Stock Option Awards

The following table summarizes option activity as of DecemberMarch 30, 2007,2008, and changes during the sixnine months then ended:

Restricted Stock Awards

A summary of nonvested shares of restricted stock awards outstanding under the Company’s 2004 Long-Term Incentive Compensation Plan as of DecemberMarch 30, 2007,2008, and changes during the sixnine months then ended, follows:

Stock-Based Compensation Valuation and Expense

10.	Income Taxes

The Company accounts for its employee stock-based compensation plans using the fair value method. The fair value method requires the Company to estimate the grant date fair value of its stock-based awards and amortize this fair value to compensation expense over the requisite service period or vesting term. To estimate the fair value of the Company’s stock option awards and employee stock purchase plan shares the Company currently uses the Black-Scholes option-pricing model. The determination of the fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of complex and subjective variables. These variables include the expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends. Due to the inherent limitations of option-valuation models available today, including future events that are unpredictable and the estimation process utilized in determining the valuation of the stock-based awards, the ultimate value realized by award holders may vary significantly from the amounts expensed in the Company’s financial statements. For restricted stock awards, grant date fair value is based upon the market price of the Company’s common stock on the date of the grant. This fair value is then amortized to compensation expense over the requisite service period or vesting term.

The weighted average assumptions used to value stock option grants and purchase rights under the Employee Stock Purchase Plan were as follows:

SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from initial estimates. Forfeitures are based primarily upon historical experience. Total estimated share-based compensation expense net of estimated forfeitures and capitalized amounts, related to the Company’s stock options, restricted stock awards and employee stock purchase plan was $4.1 million and $11.3 million, respectively, for the three and nine months ended March 30, 2008 and $2.7 million and $9.2 million, respectively, for the three and nine months ended March 25, 2007.

Approximately $781,000 and $699,000 of stock-based compensation has been recorded in inventory in the Company’s consolidated balance sheets as of March 30, 2008 and June 24, 2007, respectively.

10. Income Taxes

The variation between income taxes and income tax expense at the statutory rate of 35% is primarily due to the consolidation of our foreign operations, which are subject to income taxes at lower statutory rates.

Effective with the beginning of the first quarter of 2008, the Company adopted the provisions of FIN 48. FIN 48 contains a two-step approach to recognizing and measuring uncertain tax positions accounted for in accordance with SFAS No. 109, “Accounting for Income Taxes.” The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is cumulatively more than 50% likely to be realized upon ultimate settlement.

As a result of the implementation of FIN 48, the Company recognized an increase in total unrecognized tax benefits of $2.7 million, and accounted for the increase as a cumulative effect of a change in accounting principle that resulted in a decrease to retained earnings of $36,000 and an increase to the goodwill associated with the acquisition of COTCO, of $2.7 million. The total amount of gross unrecognized tax benefits as of the date of adoption was $8.4 million. The Company has historically classified all unrecognized tax benefits as long-term deferred tax liabilities. As a result of the adoption of FIN 48, unrecognized tax benefits have been reclassified to long-term contingent tax reserves. The total amount of gross unrecognized tax benefits remains unchanged at Decemberas of March 30, 2007.2008 is $15.2 million. The $6.8 million increase is comprised of newly acquired uncertain tax positions and re-measurement of existing uncertain tax positions relating to prior periods. Of the $8.4$15.2 million total unrecognized tax benefits, $5.2$7.9 million represents tax positions that, if recognized, would impact the effective tax rate. Although timing of the resolution and/or closure on audits is highly uncertain, the Company believes it is reasonably possible that the balanceapproximately $8.0 million of gross unrecognized tax benefits will materially change in the next 12 months.

The Company’s policy is to include interest and penalties related to unrecognized tax benefits within the income tax expense line item in the consolidated statements of income. This classification has not changed as a result of implementing the provisions of FIN 48. As of the date of adoption, the Company accrued $96,000 for the payment of interest related to unrecognized tax benefits. TheDuring the third quarter, the Company hascontinued to assess the COTCO pre-acquisition contingencies resulting in additional accrued additional interest related to uncertain tax positionspenalties of $40,000 through the second quarter.$1.2 million, which was recorded as an increase in goodwill.

The Company files U.S. federal, U.S. state, and foreign tax returns. For U.S. Federalfederal purposes, the Company is generally no longer subject to tax examinations for fiscal years ended June 26, 2005 and prior. For foreign purposes, the Company is no longer subject to examination for tax periods 2000 and prior. Certain carryforward tax attributes generated in years prior, remain subject to examination and adjustment. For U.S. state tax returns the Company is generally no longer subject to tax examinations for fiscal years prior to 1997.

Subsequent11. Commitments and Contingencies

Please refer to the endPart I, Item 3 of the first quarterCompany’s Annual Report on Form 10-K for the fiscal year ended June 24, 2007 and Part II, Item 1 of fiscal 2008, the Internal Revenue Service issued Coordinated Issue Paper (“CIP”) LMSB-04-090762 datedCompany’s Quarterly Reports on Form 10-Q for the quarterly periods ended September 27, 2007. The23, 2007 and December 30, 2007 for a description of material legal proceedings.

From time to time, various claims and litigation are asserted or commenced against the Company is inarising from or related to contractual matters, intellectual property matters, product warranties and personnel and employment disputes. Based on information currently available, management does not believe the processultimate outcome of evaluating the impact the issuance of this CIPany pending matters will have a material adverse effect on its consolidatedthe Company’s financial statements.condition, results of operations or cash flows. However, because of the nature and inherent uncertainties of litigation, should the outcome of these actions be unfavorable, the Company’s business, financial position, results of operations or cash flows could be materially and adversely affected.

12. Recent Accounting Pronouncements

In December 2006,2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations,”Combinations” (“SFAS 141R”). This new standard represents the outcome of the FASB’s joint project with the International Accounting Standards Board and is intended to improve, simplify and converge internationally the relevance, representational faithfulness, and comparabilityaccounting for business combinations in consolidated financial statements.

SFAS 141R replaces SFAS No. 141, “Business Combinations,” however, it retains the fundamental requirements of the informationformer standard that a reportingthe acquisition method of accounting (previously referred to as the purchase method) be used for all business combinations and for an acquirer to be identified for each business. SFAS 141R defines the acquirer as the entity provides in its financial reports about a business combination and its effects. This Statement applies to all transactions or other events in which an entitythat obtains control of one or more businesses in the business combination and combinations achieved withoutestablishes the transferacquisition date as the date that the acquirer achieves control. SFAS 141R requires the acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose to investors and other users all of consideration. The standardthe information they need to evaluate and understand the nature and financial effect of the business combination. SFAS 141R is effective forbeginning in the CompanyCompany’s fiscal 2010. SFAS 141R will be applied to business combinations that are consummated beginning in fiscal 2010. Earlier adoption is not permitted. The issuance of this Statement has no current impact on the Company.

In December 2006, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51, (“SFAS 160”) to improve the relevance, comparability, and transparency of the financial information that a reporting entity provides in its consolidated financial statements. This Statement applies to all entities that prepare consolidated financial statements, except not-for-profit organizations, but will affect only those entities that have an outstanding noncontrolling interest in one or more subsidiaries or that deconsolidate a subsidiary. This Statement is effective for the Company beginning in fiscal 2010. Earlier adoption is prohibited. The issuance of this Statements has no current impact on the Company.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB Statement No. 115” (“SFAS 159”). SFAS 159 permits entities to choose to measure certain financial assets and liabilities at fair value at specified election dates. The statement also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. The statement is effective for the Company beginning in fiscal 2009. The Company has not yet determined the impact, if any, of the adoption of SFAS 159.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” (“SFAS 157”) to provide enhanced guidance when using fair value to measure assets and liabilities. SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. The standard applies whenever other standards require or permit assets or liabilities to be measured at fair value and, while not requiring new fair value measurements, may change current practices. The standardSFAS 157 is effective for the Company beginning in fiscal 2009. The Company is currently evaluating the impact SFAS 157 will have on its consolidated financial statements.

Please referIn February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB Statement No. 115” (“SFAS 159”). SFAS 159 permits entities to Part I, Item 3choose to measure certain financial assets and liabilities at fair value at specified election dates. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS 159 is effective for the Company beginning in fiscal 2009. The Company has no yet determined the impact, if any, of the Company’s Annual Reportadoption of SFAS 159.

In February 2008, the FASB issued FASB Staff Position (“FSP”) FAS 157-1 and FSP FAS 157-2. FSP FAS 157-1 amends SFAS 157 to exclude SFAS No. 13, “Accounting for Leases” (“SFAS 13”) and other accounting pronouncements that address fair value measurements for purposes of lease classification or measurement under SFAS 13. FSP 157-2 delays the effective date of SFAS 157 for non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on Form 10-K for the fiscal year ended June 24, 2007 and Part II, Item 1 ofa recurring basis. FSP 157-1 will be effective beginning in the Company’s Quarterly Reportfirst quarter of fiscal 2009 upon adoption of SFAS 157 and FSP 157-2 is effective immediately. The Company continues to evaluate SFAS 157, which will become effective beginning in its first quarter of fiscal 2009, and has not yet determined whether it will result in a change to its fair value measurements.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133” (“SFAS 161”) which is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on Form 10-Q for the quarterly period ended September 23, 2007 for a description of material legal proceedings, in addition to the proceedings discussed below.

Honeywell Litigation

On October 19, 2007, Honeywell International, Inc.an entity’s financial position, financial performance and Honeywell Intellectual Properties Inc. commenced a patent infringement lawsuit against us and a third party by filing a complaintcash flows. SFAS 161 is effective beginning in the U.S. District Court for the Eastern DistrictCompany’s second quarter of Texas. In the complaint, the plaintiffs allege that we are infringing U.S. Patent No. 6,373,188, entitled “Efficient Solid-State Light Emitting Device with Excited Phosphors for Producing a Visible Light Output.” The complaint seeks damages in an unspecified amount, an injunction against future infringements, attorneys’ fees and costs. We have answered, denying any infringement and seeking declaratory judgment that the patent is invalid, unenforceable and not infringed.

Other Matters

fiscal 2009. The Company is currently a party to other legal proceedings incidental to its business. Although the resolution of these matters cannot be predicted with certainty, management’s present judgment isdoes not believe that the final outcomeSFAS 161 will not likely have a material adverse effectimpact on the Company’sits consolidated financial condition or results of operations. If an unfavorable resolution occurs, the Company’s business, results of operations and financial condition could be materially adversely affected.statements.

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Information set forth in this Quarterly Report on Form 10-Q contains various “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or 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 “may,” “will,” “anticipate,” “target,” “plan,” “estimate,” “expect,” and “intend,” and other similar expressions constitute forward-looking statements. These forward-looking statements are subject to business, economic, and other risks and uncertainties, both known and unknown, and actual results may differ materially from those contained in the forward-looking statements. Any forward-looking statements we make are as of the date made and we do not intend 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. To review risk factors that could cause actual results to differ, see “Risk Factors” in Part II, Item 1A, of this report.

The following discussion is designed to provide a better understanding of our unaudited consolidated financial statements, including a brief discussion of our business and products, key factors that impacted our performance, and a summary of our operating results. The following discussion should be read in conjunction with and is qualified in its entirety by reference to, ourthe unaudited condensed consolidated financial statements includingand the notes thereto.thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q, and the consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended June 24, 2007. 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

We develop and manufacture semiconductor materials and electronic devices primarily made from silicon carbide, or SiC, gallium nitride, or GaN, and related compounds. The majority of ourcompounds, as well as lighting solutions. Our products are manufactured at our main production facilities in Durham and Research Triangle Park, North Carolina, and in our facility in Huizhou, China. We also useChina and contract manufacturers in Asia to perform some of our manufacturing steps for certain light emitting diode, or LED, and power products.Asia. We generate revenues from the following product lines:

Industry Dynamics

Our business is primarily focused on selling high-brightnessLED chips and high-power LED products.components. Industry factors affecting our business include overall demand in products using high-brightness LEDs, an intense and constantly evolving competitive environment, and intellectual property issues. Average LED sales prices generally decline each year as market players implement pricing strategies to gain or protect market share. To remain competitive, LED producers generally must increase product performance and reduce costs to support lower average sales prices.

Highlights of the SecondThird Quarter of Fiscal 2008

The following is a summary of our financial results for the three months ended DecemberMarch 30, 2007:2008:

Outlook for Fiscal 2008

We project thattarget the market for LED chip marketproducts will remain highly competitive duringcontinue to expand for the remainder of our fiscal 2008, which ends on June 29, 2008. We plantarget to expand our production capacity to meet the demand for LED components at our factory in Huizhou, China. We also target to continue our reliance on subcontractors in Asia for increased capacity as well to meet our customers’ demands for LED chips and LED lighting solutions products. The market for LED products is highly competitive and we expect it to remain this way into the foreseeable future. We also target to continue to expand our global sales, marketing, and distribution capabilities to support increased sales of our LED components, including those from our acquisitionproducts during the remainder of COTCO.fiscal 2008 and into fiscal 2009.

We plan to workfocus our research and development efforts on increasing the brightness and efficiency of our LED chips and packaged LED products. We plan to continue our work on the integration of COTCO by expanding our product offerings and customer base. We plantarget to continue cost reduction initiatives for both our LED products and SiC-based high-power products by converting some production to four-inch wafersthrough continued yield improvement efforts and transferring more of ourincreasing LED production toat our contract manufacturer in Asia and our production facilityfactory in Huizhou, China.China and contract manufacturers in Asia. In addition, we target to invest a total of $45 million to $50 million in capital expenditures during fiscal 2008. This will support unit volume growth in our new product lines and is a critical part of our overall product cost reduction initiatives.

We plan to continue to evaluate strategic investments to expand and strengthen our technology and product portfolio as well as to increase access to our targeted markets.

Critical Accounting Policies

The following discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles

generally accepted in the United States of America. In preparing our financial statements, we must make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of our financial statements. We base our assumptions, estimates and judgments on historical experience, current trends and other factors that management believes to be relevant at the time the consolidated financial statements are prepared. On a regular basis, management reviews our accounting policies, assumptions, estimates and judgments to ensure that our consolidated financial statements are presented fairly and in accordance with generally accepted accounting principles. However, because future events and their effects cannot be determined

with certainty, actual results could differ from our assumptions and estimates, and we may be exposed to gains or losses that could be material.

Our significant accounting policies are discussed in Note 2, “Summary of Significant Accounting Policies and Other Matters,” of the Notes to Consolidated Financial Statements, included in Part II, Item 8 of our Annual Report on Form 10-K for the fiscal year ended June 24, 2007. Management believes the following accounting policies are the most critical to aid in fully understanding and evaluating our reported financial results. These policies require management’s most difficult, subjective or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain. Management has reviewed these critical accounting policies and related disclosures with the Audit Committee of our Board of Directors.

Description of Policy		Judgments and Uncertainties		Effect If Actual Results Differ From From Assumptions and Adjustments Recorded
Valuation of Long-Lived Assets:
We review long-lived assets such as property, equipment, goodwill, definite lived intangible assets and patents for impairment on a routine basis and when events and circumstances indicate that the carrying value of the assets recorded in our financial statements may not be recoverable. For example, a portion of our equipment may be scrapped; certain of our patents or patent applications may be abandoned. In these cases, we would directly write off these long-lived assets.   In addition, we evaluate property, equipment and definite lived intangible assets for potential impairment by comparing the carrying value of our assets to the estimated future cash flows of the assets (undiscounted and without interest charges). If the estimated undiscounted future cash flows are less than the carrying value of the asset, we calculate an impairment loss. The impairment loss calculation compares the carrying value of the asset to the asset’s estimated fair value, which may be based on estimated discounted future cash flows. We recognize an impairment loss if the amount of the asset’s carrying value exceeds the asset’s estimated fair value. If we recognize an impairment loss, the adjusted carrying amount of the asset will be its new cost basis. For a depreciable (amortized) long-lived asset, the new cost basis will be depreciated (amortized) over the remaining useful life of that asset. For goodwill, on at least an annual basis, we evaluate impairment in a two-step process. The first step compares the fair value of the reporting unit with its carrying value. If the fair value of the reporting unit exceeds its carrying value, no impairment is recorded. If the carrying amount of the reporting unit exceeds its fair value, the		Our impairment loss calculations require management to 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. We derive the required cash flow estimates from our internal business plans.		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 record additional impairment losses that could be material to our results of operations.   Using this impairment review methodology, we recorded $307,000$0.3 million of impairments of long-lived assets during the three months ended DecemberMarch 30, 2007,2008, and $1.1$1.3 million during the sixnine months ended DecemberMarch 30, 2007.2008. We recorded no long-lived asset impairment charges during the three or sixnine months ended December 24, 2006.March 25, 2007.

Description of Policy		Judgments and Uncertainties		Effect If Actual Results Differ From From Assumptions and Adjustments Recorded
For goodwill, on at least an annual basis, we evaluate impairment in a two-step process. The first step compares the fair value of the reporting unit with its carrying value. If the fair value of the reporting unit exceeds its carrying value, no impairment is recorded. If the carrying amount of the reporting unit exceeds its fair value, the second step of the impairment analysis is performed. The second step is used to measure the amount of the impairment loss and compares the implied fair value of the reporting unit’s goodwill with the carrying amount of the reporting unit’s goodwill. If the carrying amount exceeds the implied fair value of the goodwill, an impairment loss is recognized for the excess. However, it should be noted that the loss recognized shall not be in excess of the carrying amount. Once a goodwill impairment loss is recognized, the adjusted carrying value shall be its new accounting basis.   We do not restore a previously recognized impairment loss if the asset’s carrying value decreases below its estimated fair value.

Tax Contingencies:Description of Policy		Judgments and Uncertainties		Effect If Actual Results Differ From Assumptions and Adjustments Recorded
Tax Related Contingencies:
Uncertain Tax Positions:
We are subject to periodic audits of our income tax returns by federal, foreign, state and local agencies. These audits include questions regarding our tax filing positions, including the timing and amount of deductions and the allocation of income among various tax jurisdictions. In evaluatingaccordance with Financial Accounting Standards Board, or FASB, Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109,” we evaluate the exposures associated with our various tax filing positions, including state and local taxes, we record reservespositions. We have recorded unrecognized tax benefits for what we identifyhave identified as representing those positions that are not more likely than not.not to be sustained based on technical merits of such positions. A number of years may elapse before a particular matter for which we have established a reservean unrecognized tax benefit is audited and fully resolved. Valuation Allowance:   We have also established a valuation allowance for capital loss carryforwards and unrealized losses on certain securities where we believe that it is more likely than not that the tax benefits of the items will not be realized.realized due to insufficient availability of capital gains in the carryforward period. When we establish or reduce the valuation allowance against our deferred tax assets, our income tax expense will increase or decrease, respectively in the period such determination is made.		The estimateestablishment of our tax contingencies reserve contains uncertainty becauserelated to uncertain tax positions or the assessment of a valuation allowance involve a high degree of management must use judgment to estimateand estimation concerning such considerations as assessing the exposuresrisk associated with variousa particular tax filing positions.position and forecasting future taxable earnings.		To the extent we prevail in matters for which reserveswe have been established,recorded an unrecognized benefit or are required to pay amounts in excess of our reserves,what we have recorded 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 result in an increase in our effective 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. When we establish or reduce the valuation allowance against our deferred tax assets, our income tax expense will increase or decrease, respectively in the period such determination is made. As of December 30, 2007, we had established tax reserves of $5.8 million and a valuation allowance of $2.8 million.

Description of Policy		Judgments and Uncertainties		Effect If Actual Results Differ From From Assumptions and Adjustments Recorded
Inventories:
We value our inventory at the lower of cost of the inventory or fair market value by establishing a write-down or an inventory loss reserve.   We base our lower of cost or market write-down on the excess carrying value of the inventory, which is typically its cost, over the amount that we expect to realize from the ultimate sale of the inventory based upon our assumptions regarding the average sales price to be received for the product.		Our inventory reserve is based on our analysis of sales levels by product and projections of future customer demand derived from historical order patterns and input received from our customers and our sales team. To mitigate uncertainties, we reserve for all inventory greater than twelve months old, unless there is an identified need for the inventory. In addition, we reserve for items that are considered obsolete based on changes in customer demand, manufacturing process changes or new product introductions that may eliminate demand for a product. When inventory is physically destroyed, we remove the inventory and the associated reserve from our financial records.		If our estimates regarding customer demand and physical inventory losses are inaccurate or changes in technology affect demand for certain products in an unforeseen manner, we may be exposed to losses or gains in excess of our established reserves that could be material.   As of DecemberMarch 30, 20072008 the amount of our inventory reserve was $4.7$5.0 million.   A 10% increase or decrease in our actual inventory reserve at DecemberMarch 30, 20072008 would have affected net income by approximately $359,000$380,000 for the three months ended DecemberMarch 30, 2007.2008.
Accruals for Self-Insured and Other Liabilities:
We make estimates for the amount of costs that have been incurred but not yet billed for our self-funded medical insurance, general services, including legal fees, accounting fees and other expenses.		Our liabilities contain uncertainties because we must make assumptions and apply judgment to estimate the ultimate cost to settle claims and claims incurred but not reported as of the balance sheet date. When estimating our liabilities, we consider a number of factors, including interviewing our service providers for bills that have not yet been received. For self-insured liabilities, we estimate our liabilities based on historical claims experience.		If actual costs billed to us are not consistent with our assumptions and judgments, our expenses could be understated or overstated and these adjustments could materially affect our net income.