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 (Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (Exchange Act). All information contained in this report relative to future markets for our products and trends in and anticipated levels of revenue, gross margins and expenses, as well as other statements containing words such as "believe," "project," "may," "will," "anticipate," "target," "plan," "estimate," "expect" and "intend" and other similar expressions constitute forward-looking statements. These forward-looking statements are subject to business, economic and other risks and uncertainties, both known and unknown, and actual results may differ materially from those contained in the forward-looking statements. Any forward-looking statements we make are as of the date made and we have no duty to update them if our views later change. These forward-looking statements should not be relied upon as representing our views as of any date subsequent to the date of this Quarterly Report. Examples of risks and uncertainties that could cause actual results to differ materially from historical performance and any forward-looking statements include, but are not limited to, those described in "Risk Factors" in Part II, Item 1A of this Quarterly Report.

The following discussion is designed to provide a better understanding of our unaudited consolidated financial statements, including a brief discussion of our business and products, key factors that impacted our performance, and a summary of our operating results. The discussion should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q, and the consolidated financial statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended June 29, 2008. 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 of Our Business and Products

Cree, Inc. ("Cree," "we," "our," or "us,") is a manufacturer of semiconductor materials and devices primarily based on silicon carbide (SiC), gallium nitride
(GaN) and related compounds. We currently focus on light emitting diode (LED)
products, which consist of LED chips, LED components and LED lighting products. We also develop power and radio frequency (RF) products, including power switching and RF devices. Most of our revenues are generated from the following:

• LED products. We derive the largest portion of our revenue from the sale of our LED products. Our LED products consist of our LED chips, LED components, including our XLamp® LED components and high-brightness LED components, and LED lighting products.

• Materials products. Revenues include the sale of wafers that are based on SiC and GaN, which are used in manufacturing LEDs, RF devices, and power devices and for research and development. They also include revenues from certain materials related licensing arrangements.

• Power and RF products. These products include power switching devices made from SiC and also include RF devices made from SiC or GaN.

• Contracts with government agencies. Government agencies provide us with funding to support the development of primarily SiC and GaN based new technology.

The majority of our products are produced through fabrication processes primarily conducted at our two main production facilities located in Durham, North Carolina and Huizhou, China. In some circumstances, where economically beneficial, we also use contract manufacturers for certain aspects of product fabrication.

Operating Segments

We currently operate our business as one reportable segment. In fiscal 2005, we operated our business in two reportable segments. In the fourth quarter of fiscal 2005, we announced the closure of the Cree Microwave segment, our silicon-based RF and microwave semiconductor business located in Sunnyvale, California. Effective December 25, 2005, we reported Cree Microwave as a discontinued operation.

Industry Dynamics

Our business is primarily focused on selling our LED products. LEDs are currently used to provide energy-efficient lighting in the automotive, mobile phone, liquid crystal display (LCD) backlighting, gaming, signals, indoor and outdoor illumination and video screen markets. LED lighting products are in the initial stages of introduction to the general illumination market. As LED technology continues to develop and improve, we believe the potential market for LED lighting applications will continue to expand.

Select industry factors affecting our business include, among others:

• Overall demand for products and applications using LEDs. Our LEDs are used in a wide range of applications, including the developing market of LED lighting. The pace of adoption of LED lighting technology for the general illumination market will impact the demand for LEDs. Although we have seen increased adoption of LEDs in lighting products over the last several quarters, the recession has reduced demand for LEDs in consumer, mobile and automotive applications.

• Economic Recession. The economic recession has reduced demand for some of our products and reduced visibility in demand from both our distributors and other customers. A prolonged recession may impact the viability of our vendors and customers, which could result in supply constraints from vendors and reduced customer demand. In addition, an inability to obtain financing could impact our customers' ability to pay us on time or at all. This has increased the risk that our actual results could differ from our targets.

• Intense and constantly evolving competitive environment. Competition in the industry is intense. Product pricing pressures exist as market participants often undertake pricing strategies to gain or protect market share. To remain competitive, market participants generally must increase product performance and reduce costs to support lower average sales prices. As overall market demand slows, pricing pressure generally increases.

• Intellectual property issues. Market participants rely on patented and non-patented proprietary information relating to product design, manufacturing and other core competencies of their business. Protection of intellectual property is vital. Litigation and threatened litigation regarding intellectual property is common in our industry.

Highlights of the Third Quarter of Fiscal 2009

Like most other companies, we faced a challenging global economic environment in the third quarter of fiscal 2009, which resulted in lower demand for certain of our LED products, including those used in mobile, automotive, and some consumer applications. However, more than offsetting this decline was the continuing adoption of our LED products into other applications such as the general illumination market and some spot orders for SiC Schottky diodes, which helped the performance of our power and RF business.

The following is a summary of our financial results for the three months ended March 29, 2009:

• Our year over year revenues increased approximately 5% to $131.1 million;

• Our year over year gross margin percentage (gross profit as a percent of revenue) increased to 36.1% from 34.8% in the prior year;

• We achieved income from operations of $2.9 million in the third quarter of fiscal 2009 compared to income from operations of $3.6 million in the third quarter of fiscal 2008. Net income per diluted share was $0.05 compared to $0.06 for the third quarter of fiscal 2008;

• Combined cash, cash equivalents and marketable investments increased $39.4 million to $404.9 million at March 29, 2009 from $365.5 million at December 28, 2008;

Results of Operations

The following table sets forth certain consolidated statement of income data for
the periods indicated:



                                                                          Three Months Ended
                                                             March 29, 2009               March 30, 2008
                                                                          % of                         % of
(Dollars in Thousands, Except Per Share Amounts)          Dollars        Revenue       Dollars        Revenue
Net revenue                                              $  131,144        100.0 %    $  124,986        100.0 %
Cost of revenue                                              83,793         63.9 %        81,437         65.2 %

Gross profit                                                 47,351         36.1 %        43,549         34.8 %

Research and development                                     17,071         13.0 %        15,405         12.3 %
Sales, general and administrative                            21,043         16.0 %        21,076         16.9 %
Amortization of acquistion related intangibles                4,062          3.1 %         4,225          3.4 %
Loss (gain) on disposal or impairment of assets               2,255          1.7 %          (722 )       -0.6 %

Income from operations                                        2,920          2.3 %         3,565          2.8 %
Gain on sale of investments, net                                 13          0.0 %            -           0.0 %
Other non-operating income                                       28          0.0 %           129          0.1 %
Interest income, net                                          1,837          1.4 %         3,755          3.0 %

Income from continuing operations before income taxes         4,798          3.7 %         7,449          5.9 %
Income tax expense                                              768          0.6 %         1,787          1.4 %

Income from continuing operations                             4,030          3.1 %         5,662          4.5 %
Loss from discontinued operations                               (15 )        0.0 %            (2 )        0.0 %

Net income                                               $    4,015          3.1 %    $    5,660          4.5 %

Diluted EPS                                              $     0.05                   $     0.06


                                                                          Nine Months Ended
                                                             March 29, 2009               March 30, 2008
                                                                          % of                         % of
(Dollars in Thousands, Except Per Share Amounts)          Dollars        Revenue       Dollars        Revenue
Net revenue                                              $  419,145        100.0 %    $  357,371        100.0 %
Cost of revenue                                             265,935         63.4 %       237,286         66.4 %

Gross profit                                                153,210         36.6 %       120,085         33.6 %

Research and development                                     52,787         12.6 %        43,083         12.1 %
Sales, general and administrative                            65,804         15.7 %        57,449         16.1 %
Amortization of acquistion related intangibles               12,186          2.9 %        12,321          3.4 %
Loss on disposal or impairment of assets                      3,305          0.8 %           487          0.1 %

Income from operations                                       19,128          4.6 %         6,745          1.9 %
Gain on sale of investments, net                                 78          0.0 %        14,117          4.0 %
Other non-operating income                                      181          0.0 %           207          0.1 %
Interest income, net                                          7,168          1.7 %        11,986          3.4 %

Income from continuing operations before income taxes        26,555          6.3 %        33,055          9.2 %
Income tax expense                                            5,740          1.4 %         7,885          2.2 %

Income from continuing operations                            20,815          5.0 %        25,170          7.0 %
Loss from discontinued operations                              (185 )        0.0 %          (176 )        0.0 %

Net income                                               $   20,630          4.9 %    $   24,994          7.0 %

Diluted EPS                                              $     0.23                   $     0.29

Revenues

Revenues were comprised of the following (in thousands, except percentages):



                                    Three Months Ended                                  Nine Months Ended
                                 March 29,      March 30,                           March 29,      March 30,
                                    2009           2008             Change             2009           2008             Change
LED products                     $  112,644     $  105,654     $  6,990       7 %   $  363,113     $  298,159     $ 64,954      22 %
Percent of total revenues                86 %           85 %                                87 %           83 %
Materials products                    5,624          6,327         (703 )   -11 %       17,281         22,329       (5,048 )   -23 %
Percent of total revenues                 4 %            5 %                                 4 %            6 %
Power and RF products                 8,609          6,179        2,430      39 %       18,771         14,976        3,795      25 %
Percent of total revenues                 7 %            5 %                                 4 %            4 %

Total product revenues              126,877        118,160        8,717       7 %      399,165        335,464       63,701      19 %
Percent of total revenues                97 %           95 %                                95 %           94 %
Contracts                             4,267          6,826       (2,559 )   -37 %       14,398         21,907       (7,509 )   -34 %
Percent of total revenues                 3 %            5 %                                 3 %            6 %
Upfront licensing fees                   -              -            -        0 %        5,582             -         5,582     100 %
Percent of total revenues                 0 %            0 %                                 1 %            0 %

Total revenues                   $  131,144     $  124,986     $  6,158       5 %   $  419,145     $  357,371     $ 61,774      17 %

LED Products

We derive the largest portion of our revenue from the sale of LED products which comprised approximately 86% and 85% of our total revenues for the third quarter of fiscal 2009 and fiscal 2008, respectively. For the nine months ended March 29, 2009 and March 30, 2008, revenue from the sale of our LED products comprised approximately 87% and 83% of our total revenues, respectively.

Revenue from our LED products increased 7% to $112.6 million in the third quarter of fiscal 2009 from $105.7 million in the third quarter of fiscal 2008. Revenues increased from the prior year quarter due to growth in sales of our lighting class LED products, particularly our LED components, which were partially offset by lower demand for our LED products for use in automotive, mobile and certain consumer products.

For the nine months ended March 29, 2009, revenue from our LED products increased approximately 22% to $363.1 million from $298.2 million for the nine months ended March 30, 2008. Strong sales growth from our LED components drove this year over year increase, more than offsetting a slight decline in LED chip sales. Additionally, sales in the first nine months of fiscal 2009 benefited from the acquisition of LED Lighting Fixtures, Inc. (now Cree LED Lighting Solutions, Inc.) (LLF) in the third quarter of fiscal 2008. The blended average selling price for our LED products increased approximately 30% and 41% for the three and nine month periods ended March 29, 2009, respectively, from the comparable prior year periods. This year over year increase was due to a shift in product mix to a higher proportion of revenues generated from sales of our LED components and LED lighting products.

Materials Products

Materials product sales comprised approximately 4% and 5% of our total revenues for the third quarter of fiscal 2009 and 2008, respectively, compared to 4% and 6% of our total revenues for the nine month periods ended March 29, 2009 and March 30, 2008, respectively.

Revenue from materials products decreased 11% to $5.6 million in the third quarter of fiscal 2009 from $6.3 million in the third quarter of fiscal 2008. For the nine months ended March 29, 2009, revenue from materials products decreased 23% to $17.3 million from $22.3 million for the nine months ended March 30, 2008. These decreases were due primarily to a lack of product sales to Charles & Colvard, Ltd. (Charles & Colvard) for use in gemstone applications. We currently have no backlog from Charles & Colvard and do not know when or if future orders will be placed.

Power and RF Products

Revenues from our power and RF products comprised approximately 7% and 5% of our total revenues for the third quarter of fiscal 2009 and 2008, respectively. For the nine month periods ended March 29, 2009 and March 30, 2008, revenues from our power and RF products comprised approximately 4% of our total revenues.

Revenue from power and RF increased approximately 39% to $8.6 million in the third quarter of fiscal 2009 from $6.2 million in the third fiscal quarter of 2008. For the nine months ended March 29, 2009 revenue increased 25% to $18.8 million from $15.0 million for the nine months ended March 30, 2008. The increase in our power and RF business was primarily due to some spot orders for SiC Schottky diodes during the third quarter. In addition, for power products, the increase was due to an increase in unit shipments of products partially offset by a decrease in average selling prices. RF product revenues increased primarily due to improved product mix.

Contracts

Revenues from our contracts comprised approximately 3% and 5% of our total revenues for the third quarter of fiscal 2009 and 2008, respectively, compared to approximately 3% and 6% of our total revenues for the nine month periods ended March 29, 2009 and March 30, 2008, respectively.

Revenues from contracts decreased 37% to $4.3 million in the third quarter of fiscal 2009 from $6.8 million in the third quarter of fiscal 2008. For the nine months ended March 29, 2009 revenues from contracts decreased 34% to $14.4 million from $21.9 million for the nine months ended March 30, 3008. These decreases were in large part due to the completion of certain long-term contracts. In addition, fluctuations in contract revenue were due to changes in the timing of the initiation of research contracts, the value of those contracts and timing of the work performed.

Up-Front Licensing Fees

From time to time, we may enter into licensing arrangements related to our intellectual property. In certain instances, these arrangements may include up-front payments to us that, depending on the specific terms and underlying nature of the arrangement, may allow for immediate revenue recognition. For the three months ended March 29, 2009, we had no up-front license fee revenue. For the nine months ended March 29, 2009, we recognized $5.6 million of revenues related to up-front payments due for licensing arrangements. We had no such up-front licensing fee revenues in the comparable prior year periods.

Gross Profit

Cost of revenue includes materials, labor and overhead costs incurred internally
or paid to contract manufacturers to produce our products. Gross profit and
gross margin percentage (gross profit as a percentage of revenue) were as
follows (in thousands, except percentages):



                                       Three Months Ended                                  Nine Months Ended
                                    March 29,       March 30,                          March 29,      March 30,
                                      2009            2008             Change             2009           2008             Change
Products, net                      $    46,676     $    42,225     $ 4,451      11 %   $  145,489     $  115,698     $ 29,791      26 %
Product gross margin                      36.8 %          35.7 %                             36.4 %         34.5 %
Contracts, net                             675           1,324        (649 )   -49 %        2,645          4,387       (1,742 )   -40 %
Contract gross margin                     15.8 %          19.4 %                             18.4 %         20.0 %
Upfront licensing fees                      -               -           -        0 %        5,076             -         5,076     100 %
Licensing fee gross margin                 0.0 %           0.0 %                             90.9 %          0.0 %

Total gross profit                 $    47,351     $    43,549     $ 3,802       9 %   $  153,210     $  120,085     $ 33,125      28 %
Total gross margin                        36.1 %          34.8 %                             36.6 %         33.6 %

Gross profit from continuing operations in the third quarter of fiscal 2009 increased approximately 9% to $47.4 million from $43.5 million in the third quarter of fiscal 2008. For the nine months ended March 29, 2009 gross profit increased approximately 28% to $153.2 million from $120.1 million for the nine months ended March 30, 2008. For the three months ended March 29, 2009 our gross margin percentage increased to 36.1% from 34.8% for the three months ended March 30, 2008. For the nine months ended March 29, 2009 our gross margin percentage increased to 36.6% from 33.6% for the nine months ended March 30, 2008. Factors contributing to the increase in gross margin percentage were changes in product mix to higher margin products and higher LED product yields. For the nine month period ended March 29, 2009, revenues from certain licensing arrangements contributed approximately $5.1 million of gross profit.

Research and Development

Research and development (R&D) expenses include costs associated with the development of new products, enhancements of existing products and general technology research. These costs consist primarily of employee salaries and benefits, occupancy costs, consulting costs and the cost of development equipment, R&D materials and supplies.

The following sets forth our research and development expenses in dollars and as a percentage of revenues (in thousands, except percentages):

                                       Three Months Ended                                Nine Months Ended
                                    March 29,       March 30,                        March 29,        March 30,
                                      2009            2008            Change            2009            2008            Change
Research and development           $    17,071     $    15,405     $ 1,666   11 %   $     52,787     $    43,083     $ 9,704   23 %
Percent of total revenues                   13 %            12 %                              13 %            12 %

Research and development expenses in the third quarter of fiscal 2009 increased 11% to $17.1 million from $15.4 million in the third quarter of fiscal 2008. For the nine months ended March 29, 2009 research and development expenses increased 23% to $52.8 million from $43.1 million for the nine months ended March 30, 2008. The increase was due to our continued research and development activities focusing on higher brightness LED chips, new and improved LED components, new LED lighting products, costs related to the transition to larger wafers, and power and RF initiatives.

Sales, General and Administrative

Sales, general and administrative expenses are composed primarily of costs associated with our sales and marketing personnel and our executive and administrative personnel (for example, legal, finance, information technology and human resources) and consist 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), 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 revenues (in thousands, except percentages):

                                         Three Months Ended                               Nine Months Ended
                                      March 29,       March 30,                       March 29,        March 30,
                                        2009            2008           Change            2009            2008            Change
Sales, general and administrative    $    21,043     $    21,076     $ (33 )   0 %   $     65,804     $    57,449     $ 8,355   15 %
Percent of total revenues                     16 %            17 %                             16 %            16 %

Sales, general and administrative expenses from continuing operations in the third quarter of fiscal 2009 decreased slightly to $21.0 million from $21.1 million in the third quarter of fiscal 2008. For the nine months ended March 29, 2009, sales, general and administrative expenses increased 15% to $65.8 million from $57.4 million for the nine months ended March 30, 2008. Sales, general and administrative expenses were virtually flat comparing the three months ended March 29, 2009 to the three months ended March 30, 2008 as we were successful in controlling costs in response to uncertain market conditions. The increase in comparing the nine months ended March 29, 2009 to the nine months ended March 30, 2008 was due primarily to increased spending on sales and marketing as we expanded our sales channels and the acquisition of LLF during the third quarter of fiscal 2008. Additionally, costs increased due to the general expansion of our business and increased employee compensation costs.

Amortization of Acquisition Related Intangibles

As a result of our acquisitions, we have recorded various intangible assets that
require amortization, principally customer relationships and developed
technologies. Amortization of intangible assets related to our acquisitions is
as follows (in thousands):



. . .