Income Taxes

12 Months Ended

Jun. 30, 2019

In December 2017, the Securities and Exchange Commission issued Staff Accounting Bulletin 118 (SAB 118) to provide guidance on accounting for the tax effects of the Tax Cuts and Jobs Act of 2017 (the Tax Legislation) enacted on December 22, 2017. SAB 118 allowed for a measurement period, not to extend beyond one year from the Tax Legislation date of enactment, for companies to complete the accounting under ASC 740 - Income Taxes. The SAB 118 measurement period concluded during the six months ended December 30, 2018, and consistent with the guidance provided in SAB 118, the Company has completed the accounting for the income tax effects of the Tax Legislation.

The following were the components of loss before income taxes:



	Fiscal Years Ended
(in millions of U.S. Dollars)	June 30, 2019			June 24, 2018			June 25, 2017
Domestic		($69.4	)		($50.4	)		($42.5	)
Foreign	24.2			32.8			35.4
Loss before income taxes		($45.2	)		($17.6	)		($7.1	)

The following were the components of income tax expense (benefit):



	Fiscal Years Ended
(in millions of U.S. Dollars)	June 30, 2019			June 24, 2018			June 25, 2017
Current:
Federal		$2.4			$36.0			$9.0
Foreign	10.1			4.5			6.0
State	0.3			1.1			0.5
Total current	12.8			41.6			15.5
Deferred:
Federal	(1.9		)	(45.8		)	59.4
Foreign	2.0			6.1			0.4
State	(0.2		)	(3.1		)	5.7
Total deferred	(0.1		)	(42.8		)	65.5
Income tax expense (benefit)		$12.7			($1.2	)		$81.0

Actual income tax expense (benefit) differed from the amount computed by applying each period's U.S. federal statutory tax rate to pre-tax earnings as a result of the following:



	Fiscal Years Ended
(in millions of U.S. Dollars)	June 30, 2019			% of Loss		June 24, 2018			% of Loss		June 25, 2017			% of Loss
Federal income tax provision at statutory rate		($9.5	)	21	%		($5.0	)	28	%		($2.5	)	35	%
(Decrease) increase in income tax expense resulting from:
State tax provision, net of federal benefit	(1.4		)	3	%	(3.4		)	19	%	0.5			(7	)%
Tax exempt interest	(0.4		)	1	%	(1.2		)	7	%	(1.2		)	17	%
48C investment tax credit	—			—	%	(1.6		)	9	%	(3.8		)	54	%
Increase (decrease) in tax reserve	0.5			(1	)%	0.1			(1	)%	(3.3		)	46	%
Research and development credits	(3.9		)	9	%	(1.7		)	10	%	(1.3		)	18	%
Foreign tax credit	(0.5		)	1	%	(39.4		)	224	%	(0.2		)	3	%
Increase in valuation allowance	8.2			(18	)%	(24.5		)	139	%	93.3			(1,314	)%
Stock-based compensation	—			—	%	9.0			(51	)%	1.2			(17	)%
Statutory rate differences	1.9			(4	)%	(2.0		)	11	%	(5.0		)	70	%
Foreign earnings taxed in U.S.	0.9			(2	)%	52.1			(296	)%	0.6			(8	)%
Foreign currency fluctuations	0.7			(2	)%	(1.3		)	7	%	0.8			(11	)%
Other foreign adjustments	(0.1		)	0	%	(0.4		)	2	%	1.3			(18	)%
Net operating loss carryback	—			—	%	(0.1		)	1	%	0.5			(7	)%
Provision to return adjustments	11.8			(26	)%	—			—	%	0.2			(3	)%
Tax on distributable foreign earnings	1.0			(2	)%	5.4			(31	)%	—			—	%
Impact of rate changes	2.7			(6	)%	11.2			(64	)%	—			—	%
Expiration of state credits	1.2			(3	)%	1.3			(7	)%	—			—	%
Other	(0.4		)	1	%	0.3			(2	)%	(0.1		)	1	%
Income tax expense (benefit)		$12.7		(28	)%		($1.2	)	7	%		$81.0		(1,141	)%

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities were as follows:



(in millions of U.S. Dollars)	June 30, 2019			June 24, 2018
Deferred tax assets:
Compensation		$9.6			$3.3
Inventories	14.6			16.7
Sales return reserve and allowance for bad debts	3.2			6.6
Warranty reserve	0.3			8.2
Federal and state net operating loss carryforwards	137.1			10.1
Federal credits	20.0			49.1
State credits	2.9			3.5
48C investment tax credits	25.9			28.0
Investments	—			0.7
Stock-based compensation	11.3			21.3
Deferred revenue	22.6			2.6
Other	4.3			1.6
Total gross deferred assets	251.8			151.7
Less valuation allowance	(185.2		)	(127.4		)
Deferred tax assets, net	66.6			24.3

Deferred tax liabilities:
Property and equipment	(20.1		)	(15.1		)
Intangible assets	(16.9		)	(2.3		)
Investments	(0.9		)	(0.9		)
Foreign earnings recapture	(2.0		)	(1.9		)
Taxes on unremitted foreign earnings	(2.4		)	(1.4		)
Convertible notes	(20.7		)	—
Total gross deferred liability	(63.0		)	(21.6		)
Deferred tax asset, net		$3.6			$2.7

The components giving rise to the net deferred tax assets (liabilities) have been included in the consolidated balance sheets as follows:



	Balance at June 30, 2019
(in millions of U.S. Dollars)	Assets		Liabilities
U.S. federal income taxes		$—		$—
Foreign income taxes	5.6		(2.0		)
Total		$5.6		($2.0	)



	Balance at June 24, 2018
(in millions of U.S. Dollars)	Assets		Liabilities
U.S. federal income taxes		$—		($2.1	)
Foreign income taxes	5.8		(1.0		)
Total		$5.8		($3.1	)

The Company assesses all available positive and negative evidence to estimate if sufficient future taxable income will be generated to utilize the existing deferred tax assets by jurisdiction. The Company has concluded that it is necessary to recognize a full valuation allowance against its U.S. and Luxembourg deferred tax assets as of June 30, 2019. While the Company has concluded

that a full U.S. valuation allowance is appropriate as of June 30, 2019, as a result of improving Company performance and future U.S. projected income, it is reasonably possible that the assessment of the realizability of the U.S. deferred tax assets could change within the next twelve months resulting in a full or partial release of the U.S. valuation allowance. As of June 24, 2018, the U.S. valuation allowance was $122.2 million. For the fiscal year ended June 30, 2019, the Company increased the U.S. valuation allowance by $55.4 million due to the deferred tax impact of the sale of the Lighting Products business unit including the sale of Cree Canada Corp. and Cree Europe S.r.l, offset by the deferred tax impact of the Notes issuance and the impact of the IRC Section 965(n) election related to the accounting of the Tax Legislation. As of June 24, 2018, the Luxembourg valuation allowance was $5.2 million. For the fiscal year ended June 30, 2019, the Company increased this valuation allowance by $2.4 million due to year-to-date income in Luxembourg.

As of June 30, 2019, the Company had approximately $34.6 million of foreign net operating loss carryovers, of which $30.3 million are offset by a valuation allowance. Of the Company's foreign net operating loss carryovers, $24.0 million have no carry forward limitation and the remaining $10.6 million will begin to expire in fiscal 2035. As of June 30, 2019, the Company had approximately $567.3 million of federal net operating loss carryovers and $216.6 million of state net operating loss carryovers which are fully offset by a valuation allowance. Additionally, the Company had $46.4 million of federal and $3.7 million of state income tax credit carryforwards which are fully offset by a valuation allowance. The state net operating loss carryovers will begin to expire in fiscal 2020. The federal and state income tax credit carryforwards will begin to expire in fiscal 2033 and fiscal 2020, respectively.

U.S. GAAP requires a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is cumulatively more than 50% likely to be realized upon ultimate settlement.

As of June 24, 2018 the Company’s liability for unrecognized tax benefits was $8.6 million. During the fiscal year ended June 30, 2019, the Company recognized a $0.4 million decrease to the liability for unrecognized tax benefits resulting from a $0.5 million increase related to intercompany transactions recently challenged by the German tax authority, offset by a $0.9 million decrease due to statue expiration. As a result, the total liability for unrecognized tax benefits as of June 30, 2019 was $8.2 million. If any portion of this $8.2 million is recognized, the Company will then include that portion in the computation of its effective tax rate. Although the ultimate timing of the resolution and/or closure of audits is highly uncertain, the Company believes it is reasonably possible that $1.0 million of gross unrecognized tax benefits will change in the next 12 months as a result of statute requirements or settlement with tax authorities.

The following is a tabular reconciliation of the Company’s change in uncertain tax positions:



	Fiscal Years Ended
(in millions of U.S. Dollars)	June 30, 2019			June 24, 2018			June 25, 2017
Balance at beginning of period		$8.6			$13.3			$17.7
Decrease related to current year change in law	—			(4.7		)	—
Increases related to prior year tax positions	0.5			0.6			—
Decreases related to prior year tax positions	—			(0.1		)	(0.1		)
Settlements with tax authorities	—			(0.1		)	(0.6		)
Expiration of statute of limitations for assessment of taxes	(0.9		)	(0.4		)	(3.7		)
Balance at end of period		$8.2			$8.6			$13.3

The Company's policy is to include interest and penalties related to unrecognized tax benefits within the income tax expense (benefit) line item in the consolidated statements of operations. Interest and penalties relating to unrecognized tax benefits recognized in the consolidated statements of operations totaled less than $0.1 million for the fiscal years ending June 30, 2019, June 24, 2018, and June 25, 2017. The Company accrued less than $0.1 million for interest and penalties relating to unrecognized tax benefits in the consolidated balance sheets as of June 30, 2019 and June 24, 2018.

The Company files U.S. federal, U.S. state and foreign tax returns. For U.S. federal purposes, the Company is generally no longer subject to tax examinations for fiscal years prior to 2016. For U.S. state tax returns, the Company is generally no longer subject to tax examinations for fiscal years prior to 2015. For foreign purposes, the Company is generally no longer subject to examination for tax periods prior to 2009. Certain carryforward tax attributes generated in prior years remain subject to examination, adjustment and recapture.

The Company provides for income taxes on the earnings of foreign subsidiaries unless the subsidiaries’ earnings are considered indefinitely reinvested outside the United States. As of June 30, 2019, the Company has approximately $129.9 million of undistributed earnings for certain non-U.S. subsidiaries. The Company has determined that $125.5 million of the $129.9 million of undistributed foreign earnings are expected to be repatriated in the foreseeable future. The Company accrued a deferred tax liability of $2.4 million for foreign income taxes expected to be withheld upon repatriation of the $125.5 million foreign earnings. As of June 30, 2019, the Company has not provided income taxes on the remaining undistributed foreign earnings of $4.4 million as the Company continues to maintain its intention to reinvest these earnings in foreign operations indefinitely. If, at a later date, these earnings were repatriated to the United States, the Company would be required to pay approximately $0.2 million in taxes on these amounts.