[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 30, 2018
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 0-21154
CREE, INC.
(Exact name of registrant as specified in its charter)
North Carolina
56-1572719
(State or other jurisdiction of incorporation or
organization)
(I.R.S. Employer Identification No.)
4600 Silicon Drive
Durham, North Carolina
27703
(Address of principal executive offices)
(Zip Code)
(919) 407-5300
(Registrant’s telephone number, including area code)
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 has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Yes [ X ] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [X]
Accelerated filer [ ]
Non-accelerated filer [ ]
Smaller reporting company [ ]
Emerging growth company [ ]
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Securities Act. [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No[ X]
The number of shares outstanding of the registrant’s common stock, par value $0.00125 per share, as of January 25, 2019, was 103,224,252.
Total cash, cash equivalents and short-term investments
723,668
387,085
Accounts receivable, net
192,052
153,875
Income tax receivable
1,295
2,434
Inventories
313,312
296,015
Prepaid expenses
25,314
28,310
Other current assets
20,570
20,191
Current assets held for sale
—
2,180
Total current assets
1,276,211
890,090
Property and equipment, net
675,940
661,319
Goodwill
620,330
620,330
Intangible assets, net
374,219
390,054
Other long-term investments
48,431
57,501
Deferred income taxes
7,939
6,451
Other assets
11,480
11,800
Total assets
$3,014,550
$2,637,545
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable, trade
$143,455
$151,307
Accrued salaries and wages
59,974
53,458
Income taxes payable
2,092
—
Accrued contract liabilities (Note 2)
53,912
—
Other current liabilities
35,292
43,528
Total current liabilities
294,725
248,293
Long-term liabilities:
Long-term debt
—
292,000
Convertible notes, net
458,000
—
Deferred income taxes
2,235
3,056
Other long-term liabilities
36,085
22,115
Total long-term liabilities
496,320
317,171
Commitments and contingencies (Note 12)
Shareholders’ equity:
Preferred stock, par value $0.01; 3,000 shares authorized at December 30, 2018 and June 24, 2018; none issued and outstanding
—
—
Common stock, par value $0.00125; 200,000 shares authorized at December 30, 2018 and June 24, 2018; 103,073 issued and outstanding at December 30, 2018 and 101,488 shares issued and outstanding at June 24, 2018
129
127
Additional paid-in-capital
2,703,601
2,549,123
Accumulated other comprehensive income, net of taxes
856
596
Accumulated deficit
(485,928
)
(482,710
)
Total shareholders’ equity
2,218,658
2,067,136
Non-controlling interest
4,847
4,945
Total liabilities and equity
$3,014,550
$2,637,545
The accompanying notes are an integral part of the consolidated financial statements.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Note 1 – Basis of Presentation and New Accounting Standards
Overview
Cree, Inc. (the Company) is an innovator of wide bandgap semiconductor products for power and radio-frequency (RF) applications, lighting-class light emitting diode (LED) products, and lighting products. The Company's products are targeted for applications such as transportation, power supplies, inverters, wireless systems, indoor and outdoor lighting, electronic signs and signals, and video displays.
The Company's Wolfspeed segment's products consist of silicon carbide (SiC) and gallium nitride (GaN) materials, power devices and RF devices based on silicon (Si) and wide bandgap semiconductor materials. The Company's materials products and power devices are used in solar, electric vehicles, motor drives, power supplies and transportation applications. The Company's materials products and RF devices are used in military communications, radar, satellite and telecommunication applications.
The Company's LED Products segment's products consist of LED chips and LED components. The Company's LED products enable its customers to develop and market LED-based products for lighting, video screens, automotive and specialty lighting applications.
The Company's Lighting Products segment's products primarily consist of LED lighting systems and lamps. The Company designs, manufactures and sells lighting fixtures and lamps for the commercial, industrial and consumer markets.
The majority of the Company's products are manufactured at its production facilities located in North Carolina, Wisconsin, Arkansas, California and China. The Company also uses contract manufacturers for certain products and aspects of product fabrication, assembly and packaging. The Company operates research and development facilities in North Carolina, Arizona, Arkansas, California, Wisconsin, Italy and China (including Hong Kong).
Cree, Inc. is a North Carolina corporation established in 1987 and is headquartered in Durham, North Carolina.
The Company's three reportable segments are:
•
Wolfspeed
•
LED Products
•
Lighting Products
For financial results by reportable segment, please refer to Note 13, "Reportable Segments."
Basis of Presentation
The consolidated financial statements presented herein have been prepared by the Company and have not been audited. In the opinion of management, all normal and recurring adjustments necessary to fairly state the consolidated financial position, results of operations, comprehensive (loss) income, shareholders' equity and cash flows at December 30, 2018, and for all periods presented, have been made. All intercompany accounts and transactions have been eliminated. The consolidated balance sheet at June 24, 2018 has been derived from the audited financial statements as of that date.
These financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) for interim information and with the instructions to Form 10-Q and Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for annual financial statements. These financial statements should 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, 2018 (fiscal 2018). The results of operations for the three and six months ended December 30, 2018 are not necessarily indicative of the operating results that may be attained for the entire fiscal year ending June 30, 2019 (fiscal 2019).
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and the disclosure of contingent assets and liabilities. Actual amounts could differ materially from those estimates.
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09: Revenue from Contracts with Customers (Topic 606). The FASB has subsequently issued multiple ASUs which amend and clarify the guidance in 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 Company adopted this standard on June 25, 2018. The cumulative effect of this adjustment recorded to beginning retained earnings as of June 25, 2018 was $10.3 million, and the Company did not recognize a discrete tax impact related to the opening deferred tax balance as of June 25, 2018 due to the full U.S. valuation allowance. The Company recognized a loss of revenue of approximately $1.6 million for the six months ended December 30, 2018, and expects the ongoing effect to be immaterial to the consolidated financial statements. See Note 2, "Revenue Recognition," for discussion of the impacted financial statement line items.
Goodwill Impairment Testing
In January 2017, the FASB issued ASU No. 2017-04: Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The ASU simplifies the manner in which an entity is required to test for goodwill impairment by eliminating Step 2 from the goodwill impairment test. Additionally, the ASU removes the requirement for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails such qualitative test, to continue to perform Step 1 of the goodwill impairment test. The Company early adopted this standard in the third quarter of fiscal 2018.
Fair Value Measurement Disclosure
In August 2018, the FASB issued ASU 2018-13: Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. The ASU modifies the disclosure requirements required for fair value measurements. The Company early adopted this standard in the first quarter of fiscal 2019.
Cloud Computing Arrangements
In August 2018, the FASB issued ASU 2018-15: Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract. The ASU allows companies to capitalize implementation costs incurred in a hosting arrangement that is a service contract over the term of the hosting arrangement, including periods covered by renewal options that are reasonably certain to be exercised. The Company early adopted this standard in the first quarter of fiscal 2019. There was no significant impact on the financial statements.
Nonemployee Stock Compensation
In June 2018, the FASB issued ASU 2018-07: Compensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. The ASU applies to all share-based payment transactions in which a grantor acquires goods or services to be used or consumed in a grantor's own operations by issuing share-based payment awards. The Company early adopted this standard in the second quarter of fiscal 2019. There was no material impact upon adoption of this standard.
In February 2016, the FASB issued ASU No. 2016-02: Leases (Topic 842) and ASU 2018-10: Codification Improvements to Topic 842, Leases. The FASB has subsequently issued multiple ASUs which amend and clarify the guidance in Topic 842. These ASUs require that a lessee recognize in its statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. The asset will be based on the liability, subject to adjustment, such as for initial direct costs. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. For income statement purposes, leases are still required to be classified as either operating or finance. Operating leases will result in straight-line expense while finance leases will result in a front-loaded expense pattern. The effective date will be the first quarter of the Company's fiscal year ending June 28, 2020, using the modified retrospective method. The Company is currently analyzing the impact of this new pronouncement.
Effective June 25, 2018, the Company adopted ASC Topic 606: “Revenue from Contracts with Customers," and all related accounting standard updates, using the modified retrospective method applied to contracts not completed as of June 25, 2018. Results for all reporting periods subsequent to adoption are presented under Topic 606, while prior period amounts are not adjusted and continue to be reported in accordance with the Company's historic revenue recognition policy under ASC Topic 605: “Revenue Recognition."
The Company follows a five-step approach defined by the new standard for recognizing revenue, consisting of (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.
Master supply or distributor agreements are in place with the majority of the Company's customers and contain terms and conditions including, but not limited to payment, delivery, incentives, and warranty. These agreements typically do not require minimum purchase commitments. In the case an agreement is not present, the Company considers a purchase order, which is governed by the Company’s standard terms and conditions, to be a contract.
Substantially all of the Company's revenue, 98% and 96% in fiscal 2018 and 2017, respectively, is derived from product sales. Revenue is recognized at a point in time based on the Company’s evaluation of when the customer obtains control of the products, and all performance obligations under the terms of the contract are satisfied. If customer acceptance clauses are present and it cannot be objectively determined that control has been transferred based on the contract and shipping terms, revenue is only recorded when customer acceptance is received and all performance obligations have been satisfied. Sales of products typically do not include more than one performance obligation.
Pricing terms are negotiated independently on a stand-alone basis. Revenue is measured based on the amount of net consideration the Company expects to be entitled to in exchange for products or services. Variable consideration is recognized as a reduction of net revenue with a corresponding reserve at the time of revenue recognition, and consists primarily of sales incentives or rebates, price concessions, and return allowances. Variable consideration is estimated based on contractual terms, historical analysis of customer purchase volumes, or historical analysis using specific data for the type of consideration being assessed. The Company offers product warranties and establishes liabilities for estimated warranty costs based upon historical experience and specific warranty provisions. Warranty liability estimates are included in cost of sales in the Company’s Consolidated Statements of (Loss) Income, and further detail is presented in Note 12, "Commitments and Contingencies."
Contract liabilities primarily include deferred revenue, price protection guarantees, and various rights of return. These items were previously presented as a reduction of accounts receivable on the consolidated balance sheet. The adjustments do not impact net cash used in operating activities; however, they do impact the changes in operating assets and liabilities for the related accounts within the disclosure of operating activities on the statement of cash flows.
Practical Expedients and Exemptions
The Company does not disclose the value of unsatisfied performance obligations for contracts with an original expected length of one year or less.
Incidental contract costs that are not material in context of the delivery of products are expensed as incurred. Sales commissions are expensed when the amortization period is less than one year. Contract assets, such as costs to obtain or fulfill contracts, are an insignificant component of the Company’s revenue recognition process. The majority of the Company’s fulfillment costs as a manufacturer consist of inventory, fixed assets, and intangible assets, all of which are accounted for under the respective guidance for those asset types.
The Company’s accounts receivable balance represents the Company’s unconditional right to receive consideration from its customers with contracts. Payments are due within 12 months of completion of the performance obligation and invoicing, and therefore do not contain significant financing components.
Sales tax, value-added tax, and other taxes the Company collects concurrent with revenue-producing activities are excluded from revenue, and shipping and handling costs are treated as fulfillment activities and included in cost of sales in the Company’s Consolidated Statements of (Loss) Income.
Opening Balance Adjustments
The following table summarizes the impacts of adopting the new revenue standard on the Company's unaudited consolidated balance sheet (in thousands):
The following table presents disaggregated revenue by geography (in thousands):
Three Months Ended
Six Months Ended
December 30, 2018
December 24, 2017
December 30, 2018
December 24, 2017
United States
$174,852
$175,839
$358,982
$344,392
China
106,060
103,888
207,170
194,385
Europe
70,571
40,353
146,760
88,623
Other
61,553
47,790
108,391
100,868
Total Revenue
$413,036
$367,870
$821,303
$728,268
Note 3 – Acquisition
Infineon Technologies AG Radio Frequency Power Business
On March 6, 2018, the Company acquired certain assets of the Infineon Technologies AG (Infineon) Radio Frequency Power Business (RF Power), pursuant to an asset purchase agreement with Infineon in exchange for a base purchase price of $429 million, subject to certain adjustments. As part of the agreement, the Company paid $427 million of cash on the purchase date and agreed to purchase certain additional non-U.S. property and equipment related to the RF Power business from Infineon for approximately $2 million, which was completed during the fourth quarter of fiscal 2018. The acquisition allows the Company to expand its product portfolio into the wireless market.
The acquisition of the RF Power business from Infineon was accounted for as a business combination. The assets, liabilities, and operating results of the RF Power business have been included in the Company's consolidated financial statements from the date of acquisition. Additionally, the RF Power business's results from operations are reported as part of the Company's Wolfspeed segment. The results of the RF Power business are reflected in the Company's Consolidated Statements of (Loss) Income for the three and six months ended December 30, 2018.
The purchase price has been allocated to the assets acquired and liabilities assumed based on their estimated fair values as follows (in thousands):
The amortization periods for intangible assets acquired are as follows (in thousands, except for years):
Asset Amount
Estimated Life in Years
Lease agreement
$1,000
10
Customer relationships
92,000
15
Developed technology
44,000
14
Non-compete agreements
12,000
4
Total identifiable intangible assets
$149,000
The weighted average amortization periods for intangibles was 13.8 years. Goodwill largely consists of manufacturing and other synergies of the combined companies, and the value of the assembled workforce. For tax purposes, in accordance with Internal Revenue Code Section 197, $245 million of goodwill will be amortized over 15 years.
The Company incurred total transaction costs related to the acquisition of approximately $0.1 million which were expensed in the first and second quarter of fiscal 2019 in accordance with U.S. GAAP.
Supplemental Pro Forma Financial Information
The following unaudited pro forma consolidated financial information reflects the results of operations of the Company as if the RF Power transaction had occurred at the beginning of the fiscal year prior to the fiscal year of acquisition, after giving effect to certain purchase accounting adjustments (in thousands, except per share amounts):
Three Months Ended
Six Months Ended
December 24, 2017
December 24, 2017
Revenue
$393,119
$778,358
Net income (loss)
11,002
(17,550
)
Earnings per share, basic
$0.11
($0.18
)
Earnings per share, diluted
$0.11
($0.18
)
These amounts have been calculated after applying the Company's accounting policies and adjusting the results of the RF Power business to give effect to events and transactions that are directly attributable to the RF Power business transactions, including the elimination of sales by the Company to the RF Power business prior to acquisition, additional depreciation and amortization that would have been charged assuming the fair value adjustments primarily to property and equipment and intangible assets had been applied at the beginning of fiscal 2017, together with the consequential tax effects. Excluded from the pro forma net income and the earnings per share amounts for the three months and six months ended December 24, 2017 are one-time acquisition costs and foreign currency gains attributable to the RF Power business of $0.1 million. This supplemental pro forma information has been prepared for comparative purposes and does not purport to be indicative of what would have occurred had the acquisition been made at the beginning of fiscal 2017, nor is it indicative of any future results.
On July 8, 2015, the Company closed on the acquisition of Arkansas Power Electronics International, Inc. (APEI), a global leader in power modules and power electronics applications, pursuant to a merger agreement with APEI and certain shareholders of APEI, whereby the Company acquired all of the outstanding share capital of APEI in exchange for a base purchase price of $13.8 million, subject to certain adjustments. In addition, if certain goals were achieved over the subsequent two years, additional cash payments totaling up to $4.6 million were to be made to the former APEI shareholders. Payments totaling $2.8 million were made to the former APEI shareholders in July 2016 based on achievement of the first-year goals. The final payment of $1.9 million was made in July 2017 based on achievement of the second-year goals. In connection with this acquisition, APEI became a wholly owned subsidiary of the Company, renamed Cree Fayetteville, Inc. (Cree Fayetteville). Cree Fayetteville is not considered a significant subsidiary of the Company and its results from operations are reported as part of the Company's Wolfspeed segment.
Note 4 – Financial Statement Details
Accounts Receivable, net
The following table summarizes the components of accounts receivable, net (in thousands):
December 30, 2018
June 24, 2018
Billed trade receivables
$192,432
$215,077
Unbilled contract receivables
3,655
966
196,087
216,043
Allowance for sales returns, discounts and other incentives
—
(56,800
)
Allowance for bad debts
(4,035
)
(5,368
)
Accounts receivable, net
$192,052
$153,875
Inventories
The following table summarizes the components of inventories (in thousands):
December 30, 2018
June 24, 2018
Raw material
$97,682
$95,890
Work-in-progress
106,103
104,300
Finished goods
109,527
95,825
Inventories
$313,312
$296,015
Other Current Liabilities
The following table summarizes the components of other current liabilities (in thousands):
Accumulated Other Comprehensive Income, net of taxes
The following table summarizes the components of accumulated other comprehensive income, net of taxes (in thousands):
December 30, 2018
June 24, 2018
Currency translation gain
$4,541
$5,075
Net unrealized loss on available-for-sale securities
(3,685
)
(4,479
)
Accumulated other comprehensive income, net of taxes
$856
$596
Non-Operating (Expense) Income, net
The following table summarizes the components of non-operating (expense) income, net (in thousands):
Three Months Ended
Six Months Ended
December 30, 2018
December 24, 2017
December 30, 2018
December 24, 2017
Foreign currency gain (loss), net
$27
$462
($571
)
$1,228
(Loss) gain on sale of investments, net
(107
)
1
(107
)
47
(Loss) gain on equity investment, net
(1,880
)
24,746
(8,524
)
21,479
Interest (expense) income, net
(3,671
)
1,467
(6,032
)
2,617
Other, net
167
53
266
291
Non-operating (expense) income, net
($5,464
)
$26,729
($14,968
)
$25,662
The change in (loss) gain on equity investment, net is due to the decrease in the Lextar Electronics Corporation (Lextar) stock price.
Reclassifications Out of Accumulated Other Comprehensive Income, net of taxes
The following table summarizes the amounts reclassified out of accumulated other comprehensive income, net of taxes (in thousands):
Accumulated Other Comprehensive Income Component
Amount Reclassified Out of Accumulated Other Comprehensive Loss
Affected Line Item in the Consolidated Statements of (Loss) Income
Three Months Ended
Six Months Ended
December 30, 2018
December 24, 2017
December 30, 2018
December 24, 2017
Net unrealized (loss) gain on available-for-sale securities, net of taxes
($107
)
$1
($107
)
$47
Non-operating (expense) income, net
Less income tax effect
—
—
—
—
Income tax expense (benefit)
Total reclassifications
($107
)
$1
($107
)
$47
Note 5 – Investments
Investments consist of municipal bonds, corporate bonds, U.S. agency securities, U.S. treasury securities, variable rate demand notes, commercial paper and certificates of deposit. All short-term investments are classified as available-for-sale. Other long-term investments consist of the Company's ownership interest in Lextar.
The following tables present the gross unrealized losses and estimated fair value of the Company's short-term investments, aggregated by investment type and the length of time that individual securities have been in a continuous unrealized loss position (in thousands, except numbers of securities):
December 30, 2018
Less than 12 Months
Greater than 12 Months
Total
Fair Value
Unrealized Loss
Fair Value
Unrealized Loss
Fair Value
Unrealized Loss
Municipal bonds
$10,061
($17
)
$83,126
($736
)
$93,187
($753
)
Corporate bonds
99,699
(263
)
38,162
(686
)
137,861
(949
)
U.S. agency securities
3,975
(3
)
—
—
3,975
(3
)
U.S. treasury securities
40,478
(14
)
3,894
(29
)
44,372
(43
)
Total
$154,213
($297
)
$125,182
($1,451
)
$279,395
($1,748
)
Number of securities with an unrealized loss
183
102
285
June 24, 2018
Less than 12 Months
Greater than 12 Months
Total
Fair Value
Unrealized Loss
Fair Value
Unrealized Loss
Fair Value
Unrealized Loss
Municipal bonds
$97,470
($861
)
$3,642
($78
)
$101,112
($939
)
Corporate bonds
61,453
(1,088
)
1,486
(62
)
62,939
(1,150
)
U.S. agency securities
3,884
(38
)
—
—
3,884
(38
)
U.S. treasury securities
—
—
—
—
—
—
Total
$162,807
($1,987
)
$5,128
($140
)
$167,935
($2,127
)
Number of securities with an unrealized loss
151
6
157
The Company utilizes specific identification in computing realized gains and losses on the sale of investments. Realized gains and losses from the sale of investments are included in non-operating (expense) income, net in the consolidated statements of (loss) income and unrealized gains and losses are included as a separate component of equity, net of tax, unless the loss is determined to be other-than-temporary.
The Company evaluates its investments for possible impairment or a decline in fair value below cost basis that is deemed to be other-than-temporary on a periodic basis. It considers such factors as the length of time and extent to which the fair value has been below the cost basis, the financial condition of the investee, and its ability and intent to hold the investment for a period of time that may be sufficient for an anticipated full recovery in market value. Accordingly, the Company considered declines in its investments to be temporary in nature, and did not consider its securities to be impaired as of December 30, 2018 and June 24, 2018.
The contractual maturities of short-term investments as of December 30, 2018 were as follows (in thousands):
Under U.S. GAAP, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the exit price) in an orderly transaction between market participants at the measurement date. In determining fair value, the Company uses various valuation approaches, including quoted market prices and discounted cash flows. U.S. GAAP also establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are obtained from independent sources and can be validated by a third party, whereas unobservable inputs reflect assumptions regarding what a third party would use in pricing an asset or liability. The fair value hierarchy is categorized into three levels based on the reliability of inputs as follows:
•
Level 1 - Valuations based on quoted prices in active markets for identical instruments that the Company is able to access. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.
•
Level 2 - Valuations based on quoted prices in active markets for instruments that are similar, or quoted prices in markets that are not active for identical or similar instruments, and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.
•
Level 3 - Valuations based on inputs that are unobservable and significant to the overall fair value measurement.
The financial assets for which the Company performs recurring fair value remeasurements are cash equivalents, short-term investments and long-term investments. As of December 30, 2018, financial assets utilizing Level 1 inputs included money market funds and U.S. treasury securities, and financial assets utilizing Level 2 inputs included municipal bonds, corporate bonds, U.S. agency securities, U.S. treasury securities, certificates of deposit, commercial paper, variable rate demand notes and common stock of non-U.S. corporations. Level 2 assets are valued based on quoted prices in active markets for instruments that are similar or using a third-party pricing service's consensus price, which is a weighted average price based on multiple sources. These sources determine prices utilizing market income models which factor in, where applicable, transactions of similar assets in active markets, transactions of identical assets in infrequent markets, interest rates, bond or credit default swap spreads and volatility. The Company did not have any financial assets requiring the use of Level 3 inputs as of December 30, 2018.