WOLFSPEED, INC. 10-Q

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 (the Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). All information contained in this report relative to future markets for our products and trends in and anticipated levels of revenue, gross margins and expenses, as well as other statements containing words such as “believe,” “project,” “may,” “will,” “anticipate,” “target,” “plan,” “estimate,” “expect” and “intend” and other similar expressions constitute forward-looking statements. These forward-looking statements are subject to business, economic and other risks and uncertainties, both known and unknown, and actual results may differ materially from those contained in the forward-looking statements. Any forward-looking statements we make are as of the date made, and except as required under the U.S. federal securities laws and the rules and regulations of the Securities and Exchange Commission (the SEC), we have no duty to update them if our views later change. These forward-looking statements should not be relied upon as representing our views as of any date subsequent to the date of this Quarterly Report. Examples of risks and uncertainties that could cause actual results to differ materially from historical performance and any forward-looking statements include, but are not limited to, those described in “Risk Factors” in Part II, Item 1A of this Quarterly Report. Executive Summary The following discussion is designed to provide a better understanding of our unaudited consolidated financial statements, including a brief discussion of our business and products, key factors that impacted our performance and a summary of our operating results. The following discussion should be read in conjunction with the unaudited consolidated financial statements and the notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q, and the consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the fiscal year ended June 30, 2019. Historical results and percentage relationships among any amounts in the financial statements are not necessarily indicative of trends in operating results for any future periods. Overview Cree, Inc. (Cree, we, our, or us) is an innovator of wide bandgap semiconductors, focused on silicon carbide and gallium nitride materials, products for power and radio-frequency (RF) applications and specialty lighting-class light emitting diode (LED) products. Our silicon carbide and gallium nitride (GaN) materials and products are targeted for applications such as transportation, power supplies, inverters, wireless systems, and our LEDs are targeted for indoor and outdoor lighting, electronic signs and signals and video displays. We operate in two reportable segments: • Wolfspeed , which consists of silicon carbide and GaN materials, power devices and RF devices based on wide bandgap semiconductor materials and silicon. Our materials products and power devices are used in electric vehicles, motor drives, power supplies, solar and transportation applications. Our materials products and RF devices are used in military communications, radar, satellite and telecommunication applications. • LED Products , which consists of LED chips and LED components. Our LED products enable our customers to develop and market LED-based products for lighting, video screens, automotive and specialty lighting applications. In addition, we previously designed, manufactured and sold LED lighting fixtures and lamps for the commercial, industrial and consumer markets. We referred to these product lines as the Lighting Products business unit. On May 13, 2019, we sold our Lighting Products business unit to IDEAL Industries, Inc. (IDEAL) and have classified this business unit as discontinued operations. The Lighting Products business unit represented the Lighting Products segment disclosed in our historical financial statements. The majority of our products are manufactured at our production facilities located in North Carolina, California, Arkansas and China. We also use contract manufacturers for certain products and aspects of product fabrication, assembly and packaging. We operate research and development facilities in North Carolina, Arizona, Arkansas, California and China (including Hong Kong). Cree, Inc. is a North Carolina corporation established in 1987, and our headquarters are in Durham, North Carolina. For further information about our consolidated revenue and earnings, please see our consolidated financial statements included in Item 1 of this Quarterly Report. 32 Table of Contents Industry Dynamics and Trends There are a number of industry factors that affect our business which include, among others: • COVID-19 Outbreak. The novel strain of coronavirus (COVID-19) has spread globally, including locations where we do business. The full extent of the outbreak, related business and travel restrictions and changes to behavior intended to reduce its spread are uncertain as of the date of this Quarterly Report as this continues to evolve globally. The potential effects of COVID-19 could impact us in a number of other ways including, but not limited to, the impact on employees becoming ill, quarantined, or otherwise unable to work or travel due to illness or governmental restriction, the impact on customers and their related demand and/or purchases, the impact on our suppliers on their ability to fulfill our orders, and the overall impact of the aforementioned items that could cause output challenges. Additionally, COVID-19 could have a number of additional adverse effects, including additional laws and regulations affecting our business, fluctuations in foreign currency markets and the credit risks of our customers. • Overall Demand for Products and Applications using silicon carbide power devices, GaN and silicon RF devices, and LEDs . Our potential for growth depends significantly on the adoption of silicon carbide and GaN materials and device products in the power and RF markets, the continued use of silicon devices in the RF telecommunications market, the continued adoption of LEDs and LED lighting, and our ability to win new designs for these applications. Demand also fluctuates based on various market cycles, continuously evolving industry supply chains, trade and tariff terms, as well as evolving competitive dynamics in each of the respective markets. These uncertainties make demand difficult to forecast for us and our customers. • Governmental Trade and Regulatory Conditions . Our potential for growth, as with most multi-national companies, depends on a balanced and stable trade, political, economic and regulatory environment among the countries where we do business. Changes in trade policy such as the imposition of tariffs or export bans to specific customers or countries could reduce or limit demand for our products in certain markets. • Intense and Constantly Evolving Competitive Environment. Competition in the industries we serve is intense. Many companies have made significant investments in product development and production equipment. Product pricing pressures exist as market participants often undertake pricing strategies to gain or protect market share, increase the utilization of their production capacity and open new applications in the power, RF and LED markets we serve. To remain competitive, market participants must continuously increase product performance, reduce costs and develop improved ways to serve their customers. To address these competitive pressures, we have invested in research and development activities to support new product development, lower product costs and deliver higher levels of performance to differentiate our products in the market. In addition, we invest in systems, people and new processes to improve our ability to deliver a better overall experience for our customers. • Technological Innovation and Advancement. Innovations and advancements in materials, power, RF, and LED technologies continue to expand the potential commercial application for our products. However, new technologies or standards could emerge or improvements could be made in existing technologies that could reduce or limit the demand for our products in certain markets. • Intellectual Property Issues. Market participants rely on patented and non-patented proprietary information relating to product development, manufacturing capabilities and other core competencies of their business. Protection of intellectual property is critical. Therefore, steps such as additional patent applications, confidentiality and non-disclosure agreements, as well as other security measures are generally taken. To enforce or protect intellectual property rights, litigation or threatened litigation is common. Overview of the nine months ended March 29, 2020 The following is a summary of our financial results for the nine months ended March 29, 2020: • Revenue decreased to $698.2 million for the nine months ended March 29, 2020 from $828.7 million for the nine months ended March 31, 2019. • Gross profit decreased to $197.5 million for the nine months ended March 29, 2020 from $302.3 million for the nine months ended March 31, 2019. Gross margin was 28.3% for the nine months ended March 29, 2020 and 36.5% for the nine months ended March 31, 2019. • Operating loss was $145.1 million for the nine months ended March 29, 2020 compared to operating income of $9.7 million for the nine months ended March 31, 2019. • Diluted loss per share from continuing operations was $1.41 for the nine months ended March 29, 2020 compared to $0.23 for the nine months ended March 31, 2019. • Combined cash, cash equivalents and short-term investments was $852.9 million at March 29, 2020 and $1,051.4 million at June 30, 2019. 33 Table of Contents • Cash used in operating activities from continuing operations was $39.5 million for the nine months ended March 29, 2020 compared to cash provided by operating activities from continuing operations of $179.7 million for the nine months ended March 31, 2019. • Purchases of property and equipment were $168.9 million for the nine months ended March 29, 2020 compared to $93.3 million for the nine months ended March 31, 2019. Business Outlook We are uniquely positioned as an innovator in both of our business segments. The strength of our balance sheet and operating cash flow provides us the ability to invest in our businesses, as indicated by our planned construction of a state-of-the-art, automated 200mm capable silicon carbide and GaN fabrication facility and a large materials factory to expand our silicon carbide capacity which was announced in May 2019. We are focused on the following priorities to support our goals of delivering higher revenue and shareholder returns over time: • Wolfspeed - invest in the business to expand the scale, further develop the technologies, and accelerate the growth opportunities of silicon carbide materials, silicon carbide power devices and modules, and GaN and silicon RF devices. • LED Products - focus our efforts where our best-in-class technology and application-optimized solutions are differentiated and valued. In regards to COVID-19, our manufacturing facilities in the United States are currently operating as essential businesses in states that have issued shelter in place orders. We have instituted strict measures that balance employee safety with meeting the needs of business operations. These measures include increased employee sick days, robust health screening, social distancing policies and cleaning protocols to ensure the safety of our employees and the protection of our customers, suppliers, and partners. Our strong balance sheet and our ability to continue operations allows us to navigate the current environment while maintaining our capital expenditure plans to support future growth, including the construction of new facilities in New York and North Carolina. Even so, our short-term impacts from COVID-19 to our financial position, results of operations and cash flows are uncertain. 34 Table of Contents Results of Operations Selected consolidated statements of operations data for the three and nine months ended March 29, 2020 and March 31, 2019 is as follows: Three months ended Nine months ended March 29, 2020 March 31, 2019 March 29, 2020 March 31, 2019 (in millions of U.S. Dollars, except share data) Dollars % of Revenue Dollars % of Revenue Amount % of Revenue Amount % of Revenue Revenue, net $215.5 100.0 % $274.0 100.0 % $698.2 100.0 % $828.7 100.0 % Cost of revenue, net 154.1 71.5 173.5 63.3 500.7 71.7 526.4 63.5 Gross profit 61.4 28.5 100.5 36.7 197.5 28.3 302.3 36.5 Research and development 46.7 21.7 40.7 14.9 137.7 19.7 117.2 14.1 Sales, general and administrative 49.7 23.1 50.6 18.5 160.1 22.9 143.7 17.3 Amortization or impairment of acquisition-related intangibles 3.7 1.7 3.9 1.4 10.9 1.6 11.7 1.4 Loss on disposal or impairment of other assets 0.3 0.1 5.3 1.9 2.1 0.3 5.7 0.7 Other operating expense 10.8 5.0 11.1 4.1 31.8 4.6 14.3 1.7 Operating (loss) income (49.8) (23.1) (11.1) (4.1) (145.1) (20.8) 9.7 1.2 Non-operating expense, net 14.5 6.7 8.4 3.1 7.8 1.1 23.7 2.9 Loss before income taxes (64.3) (29.8) (19.5) (7.1) (152.9) (21.9) (14.0) (1.7) Income tax (benefit) expense (2.9) (1.3) 2.8 1.0 (1.2) (0.2) 9.3 1.1 Net loss from continuing operations ($61.4) (28.5) ($22.3) (8.1) ($151.7) (21.7) ($23.3) (2.8) Net loss from discontinued operations — — (205.4) (75.0) — — (218.0) (26.3) Net loss (61.4) (28.5) (227.7) (83.1) (151.7) (21.7) (241.3) (29.1) Net income attributable to non-controlling interest 0.2 0.1 0.1 — 0.5 0.1 0.1 — Net loss attributable to controlling interest ($61.6) (28.6) ($227.8) (83.1) ($152.2) (21.8) ($241.4) (29.1) Basic and diluted loss per share Continuing operations attributable to controlling interest ($0.57) ($0.22) ($1.41) ($0.23) Net loss attributable to controlling interest ($0.57) ($2.20) ($1.41) ($2.35) Revenue Revenue was comprised of the following: Three months ended Nine months ended (in millions of U.S. Dollars) March 29, 2020 March 31, 2019 Change March 29, 2020 March 31, 2019 Change Wolfspeed revenue $113.9 $141.2 ($27.3) (19) % $362.3 $403.9 ($41.6) (10) % Percent of revenue 53 % 52 % 52 % 49 % LED Products revenue 101.6 132.8 (31.2) (23) % 335.9 424.8 (88.9) (21) % Percent of revenue 47 % 48 % 48 % 51 % Total revenue $215.5 $274.0 ($58.5) (21) % $698.2 $828.7 ($130.5) (16) % Wolfspeed Segment Revenue The decrease in Wolfspeed segment revenue for the three and nine months ended March 29, 2020 compared to the three and nine months ended March 31, 2019 was due to the ongoing trade dispute between the United States and China, along with recent supply, labor, output and customer impacts due to the COVID-19 outbreak. The Wolfspeed products segment had a 33% decrease in overall average selling prices (ASP) offset by a 20% increase in the number of units sold for the three months ended March 29, 2020 and a 3% increase in ASP offset by a 13% decrease in the number of units sold for the nine months ended March 29, 2020. 35 Table of Contents LED Products Segment Revenue The decrease in LED Products segment revenue for the three and nine months ended March 29, 2020 compared to the three and nine months ended March 31, 2019 was due to overall market softness in global LED demand as well as supply, labor and output challenges due to the COVID-19 outbreak. The LED Products segment had a 14% decrease in the number of units sold and an 11% decrease in ASP for the three months ended March 29, 2020 and a 10% decrease in the number of units sold and a 12% decrease in ASP for the nine months ended March 29, 2020. Gross Profit and Gross Margin Gross profit and gross margin were as follows: Three months ended Nine months ended (in millions of U.S. Dollars) March 29, 2020 March 31, 2019 Change March 29, 2020 March 31, 2019 Change Wolfspeed gross profit $45.5 $68.8 ($23.3) (34) % $146.3 $193.9 ($47.6) (25) % Wolfspeed gross margin 39.9 % 48.7 % 40.4 % 48.0 % LED Products gross profit 20.3 37.0 (16.7) (45) % 68.9 121.8 (52.9) (43) % LED Products gross margin 20.0 % 27.9 % 20.5 % 28.7 % Unallocated costs (4.4) (3.9) (0.5) (13) % (17.7) (10.8) (6.9) (64) % COGS acquisition related costs — (1.4) 1.4 100 % — (2.6) 2.6 100 % Consolidated gross profit $61.4 $100.5 ($39.1) (39) % $197.5 $302.3 ($104.8) (35) % Consolidated gross margin 28.5 % 36.7 % 28.3 % 36.5 % Wolfspeed Segment Gross Profit and Gross Margin The decrease in Wolfspeed segment gross profit and gross margin for the three months ended March 29, 2020 compared to the three months ended March 31, 2019 are primarily due to higher costs driven by lower yields on new product introductions, changes in customer and product mix, and underutilization at our Morgan Hill facility. The decrease in Wolfspeed segment gross profit and gross margin for the nine months ended March 29, 2020 compared to the nine months ended March 31, 2019 are primarily due to higher costs driven by lower yields on new product introductions, changes in customer and product mix, underutilization at our Morgan Hill facility and higher inventory reserves related to product manufactured for Huawei Technologies Co., Ltd. and its affiliates in the second quarter of fiscal 2020. LED Products Segment Gross Profit and Gross Margin The decreases in LED Products segment gross profit and gross margin for the three and nine months ended March 29, 2020 compared to the three and nine months ended March 31, 2019 are primarily due to lower revenue as a result of decreasing demand, as well as underutilization resulting from lower factory volumes and higher product costs. Unallocated Costs Unallocated costs primarily consist of manufacturing employees' stock-based compensation, expenses for annual incentive plans, and matching contributions under our 401(k) plan. These costs were not allocated to the reportable segments' gross profit because our CODM does not review them regularly when evaluating segment performance and allocating resources. Unallocated costs stayed relatively flat for the three months ended March 29, 2020 compared to the three months ended March 31, 2019. The increase in unallocated costs for the nine months ended March 29, 2020 compared to the nine months ended March 31, 2019 were primarily attributable to increased stock-based compensation and matching contributions under our 401(k) plan. Increases in these categories were primarily the result of increased headcount. COGS Acquisition Related Costs The COGS acquisition related cost adjustment includes inventory fair value amortization of the fair value increase to inventory recognized at the date of acquisition, and other RF Power acquisition costs, impacting cost of revenue for fiscal 2018. These costs were not allocated to the reportable segments’ gross profit for fiscal 2019 because they represent an adjustment which does not provide comparability to the corresponding prior period and therefore were not reviewed by our CODM when evaluating segment performance and allocating resources. 36 Table of Contents Research and Development Research and development expenses include costs associated with the development of new products, enhancements of existing products and general technology research. These costs consisted primarily of employee salaries and related compensation costs, occupancy costs, consulting costs and the cost of development equipment and supplies. Research and development expenses were as follows: Three months ended Nine months ended (in millions of U.S. Dollars) March 29, 2020 March 31, 2019 Change March 29, 2020 March 31, 2019 Change Research and development $46.7 $40.7 $6.0 15 % $137.7 $117.2 $20.5 17 % Percent of revenue 22 % 15 % 20 % 14 % The increases in research and development expenses for both periods was primarily due to our continued investment in our silicon carbide and GaN technologies. Our research and development expenses vary significantly from year to year based on a number of factors, including the timing of new product introductions and the number and nature of our ongoing research and development activities. Sales, General and Administrative Sales, general and administrative expenses were comprised primarily of costs associated with our sales and marketing personnel and our executive and administrative personnel (for example, finance, human resources, information technology and legal) and consisted of salaries and related compensation costs; consulting and other professional services (such as litigation and other outside legal counsel fees, audit and other compliance costs); marketing and advertising expenses; facilities and insurance costs; and travel and other costs. Sales, general and administrative expenses were as follows: Three months ended Nine months ended (in millions of U.S. Dollars) March 29, 2020 March 31, 2019 Change March 29, 2020 March 31, 2019 Change Sales, general and administrative $49.7 $50.6 ($0.9) (2) % $160.1 $143.7 $16.4 11 % Percent of revenue 23 % 18 % 23 % 17 % Sales, general and administrative expenses stayed relatively flat for the three months ended March 29, 2020 compared to the three months ended March 31, 2019. The increase in sales, general and administrative expenses for the nine months ended March 29, 2020 compared to the nine months ended March 31, 2019 are primarily due to increases in salaries and benefits, stock-based compensation and professional service fees related to transition services from the sale of the Lighting Products business unit. Amortization or Impairment of Acquisition-Related Intangibles As a result of our acquisitions, we have recognized various amortizable intangible assets, including customer relationships, developed technology, non-compete agreements and trade names. Amortization of intangible assets related to our acquisitions was as follows: Three months ended Nine months ended (in millions of U.S. Dollars) March 29, 2020 March 31, 2019 Change March 29, 2020 March 31, 2019 Change Customer relationships $1.5 $1.8 ($0.3) (17) % $4.6 $5.4 ($0.8) (15) % Developed technology 1.4 1.3 0.1 8 % 4.0 4.0 — — % Non-compete agreements 0.8 0.8 — — % 2.3 2.3 — — % Total amortization $3.7 $3.9 ($0.2) (5) % $10.9 $11.7 ($0.8) (7) % Amortization of intangible assets stayed fairly consistent due to the absence of significant intangible-related activity between the periods. Amortization of customer relationships decreased slightly in each period due to certain intangible assets relating to customer relationships reaching the end of their amortization period in fiscal 2019. 37 Table of Contents Loss on Disposal and Impairment of Other Assets We operate a capital-intensive business. As such, we dispose of a certain level of our equipment in the normal course of business as our production processes change due to production improvement initiatives or product mix changes. Due to the risk of technological obsolescence or changes in our production process, we regularly review our long-lived assets and capitalized patent costs for possible impairment. Loss on disposal or impairment of other assets were as follows: Three months ended Nine months ended (in millions of U.S. Dollars) March 29, 2020 March 31, 2019 Change March 29, 2020 March 31, 2019 Change Loss on disposal or impairment of other assets $0.3 $5.3 ($5.0) (94) % $2.1 $5.7 ($3.6) (63) % Loss on disposal or impairment of other assets for the three months ended March 29, 2020 primarily relates to write-offs of impaired or abandoned patents. Loss on disposal or impairment of other assets for the nine months ended March 29, 2020 primarily relates to write-offs of impaired or abandoned patents as well as the impairment of certain leasehold improvements. Loss on disposal or impairment of other assets for the three and nine months ended March 31, 2019 primarily relates to an impairment of other assets in conjunction with our disposal of the Lighting Products business unit. Other Operating Expense Other operating expense was as follows: Three months ended Nine months ended (in millions of U.S. Dollars) March 29, 2020 March 31, 2019 Change March 29, 2020 March 31, 2019 Change Factory optimization restructuring $1.1 $— $1.1 100 % $3.5 $— $3.5 100 % Severance and other restructuring — — — — % 0.8 2.6 (1.8) (69) % Total restructuring costs 1.1 — 1.1 100 % 4.3 2.6 1.7 65 % Project, transformation and transaction costs 7.0 10.1 (3.1) (31) % 20.4 10.7 9.7 91 % Factory optimization start-up costs 2.1 — 2.1 100 % 5.0 — 5.0 100 % Non-restructuring related executive severance 0.6 1.0 (0.4) (40) % 2.1 1.0 1.1 110 % Other operating expense $10.8 $11.1 ($0.3) (3) % $31.8 $14.3 $17.5 122 % Factory optimization restructuring costs relate to the movement of equipment as well as disposals on certain long-lived assets. Severance and other restructuring costs relate to corporate restructuring plans. See Note 15, "Restructuring," to our unaudited consolidated financial statements in Part I, Item 1 of this Quarterly Report for additional information on our restructuring costs. Project, transformation and transaction costs primarily relate to professional services fees associated with acquisitions, divestitures and internal transformation programs. Factory optimization start-up costs are additional start-up costs as part of our factory optimization efforts, which began in the fourth quarter of fiscal 2019. Other operating expense stayed relatively flat for the three months ended March 29, 2020 compared to the three months ended March 31, 2019. The increase in other operating expense for the nine months ended March 29, 2020 compared to the nine months ended March 31, 2019 was primarily due to increased project, transformation and transaction costs and the addition of factory optimization start-up costs in fiscal 2020. 38 Table of Contents Non-Operating Expense, net Non-operating expense, net was comprised of the following: Three months ended Nine months ended (in millions of U.S. Dollars) March 29, 2020 March 31, 2019 Change March 29, 2020 March 31, 2019 Change (Gain) loss on sale of investments, net ($1.2) $— ($1.2) (100) % ($1.3) $0.1 ($1.4) (1,400) % Loss on equity investment, net $19.1 $3.8 $15.3 403 % $9.2 $12.4 ($3.2) (26) % Gain on arbitration proceeding (8.0) — (8.0) (100) % (8.0) — (8.0) (100) % Foreign currency loss (gain), net 0.3 0.5 (0.2) (40) % (0.8) 1.1 (1.9) (173) % Interest expense 7.5 7.4 0.1 1 % 22.6 18.8 3.8 20 % Interest income (3.1) (3.6) 0.5 14 % (13.5) (9.0) (4.5) (50) % Other, net (0.1) 0.3 (0.4) (133) % (0.4) 0.3 (0.7) (233) % Non-operating expense, net $14.5 $8.4 $6.1 73 % $7.8 $23.7 ($15.9) (67) % Loss on equity investment, net . The loss on equity investment for the three and nine months ended March 29, 2020 was due to the decrease in fair value of our Lextar Electronics Corporation (Lextar) investment. Lextar’s stock is publicly traded on the Taiwan Stock Exchange and its share price increased from 14.75 New Taiwanese Dollars (TWD) per share at June 30, 2019 to 18.40 TWD at December 29, 2019 but then decreased to 11.45 TWD at March 29, 2020. The loss on equity investment for the three and nine months ended March 31, 2019 was due to Lextar’s share price decreasing from 21.00 TWD per share at June 24, 2018 to 17.85 TWD at December 30, 2018 and to 16.40 TWD at March 31, 2019. This volatile stock price trend may continue in the future given the risks inherent in Lextar’s business and trends affecting the Taiwan and global equity markets. We have a 16% common stock ownership interest in Lextar and utilize the fair value option in accounting for the ownership interest. Any future stock price changes will be recorded as further gains or losses on equity investment based on the increase or decrease, respectively, in the fair value of the investment during the applicable fiscal period. Further losses could have a material adverse effect on our results of operations. Gain on arbitration proceeding . The gain on arbitration proceeding relates to an award from an arbitration proceeding in the third quarter of fiscal 2020 with a former vendor in which we were awarded damages for defective inventory. Foreign currency loss (gain), net. The loss in foreign currency for the three months ended March 29, 2020 was due to a slight weakening of the TWD against the United States Dollar, which caused foreign currency remeasurement losses on our investment in Lextar. This loss slightly offset gains experienced in the first two quarters of our fiscal year, lowering our foreign currency gain for the nine months ended March 29, 2020. Interest expense . The increase in interest expense for the nine months ended March 29, 2020 compared to the nine months ended March 31, 2019 was due to the current year having a full year of interest expense on our 0.875% convertible senior notes due September 1, 2023 (the 2023 Notes), which were sold on August 24, 2018. Interest income. The increase in interest income for the nine months ended March 29, 2020 compared to the nine months ended March 31, 2019 was due to higher balances on our short-term investments. Income tax (benefit) expense Income tax (benefit) expense and our effective tax rate was as follows: Three months ended Nine months ended (in millions of U.S. Dollars) March 29, 2020 March 31, 2019 Change March 29, 2020 March 31, 2019 Change Income tax (benefit) expense ($2.9) $2.8 ($5.7) (204) % ($1.2) $9.3 ($10.5) (113) % Effective tax rate 5 % (14) % 1 % (66) % The change in our effective tax rate for the three months ended March 29, 2020 was primarily due to a net $5.1 million discrete tax benefit related to net operating loss provisions of the Coronavirus Aid, Relief and Economic Security Act ("CARES Act"). The change in our effective tax rate for the nine months ended March 29, 2020 was primarily due to the discrete tax benefit related to net operating loss provisions of the CARES Act and a decrease in projected income derived from international locations for the full year due to impacts of COVID-19. 39 Table of Contents In general, the variation between our effective income tax rate and the U.S. statutory rate of 21% is primarily due to: (i) changes in our valuation allowances against deferred tax assets in the U.S. and Luxembourg, (ii) projected income for the full year derived from international locations with differing tax rates than the U.S., and (iii) projected tax credits generated. Net Loss from Discontinued Operations We recorded a net loss from discontinued operations of $205.4 million and $218.0 million fo r the three and nine months ended March 31, 2019, which related to operational results of the discontinued operations of the Lighting Products business unit. We did not have any discontinued operations related activity for the three and nine months ended March 29, 2020. 40 Table of Contents Liquidity and Capital Resources Overview We require cash to fund our operating expenses and working capital requirements, including outlays for research and development, capital expenditures, strategic acquisitions and investments. Our principal sources of liquidity are cash on hand, marketable securities, cash generated from operations and availability under our line of credit. Our ability to generate cash from operations has been one of our fundamental strengths and has provided us with substantial flexibility in meeting our operating, financing and investing needs. We have a $125 million line of credit as discussed in Note 9, “Long-term Debt,” in our consolidated financial statements included in Part I, Item 1 of this Quarterly Report. The purpose of this facility is to provide short term flexibility to optimize returns on our cash and investment portfolio while funding share repurchases, capital expenditures and other general business needs. Additionally, on April 21, 2020 we issued and sold a total of $575.0 million aggregate principal amount of 1.75% convertible senior notes (the 2026 Notes), as discussed in Note 16, "Subsequent Events," in our consolidated financial statements included in Part I, Item 1 of this Quarterly Report. The total net proceeds of the 2026 Notes was $561.4 million, of which we used $144.3 million to repurchase $150.2 million aggregate principal amount of our 2023 Notes. We expect to use the remainder of the net proceeds for general corporate purchases. Based on past performance and current expectations, we believe our current working capital, availability under our line of credit and anticipated cash flows from operations will be adequate to meet our cash needs for our daily operations and capital expenditures for at least the next 12 months. With our strong working capital position, we believe that we have the ability to continue to invest in further development of our products and, when necessary or appropriate, make selective acquisitions or other strategic investments to strengthen our product portfolio, secure key intellectual properties and/or expand our production capacity. From time to time, we evaluate strategic opportunities, including potential acquisitions, joint ventures, divestitures, spin-offs or investments in complementary businesses, and we continue to make such evaluations. We may also access capital markets through the issuance of debt or additional shares of common stock in connection with the acquisition of complementary businesses or other significant assets or for other strategic opportunities. The full extent to which COVID-19 may impact our results of operations or liquidity is uncertain. Currently, the local governments in the locations in which we operate have designated our Company as an essential business, but our operations have, and likely will continue, to experience supply, labor, demand and output challenges. We continue to monitor the impact that the COVID-19 pandemic is having on our business, the semiconductor and LED industries, and the economies in which we operate. We anticipate our future results of operations, including the results for fiscal 2021, will be materially impacted by COVID-19, but at this time do expect the impact from the COVID-19 outbreak will have a material effect on our liquidity or financial position. However, given the speed and frequency of continuously evolving developments with respect to this pandemic, we cannot reasonably estimate the magnitude of the impact to our results of operations, and, if the outbreak continues on its current trajectory, such impacts could grow and become material to our liquidity or financial position. To the extent our customers and suppliers continue to be materially and adversely impacted by COVID-19, this could reduce the availability, or result in delays, of materials or supplies to or from us, which in turn could materially interrupt our business operations. Liquidity Our liquidity and capital resources primarily depend on our cash flows from operations and our working capital. The significant components of our working capital are liquid assets such as cash and cash equivalents, short-term investments, accounts receivable and inventories reduced by trade accounts payable. The following table presents the components of our cash conversion cycle: Three months ended March 29, 2020 June 30, 2019 Change Days of sales outstanding (a) 53 34 19 Days of supply in inventory (b) 99 104 (5) Days in accounts payable (c) (73) (72) (1) Cash conversion cycle 79 66 13 a) Days of sales outstanding (DSO) measures the average collection period of our receivables. DSO is based on the ending net trade receivables less receivable related accrued contract liabilities and the revenue, net for the quarter then ended. DSO is calculated by dividing ending accounts receivable, less receivable related accrued contract liabilities, by the average net revenue per day for the respective 90-day period. 41 Table of Contents b) Days of supply in inventory (DSI) measures the average number of days from procurement to sale of our product. DSI is based on ending inventory and cost of revenue, net for the quarter then ended. DSI is calculated by dividing ending inventory by average cost of revenue, net per day for the respective 90-day period. c) Days in accounts payable (DPO) measures the average number of days our payables remain outstanding before payment. DPO is based on ending accounts payable and cost of revenue, net for the quarter then ended. DPO is calculated by dividing ending accounts payable and accrued expenses (less accrued salaries and wages) by the average cost of revenue, net per day for the respective 90-day period. The increase in our cash conversion cycle was primarily driven by an increase in days of sales outstanding related to short-term shipping delays at the end of the quarter as a result of the COVID-19 outbreak. As of March 29, 2020, we had unrealized losses on our investments of $2.4 million. All of our investments had investment grade ratings, and any such investments that were in an unrealized loss position at March 29, 2020 were in such position due to interest rate changes, sector credit rating changes, company-specific rating changes or negative market conditions surrounding the COVID-19 outbreak. We intend and believe that we have the ability to hold such investments for a period of time that will be sufficient for anticipated recovery in market value, and we currently expect to receive the full principal or recover our cost basis in these securities. The declines in value of the securities in our portfolio are considered to be temporary in nature and, accordingly, we do not believe these securities are impaired as of March 29, 2020. We will continue to assess if ongoing developments related to the outbreak may cause these unrealized losses to become other than temporary. Cash Flows In summary, our cash flows were as follows: Nine months ended March 29, 2020 March 31, 2019 Change Cash (used in) provided by operating activities ($39.5) $189.0 ($228.5) (121) % Cash used in investing activities (152.2) (192.5) 40.3 21 % Cash provided by financing activities 14.4 341.0 (326.6) (96) % Effect of foreign exchange changes (0.2) (0.2) — — % Net change in cash and cash equivalents ($177.5) $337.3 ($514.8) (153) % Cash Flows from Operating Activities Net cash used in operating activities decreased primarily due to lower net earnings and a decrease in overall working capital mainly driven by decreases in inventory and payables, as well as significant cash inflows from customer reserve deposits in the prior year. Total cash provided by operating activities for the nine months ended March 31, 2019 includes $9.3 million of cash provided by operating activities of discontinued operations. Cash Flows from Investing Activities Our investing activities primarily relate to short-term investment transactions, purchases of property and equipment and payments for patents and licensing rights. Cash used in investing activities decreased in the nine months ended March 29, 2020 compared to the nine months ended March 31, 2019 primarily due to $97.2 million less net purchases of short-term investments offset by an increase in property and equipment purchases of $75.6 million. Total cash used in investing activities for the nine months ended March 31, 2019 includes $15.4 million of cash used in investing activities of discontinued operations. For fiscal 2020, we target approximately $240.0 million of capital investment, which is primarily related to infrastructure projects to support our longer term growth and strategic priorities. Cash Flows from Financing Activities For the nine months ended March 29, 2020, our financing activities primarily consisted of net proceeds of $14.8 million from issuances of common stock pursuant to the exercise of employee stock options. For the nine months ended March 31, 2019, our financing activities primarily consisted of proceeds of $575.0 million from the issuance of the 2023 Notes and net proceeds of $70.9 million from issuances of common stock pursuant to the exercise of employee stock options, partially offset by the net repayment on our line of credit of $292.0 million and the payment of debt issuance costs of $12.9 million from the issuance of the 2023 Notes. 42 Table of Contents Off-Balance Sheet Arrangements We do not use off-balance sheet arrangements with unconsolidated entities or related parties, nor do we use any other forms of off-balance sheet arrangements. Accordingly, our liquidity and capital resources are not subject to off-balance sheet risks from unconsolidated entities. As of March 29, 2020, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K. Critical Accounting Policies and Estimates Leases (new for fiscal 2020 due to ASC 842 Adoption) At lease inception, we determine an arrangement is a lease if the contract involves the use of a distinct identified asset, the lessor does not have substantive substitution rights and we obtain control of the asset throughout the period by obtaining substantially all of the economic benefit of the asset and the right to direct the use of the asset. Right-of-use assets represent our right to use an underlying asset during the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Assets and liabilities are recognized based on the present value of lease payments over the lease term. Most leases include one or more options to renew, with renewal terms that can extend the lease term from one to five years or more. The exercise of the renewal option is at our sole discretion and we consider these options in determining the lease term used to establish our right-of-use assets and lease liabilities. We will remeasure our lease liability and adjust the related right-of-use asset upon the occurrence of the following: lease modifications not accounted for as a separate contract; a triggering event that changes the certainty of the lessee exercising an option to renew or terminate the lease, or purchase the underlying asset; a change to the amount probable of being owed by us under a residual value guarantee; or the resolution of a contingency upon which the variable lease payments are based such that those payments become fixed. Because most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at the lease commencement date in determining the present value of lease payments. We use the implicit rate when readily determinable. Operating lease expense is generally recognized on a straight-line basis over the lease term. Finance lease assets are amortized on a straight-line basis over the shorter of the useful life of the asset or the lease term. Interest expense on the finance lease liability is recognized using the effective interest rate method and is presented within interest expense on our consolidated statements of operations. We have agreements with lease and non-lease components, which are accounted for as a single lease component. Leases with a lease term of 12 months or less are not recorded on the balance sheet. We recognize lease expense for these leases on a straight-line basis over the lease term. Variable lease payment amounts that cannot be determined at the commencement of the lease, such as increases in lease payments based on changes in index rates, are not included in the right-of-use assets or liabilities. These variable lease payments are expensed as incurred. For information about our other critical accounting policies and estimates, see the “Critical Accounting Policies and Estimates” section of “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended June 30, 2019. Recent Accounting Pronouncements For a description of recent accounting pronouncements, including the expected dates of adoption and the estimated effects, if any, on our consolidated financial statements, see Note 1, “Basis of Presentation and New Accounting Standards,” to our unaudited consolidated financial statements in Part I, Item 1 of this Quarterly Report. 43 Table of Contents Item 3. Quantitative and Qualitative Disclosures About Market Risk For quantitative and qualitative disclosures about our market risks, see “Part II. Item 7A. Quantitative and Qualitative Disclosures About Market Risk” of our Annual Report on Form 10-K for the fiscal year ended June 30, 2019. There have been no material changes to the amounts presented therein.