What changed in this filing

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Item 2. Management’s Discussion and Analysis

2020-10-29 compared with 2020-04-30 · 169 added, 165 removed, 195 unchanged (63% of the section changed)

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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.

(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.

(Cree, we, our, or us) is an innovator of wide bandgap semiconductors, focused on silicon carbide and gallium nitride materials, devices 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 devices are targeted for applications such as transportation, power supplies, inverters and wireless systems.

Our LEDs are targeted for use in indoor and outdoor lighting, electronic signs and signals and video displays.

We operate in two reportable segments:

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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).

Additionally, we are in the process of building a silicon carbide fabrication facility in New York.

We operate research and development facilities in North Carolina, Arizona, Arkansas, New York, California and China (including Hong Kong).

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.

As discussed more fully in "Business Outlook", on October 18, 2020, we entered into a definitive agreement to sell certain assets and subsidiaries comprising our LED Products segment (the LED Business) to SMART Global Holdings, Inc.

(SGH) and its wholly owned subsidiary Chili Acquisition, Inc.

(collectively with SGH, SMART) for up to $300 million, including fixed upfront and deferred payments and contingent consideration (the LED Business Divestiture).

We will retain certain assets used in and pre-closing liabilities associated with the LED Products segment.

Following the LED Business Divestiture, we will operate solely in our Wolfspeed segment.

Industry Dynamics and Trends

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• 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.

COVID-19 has continued to spread globally, including locations where we do business.

While the financial impact of COVID-19 on our results is difficult to measure, we believe it has had an unfavorable impact on our operating income.

The potential effects of COVID-19 could affect us in a number of 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' ability to fulfill our orders, and the overall impact of the aforementioned items that could cause output challenges and increased costs.

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.

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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.

Changes in trade policy such as the imposition or extension 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.

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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.

• 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.

Overview of the three months ended September 27, 2020

Financial results for the three months ended September 27, 2020 include the impacts of a $105.7 million goodwill impairment charge associated with our determination as of September 27, 2020 that it was more likely than not that we would sell all or a portion of the assets comprising the LED Products segment below carrying value.

The following is a summary of our financial results for the three months ended September 27, 2020:

• Revenue decreased to $216.6 million for the three months ended September 27, 2020 from $242.8 million for the three months ended September 29, 2019.

• Gross profit decreased to $54.0 million for the three months ended September 27, 2020 from $74.2 million for the three months ended September 29, 2019.

Gross margin was 24.9% for the three months ended September 27, 2020 and 30.6% for the three months ended September 29, 2019.

• Operating loss was $170.0 million for the three months ended September 27, 2020 compared to $38.9 million for the three months ended September 29, 2019.

• Diluted loss per share was $1.68 for the three months ended September 27, 2020 compared to $0.35 for the three months ended September 29, 2019.

• Combined cash, cash equivalents and short-term investments was $1,138.5 million at September 27, 2020 and $1,251.7 million at June 28, 2020.

• Cash provided by operating activities was $0.4 million for the three months ended September 27, 2020 compared to cash used in operating activities of $20.0 million for the three months ended September 29, 2019.

• Purchases of property and equipment were $114.0 million for the three months ended September 27, 2020 compared to $42.0 million for the three months ended September 29, 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.

We believe we are uniquely positioned as an innovator in the global semiconductor industry.

The strength of our balance sheet and ability to generate cash provides us the ability to invest in our business, as indicated by our planned construction of a state-of-the-art, automated 200mm capable silicon carbide fabrication facility and a large materials factory to expand our silicon carbide capacity, each of which was announced in May 2019.

In September 2019, we announced our intention to build the new fabrication facility in Marcy, New York to complement the factory expansion already underway at our U.S.

campus headquarters in Durham, North Carolina.

Construction on the new fabrication facility commenced in the fourth quarter of fiscal 2020.

When completed, the LED Business Divestiture will represent a key milestone in our transformation to be a global semiconductor powerhouse focused on disruptive technology solutions for high-growth applications.

This transaction positions us with a sharpened strategic focus to lead the semiconductor industry transition from silicon to silicon carbide and further strengthens our financial position, which we target to support continued investments to capitalize on multi-decade growth opportunities across electrical vehicles (EVs), 5G and industrial applications.

We are focused on investing in the Wolfspeed 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.

We believe these efforts will support our goals of delivering higher revenue and shareholder returns over time.

In addition, we are focused on improving the number of usable items in a production cycle (yield) as our manufacturing technologies become more complex.

Despite increased complexities in our manufacturing process, we believe we are in a position to improve yield levels to support our future growth.

In regards to COVID-19, our manufacturing facilities in the United States are currently operating as essential businesses.

We have instituted strict measures designed to 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.

Our manufacturing facilities in China briefly closed mid-third quarter of fiscal 2020 and have remained open since that time.

Our manufacturing facilities in China mostly support the LED Products segment and will transfer to SMART in connection with the LED Business Divestiture through the sale of our ownership interest in Cree Huizhou Solid State Lighting Company Limited.

We believe the strength of our balance sheet and our ability to continue operations allow 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 additional production capacity in North Carolina.

Even so, our short-term impacts from COVID-19 to our financial position, results of operations and cash flows are uncertain.

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

Selected consolidated statements of operations data for the three months ended September 27, 2020 and September 29, 2019 is as follows:

Three months ended

September 27, 2020 September 29, 2019

(in millions of U.S.

Dollars, except share data) Dollars % of Revenue Dollars % of Revenue Amount % of Revenue Amount % of Revenue

Dollars, except share data) Amount % of Revenue Amount % of Revenue

Revenue, net $216.6 100.0 % $242.8 100.0 %

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Amortization or impairment of acquisition-related intangibles 3.6 1.7 3.6 1.5

Loss on disposal or impairment of other assets 0.3 0.1 5.3 1.9 2.1 0.3 5.7 0.7

(Gain) loss on disposal or impairment of other assets (0.2) (0.1) 1.0 0.4

Goodwill impairment 105.7 48.8 — —

Other operating expense 13.4 6.2 7.2 3.0

Operating (loss) income (170.0) (78.5) (38.9) (16.0)

Non-operating expense, net 14.5 6.7 8.4 3.1 7.8 1.1 23.7 2.9

Non-operating expense (income), net 14.0 6.5 (1.6) (0.7)

Loss before income taxes (184.0) (84.9) (37.3) (15.4)

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)

Income tax expense 0.1 — 0.5 0.2

Net loss (184.1) (85.0) (37.8) (15.6)

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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 ($1.68) ($0.35)

Revenue was comprised of the following:

Three months ended Nine months ended

Three months ended

(in millions of U.S.

Dollars) March 29, 2020 March 31, 2019 Change March 29, 2020 March 31, 2019 Change

Dollars) September 27, 2020 September 29, 2019 Change

Wolfspeed revenue $115.5 $127.7 ($12.2) (10) %

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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.

The decrease in Wolfspeed segment revenue was primarily due to supply and demand factors relating to the COVID-19 pandemic, the ongoing trade dispute between the United States and China, which has led some customers to adjust their materials-related supply chain to other suppliers and the timing of shipments to certain customers.

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.

The decrease in LED Products segment revenue was primarily due to decreases in demand related to COVID-19 and factory capacity restrictions.

Gross Profit and Gross Margin

Gross profit and gross margin were as follows:

Three months ended Nine months ended

Three months ended

(in millions of U.S.

Dollars) March 29, 2020 March 31, 2019 Change March 29, 2020 March 31, 2019 Change

Dollars) September 27, 2020 September 29, 2019 Change

Wolfspeed gross profit $42.3 $59.0 ($16.7) (28) %

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Unallocated costs (1)

COGS acquisition related costs — (1.4) 1.4 100 % — (2.6) 2.6 100 %

(10.7) (6.9) (3.8) (55) %

Consolidated gross profit $54.0 $74.2 ($20.2) (27) %

Consolidated gross margin 24.9 % 30.6 %

(1) Unallocated costs for the three months ended September 27, 2020 include $0.9 million in incremental manufacturing costs relating to COVID-19.

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.

The decreases in Wolfspeed segment gross profit and gross margin are primarily due to higher costs, customer mix and impacts from decreased revenue.

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.

The increases in LED Products segment gross profit and gross margin are primarily due to more favorable product and customer mix, offset by impacts from decreased revenue.

Unallocated Costs

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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.

For the first quarter of fiscal 2021, unallocated costs also include incremental costs relating to operating our manufacturing operations during the COVID-19 pandemic.

These incremental costs are primarily comprised of increased cleaning costs, cleaning supplies and protective equipment, as well as the costs from implementing preventative safety measures, including increased wellness checks and time off policies.

Unallocated costs increased primarily due to incremental operational costs as a result of operating our manufacturing operations during the COVID-19 pandemic and underutilization charges related to transitioning certain LED Products operations to Wolfspeed operations as part of our factory optimization efforts.

Additionally, increased stock based compensation was offset by a decrease in annual incentive expense.

Research and Development

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Research and development expenses were as follows:

Three months ended Nine months ended

Three months ended

(in millions of U.S.

Dollars) March 29, 2020 March 31, 2019 Change March 29, 2020 March 31, 2019 Change

Dollars) September 27, 2020 September 29, 2019 Change

Research and development $49.6 $43.7 $5.9 14 %

Percent of revenue 23 % 18 %

The increases in research and development expenses for both periods was primarily due to our continued investment in our silicon carbide and GaN technologies.

The increase in research and development expenses is primarily due to our continued investment in our silicon carbide and GaN technologies, including the development of existing silicon carbide materials and fabrication technology for next generation platforms and expansion of our Power and RF product portfolio.

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;

Sales, general and administrative expenses are 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 consists 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);

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Sales, general and administrative expenses were as follows:

Three months ended Nine months ended

Three months ended

(in millions of U.S.

Dollars) March 29, 2020 March 31, 2019 Change March 29, 2020 March 31, 2019 Change

Dollars) September 27, 2020 September 29, 2019 Change

Sales, general and administrative $51.9 $57.6 ($5.7) (10) %

Percent of revenue 24 % 24 %

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.

The decrease in sales, general and administrative expenses is primarily due to decreases in stock based compensation, as stock based compensation expense for the three months ended September 29, 2019 included certain adjustments relating to former executives’ awards.

Additionally, our travel costs decreased as a result of the COVID-19 pandemic and we incurred lower legal fees in the current quarter, partially offset by increased information technology costs.

Amortization or Impairment of Acquisition-Related Intangibles

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Amortization of intangible assets related to our acquisitions was as follows:

Three months ended Nine months ended

Three months ended

(in millions of U.S.

Dollars) March 29, 2020 March 31, 2019 Change March 29, 2020 March 31, 2019 Change

Dollars) September 27, 2020 September 29, 2019 Change

Customer relationships $1.5 $1.5 $— — %

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Total amortization $3.6 $3.6 $— — %

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.

Amortization of acquisition-related intangible assets stayed consistent due to the absence of acquisition-related intangible activity between the periods, as well as no impairments.

Amortization of acquisition-related intangibles relate to operations under our Wolfspeed segment.

Loss on Disposal and Impairment of Other Assets

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Loss on disposal or impairment of other assets were as follows:

Three months ended Nine months ended

Three 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.

Dollars) September 27, 2020 September 29, 2019 Change

(Gain) loss on disposal or impairment of other assets ($0.2) $1.0 ($1.2) (120) %

Gain on disposal or impairment of other assets for the three months ended September 27, 2020 primarily relates to proceeds from asset sales offset by write-offs of impaired or abandoned patents.

Loss on disposal or impairment of other assets for the three months ended September 29, 2019 primarily relates to write-offs of impaired or abandoned patents.

Goodwill Impairment

We review goodwill for impairment whenever events or circumstances indicate potential impairment.

In the first quarter of fiscal 2021, we determined we would more likely than not sell all or a portion of the assets comprising the LED Products segment below carrying value.

As a result of this triggering event, we recorded an impairment to goodwill of $105.7 million as of September 27, 2020.

As of September 27, 2020, we had not met the held-for-sale criteria.

No goodwill impairment was made as of September 29, 2019.

Other Operating Expense

Other operating expense was as follows:

Three months ended Nine months ended

Three months ended

(in millions of U.S.

Dollars) March 29, 2020 March 31, 2019 Change March 29, 2020 March 31, 2019 Change

Dollars) September 27, 2020 September 29, 2019 Change

Factory optimization restructuring $1.6 $1.2 $0.4 33 %

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Other operating expense $13.4 $7.2 $6.2 86 %

Factory optimization restructuring costs relate to the movement of equipment as well as disposals on certain long-lived assets.

Factory optimization restructuring costs relate to facility consolidations 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.

Project, transformation and transaction costs primarily relate to professional services fees associated with completed and potential acquisitions and divestitures, as well as internal transformation programs focused on optimizing our administrative processes and upgrading our enterprise resource planning (ERP) system to support our expected future growth.

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.

Non-Operating Expense, net

Non-operating expense, net was comprised of the following:

Three months ended Nine months ended

These efforts are focused on expanding our production footprint to support expected growth in the Wolfspeed segment.

Other operating expense increased primarily from increased project costs related to the LED Business Divestiture and a corporate restructuring event in the first quarter of fiscal 2021.

Non-Operating Expense (Income), net

Non-operating expense (income), net was comprised of the following:

Three 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 %

Dollars) September 27, 2020 September 29, 2019 Change

Loss (gain) on equity investment, net $3.4 ($3.5) $6.9 (197) %

Foreign currency loss, net — 0.1 (0.1) (100) %

Interest income (2.7) (5.5) 2.8 (51) %

Interest expense, net of capitalized interest 13.1 7.4 5.7 (77) %

Other, net 0.2 (0.1) 0.3 (300) %

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.

Non-operating expense (income), net $14.0 ($1.6) $15.6 (975) %

Loss (gain) on equity investment, net .

The loss on equity investment for the three months ended September 27, 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 decreased from 19.90 New Taiwanese Dollars (TWD) per share at June 28, 2020 to 18.70 TWD at September 27, 2020.

The gain on equity investment for the three months ended September 29, 2019 was due to Lextar’s share price increasing from 14.75 TWD per share at June 30, 2019 to 16.05 TWD at September 29, 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.

In June 2020, Lextar announced a plan to restructure under a holding company with EPISTAR Corporation (EPISTAR) via a share swap.

As approved by the shareholders of Lextar and EPISTAR at the meetings held on August 7, 2020, we will receive 0.275 shares of common stock of the holding company, to be named ENNOSTAR Inc.

(ENNOSTAR), for each share for Lextar common stock once the share swap is effected (currently scheduled for January 6, 2021), representing in the aggregate an approximately 3.3% common stock ownership interest in ENNOSTAR.

The shares of ENNOSTAR will be listed on the Taiwan Stock Exchange.

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.

Foreign currency loss, net.

Foreign currency loss (gain), net, primarily consists of remeasurement adjustments resulting from our Lextar investment and from our international subsidiaries.

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

The decrease in interest income was due to significant reductions in investment returns on our short-term investment securities.

Interest expense, net of capitalized interest .

The increase in interest expense was primarily due to the addition of our 1.75% convertible senior notes due May 1, 2026 (2026 Notes), which were sold on April 21, 2020.

Income tax expense

Income tax expense and our effective tax rate was as follows:

Three 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) %

Dollars) September 27, 2020 September 29, 2019 Change

Income tax expense $0.1 $0.5 ($0.4) (80) %

Effective tax rate — % (1) %

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.

Our effective tax rate remained steady due to relatively consistent year-to-date income in jurisdictions where we do not recognize a full valuation allowance.

In general, the variation between our effective income tax rate and the U.S.

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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.

Liquidity and Capital Resources

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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.

The purpose of this facility is to provide short term flexibility to optimize returns on our cash and investment portfolio while funding 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 2026 Notes, as discussed in Note 9, “Long-term Debt,” 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 0.875% convertible senior notes due September 1, 2023 (the 2023 Notes).

We expect to use the remainder of the net proceeds for general corporate purposes.

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.

With the strength of our 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.

For example, we recently entered into a definitive agreement with SMART regarding the LED Business Divestiture, which, when completed, will provide us with $50 million in up front payments, a $125 million unsecured promissory note due in August 2023 and the potential of up to $125 million in contingent consideration.

We may also access capital markets through the issuance of debt or additional shares of common stock, which we may use in connection with the acquisition of complementary businesses or other significant assets or for other strategic opportunities or general corporate purposes.

We are currently building a new silicon carbide fabrication facility in Marcy, New York, to expand capacity for our silicon carbide device business.

We expect to invest approximately $1.0 billion in construction, equipment and other related costs for the new facility through fiscal 2024, of which approximately $500 million is expected to be reimbursed in future fiscal years by the State of New York through a grant program administered by the State of New York Urban Development Corporation (doing business as Empire State Development).

Given our current cash position, we believe we are positioned to adequately fund the construction of the facility.

The full extent to which COVID-19 may impact our results of operations or liquidity is uncertain.

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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.

We anticipate our future results of operations, including the results for fiscal 2021, will be materially impacted by COVID-19, but at this time we do not 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.

To the extent our 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.

Our liquidity and capital resources primarily depend on our cash flows from operations and our working capital.

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Three months ended

March 29, 2020 June 30, 2019 Change

September 27, 2020 June 28, 2020 Change

Days of sales outstanding (a)

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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.

The decrease in our cash conversion cycle was primarily driven by increased accounts payable balances relating to investment at our future silicon carbide fabrication facility in New York.

As of September 27, 2020, we had unrealized losses on our short-term investments of $0.1 million.

All of our short-term investments had investment grade ratings, and any such investments that were in an unrealized loss position at September 27, 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 evaluate our short-term investments for expected credit losses.

We believe we are able to and we intend to hold each of the investments held with an unrealized loss as of September 27, 2020 until the investments fully recover in market value.

No allowance for credit losses was recorded as of September 27, 2020.

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) %

Three months ended

September 27, 2020 September 29, 2019 Change

Cash provided by (used in) operating activities $0.4 ($20.0) $20.4 (102) %

Cash used in investing activities (16.0) (52.3) 36.3 69 %

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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.

Net cash provided by operating activities increased primarily due to improved working capital.

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 used in investing activities decreased primarily due to increased net proceeds from short-term investments of $108.5 million offset by an increase in property and equipment purchases of $72.0 million.

For fiscal 2021, we target approximately $400.0 million of net capital investment, which is primarily related to capacity and infrastructure projects to support our Wolfspeed segment longer-term growth and strategic priorities.

This target is highly dependent on the timing and overall progress on the construction of our new silicon carbide fabrication facility in New York and is net of expected reimbursements from Empire State Development under a Grant Disbursement Agreement (GDA).

For more details on the GDA, see Note 13, "Commitments and Contingencies," to our unaudited consolidated financial statements in Part I, Item 1 of this Quarterly Report.

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.

For the three months ended September 27, 2020, our financing activities primarily consisted of net proceeds of $3.7 million from issuances of common stock pursuant to the exercise of employee stock options.

For the three months ended September 29, 2019, our financing activities consisted of net proceeds of $5.4 million from issuances of common stock pursuant to the exercise of employee stock options.

Off-Balance Sheet Arrangements

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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.

As of September 27, 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.

Allowance for Available-for-sale Debt Securities (new for fiscal 2021 due to ASC 326 Adoption)

Available-for-sale debt securities in an unrealized loss position at each measurement date are individually evaluated for expected credit losses.

First, we determine our intent and ability to hold the security in an unrealized loss position until it recovers its fair value.

If we do not have the intent or ability to hold the security until recovery, we recognize an expected credit loss equal to the decrease in fair value.

If we have the intent and ability to hold the security until recovery, we evaluate if the unrealized loss is the result of credit related factors, primarily using qualitative data.

If we determine the security has an unrealized loss as a result of credit related factors, we use a discounted cash flow model to determine the present value of expected cash flows.

If the security has a present value of expected cash flows less than its amortized cost, we record an allowance and an expense equal to the amount of the unrealized loss.

If the investment recovers its fair value, the allowance is reversed and a recovery is recognized in earnings.

We record any unrealized loss related to market interest rate changes or other non-credit related factors as an adjustment to other comprehensive income.

We do not include accrued interest in our assessment of credit losses for available-for-sale debt securities.

We record losses related to noncollectable interest receivable as an adjustment to interest income in the period the losses are realized.

Allowance for Doubtful Accounts (updated for fiscal 2021 due to ASC 326 Adoption)

Receivables are evaluated for expected credit losses on a collective (pool) basis and aggregated on the basis of similar risk characteristics, including customers' financial strength, credit standing, payment history and historical defaults, as well as geographical and industry conditions.

Pooling criteria is evaluated each period to ensure the risk profile for each pool is consistent with the prior period.

If a receivable does not fit into defined risk pool, it is evaluated for expected credit losses on an individual basis.

Each risk pool is assigned an expected credit loss rate (if any), which is calculated by considering historical write offs, current market conditions, forecast data and other qualitative data.

Expected credit losses are recorded each period by applying the expected credit loss rates to the total balance of each defined risk pool.

For information 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 28, 2020.

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What changed 10-Q

Item 2. Management’s Discussion and Analysis