Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Executive Summary
The following discussion is designed to provide a better understanding of our audited consolidated financial statements and notes thereto, 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 our consolidated financial statements included in Item 8 of this Annual Report. 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. Unless otherwise noted, the following information and discussion relates to our continuing operations.
Industry Dynamics and Trends
There are a number of industry factors that affect our business which include, among others:
• COVID-19 Pandemic. The global health crisis caused by COVID-19 and its resurgences has impacted and may continue to negatively impact global economic activity, which, despite progress in vaccination efforts, remains uncertain and cannot be predicted with confidence. In addition, variants of COVID-19 continue to emerge. While vaccines have proven effective in preventing serious illnesses and hospitalizations, there is no assurance that such vaccines will remain effective against new variants or that the protection conferred by existing vaccines will not wane over time. Since its beginning in the early months of 2020, the COVID-19 pandemic has affected 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' and contract manufacturers' ability to fulfill our orders on a timely basis, and the overall impact of the aforementioned items that could cause output challenges and increased costs. The full extent to which the COVID-19 pandemic may impact our results of operations or liquidity remains uncertain. Our operations have experienced, 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 industry, and the economies in which we operate.
• Overall Demand for Products and Applications Using Our Wolfspeed Materials and Devices . 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 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, inflationary impacts, as well as evolving competitive dynamics in each of the respective markets. These uncertainties make demand difficult to forecast for us and our customers. Lately, we have seen demand increase across all our product lines, which we believe reflects the value that the industry places on a transition to Silicon Carbide materials and devices. Particularly, we have seen significantly higher demand for our power products as the world has continued to focus on and adopt higher efficiency energy solutions, including electrical vehicle (EV) and related technologies. We believe these trends could have a significant positive impact on revenues in future periods as we increase capacity to meet increased demand.
• Supply Constraints. The semiconductor industry has experienced supply constraints for certain items. While we have successfully managed through challenges relating to obtaining certain necessary raw materials and production and processing equipment thus far, we expect the supply situation for these items to remain tight for at least the next few quarters. In addition, the ongoing military conflict between Russia and Ukraine may further exacerbate supply constraints. The current high demand for our products has also led to supply constraints for our customers. We are working closely with our customer base to best match our supply to their demand. We have taken steps to provide continuity to our customers, to the extent possible, although we expect that constraints may continue to limit our shipments in the near term.
• Governmental Trade and Regulatory Conditions . Our potential for growth, as with most multi-national companies, depends on a balanced and stable trade, political, geopolitical, economic and regulatory environment among the countries where we do business. 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. Competition in the industries we serve is intense. Many companies have made significant investments in product development, production equipment and production facilities. 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
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improve our ability to deliver a better overall experience for our customers. 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 and RF markets we serve.
• Technological Innovation and Advancement. Innovations and advancements in materials, power, and RF 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.
Fiscal 2022 Overview
The following is a summary of our financial results for the year ended June 26, 2022:
• Our year-over-year revenue increased by $220.6 million to $746.2 million.
• Gross margin increased to 33.4% from 31.3%. Gross profit increased to $249.3 million from $164.6 million.
• Operating loss from continuing operations was $247.8 million in fiscal 2022 compared to $313.9 million in fiscal 2021. As discussed further below, operating loss from continuing operations for fiscal 2021 includes a $73.9 million expense related to the modification of our long-range plan regarding a building site in Durham, North Carolina.
• Diluted loss per share from continuing operations was $2.46 in fiscal 2022 compared to $3.04 in fiscal 2021.
• Combined cash, cash equivalents and short-term investments increased to $1,198.8 million at June 26, 2022 from $1,154.6 million at June 27, 2021.
• Convertible notes, net was $1,021.6 million at June 26, 2022 and $823.9 million at June 27, 2021.
• Net cash used in operating activities of continuing operations was $154.2 million in fiscal 2022 compared to net cash used in operating activities of continuing operations of $112.5 million in fiscal 2021.
• Purchases of property and equipment, net were $505.9 million (net of $139.0 million in reimbursements) in fiscal 2022 compared to $559.8 million (net of $10.7 million in reimbursements) in fiscal 2021.
• Design-ins were $6.4 billion in fiscal 2022 compared to $2.9 billion in fiscal 2021.
Business Outlook
We believe we are uniquely positioned as an innovator in the global semiconductor industry. The strength of our balance sheet provides us the ability to invest in our business, as indicated by our new state-of-the-art, automated 200mm Silicon Carbide device fabrication facility in Marcy, New York, which started running qualification lots in the fourth quarter of fiscal 2022, and an expansion of our materials factory at our U.S campus headquarters in Durham, North Carolina, both of which will increase our production capacity. In fiscal 2022, we incurred $70.0 million of start-up and pre-production costs related to the ramping of production at the Marcy, New York facility. In fiscal 2023, we expect approximately $100 million of start-up and underutilization costs primarily related to ramping of production at the Marcy, New York facility.
The completion of the LED Business Divestiture on March 1, 2021 represented a key milestone in our transformation to be a global semiconductor powerhouse focused on disruptive technology solutions for high-growth applications. This transaction positioned us with a sharpened strategic focus to lead the semiconductor industry transition from silicon to Silicon Carbide and further strengthened our financial position, which we plan to utilize in order 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 our 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, particularly as we transition to our new Silicon Carbide device fabrication facility in Marcy, New York.
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We believe we have the ability to navigate the current environment while maintaining our capital expenditure plans to support future growth, including the completion and build out of our new facility in New York and additional production capacity in North Carolina. Even so, the short-term impacts from COVID-19 to our financial position, results of operations and cash flows remain uncertain.
We continue to closely monitor the ongoing military conflict between Russia and Ukraine to evaluate our potential exposure to this conflict. We do not have significant credit, supplier or customer concentrations in Russia, Belarus or Ukraine at this time. As a result, we do not currently expect any material impacts to our consolidated financial statements. However, we believe the full impact of the conflict remains uncertain and we continue to assess if ongoing developments, such as further sanctions or other increased involvement from countries where we operate and do business, may cause future material impacts to our consolidated financial statements.
Change in Estimate
As a result of the LED Business Divestiture and our continued investment in 200mm technology, we evaluated the useful lives applied to certain machinery and equipment assets by considering industry standards and reviewing the assets' historical and estimated future use. In the first quarter of fiscal 2022, we increased the expected useful lives of these assets by two to five years to more closely reflect the estimated economic lives of those assets. This change in estimate was applied prospectively effective for the first quarter of fiscal 2022, and resulted in a decrease in depreciation expense of $33.3 million for the fiscal year ended June 26, 2022. Approximately $10.4 million of the decrease in year-to-date depreciation expense resulted in a net reduction of inventory as of June 26, 2022 and the remaining $22.9 million resulted in an improvement in both loss before income taxes and net loss, of which $19.6 million related to an improvement in gross profit. This change in estimate resulted in an improvement in year-to-date basic and diluted loss per share of $0.19 per share.
Design-ins
Design-ins are customer commitments to purchase our product and are one of the factors we use to forecast long-term demand and future revenue. To meet the qualification of a design-in, the customer provides us with documentation (e.g., a letter of intent, statement of work or developmental contract) that can include details such as the expected delivery timeline, estimated price, necessary capacity and required support. A design-in, even with a formal commitment, does not always convert to future revenue for a variety of reasons, including, but not limited to, the customer delaying or abandoning the project, capacity constraints, timeline challenges, and/or technology changes. Therefore management uses the design-in amount as a guide to forecast future demand but it should not be taken as an absolute indicator of future revenue.
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Results of Operations
Selected consolidated statement of operations data for the years ended June 26, 2022, June 27, 2021 and June 28, 2020 is as follows:
Fiscal Years Ended
June 26, 2022 June 27, 2021 June 28, 2020
(in millions of U.S. Dollars, except share data) Amount % of Revenue Amount % of Revenue Amount % of Revenue
Revenue, net $746.2 100.0 % $525.6 100.0 % $470.7 100.0 %
Cost of revenue, net 496.9 66.6 % 361.0 68.7 % 312.2 66.3 %
Gross profit 249.3 33.4 % 164.6 31.3 % 158.5 33.7 %
Research and development 196.4 26.3 % 177.8 33.8 % 152.0 32.3 %
Sales, general and administrative 203.5 27.3 % 181.6 34.6 % 181.7 38.6 %
Amortization or impairment of acquisition-related intangibles 13.6 1.8 % 14.5 2.8 % 14.5 3.1 %
Abandonment of long-lived assets — — % 73.9 14.1 % — — %
(Gain) loss on disposal or impairment of other assets (0.3) — % 1.6 0.3 % 1.5 0.3 %
Other operating expense 83.9 11.2 % 29.1 5.5 % 32.9 7.0 %
Operating loss (247.8) (33.2) % (313.9) (59.7) % (224.1) (47.6) %
Non-operating expense (income), net 38.3 5.1 % 26.3 5.0 % (18.5) (3.9) %
Loss before income taxes (286.1) (38.3) % (340.2) (64.7) % (205.6) (43.7) %
Income tax expense (benefit) 9.0 1.2 % 1.1 0.2 % (8.0) (1.7) %
Net loss from continuing operations (295.1) (39.5) % (341.3) (64.9) % (197.6) (42.0) %
Net income (loss) from discontinued operations 94.2 12.6 % (181.2) (34.5) % 7.0 1.5 %
Net loss (200.9) (26.9) % (522.5) (99.4) % (190.6) (40.5) %
Net income attributable to noncontrolling interest — — % 1.4 0.3 % 1.1 0.2 %
Net loss attributable to controlling interest ($200.9) (26.9) % ($523.9) (99.7) % ($191.7) (40.7) %
Basic and diluted loss per share
Continuing operations ($2.46) ($3.04) ($1.83)
Net loss attributable to controlling interest ($1.67) ($4.66) ($1.78)
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Revenue
Revenue was comprised of the following:
Fiscal Years Ended Year-Over-Year Change
(in millions of U.S. Dollars) June 26, 2022 June 27, 2021 June 28, 2020 2021 to 2022 2020 to 2021
Revenue $746.2 $525.6 $470.7 $220.6 42 % $54.9 12 %
The increase in revenue for fiscal 2022 compared to fiscal 2021 was primarily due to increased demand across all of our product lines, as well as increased production capacity for our power and materials product lines to meet the strong demand during the period.
The increase in revenue for fiscal 2021 compared to fiscal 2020 was primarily due to increases in demand for power and RF devices and increases in production capacity for our power devices.
Gross Profit and Gross Margin
Gross profit and gross margin were as follows:
Fiscal Years Ended Year-Over-Year Change
(in millions of U.S. Dollars) June 26, 2022 June 27, 2021 June 28, 2020 2021 to 2022 2020 to 2021
Gross profit $249.3 $164.6 $158.5 $84.7 51 % $6.1 4 %
Gross margin 33 % 31 % 34 %
The increase in gross profit for fiscal 2022 compared to fiscal 2021 was primarily due to increased revenues in the current period and lower manufacturing costs, including the impact of increasing the expected useful lives of certain machinery and equipment assets to more closely reflect the estimated economic lives of those assets. The increase in gross margin for fiscal 2022 compared to fiscal 2021 was primarily due to the same factors as the increase to gross profit, partly offset by product mix.
The increase in gross profit for fiscal 2021 compared to fiscal 2020 was primarily due to increased revenues in the current period. The decrease in gross margin for fiscal 2021 compared to fiscal 2020 was primarily due to an unfavorable product mix shift and higher factory costs as we continued to bring on additional capacity.
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 costs also include developing supporting technologies for expansion of our new Silicon Carbide device fabrication facility in Marcy, New York.
Research and development expenses were as follows:
Fiscal Years Ended Year-Over-Year Change
(in millions of U.S. Dollars) June 26, 2022 June 27, 2021 June 28, 2020 2021 to 2022 2020 to 2021
Research and development $196.4 $177.8 $152.0 $18.6 10 % $25.8 17 %
Percent of revenue 26 % 34 % 32 %
The increases in research and development expenses were 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.
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Sales, General and Administrative
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 consist of salaries and related compensation costs; consulting and other professional services (such as litigation and other outside legal counsel fees, audit and other compliance costs); marketing and advertising expenses; facilities and insurance costs; and travel and other costs.
Sales, general and administrative expenses were as follows:
Fiscal Years Ended Year-Over-Year Change
(in millions of U.S. Dollars) June 26, 2022 June 27, 2021 June 28, 2020 2021 to 2022 2020 to 2021
Sales, general and administrative $203.5 $181.6 $181.7 $21.9 12 % ($0.1) — %
Percent of revenue 27 % 35 % 39 %
The increase in sales, general and administrative expenses in fiscal 2022 compared to fiscal 2021 was primarily due to increased salaries and benefits from increased headcount, including incentive based stock-based compensation, as well as increased consulting, legal and travel costs, partially offset by a decrease in costs related to transition services incurred in the first half of fiscal 2021 in connection with the sale of our former Lighting Products business unit.
Sales, general and administrative expenses stayed fairly steady in fiscal 2021 compared to fiscal 2020. Increased salaries and benefits, including incentive based stock-based compensation and commissions, were partially offset by decreased information technology costs and professional and legal fees. Additionally, further offsetting decreases related to a decrease of travel costs as a result of travel restrictions related to the COVID-19 pandemic and employee relocation expenses.
Amortization or Impairment of Acquisition-Related Intangibles
As a result of our acquisitions, we recognize various amortizable intangible assets, including customer relationships, developed technology and non-compete agreements.
Amortization of intangible assets related to our acquisitions was as follows:
Fiscal Years Ended Year-Over-Year Change
(in millions of U.S. Dollars) June 26, 2022 June 27, 2021 June 28, 2020 2021 to 2022 2020 to 2021
Customer relationships $6.1 $6.1 $6.1 $— — % $— — %
Developed technology 5.4 5.4 5.4 — — % — — %
Non-compete agreements 2.1 3.0 3.0 (0.9) (30) % — — %
Total $13.6 $14.5 $14.5 ($0.9) (6) % $— — %
Amortization of acquisition-related intangible assets decreased in fiscal 2022 compared to fiscal 2021 due to an intangible asset relating to non-compete agreements reaching the end of its useful life during fiscal 2022. No other significant acquisition-related intangible activity or impairments occurred in the periods reported.
Abandonment of Long-Lived Assets
In the fourth quarter of fiscal 2021, we modified our long-range plan regarding a portion of our Durham, North Carolina campus originally intended for expanding our LED production capacity that we had considered using to expand the manufacturing footprint for our Silicon Carbide materials product line. After we complete our current ongoing Silicon Carbide materials production capacity expansion in Durham, we plan on further expansion of our Silicon Carbide materials production capacity outside of the Durham campus. As a result, we decided we will no longer complete the construction of certain buildings on the Durham campus. Accordingly, an expense of $73.9 million was recorded based upon an updated valuation of the property in connection with the preparation of our financial statements for the fiscal year ended June 27, 2021.
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(Gain) loss on Disposal or 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.
(Gain) loss on disposal or impairment of other assets were as follows:
Fiscal Years Ended Year-Over-Year Change
(in millions of U.S. Dollars) June 26, 2022 June 27, 2021 June 28, 2020 2021 to 2022 2020 to 2021
(Gain) loss on disposal or impairment of other assets ($0.3) $1.6 $1.5 ($1.9) (119) % $0.1 7 %
(Gain) loss on disposal or impairment of other assets primarily relate to proceeds from asset sales offset by write-offs of fixed asset projects, as well as the write-offs of impaired or abandoned patents. Additionally, the gain on disposal or impairment of other assets for the fiscal year ended June 26, 2022 includes a $0.7 million net gain related to consideration received from the early payment of the unsecured promissory note issued by SGH at the closing of the LED Business Divestiture (the Purchase Price Note), as discussed in Note 3, "Discontinued Operations," in our consolidated financial statements included in Item 8 of this Annual Report.
Other Operating Expense
Other operating expense was comprised of the following:
Fiscal Years Ended Year-Over-Year Change
(in millions of U.S. Dollars) June 26, 2022 June 27, 2021 June 28, 2020 2021 to 2022 2020 to 2021
Factory optimization restructuring $6.1 $7.6 $8.5 ($1.5) (20) % ($0.9) (11) %
Severance and other restructuring 1.2 3.4 0.6 (2.2) (65) % 2.8 467 %
Total restructuring costs 7.3 11.0 9.1 (3.7) (34) % 1.9 21 %
Project, transformation and transaction costs 6.6 7.3 12.2 (0.7) (10) % (4.9) (40) %
Factory start-up costs 70.0 8.0 9.5 62.0 775 % (1.5) (16) %
Non-restructuring related executive severance — 2.8 2.1 (2.8) (100) % 0.7 33 %
Other operating expense $83.9 $29.1 $32.9 $54.8 188 % ($3.8) (12) %
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 18, "Restructuring," in our consolidated financial statements included in Item 8 of this Annual Report for additional information on our restructuring costs.
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.
Factory start-up costs are start-up costs incurred as part of our factory optimization efforts to expand our production footprint to support expected growth. Our factory optimization efforts began in fiscal 2019 and ended in fiscal 2022. Additionally, we began incurring start-up costs related to the opening of a new Silicon Carbide device fabrication facility in Marcy, New York in the third quarter of fiscal 2022.
The increase in other operating expense in fiscal 2022 compared to fiscal 2021 was primarily due to increased factory start-up costs as we continued our expansion of a new Silicon Carbide device fabrication facility in Marcy, New York, partially offset by a decrease in total restructuring costs and non-restructuring related executive severance.
The decrease in other operating expense in fiscal 2021 compared to fiscal 2020 was primarily due to decreased project, transformation and transaction costs, partially offset by a slight increase in total restructuring costs.
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Non-Operating Expense (Income), net
Non-operating expense (income), net was comprised of the following:
Fiscal Years Ended Year-Over-Year Change
(in millions of U.S. Dollars) June 26, 2022 June 27, 2021 June 28, 2020 2021 to 2022 2020 to 2021
Gain on sale of investments, net ($0.3) ($0.4) ($1.5) $0.1 (25) % $1.1 73 %
Gain on equity investment — (8.3) (14.2) 8.3 100 % 5.9 42 %
Loss (gain) on debt extinguishment 24.8 — (11.0) 24.8 100 % 11.0 100 %
Gain on arbitration proceedings — — (7.9) — — % 7.9 100 %
Interest income (11.8) (10.1) (16.3) (1.7) (17) % 6.2 38 %
Interest expense 25.1 45.4 34.9 (20.3) (45) % 10.5 30 %
Other, net 0.5 (0.3) (2.5) 0.8 267 % 2.2 88 %
Non-operating expense (income), net $38.3 $26.3 ($18.5) $12.0 46 % $44.8 242 %
Gain on equity investment. The gain on equity investment for fiscal 2021 and 2020 relates to changes in fair value of our previously held ENNOSTAR Inc. (ENNOSTAR) investment. In the fourth quarter of fiscal 2021, we liquidated our common stock ownership interest in ENNOSTAR. We no longer hold any equity interest in ENNOSTAR.
Loss (gain) on debt extinguishment . In the second quarter of fiscal 2022, all of our then-outstanding 2023 Notes were converted into shares of our common stock, which resulted in a loss on extinguishment of $24.8 million. Additionally, in the fourth quarter of fiscal 2020, we recognized a gain on partial debt extinguishment as a result of spending $144.3 million to repurchase $150.2 million of the principal amount held on our previously held 2023 Notes. See Note 10, "Long-term Debt," to our consolidated financial statements in Item 8 of this Annual Report for additional information.
Gain on arbitration proceedings . The gain on arbitration proceedings primarily 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. Additionally, a small legal settlement was paid in the fourth quarter of fiscal 2020.
Interest income . The increase in interest income in fiscal 2022 compared to fiscal 2021 was primarily due to interest income received on our previously held note receivable from SGH in connection with the LED Business Divestiture, partially offset by decreased investment returns from our short-term investment securities. The decrease in interest income in fiscal 2021 compared to fiscal 2020 was primarily due to significant reductions in investment returns on our short-term investment securities.
Interest expense . The decrease in interest expense in fiscal 2022 compared to fiscal 2021 was primarily due to capitalizing interest on the 2026 Notes in connection with the building of our new Silicon Carbide device fabrication facility in New York, which we began capitalizing in the fourth quarter of fiscal 2021. The decrease in interest expense resulting from the extinguishment of the 2023 Notes in the second quarter of fiscal 2022 was mostly offset by an increase in interest expense from the sale of the 2028 Notes in the third quarter of fiscal 2022. The increase in interest expense in fiscal 2021 compared to fiscal 2020 was primarily due to the addition of the 2026 Notes on April 21, 2020, partially offset by a partial extinguishment of our then-outstanding 2023 Notes.
Other, net. Other, net, primarily includes (i) foreign currency (gain) loss, net resulting from remeasurement adjustments from our international subsidiaries, (ii) net losses on the Wafer Supply Agreement entered into in fiscal 2021, pursuant to which we supply CreeLED with certain Silicon Carbide materials and fabrication services for up to four years, and (iii) a loss related to receiving an early payment for the Purchase Price Note. See Note 2, "Discontinued Operations," in our consolidated financial statements included in Item 8 of this Annual Report for additional information on the Wafer Supply Agreement and the loss on early payment of the Purchase Price Note.
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Income Tax Expense (Benefit)
Income tax expense (benefit) and our effective tax rate was as follows:
Fiscal Years Ended Year-Over-Year Change
(in millions of U.S. Dollars) June 26, 2022 June 27, 2021 June 28, 2020 2021 to 2022 2020 to 2021
Income tax expense (benefit) $9.0 $1.1 ($8.0) 7.9 718 % 9.1 114 %
Effective tax rate (3) % — % 4 %
The change in the effective tax rate from 0% in fiscal 2021 to (3)% in fiscal 2022 was primarily due to $7.3 million of income tax expense recognized in the second quarter of fiscal 2022 related to the restructuring of our Luxembourg holding company. This restructuring is discussed further in Note 14, "Income Taxes," to our consolidated financial statements included in Item 8 of this Annual Report.
The change in the effective tax rate from 4% in fiscal 2020 to 0% in fiscal 2021 was primarily due to the increased tax benefit recorded in fiscal 2020 related to net operating loss provisions of the Coronavirus Aid, Relief, and Economic Security Act.
In general, the variation between our effective income tax rate and the current U.S. statutory rate of 21.0% is primarily due to: (i) changes in our valuation allowances against deferred tax assets, (ii) income derived from international locations with differing tax rates than the U.S., and (iii) tax credits generated.
Net Loss from Discontinued Operations
As discussed above, we have classified the results of our former LED Products segment as discontinued operations in our consolidated statements of operations for all periods presented. We ceased recording depreciation and amortization of long-lived assets of the LED Business upon classification as discontinued operations in October 2020.
We recorded net income from discontinued operations of $94.2 million, net loss from discontinued operations of $181.2 million and net income from discontinued operations of $7.0 million in fiscal 2022, 2021 and 2020, respectively.
Net income from discontinued operations in fiscal 2022 relates to the receipt of an unsecured promissory note from CreeLED as additional consideration to satisfy the earnout obligations pursuant to the Asset Purchase Agreement (the LED Purchase Agreement), dated October 18, 2020, as amended. The additional consideration was based upon the revenue and gross profit performance of the LED Business in the first four full fiscal quarters following the closing.
Net loss from discontinued operations in fiscal 2021 includes a $112.6 million goodwill impairment, a $19.5 million impairment to assets held for sale associated with the LED Business Divestiture and a $29.1 million loss on sale. Additionally, total costs to sell of $27.4 million were recognized throughout fiscal 2021 and fiscal 2020 and are included in net (loss) income from discontinued operations for those periods.
Liquidity and Capital Resources
Overview
We require cash to fund our operating expenses and working capital requirements, including the purchase of goods and services in the ordinary course of business such as raw materials, supplies and capital equipment, as well as outlays for research and development, strategic acquisitions and investments. Our principal sources of liquidity are cash on hand, marketable securities and, as described further below, availability under our line of credit.
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 the strength of our working capital position, we believe that we have the ability to continue to invest in expansion of our production capacity, further development of our products and, when necessary or appropriate, make selective acquisitions or other strategic investments to strengthen our product portfolio or secure key intellectual properties.
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Sources of Liquidity
The following table sets forth our cash, cash equivalents and short-term investments:
(in millions of U.S. Dollars) June 26, 2022 June 27, 2021 Change
Cash and cash equivalents $449.5 $379.0 $70.5
Short-term investments 749.3 775.6 (26.3)
Total cash, cash equivalents and short-term investments $1,198.8 $1,154.6 $44.2
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.
In the third quarter of fiscal 2021, we implemented an at-the-market program (the ATM program) in which we sold 4,222,511 shares of our common stock at a weighted average price of $118.41 per share for total gross proceeds of approximately $500.0 million and net proceeds of approximately $489.1 million, after $10.0 million in commissions to the managers of the program and $0.9 million in other offering costs.
In the fourth quarter of fiscal 2021, we liquidated our common stock ownership interest in ENNOSTAR and received net proceeds of $66.4 million.
In the second quarter of fiscal 2022, all outstanding 2023 Notes were surrendered for conversion following our issuance on December 8, 2021 of a notice to holders of the 2023 Notes calling for the redemption of all outstanding 2023 Notes, resulting in the settlement of the previously outstanding $424.8 million aggregate principal amount of 2023 Notes in approximately 7.1 million shares of our common stock.
In the third quarter of fiscal 2022, we issued and sold a total of $750.0 million aggregate principal amount of the 2028 Notes, as discussed in Note 10, “Long-term Debt,” in our consolidated financial statements included in Item 8 of this Annual Report. The total net proceeds of the 2028 Notes was $732.3 million, of which we used $108.2 million to fund the cost of entering into capped call transactions, which are expected generally to reduce the potential dilution to our common stock upon any conversion of the 2028 Notes and/or offset any potential cash payments we are required to make in excess of the principal amount of the converted 2028 Notes, as the case may be, upon conversion of the 2028 Notes. We expect to use the remainder of the net proceeds for general corporate purposes. In addition, during the third quarter of 2022, we received an early payment for the Purchase Price Note resulting in receipt of the principal amount of $125.0 million along with outstanding accrued and unpaid interest as of the payment date.
We have a $125 million line of credit as discussed in Note 10, “Long-term Debt,” in our consolidated financial statements included in Item 8 of this Annual Report, all of which was available for borrowing as of June 26, 2022. The purpose of this credit 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. On January 25, 2022, we entered into an amendment to the credit agreement governing the line of credit that extends the maturity date by three years to January 9, 2026 and adopted secured overnight financing rate (SOFR) interest rates as the benchmark interest rate under the credit agreement.
As of June 26, 2022, we had unrealized losses on our short-term investments of $23.0 million. All of our short-term investments had investment grade ratings, and any such investments that were in an unrealized loss position at June 26, 2022 were in such position due to interest rate changes, sector credit rating changes, company-specific rating changes or volatile market conditions related to the conflict in Ukraine and the ongoing COVID-19 pandemic. 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 June 26, 2022 until the investments fully recover in market value. No allowance for credit losses was recorded as of June 26, 2022.
From time to time, we evaluate strategic opportunities, including potential acquisitions, joint ventures, divestitures, spin-offs or investments in complementary businesses, and we have continued to make such evaluations. For example, in March 2021 we completed the LED Business Divestiture, which provided us with (i) $50 million in cash, subject to customary adjustments, (ii) a $125 million unsecured promissory note due in August 2023 (which amount plus accrued and unpaid interest was prepaid during the third quarter of 2022), and (iii) an earn-out payment of $101.8 million based on the revenue and gross profit performance of the LED Business in the first four full fiscal quarters following the closing, which is payable in the form of an unsecured promissory note due March 2025. We may also access capital markets through the issuance of debt or equity, 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.
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Expected Uses of Liquidity
For fiscal 2023, we target approximately $550 million of net capital investment, which is primarily related to capacity and infrastructure projects to support longer-term growth and strategic priorities. We are exploring additional expansion options and will update targeted net capital investment if and when those capacity expansion options are announced. This target is highly dependent on the timing and overall progress on our new Silicon Carbide fabrication facility in New York and is net of approximately $275 million of expected reimbursements from the State of New York Urban Development Corporation under the GDA during the fiscal year.
We recently opened our new Silicon Carbide device fabrication facility in Marcy, New York, to expand capacity for production of our Silicon Carbide devices. We expect to invest approximately $2.0 billion, an increase from our previously expected $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 over time 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). The increase is primarily due to capacity expansions now planned at the site as a result of increased projected demand. As of June 26, 2022, we have spent approximately $750 million and received approximately $150 million in reimbursements. Given our current cash position, we believe we are positioned to adequately fund the remaining construction of the facility.
In addition to ordinary operating expenses, our estimated future obligations consist of leases, debt, and interest on long-term debt. For a description of contractual obligations, including lease and debt obligations, see Note 5, "Leases," Note 10, "Long-term Debt," and Note 15, "Commitments and Contingencies," in our consolidated financial statements included in Item 8 of this Annual Report.
Cash Flows
In summary, our cash flows were as follows (in millions of U.S. Dollars):
Fiscal Years Ended Year-Over-Year Change
June 26, 2022 June 27, 2021 June 28, 2020 2021 to 2022 2020 to 2021
Cash used in operating activities ($154.2) ($125.5) ($29.0) ($28.7) ($96.5)
Cash used in investing activities (391.0) (448.6) (486.9) 57.6 38.3
Cash provided by financing activities 615.9 504.1 464.3 111.8 39.8
Effect of foreign exchange changes (0.2) 0.2 (0.1) (0.4) 0.3
Net increase (decrease) in cash and cash equivalents $70.5 ($69.8) ($51.7) $140.3 ($18.1)
Cash Flows from Operating Activities
Net cash used in operating activities increased in fiscal 2022 compared to fiscal 2021 primarily due to decreased working capital as a result of inventory growth and increased receivables as a result of revenue growth.
Net cash used in operating activities increased in fiscal 2021 compared to fiscal 2020 primarily due to an increase in net loss during the period and decreased cash provided by operating activities of discontinued operations, as well as slightly decreased working capital.
Total cash flows from operating activities in fiscal 2021 and 2020 includes ($13.0) million and $62.6 million of cash (used in) 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 property and equipment related reimbursements.
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The decrease in net cash used in investing activities in fiscal 2022 compared to fiscal 2021 was primarily due to a $128.3 million increase in property and equipment related reimbursements from the State of New York Urban Development Corporation under a Grant Disbursement Agreement (the GDA) and a $81.3 million net increase in proceeds from the LED Business Divestiture. These increases in proceeds from investing activities were partially offset by a $74.4 million increase in purchases of property and equipment and a $12.5 million decrease in net proceeds from short-term investments. Additionally, we received $66.4 million in net proceeds from the liquidation of our ENNOSTAR equity investment in fiscal 2021.
The decrease in net cash used in investing activities in fiscal 2021 compared to fiscal 2020 was primarily due to an increase in net proceeds from short-term investments of $247.8 million, net proceeds from the sale of the LED Business of $43.7 million, net proceeds from the liquidation of our ENNOSTAR equity investment of $66.4 million and $10.7 million of property related reimbursements under the GDA, partially offset by an increase in property and equipment purchases of $340.6 million.
For more details on the GDA, see Note 15, "Commitments and Contingencies," in our consolidated financial statements included in Item 8 of this Annual Report.
Total cash used in investing activities in fiscal 2021 and 2020 includes $0.3 million and $12.4 million, respectively, of cash used in investing activities of discontinued operations.
Cash Flows from Financing Activities
Net cash provided by financing activities in fiscal 2022 primarily consisted of $732.3 million in net proceeds from issuing the 2028 Notes and $22.4 million of proceeds from the issuance of common stock, partially offset by $108.2 million in cash paid for the capped call transactions and $29.1 million in tax withholdings on vested equity awards.
Net cash provided by financing activities in fiscal 2021 primarily consisted of net proceeds of $503.5 million from issuances of common stock in connection with the ATM program in the third quarter of fiscal 2021 and issuances of common stock pursuant to the exercise of employee stock options.
Net cash provided by financing activities in fiscal 2020 primarily consisted of proceeds of $575.0 million from the issuance of the 2026 Notes and net proceeds of $59.5 million from issuances of common stock pursuant to the exercise of employee stock options, partially offset by payments on long-term debt of $145.1 million, the payment of $13.6 million in debt issuance costs from the issuance of the 2026 Notes and incentive-related refundable escrow deposits of $11.5 million relating to the construction of our new Silicon Carbide fabrication facility in New York.
Financial and Market Risks
We are exposed to financial and market risks, including changes in interest rates, currency exchange rates and commodities risk. We have entered, and may in the future enter, into foreign currency derivative financial instruments in an effort to manage or hedge some of our foreign exchange rate risk. We may not be able to engage in hedging transactions in the future, and even if we do, foreign currency fluctuations may still have a material adverse effect on our results of operations and financial performance. All of the potential changes noted below are based on sensitivity analysis performed on our financial positions at June 26, 2022 and June 27, 2021. Actual results may differ materially.
Interest Rate Risk
We maintain an investment portfolio principally composed of money market funds, municipal bonds, corporate bonds, U.S. agency securities, U.S. treasury securities, commercial paper, certificates of deposit, and variable rate demand notes. In order to minimize risk, our cash management policy permits us to acquire investments rated “A” grade or better. As of June 26, 2022 and June 27, 2021, our cash equivalents and short-term investments had a fair value of $993.6 million and $979.8 million, respectively. If interest rates were to hypothetically increase by 100 basis points, the fair value of our short-term investments would decrease by $9.9 million at June 26, 2022 and $9.8 million at June 27, 2021.
Additionally, as part of the completed LED Business Divestiture, we hold a $101.8 million unsecured promissory note due in March 2025, which was received as an earnout payment. The promissory note bears interest at the London Interbank Offered Rate (LIBOR) plus 3%. A hypothetical increase in interest rates by 100 basis points would result in an immaterial impact to interest income as of June 26, 2022.
As of June 26, 2022, we maintain a secured revolving line of credit under which we can borrow, repay and reborrow loans from time to time prior to its scheduled maturity date of January 9, 2026. As of June 26, 2022 and June 27, 2021, no balances were outstanding under the line of credit.
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Currency Rate and Price Risk
All of our operations have a functional currency of the U.S. Dollar. However, we operate internationally and have transactions denominated in foreign currencies, and therefore we are exposed to currency exchange rate risks. Fluctuations in exchange rates may adversely affect our expenses and results of operations as well as the value of our assets and liabilities.
Commodities
We utilize significant amounts of precious metals, gases and other commodities in our manufacturing processes. General economic conditions, market specific changes or other factors outside of our control may affect the pricing of these commodities. We do not use financial instruments to hedge commodity prices.
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 June 26, 2022, we did not have any off-balance sheet arrangements, as defined in Item 303(b) of SEC Regulation S-K.
Critical Accounting Estimates
Our consolidated financial statements are prepared in accordance with U.S. GAAP. In the application of U.S. GAAP, we are required to make estimates that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities in our consolidated financial statements. Changes in the accounting estimates from period to period are reasonably likely to occur. Accordingly, actual results could differ significantly from the estimates made by management. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation of our financial condition or results of operations may be affected.
We evaluate our estimates on an ongoing basis, including those related to revenue recognition, valuation of inventories, tax related contingencies, valuation of stock-based compensation, valuation of long-lived and intangible assets, other contingencies and litigation, among others. We base our estimates on historical experience and on various other assumptions, including expected trends that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.
Our significant accounting policies and a description of recent accounting pronouncements are discussed in Note 2, “Basis of Presentation and Summary of Significant Accounting Policies,” to our consolidated financial statements included in Item 8 of this Annual Report. We believe that the following are our most critical accounting estimates, each of which is critical to the portrayal of our financial condition and results of operations and requires our most difficult, subjective and complex judgments. Our management has reviewed our critical accounting estimates and the related disclosures with the Audit Committee of our Board of Directors.
Revenue Recognition
For the year ended June 26, 2022, approximately a third of our revenue was from sales to distributors. Distributors stock inventory and sell our products to their own customer base, which may include: value added resellers; manufacturers who incorporate our products into their own manufactured goods; or ultimate end users of our products. We recognize revenue upon shipment of our products to our distributors. This arrangement is often referred to as a “sell-in” or “point-of-purchase” model as opposed to a “sell-through” or “point-of-sale” model, where revenue is deferred and not recognized until the distributor sells the product through to their customer.
Our distributors may be provided limited rights that allow them to return a portion of inventory (product exchange rights or stock rotation rights) and receive credits for changes in selling prices (price protection rights) or customer pricing arrangements under our “ship and debit” program or other targeted sales incentives. When determining our net revenue, we make significant judgments and estimates corresponding with product shipments. We recognize a reserve for estimated future returns, changes in selling prices, and other targeted sales incentives when product ships. We also recognize an asset for the estimated value of product returns that we believe will be returned to inventory in the future and resold, and these estimates are based upon historical data, current economic trends, distributor inventory levels and other related factors. Our financial condition and operating results are dependent upon our ability to make reliable estimates. Actual results may vary and could have a significant impact on our operating results.
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Under the ship and debit program, products are sold to distributors at negotiated prices and the distributors are required to pay for the products purchased within our standard commercial terms. Subsequent to the initial product purchase, a distributor may request a price allowance for a particular part number(s) for certain target customers, prior to the distributor reselling that particular part to the customer. If we approve an allowance and the distributor resells the product to the target customer, we credit the distributor according to the allowance we approved. These credits are applied against a reserve we establish upon initial shipment of product to the distributor.
Inventories
Inventories are stated at the lower of cost or net realizable value. We write-down our inventories for estimated obsolescence equal to the difference between the cost of the inventory and its estimated market value based upon an aging analysis of the inventory on hand, specifically known inventory-related risks (such as technological obsolescence), and assumptions about future demand. We also analyze sales levels by product type, including historical and estimated future customer demand for those products to determine if any additional reserves are appropriate. For example, we adjust for items that are considered obsolete based upon changes in customer demand, manufacturing process changes or new product introductions that may eliminate demand for the product. In addition, our international sales and purchases are subject to numerous United States and foreign laws and regulations which may limit or restrict our sales and shipments to foreign customers. Any adjustment to our inventories as a result of an estimated obsolescence or net realizable condition is reflected as a component of our cost of revenue. At the point of the loss recognition, a new, lower-cost basis for that inventory is established, and any subsequent improvements in facts and circumstances do not result in the restoration or increase in that newly established lower-cost basis.
In order to determine what costs can be included in the valuation of inventories, we determine normal capacity for our manufacturing facilities based on historical patterns. If our estimates regarding customer demand are inaccurate, or market conditions or technology change in ways that are less favorable than those projected by management, we may be required to take excess capacity charges in accordance with U.S. GAAP, which could have an adverse effect on our operating results.
Deferred Tax Asset Valuation Allowances
In accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 740, “Income Taxes” (ASC 740), we evaluate all available evidence, both positive and negative, to determine whether, based on the weight of that evidence, a deferred tax asset is more likely than not to be realized. In assessing the adequacy of a recognized valuation allowance, we consider all available positive and negative evidence to estimate if sufficient future taxable income of the right character will be generated to utilize the existing deferred tax assets by jurisdiction. This consideration includes a variety of factors such as historical and projected future taxable income and prudent and feasible tax planning strategies. When we establish or increase a valuation allowance, our income tax expense increases in the period such determination is made. If we decrease a valuation allowance, our income tax expense decreases in the period such a determination is made.
Tax Contingencies
We are subject to periodic audits of our income tax returns by federal, state, local and foreign agencies. These audits typically include questions regarding our tax filing positions, including the timing and amount of deductions and the allocation of income among various tax jurisdictions. In accordance with ASC 740, we regularly evaluate the exposures associated with our various tax filing positions. ASC 740 states that a tax benefit should not be recognized for financial statement purposes for an uncertain tax filing position where it is not more likely than not (likelihood of greater than 50%) of being sustained by the taxing authorities based on the technical merits of the position.
In accordance with the provisions of ASC 740, we establish unrecognized tax benefits (as a reduction to the deferred tax asset or as an increase to other liabilities) to reduce some or all of the tax benefit of any of our tax positions at such time that we determine the position has become uncertain based upon one of the following: the tax position is not “more likely than not” to be sustained; the tax position is “more likely than not” to be sustained, but for a lesser amount; or the tax position is “more likely than not” to be sustained, but not in the financial period in which the tax position was originally taken. For purposes of evaluating whether or not a tax position is uncertain, we presume the tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information; the technical merits of a tax position are derived from authorities such as legislation and statutes, legislative intent, regulations, rulings and case law and their applicability to the facts and circumstances of the tax position; and each tax position is evaluated without consideration of the possibility of offset or aggregation with other tax positions taken. We adjust these unrecognized tax benefits, including any impact on the related interest and penalties, in light of changing facts and circumstances, such as the progress of a tax audit.
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A number of years may elapse before a particular matter for which we have established an unrecognized tax benefit is audited and fully resolved. To the extent we prevail in matters for which we have established an unrecognized benefit or are required to pay amounts in excess of what we have recognized, our effective tax rate in a given financial statement period could be materially affected. An unfavorable tax settlement might require use of our cash, existing deferred tax assets, and/or result in an increase in our effective tax rate in the year of resolution. A favorable tax settlement would be recognized as a reduction in our effective tax rate in the year of resolution.
Stock-Based Compensation
We account for awards of stock-based compensation under our employee stock-based compensation plans using the fair value method. Accordingly, we estimate the grant date fair value of our stock-based awards and amortize this fair value to compensation expense over the requisite service period or vesting term. We currently use the Black-Scholes option-pricing model to estimate the fair value of our Employee Stock Purchase Plan (ESPP) awards. The grant date fair value of performance stock units that vest upon meeting certain market conditions is estimated using the Monte Carlo valuation model. The determination of the fair value of stock-based awards on the date of grant using an option-pricing model is affected by our then current stock price as well as assumptions regarding a number of complex and subjective variables. These variables include the expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, the risk-free interest rate and expected dividends.
Due to the inherent limitations of option-valuation models, future events that are unpredictable and the estimation process utilized in determining the valuation of the stock-based awards, the ultimate value realized by award holders may vary significantly from the amounts expensed in our financial statements. For restricted stock and stock unit awards, grant date fair value is based upon the market price of our common stock on the date of the grant. This fair value is then amortized to compensation expense over the requisite service period or vesting term. As of June 26, 2022, we have $82.3 million of unrecognized compensation cost related to nonvested awards, which is expected to be recognized over a weighted average period of 1.85 years.
We estimate expected forfeitures at the time of grant and revise this estimate, if necessary, in subsequent periods if actual forfeitures differ from initial estimates. Our determination of an estimated forfeiture rate is primarily based upon a review of historical experience but may also include consideration of other facts and circumstances we believe are indicative of future activity. The assessment of an estimated forfeiture rate will not alter the total compensation expense to be recognized, only the timing of this recognition as compensation expense is adjusted to reflect instruments that actually vest.
Long-Lived Assets
We evaluate long-lived assets such as property, equipment and finite-lived intangible assets, such as patents, for impairment whenever events or circumstances indicate that the carrying value of the assets recognized in our financial statements may not be recoverable. Factors that we consider include whether there has been a significant decrease in the market value of an asset, a significant change in the way an asset is being used, or a significant change, delay or departure in our strategy for that asset. Our assessment of the recoverability of long-lived assets involves significant judgment and estimation. These assessments reflect our assumptions, which, we believe, are consistent with the assumptions hypothetical marketplace participants use. Factors that we must estimate when performing recoverability and impairment tests include, among others, the economic life of the asset, sales volumes, prices, cost of capital, tax rates, and capital spending. These factors are often interdependent and therefore do not change in isolation. If impairment is indicated, we first determine if the total estimated future cash flows on an undiscounted basis are less than the carrying amounts of the asset or assets. If so, an impairment loss is measured and recognized. Our impairment loss calculations require that we apply judgment in estimating future cash flows and asset fair values, including estimating useful lives of the assets. To make these judgments, we may use internal discounted cash flow estimates, quoted market prices when available and independent appraisals as appropriate to determine fair value. If actual results are not consistent with our assumptions and judgments used in estimating future cash flows and asset fair values, we may be required to recognize additional impairment losses which could be material to our results of operations. For example, we recognized an impairment to assets held for sale associated with the LED Business Divestiture of $19.5 million during the second fiscal quarter of 2021.
After an impairment loss is recognized, a new, lower cost basis for that long-lived asset is established. Subsequent changes in facts and circumstances do not result in the reversal of a previously recognized impairment loss.
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Goodwill
We test goodwill for impairment at least annually as of the first day of the fiscal fourth quarter, or when indications of potential impairment exist. We monitor for the existence of potential impairment indicators throughout the fiscal year. We conduct impairment testing for goodwill at the reporting unit level. Reporting units, as defined by FASB ASC 350, “Intangibles - Goodwill and Other,” may be operating segments as a whole or an operation one level below an operating segment, referred to as a component. We have determined that we operate as one operating and reportable seg ment.
We may initiate goodwill impairment testing by considering qualitative factors to determine whether it is more likely than not that a reporting unit’s carrying value is greater than its fair value. Such factors may include the following, among others: a significant decline in the reporting unit’s expected future cash flows; a sustained, significant decline in our stock price and market capitalization; a significant adverse change in legal factors or in the business climate, unanticipated competition; and slower growth rates; as well as changes in management, key personnel, strategy, and customers. If our qualitative assessment indicates that goodwill impairment is more likely than not, we determine the amount by which the reporting unit's carrying value exceeds its fair value, not to exceed the carrying amount of goodwill.
We compare the fair value of the reporting unit to its carrying value, including goodwill. We derive a reporting unit ’ s fair value through a combination of the market approach (a guideline transaction method) and the income approach (a discounted cash flow analysis). The market and income approaches require significant judgment, including estimation of future revenues, gross margins, and operating expenses, which are dependent on internal forecasts, current and anticipated economic conditions and trends, selection of market multiples through assessment of the reporting unit’s performance relative to peer competitors, the estimation of the long-term revenue growth rate and discount rate from the capital asset pricing model and the determination of our weighted average cost of capital. Changes in these estimates and assumptions could materially affect the fair value of the goodwill reporting unit, potentially resulting in a non-cash impairment charge. The fair values are reconciled back to our consolidated market capitalization.
If the fair value of a reporting unit exceeds its carrying value, then we conclude that no goodwill impairment has occurred. If the carrying value of the reporting unit exceeds the fair value, we recognize an impairment loss in an amount equal to the excess, not to exceed the carrying value of the reporting unit ’ s goodwill. Once an impairment loss is recognized, the adjusted carrying value of the goodwill becomes the new accounting basis of the goodwill for the reporting unit.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
See the section entitled “Financial and Market Risks” included in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 of this Annual Report.
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