WOLFSPEED, INC. 
Information set forth in this Quarterly Report on Form 10-Q contains various "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended (the Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). All information contained in this report relative to future markets for our products and trends in and anticipated levels of revenue, gross margins and expenses, as well as other statements containing words such as "believe," "project," "may," "will," "anticipate," "target," "plan," "estimate," "expect" and "intend" and other similar expressions constitute forward-looking statements. These forward-looking statements are subject to business, economic and other risks and uncertainties, both known and unknown, and actual results may differ materially from those contained in the forward-looking statements. Any forward-looking statements we make are as of the date made, and except as required under theU.S. federal securities laws and the rules and regulations of theSecurities and Exchange Commission (theSEC ), we have no duty to update them if our views later change. These forward-looking statements should not be relied upon as representing our views as of any date subsequent to the date of this Quarterly Report. Examples of risks and uncertainties that could cause actual results to differ materially from historical performance and any forward-looking statements include, but are not limited to, those described in "Risk Factors" in Part II, Item 1A of this Quarterly Report. Executive Summary The following discussion is designed to provide a better understanding of our unaudited consolidated financial statements, including a brief discussion of our business and products, key factors that impacted our performance and a summary of our operating results. The following discussion should be read in conjunction with the unaudited consolidated financial statements and the notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q, and the consolidated financial statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the fiscal year endedJune 28, 2020 . Historical results and percentage relationships among any amounts in the financial statements are not necessarily indicative of trends in operating results for any future periods.
Overview
Cree, Inc. (Cree, we, our, or us) is an innovator of wide bandgap semiconductors, focused on silicon carbide and gallium nitride (GaN) materials, and devices for power and radio-frequency (RF) applications. Our silicon carbide and gallium nitride materials and devices are targeted for applications such as transportation, power supplies, inverters and wireless systems. In addition, we are an innovator of specialty lighting-class light emitting diode (LED) products. Our LEDs are targeted for use in indoor and outdoor lighting, electronic signs and signals and video displays. As discussed more fully in "Business Outlook", onOctober 18, 2020 , we entered into a definitive agreement to sell certain assets and subsidiaries comprising our former LED Products segment (the LED Business) to SMART Global Holdings, Inc. (SGH) and its wholly owned newly-created acquisition subsidiary (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 through ourWolfspeed business. The LED Business Divestiture represents a strategic shift that will have a major effect on our operations and financial results. As a result, we have classified the results and cash flows of the LED Products segment as discontinued operations in our consolidated statements of operations and consolidated statements of cash flows for all periods presented. Additionally, the related assets and liabilities associated with the discontinued operations are classified as held for sale in the consolidated balance sheets. Unless otherwise noted, discussion within this Quarterly Report to the consolidated financial statements relates to our continuing operations. Our continuing operations consist of theWolfspeed business, which includes silicon carbide and GaN materials, power devices and RF devices based on wide bandgap semiconductor materials and silicon. Our materials products and power devices are used in electric vehicles, motor drives, power supplies, solar and transportation applications. Our materials products and RF devices are used in military communications, radar, satellite and telecommunication applications. The majority of our products are manufactured at our production facilities located inNorth Carolina ,California ,Arkansas andChina . We also use contract manufacturers for certain products and aspects of product fabrication, assembly and packaging. Additionally, we are in the process of building a silicon carbide fabrication facility inNew York . We operate research and development facilities inNorth Carolina ,Arizona ,Arkansas ,New York ,California andChina (includingHong Kong ). 33 -------------------------------------------------------------------------------- Table of ContentsCree, Inc. is aNorth Carolina corporation established in 1987, and our headquarters are inDurham, 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. Industry Dynamics and Trends There are a number of industry factors that affect our business which include, among others: •COVID-19 Outbreak. 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 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 the pandemic continues to evolve globally. 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. •Overall Demand for Products and Applications using silicon carbide power devices, GaN and silicon RF devices, and LEDs. Our potential for growth depends significantly on the adoption of silicon carbide and GaN materials and device products in the power and RF markets, the continued use of silicon devices in the RF telecommunications market, the continued adoption of LEDs and LED lighting, and our ability to win new designs for these applications. Demand also fluctuates based on various market cycles, continuously evolving industry supply chains, trade and tariff terms, as well as evolving competitive dynamics in each of the respective markets. These uncertainties make demand difficult to forecast for us and our customers. •Governmental Trade and Regulatory Conditions. Our potential for growth, as with most multi-national companies, depends on a balanced and stable trade, political, economic and regulatory environment among the countries where we do business. Changes in trade policy such as the imposition 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. Product pricing pressures exist as market participants often undertake pricing strategies to gain or protect market share, increase the utilization of their production capacity and open new applications in the power, RF and LED markets we serve. To remain competitive, market participants must continuously increase product performance, reduce costs and develop improved ways to serve their customers. To address these competitive pressures, we have invested in research and development activities to support new product development, lower product costs and deliver higher levels of performance to differentiate our products in the market. In addition, we invest in systems, people and new processes to improve our ability to deliver a better overall experience for our customers. •Technological Innovation and Advancement. Innovations and advancements in materials, power, RF, and LED technologies continue to expand the potential commercial application for our products. However, new technologies or standards could emerge or improvements could be made in existing technologies that could reduce or limit the demand for our products in certain markets. •Intellectual Property Issues. Market participants rely on patented and non-patented proprietary information relating to product development, manufacturing capabilities and other core competencies of their business. Protection of intellectual property is critical. Therefore, steps such as additional patent applications, confidentiality and non-disclosure agreements, as well as other security measures are generally taken. To enforce or protect intellectual property rights, litigation or threatened litigation is common. Overview of the six months endedDecember 27, 2020 The following is a summary of our financial results for the six months endedDecember 27, 2020 : •Revenue decreased to$242.5 million for the six months endedDecember 27, 2020 from$248.4 million for the six months endedDecember 29, 2019 . •Gross profit decreased to$76.8 million for the six months endedDecember 27, 2020 from$88.1 million for the six months endedDecember 29, 2019 . Gross margin was 31.7% for the six months endedDecember 27, 2020 and 35.5% for the six months endedDecember 29, 2019 . 34 -------------------------------------------------------------------------------- Table of Contents •Operating loss was$119.8 million for the six months endedDecember 27, 2020 compared to$105.6 million for the six months endedDecember 29, 2019 . •Diluted loss per share from continuing operations was$1.18 for the six months endedDecember 27, 2020 compared to$0.90 for the six months endedDecember 29, 2019 . •Combined cash, cash equivalents and short-term investments was$968.7 million atDecember 27, 2020 and$1,239.7 million atJune 28, 2020 . •Cash used in operating activities from continuing operations was$32.1 million for the six months endedDecember 27, 2020 compared to$39.6 million for the six months endedDecember 29, 2019 . •Purchases of property and equipment were$257.5 million for the six months endedDecember 27, 2020 compared to$100.3 million for the six months endedDecember 29, 2019 . 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 planned construction of a state-of-the-art, automated 200mm silicon carbide fabrication facility and a large materials factory to expand our silicon carbide capacity, each of which was announced inMay 2019 . InSeptember 2019 , we announced our intention to build the new fabrication facility inMarcy, New York to complement the factory expansion already underway at ourU.S. campus headquarters inDurham, 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 ourWolfspeed 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 fabrication facility inMarcy, New York . In regards to COVID-19, our manufacturing facilities inthe 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 manufacturing facilities inChina briefly closed mid-third quarter of fiscal 2020 and have remained open since that time. Our manufacturing facilities inChina 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 inCree 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 inNew York and additional production capacity inNorth Carolina . Even so, our short-term impacts from COVID-19 to our financial position, results of operations and cash flows are uncertain. 35 -------------------------------------------------------------------------------- Table of Contents Results of Operations Selected consolidated statements of operations data for the three and six months endedDecember 27, 2020 andDecember 29, 2019 is as follows: Three months ended Six months ended December 27, 2020 December 29, 2019 December 27, 2020 December 29, 2019 (in millions ofU.S. Dollars, except share data) Amount % of Revenue Amount % of Revenue Amount % of Revenue Amount % of Revenue Revenue, net$127.0 100.0 %$120.7 100.0 %$242.5 100.0 %$248.4 100.0 % Cost of revenue, net 85.7 67.5 85.1 70.5 165.7 68.3 160.3 64.5 Gross profit 41.3 32.5 35.6 29.5 76.8 31.7 88.1 35.5 Research and development 45.5 35.8 38.7 32.1 86.7 35.8 73.9 29.8 Sales, general and administrative 46.8 36.9 45.0 37.3 90.8 37.4 94.0 37.8 Amortization or impairment of acquisition-related intangibles 3.6 2.8 3.6 3.0 7.2 3.0 7.2 2.9 Loss on disposal or impairment of other assets 0.4 0.3 0.8 0.7 0.7 0.3 1.6 0.6 Other operating expense 2.6 2.0 10.9 9.0 11.2 4.6 17.0 6.8 Operating loss (57.6) (45.4) (63.4) (52.5) (119.8) (49.4) (105.6) (42.5) Non-operating (income) expense, net (3.1) (2.4) (5.0) (4.1) 10.8 4.5 (6.6) (2.7) Loss before income taxes (54.5) (42.9) (58.4) (48.4) (130.6) (53.9) (99.0) (39.9) Income tax benefit (0.2) (0.2) (0.5) (0.4) (1.0) (0.4) (1.8) (0.7) Net loss from continuing operations ($54.3 ) (42.8) ($57.9 ) (48.0) ($129.6 ) (53.4) ($97.2 ) (39.1) Net (loss) income from discontinued operations (28.4) (22.4) 3.9 3.2 (137.2) (56.6) 5.4 2.2 Net loss (82.7) (65.1) (54.0) (44.7) (266.8) (110.0) (91.8) (37.0) Net income from discontinued operations attributable to noncontrolling interest 0.3 0.2 0.3 0.2 0.6 0.2 0.3 0.1 Net loss attributable to controlling interest ($83.0 ) (65.4) ($54.3 ) (45.0) ($267.4 ) (110.3) ($92.1 ) (37.1) Basic and diluted loss per share Continuing operations ($0.49 ) ($0.54 ) ($1.18 ) ($0.90 ) Net loss attributable to controlling interest ($0.75 ) ($0.50 ) ($2.42 ) ($0.86 ) Revenue
Revenue was comprised of the following:
Three months ended Six months ended
(in millions of U.S.
Dollars) December 27, 2020 December 29, 2019 Change December 27, 2020 December 29, 2019 Change
Revenue $127.0 $120.7 $6.3 5 % $242.5 $248.4 ($5.9 ) (2) %
Revenue
Revenue for the three months ended December 27, 2020 compared to the three
months ended December 29, 2019 increased due to increases in the demand for
power and RF devices.
Revenue for the six months ended December 27, 2020 compared to the six months
ended December 29, 2019 decreased due to supply and demand factors relating to
the COVID-19 pandemic and lower RF demand in China offset by increased demand
and production capacity for our power applications.
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Gross Profit and Gross Margin
Gross profit and gross margin were as follows:
Three months ended Six months ended
(in millions of December 27, December 29, December 27, December 29,
U.S. Dollars) 2020 2019 Change 2020 2019 Change
Gross profit $41.3 $35.6 $5.7 16 % $76.8 $88.1 ($11.3 ) (13) %
Gross margin 32.5 % 29.5 % 31.7 % 35.5 %
Gross Profit and Gross Margin
The increase in gross profit and gross margin for the three months ended
December 27, 2020 compared to the three months ended December 29, 2019 are
primarily due to increased revenues in the current period and the impact of
higher inventory reserves related to product originally manufactured for Huawei
Technologies Co., Ltd. and its affiliates (collectively, "Huawei") in the prior
period that the Company was prevented from selling to Huawei, partially offset
by unfavorable product mix shift.
The decrease in gross profit and gross margin for the six months ended December
27, 2020 compared to the six months ended December 29, 2019 are primarily due
unfavorable product mix shift, partially offset by the impact of higher
inventory reserves related to product originally manufactured for Huawei in the
prior period that the Company was prevented from selling to Huawei.
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 our planned expansion to a new silicon
carbide fabrication facility in Marcy, New York .
Research and development expenses were as follows:
Three months ended Six months ended
(in millions of U.S. December 27, December 29, December 27, December 29,
Dollars) 2020 2019 Change 2020 2019 Change
Research and development $45.5 $38.7 $6.8 18 % $86.7 $73.9 $12.8 17 %
Percent of revenue 36 % 32 % 36 % 30 %
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.
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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 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); marketing and advertising
expenses; facilities and insurance costs; and travel and other costs.
Sales, general and administrative expenses were as follows:
Three months ended Six months ended
December 27, December 29, December 27, December 29,
(in millions of U.S. Dollars) 2020 2019 Change 2020 2019 Change
Sales, general and
administrative $46.8 $45.0 $1.8 4 % $90.8 $94.0 ($3.2 ) (3) %
Percent of revenue 37 % 37 % 37 % 38 %
The increase in sales, general and administrative expenses for the three months
ended December 27, 2020 compared to December 29, 2019 was primarily due to
higher professional service fees and increased information technology costs.
The decrease in sales, general and administrative expenses for the six months
ended December 27, 2020 compared to December 29, 2019 was primarily due
decreases in stock-based compensation expense, in part due to the impact of
modifications to existing equity awards in the prior period. Additionally, our
travel costs decreased as a result of the COVID-19 pandemic.
Amortization or Impairment of Acquisition-Related Intangibles
As a result of our acquisitions, we have recognized various amortizable
intangible assets, including customer relationships, developed technology,
non-compete agreements and trade names.
Amortization of intangible assets related to our acquisitions was as follows:
Three months ended Six months ended
(in millions of U.S.
Dollars) December 27, 2020 December 29, 2019 Change December 27, 2020 December 29, 2019 Change
Customer relationships $1.6 $1.6 $- - % $3.1 $3.1 $- - %
Developed technology 1.2 1.2 - - % 2.6 2.6 - - %
Non-compete agreements 0.8 0.8 - - % 1.5 1.5 - - %
Total amortization $3.6 $3.6 $- - % $7.2 $7.2 $- - %
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.
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.
Loss on disposal or impairment of other assets were as follows:
Three months ended Six months ended
(in millions of U.S.
Dollars) December 27, 2020 December 29, 2019 Change December 27, 2020 December 29, 2019 Change
Loss on disposal or
impairment of other
assets $0.4 $0.8 ($0.4 ) (50) % $0.7 $1.6 ($0.9 ) (56) %
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.
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Other Operating Expense
Other operating expense was as follows:
Three months ended Six months ended
(in millions of U.S. Dollars) December 27, 2020 December 29, 2019 Change December 27, 2020 December 29, 2019 Change Factory optimization restructuring$1.3 $1.2 $0.1 8 %$2.9 $2.4 $0.5 21 % Severance and other restructuring - - - - % 2.8 0.8 2.0 250 % Total restructuring costs 1.3 1.2 0.1 8 % 5.7 3.2 2.5 78 % Project, transformation and transaction costs 0.1 7.9 (7.8) (99) % 1.3 9.4 (8.1) (86) % Factory optimization start-up costs 1.2 1.5 (0.3) (20) % 4.2 2.9 1.3 45 % Non-restructuring related executive severance - 0.3 (0.3) (100) % - 1.5 (1.5) (100) % Other operating expense$2.6 $10.9 ($8.3 ) (76) %$11.2 $17.0 ($5.8 ) (34) % 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 14, "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 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. These efforts are focused on expanding our production footprint to support expected growth in theWolfspeed business. The decreases in other operating expense was primarily due to decreased project and transaction costs, driven by higher continuing operations project and transaction activity in the prior period. Non-Operating (Income) Expense, net Non-operating (income) expense, net was comprised of the following: Three months ended Six months ended (in millions ofU.S. Dollars) December 27, 2020 December 29, 2019 Change December 27, 2020 December 29, 2019 Change Gain on sale of investments, net ($0.2 ) ($0.1 ) ($0.1 ) 100 % ($0.2 ) ($0.1 ) ($0.1 ) 100 % Gain on equity investment, net ($10.4 ) ($6.4 ) ($4.0 ) 63 % ($7.0 ) ($9.9 )$2.9 (29) % Foreign currency loss, net (2.2) (1.3) (0.9) 69 % (2.4) (1.2) (1.2) 100 % Interest income (2.2) (4.7) 2.5 (53) % (4.9) (10.2) 5.3 (52) % Interest expense, net of capitalized interest 11.9 7.7 4.2 (55) % 25.0 15.1 9.9 (66) % Other, net - (0.2) 0.2 (100) % 0.3 (0.3) 0.6 (200) % Non-operating (income) expense, net ($3.1 ) ($5.0 )$1.9 (38) %$10.8 ($6.6 )$17.4 (264) % Gain on equity investment, net. The gain on equity investment for the three and six months endedDecember 27, 2020 was due to changes in fair value of ourLextar Electronics Corporation (Lextar) investment. During the six months endedDecember 27, 2020 , Lextar's stock was publicly traded on theTaiwan Stock Exchange and its share price decreased from 19.90 New Taiwanese Dollars (TWD) per share atJune 28, 2020 to18.70 TWD atSeptember 27, 2020 before increasing to22.25 TWD atDecember 27, 2020 . 39 -------------------------------------------------------------------------------- Table of Contents The gain on equity investment for the three and six months endedDecember 29, 2019 was due to Lextar's share price increasing from14.75 TWD per share atJune 30, 2019 to16.05 TWD atSeptember 29, 2019 and to18.40 TWD atDecember 29, 2019 . This volatile stock price trend may continue in the future given the risks inherent in Lextar's business and trends affecting theTaiwan and global equity markets. As of December, 27, 2020, we had a 16% common stock ownership interest in Lextar and utilize the fair value option in accounting for the ownership interest. InJune 2020 , Lextar announced a plan to restructure under a holding company withEPISTAR Corporation (EPISTAR ) via a share swap. EffectiveJanuary 6, 2021 , we received 0.275 shares of common stock of the holding company named ENNOSTAR Inc. (ENNOSTAR) for each of our shares of Lextar common stock, representing in the aggregate an approximately 3.3% common stock ownership interest in ENNOSTAR. The shares of ENNOSTAR are listed on theTaiwan 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. Foreign currency loss, net. Foreign currency loss, net, primarily consists of remeasurement adjustments resulting from our Lextar investment and from our international subsidiaries. Interest income. 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 dueMay 1, 2026 (2026 Notes), which were sold onApril 21, 2020 , partially offset by the partial repurchase of our 0.875% convertible senior notes dueSeptember 1, 2023 (2023 Notes) soon after the sale of the 2026 Notes. Income tax benefit Income tax benefit and our effective tax rate was as follows: Three months ended Six months ended (in millions of U.S. December 27, December 29, December 27, December 29, Dollars) 2020 2019 Change 2020 2019 Change Income tax benefit ($0.2 ) ($0.5 )$0.3 (60) % ($1.0 ) ($1.8 )$0.8 (44) % Effective tax rate - % 1 % 1 % 2 % The change in our effective tax rate for the three and six months endedDecember 27, 2020 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 theU.S. statutory rate of 21% is primarily due to: (i) changes in our valuation allowances against deferred tax assets in theU.S. and Luxembourg, (ii) projected income for the full year derived from international locations with differing tax rates than theU.S. , and (iii) projected tax credits generated. Net (loss) income 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 Products business upon classification as discontinued operations inOctober 2020 . Net loss from discontinued operations was$28.4 million and$137.2 million for the three and six months endedDecember 27, 2020 , respectively. Net income from discontinued operations was$3.9 million and$5.4 million for the three and six months endedDecember 29, 2019 . 40 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources Overview We require cash to fund our operating expenses and working capital requirements, including outlays for research and development, capital expenditures, strategic acquisitions and investments. Our principal sources of liquidity are cash on hand, marketable securities, cash generated from operations and availability under our line of credit. 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 capital expenditures and other general business needs. Additionally, onApril 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 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 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. 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, we recently entered into a definitive agreement with SMART regarding the LED Business Divestiture, which, when completed, will provide us with$50 million in upfront payments, a$125 million unsecured promissory note due inAugust 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 inMarcy, 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 theState of New York through a grant program administered by theState of New York Urban Development Corporation (doing business asEmpire 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. Currently, the local governments in the locations in which we operate have designated our Company as an essential business, but our operations have, and likely will continue, to experience supply, labor, demand and output challenges. We continue to monitor the impact that the COVID-19 pandemic is having on our business, the semiconductor and LED industries, and the economies in which we operate. We anticipate our future results of operations, including the results for fiscal 2021, will be materially impacted by COVID-19, but at this time 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 suppliers continue to be materially and adversely impacted by COVID-19, this could reduce the availability, or result in delays, of materials or supplies to or from us, which in turn could materially interrupt our business operations. Liquidity Our liquidity and capital resources primarily depend on our cash flows from continuing operations and our working capital. The significant components of our working capital are liquid assets such as cash and cash equivalents, short-term investments, accounts receivable and inventories reduced by trade accounts payable. 41 -------------------------------------------------------------------------------- Table of Contents The following table presents the components of our cash conversion cycle: Three months ended December 27, 2020 June 28, 2020 Change Days of sales outstanding (a) 49 53 (4) Days of supply in inventory (b) 134 117 17 Days in accounts payable (c) (115) (115) - Cash conversion cycle 68 55 13 a)Days of sales outstanding (DSO) measures the average collection period of our receivables. DSO is based on the ending net trade receivables less receivable related accrued contract liabilities and the revenue, net for the quarter then ended. DSO is calculated by dividing ending accounts receivable, less receivable related accrued contract liabilities, by the average net revenue per day for the respective 90-day period. b)Days of supply in inventory (DSI) measures the average number of days from procurement to sale of our product. DSI is based on ending inventory and cost of revenue, net for the quarter then ended. DSI is calculated by dividing ending inventory (excluding inventory related to a future Wafer Supply and Fabrication Services Agreement to be entered into in connection with the LED Business Divestiture (the "Wafer Supply Agreement")) by average cost of revenue, net per day for the respective 90-day period. c)Days in accounts payable (DPO) measures the average number of days our payables remain outstanding before payment. DPO is based on ending accounts payable and cost of revenue, net for the quarter then ended. Due to the significant amount of capital expenditures associated with our future silicon carbide fabrication facility inNew York , we exclude accounts payable related to capital expenditures in connection with the facility. DPO is calculated by dividing ending accounts payable and accrued expenses (less accrued salaries and wages and accounts payable balances related to our future silicon carbide fabrication facility inNew York ) 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 increased inventory balances as we expand production. As ofDecember 27, 2020 , we had unrealized losses on our short-term investments of less than$0.1 million . All of our short-term investments had investment grade ratings, and any such investments that were in an unrealized loss position atDecember 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 ofDecember 27, 2020 until the investments fully recover in market value. No allowance for credit losses was recorded as ofDecember 27, 2020 . Cash Flows In summary, our cash flows were as follows: Six
months ended
December 27, 2020 December 29, 2019 Change
Cash used in operating activities ($25.9 ) ($11.8 ) ($14.1 ) 119 %
Cash used in investing activities (49.8) (120.5) 70.7 59 %
Cash provided by financing activities 14.5 14.5 - - %
Effect of foreign exchange changes 0.5 (0.1) 0.6 (600) %
Net change in cash and cash equivalents ($60.7 ) ($117.9 ) $57.2 (49) %
Cash Flows from Operating Activities
Net cash used in operating activities increased primarily due to decreased
working capital in the current period.
Total cash provided by operating activities includes $6.2 million and $27.8
million of cash provided by operating activities from discontinued operations
for the six months ended December 27, 2020 and December 29, 2019 .
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 primarily due to increased net
proceeds from short-term investments of $227.7 million partially offset by an
increase in property and equipment purchases of $157.2 million .
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For fiscal 2021, we target approximately $550.0 million of net capital
investment, which is primarily related to capacity and infrastructure projects
to support our Wolfspeed business 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.
Total cash used in investing activities includes $2.7 million and $0.4 million
of cash provided by investing activities from discontinued operations for the
six months ended December 27, 2020 and December 29, 2019 .
Cash Flows from Financing Activities
For the six months ended December 27, 2020 , our financing activities primarily
consisted of net proceeds of $15.2 million from issuances of common stock
pursuant to the exercise of employee stock options.
For the six months ended December 29, 2019 , our financing activities consisted
of net proceeds of $14.6 million from issuances of common stock pursuant to the
exercise of employee stock options.
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 December 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
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 a 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 on 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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Recent Accounting Pronouncements
For a description of recent accounting pronouncements, including the expected
dates of adoption and the estimated effects, if any, on our consolidated
financial statements, see Note 1, "Basis of Presentation and New Accounting
Standards," to our unaudited consolidated financial statements in Part I, Item 1
of this Quarterly Report.
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