Wolfspeed Inc (WOLF) 2011 Q4 法說會逐字稿

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  • Operator

  • Good afternoon.

  • My name is Keisha and I will be your conference facilitator today.

  • At this time I would like to welcome everyone to the Cree Inc.

  • 2011 financial results conference call.

  • All lines have been placed on mute to prevent any background noise.

  • After the speakers' remarks, there will be a question-and-answer period.

  • (Operator Instructions)

  • As a reminder, ladies and gentlemen, this conference is being recorded today August 9, 2011.

  • Thank you.

  • I would now like to introduce Raiford Garrabrant, Director of Investor Relations of Cree Inc.

  • Mr.

  • Garrabrant, you may begin your conference.

  • Raiford Garrabrant - Director, IR

  • Thank you, Keisha, and good afternoon.

  • Welcome to Cree's fourth-quarter fiscal 2011 earnings conference call.

  • By now you should have all received a copy of the press release.

  • If you did not receive a copy, please call our office at 919-287-7895 and we will be pleased to assist you.

  • Today Chuck Swoboda, our Chairman and CEO; and John Kurtzweil, Cree's CFO, will report on our results for the fourth quarter of fiscal year 2011.

  • Please note that we will be presenting both GAAP and non-GAAP financial results in our remarks during today's call which are reconciled in our press release and financial metrics posted in the investor relations section of our website at www.cree.com under quarterly results and the financial information tab.

  • Today's presentations include forward-looking statements about our business outlook and we may make other forward-looking statements during the call.

  • These may include comments concerning trends in revenue, gross margin and earnings; plans for new products and other forward-looking statements indicated by words like anticipate, expect, target and estimate.

  • Such forward-looking statements are subject to numerous risks and uncertainties.

  • Our press release today and the SEC filings noted in the release mention important factors that could cause actual results to differ materially.

  • Also, we would like to note that we will be limiting our comments regarding Cree's fourth quarter of fiscal year 2011 to a discussion of the information included in our earnings release and the metrics posted on our website.

  • We will not be able to answer any questions that would involve providing additional financial information about the quarters beyond the comments made in the prepared remarks.

  • This call is being recorded on behalf of the Company.

  • The presentations and the recording of this call are copyrighted property of the Company and no other recording, reproduction or transcription is permitted unless authorized by the Company in writing.

  • Consistent with our previous conference calls, we are requesting that only sell-side analysts ask questions during the Q&A session.

  • Also, since we plan to complete the call in the allotted time of one hour, we ask that analysts limit themselves to one question and one follow-up.

  • We recognize that other investors may have additional questions and we welcome you to contact us after the call by e-mail or phone at 919-287-7895.

  • We are also webcasting our conference call and a replay will be available on our website through August 23, 2011.

  • Now I would like to turn the call over to Chuck.

  • Chuck Swoboda - Chairman, President, CEO

  • Thank you, Raiford.

  • Fiscal 2011 was both a successful and challenging year for Cree.

  • We continued to have success leading the LED lighting evolution and growing our LED lighting business while at the same time managing through a tough business cycle for our LED component and LED chip product lines.

  • For the year, revenue increased 14% to $988 million while non-GAAP earnings increased 4% to $187 million or $1.70 per diluted share.

  • For fiscal Q4 revenue increased 11% from Q3 to $243 million and non-GAAP net income increased 2% sequentially to $30.6 million or $0.28 per diluted share.

  • Revenue was at the high end of our target range while profits were in the middle of our target range for the quarter.

  • The revenue growth in Q4 was driven primarily by strong growth in sales of LED lighting products to our commercial and retail customers, solid growth in XLamp LED component sales driven by a rebound in demand across applications from our direct customers and through distribution which offset slightly lower LED chip, power and RF sales that were in line with our targets.

  • Non-GAAP gross margin was 39% in Q4 which was within our target range for the quarter of 40% plus or minus.

  • Consistent with our plan for the quarter, the gross margin was driven by several factors -- lower factory utilization as we slowed LED production to reduce inventory and a very competitive LED pricing environment which was partially offset by yield improvements and other cost reductions.

  • Cash and investments increased to $1.1 billion.

  • We remain in a strong position to invest in our business to lead the market and we also continue to evaluate potential opportunities to enable us to drive change in the industry and accelerate the adoption of LED lighting.

  • We made progress on all four of our key objectives for fiscal 2011.

  • We continue to build momentum in growing our LED lighting business and delivered a range of revolutionary new market leading products including our CR6 downlight, high output power lamps and CR series troffers that set new standards for performance, color, quality, cost and payback.

  • Our success over the last year has reinforced the value of having a lighting systems product line to complement our components business and gives us the ability to drive the market and LED lighting adoption.

  • We grew the LED component business year-over-year despite a very tough business cycle by continuing to enable the market with innovative application optimized new product platforms including our XM, MLE, MTG, CXA arrays and LMR modules.

  • The 150 mm development is on schedule.

  • We have qualified the first products and the initial production ramp has started in our fiscal Q1.

  • We made progress in growing the power and RF product line and we released the first silicon carbide power MOSFET.

  • Orders are tracking slightly ahead of this point last quarter as overall demand has rebounded from earlier in the year.

  • The growth in demand is coming from LED components and LED lighting although we continue to operate in a competitive environment with short lead times and limited visibility.

  • Sales through our LED component distributor partners grew nicely in Q4 and we were able to reduce channel inventories during the quarter.

  • I will now turn the call over to John Kurtzweil to review our fourth-quarter and year-end financial results in more detail as well as our targets for the first quarter of fiscal 2012.

  • John Kurtzweil - CFO, EVP Finance and Treasurer

  • Thank you, Chuck.

  • I will be providing commentary on our financial statements on both a GAAP and non-GAAP basis which is consistent with how management measures Cree's results internally.

  • However, non-GAAP results are not in accordance with GAAP and may not be comparable to non-GAAP information provided by other companies.

  • Non-GAAP information should be considered a supplement to and not a substitute for financial statements prepared in accordance with GAAP.

  • A reconciliation of non-GAAP information to the corresponding GAAP measures for all quarters mentioned on this call is posted on our website along with a history summary of other key metrics.

  • For fiscal 2011 revenue increased 14% year over year to $988 million as compared to $867 million for the prior year.

  • GAAP earnings were $146.5 million and $1.33 per diluted share for fiscal 2011 while non-GAAP earnings increased 4% year over year to $186.8 million and $1.70 per share.

  • Non-GAAP earnings exclude $40 million of expense net of tax or $0.37 per diluted share from the amortization of acquired intangibles and stock-based compensation expense.

  • Cash provided by operations was $253 million.

  • Free cash flow was $14 million and we exited fiscal 2011 with $1.1 billion in cash and investments while continuing to be debt-free.

  • For the fourth quarter fiscal 2011, revenue was $243 million which was on the high end of our targeted range of $225 million to $245 million.

  • This is an 11% increase sequentially.

  • GAAP net income was $19.8 million, an increase of 5% sequentially.

  • GAAP diluted earnings per share were $0.18.

  • On a non-GAAP basis, net income was $30.6 million, an increase of 2% sequentially.

  • Non-GAAP diluted earnings per share were $0.28.

  • Non-GAAP net income excludes $10.8 million of expense net of tax or $0.10 per diluted share from the amortization of acquired intangibles and stock-based compensation expense.

  • We ended the quarter with $1.1 billion of cash and investments which increased $13 million since the end of March.

  • Cash provided by operations was $64.5 million.

  • Depreciation and amortization was $30.2 million.

  • CapEx for the quarter was $48 million and free cash flow was $16.6 million.

  • Q4 GAAP gross margin was 38.1% while non-GAAP gross margin was 38.8% which excludes stock-based compensation of $1.5 million.

  • This was in line with our non-GAAP target of 40% plus or minus.

  • Operating expenses for Q4 were $72.5 million on a GAAP basis and $61.4 million on a non-GAAP basis.

  • Non-GAAP operating expenses exclude approximately $8.4 million of stock-based compensation expense and $2.7 million of charges for amortization of acquired intangibles.

  • Non-GAAP R&D expenditures decreased $0.8 million sequentially and were $1.4 million lower than our target for the quarter primarily due to the timing of various R&D projects.

  • We successfully qualified our first products as part of our 150 mm wafer development program.

  • Non-GAAP SG&A expenditures were $1.9 million higher than target primarily related to IP litigation expenses.

  • This resulted in non-GAAP operating income of $32.8 million which was in line with our target.

  • Net interest income and other for the quarter was $3.1 million.

  • The effective tax rate for the quarter was 14.8% which is above our target of 14%.

  • For the year, we ended with a tax rate of 17.8%.

  • Day sales outstanding were 44 days as compared to 52 at the end of March.

  • Inventory days declined to 106 days from 119 at the end of March.

  • Inventory increased by $6.9 million to $176.5 million during the quarter.

  • The increase was primarily related to our LED lighting product line to support targeted growth in fiscal Q1.

  • LED chips and components inventory declined sequentially.

  • For fiscal 2011 we authorized capital additions of $204 million.

  • Our capital authorization target for fiscal 2012 is approximately $160 million although our current capital spending is focused primarily on new product related areas, as our current factory utilization should provide sufficient first capacity in the near term.

  • At this time, we target Q1 revenue to be in a range of $245 million to $255 million which is being driven by a number of factors including double-digit growth in LED lighting, mid-single-digit growth in LED components, flat to lower LED chip sales and power and RF slightly lower due to lower demand from our solar inverter related customers.

  • GAAP and non-GAAP gross margins are targeted to be 38 to 39%.

  • This target factors in the competitive pricing environment and higher inventory costs in Q4 partially offset by incrementally higher factory utilization and cost reduction programs.

  • Our GAAP gross margin targets include stock-based compensation expense of approximately $2.1 million while our non-GAAP targets do not.

  • Our long-term goal for gross margins continues to be in the mid-40s but over the short to mid-term, our goal is to get back into the low 40s.

  • To hit the short-term goal, we target improvements later in our fiscal year for new product introductions, higher factory utilization rates and cost reductions from programs such such as the transition to 150 mm wafers.

  • We are targeting non-GAAP R&D expense to increase by approximately $2 million in Q1 to further support new LED chip development, the 150 millimeter LED chip product qualifications, new LED component platforms and continued investment in our LED lighting products.

  • We target non-GAAP selling expense to increase by approximately $1 million and for G&A to be down approximately $2 million based on lower litigation costs.

  • We target asset impairments of approximately $0.5 million for the quarter.

  • Our GAAP operating expense targets include non-cash stock-based compensation expense of $2.6 million in R&D plus $7.6 million in SG&A and charges for amortization of acquired intangibles in the amount of $2.2 million.

  • As a result of the higher targeted revenue, similar gross margins and a slight increase in operating expense, we are targeting a sequential increase in operating income for fiscal Q1.

  • Net interest income and other is targeted to be approximately $2.2 million.

  • We target our tax rate to be between 20% for both fiscal Q1 and fiscal 2012.

  • This is an increase of slightly over 2 points from fiscal 2011 and is primarily related to the expiration of the R&D tax credit at the end of December 2011 along with a mix shift of income to countries that have higher tax rates.

  • The resulting impact for fiscal Q1 is approximately $0.02 over the fiscal Q4 rate.

  • GAAP net income for Q1 is targeted at $16 million to $19 million.

  • Based on an estimated 110.2 million diluted shares outstanding, our GAAP EPS target is $0.14 to $0.17 per diluted share.

  • Non-GAAP net income is targeted to be $27.5 million to $31 million or $0.25 to $0.28 per diluted share.

  • Our non-GAAP EPS target excludes amortization of acquired intangibles and non-cash stock-based compensation in the amount of $0.11.

  • Thank you and I will now turn the discussion back to Chuck.

  • Chuck Swoboda - Chairman, President, CEO

  • Thanks, John.

  • As we begin fiscal 2012, we are focused on three priorities to drive our business in the year ahead.

  • Our first priority is to continue to lead the market and drive adoption of LED lighting.

  • We are focused on developing innovative new LED lighting systems to drive adoption and new LED components that enable our customers to deliver a more competitive payback versus traditional lighting.

  • We understand that our leadership in indoor lighting systems can cause some anxiety among our LED component customers.

  • But I believe they are finding that our success is accelerating adoption and therefore expanding the overall market opportunity for LED lighting.

  • Our lighting product line has clearly helped to set new standards in the industry and we can't afford to slow down because we've only scratched the surface in what is possible at the lighting systems level.

  • We plan to continue to invest in this product line to foster LED component innovation and find new ways to drive the market and obsolete the old energy wasting technology [in all light] application.

  • We made great progress in the last year with the growth in our lighting business and continued technology leadership in both components and systems.

  • The introduction of our CR series downlights and troffers, our success with new channels like the Home Depot and overall LED performance gains have given us a solid foundation and are helping us lead the market.

  • Our new application optimized LED platforms have enabled our customers to deliver higher performance and lower cost products to compete against traditional lighting across a range of new applications.

  • We need to continue to innovate and drive the technology to increase performance at both the LED component and systems level so that we can deliver even shorter paybacks for our system-level products and enable even lower costs for our component customers products.

  • Our second priority is to accelerate cost reductions and drive operational improvements to increase the profitability of our business.

  • We are targeting improvements in several areas over the next year.

  • We target lower LED costs from the conversion to 150 mm wafers, higher factory utilization as well as yield and productivity improvements.

  • We target lower LED and system costs from new lower cost product designs that are under development.

  • And we target improved operating leverage from higher revenues across our LED system and component product lines.

  • We have successfully qualified the first 150 mm chip level products and we have started production of these products in our fiscal Q1.

  • This transition is scheduled to continue throughout our fiscal year as we qualify additional product families on the larger wafers.

  • While we target 150 mm-based LED chips to be 30% lower cost than chips produced on 100 mm wafers, we forecast that we'll see most of this benefit in the second half of fiscal 2012 after we have come up the learning curve in manufacturing and once we have converted a majority of products to the larger wafers.

  • This benefit will also be affected by factory utilization levels.

  • We're currently targeting incrementally higher factory utilization in Q1 as we increase production volumes over the next several quarters.

  • However, this may change depending on market demand and other competitive factors.

  • Our third priority is to grow the [power and RF] product line and expand beyond niche applications.

  • We made solid progress over the last year improving yields, expanding the product line and getting our first silicon carbide MOSFET released.

  • The core value of this product line is energy savings for power switching applications.

  • Our success over the last couple of years demonstrates that silicon carbide powered devices can deliver better performance and a better payback against silicon based power devices.

  • We target continued investment in R&D for new diode and switch products focused on more mainstream and higher volume power switching applications.

  • We made good progress growing the revenue of this product line in the first half of fiscal 2011 until the slowdown in solar inverter demand.

  • We see this as a temporary market correction and we target the combination of new products and expanded sales coverage to drive growth in the power product line in the second half of fiscal 2012.

  • As we look ahead to Q1, demand has improved from earlier in the calendar year but we are still operating in a short lead time environment with limited visibility.

  • Our backlog is slightly ahead of this point last quarter and distributor sales trends are positive.

  • We target Q1 revenue to increase to a range of $245 million to $255 million driven by double-digit growth in LED lighting products, mid-single-digit growth in LED components, flat to lower LED chip sales and lower power sales due to lower demand from our solar inverter related customers.

  • We target Q1 non-GAAP gross margins in a similar range as Q4 at 38% to 39% as we get some benefit from incrementally higher factory utilization and cost reduction programs which are offset by higher inventory costs from Q4 and the competitive pricing environment.

  • We target higher gross profits to be partially offset by incrementally higher R&D, sales and marketing spending which results in incrementally higher operating profit.

  • The targeted increase in operating profit will be partially offset by an increase in our tax rate to 20%.

  • As a result we target non-GAAP earnings in Q1 of $0.25 to $0.28 per diluted share.

  • Please note that our non-GAAP targets exclude amortization of intangibles, stock-based compensation expense and related tax effects.

  • Fiscal 2011 was a year of continued progress in driving the LED lighting revolution.

  • Our LED lighting product line has enabled us to reinvent the market for downlights and our new CR troffer product line opens up large new markets for LED lighting in general office indoor applications.

  • Despite our success, the reality is that we're just getting started changing this industry and we need to continue to invest in this area to drive adoption and lead the market.

  • Our LED components product line has continued to set the standard in brightness and efficiency and we need to keep pushing the limits to make LED lighting more successful against traditional lighting technology and stay ahead of the competition.

  • We are well positioned to continue to lead the lighting revolution and we look forward to taking on new challenges and building on our track record of innovation to continue to change the market in the year ahead.

  • Along these lines, we're off to a great start in fiscal 2012.

  • It has been said that the cheapest, lowest impact and most abundant energy is the energy that we never use.

  • We recently announced the achievement of a prototype LED light source that exceeds the DOE's L Prizes 21st Century Lamp targets of 150 lumens per watt and 1200 lumens before the complete specification has even been defined.

  • This revolutionary LED system delivers 20% more light than a standard 75 watt incandescent bulb but consumes only 8.7 watts of electricity.

  • If LED lights with this level of performance are fully deployed, this ultra-efficient lighting could reduce our nation's total annual electrical energy consumption by 16.5% which would take us back to annual consumption levels last seen in 1987 which coincidentally is the year Cree was founded.

  • This incredible achievement could be accomplished by simply replacing our existing lighting with the new LED-based lighting systems like the one we demonstrated.

  • This large-scale potential reduction in energy consumption is the foundation for the LED lighting revolution and we are focused on continuing to lead.

  • We will now take analyst questions.

  • Operator

  • (Operator Instructions) Chris Blansett.

  • Chris Blansett - Analyst

  • I had a quick one here.

  • You mentioned that your utilization rates are going to uptick slightly in the first fiscal quarter.

  • I wanted to get a feel for how you think your inventories are going to trend during the quarter.

  • And then the second question was related to the impact of the ramp of 150 mm on your overall gross margin profile for the quarter.

  • John Kurtzweil - CFO, EVP Finance and Treasurer

  • Yes, so right now the idea is that we should start to see utilization come up a little bit and the assumption there in that is that we will -- actually our target is to reduce inventory -- internal inventory from where we exited last quarter.

  • So if we're able to achieve the revenue targets and inventory goes down, that will move days down even further than where we exited last quarter.

  • As far as the 150 mm impact, you know in Q1 what we're really going to see is we're really be starting the first products into production and they're in the fab now and they're processing through.

  • I don't think you are going to see a big gross margin impact in the near term because really what we're doing is just getting the first products ramped up.

  • The bigger lever in the short term is going to be some of the traditional yield activities, the utilization increase as well as a variety of new products that we're bringing on line that are designed to be lower cost to start with.

  • Those are probably the bigger near-term drivers.

  • And as I commented earlier, I really think 150 is going to be more of a second-half benefit.

  • Not that we won't get some incremental benefit along the way, but the reality is until you get the majority of the products converted and you get the utilization rates up, it's really you're battling utilization as a bigger cost driver in the short term.

  • But clearly it should help us in more of the second-half of the year at this point.

  • Chris Blansett - Analyst

  • A quick follow-up was -- so your utilizations in the fourth fiscal quarter were relatively sideways with the third fiscal quarter?

  • John Kurtzweil - CFO, EVP Finance and Treasurer

  • No, they were actually lower, Chris.

  • We actually saw that -- it varies across the factory, but to give you a little bit of color, I think in some parts of the factory, we probably had utilization as low as about 60% during the quarter.

  • I don't have a specific target for you this quarter will but it should go up incrementally especially as we proceed through this quarter.

  • So I think Q4 right now looks like the low point over the last couple quarters.

  • Chris Blansett - Analyst

  • Thank you, appreciate it.

  • Operator

  • Steve Milunovich, BofA Merrill Lynch.

  • Steven Milunovich - Analyst

  • Hey, Chuck, could you dive a little bit more into the demand side?

  • Last couple quarters, distributors have been the problem, it sounds like that came back a bit.

  • I think you said inventory at distributors is down.

  • So it sounds like there was reasonable sellthrough.

  • Can you talk about what applications you think are improving and specifically talk about what's going on in Asia from what you can tell and particularly in the China streetlamp area, when that is likely to pick up?

  • Chuck Swoboda - Chairman, President, CEO

  • Alright, let me see if I can get all of those, and if I don't, remind me.

  • So overall, distributor sales definitely picked up last quarter.

  • We saw solid sales from the distributors to their customers across geographies and across applications.

  • So -- and we also saw an increase in direct sales.

  • So we actually had relatively broad-based growth of application, geography and by channel.

  • The result was we actually had distributor inventories decline quarter over quarter, and that's actually two quarters in a row.

  • So I feel like that's at a pretty healthy position.

  • Obviously that's subject to continuing to drive demand which is the biggest lever we have there.

  • But obviously that continued to improve through the quarter.

  • As far as Asia or China specific, I would say that what we saw in Asia and as well as in China is we didn't see any one application.

  • I think we saw growth really across applications; so everything from street lights, indoor commercial, some of the bulb replacement markets.

  • Really we're seeing demand kind of across applications.

  • So wouldn't put it on any one specific area.

  • It was really incremental growth across a range of applications that was driving the business.

  • Steven Milunovich - Analyst

  • Can you indicate what percentage of your revenue for the full year was from China?

  • Chuck Swoboda - Chairman, President, CEO

  • I know that's going to be in the K.

  • I want to say roughly -- I want to say 36%.

  • It might be plus or minus that, right, John?

  • John Kurtzweil - CFO, EVP Finance and Treasurer

  • Yes.

  • Chuck Swoboda - Chairman, President, CEO

  • It's 36%.

  • So what that would say is that while China grew last year, is the non-China business grew faster.

  • But China was up incrementally and the rest of the business was up a little bit more last year.

  • Operator

  • Dale Pfau, Cantor Fitzgerald.

  • Dale Pfau - Analyst

  • If we kind of call last quarter then, your third quarter the bottom and we're starting to see demand pick up, could you talk a little bit about the competitive landscape, anybody new, anybody old dropping away?

  • And also talk about the pricing pressure -- it looks like over the last say 12 months, it's been a little bit stronger than historical norms.

  • Do you think you see that pricing pressure in the next several quarters being in the range of historical norms or continuing pressure?

  • Then I've got a follow-up.

  • Chuck Swoboda - Chairman, President, CEO

  • Okay, Dale, so definitely from a demand standpoint, it looks at this point given where the orders were in Q4 and what our targets are for Q1 that Q3 was the bottom.

  • With that being said, we are in a short lead time environment.

  • So that given the trends that we are seeing today.

  • With that being said, what's going on with the competition?

  • I would say our main competition comes from our traditional competitors.

  • So more times than not it's gonna be one of the big three that we've traditionally competed with primarily lighting class LEDs for lighting class applications.

  • We do see and depending on the market and the applications some amount of competitors that I'll call it that next tier, generally these are competitors based out of Asia, it will range on different accounts, different applications and different approaches.

  • But I would say that we see the activity, but today it's really -- the real pressure is coming from the traditional competitors from what's driving the business standpoint.

  • but we're obviously watching the new guys as well.

  • In terms of pricing pressure, definitely Q2 and Q3 were more competitive, more severe pricing than I would consider to be a historical average.

  • Last quarter the pricing still competitive, but I think the words I would use is it's moderated and I think we're now getting back more into a historical range and that would be -- that was our old range was annually we'd see 25 to 30% a year.

  • Now that's a little premature to say we're in that range, but I would say given what we saw in Q4, what we're targeting this quarter, it feels more like that.

  • But again, Dale, when you don't have a big backlog and we are -- the leadtimes are relatively short, I hesitate to try to forward project that too much but that's what we're seeing at least in the near-term.

  • Dale Pfau - Analyst

  • And then my follow-up has to do with -- out there on the technology improvement side, you've been pushing your luminosity and so on pretty quickly.

  • And are you still leading your competitors?

  • Are your customers saying no they don't really care about that anymore and I don't know, 120 is good enough?

  • Can you talk about that a little bit and any changes you see over the next again 12 months?

  • Chuck Swoboda - Chairman, President, CEO

  • I would say clearly from a pure capability standpoint R&D result-wise, I feel very comfortable we're still out setting some standards that most people aren't expecting.

  • I think when it comes to the production business, I think against our main competitors, on average we still have a lead.

  • But it's become a more competitive environment with everyone fighting for the same pieces of business.

  • But I would say overall, clearly it's a more competitive environment there, but I think our trick is how do we take more of this R&D results and bring it into production.

  • Because we've demonstrated capabilities significantly beyond what we're doing in production today.

  • So that's our challenge over the next year.

  • When it comes to is there a good enough market, for the things that we are focused on, we see customers pretty rapidly continuing to go after the higher output devices in terms of both total lumens per package and lumens per watt.

  • And what we are seeing is -- and again this may not be true in all applications, but so many of the applications today are on the limits of what it takes to really meet -- for example, even a lightbulb, they're trying to meet ENERGY STAR which puts a lot of pressure in a very small package to get high efficiency with low wattage.

  • In some of the street lighting applications, it's about driving more payback in terms of performance and also simplifying their designs and solving some of the thermal issues there.

  • And in the indoor commercial, it's a cost lever.

  • So today, I am still seeing lots of demand for the high-end devices.

  • In fact if anything in the last six months, the high-end devices have probably even become more of a focus of our customer base.

  • Operator

  • Harsh Kumar, Morgan Keegan.

  • Harsh Kumar - Analyst

  • Two questions.

  • Chuck, how would you characterize the inventory and pricing in LED lighting products versus non-LED lighting components?

  • So in other words, general lighting versus the rest.

  • Chuck Swoboda - Chairman, President, CEO

  • When you say -- are you talking about the systems products versus components or (multiple speakers)

  • Harsh Kumar - Analyst

  • Components.

  • Chuck Swoboda - Chairman, President, CEO

  • Harsh, most of our business today is -- I would say that we're -- over three-quarters of our sales are lighting related.

  • So pretty much what we're reporting is lighting trends.

  • We still obviously have a nice business in video screens, but the rest of those applications are pretty small.

  • So pretty much most of our sales and our inventory is focused on the lighting market and applications.

  • It's probably a little bit different in the chip business.

  • But in terms of the big numbers, it's really lighting oriented within components.

  • Harsh Kumar - Analyst

  • Got it, got it, helpful.

  • And then if I was to look at your margins, Chuck, of 38 and change and guidance as well, how much do you think is pricing, the step decline, versus yields?

  • And which do you think is a bigger factor here?

  • Chuck Swoboda - Chairman, President, CEO

  • I would say that actually -- I think we have made -- I think our yields is what has helped us continue to deliver pretty good margins relatively speaking.

  • I know they're not what they were, but if you look at what's happened from a utilization standpoint and a market pricing competitive standpoint, our yield improvements have been a real benefit to us.

  • I think the other thing to keep in mind is I would say is utilization and pricing are the two biggest levers on the business right now.

  • So our focus really gets back to what can we do to drive adoption?

  • If you drive adoption, that drives demand, and demand drives utilization and the whole model works.

  • And that's really why you hear me keep coming back to that.

  • The way we want to drive this business is if we can enable our customers to be more successful against attritional technology, we can drive demand and that will load up the factory and the rest of the leverage comes from there.

  • Operator

  • Josep Pujal.

  • Josep Pujal - Analyst

  • Good afternoon, gentlemen, it's nice to see some stability in the market.

  • Do you have a view on liquidity available for energy savings ROI projects, high ROI projects?

  • And given your balance sheet, would Cree consider any such opportunities to finance energy savings projects such as streetlights for instance, just to pick something randomly?

  • Chuck Swoboda - Chairman, President, CEO

  • Yes, so, Jesse, today obviously as a component supplier, we have not ventured down that road.

  • So for example, the streetlight business, we are a supplier to a number of companies there, and so that would be really more of an opportunity for them.

  • When you get into the indoor lighting applications, with the new CR series troffers and our CR series downlights, the whole idea was how do we drive some of those energy savings type applications.

  • What we have found is there is money available and there is an interest in the larger energy saving industry to use lighting as one of their projects.

  • But it is a -- what I say -- it's one of many they're trying to do.

  • Our focus is a little bit different.

  • With our troffer, we are trying to push the price and the payback so low that we can have a lighting specific discussion.

  • And what we're seeing is some applications, we can get down into that one to two year range depending on what technology is in there today.

  • And when we push it into that range, most people are looking at a self finance because the payback is relatively short.

  • So our basic model is how do we push the paybacks so low that we can go after straight up capital projects where we don't have to get into complicated financing.

  • With that being said, if that's something it takes to enable some of those applications, I think we will absolutely consider it, and it's not on the short-term list of things to do.

  • And really our focus there is innovate our way into products that pay for themselves quick enough that it's not necessary.

  • Josep Pujal - Analyst

  • As maybe a follow-up to that, can you give us any color on the traction of the troffer product for instance which was pretty busy at the light fare show, your booth was, that is, how much sales have you had from the product or what kind of distribution have you received thus far?

  • Chuck Swoboda - Chairman, President, CEO

  • So far we would say that the initial sales are good or better than what we expected but we didn't -- I have to tell you.

  • One of the things we learned with the downlight before is a new lighting product that no one has ever seen or considered before is not something that you're going to instantly design in.

  • So really we launched it in May at the show, we spent the last two months getting all of our agents and a lot of the specifiers up to speed on how the product works, what is that cost savings.

  • I would say they are now really getting into the mode of going after the bigger projects.

  • So I would estimate that -- and we saw this in our other products -- we will see a lot more over the next six to nine months as the normal cycle of going in, bidding on a project, getting the capital approved and doing the installation.

  • We're going to have to go through that phase to truly measure this.

  • There's nothing I have seen that's disappointing.

  • In fact I think that what we had to solve after the last show was almost -- we had to work through a process of where it was almost a phenomenon, is it too good to be true?

  • And so we spent some time really educating people, it truly does work this way.

  • Here's the payback.

  • We really can give you these savings.

  • So there's a bit of an education lag.

  • But I mean I'm pleased where we're at.

  • But in terms of revenue, we are probably six to nine months from really seeing what kind of leverage we can get there.

  • Operator

  • Andrew Huang, Sterne Agee.

  • Andrew Huang - Analyst

  • Okay, so just a big picture question.

  • Obviously, everyone is concerned about the global economy and the effect that has on spending.

  • So maybe could you share with us what your biggest customers are saying on LED lighting?

  • Chuck Swoboda - Chairman, President, CEO

  • When you say LED lighting, the customers that are buying lighting systems or the customers that are buying components?

  • Andrew Huang - Analyst

  • Customers that are buying components.

  • Chuck Swoboda - Chairman, President, CEO

  • So, Andrew, what we see there is that we see continued activity across the applications.

  • We haven't seen any significant change.

  • In fact there are some specific things like obviously Japan is a good market right now, but it's not a big component business for us.

  • But that is an example.

  • There are some specific things that are related to pure energy saving programs.

  • With that being said, it's more of a general market.

  • I think what we're seeing is that most of our customers are continuing to expand their lighting product lines and starting to find ways to get products that instead of being just a niche 'hey I've got an LED system,' starting to look for how do they really go out and deliver products that have legitimate payback head-to-head against the traditional technology.

  • Now, I say that -- remember we're still early days.

  • If the market is 4 to 5% adoption, we're still really early in the cycle.

  • But I think that's what most of our customers are working on and although we have some large customers, it's a relatively broad customer base.

  • A lot of it is through distribution.

  • So it's more broad market trends.

  • And if there's an effect from the recent market issues, we have not yet seen it flow through our customer order patterns and we haven't seen it flow through the demand.

  • So at this time, obviously going to watch that closely, but the trends we gave you is what we've been seeing up until through today.

  • Andrew Huang - Analyst

  • Okay, can you give us a sense of how much lower your LED lighting systems margins are relative to the corporate average?

  • So are they more in the 20% to 30% range or more like the 30% to 40% range?

  • Chuck Swoboda - Chairman, President, CEO

  • So, I would say components is clearly ahead of the pack there and then chips and lighting systems are in a similar range.

  • I can't give you a specific number, but I don't think the gap is maybe quite as big as some people might perceive.

  • But I really just can't break it out for you.

  • We're lagging, but not significantly behind making progress.

  • But we have more work to do there.

  • Operator

  • Amman Zaman.

  • Ahmar Zaman - Analyst

  • Just switching topics to backlighting, what are you seeing on that front?

  • And do you need backlighting to return to meet your -- to continue to grow your utilization meaningfully over the next few quarters?

  • Chuck Swoboda - Chairman, President, CEO

  • So today we have almost no exposure to backlighting.

  • We have a little bit of incremental business there.

  • It's through our chip business.

  • So there is some marginal benefit or not, but it's a relatively small number.

  • In fact it's a very small percentage of the overall applications today.

  • I don't think -- we built our plan really focused on driving lighting and then continuing to focus on our video screen business for our high-bright LEDs.

  • So that's really the two biggest markets that drive our plan right now.

  • There will be some incremental benefit along the smaller applications.

  • But it's not a big part of our plan.

  • Now, I say that but there is the related effect of what happens in backlighting does affect overall industry capacity and utilization.

  • So I think today most people are bracing for pretty low backlighting demand in the near term from what I've read from the other companies out there.

  • So I think my sense is if there is a pickup, the one benefit we might see is it might reduce -- it might help overall industry utilization, which is probably a net benefit to Cree, but it's not a direct part of the strategy right now for our sales.

  • Ahmar Zaman - Analyst

  • Thanks, as a follow-up, I guess just your tone sounds remarkably more positive this quarter than last quarter.

  • What has changed in general lighting specifically that it's turned things around -- turned demand around so meaningfully for you?

  • Chuck Swoboda - Chairman, President, CEO

  • The tone is pretty -- it's gonna generally fluctuate when revenue's going up or down a little bit there.

  • So that's probably why you hear a different tone.

  • Obviously it's very encouraging for us to see some of the activity.

  • You know I think the market continues to incrementally move forward.

  • I think the challenge is that there's so many different applications and they're all moving at different rates at different times, and we've been working as well through some inventory corrections which has kind of muted the results.

  • I would say what's encouraging to us is that it's relatively broad.

  • We're seeing a combination not just of our products that we've been selling, but some of the new products.

  • The last that nine months we've introduced a wide array of products designed for specific applications.

  • Our strategy was if you optimize the LED around the application, we can help the customer develop a better product to make it effectively lower cost and better in the end-market.

  • I think we're starting to see the first parts of traction there.

  • Designing in new LED components doesn't happen overnight.

  • It's always been a business that takes you know a good six, nine, sometimes 12 months to get through that cycle to get some momentum going.

  • So I think that's what's encouraging us.

  • And the only caution really is that the business isn't where we've got big backlogs or great visibility going forward.

  • So we're really responding to the business in a short lead time environment.

  • And so that's where you get the encouraging revenue trends but still some caution because we just don't have great visibility.

  • Operator

  • Joshua Paradise, Morgan Stanley.

  • Joshua Paradise - Analyst

  • Congratulations on the traction in the LED lighting in the systems business.

  • Can you give some more detail on how big that business is today as a percent of sales and how big -- what percent of the business you think it could become?

  • Chuck Swoboda - Chairman, President, CEO

  • So, it's still a relatively modest piece of the business.

  • We don't break it out specifically in any of our other filings.

  • So I can't give it to you.

  • But I would say -- what could it become?

  • Look, the core strategy is get the market moving, get some incremental revenue growth there, at the same time drive components.

  • And what we've seen though is that our ability to actually focus on an application -- and we really only participate in a couple of applications there today, we can generate some pretty good traction.

  • So I think I would expect that business to continue to grow over the next year.

  • That's certainly our goal.

  • Whether that will happen, it's going to be a lot of different factors.

  • But we're gonna continue to come up with a lot of innovative products and build that.

  • So I think what you'll see is is that components is still a major part of the revenue and the earnings.

  • At the same time, I think we can start to make that business add some incremental upside both from a revenue and hopefully some earnings as we get the margins up there.

  • So to me it is an opportunity to maybe offset some of the competitive factors that we see on a day-to-day basis in components by being able to focus on specific applications and drive adoption.

  • Operator

  • Mark Heller.

  • Mark Heller - Analyst

  • Had a quick question.

  • John, can you say -- I know you said utilization was maybe as low as [60]% but is there an average utilization yet for the quarter?

  • And I was wondering if you could estimate what the gross margin impact was from the low utilization.

  • So say if you were running at 95% utilization, whatever normal is, what would the normalized gross margin be in the fiscal fourth quarter?

  • John Kurtzweil - CFO, EVP Finance and Treasurer

  • Well, what we saw last quarter and as Chuck said, we saw some areas of factory down in the 60% range.

  • Now for that, we saw higher inventory costs that are going to flow through this quarter.

  • In terms of the gross margin impact, you saw it was a little bit lower than what we had targeted at the lower end of our target range.

  • So that's about what the impact is.

  • And going forward, what we expect to do is see a little bit better utilization and that's going to help offset some of the pricing pressures we see.

  • Chuck Swoboda - Chairman, President, CEO

  • Keep in mind on that that while the utilization should start to improve this quarter incrementally, we do have the higher costs from Q4.

  • Some of those will still have to flow through this quarter.

  • So the key is if we continue to drive revenue, those lower costs should start to affect the business as we exit this quarter and put us in a better position subject to end demand next quarter.

  • Mark Heller - Analyst

  • Okay and on ASPs, I know you talked about it a little bit, but sequentially can you talk about how they've trended in fiscal Q4 and what they're looking liking Q1?

  • Was it like a double-digit decline in Q4 and sort of single-digit decline in Q1?

  • Could you just talk about that?

  • Chuck Swoboda - Chairman, President, CEO

  • So ASPs, you've gotta be alittle careful because ASPs include mix.

  • So actually what you'd see is our ASPs are up but that is a mix phenomenon between product lines.

  • If you look at it on LED component product to product basis, the best call I can give you is that it moderated in Q4 from where it was in Q3.

  • So the declines are less and they are becoming more in line with the historical range.

  • And we are targeting a similar level in Q1.

  • So we're targeting Q4 and Q1 to be kind of similar and I would put it within the boundaries of that historical 25 to 30% annual range.

  • With that being said, again, we don't have visibility beyond Q1 at this point but that is what we are modeling.

  • Operator

  • Carter Shoop.

  • Carter Shoop - Analyst

  • Could you help us better understand how your visibility has improved over the past three months?

  • Maybe try to provide a few numbers on lead times or kind of the bookings growth you have seen?

  • I noticed that you narrowed your revenue range for the upcoming quarter but it's not clear to me how much of that is due to the fact you guys have an extra month of visibility this quarter versus last quarter.

  • Chuck Swoboda - Chairman, President, CEO

  • Carter, the way I would think about it is that you know total visibility, the backlog at this point is slightly ahead of where it was last quarter.

  • I would say that we don't have -- we don't really have forward-looking visibility much better at this point.

  • A narrow range is exactly what you guesses for later in the quarter.

  • So we are narrowing the range because we're later in the quarter.

  • I think the one thing that is encouraging is we obviously now have several months worth of positive sales trends.

  • So that's not visibility, it's more of a we're seeing what the industry is doing around us.

  • So I'd say we are encouraged by the trends we have backwards looking but we still don't have that forward-looking view like we had a year ago to where we could kind of really project it.

  • So the best example I could say is the revenue trends are better than they were six months ago but that's more backwards looking.

  • And as far as forward-looking goes, it's still short leads times or roughly -- I would say roughly still four weeks now, that's on average.

  • There are definitely some new products that have longer lead times.

  • But in terms of the average, you are still running in a relatively short lead time environment.

  • And that's really a function of the fact that our utilization is relatively low and so is the industry's.

  • Carter Shoop - Analyst

  • That's helpful, thanks.

  • And a follow-up question, maybe a little bit longer-term question here.

  • How do you see the geographical mix changing over the next two to three years for the Company?

  • Do you expect to see China continue to decrease as a percentage of sales going forward?

  • Chuck Swoboda - Chairman, President, CEO

  • I don't -- it may come down a little bit.

  • We still have a lot of emphasis there.

  • I think what you will probably see is that we have made an investment to really improve our channels in North America, in Europe and in Asia outside of the China market specifically.

  • So I think what you'll see is that I would expect China to grow, but I would expect the growth rates in some of those other markets to potentially be higher simply because two or three years ago, our best sales team was in -- we had more sales resources in China than anywhere else and I think we're building a more balanced salesforce.

  • So that's kind of the way of I think about it.

  • Carter Shoop - Analyst

  • That's helpful, thank you.

  • Operator

  • Jed Dorsheimer.

  • Jed Dorsheimer - Analyst

  • So thanks for taking my question.

  • I have two today.

  • I guess the first one -- you know with China sort of falling off with -- the fact that you've successfully gotten the L Prize before the specs are out, have you changed your tune -- and you've partnered with a nice large traditional bulb guy -- have you changed your tune and become more bullish on the replacement bulb market?

  • Chuck Swoboda - Chairman, President, CEO

  • So that's a great question.

  • The answer is no.

  • I think you have got to think about the bulb market two ways.

  • There's kind of the consumer replacement bulb market, and I think there our strategy is to be a component supplier to the major systems companies.

  • I think the consumer bulb business is a unique business with lots of different factors and I think we can be most effective selling LEDs.

  • I think you will see us continue to do some things on the professional side.

  • So you know we have our PAR 38 and our LBR-30.

  • Those are really professional, more very -- almost retrofit type applications.

  • We will still do some things there, but I think when it comes to -- at least for the foreseeable future when it comes to the consumer market, I think we see those as opportunities to drive technology, to spur innovation.

  • But there's a difference between doing that and being able to effectively get products to the market and for all the channel issues.

  • At least for the time being, our plan is that we're going to leave that to our component customers and focus really on where we think we can drive innovation, really at more some of the other system areas like the troffer.

  • Jed Dorsheimer - Analyst

  • Sure, I guess what I was trying to get at is did you see that a bit more as a growth driver whereas before I think you were -- and maybe you still are -- but I think the growth driver that you talked about was some of the street lighting market.

  • And then as my follow-up question, in terms of carrying your inventory levels, typically going into a transition, you want to carry higher inventory.

  • So if we just took a scenario analysis and looked at hypothetically keeping sales flat post the transition, where do you think inventories would come out in terms of day sales as you go through that six-inch transition?

  • Chuck Swoboda - Chairman, President, CEO

  • Wow, I don't -- so your kins of question is a year from now if get through the transition, we have the majority of products, where is day sales?

  • I think over time, you will see the day sales come down.

  • But we actually last quarter, we actually reduced inventory both in chips and components.

  • Actually the growth was in the lighting business.

  • And I think in the short term we're actually not increasing inventory in the chip area for the 150 mm transition.

  • And the reason is that you don't have to be quite so conservative on inventory when you have low utilization.

  • We have tons of flexibility in the factory right now.

  • So given that utilizations are lower, we're going to be able to work on the transition and probably do it leaner than we might do it if the factory was full.

  • So I think we have a little bit more flexibility.

  • So I think when you have to look at our inventory, there's so many moving pieces.

  • Chips was down last quarter, components was down, lighting was actually up as we built really up the supply chain both from a raw whip and a finished goods standpoint for some projects we're working on.

  • So I'm not sure that -- we have already kind of started to manage that inventory and I don't see dramatic shifts in the inventory here over the next couple of quarters because I think we already kind of got ahead of the curve a little bit on chips and components.

  • Operator

  • Olga Levinson.

  • Olga Levinson - Analyst

  • I was hoping you could talk a little bit more on the implications for your gross margins from the move or the increasing mix in the actual LED modules and the lighting systems themselves.

  • Specifically, I guess outside of the fact that it's a little lower than the components business, how do you think about the actual transfer pricing between components and systems and whether this move will actually pull down the component gross margins as you go forward?

  • Chuck Swoboda - Chairman, President, CEO

  • Yes, well, when we sell products between the businesses, we're not reporting the gross margin on that.

  • So you only get it reported once when we sell the lighting system.

  • So it's transferred internally at cost.

  • So essentially what you're seeing is the real gross margin whether we sell a chip at the chip level, a component at component -- those are the margins for products that are sold as finished products, not within the Company.

  • That's how we manage that today.

  • As far as the implications going forward, our goal is to continue to drive improvements at the systems level so that as that business -- if it does incrementally increase, that we're able to still drive the business towards our near-term targets of getting it back into the low 40% range.

  • Olga Levinson - Analyst

  • Got it.

  • And then in terms of your comments on the potential CapEx into fiscal 2012 of $160 million, can you talk about what percentage of that is targeted at incremental capacity rather than just converting to 150 mm?

  • Chuck Swoboda - Chairman, President, CEO

  • Most of the short-term spending there is really technology oriented.

  • So there's capacity -- there's capital for pure capacity and there's capital really to support new technology.

  • We are continuing to do new developments, new chip designs, new process technologies, new manufacturing steps.

  • The investments we're making in the near term are really going to be technology oriented.

  • And then as the utilizations come up, that's when we would start to spend more of the money on capacity.

  • As John said in his comments earlier, in the short term very little of our short-term CapEx is for capacity just because the utilization rates give us plenty of buffer in the near term.

  • So we will continue to invest but it will be at a lower rate until we see the demand and the utilization rates pickup.

  • Olga Levinson - Analyst

  • Got it and just a final question --.

  • Operator

  • Satya Kumar.

  • Satya Kumar - Analyst

  • I know you guys mentioned that your lead times are lower.

  • I was wondering if you could quantify where is that in terms of weeks?

  • Chuck Swoboda - Chairman, President, CEO

  • I would say on average a component lead time is probably four weeks, and that would be for the main high runners.

  • There are definitely products that are farther than that.

  • They would tend to be some of the application optimized products or some of the high-end ones have longer lead times.

  • And that's about what it was three months ago.

  • So the lead times have not changed dramatically right now.

  • What we've seen is an increase in demand.

  • But the industry is taking it advantage of the fact that Cree and others have very short lead times.

  • Satya Kumar - Analyst

  • Do you break out sales -- what portion of sales was to distributors versus others and how that portion might have grown in fiscal Q4?

  • Chuck Swoboda - Chairman, President, CEO

  • We don't break it out.

  • What I can tell you on a qualitative basis is that both of them grew.

  • I don't have it in front of me which one grew faster but both of them grew last quarter.

  • Operator

  • Hans Mosesmann.

  • Hans Mosesmann - Analyst

  • Can you guys confirm what was your long-term gross margin model?

  • I think you said mid-40s.

  • I thought it was in the mid to high 40s?

  • Chuck Swoboda - Chairman, President, CEO

  • What we've done is -- really the point there was to focus people on right now last quarter we were right around 39.

  • This quarter's target is 38 to 39.

  • And really it's more of a shift -- in the near to midterm, our goal is how do we drive the business back in the low 40s and then we'll worry about what the model is from there.

  • So it's really more of a focus on -- we still have our long-term goals but at the same time, the reality is what most people are focused on including us is how do we drive up that utilization, how do we drive demand which will then basically give us the leverage to get the margins back up at least at the next step into the low 40s.

  • Hans Mosesmann - Analyst

  • Yes, I understand that.

  • I just wanted you to confirm that it's mid to high 40s and I have a follow-up just on the use of sapphire versus silicone carbide.

  • Thanks.

  • Chuck Swoboda - Chairman, President, CEO

  • Actually I think what John said is he threw out mid-40s and my point to that would be is I'm not overly trying to push that number one way or another right now.

  • So mid-40s is as good a long-term target as any, but that's really not what our focus is.

  • Our focus is really how do we in the near to midterm get the business back into the low 40s and then we'll worry about the next step from there.

  • So it's definitely on our long-term goal and we're using mid-40s, but the focus is really internally and where we think with most investors is really how do we get it moving back in the right direction in the near to midterm.

  • Hans Mosesmann - Analyst

  • Fair enough.

  • And then can you parse out if you can if you're using sapphire wafers or substrates versus silicone carbide and what's the mix if that matters?

  • Chuck Swoboda - Chairman, President, CEO

  • Hans, we're only using sapphire in R&D at this point.

  • We still are doing all of our volume production on silicon carbide wafers.

  • Operator

  • There's no further questions.

  • Chuck Swoboda - Chairman, President, CEO

  • Thank you for your time today.

  • We appreciate your interest and support and look forward to reporting our first-quarter results on October 18.

  • Goodnight.

  • John Kurtzweil - CFO, EVP Finance and Treasurer

  • Thank you.

  • Operator

  • This concludes today's conference call.

  • Thank you for your participation.

  • You may now disconnect.