Wolfspeed Inc (WOLF) 2012 Q2 法說會逐字稿

Good afternoon.

My name is Patrick, and I will be your conference facilitator today.

At this time, I would like to welcome everyone to the Cree Incorporated second-quarter 2012 earnings 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, January 17, 2012.

Thank you.

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

Mr.

Garrabrant, you may begin your conference.

Thank you, Patrick, and good afternoon.

Welcome to Cree's second-quarter fiscal 2012 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, our CFO, will report on our results for the second quarter of fiscal year 2012.

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 second quarter of fiscal year 2012 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 quarter 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 before reentering the queue.

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 February 1, 2012.

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

Thank you, Raiford.

Our second-quarter results demonstrated the strength in our expanded lighting product line, with strong growth in sales of both indoor and outdoor products.

LED revenue was down 1% from Q1, due to a challenging competitive environment, but performed better than the market overall.

Power and RF sales were also lower, due to continued softness in device sales for solar and RF applications.

The current business environment has reinforced the value of our market leadership position in LEDs and lighting, as well as the power of having truly innovative products that change the market and drive adoption.

Q2 revenue increased 13% from Q1, to $304 million, while non-GAAP net income increased 2% to $29 million, or $0.25 per diluted share.

Revenue and non-GAAP earnings per share were on the low end of our target range for the quarter, and the results included a $0.02 per share benefit, due to a lower tax rate than we had originally targeted for the quarter.

Revenue growth in Q2 was driven by $44 million increase in lighting sales; this included the benefit of Ruud Lighting sales for the entire quarter and double-digit organic sequential growth in both indoor and outdoor products.

This was offset by a $3 million decline in LED sales, as slightly higher XLamp LED sales were offset by lower high bright LED and chip sales, and a $6 million decline in power and RF sales.

Non-GAAP gross margin was 35.3% in Q2, which is lower than our target range of 37% to 38%.

The difference versus our target range was driven by several factors -- LED margins were lower due to increased pricing pressure across the product range and lower LED factory utilization, as we reduced inventory across product lines.

These factors offset the progress we made on yield improvements and cost-reduction programs.

Indoor and outdoor lighting product margins improved, driven primarily by cost reductions.

Power and RF margins declined, due to lower factory utilization related to lower demand.

We continue to take a conservative approach on factory starts to reduce inventory, while also trying to maintain flexibility to respond to short lead time expectations in the market.

As a result, inventory declined by $16 million, to 85 days in Q2.

While this increased short-term margin pressure, it puts the factory in a better position to realize cost reductions and respond to future demand.

Cash and investments increased to $687 million, due to solid profitability, improvements in working capital, and reduced capital spending.

With the productivity and yield improvements that we have made over the last several quarters, we are spending a fraction on CapEx versus previous years, as our current LED chip factory has the capability to increase output 60% to 70% from current levels with minimal incremental investment.

We continue to qualify additional products on 150-millimeter, but have slowed the rate of transition to take advantage of existing excess capacity.

With some additional investment in 150-millimeter tooling and equipment, our current LED chip factory should be able to increase output by another 100%.

In total, we have the ability to more than triple LED chip production output from current levels, and are well-positioned to support significant growth in LED lighting over the next 12 to 24 months.

Free cash flow was $58 million in Q2, and we remain in a strong position to continue to invest in our business and lead the market and accelerate the adoption of LED lighting.

LED orders are tracking behind this point last quarter, as customers and distributors are trying to minimize their inventory and utilize short lead times.

We saw a similar pattern in our fiscal Q3 each of the last two years for LED products, as the Chinese New Year holiday effectively reduced demand in the beginning of the quarter, before a strong rebound post Chinese New Year.

We are currently targeting a good second half of the quarter once again, driven by end demand, which will be a significant variable for the quarter.

Q2 sales through our LED component distributors were similar to Q1, and channel inventories were essentially flat.

Lighting backlog is slightly ahead of this point last quarter, and we know that this is a typically slower quarter for outdoor products due to lack of installations in the winter months.

We see a strong pipeline of new projects for both indoor and outdoor products and target overall growth in Q3, as we remain very encouraged by the success of this product line and our ability to drive adoption in the market.

I will now turn the call over to John Kurtzweil to review our second-quarter financial results in more detail, as well as our targets for the third quarter of fiscal 2012.

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

For the second quarter of fiscal 2012, revenue increased 13% sequentially to $304 million, which is within our target range of $300 million to $320 million.

Our revenue by category is as follows -- LED products revenue was $194.2 million, which includes LED components, LED chips, and materials; lighting products revenue was $95.7 million, which consists of revenue from our indoor and outdoor LED lighting products, plus traditional lighting systems; and power and RF products revenue was $14.2 million.

GAAP net income was $12.1 million.

GAAP diluted earnings per share were $0.10.

On a non-GAAP basis, net income was $28.7 million.

Non-GAAP diluted earnings per share were $0.25.

Non-GAAP net income excludes $16.6 million of expense, net of tax, or $0.15 per diluted share from the amortization of acquired intangibles, stock-based compensation expense, and the step-up value of the finished goods inventory related to the Ruud Lighting acquisition in our first fiscal quarter.

Q2 GAAP gross margin was 34.6%, while non-GAAP gross margin was 35.3%, which excludes stock-based compensation of $16 million -- or $1.6 million, and $0.5 million related to the final portion of the step-up value of the finished goods inventory that flowed through during the quarter.

This was below our non-GAAP target of between 37% to 38%, due to a $17 million reduction in WIP and finished goods inventory in the quarter and increased pricing pressure.

Operating expenses for Q2 were $92.9 million on a GAAP basis and $76 million on non-GAAP basis.

Non-GAAP operating expenses exclude approximately $9.6 million of stock-based compensation expense and $7.4 million of charges for amortization of acquired intangibles.

Non-GAAP R&D expenditures increased $1.3 million sequentially, and were in line with our target for the quarter.

Non-GAAP SG&A expenditures increased $7 million sequentially, but were approximately $2.5 million lower than our target, primarily related to lower-than-planned selling expenses and legal fees.

Net interest income and other for the quarter was $1.7 million, which was in line with our target.

The tax rate was 13%, which is below our target of 21.5% for the quarter.

This is primarily due to a higher ratio of fixed investment tax credits relative to our pretax income.

We target to be at this rate for the balance of the year.

We ended the quarter with $687 million in cash and investments.

Cash from operations was $81 million and capital expenditures were $23 million, which resulted in free cash flow of $58 million.

Depreciation and amortization for the quarter was $36 million.

We did a great job managing working capital in the quarter.

Days outstanding were 46 days, accounts receivable decreased $9 million to $156 million.

Inventory days were 85, with inventory decreasing by $16.3 million to $187.4 million.

Capital additions were $23 million in the second quarter.

We are actively managing this while continuing to invest in the strategic priorities to lead the market, drive adoption of LED lighting, and accelerate cost reductions.

Based on our prior capital additions, along with incremental investments, we are well-positioned from a capacity point over the next 12 to 24 months to support significant growth.

We have updated our PP&E commitment target for the fiscal year to be approximately $75 million to $80 million.

At this time, we target Q3 revenue to be in a range of $290 million to $310 million, which is comprised of -- single-digit growth in lighting, driven by strong growth in indoor and flat to seasonally lower outdoor sales; LED product sales down a few percent, which includes XLamp LED sales flat to down a few percent; and seasonally lower high bright LED chip and material sales; and power and RF sales in a similar range as Q2.

GAAP gross margins are targeted to be 34% to 35%, and non-GAAP gross margins are targeted to be 35% to 36%, both of which are similar to the margins in Q2.

These targets factor in benefits from cost-reduction programs, which are offset by the competitive pricing environment.

Our GAAP gross margin targets include stock-based compensation expense of $2.2 million, while our non-GAAP targets do not.

We are targeting non-GAAP R&D expense to increase slightly in Q3.

We target non-GAAP selling expense to increase by approximately $1 million to $2 million, and for G&A to be up approximately $1 million.

The decrease in selling is primarily related to high -- excuse me, the increase in selling is primarily related to higher commissions, due to increased sales of our lighting products through our lighting agent channels, with the G&A increase primarily related to legal fees.

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 approximately $2.6 million in R&D, plus $7.3 million in SG&A, and charges for amortization of acquired intangibles in the amount of $7.4 million.

Net interest income and other is targeted to be approximately $1.6 million.

We target our tax rate to be 13% for both fiscal Q3 and Q4.

GAAP net income for Q3 is targeted to be between $4 million to $12 million, based on an estimated 116.4 million diluted shares outstanding.

Our GAAP EPS target is between $0.04 to $0.10 per diluted share.

Non-GAAP net income is targeted to be between $21 million to $29 million, or $0.18 to $0.25 per diluted share.

Our non-GAAP EPS targets exclude amortization of acquired intangibles and non-cash stock-based compensation in the amount of $0.15 per share.

Thank you.

I will now turn the discussion back to Chuck.

Thanks, John.

We are focused on three priorities to drive our business in fiscal 2012.

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 and LED components that enable our customers to deliver a more competitive payback versus traditional lighting.

Our lighting sales growth demonstrates that we have good momentum and are on the right track for both our indoor and outdoor products.

The project backlog is growing, and we should see additional revenue synergies from a combined sales team, stronger agent network, and expanded product line over the next several quarters.

The new product pipeline is growing, with several next-generation products in development that are designed to address large existing markets with improved performance, better payback, and costs that result in higher product margins.

We made good progress on the Ruud Lighting integration in Q2.

We successfully transferred CR troffer production to Racine, which increases capacity and is targeted to provide cost leverage starting in fiscal Q3.

We also transitioned all lighting-related customer service activities to Racine, which will provide our customers a common interface for indoor and outdoor products and should improve our ability to respond to customer requests.

On the LED component side, we recently announced the breakthrough next-generation XLamp XB-D LED component.

This is the most important LED platform we have released in the last two years, as this product delivers twice the lumens per dollar of previous-generation lighting class LEDs.

This new platform combines a new LED chip and optical system in the industry's smallest lighting class package and fundamentally changes the cost per lumen curve, which helps drive LED lighting adoption.

The product is released to production, and we are working with customers on new designs, with the goal to have the first customer products in production during our fiscal Q4.

In addition to the XB-D announcement, we continue to expand our customer offering with new application-optimized components and services to enable our customers.

We extended our industry-leading TEMPO Evaluation Services, with the addition of thermal simulation capabilities and advanced photometric testing.

We also released a new family of high-voltage LEDs that can enable the use of more efficient, smaller drivers to lower cost in compact lighting applications.

We released the LMH2 LED module family, which features Cree TrueWhite technology and delivers 80 lumens per watt system efficiency, combined with CRI greater than 90.

We are seeing the benefits of our continued focus on R&D with new products that can enable the next wave of LED lighting adoption.

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

We made a lot of progress in Q2 on a number of cost-reduction activities, but the short-term gains were offset by the aggressive pricing environment and low factory utilization.

It will take time and increased volume to fully realize the benefit of many of these improvements.

We also continued to make progress on 150-millimeter qualifications.

However, as I said earlier, we are delaying the rate of conversion to take advantage of existing 100-millimeter capacity.

This will allow us to better utilize the current factory to deliver the lowest cost in the near term, while still doing the work to enable the full conversion as business needs warrant over the next three to six quarters.

We continue to work on operational improvements across the Company, and believe there is leverage in our existing infrastructure.

However, the real profit leverage comes from innovation, and we are not slowing down.

Driving adoption with innovative systems, products, and services is what drives volume and provides the opportunity to utilize our technology advantages, to increase margins during what we target to be a tremendous growth opportunity over the next few years.

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

We continued to make progress in R&D, while sales declined in both power and RF product lines in Q2.

The power sales decline is due primarily to continued weakness in the solar inverter demand.

We continue to see good design activity, but there appears to be several quarters of inventory in the supply chain.

We continued to drive innovation in both diode and MOSFET products, in an effort to open up new applications to expand the market.

RF product sales declined due to a delay in the military program, but we believe this is primarily a timing issue and target incremental growth in RF sales for Q3.

As I explained earlier, Q3 total Company backlog is behind last quarter's run rate.

We see good trends in lighting, but this is a short lead time business and we know that outdoor lighting demand is typically lower in the winter quarter.

In LEDs, we continue to operate in a very competitive business environment, and the Chinese New Year holiday is expected to result in a slow first half of the quarter, which makes it challenging to forecast the business.

Demand in the second half of the quarter will be critical to achieving our Q3 revenue targets of $290 million to $310 million, which is comprised of -- single-digit growth in lighting, driven by strong growth in indoor and flat to seasonally lower outdoor sales; LED product sales down a few percent, which includes XLamp LED sales flat to down a few percent; and seasonally lower high bright LED chip and material sales; and power and RF sales in a similar range as Q2.

We target Q3 non-GAAP gross margins in a similar range as Q2, at 35% to 36%, as cost reductions are offset by the competitive pricing environment in the LED product line and low factory utilization.

We target R&D in a similar range as [Q3], with higher sales and marketing expense to support the growth in lighting, increase sales through the agent channel, and new product introductions.

G&A is also targeted to be higher, based primarily on the timing of patent-related litigation.

As a result, we target non-GAAP earnings in Q3 of $0.18 to $0.25 per diluted share.

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

The near-term business challenges are a function of the competitive market environment and LED supply getting ahead of demand.

Our success in this environment has demonstrated that our strategy is working, and we continue to see a path to revenue growth, higher gross margins, and improved operating leverage.

There will be variability along the way, which is the nature of new technology and emerging markets.

However, our business outlook remains very optimistic, based on a number of factors.

The lighting market is big, and LED adoption is low.

This includes traditional renovation and new construction markets, and also a tremendous upgrade opportunity.

We are the leader.

Our indoor and outdoor LED lighting products are winning today.

Our new XLamp XB-D LED fundamentally changes the game with twice the lumens per dollar, and we have a pipeline of innovation to further improve payback, which drives adoption.

Our LED expertise and vertical integration enables us to develop innovative lighting products to open new markets first, and then use our LEDs to enable other lighting companies to win with their own products.

While LED market dynamics have reduced our operating results over the last year, they have also accelerated the price-per-lumen curve, which should accelerate adoption, and will likely pressure the weaker players to consolidate or exit the market.

This process is healthy for the market, and should provide an improved business environment for market leaders like Cree going forward.

We remain confident that innovation drives payback, payback drives adoption, and adoption expands the market for our own lighting products and our customers' products.

We will now take analyst questions.

(Operator Instructions) Chris Blansett, JPMorgan.

Chuck, I had a question related to new product launches, which you mentioned in your comments.

Are there some -- maybe some timelines or thought processes throughout the year, when we should expect waves of new products to hit the market?

You know, Chris, there is no specific timeline, in terms of -- there is not a regular schedule.

Right now, obviously, the -- probably the biggest thing happening is the XB-D.

So, that product gets launched this quarter, really won't see -- really won't have a chance to get that designed and then start driving the business until sometime in next quarter.

There is a design cycle, obviously, we have to go through there.

So, I think what you will see is -- the way I think about it is -- LED components kind of come at some fairly regular interval.

If you look at last quarter, I think there was four or five products.

I think you can continue to expect us to innovate there.

I think in lighting, there is no set schedule.

We do have the two big lighting shows coming up, so my guess is, is you could expect to -- if we don't release them, at least hear announcements about new products a lot more here later in the spring, as we go through the light and building show in Germany and then the light fair, I don't know if it's in -- I think it's in Vegas this year.

So, I think it will be -- those two will kind of be the next big milestones.

It doesn't mean we won't do some new products between now and then, but those are kind of the next big time.

Brian Lee, Goldman Sachs.

My question was on volumes.

This is about three quarters in a row where revenue has been flat after adjusting for a full quarter of Ruud Lighting last quarter.

So, I'm wondering -- when you say your future business outlook remains optimistic, does this apply toward all the segments of the business?

Or are you specifically talking to the system segment?

And I guess, what are you seeing specifically over the next 12 months or so that gives you confidence that this might be the bottom and you will see a recovery and growth?

Thanks.

Yes.

So, Brian, first of all, on the lighting, we had organic growth in both the indoor and outdoor lighting product lines.

So, part of the optimism comes from lighting.

We have obviously had some pretty consistent sales momentum growth there over the last number of quarters on the indoor.

And over the last two quarters, with the acquisition of Ruud, I think we have seen that not just the addition of the acquisition, but the actual business itself, is gaining momentum.

So, lighting momentum is the first piece.

And then, the second piece is -- is that if you look at the LED business, which is really driven by the XLamp product line, as we look at new products -- XB-D, we are talking about twice the lumens per dollar, that is a pretty dramatic change in the marketplace.

And so, I see things like that, plus the fact that, as I said in my comments earlier, the cost-per-lumen curve is lower on a broad market basis than it probably -- we would have expected a year ago.

And I think the combination of products that we can push into the market and the general trends, that is going to push adoption, which I think then drives volume in the market.

So, that is where my optimism comes from, both of those pieces.

And we just have to work through the short-term operating issues to get there.

Dale Pfau, Cantor Fitzgerald.

I have a housekeeping question, and then a real question.

Could you please give me your stock-based compensation for both R&D and SG&A, if you could?

And then, my question is -- on the 150-millimeter transition, about what percentage of your products are moved -- are onto that now, Chuck?

And then, could you give us an indication of what your utilization was in the quarter?

Yes, Dale, I'm going to let John try to figure out your stock-based comp number while I'm answering your other question.

But on the 150-millimeter, it increased slightly.

I don't have an exact number for you.

I would say that it's going up, but it's relatively small percentage overall.

What we are actually doing is, while we are qualifying additional products, we are not converting large piece of the production, just because we have the capacity available today.

And that really gets to your second question, which is -- if you look at capacity across the Company, it's a little hard to give you an exact number.

But if we just use the wafer fab as probably the highest capital area, it ran at about 60% utilization last quarter.

And John, do you have the number for Dale on the other one?

Yes.

On the stock-based comp, it was about $9.6 million total for OpEx, of which $2.2 million was for R&D.

Great.

Thank you very much.

Harsh Kumar, Morgan Keegan.

Chuck, a quick question for you on gross margins.

Sounds like listening to your commentary, the driver here is pricing.

But I'm also curious where Ruud is qualitatively, if you can talk about where it sits relative to corporate.

And how long do you think, or what do you have to do to get it up to corporate?

And how is it going relative to your original plan, now that you have had it for a quarter?

Yes.

So, Harsh, on the margin question, I think, first of all, if you look at where we were from last quarter, if you look at kind of the delta, I think you have to keep two things.

I think part of it is pricing-related, but I think part of it is, is when you -- we burned, I think, $16 million in total inventory.

That definitely impacted the quarter.

So, I would say a piece of that, a big piece of that is the inventory burn, and part of that is pricing a little more aggressive than we expected.

So, that is kind of what is different than we thought.

I think if you look at the lighting segment, both indoor and outdoor margins improved last quarter; so quarter to quarter, we saw an improvement in both.

I think that lighting margins are a little below the corporate average, but they probably have improved the most recently.

And so, I'm feeling that it's going to take a little bit of time, but as we do new product designs that are designed to take advantage of how we get system costs down, I see an opportunity for improved margins on the lighting side.

And frankly, I see it on the LED side, as the new products come out that help us drive volume.

Jesse Pichel, Jefferies.

You mentioned you are holding back on the 150 transition, because that would just lower your utilization.

How long would it take you then to convert all of your capacity to 150, should demand pick up?

And what type of cost down would that allow at this point?

Yes.

So, Jesse, right now we are running at about 60% utilization, which says we have a lot of upside in the existing capacity.

And we are running -- we do have some 150-millimeter on, but it's a relatively modest amount.

Timing-wise, I would say that the goal would be -- let's drive that utilization up, and then we will use the 150 conversion, which will be -- there is some additional cost.

Part of that is bringing in some 150 equipment, but part of it is converting the 100-millimeter equipment.

That is cheaper than adding new capacity from the start.

But how fast could we do it?

I think as we get through the end of this year, it will be kind of at our choice.

My guess is it's probably a three- to six-month time frame, if we really wanted to go fast.

But I don't see that that is a near term -- not even near term, something we are thinking.

If we can add 60% of the volume with what we have today, I'm focused on how to drive that up first.

But that is where you kind of get that 3X number I threw out in my comments earlier.

That is the kind of leverage we have, the combination of using our existing factory and then converting to 150.

Cost leverage -- I think we are going to get more cost leverage in the near term from cost reductions, yield improvements, productivity, utilization, and the new products.

There is a lot of leverage in those five areas, and that is what the focus is.

And then, as that volume comes up, what we have said in the past is that we had targeted that at an equivalent level of utilization; 150 gives you somewhere in the 30% to 40% cost leverage beyond that.

But right now, we are focused on those other levers, and I think that is where we have to be.

Andrew Huang, Sterne Agee.

So, Chuck, you have talked repeatedly about XB-D giving you twice the lumens per dollar.

But maybe you can give us a sense of how much lower your production costs are for XB-D?

I would say that XB-D, we would anticipate that it allows us to double the lumens per dollar, in terms of what we can sell it for.

And it should allow us to do something similar from a cost level.

Ahmar Zaman, Piper Jaffray.

Chuck, you mentioned pricing as sort of the culprit for gross margins, weaker than expected gross margins.

Can you give us broader color as to regionally where you saw the pricing pressure?

And also, was it more indoor versus outdoor lighting or on components?

Any color you can give on where you saw the pricing pressure.

Yes.

First of all, I want to clarify -- I would say the margin delta is two pieces -- the inventory burn, which lowered utilization, and pricing were about equal parts of the delta.

So, I want to clarify that.

But in terms of the pricing piece of it, I would say not as much a regional issue as it was an application.

I would say that the area that was off the most was really the LED bulb segment.

And what we saw there is -- is not on the next design, but really on the running designs, where they are going through constant design revs, that there is probably where we have seen the most aggressive competition.

And it's an area where it's not just high-power LEDs, but you also have mid-power LEDs competing in that segment.

So, that is really where I would say -- I mean, pricing was more aggressive generally, but that would be the one segment that probably was different more than we expected.

Vishal Shah, Deutsche Bank.

This is Scott Reynolds for Vishal Shah.

I just wanted to get an idea of what the utilization rates look across the industry.

And also, could you guys possibly quantify what the impact to gross margins were from the underutilization in the quarter?

So, I don't have an impact on the underutilization for the quarter.

Across the industry, obviously, there's people reporting a variety of different things out there.

I have heard people talk about running at 50% to 60% utilization.

I have heard some people say a little higher, some people a little lower, but that is kind of the number.

I know there was an industry report that I think came out in the last couple days that said that they thought the industry was running at around 55%.

Now, you have to be a little bit careful.

Not all capacity is equal, and it can't all serve the same markets.

So, the fact that there is excess capacity doesn't mean all those same -- that capacity can't all serve, for example, the high-power market versus the mid-power versus the low.

There is a mix and matching, but I think that is the broad brush of the industry.

Steve Milunovich, Bank of America.

The guidance is a flattish gross margin again.

So, are you for now kind of in a catch-22, where you need to get to the 6-inch wafers to get the cost down, but you can't get there because utilization is too low?

And you, I think, roughly halved your CapEx plan from what you said last quarter.

And you are now talking three to six months off, I guess, or at least a couple quarters away.

So, is that kind of how the short-term looks here until demand comes back?

Utilization goes up, and then you can move quickly to 6-inch wafers?

Yes, Steve, the way I would think about it is -- Q3, we have targets 35% to 36%.

I think Q4, we don't have enough visibility to give you any insight one way or another.

Obviously, I think I commented earlier, my more longer-term outlook is fairly optimistic, both for lighting and components.

But I think the way I would think about it is -- there is leverage in utilization on its own.

I think there is -- clearly, 150 gives us a lever beyond that.

But given where we are at today, there is more cost leverage in the near term by just driving up utilization and the cost-reduction programs and the new products.

So, I think, to some extent, 150 is going to be there.

I see that as an opportunity.

But the fact is, is that the way we start to get improvements in the near term is really to focus on the drivers at hand, which is -- volume gives us some additional utilization; that is tremendous leverage for us.

We have new products coming.

That is leverage.

And then, frankly, when you have the -- when utilization, then your cost-reduction programs kick in further, because now you are not just improving yields to increase utilization -- that are offset by utilization, you can get the full benefit of them.

So, my sense is 150 is still important.

I think I said I target it more at the three- to six-quarter range now, but -- because at the end of the day, using the 60% to 70% of burst that we have right now is probably where we are going to get more near-term benefit.

Ben Schuman, Pacific Crest.

How about in terms of the process development on 150?

Would you say for the stuff that is at production scale, your cost is below what you were doing on the 100-millimeter?

Yes, if we had equivalent utilization, the 150 gives us -- we have enough experience now, we know it gives us a benefit.

I would say the problem, though, is -- is that if I were to run more of it, utilization would offset whatever benefit that was.

And frankly, there would be some capital cost to do that.

So, there is no -- obviously, there is where the lack of a near-term reason to do it is.

Daniel Amir, Lazard.

Can you give us kind of where you believe you want your target inventory days to be, compared to where it is right now?

And how should we look at CapEx potentially for next fiscal year?

Thanks.

Yes, so, if I look at inventory days right now, John, I would say a similar range as where we are at here.

I mean, plus or minus from here, we are okay.

I think it's a pretty healthy place.

And if you think about it, we are vertically integrated from the beginning to the end.

So, I think it's -- I don't know that it would go significantly lower than here; but I think at this level, it gives us lots of flexibility.

I think as far as CapEx for next year, it's a little early.

I would put it this way -- as I laid out earlier, our current factory with incremental CapEx gets us 60% to 70% more volume at the wafer fab.

Now, obviously, we have to add some packaging capacity and other things.

So, that is kind of the first lever.

Once we get past that, then there is a conversion to 150 that will cost us -- it will require more capital, but at a lower rate than we saw over the last several years, because the fact is, is parts of that -- a lot of that capital is simply conversion of 100-millimeter.

So, I would say it's likely to be, at least in the near term, lower than it has been.

And it's really going to be a function of volume, when that starts to pick up again.

And we don't have good enough guidance for you to tell you when that is, in terms of what quarter or what half of the year at this point.

We are focused on what we can do to drive that adoption and get the volume moving.

Jed Dorsheimer, Canaccord.

I have a two-part gross margin question, Chuck.

First, just a follow-up to a previous question, I think it was Harsh that asked this -- but your answer on the Ruud's gross margins is that it's slightly below corporate.

And if I go back, that was the same comment that you made when you bought Ruud; but the problem was, gross margins were at 38% at that point.

So, the first question is -- or first part is -- are you seeing this severe type of pricing pressure?

Because I thought the reason for the gross margins coming down was really on the utilization.

And then, sort of as a follow-up to that, the -- on the utilization, I used to ding you when you built inventory.

And now I guess I have to give you the benefit here.

So, if we keep utilization flat or keep inventory days flat, gross margin should have been about 37.5%.

So, it begs the question on the guidance of 35% to 36%.

What are you assuming, if you keep -- if you are comfortable with inventory days where they are?

Why not a higher gross margin there?

So, the way to think about that, Jed, is that a portion, obviously, of the inventory depends on what fixed variable you do and where that inventory is across the factory.

So, inventory at a lighting fixture versus inventory at a chip has a very different effect on the business.

What I commented earlier was -- is that gross margin from what our targets were, about half the delta was inventory-related and half was pricing.

So, I think you would have to factor that in to kind of -- to your thinking there.

So, it wouldn't have been 37.5%, as you had just suggested.

But you are right, it's a piece of it -- roughly half is my guess.

If I think about it going forward, what we have built in is we are not targeting -- obviously, if you look at the revenue guidance, we are looking at relatively flat revenue.

Lighting up a little bit, LEDs down a little bit.

So, while we won't have an inventory burn, we will have a little bit lower LED volume.

So, we are roughly planning for effectively similar utilization levels as last quarter.

So, if the utilization is relatively similar, then what we are counting on -- which is low, then we are counting on the fact that our cost reductions will offset the pricing on the other side.

That is kind of how you get your head around the gross margins.

As far as Ruud goes, look, we don't -- we are not breaking out the two pieces.

What I can tell you is from Q1 to Q2, both indoor and outdoor gross margins did go up.

They are tracking below the overall Company gross margins.

And a function of that is -- overall, is -- as we do have lower utilization, those higher costs flow all the way through the factory.

So, I think they are having an effect on the overall business, but it is getting better.

It's tracking a little bit behind.

And obviously, our targets are, as you know, to continue to drive that up -- not only to corporate average, but hopefully have both of them increase going forward.

Thanks.

Alex Gauna, JMP Securities.

Chuck, I believe you answered that the worst of the pricing pressure is being experienced in the bulb component.

I think earlier in the call, you had also talked about the high bright product areas being more under pressure.

Are there any new developments in terms of the bulb players, whether out of Korea or China, that are impacting that?

Or some of the tier-one guys?

I believe I have heard that you guys are coming up with similar packaging and bonding and things to make yourselves more competitive.

Is there any dynamic there?

And then, in terms of getting gross margins moving more favorably in the other direction, is there any risk to this mid-tier percolating up to challenge some of your XLamp, your XB-D product lines?

Are you in a position now where XLamp and XB-D can start driving some of those mid-range players back out of the market?

Yes, so, let me talk first a little bit about bulbs, and see if I can address kind of your thought there.

It's -- so, I think in the bulb segment, what we are seeing is, is that there is competition, both from I will call kind of the tier-one, the more traditional, high-power guys selling into that application.

And you have mid-tier guys coming up.

And it's really in the consumer segment.

So, we have to be a little careful on bulbs, because bulbs really has a commercial component and a consumer.

And where you see the biggest deltas is in the consumer side, where they are not going for efficiency, they are not actually trying to even increase the performance.

They are trying to take existing 40-watt or 60-watt designs and squeeze a little bit more cost out.

That is where we are seeing the dynamic.

As far as -- how does that affect the rest of the business?

I would say that the fixture markets that we sell into are -- we are tracking much more in line with what we had targeted for the quarter.

There is more pricing pressure.

But I would say the bulb segment is significantly different than the rest of them today.

And so, what it tells me is -- and we have seen this in our new products -- is there is definitely still segments where the high-power LEDs -- in fact, quite a number of them that are mostly fixture based, where the high-power LED does drive differentiation at the system level.

And so, you have a different pricing dynamic there.

As far as beating back the mid-tier guys, I think for certain applications, it's going to be an interesting choice going forward.

I think right now you have people throwing excess capacity at the market, and some of those guys are the same guys reporting negative operating margins.

So, I think we have to realize that there is a pretty aggressive approach.

What we are trying to do is invent products that I think will allow us to compete in these segments, with a cost structure that is also a rational one going forward.

So, I like our chances with some of the new products, but I'm not going to -- I think we are going to wait and see how we do going after some of those applications.

And frankly, bulbs has always been kind of a piece of the business where we like to participate in it.

It's nice for some pieces of volume, but at the end of the day, it's not the most important segment.

And we are more focused on driving the core fixture markets.

Stephen Chin, UBS.

Just wanted to follow up on that new CapEx spending plan.

Can you help us quantify what quarterly sales you think this new CapEx plan can support?

I think, Chuck, you said you can get about 60% higher volumes from the factory; so can Cree hit these higher sales levels, of say $500 million per quarter, even with the smaller CapEx plan?

Thanks.

Yes, we don't have -- that is going to vary dramatically based on mix, if we sell -- where the products get sold at, if those are LEDs that end up in systems versus LEDs that we sell as LEDs, if they are high-power versus mid-power versus chip sales.

So, there is no good way to give you an exact correlation to what that means in revenue.

Obviously, it's a lot of volume, but I can't give you a revenue equivalent of that.

Amir Rozwadowski, Barclays Capital.

If we think about, Chuck, some of the levers that you folks have to manage your expenses, it seems like you have enough levers in the event demand recovers to the growth level that you expect it to, to sort of help boost your gross margin trajectory from the current level.

What I'm trying to assess is -- what are we missing?

We generally see the opportunities for LED penetration of the general lighting market, but it does seem as though the adoption curve is taking a bit more than expected.

And I'm just trying to understand -- you folks seem to be doing what you can from the cost side; I'm just trying to understand what we need to look out for that can either give us some level of visibility that this inflection point is at least upon us in the near term.

It's a great question.

I wish I -- wish I could answer that exactly.

Here is how I think about it.

The best leading indicator we have is -- we have an indoor and an outdoor product line that are in the North American fixture business every day.

And the indoor product line, I think for every quarter for the last three years has been growing; but it started at a really small base.

And the outdoor product line that was part of Ruud, it was their beta LED product line that's now part of our combined business, it's essentially been growing over the same time period.

But we are coming from a market where no one had heard of LEDs and it wasn't out there.

And so, at the end of the day, we are winning business.

Obviously, you can see in the revenue growth, there is success.

The question is, how do you take it to some fundamentally higher level?

And what we believe is, is you have got to get the cost performance to where the payback or the ROI, however you want to look at it, makes it easier for the customer to make the decision today.

There is still many cases where the traditional lighting is winning, and because much of the lighting is bought on first cost.

So, a lot of what we are dealing with is getting people to think about lighting as a cost of ownership.

You know, what most people don't appreciate is, if you were building a new parking garage today, you could buy cheaper lights that aren't LED; but if you did, you would be losing money over the next few years pretty quickly, because LEDs have that good of a payback in that example.

But the problem is, there is still a lot being done that way.

So, there is a lot of market training, a lot of building the channels, and a lot of product choice that has to be created.

If you look at a lighting catalog, there is tens of thousands of products.

It's in fact the reason why it may be frustrating that it doesn't go faster.

We are actually happy with what we are able to do with our own product lines.

It's also, I think, the market is harder for other companies to penetrate because you are going after so many different applications at the same time.

So, I think lighting is our leading indicator.

It's why we are optimistic.

I think we see success with our other customers.

The key is, how do we give them -- how do we make their value proposition of their products better, to get that customer to say yes to LED versus the other technology?

And that is just about moving down the curve.

And where that inflection point is, I think we are all going to know it about 6 to 12 months after it happens.

Carter Shoop, KeyBanc.

The first question is on the potential stock buyback -- obviously, with the reduced CapEx need going forward, any thoughts there?

And then, also, the second question is on SG&A going forward.

If you look at kind of your guidance for March 2012, you compare that to two years ago, your SG&A and R&D combined is growing almost three times faster than your sales.

Can you talk a little bit about your outlook for that?

Can we keep SG&A growth in line with sales?

Can we keep it below?

And what are some of the drivers there?

Yes, on the stock buyback, we are not -- no real speculation at this point.

Obviously, we have an authorized program out there.

We will evaluate it, and we will generally report it after it has happened.

On the other side, I think if you look at SG&A, two things to consider.

Over the last two years, there has been growth for two things.

We have launched a lighting business, which required a brand-new channel and a whole lot of infrastructure to basically get into -- to make indoor lighting happen.

And then, with the acquisition of Ruud, we acquired that as well.

And it's a different cost structure-style business from an SG&A, relatively speaking.

But with that being said, is there leverage?

I think if you go back and you look at 2008 to 2010, you will see the exact opposite trend.

You will see pretty tremendous revenue growth and very little SG&A increase.

So, I do think there is leverage.

I think it's about making the core investments in the channel to drive the business.

And then, I think when you start to see adoption in nice chunks, then you get paid back on the other side.

Obviously, it's nice to say right now when that hasn't happened yet; but that is the belief, and that is how we are managing the business.

Ramesh Misra, Brigantine Advisors.

In regards to your capacity comment about being able to almost triple capacity with relatively modest CapEx and a modest transition to 150-millimeters, would you say that that is similar, that is a similar case in that of many of your other competitors?

Under which circumstance that, even if we have a modest uptick in demand, there will still be a ton of capacity chasing that modest uptick?

I think you would have to -- the answer is, I think, it depends on where the demand is.

If the demand is in lighting, not all of the demand can service it today.

We know that there are -- building a lighting class LED for most applications, not everyone's capacity can get there.

So, I think it has probably more to do with the dynamics and the companies, the tier-one suppliers that can service that segment of the market.

And so, I think that is one piece out there.

Two, we made a lot of investment to get to 150 ahead of the curve that we never fully implemented.

So, that is one of the reasons we are in such a good position today.

I know that there is probably some other companies that have done that, but I think the majority of companies that I'm aware of are still -- are not nearly as far down that curve.

And so, I think you are going to be looking at -- they are going to have to make a choice of where that extra capital has a value to it.

And I think the thing that is kind of -- coming at it from the other side is a number of companies out there that are in a pretty tough position from an operating margin standpoint.

So, I think they are going to be kind of pressured from the other side.

So, my sense is, yes, there is available capacity out there.

I think you have to be a little careful using the 150 numbers on a broad brush on the industry, because effectively, that is buying new capacity.

Maybe it's a little cheaper than buying standard capacity, but it is effectively new capacity.

And those capital dollars, my guess is, will be somewhat a function of people's ability to generate profits from them.

Brian Lee, Goldman Sachs.

Can you elaborate on the typical seasonality that you see in the lighting segment?

And I guess more specifically, the trend off of Q1, because it seems like you are suggesting this could be a low point in the year for your lighting business.

Yes, Brian -- so, what happens is, is that in our indoor business, it's been growing pretty consistently.

So, it really hasn't had a seasonality to it at this point.

It's the outdoor business, though, that the guys, the team in Racine has had a pretty good experience that, especially in outdoor-based lighting products, this quarter is the seasonally low quarter.

So, typically, it's our fiscal Q3, the winter quarter is where you are going to typically see lighting -- in most cases, it's going to be down from Q2 and then up again.

So, there is -- and that is really just a function of there is not as many installations.

What we are targeting for this quarter is that it could be flat to maybe down a little bit.

And the reason we have a slightly different view is that we are just looking for strength of some of the LED projects to offset some of the seasonality there.

And obviously, on indoor, we are targeting that to continue to grow.

Dale Pfau, Cantor Fitzgerald.

Could you talk a little about -- what was your percentage of LED sales into the distribution channel?

And you mentioned that you thought distribution channels were about the same as last quarter.

Could you talk a little bit about that and how you see that developing?

Dale, I don't have a percentage for you, but I can tell you the percentages were roughly the same as Q1.

Inventory levels were about the same.

So, it was really pretty much what we sold, they sold through.

It's fairly consistent.

Distribution is running leaner, significantly leaner, than it was a year ago at this time.

I think that is one of the other factors that is probably different -- is that we have distribution, having less inventory than a year ago, and we know that our customers have less inventory.

So, the dynamic we are managing right now is the customer is expecting the distributor to have inventory, or for us to be able to ship extremely fast.

And it's one of the reasons that is leading to the low visibility.

So, if the lighting applications keep going, demand will be there; and if there is not a lot of inventory, we are targeting the sell-through.

But that is kind of how we are modeling it right now, and distribution continued to be an important piece.

But it's an -- it's relatively similar level of importance to the direct business as it was the last couple quarters.

Chris Blansett, JPMorgan.

Chuck, I wanted to follow up in a quick question about the subsidies that are coming online from a lot of the utilities in the US, and how you see this rolling out throughout the year and how you think this impacts adoption of LED lighting products.

So, Chris, it's going to obviously vary dramatically by region and utility.

So, we have already seen the benefits today, that there are consumer-level rebates available on our CR6 product that is sold through Home Depot, as an example.

I think as these rebates come on, though, you are going to see -- what we have seen is, there is clearly demand.

I think the key is, what products meet those product needs -- what product meets the specifications required?

So, they typically -- they are not always general.

In some cases, they are product-specific.

In some cases, they are more efficiency based-specific.

And it's going to vary.

I think it's a net positive; but it's hard to give you one answer, because pretty much every utility or every subsidy that is out there, wherever they are coming from, it's pretty unique to the local market.

So, it's a matter of getting your channel to be able to adapt to what the market is offering, and connect the products with that.

But it's a net positive, but not like a broad brush one.

You have to work each of them in each region.

Andrew Huang, Sterne Agee.

So, if you could roll back the clock to the beginning of 2011, what one decision would you have made differently?

Wow, Andrew, that is a pretty philosophical question for earnings.

I think I would have invested even more money in R&D sooner.

Because the only thing that drives -- at the end of the day, it comes back to the same story throughout Cree's almost 25-year history -- if you drive the innovation, it's what changes the market, and that is what drives the business.

And whether you are selling LEDs for lighting, you are selling LEDs for backlighting or video screens or car dashboards or any of those things.

And I think we are always hesitant to remember that it starts with the innovation, and that is what we have to drive.

Harsh Kumar, Morgan Keegan.

Hey, Chuck, now that you have had the lighting business in its current shape for a quarter or so, how do you see the growth rate -- what do you think is the growth rate for that business?

Are we talking double-digit consistently every quarter sequentially?

Or maybe just you can give us an annual run rate that we should be sort of bogeying for.

Wow.

So, Harsh, I don't have a good number for you.

I can tell you that you have to keep in mind that we are going to assume that our Q3, the winter quarter, is going to typically have the lowest rate, just because we have some seasonality.

But if you get outside that quarter, I would certainly like to see double-digit growth rates on the LED portion of the business.

The non-LED portion of the business I wouldn't expect to change dramatically.

But I think that would be a good target.

I think it's going to vary from quarter to quarter.

I think if you -- if you get -- we kind of have to be careful just saying that is what it will be, because I think you are going to see it come in chunks.

So, new products that open up new applications can drive some pretty significant growth; but in between product cycles, I think it will kind of ebb and flow.

But on an average, I would say for three of the four quarters that is not a -- it's a good guess, But again, it's a little early to call to give you any specific targets.

Thank you.

This ends our Q&A session.

I will pass it back to Management for closing remarks.

Thank you for your time today.

We appreciate your interest and support, and look forward to reporting our third-quarter results on April 17.

Good night.

Good night.

Thank you.

Ladies and gentlemen, thank you for participating in today's program.

This concludes the program.

You may all disconnect.