Wolfspeed Inc (WOLF) 2012 Q3 法說會逐字稿

Good afternoon.

My name is Huey and I'll be your conference facilitator today.

At this time I'd like to welcome everyone to Cree Incorporated's fiscal year 2012 third-quarter 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, April 17, 2012.

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

Thank you, Huey, and good afternoon.

Welcome to Cree's third-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 third 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'd like to note that we'll be limiting our comments regarding Cree's third-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 call, we are requesting that only sale 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 May 1, 2012.

Now I'd like to turn the call over to Chuck.

Thank you, Raiford.

Q3 revenue was $285 million with non-GAAP net income of $23 million, or $0.20 per diluted share.

Revenue was slightly below our target range as LEDs and power and RF were in line with our targets, but lighting product line was lower than expected, as our move to new agents during the integration with Ruud cause more disruption to the project pipeline than we had anticipated.

All three product lines saw improved order rates in March and we target solid growth in our fiscal Q4.

Non-GAAP earnings per share were in the middle of our target range for the quarter, as strong factory execution offset lower revenue.

The revenue trends in Q3 were as follows, $9 million decrease in lighting sales as both product lines lost short-term momentum due to the agent transition, but indoor sales were most affected due to shorter project cycles and the availability of traditional alternatives.

This transition is targeted to drive revenue synergies in the first half of fiscal 2013.

We do not believe the decrease in lighting sales was an indication of lower end-user demand.

$13 million decline in LED sales, which was in line with our seasonally lower targets.

LED component sales improved post Chinese new year and we target improved market demand in Q4.

$3 million increase in power and RF sales as demand in both product lines started to improve.

Non-GAAP gross margin was 35.6% in Q3, which was 30 basis points higher than Q2 and within our target range, due to solid execution across the Company.

Factory utilization increased slightly in Q3 which combined with cost reductions, productivity and yield improvements offset the pricing declines at the quarter.

The LED market remains very competitive, but we target improved margins as our new products gain traction in the market.

We continue to closely manage inventory in LEDs, power and RF, to similar levels as Q2, while working to respond to short lead time expectations in the market.

We increased inventory and lighting in anticipation of new product launches and higher demand in Q4.

As a result, overall inventory increased by $9 million to 96 days.

Cash and investments increased to $710 million due to solid execution and reduced capital spending.

We continue to be in a strong position to significantly increase LED chip production from current levels with modest capital spending, and we are well-positioned to support significant growth in LED lighting.

Free cash flow was $22 million in Q3, and our ability to generate solid free cash flow in a challenging market bodes well for the Company as we target increased revenues in Q4.

Overall company backlog is stronger than it was at this point last quarter, with lighting, LEDs, and power and RF orders all tracking ahead of Q3.

The lighting order rate has improved for both indoor and outdoor products.

LED customers continue to maintain low inventory levels and rely on short lead times, but the demand forecast from both our customers and distributors have improved.

Q3 sales through our LED component distributors were lower than Q2, but in line with seasonal trends and channel inventories were in a similar range.

Power and RF demand has also improved.

I will now turn the call over to John Kurtzweil to review our third quarter financial results in more detail, as well as our targets for the fourth 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 third quarter of fiscal 2012, revenue decreased 6% sequentially to $285 million, compared to our target range of $290 million to $310 million.

Our revenue by product group is as follows, LED product revenue was $180.9 million which includes LED components, LED chips and materials.

Lighting products revenue was $86.5 million, which consists of revenue from our indoor and outdoor LED lighting products, plus traditional lighting systems and power RF products revenue was $17.3 million.

GAAP net income was $9.5 million, GAAP diluted earnings per share were $0.08.

On a non-GAAP basis, net income was $23.3 million, non-GAAP diluted earnings per share were $0.20, as compared to our target of $0.18 to $0.25.

Non-GAAP net income excludes $13.8 million of expense net of tax, or $0.12 per diluted share from the amortization of acquired intangibles, stock-based compensation, and certain one-time tax adjustments.

Future GAAP gross margin was 34.9%, while non-GAAP gross margin was 35.6%, which excludes stock-based compensation of $2.1 million.

This was in the middle of our non-GAAP targets of between 35% to 36%.

Operating expenses for Q3 were $94.4 million on a GAAP basis, and $76.9 million on a non-GAAP basis.

Non-GAAP operating expenses exclude approximately $10.1 million of stock-based compensation expense and $7.4 million of charges for amortization of acquired intangibles.

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

Non-GAAP SG&A expenditures increased to $0.5 million sequentially, but were approximately $2 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 $2.2 million, which was slightly higher than our target.

Our GAAP tax rate includes a one-time benefit of $3.2 million, primarily due to a favorable conclusion related to a prior year's tax audit.

This resulted in a negative tax rate of 32%, which was better than our target of 13% for the quarter.

Our non-GAAP tax rate was 13% as we did not include this benefit, so as to provide a more transparent view of the financial results for the quarter.

We target the fourth fiscal quarter tax rate to be 13%.

We ended the quarter with $710 million in cash and investments.

Cash from operations was $48 million, and capital expenditures were $26 million, including $4 million related to patents, which resulted in free cash flow of $22 million.

Depreciation and amortization for the quarter was $37 million.

Days sales outstanding were 53 days, as compared to 46 at the end of December as the quarters revenue was more back end loaded.

Inventory days on hand were 96 days, as compared to 85 days, at the end of December.

Inventory increased by $9.5 million to $196.8 million during the quarter.

LED, power, and RF inventory was down slightly for the quarter, with the increase in the lighting products area in anticipation of new product launches and higher demand in Q4.

PP&E additions were $22 million in the 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 believe we are well-positioned from a capacity point to support significant growth.

We have updated our PP&E commitment target for the fiscal year to be approximately $65 million to $70 million.

At this time, we are targeting Q4 revenue to be in a range of $295 million to $315 million, which is comprised of double-digit growth in lighting, driven by strong growth in indoor and outdoor sales.

Single-digit growth in LED product sales from both the direct and distribution customers, and incrementally higher power and RF sales.

We target GAAP gross margins to be 35% plus or minus and non-GAAP gross margins to improve in Q4 to 36% plus or minus.

These targets depend on slightly improved factory utilization and cost reduction efforts, which are somewhat offset by product mix and the competitive environment.

Our GAAP gross margin targets include stock-based compensation expense of approximately $2.5 million, while our non-GAAP targets do not.

We are targeting non-GAAP R&D expense in Q4 to be in a similar range as Q3.

We target non-GAAP SG&A expense to increase by $4 million plus or minus.

The increase in selling is primarily related to higher commissions due to increased sales of our lighting products through our lighting agent channel, and three major lighting trade shows 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 targets include non-cash stock-based compensation expense of approximately $2.9 million in R&D, plus $8.4 million in SG&A.

And charges for amortization of acquired intangibles in the amount of $7.4 million.

Net interest income in other is targeted to be approximately $1.8 million.

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

GAAP net income for Q4 is targeted to be between $5 million and $12 million, based on an estimated 116.6 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 $23 million to $30 million, or $0.20 to $0.26 per diluted share.

Our non-GAAP EPS target excludes amortization of acquired intangibles, and non-cash stock-based compensation in the amount of $0.16 per share.

Thank you.

I will now turn the discussion back to Chuck.

Thanks, John.

We remain 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.

In January, we took the next step in our integration of the Cree lighting and BetaLED product lines, as we combined the two product lines into a single lighting agency for each major market.

In most every market, we now have a new agency for either the Cree or BetaLED product line.

In some cases, we selected a new agency for both product lines.

As a result, we lost some sales momentum in the short-term, especially on the Cree indoor product line.

A number of projects were delayed and some projects simply moved ahead with traditional technology in the near term.

While this was disruptive in the short-term, we believe we made the right decision for the mid to longer-term as we were able to upgrade our agents by leveraging the strength of the combined product lines.

Q4 is an important time for Cree and the lighting industry as there are three major trade shows during the quarter, Light plus Building in Frankfurt, Germany, Light Fair in Las Vegas, and Light Fair in Guangzhou, China.

The excitement and momentum for LED lighting continues to build as more companies begin to offer LED based products.

But LED lighting is still generally positioned as a premium product.

While the industry is moving, our challenge at Cree is to keep raising the bar with innovative new products that deliver better payback and move LED lighting closer to price parity with conventional technology.

Over the last several weeks, we announced a series of new lighting products, which lead the market and we believe will open new applications to LED lighting.

The big news is our new XSP Series LED Street Lights, which are redefining the economics of LED street lights.

This product more than doubles the lumens per dollar and takes payback to the next level with performance that pays for itself and more.

There's now no economic reason for the municipalities to deploy anything else for these types of applications.

This is also the first Cree outdoor product to leverage an integrated development approach from the LED chip to the lighting system.

We recently expanded our industry-leading CR Troffer product line to address more applications and to eliminate the use of antiquated fluorescent technology in newer retrofit commercial and industrial settings.

We released our new [Aero Blaze] outdoor product line, which combines great performance and cutting-edge new design.

This product goes beyond the traditional view of outdoor lighting, which was limited by decades old lamp technology, and is the first outdoor product to take full advantage of the latest generation of high-power LEDs to deliver all the benefits of LED lighting and great design.

Despite the number of new products, we are still just getting started.

We continue to look for new opportunities where our innovation can help change the industry and drive LED lighting adoption.

On the LED component side, we recently announced another LED performance milestone, as we developed a prototype LED which produced 254 lumens per watt.

While this is an R&D result, we have a track record of translating these types of breakthroughs into higher performance LED components and production.

These high lumen per watt results, which only a few years ago were not even considered possible, continue to demonstrate that there are untapped areas where innovation can help drive the market.

We started shipping both our XLamp XB-D and XT products during the quarter, based on our new SCQ technology platform.

And we recently announced high-voltage versions of these products.

The customer reaction to this product family has been very positive, and there's a lot of design activity around these products, both for new design as well as upgrades to existing ones.

We target incremental revenue growth from these products in Q4 and a growing pipeline of design activity for the first half of fiscal 2013.

We recently announced our next generation XLamp MTG LED based on SCQ technology, which is 25% brighter than the previous version.

We also released an expanded portfolio of XLamp LMH2 modules, which are now available in 2,000 and 3,000 lumen versions.

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

We made good progress in Q3 in cost reduction, productivity and yield improvement.

We're producing more LEDs per wafer with lower costs and at similar utilization levels as Q2.

Factory execution was very good in Q3, as we delivered gross margins within our target range, despite lower revenue than we had targeted.

This illustrates the gains we've made in factory efficiency and puts us in a good position to support the higher revenue targeted for fiscal Q4.

We continue to closely manage operating expenses in Q3, while still investing in the areas that we believe will enable future growth.

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

Sales started to improve in Q3 as we saw growth in both the power and RF product lines.

We target incremental growth in power and RF again in Q4, but as we talk to more customers about their future applications, it is becoming clear that a new generation of higher power devices and modules are going to be needed to realize the full value of the technology and drive adoption.

While we continue to work on near-term design, we plan to increase our investment in developing these next generation products, as we engage customers in applications based on where the technology is going, not where it is at today.

As I explained earlier, Q4 total company backlog is ahead of last quarter's run rate.

We see good trends in lighting and LEDs, but we still have limited order visibility.

Both product lines are operating with short lead times, which increased the variability and reduced the accuracy of our forecast.

Based on our current backlog forecasts and trends in the business, we are targeting Q4 revenue to increase to a range of $295 million to $315 million, which is comprised of double-digit growth in lighting driven by strong growth in indoor and outdoor sales, single-digit growth in LED product sales from both direct and distribution customers, and incrementally higher and higher power and RF sales.

We target non-GAAP gross margins to improve in Q4 to 36% plus or minus, depending on revenue as slightly improved factory utilization is somewhat offset by product mix and the competitive environment.

We target R&D spending in a similar range as Q3, while sales and marketing expense will be higher to support the three major lighting trade shows in the quarter and higher sales cost associated with higher revenue.

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 Q4 of $0.20 to $0.26 per diluted share.

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

Our focus remains on driving adoption through innovation.

We're seeing the success of the lighting products we've introduced in the last year, but we have to continue to push the envelope and develop products with even better performance and faster payback.

Our new XLamp LED products, based on the SCQ platform, have changed the parameters of lighting system design, which should enable our customers to deliver more lumens per dollar and open new markets to LED lighting.

Our recently announced series of new LED and lighting products should help us further challenge the traditional technology, but the cycle of innovation is far from complete.

We are committed to continuing to push the technology to deliver LED lighting that is better than what it replaces with costs that approach parity with the traditional technology.

This is the road to widespread adoption that drives our business and drives the transformation of the lighting industry.

With a track record of success and innovation, we believe we are well-positioned to continue to lead this transition and drive growth in our business.

We will now take analyst questions.

(Operator Instructions).

Brian Lee, Goldman Sachs.

How much of the fourth-quarter revenue guidance is covered by current backlog?

How does that compare to where you were last quarter?

I'm wondering how much you need orders to pick up through the quarter here to feel good about your guidance targets, since you say order visibility is limited right now.

My follow-up question is, what assumptions are baked into the fourth quarter guidance on pricing and volume across the segment?

If you can quantify, at least directionally, that would be great.

I think if you look at where we're at, Q4, the backlog is ahead of where we were at this point last quarter, so that's a positive sign.

We are obviously seeing better booking trends.

I think the reason I make the comment about limited visibility is that it is still a short lead time business.

While we are ahead of the rate last quarter, which is obviously driving our forecast, I think it's also important to understand that both the LED business and the lighting business are relatively short lead times.

We still have some work to do for the quarter, but obviously we're heading in the right direction.

I think your other question was about pricing, and if I look at the assumptions there, Q3 came in pretty much in line with what we were expecting for Q2, and I'd say Q4 is going to be in a similar range.

I don't have a specific number for you, but it is still a very competitive environment but with that being said, it's definitely not quite as aggressive of a pricing environment as it was a year ago.

So competitive, but a little bit more reasonable today.

Chris Blansett, JPMorgan.

A lot of your competitors seem to be seeing a much bigger inflection off of what looks to be the trough quarter of Q1 here, then you are.

Your midpoint of your guidance is up 7.5, and so when I look at your lighting business you're only getting back into the Q4 level to where you were in the Q1 level here of revenue.

I'm kind of wondering to see on a follow-up, how does this translate to utilization rates from fiscal Q3 to Q4?

Seems like you're not quite seeing the snap back that some of your peers are.

Well, Chris, you've got to be a little bit careful with that.

Obviously our LED lighting business scale is a little bit different than most of the other people out there, and the fact is that when we did the agent transition in last quarter, we went through a process where I think 80% of the agents are new to either the BetaLED line or the Cree line.

That's a lot of agent retraining and a lot of momentum to build back.

Obviously, we are more optimistic now because we have seen the projects pipeline come back, we've seen the backlog come back but I think what you're seeing is really a function of that transition.

I'm pretty optimistic going forward about where that's at.

We do have to recover from the lost momentum last quarter, so I think long-term we are on the right track.

Short-term, you've got to work through the transition.

With that being said, as far as utilization, we're looking at similar to slightly better in Q4.

Obviously, we are targeting growth in the LED business, which is going to drive utilization more than anything.

I would say given the fact that we're continuing to make yield improvements in some of the other product changes, it's only slight improvement at this point.

Most of what we're targeting, the benefit to come from this quarter is continued strong execution.

Jesse Pichel, Jefferies.

Some of the weaker top line appears to be this agency shift.

Was that due to the Ruud acquisition?

Or change in demand dynamics?

Was that agency dislocation factored into your prior guidance?

It is basically the difference between our target and where we came in is almost exclusively related to the agency shift that we saw in the lighting product line.

LED business came in line pretty much with the targets, power and RF, pretty much with the targets, lighting came in below and what we saw was we made the shift to the agencies and we saw disruption on both sides, but affected the indoor more, and that's just a function of the fact that, that's a shorter, really a shorter cycle business and really more the indoor agents change.

When we look at that, to us that's a function of the transition.

What we wanted to do from the beginning is we wanted to combine these two product lines and actually end up with a stronger channel to drive adoption.

At some point, we had to bring the two product lines together.

Obviously in our targets, we did not factor in quite as much momentum loss, and it's one of those things that now that we're through it, I still believe we made the right move and we're on the right track, but clearly came in low rate lower than we had targeted for the quarter.

Would that reason also explain potentially as the prior caller asked, a more modest pick up versus some of your peers because of this agency shift and loss of momentum?

I think what we've got to realize is that you shift that many agents, what we're glad to see is the backlog coming back, we're glad to see the product pipeline, but we basically sured up the channel pretty good for the quarter there.

I think that if you look at from where we were mid-quarter last quarter, we're targeting nice growth.

We're still looking at double digits from what we did.

Obviously if you compare that to December, it's only slightly up from there, but I think the important point to us is the momentum's back and if I look at the project backlog and the combination of new products coming, I feel pretty good.

I also think that you've got to be a little careful benchmarking scale of the two business is at this point.

I think obviously we're pretty deep down the road in the LED lighting conversion, and so I think at least the base of business we are working off of is a little bit different at this point.

Dale Pfau, Cantor Fitzgerald.

We're going to beat your agent to death here, Chuck.

About how many agents did you switch?

Over what period of time did you make that transition?

I think I missed this, are they regional or are they specific in verticals?

Bill, the regional model of agents, I think we have a little over 50 agents, and a little more than 80% of them switched.

Over 80% of the cases, the agent is new to either the indoor line, about your line or in some cases, new to both product lines.

You have less than 20% of the agencies were not disrupted by this.

It all happened in early January.

We went through a process over the first six months, looked to see who we thought would be best to drive the product line going forward, made that call in early January and did it all at once.

Obviously, I think anyone who's ever had a sales team change 80% of them at one time, you realize that it was disruptive.

Frankly, I'm pretty happy to see that overall, the fact that we changed that many and we've seen the momentum come back this quickly and seen the backlog rebuild, I feel pretty good about it from where we are at going forward at this point.

Is that both international and domestic?

This is all North America.

If you look at our non-agent business and this is probably another good indicator, look at our international business that was unaffected or some of our direct business that we sell through other channels, that business was pretty much online with our target.

If you want to take out the agent transition and look at the rest of it, that business is roughly in line with what we expected for the quarter.

That's why we're pretty confident in both the fact that the business has come back and the fact that we saw the rest of the business keep going as planned.

That's why we feel pretty comfortable that was agent transition driven and we looked into it pretty close.

Best as we can tell, we have a number of cases of delayed projects, post home projects and as I said earlier, even some projects that end up going ahead and didn't use LED at all.

It's part of the process of getting the business ready to hopefully drive adoption a whole lot harder.

Andrew Huang, Sterne, Agee.

You recently announced that your LED troffer's and street lights our at price parity with the incumbent technologies.

I think that's basically the endgame.

It seems to me that all you have to do now is sell the product, so maybe could you comment on what you have to do to get product through the channel?

Obviously, depending on the product and application, I think what we've said in a lot of cases is we've doubled lumens per dollar.

We have price parity in some applications, but what does it take to go forward?

There's a large market of people that are used to bind the traditional technology, so one of them is getting upfront costs down so that we can drive adoption.

You're still selling cost of ownership in a lot of cases, so you still have to convince people to try technology they haven't tried, you've got to get them to understand the cost of ownership, and you've got to think about it.

The fact is that when you are building an LED street light then in one case the XSP is I think comes in around $200 US for certain applications, that's the same cost of sending a bucket truck to change a light bulb.

You have to ask yourself at what point would a municipality ever want to change another light bulb when they can put a brand-new LED street light up there?

Obviously, they're going to not want to mix technologies, but I think we've really changed the conversation.

That being said, it is an industry that has been doing things a certain way a long time and there's a lot of education, there's a lot of work to be done to really get the customer to understand and appreciate that, and I think that's the road ahead of us.

Clearly from a product standpoint, at least the new products we have come out with recently, we've really got some people's attention.

Let's face it, a new product for us in outdoor, you're looking at probably -- we won't really get a good indication for a couple of quarters until that product gets out there, people test it and can start putting that into bids for new projects, and then you will really know in three, four quarters what the success is.

I think we certainly have changed the game and changed the conversation.

For my follow-up, you mentioned at R&D you are at 254 lumens per watt for components.

I was also under the impression that the theoretical max was 200, so I'm just curious if you could give us an idea of where you're average components efficacy is today?

That's going to vary.

We're selling products everywhere from -- I think we have customers down in the 100 lumen per watt range, to I know we have products up -- I don't know what the highest is out there today is, but I want to say we have products available in the 150, 160, maybe even as high as 170 lumens per watt in certain product categories.

It's going to vary with color temperature and other things.

The majority of customers are probably still in the 100 to 120 lumen per watt range.

We're seeing customers starting to design at that next level, but there's definitely a lag from when the LED comes out to when you're going to see that in the system.

If you just take the normal design cycle, if you hand someone a new LED today, depending on if it's indoor, outdoor, commercial, consumer, you could see a design cycle anyway from 6 to 18 months.

I think we're really just starting to see the products come out.

We've been at light and building the last few days and I think you're starting to see some of the products come out that use the newer LEDs, but there is still a lag effect.

Ahmar Zaman, Piper Jaffray.

My first question is, can you clarify what percentage of your LED product sales were to the back lighting channel for end market this quarter?

Essentially, there's basically a de minimus amount.

I think it's essentially less than 1%.

We were hearing that there's rush orders in back lighting in Korea and Taiwan.

You didn't participate in that?

No.

As we've said in the past, our focus is really on lighting.

We do service the video screens and some other applications, but we have really not focused on the back lighting market.

When we do participate it tends to be more of a chip oriented business, not a components level business.

Although we have seen a little bit of activity there, it's really not our focus and so I would expect you're going to see more activity on the back lighting front, both the positive and negative slings you're more likely to see from some of the suppliers out of Asia.

Vishal Shah, Deutsche Bank.

Chuck, to what extent do some of these new product introductions impacting demand from existing products to some of your customers try to qualify these new products?

Can you just update us on the 6-inch transition timing, any change on that front?

On the 6-inch, we continue to qualify new products, but we're not converting additional capacity.

The way to think about that is that there's two things you got to do.

Each product that you're going to bring over has to get qualified.

We're staying on track with that, so we have the flexibility to turn on 6-inch as the volume warrants, but we haven't made a significant increase in 6-inch percentage of starts just because at this point we want to utilize 100-millimeter capacity in the near term.

I think we're doing all the things to put ourselves in position to take advantage of it, but at this point, we're not going to put new capital in place to do that, at least not until we see the demand pick up a little bit more there.

It doesn't have any net payback.

As far as the demand old versus new products, I assume you're referring to LEDs, and so what I would tell you is that the XB-D, XT-E and all the products that use the new SCQ platform, we're seeing lots of design activity but that's not driving -- that will have some incremental benefit on demand this quarter, and frankly, those products, we have seen lead times move out in those just because of the initial demand.

With that being said, still the majority of the business is the products that have been designed in, and so I think going forward, we'll see more people convert to the new products but in the short-term, it's more incremental.

Longer-term, I would expect most customers to move down that path just because the lumens per dollar is better and frankly, that's what want them to do.

More lumens per dollar means better product on the market which should drive adoption.

Vidya Adala, Morgan Stanley.

I have two questions.

One is on the utilization levels, it looks like it's all going to track in that it is trending up.

At what level of utilization will you be more comfortable in transitioning to the 6-inch?

I'm using the 60% roughly benchmark you provided us last quarter.

My second question is, is there a difference in demand trajectory by geography?

Are you seeing a difference in Asia versus Europe versus North America at this point?

On the utilization question, I think right now, 6-inch is going to be -- when is it?

I think I said last quarter it's probably three to six quarters out when we're going to make a significant move.

I think we're going to continue to evaluate that each quarter.

The reality is last quarter, utilization was pretty similar, maybe slightly higher than in Q2.

This quarter we're targeting to be incrementally higher again, but we're not having a big shift in utilization in the short-term.

One of the reasons that being able to drive the margins up without the utilization going up significantly it's something we are happy with the factory execution that made that possible and frankly, it shows you what can be done from an execution and a new product standpoint.

I think that's the near-term focus, is let's take the incremental steps, we'll update more when we go to 6-inch later, but the fact is that really comes down to driving demand and that gets us back to let's get the new products out there, let's drive to the demand.

Which is your second question, which is demand trajectory.

If I talk about the LED product line, we are seeing strength in North America, Asia and even some strength in Europe.

I think what you're seeing is a relatively broad-based momentum in LED lighting.

To give you an anecdotal thing, we spent the last -- the Light and Building show here in Germany has been going on for three days now, and there is essentially no significant lighting company that isn't doing most of their new designs on LED.

The fact that they're working on new designs does not mean they are selling many of those products yet, but from two years ago to where we started to see the shift from the major players, pretty much all the players are now moving.

What I would expect is that when the designs start to come out, then there is some lag to when you actually get sales momentum and start to drive that, but we're relatively optimistic that the design activity is starting to lead the demand on the LED side from a lighting standpoint.

Again, I think it comes over time and we've got to keep focused on it and keep working on it quarter-by-quarter and not forget to do the products.

I think your other question might be lighting related, and that's primarily North American business, so we do have some international exposure but it's really a North American business and that's really the trends we're seeing there, which are driven by primarily the US and a little bit of Canada.

Mark Heller, CLSA.

As you guys move more and more toward a light fixture model, I'm wondering how your component customers are reacting to that.

What I will tell you is that question was asked a lot back -- when I say asked, not by the analysts but was asked a lot by our customers back in the August-September timeframe when we first announced the Ruud acquisition and explained that -- I'd say that we're eight months into it today, I think most of our customers are pretty comfortable, with where we're at.

I think what we've learned is that -- and what we believe is that if we make products that help our customers products work better, we're going to be able to sell more of them, and it's really about driving that innovation and what we've seen obviously with the XB-D and the XT-E is you get products out there that help your customers product work better and you get a lot of momentum on that.

I think it's pretty balanced, I think the other thing that the industry is coming to grips with is that the reality is that most companies that make light sources or LEDs also have a systems business, in one way or another.

I think that's not been uncommon in the lighting business.

I think it had a little bit of disruption early on, but not significant, and I would say that today it is pretty much not a significant part of any of the discussions, it's about what can our LEDs do to help our customers products be better.

When do you expect to ramp meaningfully the XT-E, XB-D LEDs and are there any implications for margins when you ramp that?

The ramp of XB-D, XT-E is going on.

We started shipping it last quarter, we will continue to ramp up this quarter.

I think I commented earlier that the lead times on that have actually moved out already so my guess is that in the short-term, we're going to be ramping that pretty much as fast as we can to meet the near-term demand.

As far as what does that mean going forward, I think we'll have to see what percentage of the business it becomes, but in terms of margins, not only did we double the lumens per dollar but we made a lot less expensive, so I would expect that product be a net positive to margins from where we are today.

Daniel Amir, Lazard.

First of all, on the agents, which is something you started in starting in January to shift over, and you probably had some visibility.

I'm just a little -- trying to understand why you actually didn't pre-announce the quarter here considering that you probably knew far in advance that you might not make the revenues for the quarter.

The second is regarding to the margins here, the guidance is flat margins, essentially but you're seeing a bit better utilization rates, a little higher revenues, so can you just give us an idea, what the moving factors here for the margins this quarter?

I'm not sure where you got a flat margins.

We're actually guiding them to go from 35.6% to 36% plus or minus, so that's actually increased margins and the utilization is relatively flat, slightly up.

We're actually targeting to get some additional execution benefits, so maybe we weren't clear earlier, but I would estimate that margins are actually moving up right now on not a significant increase in utilization.

That's a net positive.

As far as the agents go, what you have to remember is there's a lot of project based business, so while we did make the change in early January, we were working a number of projects that we thought we could still close between then and the end of the quarter and that while we had success in some of those, it wasn't until the end that several of the projects that didn't happen or got pushed out into the following quarter that we realized that we weren't going to quite get there.

It's a significant transition we made.

I think we took a pretty aggressive approach to it and in the end some of the projects didn't happen as quick as we wanted to but in the grand scheme of things, I think if you look at our revenue range, we're within a couple percent of the bottom of it.

There's a lot of moving parts in LED lighting right now, and we came in a few million below the low end of the range, but at the end of the day, it's going in the right direction, and frankly, that's what we're focused on at this point.

Carter Shoop, KeyBanc.

First question on the agents, it sounds like a couple of your larger lighting competitors forced agents that carried either data or Cree products to drop the fixtures over the past four months.

With that said, how many of your current agents still carry products manufactured by the big four North America lighting fixtures?

I'm trying to get a better sense if this headwind is completely behind Cree or if we have potential down here?

I would tell you that while there was definitely pressure put on the market, I'd say in probably 90% of the cases I think or more than that, I think we end up with the agency that we were targeting going to change.

I feel pretty good -- there was definitely a couple markets where we didn't end up with one of them but I'd say all of the -- almost every agent we have works with one of the big four today.

In many cases, the agency -- we just move from one agent to another and then in a lot of cases most of them were already a Cree agent or a Beta agent, so in our case most of the decision-making was which one did we think would be better at selling a combined product line, selling outdoor spec business and selling indoor business has really focused on more of the commercial building side of the marketplace, and a different type of customer with a different distribution element.

It was really about how do you find someone that can cover that broad range and really wants to push LED lighting?

As much as anything, a lot of it was us picking who we thought would go out there.

I would say very little of the disruption was people not wanting to stick with us, much more of it was us having to make a choice and in some cases between two pretty darn good agents we had to pick one we think would work best.

In the end, we have one of the large traditional lighting companies is pretty much part of just about every agency out there today that's of any significance, and so in many cases, it just changed who that player was.

As a follow-up question, today roughly 30% of your sales are from fixtures.

If we fast forward two to three years, do you expect that increasing or staying roughly where it is today?

Carter, obviously it's going to depend.

I think it will go in cycles, so I think what you'll see is when we're able to come out with products that I think can move the market you can see that percentage increase.

Obviously this quarter we're targeting double-digit growth in lighting, single-digit growth in LED components, which would mean it's growing a little bit faster, and that's going to be a function of some of the new product momentum.

With that being said, I think as the market turns on different segments, because our fixture business is really only focused on North America, there is a significant impact of what happens in Europe or Asia or in our other markets that's going to drive components.

It's a little hard to tell you today which market is going to gain traction and which time.

Obviously our goal is to grow both of them.

If I had to guess, lighting will probably grow net a little faster over that two to three year period of time, but I don't think it's going to be -- I think it's going to depend on what products, what segments are moving in which geographies each quarter and I think we're going to see some different factors affecting that as we move along.

Colin Rusch, ThinkEquity.

Can you talk about your investments in control technology and the next-generation integration you're seeing with control technology, and some of the utility operating systems?

I can tell you today that we have a number of approaches.

Cree's approach is a little bit different than the most of the market, so we're typically working with third-party control systems that are out there and working to design our systems to be compatible, not only with the systems that are already installed but with products that are available from others.

At this point we haven't made the bet that proprietary control system is the right way to drive the market, and I think given how much new technology is coming out of controls related, I think our open approach, at least in the near term and trying to stay compatible with several other systems, is frankly going to help us move the market a lot quicker.

I know there's different views of that, but I think we're more of the open approach to the market at this point.

A lot of changes coming.

I think right now, people talk about all the new technologies, frankly most people are installing relatively old control systems and packaging them together.

I think as we go forward, once we have an LED lighting system and you have an electronic platform, it's a pretty incredible amount of things to, and probably the most short-term thing that's got to happen is that a lot of the new installations in certain markets are going to have to be able to do daylight harvesting and you're going to have to be able to do motion sensing, just to meet some of the new codes coming, especially the ones California.

I think you'll see that become pretty much a de facto standard and then how far people go, how quickly I think is going to depend on the customer.

There is no one-size-fits-all approach to controls, and so I think we're going to take a pretty open approach to that.

Jonathan Dorsheimer, Canaccord.

A couple questions for you, or one and a follow-up I guess.

If I normalize for the inventory build, I get a little bit below 35% on the gross margin.

It seems as if -- basically a flattish utilization increase as we look to the June quarter, you're getting a nice boost moving to that 36%.

Just wondering if you could maybe provide a little bit more granularity in terms of a bridge, if you will, in terms of both in the very near term and then a little bit longer term how to get the gross margins up?

How much do you expect is coming from utilization increase, how much from some of the new products like the XB-D?

How much from the systems sort of taking costs out?

If you look at gross margin, the way to think about Q3 is this -- if you look at LEDs and power and RF, which are really the asset heavy, factory heavy parts of the business, both of those product lines were inventory neutral to actually inventory down.

There was no gross margin benefit in either one of those from an inventory build.

All of the inventory build was actually in the lighting product line.

It was pretty much focused on the raw and WIP areas.

When I look at those numbers, I don't see any significant benefit to gross margin last quarter, because it's really raw materials and WIP for a lighting ramp that we're planning for this quarter.

I would say essentially no effect, so I think what we saw last quarter was that 35.6% non-GAAP number is pretty much all coming from execution.

Utilization was just slightly higher, so it's really a combination of product mix and some great execution in terms of frankly reducing cost and making more LEDs at the same time.

We did a nice job there.

To me, near-term plan is not going to -- we're not going to get a big utilization bump in Q4, so the guidance really comes from -- we think we can continue to execute pretty darn well from a cost standpoint.

We do have some increasing mix of some of the new products, so that starts to help us and that gives us some incremental momentum in Q4 because we're targeting, relatively speaking, inventory to be generally a wash, not a significant build or burn, so that brings us back to essentially looking at just the performance of the business on that gross margin target.

If I look longer-term, utilization will always be out there as a potential upside.

Since demand, two or three quarters out, we're going to try to grow it, it's a little hard for us to predict exactly how that comes online.

We're going to focus on the things we can control, which is really about trying to drive the internal execution of new products.

Obviously we would hope that as XB-D and XT-E ramp up, we obviously design a fundamentally lower cost platform.

We would hope to get some leverage there, both from driving revenue but also from giving us some cost leverage.

When you look at the lighting systems business, as we start to come out with products that really get the economics closer, I think what you are going to see is the ability to get some more leverage there.

Obviously we're always making a trade-off of how aggressive can we be in the new lighting systems to not only take costs out, but also get the customer to think differently about how quickly to move to LED.

I think as we start to get closer to some of these price points that make the economics much more obvious, I think we'll have a chance to let some of the innovation on the LED system side give us a little bit more traction.

That's how I look at it, and that being said, 90% of our focus right now is trying to make sure we're focused on executing in Q4.

Chuck, good segue into my follow-up.

The new products that you introduced at sort of half the price point of everybody else's street light, can you provide a little bit more details on how you're getting there and maybe instill a little confidence on the systems side but that, that's not going to be dilutive to the overall business?

What I can tell you is that, that product was positioned in a way that we think would be accretive to our current gross margins for the lighting product line.

Now, that being said, how do we get there is probably the more interesting question.

That is a project that was actually started before we bought the Ruud business, and it was really a design of a system from LED chip all the way through.

We basically sat down and said, here is a problem we want to solve.

What are all the levers we have?

There's pretty much nothing the same in that version of the street light from the previous ones.

We were able to take some of the cost out of the LEDs but frankly, use higher performance LEDs and that's just a function of the LEDs keep moving.

You are taking advantage of the fact that two years from when the last one was designed, a higher performance LED cost you less than the one cost you years ago and you can do a lot more with it.

I think we looked at a different system to put the LEDs in there and some things to extract more light optically, so we've got a benefit out of the optics that gave us more efficiency, which give us more light at a lower cost.

The thermal design, because you got the efficiency got cheaper and less expensive, and it also helped us on the driver side and it was really a combination of all those pieces coming together and frankly looking at how do you build the thing to take out inefficiencies there?

As you can imagine, if you're trying to cut the cost of your product in half, and LEDs are less than half the cost, you've got to work on something other than the LEDs.

I think this is really about taking a look at the whole system.

It's not much different than what we did on troffer, just applied to the street light.

Amir Rozwadowski, Barclays.

Chuck, perhaps tailing on that question on the gross margin trajectory, it seems as though you notably made some improvements on the manufacturing side that is enabling you to drive improved gross margins, despite utilization levels, still it's only slightly improving at current levels.

How should we think about your longer-term gross margin targets?

Are the targets returning to the low 40s, mid-40s level, still on the horizon or is that something that, at least for the time being, not really where you're gearing the business towards?

Those are always long-term targets.

I think the way we think about it is -- control what we can control.

Let's work on the new products and the execution, try to get the innovation to drive the revenue, those are the three biggest levers we have to work on in the near term and frankly, that's where our focus is.

If you ask the question as more philosophical, do you still think there's a business model that supports these below 40 type gross margins?

I still believe that, that's out there.

I'm not going to give you a timeline and I don't think a lot of people like to debate that but having seen the cycles of this business before, and we've done this quite a few times, you can look at the history of Cree going through these innovation cycles and that when you come out of an innovation cycle, you have products that open markets that you didn't have access before.

You typically get some scale leverage, and it's really a question of, does the innovation you're able to create, can it extract value out of the market?

I can tell you that we're just getting started in LED lighting adoption.

And there's incredible value to be extracted when an LED system relative to a conventional one, and it's not one for one.

The LED system not only can give you lighting quality as good or better in many cases than what's out there today, we can do it with a payback to where we're generating value not just at the system for system, but the fact is we're saving the customer money, whether it be energy, maintenance, or other aspects of the design.

I think that if we can continue to innovate, there are definitely opportunities to where that innovation leads to margin leverage going forward.

Again, that's longer-term.

In the short to mid-term, what we can control is what we can see in front of us, which is get the new products out, drive the execution, drive the revenue, and that should help us start to hopefully continue to build some incremental momentum.

But that's where we're at.

From a strategic standpoint, are you looking to drive down pricing points in order to continue to drive the adoption, particularly in general lighting?

And you're willing to sacrifice some margin in order to do that?

Or is it not a trade-off like that?

I shouldn't be thinking of it as a trade-off?

I think the trade-off you're thinking of comes later when the market is more mature.

I think at this point, we're just trying to get the market turned on.

For all of the success we've had, we have had a lot of success growing a lighting business from nothing to where it is today in LEDs, and the components business, the same way.

But the fact is that LED lighting, despite all of the people showing neat products, is still a relatively small percentage of the market.

We have to turn the market on and get the industry to start thinking of LEDs as the first choice, not as an alternative choice, not as a premium choice, but as the choice.

Until we do that, we're all playing around with small numbers.

From the beginning we said our goal is to drive the LED adoption to where this is the primary light source out there.

We're looking for large market segment.

Until we do that, everything else is just an incremental conversation, so I think it's almost premature to worry about.

Your question's valid, I think it's valid though when we're talking about an industry that is at 40% or 50% adoption, not one that's a 5%.

At this point, let's get the adoption and lets innovate as fast as we can to make that happen and I think the numbers start to take care of themselves when the revenue growth -- when we drive that revenue growth and get some of the new product innovations to where we can drive that value.

We have time for one final questioner.

Satya Kumar, Credit Suisse.

I was wondering if you could comment on how much capacity you have at the moment to make XB-D XT-E and how that will ramp over the next few quarters?

And given your comments on lead times and customer demand for these products, would you look to prioritize customers where you can perhaps participate more in the value of these products?

On the capacity, I think XB-D XT-E, it generally uses much of our existing capacity, however, there are some unique processes that were developed there.

Those are the places, they are essentially bottlenecks that we have to overcome.

I think the vast majority of our capacity can be used for it, but it's really a timing issue of as we address the bottlenecks and bring on those incremental pieces of CapEx to turn that on.

It's really a timing thing.

My guess is we will be relatively limited this quarter, but knowing that it is really some key bottlenecks, I think we'll get ahead of the curve here hopefully as we start into the next fiscal quarter.

I'm not sure I remember the second part of your follow up there.

Would you look to prioritize customers where you can perhaps participate more on the value of these products in terms of queueing them relative to your customer demand?

Obviously that's a tricky one.

We want to try to support as many customers as we can because the fact is the goal is to get as many people moving with this new platform.

I think right now we're doing a good job.

The reason I talk about the lead times moving out a little bit is, it's obviously a positive sign, it's got people's attention, it shows us that I think we've hit on something that helps move the market, and we've just got to react.

In the short-term, we'll find a way to balance the different customer demands to help them keep moving and hopefully, as I've said, by the time we get into next quarter we can bounce a little better, but my guess is this quarter it will be pretty tight.

In the end we'll have to make some calls, but our goal is going to be to support as many customers as possible, frankly.

I know this topic has been beaten to death on the agent transition.

But given that your lighting sales are essentially lagging the industry over the last six months and you're going through this retraining process for the last three months and the next three months, could you see a breakout quarter perhaps as you look out into the second half where your lighting product sales actually grow much faster than the industry when you try to catch them?

How should we think about that in the back half of the year?

I think we've got to be a little bit careful taking industry numbers over a broad industry and applying it to a new technology area.

The fact is that up through last quarter, we have seen pretty solid growth in the areas we control.

Clearly, we've done an acquisition, and the outdoor lighting product line went through a transition period and I think we did that pretty well, and frankly, it shows you that, that business actually did pretty well through the lighting agent position transition.

I feel pretty good that, that one we have worked through that piece and then when we changed the agents and we took the indoor guys through the same thing, there's definitely some disruption.

I think we should be pretty careful talking about three month trends on something that's taken us five years to get here and there is a lot in front of us.

I think it's a fair data point, but I'm not sure we have a trend yet.

I think the way we see the projects coming and some of the momentum, I feel pretty good that driving growth in the lighting business is something that's just a matter of us continuing to execute and if we quit switching all of the agents, I'm sure it's going to get a lot easier to do.

Thank you.

This does conclude our time for questions and answers.

I'd like to turn the program back over to management for any additional or closing remarks.

Thank you for your time today.

We appreciate your interest, your support, and look forward to reporting our fourth quarter and fiscal year 2012 results on August 7.

Good night.

Thank you.

Ladies and gentlemen, this does conclude today's conference.

Thank you for your participation, and have a wonderful day.

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