Wolfspeed Inc (WOLF) 2013 Q1 法說會逐字稿

Good afternoon.

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

At this time, I would like to welcome everyone to Cree Incorporated's fiscal year 2013 first-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, October 16, 2012, at 5.01 p.m., Eastern Standard Time.

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

Mr. Garrabrant, you may begin your conference.

Thank you, Huey, and good afternoon.

Welcome to Cree's first-quarter fiscal 2013 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 Mike McDevitt, our Interim CFO, will report on how results for the first fiscal quarter of 2013.

Please note that we will be presenting both GAAP and non-GAAP financial results in our remarks during today's call, which are reconciled on our press release, and financial metrics posted in the Investor Relations section of our website at www.cree.com, under Quarterly Results on the Financial Information tab.

Today's presentation includes 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 will be limiting our comments regarding Cree's first quarter of fiscal year 2013 to our 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 and one follow-up.

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

We are also webcasting our conference call, and a replay will be available on her website through October 30, 2012.

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

Thank you, Raiford.

We started the year strong in Q1, with record revenue of $316 million and non-GAAP net income of $32 million, or $0.27 per diluted share.

Revenue was in the middle of our target range as LEDs, lighting, and power and RF were all in line with our forecast.

Non-GAAP earnings per share were on the high end of our target range for the quarter, due to improvement in gross margins and lower-than-targeted operating expenses.

Our results are beginning to demonstrate the enormous leverage we have in our fully integrated vertical lighting model, as we continue to increase performance and reduce costs in LED components.

We are seeing the positive impact these gains have on our LED and lighting businesses.

The revenue trends in Q1 were as follows -- lighting sales increased more than $7 million or 7% from Q4, as we continued to see good growth from both our agent and direct sales channels.

LED sales increased more than $2 million from Q4, which was in line with our target for the quarter.

Power and RF sales decreased a little less than $1 million from Q4, which was also in line with our target for the quarter.

Non-GAAP gross margin increased 120 basis points to 37.5% in Q1, which was on the high side of our target for the quarter.

The overall improvement in margin was once again driven by a combination of factory cost reductions, lower-cost new products, and slightly higher factory utilization.

While the LED market remained very competitive, pricing declines were in line with our targets for the quarter.

We continue to closely manage inventory across our factories, while working to respond to short lead time expectations in both LED and lighting markets.

Overall, we reduced inventory by $9 million in Q1 to 81 days.

Cash and investments increased to $816 million due to solid execution, focused capital spending, and higher profitability.

Free cash flow was $68 million in Q1, and the last several quarters have demonstrated our ability to convert R&D investments into innovations that result in strong free cash flow.

This is a different model than most other companies and the LED or lighting industry today, and our balance sheet gives us the ability to continue to invest in growing our business and the market for LED lighting.

Overall Company backlog is ahead of this point last quarter, with lighting and LEDs trending higher, and power and RF at similar levels.

We continue to be encouraged by our progress in LED lighting, but the macroeconomic environment is a headwind on our growth outlook and our customers' outlook.

We are focused on using new product innovation to drive growth through share gains against traditional technologies and opening new applications for LED Lighting.

I'll now turn the call over to Mike McDevitt to review our first-quarter financial results in more detail, as well as our targets for the second quarter of fiscal 2013.

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 first quarter of fiscal 2013, revenue increased 3% sequentially to a record $316 million, which was within our targeted range of $305 million to $325 million.

GAAP earnings increased to $16.1 million, or $0.14 per diluted share for the first quarter of fiscal 2013; and non-GAAP earnings increased to $31.8 million, or $0.27 per diluted share.

Non-GAAP earnings excluded $15.7 million of expense, net of tax, or $0.13 per diluted share from the amortization of acquired intangibles and stock-based compensation.

GAAP and non-GAAP earnings per share were at the high end of our targeted range.

Q1 GAAP gross margin increased 200 basis points sequentially to 36.8%, while non-GAAP gross margin increased 120 basis points to 37.5%, which excludes stock-based compensation of $2.3 million.

This was at the higher end of our non-GAAP target of 37%, plus or minus.

The gross margin improvement was the result of factory cost reductions; slightly higher factory utilization; improved production yields; product mix; and lower-cost new products.

First quarter of fiscal 2013 revenue and gross profit for our reportable segments was as follows -- LED products revenue and gross profit were $187.6 million and $75.4 million, respectively, for a 40.2% gross margin.

Lighting products revenue and gross profit were $108.1 million and $34.1 million, respectively, for a 31.6% gross margin.

Power and RF products revenue and gross profit were $20.1 million and $10.4 million, respectively, for a 51.8% gross margin.

In determining gross profit for our segments, we do not allocate certain employee benefit costs, stock-based compensation, and acquisition-related costs.

These non-allocated costs totaled $3.9 million for the first quarter of fiscal 2013, and are included to reconcile to our $116 million GAAP gross profit.

We ended the quarter with $816 million in cash and investments, a $71 million increase sequentially; which resulted from higher profitability, good working capital management, and focused capital spending.

For the quarter, cash provided by operations was $86 million, and capital expenditures were $18 million, including $5 million related to patents, which resulted in free cash flow of $68 million.

Operating expenses for Q1 were $98.8 million on a GAAP basis, and $80.9 million on a non-GAAP basis.

Non-GAAP operating expenses were $1 million less than targeted, due to lower R&D spending.

Non-GAAP operating expenses excluded approximately $10.2 million of stock-based compensation expense, and $7.7 million of charges for amortization of acquired intangibles.

Net interest income and other for the quarter was $3.4 million, which included a one-time payment received from the SemiLEDs patent litigation settlement.

Our Q1 effective tax rate was 22% for the quarter, which is higher than the 19% we targeted, as we currently target a greater portion of our fiscal 2013 earnings being in higher tax jurisdictions.

Days sales outstanding were 46 days as compared to 45 days at the end of June, as accounts receivable increased $10 million to $162 million.

Inventoried days on hand were 81 days as compared to 85 days at the end of June, as inventory decreased by $9 million to $180 million during the quarter, primarily due to a reduction in our work-in-process inventories.

Property, plant and equipment additions were $13 million for the first quarter.

For fiscal 2013, we are continuing to actively manage our capital spending.

In the near term, we target similar levels of investment of Q1 to support our strategic priorities to lead the market, drive adoption of LED Lighting, accelerate cost reductions, and support incremental capacity as needed.

While our Q2 includes a 14th week due to our fiscal calendar, we do not target a benefit to the bottom line, as the extra week falls during the holiday season.

As a result, we target average expenses for the 14th week, but lower revenue due to the holidays and the current demand environment.

At this time, we target Q2 revenue to be in a range of $320 million to $340 million.

We target Q2 GAAP gross margins to be 37.5%, plus or minus; and non-GAAP gross margins to improve to 38.5%, plus or minus.

This target is based on a number of factors that could vary, including overall demand, product mix, cost reduction programs, factory execution, and the competitive environment.

Our GAAP gross margin targets include stock-based compensation expense of approximately $2.6 million, while our non-GAAP targets do not.

We are targeting Q2 non-GAAP operating expense to increase approximately $5 million from Q1, most of which is due to the higher expense related to a 14th week, as well as increased sales and marketing to support the higher revenue and new product promotion.

Our GAAP operating expense is targeted to increase approximately $7 million from Q1, and includes non-cash stock-based compensation expense of approximately $12.4 million and charges for amortization of acquired intangibles in the amount of $7.7 million.

Loss on disposal of assets is targeted to be similar to Q1.

Net interest income and other is targeted to be approximately $1.8 million for Q2.

We currently target our tax rate to be 22% for Q2 and for fiscal 2013.

GAAP net income of -- for Q2 is targeted to be between $13 million to $19 million.

Based on an estimated 116 million diluted shares outstanding, our GAAP EPS target is between $0.12 to $0.16 per diluted share.

Non-GAAP net income is targeted to be between $31 million to $36 million, or $0.27 to $0.31 per diluted share.

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

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

Thanks, Mike.

We are focused on four priorities for fiscal 2013.

Our first priority is to accelerate adoption of LED lighting and increase sales of our indoor and outdoor lighting products.

The big news is our new 10-year LED lighting warranty that covers the industry's broadest range of products.

Our new 10-year warranty, which is based on our unrivaled experience with lighting-class LEDs and LED lighting system design, is unheard of in the traditional lighting industry, and is critical to reducing the cost of ownership.

We also announced the Cree EDGE High Output LED area and floodlight luminaires, which are capable of replacing high-output sources, such as 1000-watt metal halide; and use 50% less energy in most applications.

LED adoption continued to gain momentum in Q1, with new installations ranging from CR22 LED troffers in the Hart Senate Office Building; to LEDway street lights in Oyster Bay, New York; to THE EDGE area and parking structure luminaires for the exteriors of seven schools in Newport News, Virginia.

We are investing in sales and marketing to expand our channels, and we continue to evaluate opportunities to move the market, access new customers, and promote Cree LED lighting.

Our second priority is to drive growth in our LED component product line through innovation by leveraging the SC3 LED technology into a range of new products.

We continued to deliver on our LED components goal of more lumens per dollar with our new XLamp XP-E2 LED, delivering higher lumens per watt and more lumens per dollar to lower system costs.

This product is targeted for new designs and as an upgrade for existing XP-E and XP-G-based designs.

The transition to the new SC3 products has helped our profitability and is critical to driving the market and maintaining our competitive position.

But as a result, the amount of lights sold, measured in lumens, has increased a lot faster than revenue, and limited topline growth in the near term.

We target increased adoption to drive LED revenue growth in the latter part of fiscal 2013.

Our third priority is to leverage our technology lead in power and RF to open a new generation of applications for these products.

We are working with a number of customers on next-generation designs based on our silicon carbide power devices.

The focus is on higher power levels than we currently serve, where silicon carbide has the biggest advantage over conventional technology.

In the short term, the business is operating in a similar range as the last couple of quarters, based on the current generation of power and RF designs.

Our fourth priority is our ongoing effort to translate our product innovation into revenue and profit growth.

Our new products are driving growth in sales for LED lighting and enabling Cree to deliver more lumens per dollar in LED components.

We made solid progress improving margins over the last three quarters despite an LED market that remains highly competitive.

Our goal is to continue to leverage our new products to drive revenue growth and deliver incremental margin improvement through factory cost reductions, process improvements, and lower-cost new product design.

We remain focused on closing the price gap with conventional technology to drive adoption of LED lighting in the market.

As I explained earlier, Q2 total Company backlog is slightly ahead of this point last quarter.

The lighting demand forecast is trending higher for Q2, while the LED forecast is also up, mostly due to the incremental benefit from an extra week in our fiscal quarter.

The benefit to the bottom line is minimal, as the extra week falls during the holiday season.

This means we have a below-average revenue week, but still have an average expense week.

The LED and product lighting product lines continue to operate with short lead times, which adds variability to our forecast.

The macroeconomic environment continues to be a headwind, and continues to make some customers more cautious.

Based on our current backlog, forecasts, and trends in the business, we are targeting Q2 revenue in a range of $320 million to $340 million, which is comprised of solid growth in lighting, LED product sales flat to slightly higher, and power and RF sales flat to slightly higher.

We target non-GAAP gross margins to improving Q2 to a range of 38.5%, plus or minus.

This target improvement in gross margins builds on the momentum from the last several quarters by delivering higher revenues from a similar fixed-cost base and a higher mix of lower-cost new products.

We target non-GAAP operating expenses to increase approximately $5 million in Q2, mostly due to higher expenses from the 14th week.

As a result, we target non-GAAP earnings in Q2 of $0.27 to $0.31 per diluted share.

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

We remain focused on driving adoption through innovation.

Our new products have improved payback and fueled growth in LED lighting.

Our SC3 LED platform is delivering more lumens per dollar, which means lower-cost LED lighting systems.

This transition has limited topline growth in LED components in the near-term; but, more importantly, it has helped drive LED lighting adoption while improving our competitive position and delivering margin improvement.

Based on the trends over the past few quarters, I think it is clear that we are on the right track.

As mentioned earlier in my remarks, Cree is the only pure play LED lighting company with a fully integrated vertical model.

This puts Cree in a strong position to drive innovation and drive the market, without the burden of traditionally inefficient incumbent technologies.

We probably have the strongest balance sheet in our industry.

And there's no question we've positioned ourselves to be the leader, and bring innovative new products to market faster than our competitors.

We continue to be intensely focused on our long-term goal of 100% upgrade to LED lighting and high efficiency power conversion solutions.

We believe this adoption will significantly reduce global electrical energy consumption and drive the growth of our business.

We will now take analysts' questions.

(Operator Instructions).

Brian Lee, Goldman Sachs.

Thanks for taking the questions.

Quickly, on the gross margins, they are up 100 basis points for a few quarters running here.

So I'm wondering, when you look at drivers, which ones have run their course, in your view?

And where do you still have more leverage?

And I'm also wondering, is the 40% bogey now a reasonable fiscal 2013 target?

Brian, to your first question, if you look at our targets for this quarter, we are targeting -- effectively, the middle of our range is another 100 basis points, at 38.5% on the non-GAAP number.

So I would say that there is, pretty much in all cases, it's the same levers as the previous quarters.

We're still doing things to reduce factory costs.

So I think there is more efficiency to be gained there.

We are seeing an increase of the new products, which are fundamentally lower-cost, both in LEDs and lighting, so I think that continues to give us some opportunity going forward.

I don't think in Q2 we'll see much utilization benefit, just with the 14th week.

It's probably going to be relatively similar to last quarter, plus or minus.

But then, we're also still working on yield improvement.

So if I look at the major drivers of the last few quarters, most of them are still available to us in our targets for Q2.

And we're going to try to continue to deliver incremental benefit going forward.

Obviously that's a bit of a function of volume and the overall revenue growth, but I think there is continuing things we can do.

As far as where the long-term target is, I have to say our focus at this point is keep our heads down, try to make incremental improvement, focus on the drivers, and we'll see where it takes us.

I don't want to make any predictions at this point.

I am pleased that this is the fourth quarter in a row we've made progress.

And I think we really just want to build on that.

Part of the variability is -- while it's possible, it's hard to give anyone timing, because we just don't have great visibility on the demand environment.

And without that, it's a little bit -- a little hard to put out a target.

Okay, fair enough.

No, that's helpful.

Maybe just a quick follow-up.

Since you mentioned utilization rates, it doesn't sound like you are getting a whole lot of leverage right now from that particular lever.

But can you help us frame maybe the margin impact that you could see for, let's say, every 5 percentage points of higher utilization for me?

Thanks.

Yes, I think it's becoming less of a lever.

And the reason I say that is, we still have an opportunity to increase utilization.

It's probably more of a benefit in terms of giving us volume upside than it is to give us a significant gross margin impact.

Because if that was all LED chip revenue, it's a big number.

But when you're really looking at the fact that most of that revenue is coming from the LED components business, which gets a partial benefit from fully using the factory.

But the LED lighting business gets -- it's even a lesser impact.

There is some incremental benefit left there.

But I think in terms of -- to the overall business, it's probably smaller than we perceive, only because so much of the growth is coming in the higher value-added products.

It doesn't mean we won't get some as we drive that up.

But I think it's as important to focus on some of the things we're doing in terms of the new products, the yields and just the factory costs, as it is the utilization at this point.

Chris Blansett, JPMorgan.

Thanks, guys.

Chuck, I wanted to touch on a couple of events that happened in the past and how you think they are going to affect the Company going forward.

One was your agent transition, we're about six months past that -- 6 to 9 months past that.

And secondly was the acquisition of Ruud and the potential disruption of supply to other competitors.

So maybe if you could give us an update on how you think that's going to affect the Company over the next six months?

Are we largely through those disruptions?

Is there still some more to come?

Yes, Chris, I'd say so.

If I take the first one, agent transition, we are six months into it now.

You can see that the lighting business had a nice sequential growth quarter again.

So I feel pretty good that we're on the right track there.

Obviously, your agent team is always kind of a slowly evolving thing, because people come and go.

But I think, overall, we're in the right place there.

And probably more of our focus is less on the transition and more on the fact that, at the rate we're introducing new products, I think one of the challenges, not just for Cree but for everyone, is that the lighting industry has never had to absorb this many new products this fast, that are constantly changing.

So I think we're going to have to, as well as the rest of the industry, get better at dealing with more new products fast and making sure that we've always got the best product in front of the customer.

The product cycle is so much faster.

But I think that's something we all face, and we are working on that.

Feel pretty good about where we're at.

When it comes to the acquisition of Ruud and what that did to our customers -- and I think I maybe made a similar comment last quarter -- I feel like we have kind of moved beyond that at this point.

There was obviously some customers that raised some questions and concerns.

But we are over a year into it, and we've been competing on the merits of whether our LEDs help our customers or not.

So at this point, I don't see that being a significant factor on the business, at least in terms of changes to it.

I think that has been built into how people think about us and what we are doing in the market.

And we're back to trying to compete on the merits of the LEDs.

And the fact is, is that the only place that had an impact really was in North America.

So I think it's had a much less effect globally than anyone thought.

Or, at least, as in people perceived, I should say, it's very similar to what we thought.

And in North America, I think there is a little bit of disruption, but about what we thought there, as well.

I think we're moving forward.

Okay.

I had a quick follow-up related to your thoughts on seasonality of LED lighting this year; a lot of new products coming and going, and how you think that affects the trends this year and next year, with a lot of changes, as you said, in the product availability?

The good news is as we bring new products out, they are generally better in terms of price/performance; they have better payback.

So I think we're making the business model better.

At the same time, there is a lag, as you know, because it's just -- the cycle to take a new product out there, get it put into a project and convert that, is typically a 6-to 9-month process at a minimum.

And on some of the bigger jobs, it can be longer.

Obviously there is upgrade-type business where you are basically switching out products, so that's a little bit quicker.

But I think it adds an interesting dynamic.

I don't know if I can quantify it for you, other than it's a constant cycle, and it's one that -- I think if the channel had its way, it would be a lot easier if things went a little bit slower.

But we are still chasing incumbent technology.

So we're going to keep pushing really hard to get the best products out there to take on the incumbents.

Because, as I made a comment earlier, our goals is 100% LED.

I think we're going to just have to manage that, and work through it with the channel.

And, at the end of the day, if it makes the economics better, I think it will carry the day.

Dale Pfau, Cantor Fitzgerald.

Good afternoon, gentlemen.

Thanks for taking my question.

Couple questions, Chuck -- could you break out, just a little bit for us, your regional distribution on both lighting and LEDs?

And then I've got a couple of follow-ups here, real quick.

Yes, Dale, I don't have a specific number for you.

We only do the regionals on an annual basis.

And so I think if you saw that we are sitting there at about -- boy, I'm trying to remember what the numbers are.

It's, I think, about one-third China; about 15% is in Europe; about 40% of our business, or a little bit less, is North America; and the rest of the world makes up the rest.

But that's for the whole Company.

In terms of lighting versus LED, I would tell you that most of the lighting revenue -- the vast majority -- is North American.

There is a little bit of business in Europe and there is even less business elsewhere.

So it's primarily a North American business.

And then I would say that the LED business is probably Asia first; North America second; and Europe third.

But I don't have a specific breakout for you.

Okay.

And could you talk a little bit about where you are seeing particular pockets of strength, and where you are seeing pockets of weakness?

Maybe on the lighting side, talk about indoor, outdoor -- and I'm particularly interested in North America and Asia right now.

Yes, so, if I think about the lighting business or the fixture business, I think we're seeing growth in both indoor and outdoor at this time.

We know there's a bit of seasonality coming.

We know that outdoor tends to slow down a little bit in the winter months.

So we're not there yet, but I would expect that business to go a little slower as we get into -- probably, end of this quarter, early next quarter.

But in terms of what we've seen in Q1 and what our targets are in Q2, I think we are targeting growth in both of them.

If I look at it on a more global basis -- which now is not really the lighting business, but really a way to think about it from an LED standpoint -- we saw solid business across the world.

So, Asia, US, Europe, did fine.

Europe is obviously a lot smaller than the rest of them.

And it's probably had the least -- or, it has probably the most caution in that business for us.

And then I would say that in Asia what we're seeing is there is definitely -- there is building momentum for LED lighting; although I would say that the market there is a bit cautious in the short-term.

But I think the caution there has as much to do with the fact that -- I think we underestimate what it's like for them to go through a leadership transition.

And my sense is, after spending some time there a few weeks ago, that people are optimistic, but they are cautiously optimistic -- kind of waiting to go through this transition.

I think we'll get a lot better sense of China and how that market is going to respond after we get through that later this quarter and we get to the holiday.

So I think it will be interesting to see where that goes.

But I'm cautiously optimistic about China as we get into the first part of next calendar year.

And right now, I think we're going to kind of just see what happens, given that there is a lot of things going on there right now.

Andrew Huang, Sterne Agee.

Thank you.

I know you don't provide guidance beyond the current quarter, but can you give us a sense of whether there is going to be any kind of seasonality in the March quarter, especially now that lighting is about one-third of your revenue?

Well, Andrew, to follow up with what I was saying earlier, I think we have two trends in our business that -- at least we have seen in the past, have a seasonality to them.

We know that the outdoor lighting piece of the business tends to be lower, seasonally lower, in the winter months, which would be our Q3.

And we know that the LED components business tends to be seasonally lower, on average, in the March quarter because of Chinese New Year.

You effectively have one and a half weeks that don't exist in the quarter just because of the shutdown there and the holiday.

I think those are the kind of things that we are keeping an eye on.

With that being said, the offsetting factors are what is going on in the rest of the business.

A little too early to give you any specific numbers there, but I think -- and we just don't have that much visibility.

But I think, we'll have to keep in mind -- my guess is, we'll have some seasonality in the two areas I mentioned.

The question will be is what the offsetting factors are.

And at this point, it's too early to call.

Okay.

And then, I think on the last call you talked about pricing your lighting products aggressively in order to displace incumbent lighting solutions.

So my question is, with this strategy, how should we think about the direction of gross margins in lighting products over the next few years?

Well, how about I give you, maybe, a more short to midterm view, maybe not a few years out.

But if I think about what we're doing today is, we've been working like crazy to get to the next generation of products and then get to the next generation.

The idea being is that as we shrink the gap between LED lighting and the conventional technology, we are going to increase the rate of adoption, which is good for Cree and good for the industry overall.

We continue to take a pretty aggressive approach as we go after new projects.

It doesn't mean we don't want to make some incremental improvement; that is our goal.

And you saw that in the last quarter.

But at the same time, it's to drive adoption is probably the overriding factor.

So I think we'll stay in an aggressive mode here for the next foreseeable future.

We are trying to target, at the same time, incremental margin improvement.

But I think we're going to balance those two with driving the market.

As far as exactly how that balances out, it's going to be a function of a lot of different things; some of which we control, and some which we don't.

So I don't really have a specific forecast for you on that.

Smitti Srethapramote, Morgan Stanley.

Yes, thank you.

You mentioned on the last quarter's call that you saw a macroeconomic headwinds, also.

But you've mentioned that macrofundamentals in North America were stronger than the rest of the world.

Can you comment on whether you've seen any changes to the outlook for the North American market over the past quarter?

Yes, I would say I haven't seen a change in -- pretty much in any of the markets.

I'd say that it's still the same general feeling, both in North America, what we're seeing in Europe, and what we are seeing in Asia.

There is a caution, generally; but if I was to say, of the three markets, the North American market feels a little less cautious than the other two right now.

Great.

And maybe a quick follow-up to that.

As you think about topline growth in the coming quarters, can you help us get a sense of how much is coming from increased penetration among existing customers versus orders in new customers?

Well, you have to think about that probably a little bit by product line.

In lighting, almost everything we get is new customers.

Essentially, we're trying to drive adoption.

One way to think about LED lighting is, almost every LED lighting order is effectively share gain from some conventional technology that would have been purchased otherwise.

It doesn't mean we don't have repeat customers; we clearly do.

But it's much more about expanding the number of customers, the number of projects, in LED lighting.

I'd say in the LED business, it's probably more mixed.

We obviously are trying to get designed into some of the major players.

And so growing share there, or growing with them, is an important piece of it.

But at the same time, if you look at the level of LED lighting penetration, there still so many lighting companies that have not fully engaged into the LED side of the business.

I think it's probably -- there's a significant waiting on both sides.

I don't have a percentage for you, but there I would say it's a little bit more balanced between the two approaches.

Jed Dorsheimer, Canaccord.

Thanks.

Chuck, the first one on the components business and the successful introduction of the SC3 product family -- you saw benefit this quarter, certainly in gross margin.

We're seeing that flow through next quarter.

If we look at the customers that have transitioned from the XP-E product family to that XP-G, XP-D, product family under the SC3, what percentage do you think at this point have now been qualified?

Or where are you in this transition?

Are we 50%?

One-third?

Or do you think you're closer to 75%?

Jed, what I would say is is we are, in terms of customer activity, we are ahead of the actual revenue.

In Q1 it's significantly less than 50%, but it was significant.

So it's significant, but it takes a while.

I'd say probably, in terms of customers getting them to design in, we're probably, at the customer level -- and this is not revenue, but this would be who is working on it -- I think we're past the 50% point.

I don't have a great number for you, how far, but I think we're over half.

But there's a lag, obviously, as you know, between getting the customer to essentially start the new design, or build the new design, and turning that into the production.

I think if you're looking at it from a customer activity standpoint, we are pretty far down the road.

I think, in terms of how fast it flows through the revenue and how the product line shifts over, it's going to take several quarters.

And even then, there is going to be legacy designs where -- there are some customers that aren't going to switch any time in the near-term, just because -- for whatever reason -- their particular lighting product, it may not be worth it to them to go through the design until they get ready to do a new rev cycle there.

I think it will be mostly throughout this fiscal year in terms of converting the product line revenue.

But there will still be some holdovers.

And, frankly, by then, hopefully we'll be working on the next generation, whatever that will be.

Okay.

And then as my follow-up, just moving over to the lighting systems business, and just digging into the channel a little bit more in this idea in terms of driving the market, and the balance between what we as investors want to see in terms of getting some of that leverage.

As we look at the outdoor versus the indoor, and we look at your product portfolio, in the Depots here in the Northeast, your products are right around $20.

And certainly we've seen a massive increase in terms of percentage of adoption.

At what point do you think that you'll be able to pull back a little bit there?

Or do you think it's just going to be a shifting between leverage in indoor and then giving it back to the outdoor, and that it kind of balances out for the next year or two years?

Just a little bit more detail on the strategy there would be helpful.

Yes, Jed, I think it's probably -- I understand why -- so, indoor/outdoor is probably some convenient buckets, but probably not how we're thinking about it.

It's probably more application driven.

Obviously, we've done some things with Home Depot to really drive consumer awareness of that product.

At the same time, we have activities, depending on certain types of outdoor projects, where we might be equally as aggressive on that side because we want to go after some incumbent technology that hasn't been taken on.

I could probably come up with a similar example in downlights for the commercial markets; or troffers or some of the canopy lighting.

It's kind of moving around.

It's a bit of a -- it changes as we come out with new products that give us the ability to go after it.

And it happens to also come down to which incumbent technology is available or ready to be gone after.

The example I'd give you is, in our new EDGE high-output area light -- think about it as something you might go after a car dealer.

That was really designed to go after a very specific application.

And we're going to try to push that one over the edge.

Because they know that there is an incumbent technology that, really, we think we have a much better value proposition on.

At the same time, frankly, there's a lot more street lights we're doing, but that business we've got some more momentum.

So we are going to potentially position that a little bit differently.

So it's going to move around.

I think it's going to vary with -- it's a combination of strategy and opportunity available to us in the market, and what the channel gives us access to.

So it's hard to give you any one of them.

But I would say, and just generally, we are going to be in investment mode in various product categories in terms of trying to move them for the foreseeable future.

Just because, in the grand scheme of things, there is still -- in most commercial applications -- still a gap between LED and the incumbent, and we just want to close it.

Mark Heller, CLSA.

Thanks for taking my question.

Just a follow-up on the March quarter.

Again, you are on a 14-week quarter this quarter, but going to 13 for next.

So should we assume that OpEx will go back down in the March quarter?

Yes, Mark, what I would say is the majority of the increase this quarter is the 14th week.

But we are making incremental, additional investments in the business.

As you think about the March quarter, we obviously won't have the 14th week.

But at the same time, we have generally been making incremental investments each quarter.

Now, we haven't set that plan and fully fleshed out the targets, so it's a little hard to give you an exact number at this point.

Yes, we'll lose the 14th week.

But the thing I would keep in mind is, is that we are also still investing in OpEx.

So it's a little hard to give you an exact number to put in there at this point.

Okay.

And can you also give us an update on the 6-inch wafer transition?

Yes, so we made some incremental progress again.

What I'd say is, it's a pretty methodical approach.

We're trying to slowly increase the volume as the business warrants.

But it's not something we're pushing to do really quickly just because of -- the same trade-off we have had in the past, which is we'd prefer not to bring on new capital when we have existing capital to solve the problem.

It just doesn't give us much leverage.

We are moving down that road.

And I think over the next several quarters we should incrementally be shifting that percentage.

That being said, at the current rate we're going, while 150 will continue to grow, we'll still have a reasonable portion of production on 100 millimeter at the end of the year.

It will be decreasing each quarter, but I would say it's pretty methodical at this point.

It's not a quick transition.

Daniel Amir, Lazard Capital.

Thanks a lot.

A couple of questions.

First of all, what needs to happen in order to return to the growth rates that the Company saw 18 months ago, a couple of years ago?

Is it really your lighting products?

Is it really more, China needs to take off?

Is it more, new construction needs to happen in the US?

What is your takeaway as how we should -- what factors we should be looking at?

Daniel, we know we don't control the macro, and so we're not even going to try to there.

And obviously that's going to always be something that's either a headwind or a tailwind.

I don't control it; not going to worry too much about it, other than we're cognizant that it's out there and it does affect the business.

If I think about what the growth drivers are, we obviously have the lighting business which has been growing nicely each quarter over the last few.

I think we're going to continue to push that.

And it's really a game of how do you drive adoption.

Get the new products out; build the channel; access more customers; make them aware of what LED lighting can do; keep improving the value proposition.

If you drive adoption, then we should be able to drive growth in that business.

On the LED side, which is the other piece of this, really over the last several quarters, we haven't had much topline growth.

Now, that being said, we've actually made gross margin improvement each of the last few quarters, which I think is probably the more important piece.

And that has a lot to do with the SC3 transition.

We've offered our customers twice the lumens per dollar, so the lumen growth in our business is significant year-over-year.

But because of the significantly lower-cost new products, we've really limited the topline.

It is the right thing to do for our business, not only in terms of our competitive position; but, as I said, it helps the margins.

It's going to take several quarters to work through that.

And so I think as we get more and more products through that transition, then -- with LED lighting adoption growing, then, I think -- give ourselves the opportunity for the LED product line to also start to deliver more sequential growth than you've seen.

That's the plan right now.

And we're going to just keep going down that road, knowing that the macro is going to have -- it's either going to be helping us or hurting us a little bit.

But, again, I think our focus is what do we control.

Okay.

And then, on the gross margin, you mentioned a number of factors here in terms of impacting gross margins.

What is the biggest factor?

Is it really utilization?

Is it really yields?

Is it really product mix?

What's the biggest factor that would be determined -- how we should look at gross margins into next year?

Look, I know everyone wants it to be one thing; it's not.

If you look at what we've been doing over the last few quarters, without a lot of -- the easy lever is -- the semiconductor company that gets a bunch of volume and fills their factory; you get that one pretty easily.

We've only gotten very incremental benefit from utilization over the last few quarters.

This is being done -- I'll call it the old-fashioned way.

We're basically figuring out how to run the factory more efficiently.

We're developing new products which are cheaper to make, and fundamentally designing cost out of it.

In addition to some utilization, we are working the yield side of the equation, which also gives us benefits.

It's going to take -- it's taken all those things to get here.

They are all significant contributors.

And we're going to have to keep doing the same thing.

I think that, as you reduce the factory costs, you start to wonder how much more efficiency you can squeeze out.

But we've been doing that for a while, so we're going to keep trying to do that.

I think the lower-cost new products, that's a function of how will we do the -- drive innovation.

We're going to keep looking, not just to get the new products converted.

We're not stopping R&D.

We're trying to develop the next generation of lighting products and the next generation of LEDs.

If I look at those two things plus yields, those are probably the levers that we have the most control over.

And those are the ones we're going to focus on.

Obviously, additional LED volume will give us some utilization benefit.

But in the grand scheme of things, it's probably a secondary benefit to those first three.

Vishal Shah, Deutsche Bank.

Hi, thanks for taking my questions.

Chuck, two questions.

First, you mentioned margin improvement in the next quarter.

Can you talk about whether it's going to be similar in both the lighting and LED products?

Or should we assume one benefits over the other?

The goal is is that we've -- our target is to basically make incremental improvement in all three product areas.

Obviously, power and RF is a lot smaller.

And it's going to vary a bit with what that revenue does in the short term.

But on the other two, we're really targeting some incremental improvement in both.

That has been working for us over the last few quarters, and so that is where the focus is.

It's by no means -- each quarter, you've got to find a way to squeeze a little bit more out.

So far the combination of the new products, as well as the cost reductions and the yield, has been working.

And so we're really going to look at that.

And that applies in LEDs, but it applies in the lighting business to.

There are things we can do from an efficiency standpoint, as well as these new products we're bringing out; give us some better cost leverage, and will let us go after some different price points.

Both LED and lighting is going to be the two drivers of it.

But we need to -- our targets are built on that concept that we really need to make progress in both of them.

Okay, great.

And then, just one other question.

You increased your tax rate assumptions for fiscal second quarter and the full year.

Is this based on the assumption that you're going to see more revenues from North America, relative to some of the other regions?

What are your top thoughts on that?

I want Mike to jump on that one.

Yes, I think relative to North America or other higher tax jurisdictions, that's where we are seeing the earnings in.

And is that being driven mostly by better penetration and improving momentum in the outer lighting market?

What is there?

Actually, I'd say it's more of a regional -- I think what you're seeing is is that we've seen the North American market overall be a little stronger than the other markets than we originally targeted.

So I think it's really just a shift regionally, not only in the lighting product line, but a little more broadly than that.

Amir Rozwadowski, Barclays.

Thank you very much, and good afternoon, folks.

Chuck, I was wondering if we could talk a bit more on the pricing front; particularly, where do you stand in terms of price points in your systems business versus the traditional side?

Clearly you guys have been making a number of product improvements and launching new products.

But I was wondering what that gap is, and where do you expect it to go over the next year or so?

Yes, so that's a little bit tough.

If you think about lighting fixtures -- because it's going to vary in every price point; and it's going to depend on what we are competing with.

There are examples today where we have our new XSP streetlight is going to compete very favorably against certain types of outdoor lighting.

And it's going to still be more expensive than some of the cheapest low-end outdoor lighting products, for example.

If you look at the downlight business, we have our -- as, I think, Jed mentioned it earlier -- you can buy our CR6 downlight from Home Depot, I think, around $20 with rebate in the Northeast.

That's going to compare really favorably with some traditional things.

At the same time, if you take a commercial view, we have commercial LED downlights that are almost price parity with CFL commercial downlights.

So we have examples where we are very close.

But then if you go into the troffer business, we have -- our new CR22 and CR24 troffers that we came out with are fundamentally cheaper than the previous generation.

But if you get into some of the really lower-cost linear fluorescent products out there, then there is still a price gap.

It's hard to give you any one number, because there is no -- there really is no such thing as a standard in lighting.

You've got to pick what you are competing with.

So I would say we are ranging from being almost at price parity, or within 20% in probably a few cases to 2X the upfront costs in a number of other cases.

And in some cases, we are probably still 3X to 4X the cost, depending on what you're looking at.

There is a range; and, really, the goal is for the target markets, how do we keep driving that down, generation by generation?

I know it's kind of a broad-brush answer.

Unfortunately, there's no one answer to the question.

It's helpful.

As a follow-up, as we approach price parity for some of these applications on a like-for-like basis, for example, do you believe that that is what will drive the initial inflection point for demand?

Or do we need to have a better, improved macro environment with respect to new construction build, or people feeling a little bit better about spending capital on retrofits in order to see that inflection?

I'm just trying to assess whether it's you folks driving the price down to get that more competitive, or it's more of the -- we're already there, and now we're just waiting for that end market demand to pick up.

I want to make sure -- I think we have some examples of where we are there against certain types of conventional alternatives.

For the vast majority of lighting, LED is more expensive today.

So I want to make sure I didn't misrepresent the previous question.

There is definitely a gap in most of the high volume applications.

That being said, we know it's possible, because we are getting there in certain select applications.

What drives the market?

I think as you get close enough, LED adoption goes up.

And I think it goes up even if we are in a relatively tough economic situation.

The reason I believe it is, as you get close enough, then you really -- at some point, the payback is so quick on LED lighting that you are really making a fundamentally more expensive decision to put in the traditional one.

I'll give you an example.

If someone today is building a parking garage, or re-lamping a parking garage, they are going to have to look long and hard about why they are not putting LED lighting in.

Because the paybacks versus what is typically used in a parking deck, when you look at both the electricity consumption and the maintenance; it's pretty overwhelming today that you might pay a little bit more for LED lighting, but you are going to get your money back several times over during the warranty period.

And that is, maybe, the other subtlety -- as we extend the warranty periods, you make this a more compelling argument.

I think we're working the different variables.

I think the biggest key is, is that we've still got work to do to get closer to price parity.

Satya Kumar, Credit Suisse.

Hi.

Thanks for taking my question.

[Good to note], again, on the gross margins.

A year ago, it's been said that component gross margins will actually be up for you a year from now.

I don't think people have believed that.

But I guess you have benefited from these new products, like SC3, like you said.

Over the last year, your competitors have also benefited from a big adoption increase in LEDs in TVs.

I know you don't play in that market; but, nevertheless, the competition could increase more than usual in the lighting component side of things as we look into next year, because the TV part won't be a as big at tailwind for your competitors next year.

If you look at our gross margins, they've actually followed a fairly different path than many of the other guys in the business.

I think it is a function of the markets we compete in.

And I think it's also a function of the fact that we made a very big investment on the R&D side to try and innovate our way into some new, fundamentally lower-cost platforms, and that's what's paying off.

And we really worked out platforms optimized for certain applications.

Clearly, what happens in the backlighting market -- I would say it generally doesn't affect the short term.

But in the midterm, what that capacity does and what those guys try to do has an effect on the market.

Given what we've seen over the last year, it's been a pretty darn competitive environment.

I don't think we're thinking it's not going to be competitive.

Although at the same time, I'm not sure -- I don't see a catalyst to make it one way or another at this point.

I think it's going to remain competitive.

I guess I'm not a pessimist, to think that there is going to be a significant new round of competition.

I think people have made their investments, and we're dealing with it.

I think if you look at the capital rate people have been putting into the industry, it has really moderated over the last 18 to 24 months.

Will there be increased competition?

As long as we have a growing market opportunity, that's going to happen.

I think what we've got to focus on is keep innovating, come up with different ways to compete.

And that should continue to give us opportunities to win business in different ways than just by building big factories and trying to fill them up.

Yes, understood.

And then, a quick follow-up on CapEx -- selected cash flow -- how should we think about how much more room you have to grow your manufacturing before you start to significantly scale up your CapEx?

And on inventory, they like the fact that you've lowered and your inventory goes up.

Can you also give a sense of what you're inventories are at your distribution customers and in the channel?

Thanks.

Yes, I'll take that backwards.

Distributor inventory is relatively flat quarter over quarter.

So there hasn't been a significant change from the previous quarter.

And I don't really have a better sense of customers.

My sense is, customers are still maintaining very low inventories.

But we have less visibility there.

As far as CapEx, I think as Mike said earlier, we are thinking, at least in the near-term, that CapEx was going to be in a similar range.

It's a little bit hard to answer your question, because we've done so much innovation that, if you asked me two years ago, I wouldn't have thought we could have supported this volume with this capital.

Clearly the innovation side of the business has given us a lot more leverage than we expected a year or two ago.

We're going to keep pushing it as hard as we can.

We have some availability.

The key point is is that the chip factory has the most upside in it right now.

And so the idea is, is that we have available capacity, plus we have the ability to bring on the 150 -- much of that capital investment that we already made.

So I think, at least for the foreseeable short to midterm, we are in a pretty good position.

Obviously, market adoption rates and demand can change that fairly quickly on us.

But at least for the next few quarters it feels like we should be operating in this range.

Harsh Kumar, Stephens Inc.

Hey, Chuck, I was wondering if you could talk about how we should think about the growth rate of your lighting business?

Either midterm or longer term, however you want to address it.

Yes, Harsh; look, I think what we are hoping to do is continue to drive sequential growth in that business.

I'm not sure -- I think it's a little premature to know what the seasonality might do to it.

But generally speaking, we are trying to drive sequential growth each quarter there.

With that being said, that means we've got to keep innovating; we've got to keep investing in the channel.

What that rate turns out to be, I'm not spending a lot of time trying to make those predictions in the short term.

I think we're more focused on what are the levers to get there, which is really back to the conversation we had earlier.

We've got to keep bringing out products that improve the value position.

Because really what we're talking about is, how do you drive LED versus a conventional alternative?

That's really where the focus is over the next couple of years.

And this is about how do you make that value proposition more compelling.

If we do that, then I think -- not only Cree, but LED lighting in general, should see pretty solid growth.

And I think we're seeing that from a number of other people, too.

LED lighting looks to be gaining some traction, not only at Cree, but in a number of other lighting-related businesses.

Fair enough.

And then, Chuck, as a follow-up, I was wondering on the same business unit, on the lighting side -- you showed a little bit of improvement; about 70 bps this quarter in margins.

Can I ask you what you think is the biggest driver there?

Is it just the new products?

Is it something else other than that?

Harsh, I'd say it's both cost reductions -- figuring out how to do things more efficiently, taking costs out of the production; as well as getting the new products to start ramping up.

I think it's a combination of both of those that's driving the business right now.

Thank you.

And with that, that does conclude our time for questions.

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

Thank you for your time today.

We appreciate your interest and support, and look forward to reporting our second-quarter results on January 22.

Goodnight.

Goodnight, thank you.

Thank you, gentlemen.

Again, ladies and gentlemen, this does conclude today's conference.

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

Attendees, you may disconnect at this time.