Wolfspeed Inc (WOLF) 2013 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and thank you for standing by.

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 second 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, Tuesday, January 22, 2013.

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 second 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 you assist you.

Today, Chuck Swoboda, our Chairman and CEO; and Mike McDevitt, our Interim CFO, will report on our results for the second quarter of fiscal year 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 in our press release and financial metrics posted in the Investor Relations section of our website at www.cree.com under Quarterly Results in 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 will be limiting our comments regarding Cree's second quarter of fiscal year 2013 to a discussion of the information included in our earnings release and the metrics posted on our website.

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

This call is being recorded on behalf of the Company.

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

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

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

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

We are also webcasting our conference call, and a replay will be available on our website through February 5, 2013.

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

Thank you, Raiford.

Fiscal Q2 was another strong quarter as revenue increased 10% sequentially to a record $346 million, with non-GAAP net income of $37 million, or $0.32 per diluted share.

Revenue and non-GAAP earnings per share were higher than our target range due to stronger sales in both LEDs and Lighting and improved gross margins, which more than offset higher operating expenses.

Our results continue to demonstrate the leverage we have in our fully integrated vertical lighting model, which has enabled continued product innovation across our product lines and strong financial results.

The revenue trends in Q2 were as follows.

Lighting sales increased more than $14 million, or 14% from Q1, as we saw better-than-targeted growth for both our indoor and outdoor product lines.

LED sales increased more than $13 million, or 7% from Q1, which was on the high side of our target for the quarter.

Power and RF sales increased more than $2 million from Q1, which was slightly higher than our target for the quarter.

Non-GAAP gross margin increased 170 basis points to 39.2% in Q2, which was on the high end of our target for the quarter.

The overall improvement in margin was driven by factory cost reductions, increased mix of new products, and higher factory utilization due to higher revenue.

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

We continue to balance managing our inventory across our factories while responding to short lead-time expectations in both the LED and Lighting markets.

Inventory levels declined to 78 days on hand.

Cash and investments increased to $886 million due to solid execution, focused capital spending, and higher profitability.

Free cash flow was $70 million in Q2 as we continued to convert R&D investments into innovative new products.

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 slightly behind this point last quarter and in line with seasonal trends for Q3.

We are currently forecasting some softness in LEDs due to the Chinese New Year holiday and in Lighting due to the slowdown in outdoor lighting sales in cold weather regions during our third quarter.

Looking ahead, we target increased adoption to drive LED component and LED lighting revenue growth in the fourth quarter of fiscal 2013.

We remain focused on using new product innovation to drive our growth through market share gains against traditional technologies and opening new applications for LED lighting.

As we move into calendar 2013, we continue to work on new ways to drive adoption for LED lighting and build Cree's brand in the market.

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

Thank you, Chuck.

I will be providing a 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 historical summary of other key metrics.

For the second quarter of fiscal 2013, revenue increased 10% sequentially to a record $346 million, which was greater than our targeted range of $320 million to $340 million.

GAAP earnings increased sequentially to $20.4 million, or $0.18 per diluted share, for the second quarter of fiscal 2013, and non-GAAP earnings increased sequentially to $36.9 million, or $0.32 per diluted share.

Non-GAAP earnings excluded $16.5 million of expense, net of tax, or $0.14 per diluted share, from the amortization of acquired intangibles and stock-based compensation.

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

Q2 GAAP gross margins increased 170 basis points sequentially to 38.5%, and non-GAAP gross margins increased 170 basis points sequentially to 39.2%, which excludes $2.3 million of stock-based compensation.

This was at the high end of our non-GAAP target of 38.5%, plus or minus.

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

Second quarter fiscal 2013 revenue and gross profit for our reportable segments were in line or higher than our targets as follows.

LED Products revenue was $201 million, with gross profit of $84.2 million, for a 41.9% gross margin.

Lighting Products revenue was $122.7 million, with a gross profit of $41.4 million, for a 33.7% gross margin.

Power and RF Products revenue was $22.6 million, with a gross profit of $12.8 million, for a 56.6% 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 $4.9 million for the second quarter of fiscal 2013 and are included to reconcile to our $133.5 million GAAP gross profit.

We ended the quarter with $886 million in cash and investments, a $70 million increase sequentially, which resulted from higher profitability, good working capital management, and focused capital spending.

For the quarter, cash provided by operations was $92 million and capital expenditures were $22 million, including $4 million related to patents, which resulted in free cash flow of $70 million.

Operating expenses for Q2 were $108.4 million on a GAAP basis and $88.4 million on a non-GAAP basis.

Non-GAAP operating expenses were $2 million greater than targeted, due to higher sales and marketing spending that supported the higher revenue.

Non-GAAP operating expenses exclude approximately $12.3 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 $2.5 million.

Our Q2 effective tax rate was 26% for the quarter, which is higher than the 22% we targeted, due to overall higher profitability and a greater portion of our targeted fiscal 2013 earnings being in higher tax jurisdictions.

Days sales outstanding were 38 days as compared to 46 days at the end of September, as accounts receivable decreased $18 million to $145 million.

While inventory increased by $5 million to $185 million to support higher revenues, days on hand decreased to 78 days as compared to 81 days at the end of September.

Both metrics benefited from stronger demand and more linear shipments and production across the quarter.

Property, plant and equipment additions were $18 million for the second quarter.

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

In the near term, we target similar levels of investment as Q2 to support our strategic priorities to lead the market, drive adoption of LED lighting, accelerate cost reductions, and support incremental capacity as needed.

At this time, we target Q3 revenue to be in a range of $325 million to $345 million, driven by seasonal trends in our LED and Lighting segments.

We target Q3 GAAP gross margins to be similar to Q2 and non-GAAP gross margins to improve to 39.5%, 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 $2.4 million, while our non-GAAP targets do not.

We are targeting Q3 non-GAAP operating expenses to remain similar to Q2, as the Q2 14th-week spending will be reinvested to support increased marketing for new product introductions.

Our GAAP operating expense target is targeted to be similar to Q2 and includes non-cash stock-based compensation expense of approximately $11.6 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 Q2.

Net interest income and other is targeted to be approximately $2 million for Q3.

We currently target our tax rate to be 17% for Q3 and 22% for the full fiscal 2013 year.

The Q3 and fiscal 2013 tax rate includes a cumulative benefit related to the retroactive extension of the US Research and Development Credit.

This credit was extended with the enactment of the American Taxpayer Relief Act of 2012 on January 2, 2013.

Since this occurred after the close of our second quarter, a $1.9 million expected benefit for the period of January 1, 2012 through March 31, 2013 will be accounted for in our third quarter.

GAAP net income for Q3 is targeted to be between $17 million to $23 million.

Based on an estimated 116.7 million diluted shares outstanding, our GAAP EPS target is between $0.15 to $0.20 per diluted share.

Non-GAAP net income is targeted to be between $35 million to $41 million, or $0.30 to $0.35 per diluted share.

Our non-GAAP EPS targets exclude amortization of acquired intangibles, a 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 remain 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 lighting product line grew 14% sequentially in Q2, due to strong sales for both indoor and outdoor products.

This sales growth is coming from a combination of new products and overall momentum in our sales channel.

The new product momentum continues as we recently announced our revolutionary LM16 LED replacement lamp, which is designed to obsolete energy-wasting halogen MR16 lamps.

The product uses a single LED source to deliver precise optical control, glare-free lighting, and lower energy cost.

We released the next generation LR6-10L LED downlight with the industry's highest efficacy at 90 lumens per watt, which is 50% more efficient than CFL downlights and 30% more efficient than competing LED products.

We also released a high-output XSP streetlight, which is 35% brighter than the standard version, and opens a range of new roadway applications for this product family.

We continue to work on new lighting systems to further reduce the initial cost of LED lighting and improve the payback.

While our primary focus is on developing next-generation products for the markets we currently serve, we also continue to evaluate complementary new lighting applications that today are underserved by LED-based products.

Our goal is to find new ways to drive broader LED adoption and build awareness for the Cree brand.

As part of this effort, we plan to increase our marketing spending over the next few quarters to more aggressively promote our innovative new products.

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 saw an increase SC3 product sales in Q2, and based on the design activity, we target this product family to continue to increase as a percentage of LED sales over the next few quarters.

These products were designed into the recently released Best Buy insignia LED light bulb as well as into a range of customers' new lighting products.

We achieved an LED industry milestone with the release of our 200 lumen-per-watt XLamp MK-R LED, which delivers record-breaking efficacy.

We introduced the XLamp XM-L2 LEDs, which are the industry's brightest, highest performing single-die LEDs delivering 186 lumens per watt.

We also released four new CXA LED Arrays, which are the highest-efficacy lighting-class LED Arrays available.

While there is a lag time from when we introduce these products to when they are available in our customers' products, these efficacy levels should enable a new generation of LED-system designs that are not only lower cost, but set new standards for energy-efficient lighting.

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

We released our first all-silicon carbide high-frequency power module, which sets a new standard as the industry's first fully qualified all-silicon carbide module.

The new high-frequency module, which is targeted at power converters and high-voltage transportation applications, is rated at 100-amp current handling and 1,200-volt blocking.

This module allows higher efficiency, compact and lighter-weight systems that result in lower total system cost compared with conventional silicon-based technologies.

While the design cycle for these applications is typically 24 months or longer, this new module is a first step in bringing the full benefits of silicon carbide to industrial power applications.

We are focused on expanding this product family, over the next year, to give us access to additional applications.

In the near term, this business is operating in a similar range as the last couple of quarters, which is being driven by 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, LED components, and our power and RF product line.

We made solid progress improving margins over the last few quarters, despite a very competitive market environment.

In LEDs, we have to continue to deal with excess capacity in the market, although the growth in lighting over the last year has started to improve the supply-and-demand dynamic.

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 designs.

We remain focused on closing the price gap with conventional technology to drive adoption of LED lighting, which creates the growth opportunity for our LED and lighting product lines.

As I explained earlier, Q3 total-company backlog is slightly behind this point last quarter.

The LED and lighting sales forecast is trending flat to slightly lower in Q3, due primarily to seasonal trends.

The LED and lighting product lines continue to operate with short lead times, and the Chinese New Year holiday adds variability to our forecasts for the quarter.

Based on the current backlog, forecasts, and trends in the business, we are targeting Q3 revenue in a range of $325 million to $345 million, which is comprised of LED and lighting sales flat to slightly lower due to seasonality, and power and RF sales in the similar range.

We target non-GAAP gross margins to incrementally improve in Q3 to a range of 39.5%, plus or minus.

This target builds on the momentum from the last several quarters, as we continue to target incremental gains in factory efficiency and the benefit of higher new product sales to offset price declines.

We target non-GAAP operating expenses in a similar range in Q3, despite one less week, as we increase our investment in new-product marketing and brand awareness.

As a result, we target non-GAAP earnings in Q3 of $0.30 to $0.35 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.

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

Despite our success, we are not satisfied with the rate of LED lighting adoption.

With our broad understanding of the technology levers from materials through systems, we see opportunities to move the market faster.

LED lighting is not an incremental improvement for the lighting industry, it is a completely new way to deliver light.

It is an LED lighting revolution, and we continue to be intensely focused on our long-term goal of 100% upgrade to LED lighting.

We will now take analyst questions.

(Operator Instructions)

Chris Blansett, JPMorgan.

Chuck, you mentioned a number of drivers that are helping to improve your gross margin.

I wasn't sure if you could rank those in order of impact that you saw in the fourth-calendar quarter into Q1?

And then, potentially, give some commentary on how the pricing environment is?

Chris, I think the drivers -- it's pretty hard to give you a ranking because they are all, I would say, relatively speaking equal contributors.

So, factory-cost reductions continues to help us; that's a combination of lower spending and more efficiencies.

We have the benefit of an increased mix of new products, and we did get some benefit from higher utilization with the higher revenues last quarter.

They're probably -- that's probably close to the right order, but I don't have the specific breakout for you.

In terms of pricing environment -- my guess is you're probably specifically talking about the LED business, and I'd say it remained competitive, pretty much in line with what we had targeted.

I think it's better than it was one year ago; but at the same time, it's still very competitive because the fact is that there's more supply than demand on a broad basis, so that's going to continue to make the market pretty competitive.

Okay.

Second question is tied to the transition for -- that you have within the MOCVD and LED side for six inch.

How far along are you there, and how much overhead of output does that give you before you really need to start spending a lot again?

I'd say we made some incremental progress.

It's still a relatively small percentage.

I think I'd put it in the low double digits.

Now, we are making progress each quarter.

I think you'll see it go up here over the next couple of quarters as well as we just -- as we drive revenue growth, and the idea would be is to continue to increase that percentage over time.

So, I think in terms of what does it give us in terms of the ability to go further, it's a combination of things.

It's not as simple as just 150.

Obviously, as we start to see the increased utilization, while we still have upside in the factory, we are starting to see some of the first bottlenecks.

So, we are seeing it, and you see it in our targets with our capital, that we are seeing some incremental capital just to work on mostly bottlenecks.

Again, I'd say we still have upside, but it's a function more now of getting the balance in the factory right with the specific mix that is varying from quarter to quarter.

Brian Lee, Goldman Sachs.

I had two.

First, on the revenue upside, can you provide a bit more color on what specific segments or end markets drove the upside?

And then, where you might be seeing better-than-expected traction in certain new products like troffers or any others?

Yes, Brian, actually if I look at -- the answer to both questions isn't going to be much more specific because it was pretty broad-based growth.

We saw solid gains in our indoor product families, whether it be downlights [LR] or troffers, both saw solid gains.

On the outdoor, we saw nice gains in both the area lighting and in the street lighting.

So, I'd say both -- all the segments were growing reasonably well.

If you think about markets, probably easier to almost think about -- if you think about those products, that's a pretty broad set of markets.

Even if you look at it by channel, we saw solid growth pretty much across the different channels, whether it be some of the more large direct customers or the traditional agent and distribution channels.

It was a fairly solid growth for the lighting product line across the business.

Okay.

That's helpful.

And then, my follow up on the margins, maybe switching to the operating side.

OpEx is flat here on down volumes in March, so can we expect that as volumes pick back up seasonally in June, you could already be right sized from an OpEx standpoint and it would be flat again?

I'm trying to gauge the operating leverage potential in the near term.

Thank you.

Obviously in the short term, we've decided that we want to spend a little bit more money to really -- we really want to get customers in the market to understand that you can do things with LED lighting today that, frankly, the market doesn't realize is possible.

I have examples of meeting customers for the first time, and they are, frankly, surprised at what our current products can do, and they really don't have a good sense for what's coming.

So, I think we want to make that investment now.

As far as operating leverage, it's really all about we drive adoption and we drive the top line.

I think we'll see some leverage.

With that being said, I want to continue to invest in a little bit more methodical level because I think whether we are investing in R&D or we are investing in the sales and marketing side that we see an opportunity to generate a pretty good return in terms of making the market bigger and making our business bigger.

Andrew Huang, Sterne Agee.

When I talk to some of your incumbent competitors in the lighting industry, I often hear that Cree will have a tough time gaining mind share with lighting specifiers.

Can you comment on how you're addressing that?

Then, I have a follow up.

Andrew, I think -- look, there is no doubt that the large traditional players have been in this business a long time and they basically have developed really good channels and relationships.

Our approach is a little bit different.

We are focusing on a relatively limited number of big applications, but pretty focused applications, and our idea is if you develop really innovative products that change the market dynamic and change the application, then I think that's how you get attention.

So, we are going to keep innovating and showing people there's different ways to solve problems with LED lighting, and hopefully, show them there's things that LED lighting can do that they might not even realize is possible.

And, I think that will give us access to the specifiers and the people that will, in the end, buy the products.

Thank you.

Can you give us an update on what you're seeing in China, based on the government subsidies for lighting?

Yes, Andrew, not a lot of change on subsidies recently.

Obviously, they were going through the leadership transition there, but I'd say that no significant change one way or another.

I remain cautiously optimistic that we will see continued adoption in China as we go throughout the next calendar year; but at this point, no specific new updates.

Amir Rozwadowski, Barclays.

Chuck, you mentioned some of the conversations that you're having with some of your customers are still surprised by the opportunities provided by transitioning to LED lighting.

I was wondering, what type of update can you provide us in terms of the pace of those types of conversations?

Are you still needing to provide additional education when it comes to the cost savings that LED lighting can provide?

Are they a bit more educated when you approach some of them?

A little update there would be great.

We are definitely making progress.

If you just look at the last couple years, we can see the growth in LED lighting and we can see the growth in the rate of adoption.

Not only from an LED system standpoint, but as an LED supplier, obviously, we can see that in the amount of lumens we are able to sell and the number of new applications, so -- look, it's moving.

I guess my point there is really that even in a customer that's interested in LED lighting or has heard of it or is starting to become more aware, I think they underestimate the real savings that are available today.

There is still a perception in the majority of applications that LED is this new thing and it might be a way to save money, but that the old, reliable technologies are still pretty cost effective.

And, I think as we shrink the gap between -- the price gap between LED lighting and conventional technologies on one side, and we increase the performance on the other, I think people are pleasantly surprised when they actually do the math and realize that we can save them money, today, with the products we're making.

And then, if I may, a follow up.

It looks like your power and RF gross margins have been fairly strong the last couple of quarters, particularly compared with one year ago.

What's been driving this increase, and is it something that we should think of is at a sustainable level at these levels?

At the end of the day, that comes down to some great execution by our team.

And, it's really the levers, though, in the end are very similar to what we've seen in the LED side of the business.

We have made some great strides in terms of factory-cost efficiencies, both in terms of reducing costs on one side, but really getting some efficiencies and really some great innovation from a process standpoint that made the production lower cost.

We have new products that have come onto the market which, same idea, we're able to deliver more value at a lower cost, so that increasing mix has helped us out.

And then, as those two have come together, the incremental growth in the volume over the last quarter or two has definitely helped on that side.

It's really a combination of those pieces coming together.

I think the opportunity there is that we are still scratching the surface of the application.

So, we have a nice little business, but we think with some of the new products that are in development and where we can go, maybe not in the next couple quarters, but over the next couple of years, there's some larger, more mainstream applications that as these next generation products come out, and we can work with the end customers to think about system design to utilize them, that we can hopefully access some significantly larger markets, both on the power side, but also on the RF side.

It is going to take a little longer, but there is no lack of great opportunities.

In that case, it's just going to take us a little while to fully determine what the -- what we can deliver there.

Dale Pfau, Cantor Fitzgerald.

Yes, congratulations, gentlemen.

Fine quarter.

Fine outlook.

Thanks, Dale.

A couple of quick questions here.

Number one, your LED component revenue popped up for the first time in a few quarters.

Can you just talk about what led to that particular strength in the quarter?

Then, the second part of the question is regarding the guidance, which at the top end of your guidance is down just a skosh, and that's considerably better than traditional seasonality.

And, even with limited visibility, that's considerably better than I would have expected.

So, could you talk about the uppers to the upper end of that guidance that gives you the confidence to give the upper end of the guidance there?

Thanks.

Dale, the LED component growth, I think it is really a combination of getting the new products timed to get designed in and finally gaining some momentum.

We are working through this transition to the lower-cost platform, so the lumen growth has to be pretty solid to offset the fact that we are offering more lumens per dollar on the component side.

I think we just -- it was one of those quarters where new projects and some of the adoption really started to move that forward.

So I don't -- it's pretty broad-based; it's not one specific customer.

I think it's just finally gaining some momentum from all the new product activities that we've been working through over the last year.

As far as the guidance goes, if you think about it -- our basic message is that LEDs and lighting are flat to down seasonally, and so if you think about the top end of the range, that's -- we are looking at relatively flat revenue from this quarter, which would say those businesses do better and offset whatever seasonality is in there.

If you look at the middle, that's kind of got the middle of the seasonality range in it.

And then obviously, on the lower end, it says that that affects a little more, and that's really coming from the visibility.

How's it possible to grow despite the seasonality?

I think we're pretty encouraged by what we see in lighting, so that while outdoor is typically going to have some seasonal slowness, we had a pretty solid growth quarter, obviously, in Q2.

So, we would expect to see some of that momentum continue.

So, it's a little bit -- without having great visibility, we're trying to estimate what the growth that we're seeing on indoor and some of the certain projects could do to offset that seasonality.

So that's kind of the one side of it.

And on LEDs, it's kind of the same thing.

You saw some solid growth last quarter, so it's a bit of a hedge.

I don't know what's going to happen post Chinese New Year.

I think we'll wait and see how it comes out, but that's how you can get to the high end of the range.

Okay.

One last question, you've done great things on the gross margin.

Can you give us some thoughts about where you think gross margins could get back to over the course of the next 12 months?

Yes, Dale, I'm going to stick to my story which is -- our goal is try to drive some incremental improvement across the businesses this quarter, and we are going to try to do it again next quarter.

There's so much of a swing factor when it comes to what the new product mix is, how fast the uptake is, on one side.

And then, the market factors on the other side; obviously, we've been fighting a pretty good headwind in LEDs, here, for 18 to 24 months.

At the same time, I think as we continue to drive adoption, we will see more and more market growth coming forward.

It's a little hard to call where that's going to go.

I think what we can see in the near term is we see some levers, at least the ones that we control, that should give us the opportunity to make some incremental progress; and then, we're going to have to adjust to whatever happens in the market around us.

No longer-term targets, other than, we're going to try to make some more progress this quarter.

Vishal Shah, Deutsche Bank.

Chuck, just wanted to understand what percentage of your revenues for both LED products and lighting products came from new -- some of the new products that you've introduced recently?

I don't have a specific breakout for you.

I would imagine that, depending on what you consider new products, if we look at stuff that was developed in the last year, my guess is that, rough numbers, products introduced in the last year are probably 50% or more of the business right now.

Okay.

As you think about the next couple of quarters, are we looking at -- is that number increasing to 70%, 75%?

Or, it's going to be more gradual?

No, you have to remember, it's a continuing flow, right?

I don't know that that percentage is that different than what it would have been if you asked me this question 18 or 24 months ago.

The basic strategy is continue to innovate across the product lines.

So, we're generally in the business of obsoleting our own products, try to do something that drives adoption, and then drives the market further.

Today, SC3 is a big part of the LED business.

I would hope that we will be able to continue to develop new generation platforms and bring those to market and continue to drive that adoption on the LED side.

And, I think on the lighting front, in many of our products we're on the second or third-generation products today, and the goal would be is that, how do we drive to the next generation, pretty much across that product line.

We see opportunities on both sides to continue to come out with not only performance enhancements, but improvements to the cost per lumen, so that's really where our focus is.

If we are able to achieve our targets and really continue on the path we've been on over the last couple of years, I would think you'd see that remain a relatively high percentage.

That's great.

Thank you.

One other question on the lighting business, your margins improved nicely at almost 34%.

What do you think about the longer-term target for that particular segment as you think about the competitive environment?

I think you had said in the past that your goal is to drive adoption and you continue to spend on OpEx, so is 34%, 35% the longer-term target?

Or, do you think you can get back to the 40% levels that you've seen in the product side?

Yes, I'm not putting on any long-term targets.

What I'd tell you is on lighting, and it's pretty similar in the other ones, we think there are levers available to continue to innovate to reduce the cost of those systems.

Now at the same time, we're trying to reduce the costs partially because we want to continue to close the price gap with conventional technologies.

We are trying to drive adoption.

So, we are kind of balancing those two.

I think there's opportunities to drive costs down, and I think there's opportunities to use -- as we shrink that gap to drive more adoption, and we're going to try to balance those two, but in the end -- the big goal in the short term or in the mid term is to drive adoption.

Hopefully, we can do that while also achieving our other target, which is to make some incremental improvements.

But, we are going to keep pushing, and I think there's lots of technology to be developed, just it's a matter of how it comes together each quarter.

I'm sure there will be variability along the way.

I see opportunity to -- I really see continued opportunity both, not only in lighting, but really across our businesses to drive more innovation and take cost down.

Jed Dorsheimer, Canaccord.

Congratulations, Chuck.

Nice job on the quarter.

Thanks, Jed.

Just in the -- one of my concerns was around the margins in the lighting systems as you ramp that business.

This past quarter, can you give us any additional visibility into what the mix shift was?

Was the 200-basis-point improvement mostly a function of new products that were getting into the market?

Or, was it a shift between, say for example, direct versus big box in terms of channel?

Jed, what we saw is that, obviously, new products grew, but we also saw -- it was pretty much across product lines.

We definitely got a benefit from new products.

We got a benefit from, frankly, higher volumes and some lower factory costs.

As we're able to scale that up, we're getting some cost leverage there.

And then, if I think about it from a channel standpoint, we really saw growth pretty much across most of the major channels.

So, I don't know that the channel, or where the products got sold, changed it a lot.

We saw pretty solid growth both, not only on the direct side, but on the agent side and on the distribution side.

So to me, it's more about cost leverage from an execution standpoint and the new product benefits.

And then, your comment in terms of variability post Chinese New Year -- sorry, could you just elaborate on that?

What are -- is it a question or concern in terms of whether or not China turns on post Chinese New Year, or what is the concern there?

It's really a concern of visibility.

As you're aware, we go into this -- we come into the quarter, you basically run the first part of the quarter, and then essentially, many of our China customers will shut down for a week, plus.

So, I think for us, it gives us limited visibility to what demand is -- look, we have short lead times anyway.

It's more of -- until people come back and we can kind of see what the momentum is post Chinese New Year, it just adds variability and uncertainty.

No different, I would say, than any other year when we go into the Chinese New Year.

It's just it's a reminder that we have short lead times and our customers have a fairly long gap right in the middle of this quarter.

Satya Kumar, Credit Suisse.

Thanks, and a good quarter from me, as well.

Chuck, the December quarter last year was the first quarter I think we can make a clean comparison from the year-ago period for lighting business in terms of growth rates and it seems like it was the high 20s.

As I look at your March guidance, it seems like the implied revenue growth rate is actually accelerating to the high 30s.

It feels like from your comments on OpEx, you think that the growth could further increase, and you're investing more in OpEx.

How do you think about the underlying system, lighting systems growth rate, and how we should think about that over the next 12 months?

Yes, I think if you think about it on a 12-month basis, what we're trying to do is turn on some pretty big applications.

I think we have to be a little careful when we do the quarter-to-quarter numbers because there is variation depending on which segment happened to grow and timing between segments, right?

If you look at on a year over year, I would say that we think as we bring more new-generation products out and we close the gap with traditional products, LED lighting adoption should certainly increase, and then it's up to us to be able to make sure we get our fair share or better in that growth.

I don't have specific numbers for you, but clearly, the value proposition for LED lighting versus conventional technology is a lot better today than it was one year ago.

And if we keep innovating, it should continue to get better, and I think that will push us more and more into mainstream applications which should definitely expand the market.

Now, we have to then execute to make sure we get our piece, and that's where the investment comes from.

We want to make sure we're prepared to position Cree, our products, and Cree as a supplier of LED lighting systems as one of the people out there that people should be thinking about first.

Yes.

I think you gave plenty of color around this power and RF.

You seem pretty optimistic on these new products that you're coming up with that are addressing new applications.

Is there a way for us to think about the relative size or magnitude of the market that you currently address with this $80 million, give or take, revenue that you have in the power and RF business?

And, what the [time] expansion looks like, is it a factor of 2 or a factor of 10 in terms of these new markets that you're looking at in the power and RF business?

It kind of depends on how you want to define the market opportunity on power and RF.

If you think about it, our power devices basically compete anywhere you see 600-volt and higher discrete power devices today, which is a fairly large piece of the semiconductor business, dominated by silicon-based technologies.

Now, as a practical matter, we compete in a fairly narrow segment of that because we're really on the ones that are looking for some performance advantage today because the premium on silicon carbide's relatively high.

If you look at RF, same idea, primarily military applications, but you do see -- we do see some of the first commercial applications starting to take a look at gallium nitride on silicon carbide MOS.

So, I'd say we are a pretty small piece of a large potential market, so what we see happening is as we get to next-generation products, we should be able to access much larger chunks of that.

What's the size?

If you look at what the power market is, in the voltages we're talking about, it's a multi-billion dollar market.

If you look at the RF side, you're roughly looking at probably, maybe not quite $1 billion market for high-power RF.

It's maybe $800 million to $1 billion, in that range.

So, these are large potential market opportunities, but I would caution you, the technology has very interesting capabilities.

We think we can make it more and more relevant to these mainstream applications, but this is a big shift and there's a lot of work to show people how to use this technology to make their products better.

One of the keys is, much like when we started in LED lighting, you're going to have to think about the system design differently to get the benefit, so there's going to be a time lag to working through that.

But definitely, some very large potential upside in terms of the market.

Joseph Osha, Bank of America Merrill Lynch.

My congratulations on the great numbers.

Chuck, you had said before that you weren't that interested in the retail downlight market because of some of the ASP mechanics there, but you do seem to be talking a little bit more about that as I listen today.

Have your thoughts changed about what you want to do in the retail business?

When we first got into the retail downlight business, it was really an experiment where we had a way to make a downlight that Home Depot could sell for less than $50.

Between the two of us, we said let's try it and see what would happen, and I think it's obviously been a great experiment for both of us.

Essentially, the category of a retrofit downlight doesn't even really exist until we try that product out, and it let us put LED lighting in the hands of consumers in a way that most people would have said there was no consumer appetite for that.

One of the things we've learned is that, while the big market is commercial, there is -- it's interesting to let consumers work with the technology because, frankly, the feedback's faster and you can validate some of your assumptions.

I think it's been very helpful to us.

We continue to work with the Home Depot to bring out products that are, hopefully, continuing to show them new types of performance/also testing the price point.

I think it's a great way to think about the market, and probably more important than anything, raise awareness.

The math's the math.

The biggest market for LED lighting is going to be commercial industrial lighting.

It's 80% of the market.

I think it's helping us get awareness for LED lighting in ways that probably wouldn't happen as fast if we just tried to sell to the commercial market.

I guess if you hear me warming up to it a little bit, it's become a much better marketing vehicle for us than I would have thought in terms of raising awareness and getting people to think about adoption.

May I ask you what the magic number is?

People seem to -- I hear $20 a lot.

Is there sort of a number that you're encountering in terms of people being willing to make that purchase decision at the retail level?

Look, I think -- and remember, we're really focused on the downlight segment, so we're really looking at a downlight retrofit.

I think in that segment, when the product first came on the market, it was $49.95.

We sold more than either us or our retail partner thought we would.

That price has moved down to $39.95, and there's definitely price elasticity.

That market gets larger.

At $34.95, I think is the most recent pricing that you'd find in that channel, and that market has continued to expand.

I think what we're finding is that, depending on the application -- and again, our experience has really been in this downlight category, that there's been a bigger market at price points than what we had expected because I think the consumers probably -- it takes a little while, but the consumers are very practical.

They get to the value proposition faster than I think we originally gave them credit for.

So the fact is, is that if people never have to change their downlights again, they get pretty interested after they've done it a couple of times.

I think what we're learning about the price elasticity.

In terms of the magic numbers, if you go beyond the downlight, you'll hear all kinds of speculation about where bulb prices and all that stuff has to go.

I think what I'd tell you is there's obviously already a market today; but clearly, as we shrink that gap, there should be some pretty good price elasticity.

And, I don't think you have to get -- clearly, you don't have to get to the price of the incumbent incandescent bulb because the value proposition's significantly better.

I think as we see the price -- as we see products come down that curve, we should see increased adoption.

Aaron Chew, Maxim Group.

Wondering if you can just make some general comments, or provide some color on the new distributor program you introduced for your North American lighting segment last year, last November.

Just wondering if you can provide some color of the motive behind the strategy, maybe the positive, negative reactions from customers; and above all, how you can mitigate risk of it potentially posing risk to revenue in the back half of calendar '13.

Look, I think you're talking about something we call the allied program.

This is really just a way to get better awareness within distribution of what Cree's doing and how we can hopefully drive sales of LED lighting.

I think it's been a relatively -- it's an important program from building relationships, but I'd say the near-term effect has been pretty small.

It's much more about getting awareness for what we hope is a stronger distribution base to grow the business 12 to 18 months out.

I don't think we've seen a lot of significant tangible revenue gains in the short term, but hopefully, we've raised the awareness at this point.

My goal would be is that should lead to increased momentum in that channel as we look out two and three quarters.

Okay.

That's helpful.

Thanks.

Just for my follow-up.

On the component side of things -- of LED products I should say, you mentioned there's a delay for new products to really hit the income statement as customers have to get things certified and whatnot.

So I'm wondering, when do you guys, based on historic trends, expect the new XM-L2 to actually impact revenue?

And, are you already seeing some of the -- I guess it was the G and the E I think you released last year, are you already seeing that in revenue, or is it too early to benefit from?

The answer is, it takes a while, but it depends on the customer and the application.

The example I would give you is in some customers' applications a new version of a product fits right into the slot they had before.

So, if you go to a gen-two version of XPE or XPG, in some of those customer situations, that's an upgrade to an existing design.

That's relatively fast.

There's some qualification, depending on the application, but that can be a little faster.

When we came out with the SC3 platform -- that's a different platform, so in many cases, the customer has to re-lay out the board and do some ground-up requalification.

Those tend to take a little bit longer.

That's probably the range.

So, if you think about XM-L2, if someone's already using XM-L, probably a little of faster.

If you think about the other product we released, the KR -- I'll think of it in a second, the other LED we came out with.

We just did --

M-KR.

M-KR -- that one's probably going to take a little bit longer.

Thanks, Mike.

The lag, it varies, right?

So, someone who's got something that's UL certified that wants to meet design lights consortium, they've got a bit of a lag there.

Someone who's doing a more consumer-grade product, or frankly, in some of the export markets, they can move a lot faster.

It's a long-winded answer to -- it varies by customer.

If the footprint's the same, it's generally a little bit faster, but there can still be regulatory delay.

Andrew Uerkwitz, Oppenheimer & Co.

I think you've answered most of my questions, but you mentioned during an answer earlier that you thought the supply still outweighed demand on the LED side.

Can you give additional color?

You think that's picking up, getting worse?

How do you see the market evolving over the next quarter or two?

Look, I think over the last 18 months, it's obviously -- probably 18 months ago it was probably exacerbated the most, where supply got the most ahead.

I'd say in the recent quarter or two, as LED lighting adoption starts to gain and you see the increase in lumen sales, I think we're seeing some improvement but it's still supply ahead of it.

I think if I look out over the next few quarters, what that means to us is a competitive pricing environment, and I don't think that's going to change, at least not in the near term.

I think we're moving directionally correct, but it's going to take a while.

So, the way we're trying to think about the business is we're -- our targets are assuming that it's going to remain pretty competitive, at least in the near- to midterm.

A quick follow-up on that because you guys -- we view you guys as a technology leader.

Do you think, as technology's getting better, more lumens per chip or whatnot, do you think -- is that kind of exacerbating the capacity side, meaning that that's kind of growing capacity naturally?

Yes, we did definitely get some of that.

If you look at the amount of lumens we produce out of our factory with very little capital investment over the last year, we've seen a huge increase in the amount of lumens out of our factory.

I think you are going to see a variation of that across the industry.

Obviously, some suppliers take a more traditional approach, just buy more capacity.

Others have probably spent more time on the innovation side.

In general, I think that the whole LED industry -- generally speaking, the industry should expect there's some amount of innovation that will happen in the next year that will take the existing equipment base and get something more out of it.

So, that's always a bit of a headwind, but if we drive the right level of adoption, hopefully, we can really start to balance that out a little bit better.

Stephen Chin, UBS.

This is Mahavir for Stephen Chin.

Thanks for taking my question and congrats.

Thanks.

My first question, Chuck, can you elaborate on your comment in terms of the opportunities to move faster than the market?

Can you elaborate on the opportunities, and then also, is there a tradeoff in trying to aggressively push sales, or you think -- and the gross margin, or you think the new products should allow you to maintain your gross margin?

Look, I guess what I'm pointing out there is that, while we've had a lot of success growing LED lighting and we've seen increased adoption, it's still a relatively small percentage of the overall market.

And, we can see with the products we have developed in the last year and the ones that are under development, that there's a way to continue to close this gap between the cost of LED lighting and the cost of traditional technology.

So for us, it's push on the innovation engine and try to get those new products out there and close that gap more to really move the market.

In some cases, it's a -- for example, we recently came out with our own version of an MR16 LED lamp, and so why would we do that?

That's not really in the mainstream of our commercial strategy, but it was a particular segment that, while some people had done MR16s and they were okay for some applications, we didn't see the market providing something that truly was a halogen alternative, at least not in the way we were seeing it in the applications we're talking to.

So, it was a chance for us to, hopefully, push that market a little faster to LED adoption.

It doesn't mean people weren't selling a lot of LED MR16s, but at least in the places we were seeing, which were more commercial applications, we thought that there was a product improvement that could push it faster, so that's what we wanted to go do.

As far as the tradeoff goes, look, we have two goals -- try to make incremental improvement on the product lines, each of the product lines; and drive LED lighting adoption.

By definition, there's some tradeoff with that, and our goal would be is to find a way to get some incremental progress on one side and more adoption on the other.

And, if we're biased, we're more biased to adoption than we are on the margin; but honestly, we think we can find a way to do some of both.

Great.

Just a follow up, Chuck, can you compare the channel inventory now, maybe on a sequential basis, as well as on a year-on-year basis?

Thanks.

I don't know what it is year over year, but I'm assuming you're mostly talking about our LED components business, and we would have exited the December quarter -- and Mike, you can correct me if I'm wrong here, but I think we exited with -- inventory actually declined in the December quarter.

So, there's less channel inventory in LEDs at the end of December than there was at the end of September.

Is that right?

That's correct.

Yes.

Daniel Amir, Lazard Capital Markets.

I just have a general question, kind of geography related here.

How much of your business in North America is really driven, you think by the recovery of the construction market and the pickup that you're seeing in new construction there as it relates to comparison to obviously your new products that you're seeing and the declining cost of ownership of LEDs?

And then, the same question is what's the driver of what you're seeing in the China market, given that we are not seeing many subsidies in the market, where still visibility is limited, but still it's a big market for you guys?

Thanks.

I would say that for the LED lighting business in North America, most of what we see would not be construction driven or new infrastructure, it would be upgrading existing infrastructure and retrofit renovation, and I'd put that all in one big bucket.

So, I think what's happening is as LED lighting gets better, then there's either an incentive, there's already existing renovations going on that you can make LED a part of that, or you can incentivize someone to consider doing an LED lighting upgrade because the math works.

So, that's kind of what the driver is there.

As far as the China markets go, for us it's -- China is both an export market and a consumption within China.

I think the export markets are following the global trends, which is just as you get better performance, lower-cost new products, you get more adoption.

Within China, I'd say that there is some -- definitely starting to see some more indoor activity, but still more driven by outdoor than indoor, at least for our business at this point.

Okay, thanks a lot.

Thank you.

With that, that does conclude our time for questions.

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

Thank you for your time today.

We appreciate your interest and support, and we look forward to reporting our third-quarter results on April 23.

Good night.

Good night.

Thank you.

Thank you.

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

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

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