Wolfspeed Inc (WOLF) 2013 Q4 法說會逐字稿

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

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

At this time, I'd like to welcome everyone to Cree Incorporated's Fiscal Year 2013 Fourth 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, August 13, 2013.

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

Mr. Garrabrant, you may go ahead, sir.

Thank you Huey, and good afternoon.

Welcome to Cree's Fourth 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'll be pleased to assist you.

Today, Chuck Swoboda, our Chairman and CEO; and Mike McDevitt, our CFO, will report on our results for the fourth 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 and the Financial Information tab.

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

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

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

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

Also, we would like to note that we will be limiting our comments regarding Cree's fourth quarter and 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 e-mail or phone at (919)287-7895.

We are also webcasting our conference call, and a replay will be available on our website through August 27, 2013.

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

Thank you, Raiford.

Fiscal 2013 was a great year, as revenue increased 19% to a record $1.4 billion, and non-GAAP net income increased 42% to $155 million, or $1.32 per diluted share.

The growth in revenue was driven by the success of our new products in all three business segments.

The growth in non-GAAP net income was driven by higher revenue, a 27% increase in non-GAAP gross profit, and a 53% increase in non-GAAP operating income, due to improved operating leverage across the business.

Cash and investments increased $279 million in fiscal '13 to more than $1 billion, due to increased profitability and solid execution.

The combination of our earnings momentum and strong balance sheet continues to give us the ability to invest in growing our business, and the flexibility to respond to new opportunities in the market.

Fiscal Q4 revenue increased 7% to a record $375 million, with non-GAAP net income of $46 million, or $0.38 per diluted share.

Revenue and non-GAAP earnings per share were in the middle of our target range, primarily due to strong sales of the Cree LED bulb and our LED components.

The sales trends in Q4 were as follows -- lighting grew 33% year over year to $134 million; LEDs grew 17% year over year to $217 million; and power and RF grew 14% year over year to $24 million.

Non-GAAP gross margin was 38.2% in Q4, which was within our target range for the quarter, but on the low end, due to a shift in lighting product mix.

Individual product margins were generally in line with our expectations.

However, the mix was different as LED bulb sales were higher than targeted, and fixture sales were lower.

Fixture sales increased in the second half of the quarter, and the momentum has continued into fiscal Q1, as a number of large customer projects came in later in Q4 than forecast, or were delayed into fiscal Q1.

We made great progress ramping up the Cree LED bulb, and implementing a series of cost reductions during the quarter.

Although the LED bulb gross margin is lower than our overall lighting segment margins, it is improving, and we target incremental improvement in Q1 as we get the full benefit of the cost reductions we made in Q4.

Overall, the quarterly results once again demonstrate the strength of our vertically integrated product portfolio, and our ability to drive growth and create value in a wide range of LED lighting applications.

Company backlog for Q1 is ahead of this point last quarter, as we see good order momentum in our LED lighting product line, and LEDs are tracking in a similar range.

We are currently targeting solid growth in LED lighting in Q1, driven primarily by our fixture products, as well as incremental growth in LED bulb sales.

We made great progress on all four of our key objectives for fiscal 2013.

We continue to lead the market and accelerate adoption of LED lighting, with transformational products like the Cree LED bulb, and the UR series linear upgrade kit.

We increased sales of our lighting products by 48% in fiscal 2013 to $0.5 billion, driven by LED lighting products, which grew at an even faster rate.

After only five years, we've created one of the largest lighting businesses in the US.

We grew our LED component product line to $801 million by leveraging our innovative SC Cubed LED technology to more than 50% of our LED sales in Q4.

We utilized our technology lead and power in RF to open a new generation of applications for these products, as we grew sales 22% to $89 million for the year.

We translated all this product innovation into 19% revenue growth for the Company, and a 53% increase in non-GAAP operating income.

This was a very successful year.

As the leader in LED lighting, we're in a great position to take advantage of the global shift to LED lighting through both our lighting and LED products.

We remain focused on using new product innovation to drive our growth by taking share from traditional technologies.

Our new XSPR Street light, and the Cree BR30 LED floodlight are the most recent examples of what is possible in terms of opening new markets to LED lighting, and creating opportunities for Cree to both increase revenue and build our brand.

I'll now turn the call over to Mike McDevitt to review our fourth quarter and fiscal year financial results in more detail, as well as our targets for the first quarter of fiscal 2014.

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 fiscal 2013, revenue increased $221 million, or 19% year over year to a record $1.4 billion.

GAAP earnings increased 96% year over year to $87 million, and $0.74 per diluted share for fiscal 2013, and non-GAAP earnings increased 42% year over year to $155 million, and $1.32 per diluted share.

Non-GAAP earnings excludes $68 million of expense net of tax, or $0.58 per diluted share, from the amortization of acquired intangibles and stock-based compensation.

Fiscal 2013 revenue and gross profit for our reportable segments were as follows.

LED products revenue grew 6% to $801 million, and gross profit grew 19% to $345 million from fiscal 2012, for a 43% gross margin.

Lighting products revenue grew 48% to $495 million, and gross profit grew 44% to $149 million from fiscal 2012, for a 30.1% gross margin.

Power and RF products revenue grew 22% to $89 million, and gross profit grew 50% to $48 million from fiscal 2012, for a 53.8% 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 $19 million for fiscal 2013, and are included to reconcile to our $523 million GAAP gross profit.

For the year, cash provided by operations was $285 million, free cash flow was $187 million, and we exited fiscal 2013 with more than $1 billion in cash and investments while continuing to be debt-free.

For the fourth quarter of fiscal 2013, revenue increased 7% sequentially to a record $375 million, which was in the middle of our $365 million to $385 million targeted range, primarily driven by strong sales of the Cree LED bulb and LED components.

GAAP earnings increased to $28 million, or $0.23 per diluted share for the fourth quarter of fiscal 2013, and non-GAAP earnings increased to $46 million, or $0.38 per diluted share.

Non-GAAP earnings exclude $18 million of expense net of tax, or $0.15 per diluted share, from the amortization of acquired intangibles and stock-based compensation.

Non-GAAP and GAAP earnings per share were in the middle of our targeted ranges of $0.34 to $0.40 per non-GAAP, and $0.20 to $0.26 for GAAP.

Q4 GAAP gross margin was 37.5%, while non-GAAP gross margin was 38.2%, which excludes stock-based compensation of $2.5 million.

This was on the lower end of our gross margin targets due to the shift in lighting product mix.

If you exclude the product mix shift, individual product margins in the lighting segment were within our expectations.

LED products and power and RF segment gross margins both decreased sequentially due to product mix, factory cost reductions, and higher factory utilization.

For the fourth quarter of fiscal 2013, revenue and gross profit for our reportable segments were as follows -- LED products revenue was $217 million, with a gross profit of $99 million, for a 45.7% gross margin; lighting products revenue was $134 million, with a gross profit of $34 million, for a 25.1% gross margin; power and RF products was $24 million, with a gross profit of $13 million, for a 53.7% gross margin; non-allocated employee benefit and stock-based compensation costs totaled $5 million for the fourth quarter of fiscal 2013, and are included to reconcile to our $141 million GAAP gross profit.

Operating expenses for Q4 were $110 million on a GAAP basis, and $92 million on a non-GAAP basis, both of which were lower than our targets due to reduced sales commissions on lower lighting fixture sales, and lower than targeted IP litigation costs.

Non-GAAP operating expenses exclude approximately $10 million of stock-based compensation expense, and $8 million of charges for amortization of acquired intangibles.

Net interest income and other for the quarter was $2.7 million.

Our Q4 GAAP and non-GAAP tax rate was 15.8% for the quarter, which is lower than the 20% we targeted.

The Q4 tax rate was lower than targeted due to a greater portion of Q4 earnings in lower tax jurisdictions, and a tax benefit from our employee stock purchase plan.

We ended the quarter with more than $1 billion in cash and investments.

Cash from operations was $61 million, and capital expenditures were $27 million, including $5 million related to patents, which resulted in free cash flow of $34 million.

Depreciation and amortization for the quarter was $39 million.

Day sales outstanding were 46 days, as compared to 47 days at the end of March.

Inventory days on hand were 76 days, as compared to 82 days at the end of March.

Property plant and equipment additions were $22 million in the fourth quarter and $77 million for fiscal 2013.

For fiscal 2014, we are targeting approximately $120 million of property plant and equipment spending to support our new product priorities and provide incremental capacity as needed.

At this time, we target Q1 revenue to be in the range of $380 million to $400 million, which is comprised of -- solid growth in lighting driven but by LED fixtures and LED bulbs; LED product sales in a similar range with Q4; power and RF sales slightly higher.

We target Q1 GAAP gross margins to be 38.5% plus or minus, and non-GAAP gross margins to improve to 39% plus or minus.

Our targeted margin increase is based primarily on incremental lighting improvement due to an increased mix in higher-margin LED fixture sales, and the full-quarter benefit of LED bulb cost reductions implemented during Q4.

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

Our GAAP gross margin targets include stock-based compensation expense of approximately $2 million, while our non-GAAP targets do not.

We are targeting Q1 operating expenses to increase approximately $3 million from Q4.

The targeted increase is for incremental R&D spending to support new product development and cost-reduction programs, higher sales commissions from a higher targeted revenue, and increased G&A costs, which are partially offset by lower marketing spend.

Our GAAP operating expense targets include non-cash, stock-based compensation expense of approximately $11 million, and charges for amortization of acquired intangibles in the amount of $7 million.

Net interest income and other is targeted to be $2.3 million for Q1.

GAAP and non-GAAP Q1 pre-tax income is targeted to increase double digits sequentially on a percentage basis, based on a combination of higher sales, gross margin improvement, and increased operating expense leverage.

We target our tax rate to be 23% for Q1 in fiscal 2014.

The tax rate increase is primarily due to a targeted increase in US lighting sales, which results in a greater portion of our targeted fiscal 2014 earnings being in a higher tax jurisdiction.

Our fiscal 2014 and quarterly tax rates will fluctuate based on our overall earnings, the tax jurisdictions in which our income is actually earned, the expiration or extension of the US R&D tax credit, and other tax benefits that may or may not become available to Cree in future periods.

GAAP net income in Q1 is targeted to be between $28 million to $34 million.

Based on an estimated 122.4 million diluted shares outstanding, our GAAP EPS target is between $0.23 to $0.28 per diluted share.

Non-GAAP net income is targeted to be between $44 million to $50 million, or $0.36 to $0.41 per diluted share.

Our non-GAAP EPS target excludes amortization of acquired intangibles and non-cash stock-based compensation in the amount of $0.13 per share.

Thank you.

I will now turn the discussion back to Chuck.

Thanks, Mike.

We're focused on four priorities to drive our growth in fiscal 2014.

Our first priority is to continue to lead with innovation across our product lines, and drive to cost parity with conventional technology.

In lighting, we recently launched two breakthrough products that we believe can open significant new markets to LED lighting.

In June, we launched our innovative UR series linear upgrade kit that enables customers to convert their existing fluorescent fixtures to LED for less than $100 without removing the fixture.

Recently, we announced our new XSPR series street light, which is a breakthrough in LED outdoor lighting.

The XSPR is the first $99 LED street light that is designed to compete head to head with low-cost, high-pressure sodium street lights in residential applications, while delivering 65% energy savings, and a significant upgrade in light quality.

We released the CPY250 next-generation canopy fixture, which delivers increased performance at a lower initial cost; and we just released our new VG-series LED parking structure fixtures, which are designed to deliver optimal low-glare illumination, more energy savings, and a lower initial cost.

In LEDs, our SC Cubed technology enabled a new generation of power LEDs that has opened new applications for LED lighting to compete head to head with traditional incandescent, HID, and fluorescent products.

We continued to expand the product family with our new XH-series ceramic mid-power LEDs, which deliver no compromised quality and performance for lighting applications.

We expanded the CXA-series of LEDs, which are targeted at ceramic metal headlight applications, and we released our LMR2 LED module for residential down-light applications.

We are working on a next-generation LED platform to further increase price performance, and enable the next wave of new lighting applications.

In power, we expanded our silicon carbide MOSFET product offering, and released the industry's first all-silicon-carbide three-phase power module.

We also achieved a major commercial milestone for gallium nitride RF devices, as we have now shipped more than 2 million HEMP devices for telecom infrastructure applications.

Our second priority is to build the Cree brand in both the commercial and consumer lighting segment by expanding our product offerings and continuing to invest in marketing the value of the Cree LED bulb and LED lighting directly to the end user.

We made great progress with the initial launch, raising Cree's profile dramatically, with a tremendous increase in share of voice for the Cree bulb and the Cree brand, as well as a significant increase for LED lighting as a category.

We recently announced the Cree BR30 LED bulb, which is available exclusively at The Home Depot.

It delivers an LED bulb that looks like a regular VR-style floodlight bulb, lights like a regular light bulb, and is priced to give consumers a reason to switch to LED.

Our partnership with The Home Depot has demonstrated that great products at great prices, combined with a world-class retailer and a serious investment in marketing, can change both consumer behavior and a product category faster than many of the skeptics predicted.

To put this in perspective, we believe that we've sold more Cree LED bulbs at The Home Depot since our launch than they've sold of all other A19 LED bulbs combined.

We plan to continue to make significant investment in marketing the Cree LED bulb in fiscal 2014, although Q1 spending will be incrementally lower than Q4 due to the timing of the various media activities.

Our third priority is to focus on select market segments, where we can upgrade existing lighting and drive adoption, with a combination of new product offerings, short pay-back, expanded services, and an innovative channel approach.

We have had tremendous success over the last year in focused market segments, such as the petroleum and convenience store application.

We have delivered innovative products like our new CPY canopy fixture, offered the industry's first 10-year warranties, and built a channel to focus specifically on the needs of this market.

As we have stated in the past, we are not trying to be a traditional lighting Company.

We're a technology Company developing products to fundamentally change the lighting experience.

We are focused on enabling the applications that require significant product innovation to shift to LED.

This plays to our strengths in developing innovative category-changing products, and our flexibilities take new approaches to deliver LED lighting to the real users of light.

Our fourth priority is to build on the momentum of FY '13, and continue to grow revenue and profit.

We target revenue growth from new products and increased LED adoption, and profit growth from the combination of higher sales, lower cost products, and operating expense leverage.

We have a tremendous market opportunity in LED lighting, and we are focused on the applications where we can provide a better value than traditional technology, and drive LED adoption.

We target the combination of incremental volume leverage from higher revenues and lower costs from our new product design to deliver incremental margin improvement.

While this may vary from quarter to quarter with product mix, we target incremental improvement in gross margin for the year, combined with operating leverage in R&D and G&A, to drive the bottom line.

As I mentioned earlier, Q1 total Company backlog is ahead of this point last quarter, led by higher lighting orders.

The growth over the last few quarters has increased our factory volumes, and execution has become a more critical factor to supporting a higher targeted demand.

At the same time, the customer still expects short lead times, which adds variability to our forecast for the quarter.

Based on the current backlog, forecasts, and trends in the business, we are targeting Q1 revenue to grow to a range of $380 million to $400 million, which is comprised of strong growth in lighting sales, driven by LED fixtures and LED bulbs, LED sales in a similar range, and incremental growth in power and RF sales.

We target non-GAAP gross margin to incrementally improve to 39%, plus or minus.

The targeted margin improvement is based on incremental improvement in lighting, where we are targeting a benefit from an increased mix of LED fixture revenue, and a full quarter of the LED bulb cost reductions that were implemented during Q4.

We target non-GAAP operating expenses to increase approximately $3 million in Q1, driven by higher sales commissions related to higher lighting sales, higher R&D, and G&A.

As a result, we target non-GAAP earnings in Q1 of $0.36 to $0.41 per diluted share.

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

The Cree LED bulb is gaining momentum, and we are delivering innovative new LED fixture products for both indoor and outdoor applications.

While LEDs and fixtures drive the bulk of our financial results, the bulb is strategically important in driving LED adoption and building the Cree brand.

Our new products have opened new applications, improved pay-back, and fueled growth in LED lighting.

We remain focused on driving mass adoption and our long-term customer goal of 100% upgrade to LED lighting.

We will now take analysts' questions.

Thank you, sir.

(Operator Instructions)

Brian Lee, Goldman Sachs.

If I look at the mid-point of your guidance range as it implies gross margin in lighting, it's up about 400 or 500 basis points sequentially.

First, is that the right math?

How much of that improvement is being driven by LED bulb product versus the better mix?

Secondly, what needs to happen to get back to the low 30%s level from a couple quarters ago?

Then I had a quick follow-up.

Brian, I don't have that math in front of me, but generally what we're doing in the targets is, what we're looking at is really two things.

We have cost reductions that we actually implemented at the end of Q4.

When you roll those through on the bulb for a whole quarter, we should see that incremental gross profit flow right through.

Second, as we add more fixtures to the business overall, they obviously today have currently a higher margin, and so it's the combination of those two things that really drive the vast majority of the overall margin improvement from Q4 to Q1 that we're targeting.

Okay.

Any thoughts on the second part of that question, just what needs to happen to get back to the low 30s?

Again, I don't have a specific target for you on what the lighting margins are.

In fact, I haven't done the math there on what we just -- what those two things imply.

But, I feel like that we have the cost reductions available to us that I think that's a reasonable target in the not-too-distant future.

Honestly, what we're targeting for the whole Company is that we want to see incremental improvement in all the product lines.

As I look out over the year, I think we have the cost levers to do that.

We don't totally control what's going to happen in the market, but at least in the short term, I think we can see specifically a couple things that we're going to do in the near term that should -- we should see significant improvement in lighting gross margins from Q4 to Q1.

Given the fact that we just brought on a huge consumer product, I actually think that's great progress for the Business.

Okay, fair enough.

If I could squeeze in my second question on lighting growth, it seems like you guys have seen some deceleration there recently.

That's at odds with your peers, also given the growing product breadth across the portfolio.

I'm just wondering if you can help reconcile a bit as to why that is, and also what might reverse the trend going forward?

Thanks, guys.

Yes, Brian, I think you're reading too much into the one-quarter data point.

I think last quarter the data was flipped.

Everyone was wondering why our Business was accelerating and the other guys were decelerating.

I think in lighting you have to be careful, you have to look at it a little broader than quarter to quarter.

We're focused on certain markets and applications.

As those grow we're going to have some variability, but overall, I think we've grown significantly.

You can see that in our overall numbers.

I think most of the other guys in the Lighting business there selling LED-based products are growing, as well.

I think it's a net positive trend for the industry.

I think as far as we're concerned, other than some of the timing we saw last quarter, I still feel -- continue to be very optimistic about the growth rate overall.

Not only what we've done, but with the new products coming on line, we should be opening new markets and being able to continue to drive that going forward.

Again, I wouldn't read too much into a one-quarter data point, given the fact that even in that quarter we saw the order momentum pick up, and heading into this quarter we're ahead of that point.

Paul Coster, JPMorgan.

Chuck, I got the sense in the prepared remarks that maybe on the execution side there were some constraints on growth.

Does that play into this revenue growth story, as well?

Paul, what I would say is that I think LEDs grew as fast, or maybe even a little faster, than we had targeted.

We have seen that in that side of the Business, we have seen lead times move out a little bit, so there's a few constraints on that side.

I think not significant limitations, and I think we're doing things to address that, as you can see in Mike's comments earlier about adding some capacity in the near term.

In lighting, it was a function of the timing.

There is definitely, as we exited Q4, we were definitely constrained from a production standpoint.

You can either -- that has to do with when the orders come in, in the back end of the quarter.

There's just only a finite amount of capacity.

That's why I'm a bit more optimistic heading into this quarter, as long as the order flow comes in a little bit earlier, that problem should at least be less this quarter than it was last.

Now, your third objective is to go after new market segments.

Do you have the resources necessary to do that, or do you think you need to go outside the firm, make an acquisition to buy your way into new markets, new geographies?

Yes, when I say new market segments, right now I think less about geographies in the short-term, and more about applications that are unserved.

You can argue that our UR product lets us do something no one's ever really done before; which is, it's not a lighting fixture and it's not a bulb.

It's essentially a product that enables a very large chunk of electrical contractor industry to get into the LED Upgrade business.

I'll just use that as an example.

I think we see other product segments that with the right innovation that we can then go after in maybe a slightly different way.

The example I gave you earlier was the petroleum market.

There is an example where we have a slightly non-traditional way to go after those customers, really a channel that's dedicated to that industry, instead of one that's dedicated to lighting specifically.

I think in certain other specific market segments, there'll be opportunities to take a hybrid approach, which is we use our conventional channel, but also I'd say some industry-focused channels that can get us access there.

It's less about acquisition and more about products to solve problems that aren't solved yet, and then getting a sales focus on that very specific market.

Vishal Shah, Deutsche Bank.

Chuck, on the guidance for the first quarter, can you talk about the expectations for bulb versus fixture sales?

Do you expect both of those segments to be up, but fixtures to be up more than LED bulbs?

Also, are you expecting the fixture margins also to improve sequentially?

I have a follow-up.

What I would say is in terms of the growth, we're expecting good growth in fixtures and incremental growth in bulbs.

Right now, those targets are based on more growth in fixtures than there is in growth in bulbs.

Then that's -- from a fixtures standpoint, I think that makes sense.

Obviously, we've got a lot of design activity there.

On bulbs, that's more of a -- we haven't gotten into the fall season right now, so I'd expect that we're going to run at this rate.

When we get into the fall lighting season that will be another opportunity to really start to drive that growth at the next level.

That's going to be a function of how well we sell through in this fall lighting season.

I think your second question -- did I get that, or did I miss part of that, Vishal?

Well, yes.

My question was around the sell-through.

How much of the bulb growth are you seeing as coming from just inventory build at some of these stores?

At what point do you have to pass some of these cost reductions over to the end consumer, and how should we think about the margins in the long run for the bulb business?

Thank you.

What I would tell you is that bulb sales right now are ahead of our expectations at this point.

I'd think it would be reasonable to say they're probably ahead of the Home Depot's expectations.

I think their sales are doing well.

I think there is definitely some of our sales are to fill that channel so that as we try to ramp up sales further.

I don't see a significant shift in the pricing in the short term.

Obviously the market will adjust that; but right now, we decided to launch the product at a certain price point knowing that we had some innovations available to actually get the cost down.

I would expect that at least in the near term that we should be -- the bulbs should be continuing to get into a better margin position and approaching more of the lighting margins overall.

I think you also asked earlier about fixture margins, and as I said, we're targeting incremental improvement in all the product lines over the year.

We're assuming that in addition to progress on the bulb, that we'll make progress in fixtures, as well as in LEDs and in the power RF area for the year.

Jed Dorsheimer, Canaccord.

Chuck, first question is on the SC Cubed, you mentioned that it's over 50%.

This is the first quarter that you have mentioned that.

Could you give us any further indication in terms of maybe not the percentage, but how close to finished in terms of that penetration do you think you're at?

Jed, we're over the 50% point, but I would say we've got a significant -- we've still a lot of additional product to move to that technology.

I would say that we're past 50%, but not a lot past that at this point.

I also would say that I'm not sure that 100% of it will ever convert.

Obviously, there's some old legacy products that will stick around.

But I would imagine that at least for the next few quarters, we'll continue to see SC Cubed increase as a percent of the business.

As my follow-up, you had mentioned last quarter about some additional cost-downs, particularly in the packaging of the LED products.

I was wondering if you could elaborate on that.

If I could sneak one in, on the Bulb business, your bulbs are selling better than both you and Home Depot expected.

Any plans for capacity expansion on that product line?

Thanks.

Jed, not a lot of specifics I can offer to you on the LED side of the Business, other than comments I made in my prepared remarks.

I guess what I want to explain to you and to shareholders is that we believe that SC Cubed isn't the last major platform.

It's just the one we're on today.

We think there are innovations available that are going to allow us to continue to make cost strides at the LED level, as well as the things we're doing at the system level.

That's really the message there, is that we think there are definitely innovations ahead of us that will help us bring the costs down there.

As you know, more LED cost-down usually means we can expand the market overall for LED lighting.

As far as bulb capacity, we've actually increased the capacity from when we launched in March.

We have plans to continue to increase that, and it's a function somewhat of demand.

In that case, that's primarily a supply chain thing, so it's just we need a certain amount of lead time.

We have increased, and will continue to monitor that.

I feel like if we are able to drive the sales to that next level, and since we're really getting started, that would be at least our target, then I think we'll have to expand that capacity here over the next 6 to 12 months again.

Andrew Huang, Sterne Agee.

Congratulations on the A19, the BR30, and the $99 street light.

With all these great products, I'm a little bit worried about your LED component capacity.

Maybe you can comment on the factory utilization, and then what levers you have to ramp up your capacity?

Then I have a quick follow-up.

Andrew, as you know at the end of last quarter we said we're starting to have the LED factory was becoming fully utilized, and I would say it continues to run pretty full.

That's why lead times have moved out a little bit.

We have started adding capacity.

It's a combination of some incremental equipment capacity, as well as additional 150 gives us capacity.

I think we'll be in that mode here for the next few quarters.

As you see in the targets we laid out, CapEx is starting to raise up a little bit.

I don't think it's -- these aren't major chunks of capacity, but we will have to make capacity investments here over the next couple of quarters to continue to support the growth -- both in the LED product line, as well as in our internal lighting product line.

Frankly, given where we've been in the last couple years, we like having that problem to work on.

Okay.

If you look at the lighting revenue excluding bulbs, can you give us some color on what caused the hiccup in the June quarter?

Andrew, if I look at the different between Q3 and Q4, some of the bigger projects that we see on normally a routine basis -- and they're not the same projects, obviously.

You're always bidding on new ones.

Ones that we had expected to come in a little bit early in the quarter, they either came in later in Q4, or frankly, some of them got pushed into Q1.

So it's mostly project timing.

To the question that maybe you're implying is it in any one channel?

We actually saw it across channel.

It wasn't a one-off, one channel.

We actually -- it was really projects, whether it was sold through the various channels we sell at.

At this point, given that it's picked back up, there was no specific one root cause here or there.

Our best estimate right now, and I feel pretty good, given that the order rate's picked up in Q1, is that it was just timing.

[Merion Henken], Credit Suisse.

We've seen some data points recently about back lighting sales being relatively weak in Asia.

I know in 2011 the reason given for some of the margin compression that year was a spill-over of maybe mid-power chips into general lighting from back lighting.

Has the business changed enough since then to prevent that this time?

What are your expectations on margins going forward because of that issue?

I would tell you that we went through -- when the back lighting issue happened a couple years ago -- I think we saw mid-power LEDs enter the market.

I haven't really seen that dynamic go away, so I'm not sure it ever really got better, either.

I would say the competitive environment that we see from people with back lighting capacity selling mid-power LEDs has been pretty similar for the last few quarters, and I would say it remains competitive.

Our approach is a little bit different.

We're trying to focus on the applications where lumens per watt wins, where our high-power strategy build lower-cost systems, or even in our new XH-series.

We came out with a new LED last quarter, and it's actually a ceramic mid-power-style lighting-class LED.

You might look at that and go, why would you come out with a higher-end version of a mid-power?

The answer is that you can throw a bunch of plastic package LEDs in an application and that's one way to solve it, but we actually see opportunities for our customers to build not only higher-performance systems, but lower-cost by going to essentially a higher-end ceramic mid-power-style LED.

The idea is focus on that innovation.

I think with the growth we're seeing in the general lighting market, I think -- look, we don't -- can't predict the future, exactly, the competitive environment.

But at least right now, we don't see any signs of a big shift there one way or the other from whatever's going on in back lighting.

What are your expeditions with OpEx for the coming fiscal year?

It sounds like there was a little bit lower OpEx in guidance in the June quarter, and now it's a little bit up for September guidance?

What do you think for the rest of the fiscal year?

Thank you.

In the June quarter we did all the strategic things we were trying to do.

The timing there was just a function of some lower commissions just related to the lower fixture sales.

I know that there was -- IP litigation timing was less than -- it came in on the favorable.

Those are the two big switches.

For the fiscal year, we're going to continue to invest.

I think that we'll see investment across the different areas, but as I said earlier, our target for the year is to generate operating leverage.

I don't think we're going to see a lot right now.

Based on our investment strategy in sales and marketing, we're going to want to make those investments to take all these great new products and get them out into the market.

But I do think that if we generate the top-line growth that we're targeting, then we should see some leverage, both from the R&D investments, as well as on the G&A side.

Edwin Mok, Needham.

Chuck, first question -- going back to light bulb, you just launched a new bulb, this BR30 bulb, and you said that your sales at Home Depot is better than you and Home Depot expected.

Why are you so modest in your light bulb outlook for the coming quarter?

I think -- why are we modest?

One, I'd like to see -- one of the things we've been doing is that sales are ahead, but we're also planning on them growing fairly significantly -- I shouldn't say planning, we're targeting them to grow pretty significantly.

Some of that's a function of is we need the sell-through to keep going.

We've got work ahead of us.

While we are ahead of, I think, our expeditions and The Home Depot's, we both know that there's investments to be made.

We have to continue broadening the awareness of the product and the category.

They've got activities they're planning.

I think I'm just trying to be realistic that these things take, usually, time to continue to build up the momentum.

If what you're poking at is this a big opportunity?

It certainly is.

Obviously, when we launched the product there was like 5 billion light bulbs in people's houses that in the US that you can imagine converting to LED.

I think there's a big opportunity.

At the same time, there's a lot of work ahead of us to pull that off.

I think I'm just trying to balance that in the short term.

Okay, that's fair.

Then a question on gross margin of the LED Product business, right?

It picked up this quarter.

How much was that -- was come from increasing utilization?

I think last quarter you guys talked about you might have to increase some capital spending, but I thought the CapEx didn't really go up this quarter.

Is this something that we expect to come, or any way you can give us a sense how much CapEx could be for 2014?

I think the gross margin is coming a little bit from scale, and also from the benefit of lower-cost new product.

That's really what give us the benefit last quarter.

As far as capital goes, if you look at our targets for next year, I think we're targeting -- Mike, is it $120 million?

$120 million.

If you look at $120 million versus what we spent last year, you can see that we are seeing some increase in what we're planning to spend.

Keep in mind, when we start spending, you'll see that -- when we start spending, there is a lag before that equipment comes in, and you see it in the actual CapEx that shows up in the P&L.

There is a lag there.

We have started making those investments.

Craig Irwin, Wedbush Securities.

My first question's about design activity.

I was hoping you might be able to give us some color on the overall level of design activity with your customers.

Given the dynamic of double the lumens per dollar on SC Cubed, whether or not you're seeing a win rate and a growth rate of these designs that exceeds the fundamental growth rate of the LED lighting market right now, the lighting fixtures market -- and how you see this progressing over the next couple quarters?

I don't know if I can get you the granularity you're looking for.

What I can tell you is you can see last quarter for the last year when you go to SC Cubed, you're essentially offering someone twice as many lumens per dollar; so that means that you have to effectively -- for every customer you convert, you have to essentially sell them twice as much to get to the same revenue number Now that we're seeing that incremental growth, I think we've at least gotten a little bit ahead of that curve.

As far as how does that compare with the market?

That's tough for me to do, because we focus on applications where our LEDs add value, right?

We're going to focus on places where people want lumens per watt, typically higher-performance applications, people that are usually a little more sophisticated that are going to do system design to try to take total system cost out, so it's a little harder to track it towards the market.

I think on a unit basis, we've probably done real well.

On a dollar basis, because of the conversion to SC Cubed, not sure where we shake out there, exactly.

Great, thank you.

My second question was about the R&D leverage.

In your prepared remarks, you talked about R&D and SG&A leverage potentially materializing.

In the future, as you gain continued traction with the new products and existing platforms and new platforms, is it reasonable to expect R&D and SG&A leverage to potentially materialize by the back half of this fiscal year?

Or is this really still a phase where you're building for future growth?

The answer is yes, which means it's both.

We are still investing for future growth.

We are not -- look, when it comes to LED lighting, we are still in the very early stages of the transition of this technology.

This is a long road we're starting down.

I don't want to give every anyone the impression we're not going to keep investing.

I think we will, and I think we'll be investing across the platform.

However, when we look out at the next year and we look at the products that we've released, and some of the potential that we're trying to make happen over the year, I think that while sales and marketing spending will probably track pretty close with what we're trying to do from a revenue standpoint, we think there's an opportunity in our targets for some R&D and some G&A leverage.

That's really a function of if we get the revenue -- if we turn on the applications at a fast enough rate, we'll get revenue growth that frankly, as we've seen in the past, can be faster than you can actually add new R&D expenses.

Same thing on the G&A side.

That's really what we're targeting.

It really starts with growing the Business.

That would then in theory could run ahead of both R&D and G&A.

Our target for the year is some amount of operating leverage from those two areas.

Colin Rusch Northland Capital.

Thanks so much.

Can you talk a little bit about the marketing spend and how you're tracking the impact of that, and what the cycle time is on those programs?

Marketing spend is some what I call short-cycle measurements, and some long-cycle ones.

Let's talk about the short-cycle stuff.

We can see the marketing spend -- what it does in things like how much it relates to what we call share of voice.

We can look at how our marketing activity then translates into media coverage for both Cree as a brand, and as the Cree bulb.

We saw nice -- we saw a really good momentum there since we launched the bulb, so we've been real happy with that.

I think the other thing we can look at is are we seeing an increase in sales?

It's a little harder to track marketing spend directly to sales; but generally speaking, if you're investing in the marketing side and you're getting incremental revenue growth from the products you're promoting, you would assume that at least part of that.

That's a little bit harder to do a one-to-one correlation, but I think we're on the right track there.

Then the third piece is longer term, which is what are we doing to build the Cree brand?

That's not anything that I think we can measure in a one- or two-quarter time frame.

That's an investment that will really show itself over the next one or two years, as to what kind of momentum we can get there.

I think if share of voice is an indicator we're on the right track, but it's too early to see what the effectiveness on that side of it is.

Okay, great.

Can you give us a sense of the magnitude of the revenue that slipped from the June quarter into the September quarter?

Yes, I don't have a specific break-out for you.

Obviously we still ended up in the middle of our range, but it's along the lines of what we -- the upside we saw in LEDs offset the -- what we were light in and lighting.

Harsh Kumar, Stephens.

Chuck, couple of long-term questions.

If I take a very long-term stance on your Lighting business, is there a shot to get to parity with the chip gross margins, i.e., somewhere in the 35% to 40%, or what are we talking longer term on the lighting side?

Well, Harsh, that's an interesting question.

I think right now the target is keep making incremental progress.

I think we've already demonstrated that depending on what the mix is we've had lighting gross margins.

We've already demonstrated you can get into the mid-30%s range.

Do I think there's enough innovation to generate margins that can go above that?

Yes, I think if you just -- right now, what we're doing is we're taking innovation and turning it into products that are priced to compete with traditional technology.

As we start to get to the traditional technology price, more of those cost reductions should be available to us in margin, instead of just trying to compete with the traditional technology.

Again, we're just starting to get there on the first products.

I think in the short term, it's more about opening the market.

But longer-term, if you just look at the traditional lighting business they have gross margins in the mid-30%s, and I would imagine that if a traditional business with not much product differentiation is mid-30%s, I would imagine -- if you add product innovation on top of that, my longer-term target would be is that the margin opportunity should be better than that.

Very helpful, Chuck.

If I can ask you another question.

On the chip side, historically 50% margins for your Chip business have been tremendous margins.

You're at 47%-something or 46%-something right now.

Is the Cree vertical model -- i.e., the combination of lighting and your Chip business different enough that you are not any more subject to the vagaries of the commodity interplay, the global interplay of supply and demand, or are you still prone to that stuff?

I don't think you can ever say you are not affected by the market around you.

I think that's always going to have an effect on a business, unless you're in the business by yourself.

I think the vertically integrated model gives us an advantage in terms of getting new products to customers faster and to applications faster.

It gives us the insight to take our LED products to solve very specific problems and help our customers turn on those applications.

It helps us get our own lighting products through that innovation cycle faster.

I think that's the primary benefit, if you think about the real strategic side of it.

Then it means that we can take an innovation and we can participate, for example, in one market that we might have a great product idea on; but that same LED can then be applied to a different market that we would never want to be a part -- that we would never be good at from a fixtures standpoint.

As far as competition goes, I think the market's going to always have those factors, and I think they're going to vary from time to time.

What we control is, can we innovate and add value, and can we innovate and take costs out?

Right now, we feel pretty good that there's significant opportunity in both of those sides, so that's what we're focused on, because that's the piece we control.

Mark Heller, CLSA.

Chuck, I was just wondering if you could talk about the guidance for the LED Component business?

I think you guided for flat.

I'm just wondering what's driving that outlook, as opposed to growth in Q1?

The only thing that's going on there is we -- obviously, Q4 was solid, and we're doing fine heading into Q1.

The short-term challenge, though, is that we typically in the summer, our European business tends to be pretty soft.

What we have built into our targets is that we're targeting that to continue again this year.

If I look at it sans the seasonal softness, I feel pretty good about the Business.

But when you factor that in, it gets you to something in a similar range as last quarter.

Okay.

Is there a revenue capacity that we can think about for the LED Component business -- how much revenue you can generate given your current capacity?

With regard to the capacity additions that you're talking about, is that coming more from the move to 6-inch, or is it adding MSCBD capacity?

Thanks.

Revenue versus capacity.

As we exited last quarter, we definitely need to make investments to continue to support the growth there.

I think we're doing that.

I don't think it has limited us yet in any significant way, but I think we have to make those investments to keep up with it at this point.

As far as where we're doing it, we are actually doing it in multiple ways.

It is a combination of additional equipment.

It's 150-millimeter conversions, and 150-millimeter just capacity.

The other piece that I think we always lose sight of is that we're still working on a number of product innovations, so how do we increase yields?

How do we do things that frankly generate more lumens from the same factory?

Because when we do that, we can actually generate incremental revenue from the existing assets.

So we really work on all three of those in parallel.

Which one affects a quarter is going to vary each time, but I think it's really an approach to take a look at adding capacity, 150, and product innovation.

In any given quarter, one of those is going to be the bigger piece; but they're all very important to driving the model going forward.

Thank you.

Krish Sankar, Bank of America Merrill Lynch.

Chuck, I wanted to follow up on the move -- the transition to 150 millimeter.

Where are we in that?

Is there a way to quantify it in terms of percentage transition, or what innings of the transition are we in?

Then I also had a follow-up.

Yes.

I'd say that we're not quite to 50%.

We've made a lot of progress in the last year, but we're probably a little below 50% -- I don't have an exact number for you.

I would imagine that we will see incremental increase in 150 transition for at least the next year.

Given the dynamic of having a fairly robust demand environment right now, that will be an incremental addition each quarter as we go through the year.

I would expect that to continue.

Got it.

That's very helpful.

Just to follow up, trying to get into the medium-power range with your high-end ceramic, is that a market you really want to be competing in vigorously?

Seems like it's very crowded.

Or is this something that you feel will actually help with your high-power market, too?

It's interesting.

People assume that medium power means throw a lot of plastic LEDs at it, and sacrifice performance or something else.

What we're -- really, what we've done with that product is, we have a number of customers that that's one design approach, but if you give someone a much higher-performing ceramic-phase mid-power LED, they can do some things from a design standpoint.

It's not going to be for every application, but there's a number of applications where I think our customers will get a real competitive advantage.

When I say competitive advantage, their product's going to have a better price performance than the competing product out there, and that's why we did it.

It's less about another guy making mid-power LEDs, than it's really about a better way we think to do it at least for a certain number of applications that we're working on with our customers.

Thank you.

Again, as presenters, 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 first quarter results on October 22.

Good night.

Good night, thank you.

Thank you presenters, and thank you ladies and gentlemen.

Again, this does concludes today's call.

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

Attendees, you may now disconnect.