Wolfspeed Inc (WOLF) 2014 Q3 法說會逐字稿

Good afternoon.

My name is Patrick, and I will be your Conference Facilitator today.

At this time, I would like to welcome everyone to the Cree Incorporated FY14 third-quarter earnings call.

(Operator Instructions)

As a reminder, ladies and gentlemen, this conference is being recorded today, Tuesday, April 22.

Thank you.

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

You may begin your conference.

Thank you, Patrick, and good afternoon.

Welcome to Cree's third-quarter FY14 earnings conference call.

By now you should have all received a copy of the press release.

If you did not receive a copy, please call our office at 919-287-7895 and we will be pleased to assist you.

Today Chuck Swoboda, our Chairman and CEO, and Mike McDevitt, our CFO, will report on our results for the third quarter of FY14.

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 posted in 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 and 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 third quarter of FY14 to a discussion of the information included in our earnings release.

We will not be able to answer any questions that would involve providing additional financial information about the quarter beyond the comments made in our 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 May 6, 2014.

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

Thank you, Raiford.

Q3 was a solid quarter with revenue of $405 million and non-GAAP net income of $47.7 million or $0.39 per diluted share.

Revenue and operating income were in line with our target range, and the business is well positioned to grow in Q4.

The sales trends in Q3 were as follows: Lighting sales increased 35% year-over-year to $177 million.

LED sales increased 3% year-over-year to $201 million, and Power and RF sales increased 21% year-over-year to $27.4 million.

Non-GAAP gross margin was 37.8% in Q3, which was within our target range.

LED and Power and RF margins were in line with our targets, while Lighting was slightly lower as LED bulb price reductions offset a more favorable Lighting mix.

LED bulb cost reductions that support the lower price points have already been implemented and are targeted to benefit Q4.

Non-GAAP operating profit increased 20% year-over-year to $53.6 million in Q3, which is in line with our target range for the quarter.

And non-GAAP operating margin increased 30 basis points year-over-year to 13.2%.

These results, once again, demonstrate our ability to deliver strong operating results while continuing to make longer term investments in new technology and building the Cree brand.

Cash and investments increased $39 million to $1.22 billion, which puts us in a great position to increase the level of capacity investments over the next year, which Mike McDevitt will explain in his remarks.

We are also in the process of looking at potential strategic opportunities to expand the Cree product portfolio and gain access to new customers.

Company backlog for Q4 is ahead of this point last quarter and in line with normal Q4 booking trends and the targeted growth in sales.

We are forecasting growth in all three product segments in Q4 led by double-digit growth in Lighting in both LED fixtures and LED bulbs.

LED component sales are also forecast to grow nicely in Q4.

As the leader in LED lighting, we continue to take advantage of the global shift to LED lighting and our strategy to use new product innovation to drive our growth by taking share from traditional technologies.

The strategy is working, and we are well positioned to continue growing our business in FY15 as LED adoption increases.

Our brand investments have produced good results, and we plan to continue to invest in this area in the year ahead.

I'll now turn the call over to Mike McDevitt to review our third-quarter financial results in more detail as well as our targets for the fourth quarter of FY14.

Thank you, Chuck.

I will be providing commentary on our financial statements on both a GAAP and non-GAAP basis, which is consistent with how Management measures Cree's results internally.

However, non-GAAP results are not in accordance with GAAP and may not be comparable to non-GAAP information provided by other companies.

Non-GAAP information should be considered a supplement to and not a substitute for financial statements prepared in accordance with GAAP.

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

For the third quarter of FY14, revenue increased 16% year-over-year to $405 million, which was in the middle of our targeted range of $390 million to $420 million.

GAAP earnings increased 27% year-over-year to $28 million, or $0.23 per diluted share for the third quarter of FY14.

And non-GAAP earnings increased 17% year-over-year to $48 million, or $0.39 per diluted share.

Non-GAAP earnings exclude $20 million of expense net of tax or $0.16 per diluted share from the amortization of acquired intangibles and stock-based compensation.

Revenue, pretax income and GAAP and non-GAAP earnings per share were all in line with our target ranges.

Q3 GAAP gross margins were 37% and non-GAAP gross margins were 37.8%, which excludes $3.1 million of stock-based compensation.

This was within our target ranges.

FY14 third-quarter revenue and gross profit for our reportable segments were as follows: LED products revenue grew 3% year-over-year to $201 million, and gross profit grew 7% to $91.6 million for a 45.6% gross margin, which was 180 basis point increase year-over-year.

Our Q3 LED gross profit and margin increase was due to a combination of higher sales, lower cost new products, cost reductions and higher factory utilization.

Lighting products revenue grew 35% year-over-year to $177 million, and gross profit grew 21% year-over-year to $48.5 million for a 27.4% gross margin.

Lighting Fixtures revenue had strong double-digit growth year-over-year.

Gross profit and margin growth was slower than revenue growth as we had a full quarter of LED bulbs sales this year versus last year.

Power and RF products revenue grew 21% year-over-year to $27 million, and gross profit grew 30% year-over-year to $15.7 million for 57.1% gross margin, which was a 410 basis point increase year-over-year.

The revenue and gross profit growth were due to higher sales, cost reductions and higher factory utilization.

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 $5.8 million for the third quarter of FY14 and are included to reconcile to our $150 million GAAP gross profit.

Operating expenses for Q3 were $120 million on a GAAP basis and a $100 million on a non-GAAP basis, both of which were within our targeted range.

Non-GAAP operating expenses exclude approximately $13 million of stock-based compensation expense and $7 million of charges for amortization of acquired intangibles.

Our non-GAAP operating income grew 19% year-over-year to $54 million as we realized a 140 basis point improvement in our operating leverage year-over-year.

Net interest income and other for the quarters was $3.2 million.

Our Q3 GAAP and non-GAAP tax rate was 16% for the quarter, which was less than our 21% target for Q3, primarily due to the recognition of a discrete tax benefit.

We ended the quarter with $1.2 billion in cash and investments, a $39 million increase sequentially.

For the quarter, cash from operations was $60 million and capital expenditures were $41 million, including $5 million related to patents which resulted in free cash flow of $19 million.

Day sales outstanding was 49 days as compared to 46 days at the end of December, which is in line with our 50-day plus or minus target range.

Inventory days on hand increased to 89 days as compared to 81 days for the end of December.

Our inventory growth is primarily raw materials and work in process to support our targeted Lighting and LED growth.

We are raising our inventory days on hand target from 80 days to 90 days plus or minus to reflect the increased Lighting mix as we plan greater flexibility to support our quick ship program and better service our sales channels.

Property plant and equipment additions were $36 million in the third quarter.

For FY14, we have raised our target to $175 million plus or minus the property plant and equipment spending to support our new product priorities and provide incremental capacity as needed.

This increase from last quarter's forecast is primarily to make capacity investments to support forecasted growth in the business over the next year and infrastructure investments to support longer term forecasted growth.

At this time, we target Q4 revenue to increase to a range of $430 million to $460 million, which is comprised of double-digit growth in Lighting sales, LED growing single digits and Power RF sales slightly higher.

We target Q4 non-GAAP gross margins to be similar to Q3 at 37.5% plus or minus, and GAAP gross margins to be 38 -- or 36.8% plus or minus.

This Q4 target is based on the number of factors that could vary, including overall demand, product mix, factory execution and the competitive environment.

Our GAAP gross margin targets included stock-based compensation expense of approximately $3.2 million while our non-GAAP targets do not.

We are targeting Q4 operating expenses to increase approximately $7 million sequentially due primarily to higher sales costs associated with higher targeted revenue, the marketing costs to support two major lighting trade shows within the quarter, increased patent-related legal costs and a slight increase to our Cree brand spending.

We target both GAAP and non-GAAP operating profit to grow faster than revenue sequentially, even with the incremental operating expense spend.

Our GAAP operating expense targets include non cash stock-based compensation expense of approximately $13 million and charges for amortization of acquired intangibles in the amount of $7 million.

Loss on disposal of assets is targeted to be similar to Q3.

Net interest income and other is targeted to be approximately $3.5 million for Q4.

We target our Q4 tax rate to be 21%.

As a reminder, our Q4 and FY14 tax rates will fluctuate based on our overall earnings, the tax jurisdictions in which your income is actually earned, the potential reinstatement 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 for Q4 is targeted to be between $28 million to $36 million.

Based on an estimated 124 million diluted shares outstanding, our GAAP EPS target is between $0.23 to $0.29 per diluted share.

Non-GAAP net income is targeted to be between $47 million to $55 million, or $0.38 to $0.44 per diluted share.

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

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

Thanks, Mike.

We remain focused on four priorities to drive our growth in FY14.

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

In Lighting, we continue to make great progress on both fixtures and bulbs.

Our new lighting fixture products continue to gain traction in the market which helped drive sales growth in the quarter.

We saw good sales growth in indoor and outdoor even grew slightly, despite an extremely cold winter in the Central and Northeastern US.

From an R&D standpoint, we established a completely new efficiency benchmark for lighting systems with the first 200 lumen per watt LED concept luminaire that is more than twice the efficiency of the best linear fluorescent luminaires.

We also reinvented the concept of lighting controls with our self-programming one button SmartCast technology, which reduces energy consumption by more than 70%.

We continue to raise the bar on LED price performance with our new ZR LED troffer which delivers excellent light quality and aesthetics for under $100.

We extended our breakthrough XSP street lights series with the XSP area and an XSP wall pack products.

Our Lighting Fixture product line continued to build momentum in Q3 with good business growth and new product momentum that is not only closing the gap with conventional technology but also redefining what is possible in lighting.

We made the Cree LED bulb brighter and more affordable in Q3 as our relentless focus on innovation enable us to reduce pricing and expand the LED bulb product line with the introduction of 100-watt warm and cool light LED replacement bulbs.

LED bulb sales to consumers increased again in Q3 as the Cree LED bulb gains momentum and brand recognition.

As I discussed last quarter, we continue to work with The Home Depot to test the price to consumers and the trade-off between volume and margin.

The lower retail price points we announced a few weeks ago across most of the Cree LED bulb product line, have already increased sales and confirm that there is significantly more opportunity to drive LED adoption.

We remain focused on product innovation to expand our product offering and develop even lower cost next-generation bulbs to enable new price points and further adoption.

We are reinvesting most of the profits to fund additional marketing investments to generate even more awareness that the Cree LED bulb pays for itself.

In LEDs, we continue to push the boundaries of LED performance as we demonstrated the first LED component to break the 300 lumen per watt performance barrier by demonstrating a 303 lumen per watt white high-power LED.

From a product standpoint, we have established a new class of high-density lighting components by releasing a series of products across our components platform.

These new product families utilize our market-leading LED chip technology to set new standards in lumen density and deliver the first family of high-density lighting components.

We introduced the XLamp XB-H high-density LED component which delivers unrivaled lumen density and optical control from a discreet LED component.

We introduced a new series of CXA high-density arrays that double the light output of existing CXA arrays and enable new applications that have previously not been able to switch to LED.

We also introduced higher density 6000 lumen and 8000 lumen versions of our LMH2 LED module family which enable companies -- which enabled the complete replacement of ceramic-metal-halide lamps.

In Power and RF, we continue to make incremental sales progress and win new designs.

The Power product line delivered incremental growth in the quarter as we started to see some of the first small volume applications for our silicone carbide MOSFETs go into production.

This is likely to be a slow ramp, but the design win activity continues to indicate that we are on the right track.

The RF product family also continues to gain momentum as more companies are working to bring gallium nitride RF devices based on our gallium nitride chips into wireless infrastructure applications.

This is primarily design activity at this stage, but based on the increased activity, we target additional gallium based telecom hardware to be released over the next year.

Our second priority is to build the Cree brand and selling the Cree bulb continues to be the foundation of our brand strategy.

The market has responded to the success of the Cree LED bulb with new products from a number of different companies.

Despite the new competing products, Cree LED bulbs sales continued to grow in Q3.

The increased choice is great for consumers and good for LED adoption.

Our partnership with The Home Depot continues to grow with the increase in LED bulb sales, but we must remain focused on earning our place in this market with new products that move the market and give consumers more reasons to switch to LED.

We look forward to continuing to work together with The Home Depot to enable this market and continue to evaluate complementary channels as appropriate.

Our third priority is to focus on select market segments where we can upgrade existing lighting and drive adoption.

We have made good progress on new applications, like automotive dealership lighting, and we continue to expand this activity.

We also continue to test new channel approaches to engage lighting owners with complete solutions.

We've had some small scale initial success, but we are still in the early stages of determining the most effective way to do this.

However, it is clear that there will be -- there will likely be a number of new approaches that evolve to sell LED lighting to the very large and mostly untapped base of installed lighting customers.

Our fourth priority is to build on our new product momentum and continue to grow revenue and profits.

For the first three quarters of FY14, we continue to demonstrate that we are on the right track with revenue up 20% from the first three quarters of FY13 and non-GAAP operating profit up 32%, all while making significant investments in new technology, sales channels and building the Cree brand.

As I mentioned earlier, Q4 total Company backlog is ahead of this point last quarter and in line with normal Q4 booking trends and the targeted growth in sales.

We are forecasting growth in all three product segments in Q4 led by LED fixtures and LED bulbs.

Factory utilization remains high.

We are expanding capacity in the short term and making investments for the mid to longer term.

Execution is a critical factor to supporting growth in all three product lines, which continue to operate with short lead times.

This adds variability to our forecast for the quarter.

Based on our current backlog, forecasts and trends in the business, we are targeting strong Q4 revenue growth in a range of $430 million to $460 million which is comprised of double-digit growth in Lighting sales driven by strong growth in both LED fixtures and LED bulbs, single-digit growth in LED and slightly higher Power and RF sales.

We target non-GAAP gross margin to be similar to Q3 at 37.5% plus or minus.

We target non-GAAP operating expenses to increase about $7 million in Q4.

Even with the increased investments, we target non-GAAP operating profit to sequentially grow faster than sales and target non-GAAP earnings to increase in to a range of $0.38 to $0.44 per diluted share.

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

As a technology Company, we are passionate about fundamentally changing the customers lighting experience for the better.

Our strategy is working, but we are still just getting started.

Our balance sheet gives us the flexibility to continue to invest for the future.

We currently target investments in capacity, which Mike described earlier, and strategic opportunities to enhance the Cree portfolio.

We have begun to look at strategic opportunities across all our product lines.

And we are very comfortable with our current product portfolio.

We believe some opportunities may emerge over the next 24 months to leverage the Cree brand as the shift in new technology accelerates and the industry begins to go through a consolidation phase.

The strength of our operating model gives us the flexibility to make these investments and continue to maintain a strong balance sheet to support the future growth as we remain focused on our long-term customer goal of 100% upgrade to LED lighting.

We will now take analyst questions.

(Operator Instructions)

Paul Coster, JPMorgan.

By the comment already around strategic opportunity.

Why now?

What kind of consolidation do you have in mind?

And why over the next 24 months is it suddenly in your wheelhouse?

Yes, Paul, I think it's more of an indication that as we see LED adoption picking up pretty much across the industry, we -- I think there's a perspective that as that accelerates, that the landscape is going to change.

And I think the opportunities will start to become obvious that those that can access the customers and build brand and have channel that there are opportunities to combine maybe product portfolios or use some deals to access new markets.

With that being said, this is not an imminent thing, it's something that I thought that was important that we let people know we're starting to look at more seriously than we have for the last couple of years.

Okay, I have another question, a little bit more picky.

But you've increased your inventory levels intentionally in order to facilitate the quick ship and to better service your channels.

Can you give us a little bit of color to what's going on here and what it means in terms of foregone style or margins or mix that we think should therefore improve with using your balance sheet in this manner?

Yes, Paul, actually the first thing I think is that part of the builds you saw last quarter is actually just in raw materials and lift.

It's the nature of trying to scale up the production to be a much higher volume supplier, both of fixtures and bulbs.

So that's kind of the first base.

It's just really building up that supply chain.

The second piece is the finished goods, which is really in quick ship and bulbs.

And you have two different ideas there.

In quick ship we have a series of high runner fixtures that as we start to do more projects that are relatively not long design cycle projects but ones where someone decides to do a building renovation, having that inventory is critical to serving the customer.

So this is really for a series of high running products.

And then when it comes to bulbs, we explained last quarter that we went through a transition with The Home Depot where they were for the first three quarters holding strategic inventory and really that it shifted to us.

And so as that business scales up, some of that is also flowing to us.

So I think it's less about margin and more about servicing two growing pieces of the business in a way that we think is most appropriate to meet the customer expectation.

Brian Lee, Goldman Sachs.

I guess first off on the margin outlook, I was wondering if you could help delineate a little bit around the different moving pieces here for -- to the mid-year term and in terms of what's having an impact?

So if I look at commercial, I would assume you're having a higher mix of outdoor versus last quarter on seasonality.

And then in consumer lighting, the lower price points that you recently introduced are going to be flowing through for a full quarter here.

And then lastly, the additional fixed cost that I assume you would be incurring on increased capital investment that you're making here.

Directionally I'm wondering how much of the impact on the near-term margin profile are each of these moving pieces having, and are they all effectively directionally weighing on the margin outlook?

And then I have a follow up.

Yes, Brian, I would say that it's more about product mix then it is about the fixed cost investment.

So while we're making those -- that's -- the way we're doing that since we're fairly highly utilized right now, as those come on, I'd expect them to turn on and to support the additional revenue.

So I don't see that as the big swing factor.

If you look at within the Company, really what you have is two things going on.

You have Lighting has become a higher percentage of the total, so that affects the overall Company gross margin, and then mix within Lighting.

And so what we have is is that last quarter, we did get a swing to more commercial or fixture products, but the reality is is that that was offset by the fact that we implemented the cost reductions.

Going forward this quarter, Lighting is the fastest-growing segment, and we have both fixtures and bulbs growing.

So I think what you're looking at more than anything is is a product mix that's driving the guidance, which is pretty similar.

And so what that suggests is is we think we can make cost reductions in the product line so that even with the increased mix of Lighting, we can overall deliver a single or overall gross margin quarter-over-quarter.

And then if you step back a little bit, the way we think about that is is the bigger picture is we control costs, which is what we're working on.

Mix is going to move around, we're not going to control that overall.

But we're pretty confident that with revenue growth really in all the segments that we can deliver some operating margin over the mid to longer term.

And so that's the big picture way we think about that.

Okay.

Thanks, Chuck, that's helpful.

My follow up was on LED products, just wondering if you could provide a bit more color on expectations for pricing trends in that segment?

It sounds like you guys have found it a bit more optimistic on that front in recent quarters and even how tight you are in capacity.

I'm wondering if you're thinking about that as being more of a potential tailwind to the margin profile on that particular business segment?

Thank you.

Yes, so on LED products, in the short term I'd say the competitive environment, otherwise known as the pricing environment, is pretty similar to what it has been over the last few quarters.

And I would say that's what we're targeting for Q4.

With that being said, there is, obviously, two things to keep in mind.

One, we have a fairly different LED components business than most people.

We're essentially very focused on a high power, high-density segment.

And you can see the difference in our business and our margins versus a lot of the other guys out there.

But with that being said, the natural question is as we start to increase capacity because we're fully utilized and we start to hear other people in the industry talk about rising utilization, there's an obvious semi cycle that you would think is coming.

We don't see it yet, but I do think at some point we'll see that tightness that probably would do two things.

We'll see the lead times move out first and then we'll see some pricing power shift to the suppliers.

But we're not there yet and it's not in our target.

So I think it's likely but a little early.

And I think the reason we haven't seen it is that while most of the major players, our sense is are pretty full in terms of capacity utilization.

I sense that there's still a bit of extra capacity in that next tier that hasn't fully been utilized in the market.

Andrew Huang, Sterne Agee.

The first is if I take your June quarter guidance to get to the full year for FY14 and then compare that to FY13, it looks like revenue will up around 20%, gross margin is down slightly, operating expense dollars up around 15%, which gets you to about mid-20% EPS growth.

So when I look out to FY15, can you give us some general guidance of how to think about gross margins and operating leverage?

And then I have a follow up.

Yes, Andrew, you've done more math while we're on the call than I have on those metrics, but let me give you some high level.

So as I think about gross margins, I look at it a couple different ways.

We think there are things we can do or we're fairly confident that there are cost reductions that we can get to in Power and RF, in the LED segment and in the Lighting segment.

So we feel comfortable that there's lots of innovation left that will drive cost down.

The market is going to have some effect on how much of that cost be margin versus it's price erosion, and it's a little hard to call that right now.

But that's the piece we control on the one side.

From a Company gross margin standpoint or even a segment gross margin, one of the challenges is as the mix changes, let's just use within Lighting, the mix between fixtures and bulbs or even a mix within different types of fixtures, there is a swing factor there.

So the way I think about it is we're going to work on the cost reductions.

We're going to continue to drive revenue growth, and we currently see the opportunity to grow revenue, obviously in Lighting, both fixtures and bulbs.

But also we see growth opportunities next year in the Power and RF as well as in the LED segment.

So however, you want to model that mix, that's going to drive one of the variables to the equation.

From a -- as I step back, the way I think about it is, if we can drive the revenue growth we're targeting, I think we can deliver operating leverage.

And the gross margin will take care of itself because it's more about the mix between those businesses, the major swings within them.

That's the concept at this point.

Okay.

And then on your comments on the strategic transaction, if you look at the lighting industry today like all of the big players here in North America, if you look at their home pages, you see maybe 15 different brands under -- whether it is Acuity or Cooper or Philips.

So I'm curious how you feel about having other brands under the Cree name, or will you instead be maybe focused more on the channel?

Andrew, honestly, we're looking at both opportunities.

I think that we're making a pretty big Cree brand investment, but that doesn't mean we would be against if there's something out there that really was complementary to the overall portfolio we'd consider doing that.

And from a channel standpoint, I think the same idea.

What customers are underserved that we think that with our product portfolio and the other investments we're making could we generate more benefit.

And again, I want to caution, I know that I've put it out there in the script.

I did that just because I don't want people to be surprised if and when we get to the point of doing something, but it's more to share a little bit our thinking.

We get asked that question a lot by investors, is M&A on the horizon?

The answer is we're looking at it, but it's not imminent or short term.

And I would say right now if you try to guess if it's product or channel, you'd be wrong right now because we haven't decided yet because we're still looking at lots of different things.

And I don't think it's -- as I said, this is something I think will evolve over the next couple years.

Jed Dorsheimer, Canaccord.

My first one's around the -- on the Lighting products.

It's interesting to see that you guys have really emerged as one of the leading LED bulb manufacturers here.

10 years ago I wouldn't have guessed that.

My questions around channel and how we should read into a lack of a contract with Home Depot.

It seems as if from your scripted comments that the relationships strong as ever, it looks as if the products are selling pretty well and you've got elasticity.

So I guess my question is, will we -- is this the new normal?

Should we expect that some relationship would be inked, or was that a startup phase to get the bulb into the market?

And then I have a follow up.

Jed, I think you're already -- I think you can anticipate where that answers going.

Essentially, when we're starting up, when you're a brand new consumer brand in a brand new channel, there's both sides want to go through the process of having a fairly formal relationship.

I think now we've got a formal relationship, but it's called a very large business that both of us are benefiting from.

And so I don't -- I think that the concept of the contract was really an early stage piece.

And I think at this point, this is the new normal because it's really the business relationship that's driving it.

And frankly, that relationship is as good as it has ever been in the last year.

And so I feel like it's anything else, if both companies benefit from growing the business, that's usually stronger than anything else you can do.

Great.

I guess the obvious is to that end, should we start seeing Cree pop up in some additional channels?

And then as my second question, looking at -- or maybe the follow up to one of the previous questions, in the LED components, one of the things that's difficult about trying to model your Company is percentage of what's captive versus merchant in the LED components.

So should we think, your comments about hoping to see some pricing power in a positive semi cycle, should we expect that some of that leverage would be used or most of that leverage would be used internally in terms of captive capacity for the Lighting products business as a tool to further differentiate yours -- your Lighting products business?

Or should we -- how should we understand that mix?

Okay.

So let me catch the end of the first one.

So on additional channels, what we've done so far is Home Depot is our primary focus.

We have launched the bulb into commercial distribution, and it's got a nice -- I think we're getting some nice traction, but it's not of the scale of selling bulbs through The Home Depot.

And so really our -- 98% of our effort is on working with The Home Depot and frankly scaling of that business, which it takes up most of the energy.

I think we will look at some other complementary channels, Jed, but really as a secondary thing.

I wouldn't -- you shouldn't expect any significant announcements there in the near term, because, frankly, with the growth in Home Depot and the things we're doing with them as well as what we're doing in distribution, I just don't think it's the right -- we don't need that distraction in the short term.

And frankly when we do it, it's really about accessing a demographic of customer that we think we're not getting to today.

So by complementary, it's really, is there a customer that we don't access in one of our current channels?

So to me, secondary, it'll happen eventually, but I think it's a little bit more mid to longer term.

To your LED components question, clearly people look at the LED segment and they think it's a business that's up some amount year-over-year, I think we're rough with probably about 9%, 10%, something like that year-over-year.

So the merchant side has grown.

Obviously, if you look at the Lighting business, you can pretty get a proxy that that part of it's growing even faster.

With that being said, I think what happens as the pricing changes, that will benefit our merchant business, so there is some benefit there.

But we're a little bit unique already because I think we already have pricing power slightly different than others because we're fairly in a -- we're in a fairly high power -- we're in a segment that's pretty much about technology anyways.

In terms of will we keep that to help the fixture business, how will we use that?

In my mind there's really two different ways to think about it.

We're in the merchant LED components business, and we plan to stay there for the indefinite future.

So to me we'll get the benefit there just because the market will have -- there'll be more demand and supply and we'll get some pricing benefit.

In terms of the captive side of it, I think it's more important to think about it from a -- we will have much better ability to access the technology to keep the innovations going.

I think one of the challenges will be is if we get into a short supply situation, you have to make some compromises if you can't get the LEDs you want.

And by having our own factory, I think it gives us -- we're in a better position to manage through that then maybe if it was just a peer buy/sell thing on that side of the business.

Vishal Shah, Deutsche Bank.

Wanted to better understand your OpEx trend.

OpEx is going to be up about $7 million Q4.

How should we think about the areas of investment of increased spending in the near term?

And also how should we think about OpEx growth in 2015 in terms of -- in relationship to the revenue growth?

Yes, so $7 million, this is a bit of a unique quarter.

So what we have going on here is that you've got part of that growth is the timing of the Lighting marketing season.

So the way to think about it is is that the -- in the spring we have two major trade shows, Light and Building, which happens every other year, and then we have the Light Fair.

And between those two, that's a big chunk of money for the Lighting and the LED business.

So that's one of the big marketing spend numbers that's different in this quarter than in most other times.

We also have -- the fact is is that when Lighting grows, specifically lighting fixtures, that drive the sale -- incremental sales cost.

So that's going to scale with the growth in the fixture business.

Then more of the non-normal items, or maybe not within that trend, is there is some incremental spending on the brand and, frankly, bold advertising that you'll see later this quarter.

And that's really a time to refresh some of the messaging that we're doing out there.

So I think there are logical things.

We think it's still on an overall basis we're going to get more return for that in the short term.

And obviously long term, we think those are great investments.

As far as how do you think about modeling 2015, the way we're thinking about it is is that the revenue growth should be faster than the OpEx growth.

So our goal next year is to deliver operating leverage of some amount.

Obviously, it's going to fluctuate a bit based on product mix and where those investments are.

But overall, our targets are as to grow revenue and to grow operating profit a bit faster than that.

Brandon Heiken, Credit Suisse.

I was hoping you could -- if you could clarify about the capacity expansion plans?

It sounds like the CapEx guidance was a little bit higher for this year.

What do you think for next year?

And what do think the strategy will be for further outsourcing of chips?

Yes, so we just raised it in this quarter.

We raised a bit last quarter, raised it again, and so what's going on there is a couple things to think about.

So obviously, the March quarter is typically our low quarter.

So we've come out of that, business looks pretty strong.

We're relatively optimistic about the growth, and really all the product lines going into next year.

So that's guiding part of the increase.

Second, the other thing to think about is as we look out to the industry, our sense is is that as capacity becomes tighter, we also want to get a little bit ahead of the curve from a lead time standpoint.

So we're doing two different things there that are both really investments to support the growth in LED lighting, whether it be from a lighting systems, fixtures and bulb standpoint or frankly selling more components.

So that's how I would think about that piece of it.

For next year, we don't have targets yet, but I'd say roughly the exit rate of Q4 is probably the best starting point.

I'm think -- I'm looking at Mike and he's shaking his head, so I think that's how I would start modeling it.

With that being said, we have some more work to do there.

Because we do outsource some today, and I think we'll continue to look at that lever and how much we can utilize that going forward.

If you think about it, that while this is an increased, it's significantly lower capacity utilization for the amount of revenue growth than what we've seen in past growth cycles.

So I feel like we're in a good spot right now.

Obviously, the business is healthy and we have plenty of balance sheet to do this.

But I feel pretty good that we've got a nice balance right now and outsourcing will be something we'll look at.

We'll continue to look at whether or not we can expand that going forward, depending really on product mix and what parts of the market grow.

Okay, thanks.

And can you clarify when you mentioned you want to do further brand investments, does that simply mean driving the price down on the bulb?

Or are there additional increases in OpEx that we should expect or other investments for instance the strategic acquisition?

Yes, no so when I say brand investments, take strategic out of that and take out bulb pricing.

What I'm talking about there is, for example, in Q4 we will spend incrementally more in Q4 then we spent in Q3 simply promoting the Cree bulb or the brand through a combination of marketing activities.

That's everything from things we do, digital advertising to a variety of things that are really just about building the Cree brand.

Those other things would be in different parts of the OpEx bucket.

And then if you think about that again as we -- as I mentioned on the previous question, but if you net all that out and look forward, we think that the OpEx investment is a lower rate then the revenue growth.

So we're still targeting for next year that even with these investments we get operating leverage.

Edwin Mok, Needham & Company.

My question is on your cost lever that you can pull on the LED component out of the business, right?

If I look at it, you mentioned utilization is pretty high already.

And you have -- previously you had this SC-3 platform you guys are rolling out that seems like it's already fully rolled out.

Was wondering what cost lever -- can you identify some cost lever for us, you think about what you can do to drive cost down for LED components.

And in terms of maybe a new platform that you guys are working on, maybe timeframe or how we should think about that?

Yes, Edwin, the way to think about it is really two levers.

There's the traditional levers.

We're still not fully converted to 150, so we'll continue to get some benefit from full conversion that I think will happen.

Really, if we're over 50%, but I think it'll really be probably most of the next year before we get fully converted there.

So we have that as a bit of a tailwind for the next fiscal year.

And then obviously lots of productivity, things that come when you get scale, there's productivity (optimum mix).

So that's the blocking and tackling side of it.

The other piece of it is really what you're poking at I think is on the innovation side.

And so while we're doing lots of different things, to give you an example what we've done, the LED that's in the current Cree LED bulb I think is the fifth iteration in 13 months.

So to give you an idea, there's lots of innovation.

And that's about performance and cost.

And so we're going to do those types of things which are really improvement on what we've started.

And then from a platform standpoint, you won't -- I don't expect you're going to see a big SC-3 announcement.

But we actually have, if you look at the most recent products, there's technology that's starting to show up in our components that is almost, I think the buzzword a lot of people like to use is chip scale packaging.

But if you look at what's going on, there are some of our newest LED components are approaching what I would call a chip scale package.

And so there really is a quote, new platform, but it's not -- we're not branding it as such.

It's really going to start showing up.

It has in some initial products and you'll see it continually start show up over the next year, which gives us additional cost performance leverage.

And so I think you're seeing it, it probably won't have any cool nickname this time, but it's there.

I see.

Okay, great, that's helpful.

And then you talk about some new application I think you had an auto dealership in one area or one channel you are looking at.

If I look at your [LED margin], strength is in really high power.

Is that because where your LED margin is strong, does that preclude you from going after other applications?

Or are you effectively driven by the fact that you have the strength in margin therefore just focus on application but leverage that, how do you think about that?

No, it's two different things.

So the reason automotive became a big focus for us, that's really playing off the systems technology, that is part of what was three years ago the Ruud Lighting acquisition.

So there is some really great technology around high-power outdoor lighting with really precise optical control that fits great in that application.

We also have some very innovative products on the indoor side.

Now, is some of it built around our high-power platform?

Absolutely.

Our LED components strategy is high-power, high-density light that can show up either in the types of products you're thinking for outdoor or you can see us do very different things with the technology like what we're doing in the bulbs.

So most people would not consider a consumer LED bulb a high-power or high-density light source.

But the same technology we're using to win in outdoor is being used in a very different way with that chip scale packaging to compete in a very high-volume, tough low end consumer market.

So I think we're using it in both places.

In our mind, you've got to be a little careful of applying it too broadly, because it's really about what's the right application, the technology for the right specific application.

And they really have to be optimized.

And so I think we're trying to match those as we go along.

But as a merchant component supplier, it's much more the high-power, high-density.

The reality though is you could and we prove it in our own systems products everyday, use it differently in many of the indoor style applications.

Mark Heller, CLSA.

Back on the Lighting gross margins for the March quarter.

I know that originally you had guided for it to be up a bit, and I think you had anticipated a price reduction for the bulbs in the quarter.

So I guess I'm curious what was surprising to you guys in terms of the Lighting margins in the March quarter?

Yes, so the Lighting margins generally from a -- we had predicted that Lighting fixtures would be a higher percentage, so we'd get some benefit from that.

And we did get the benefit of the mix shift.

What we had not fully baked into our targets was we were testing consumer price points when we did our call in January, but there had not been a decision when those price points would get implemented.

There was actually no -- they had not been worked out yet with the Home Depot and how we were going to do that.

And so frankly, I would have thought that would have more likely happened probably early in this quarter than it would have at the end of last quarter.

So it's really -- as much as anything, it's a timing of where we decided given some other market situations, specifically how The Home Depot promotional cycle works, that it was better to get those done sooner than wait till this quarter.

And that's really what changed the numbers.

That's the biggest difference from what we had targeted to what actually happened.

And to put it in perspective, if you look at -- it only takes a couple million dollars, which is like 1.5% of cogs in our Lighting segment to move that number that much.

It's not a big number.

Okay, got it.

And then looking at the LED segment, I guess based on the guidance for the June quarter, it looks like it'll be about flat year-on-year.

Should we expect that segment to grow on a year-over-year basis in the second half of calendar 2014?

It's -- I haven't looked at the number on a second half basis.

I know for the year it's targeted to grow year-over-year, and I would target it will grow again next year, year-over-year.

As far as what's happening quarter-to-quarter, I'm not as worried about what those dynamics are because there's a lot of things going on in the current situation given that level of utilization we have to where there's a variety of constraints right now in the market.

So I think overall we feel pretty good about the growth we had last year, and I would looking ahead to next year, we're targeting a similar level of growth.

Craig Irwin, Wedbush.

Chuck, in your comments earlier, you referred to, obviously, tightening the capacity across the industry and the potential for the market being short components.

Can you discuss whether or not there's any potential benefit from that that's included in your guidance for the fourth fiscal quarter or whether or not this is something that's further out from the horizon.

Maybe you could give us some color about how you would plan for this as far as a way to capitalize on this and potentially increase the earnings power?

Yes, Craig, the way we think about it -- so first of all, no, I think at least for the horizon we have, which is this quarter, I don't think it's going to have a dramatic effect on the business.

We've basically built our targets this year not assuming that there'll be a short-term shift.

But if I look out over the next several quarters, and I honestly don't know if that's two quarters or six quarters, my sense is given the trends in the industry and the growth in LED lighting that the capacity is going to get tight.

And so our short-term strategy is to make sure that we're prepared to support both our external components customers as well as our internal customers and the growth that we're targeting there.

And that's why the additional capital investment.

As far as how we would capitalize, I don't spend -- since it's not predictable exactly when that will happen and exactly what level that'll be, because it's partially a function of what other people's capital investment strategy does, I don't bake it into the model.

I think it's generally a good thing when it happens for a finite period of time, but we're not building in.

Generally what happens is, lead times move out so that you get a more predictable factory.

And two, pricing pressure eases for a period of time.

So my guess is what you would see that is in the LED components business.

That being said, I'm not building it into the model, because it's -- we don't fully control what will happen.

It's more of an estimate of what's likely to happen given the investment cycle we've seen over the last few years or lack thereof.

Okay, excellent.

And then my second question is SKU mix.

So when we look at some of the other public competitors you have with significant volumes of LED lighting fixtures.

Obviously, their gross margins on what they're selling are materially different because of the SKU mix Cree versus these different competitors.

Can you maybe discuss for us how you prioritize your new product development and how you might prioritize potential M&A as far as whether or not you would -- will you look specifically for higher margin products?

Or if you're really looking for the products that will be profit accretive and growth accretive for the Company?

Yes, so the way I would think about it is that I think if you actually -- we don't break out our Lighting fixture business.

But I don't know that our margins there, our LED margins for that product line are significantly different than what's going on in the industry.

There's a little bit of variation, but if you look at the combined fixture business, there's not too big of a discrepancy there.

And I think it's less from SKU mix and more from the way we're approaching the market.

The difference in Cree and other companies is is they are in the business today.

So they have an existing alternative and they can offer an LED alternative.

And frankly, they use that to maximize the value of both of those.

The way Cree sells is why would you ever buy that outdated energy wasting technology by LED now?

And so we tend to be pretty aggressive on trying to get the value to the customer to get them to move sooner than they might otherwise.

And so it's truly at this point, it's more about our intent to drive adoption and drive our business growth then being able to, what I would say, take a more balanced approach because I have both sides of the portfolio.

The balance approach is great in one respect, but it also means that you have to manage the declining side of your business at transition.

And so I like our more limited SKU approach.

We're very focused on just driving adoption and making that happen.

As far as future acquisitions, what we would focus on, look obviously we're going to look at all the elements, but right now it's about helping Cree drive adoption and really gain brand and share of mind that what we do in LED lighting is really the best way to solve a lighting problem.

And it's more about how to continue to compete against this idea that it's still okay to buy the conventional technologies.

I understand a lot of people believe that, but we're selling something different.

Harsh Kumar, Stephens.

Chuck, a quick question on the bulb strategy for you guys.

I know you've said that this was a branding exercise for most part.

Is this a business that you are long term committed to, or is this strictly a branding tool?

Just curious.

Well, obviously, it's a pretty large business already.

So it's something that we take very seriously and we think that as long as there's opportunities to lead the market and drive adoption and really give consumers what we think are differentiated better products, we're going to continue to invest in that.

With that being said, we don't measure it in the same way we think about a traditional business.

Part of the benefit we get from being in that business is the brand building.

And so as we look at that, it is a product business.

We're serious about getting consumers better lighting products, and I think we've done a pretty good job so far, obviously we can keep doing better, but at the same time, there is a real branding benefit.

And so I think they go hand in hand, and I don't even think of them separately.

And I think you should assume that Cree is going to be trying to drive this market and get more adoption for the foreseeable future.

Because despite the growth, LED bulb is still a tiny percentage of the overall market.

And so I think there's so much more to be done.

Got it.

Thank you, Chuck.

And then I want to go back to one of the questions asked earlier in your comments on global components capacity.

The majors are running close to 12 with the delta smaller incrementals maybe getting there.

In the past, the Asian capacity adds have been at best non rational.

Is that a concern of yours as you basically start to see the folks in Asia start to add capacity, maybe when the majors add capacity?

Yes, look one of the comments earlier was is when does that happen and how do you factor it into your business?

And that's the challenge is that I think the majors have had a relatively logical approach to capacity, but we have gotten some companies in certain parts of Asia that are frankly being funded by their governments.

And so that's not necessarily a logical approach to accessing capital.

We'll have to see what they do.

I think we're in a different place, Harsh, because you have a lot of these companies that made all of those investments.

And even though they're starting to fill their factories, there's a number of them that are still, frankly, losing money if you look at the real numbers.

And so we'll have to see how much capital wants to chase that.

I think it's hard to call.

What I do know is that the current rate -- the last two years rate of capacity investment has been much lower than it was before that.

So even if people start to invest, again, my sense is semi companies usually have a cycle to them because it's hard to react early when most of these other companies aren't making much money at it yet.

And so -- but I think once they fill up, what we'll see is a different reaction and people will start to invest again.

And so in my mind, there's logically -- it's logical to expect some type of a semi cycle that we also come out of as well.

It's a short-term part of the market.

Avinash Kant, D.A. Davidson & Co.

Two questions.

The first one is that you talked about operating margin actually improving better than the revenue growth over this year and the next year, most likely.

What kind of cost or price decline assumptions do you have in that assumption?

Yes, well, that's pretty hard because it's going to vary across all the businesses.

So right now we're factoring an LED component for -- there is -- essentially, we're assuming the market is similar.

So we -- and then we have typical erosion in Power and RF, and in Lighting I think we're basically assuming not a big change one way or another from this year.

It's a high-level model at this point, I'll be honest with you.

But I would say that we're not projecting into our current thinking that we're going to see a significant swing one way or another.

It's really just about the fact that we think that we can grow revenue faster than we have to spend it on OpEx, and that between those two that that generates the leverage.

Okay, and the second question is that you did talk about some efficiency improvements, and you said that you had five different versions of the chips that you have been using.

Could you give us some idea in terms of maybe either the surface area of the chip that has been used historically versus now or what kind of efficiency gains have you been able to have thus far?

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

I think it's fair to say that part of those cost reductions along the way has been a reduction in chip area.

So clearly shrinking the chips, making the chip more efficiency, can shrink it is one of the things.

But there's also things that are being done at the package level.

This idea of chip scale packaging, it's not just shrink the chip, it's shrink the package.

But there's also technology improvements to more effectively extract light, make it operate better in different operating conditions.

There's really a bunch of variables that are still at work that are about maximizing the performance.

And so that's been our approach so far, and it's really given us the leverage you've seen over the last year.

Thank you.

Due to time, this ends our Q&A session today.

I'll turn it back to Management for closing remarks.

Thank you for your time today.

We appreciate your interest and support and look forward to reporting our fourth quarter and FY14 results on August 12.

Good night.

Thank you.

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

You may all disconnect.

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