Wolfspeed Inc (WOLF) 2015 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'd like to welcome everyone to the Cree, Inc.

FY15 third-quarter financial results call.

(Operator Instructions)

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

Thank you.

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

Mr. Garrabrant, you may begin your conference.

Thank you, Patrick, and good afternoon.

Welcome to Cree's third-quarter FY15 earnings conference call.

Today, Chuck Swoboda, our Chairman and CEO, and Mike McDevitt, our CFO, will report on our results for the third quarter of FY15.

Please know 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 the investor relations section of our website.

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 margins 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 FY15 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 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.

If you have additional questions, please contact us after the call by email or phone at 919-287-7895.

We are also webcasting our conference call and a replay will be available on our website through May 5, 2015.

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

Thank you, Raiford.

Fiscal Q3 revenue was $410 million, which was in line with our targets for the quarter, as better than forecasts LED demand offset worse than expected weather-related seasonality in LED lighting.

Non-GAAP net income was $25 million or $0.22 per diluted share as a lower tax rate offset reduced gross profits due to lower factory utilization, driven by inventory reductions and an unfavorable product mix.

The sales trends for Q3 were as follows.

Lighting revenue increased 27% year over year but declined 3% sequentially to $224 million as the severe winter weather in the northeastern US delayed commercial LED fixture sales.

Commercial fixture demand rebounded in late March and is targeted to grow in Q4.

LED revenue decreased 23% year over year but was better than expected at $154 million as solid external customer demand offset the normal decline related to the Chinese New Year holiday.

Power and RF revenue increased 13% year over year and was similar to Q2 at $31 million.

Q3 non-GAAP gross margin decreased to 250 basis points sequentially to 31.4% due to lower LED and lighting margins.

The margin declines were due to a number of factors but the common driver was the impact of inventory reductions in LEDs and lighting.

While we plan to reduce inventory, we burned $33 million or 10% of inventory in the quarter, which is faster than expected and resulted in a larger margin impact than targeted.

The segment gross margin trends were as follows.

Lighting segment margins decreased 26% due to product mix and factory underloading in the first half of the quarter, driven by inventory reductions and the timing of orders.

Overall, product mix was unfavorable as LED bulb sales increased as a percentage of the total.

Product mix was also unfavorable within commercial LED lighting due to the weather-related project delays.

LED segment margins declined to 35.9%, primarily due to lower factory utilization as we slowed the factory further to adjust for lower lighting revenue as part of our effort to reduce inventories across the Company.

LED pricing was also slightly lower than forecast as we reduced channel inventory for certain older generation LED products.

The power and RF segment margins were slightly lower at 53.1%, primarily due to product mix.

Although the inventory reduction is causing some near-term gross margin pressure, we believe it is the prudent choice and in line with our strategy to continue to innovate and rapidly bring new products to market to meet the evolving demands of our customers.

Q3 non-GAAP operating margin declined 6.4% due primarily to lower gross profits in LEDs and lighting.

Commercial lighting revenue is targeted to grow in Q4 with a favorable product mix that is forecast to drive increased gross profit in the quarter.

External LED revenue has stabilized but LED factory utilization was lower in Q3 as we reduced internal LED shipments due to our lighting inventory reduction efforts.

Based on our current forecast, LED volumes should stabilize in Q4 and are targeted to improve in FY16, driven by new design wins for our SC5 LED products and growth in our lighting business.

The Company backlog for Q4 is slightly ahead of this point last quarter.

We target higher lighting demand in the quarter, LEDs in a similar range as Q3, and incremental growth in power and RF sales.

Our product pipeline is strong.

We are building good sales momentum and our brand continues to get stronger.

Overall, we believe Cree is well-positioned to deliver revenue and profit growth in Q4 and FY16.

Based on this view, we repurchased another $70 million of our shares in the quarter, and have repurchased $390 million or 10.6% of our outstanding shares in the last three quarters.

I will now turn the call over to Mike McDevitt to provide additional information on our third-quarter financial results as well as our targets for the fourth quarter.

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 the call is posted on a website, along with a historical summary of other key metrics.

For the third quarter of FY15, revenue was $410 million, which was on the higher end of our targeted range of $395 million to $415 million.

GAAP earnings were $700,000 or $0.01 per diluted share for the third quarter of FY15 and Non-GAAP earnings were $25 million or $0.22 per diluted share.

Non-GAAP earnings exclude $24 million of expense net of tax, or $0.21 per diluted share, from the amortization of acquired intangibles, asset retirement charges, fair value accounting on our Lextar investment, and stock-based compensation.

GAAP earnings per share were below are targeted range due primarily to the $2.2 million decline in fair value of our Lextar investment, which was caused by a reduction in Lextar's share price during the quarter.

Q3 GAAP gross margins were 30.6%, and non-GAAP gross margins were 31.4%, which excludes $3.2 million of stock-based compensation.

Operating expenses for Q3 were $124 million on a GAAP basis and $102 million on a non-GAAP basis, both of which were down sequentially and better than targeted.

Non-GAAP operating expenses exclude approximately $13 million of stock-based compensation expense, $7 million of charges from amortization of acquired intangibles, and $2 million for asset retirement charges.

Our non-GAAP operating income was $26 million, which was on the low end of our target range for the quarter.

Our Q3 GAAP tax rate was 0% while our non-GAAP tax rate was 9% for the quarter, which was less than our 17% target for Q3.

The Q3 tax rates are lower than targeted due to lower forecasted earnings for FY15.

Our Q3 9% non-GAAP tax rate is different than our 0% GAAP tax rate due primarily to excluding the impact of our Lextar investment fair value reduction recording during the quarter.

We ended the quarter was $632 million in cash and investments, net of line of credit borrowings, a $48 million decrease sequentially.

The sequential decrease was due primarily to spending $70 million to repurchase 1.9 million Cree shares and $50 million of capital expenditures, which was partially offset by $66 million of cash provided from operations.

Q3 free cash flow was $16 million.

During the first nine months of FY15, we have spent $390 million to repurchase 11.2 million Cree shares under our FY15 $550 million authorized share repurchase program.

Days sales outstanding were 48 days, which is similar to Q2 and in line with our 50-day plus or minus target range.

During Q3, we reduced inventory by $33 million as part of our targeted inventory reduction plan.

As a result, inventory days on hand improved 13 days, decreasing from 108 days at the end of December to 95 days at the end of March.

We made excellent progress within the quarter of reducing inventory levels to get within our 90-day plus or minus target range.

Property, plant and equipment additions were $45 million and patent additions were $5 million in the third quarter.

Capital spending in Q3 was lower than Q2 and in line with our lower spending plan for FY15.

We target FY15 property, plant and equipment spending to be $200 million, plus or minus.

At this time, we target Q4 revenue to be in range of $420 million to $440 million, which is comprised of strong growth in lighting revenue led by higher commercial fixture sales, LED sales similar sequentially, and incrementally higher power and RF revenue.

We target Q4 non-GAAP gross margins to increase slightly to 32% plus or minus, and GAAP gross margins to be 31.3% plus or minus.

We target incremental lighting gross margin improvement from Q3 due to a more favorable product mix, while LED and power and RF segment margins are targeted to be similar sequentially.

Our GAAP gross margin targets include stock-based compensation expense of approximately $3.3 million while our non-GAAP targets do not.

We are targeting Q4 operating expenses to increase $5 million sequentially due primarily to higher patent litigation spending and higher sales commissions related to higher lighting revenue.

Our GAAP operating expense targets include $13 million of non-cash stock-based compensation expense, $1 million of asset retirement charges, and $7 million of charges for amortization of acquired intangibles.

We target our Q4 tax rate to be 9%.

As a reminder, our tax rates will fluctuate based on overall earnings, the tax jurisdictions in which our income is actually earned, 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 $4 million and $9 million.

Based on estimated 108.5 million diluted shares outstanding, our GAAP EPS target is between $0.04 and $0.08 per diluted share.

Non-GAAP net income is targeted to be between $26 million to $31 million or $0.24 to $0.28 per diluted share.

Our Q4 targets are based on a number of factors that could vary, including overall demand, product mix, factory execution, and the competitive environment.

Our non-GAAP EPS targets exclude amortization of acquired intangibles, asset retirement charges, changes in the fair value of our Lextar investment, and non-cash stock-based compensation in the amount of $0.20 per share.

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

Thanks, Mike.

We remain focused on four priorities to drive our business in FY15.

Our first priority is to leverage Cree technology to lower upfront customer costs and further improve payback.

Innovation is the key for Cree as we lead the market, creating value for our customers and driving growth.

In Q3, we introduced the XLamp MHD-E and MHD-G LEDs, high-powered LEDs that combine the high lumen density and reliability of a ceramic chip-on-board LED with the design and manufacturing advantages of a surface model package.

We demonstrated a proof of concept 50-kilowatt strength solor inverter prototype that utilizes our best-in-class silicon carbide MOSFET and diode technologies in a power module to enable previously unattainable levels of power density and ultra-high efficiency at one-fifth the average size and weight of today's silicon-based inverter units.

This system delivers a remarkable 50% reduction in power loss, and operates at 3 to 5 times the switching frequency of conventional silicon technology.

We introduced the LED rural utility light, or RUL series, which is designed to deliver an unprecedented combination of price, performance, and quality to accelerate adoption of LED lighting for the estimated 10 to 13 million rural street and area light fixtures currently installed in North America.

Initial customer feedback is very good and underscores the unique nature of our vertically integrated approach to LED lighting product solutions.

We expanded our leading LED bulb portfolio with the TW series LED T8-2 replacement for consumers, making inferior linear fluorescent tubes a thing of the past.

Designed for simple, wire-free installation, the Cree TW series LED T8-2 provides industry-leading compatibility, besting the competition in light quality and performance, all at an affordable price.

We provided another glimpse into the future of intelligent lighting with the introduction of the field-adjustable color temperature for SmartCast technology-enabled CR series LED troffers.

This is the first of Cree's industry-leading luminaires to feature instantly adjustable color temperature, delivering at dynamic, customizable lighting experience for the building managers and occupants, at no additional cost.

Our second priority is to continue to drive LED lighting growth and build the Cree brand in both the consumer and commercial markets.

The LED lighting business grew 27% year over year in the third quarter, despite the weather-related challenges in the northeastern US which delayed numerous projects.

We've made good progress growing both the volume and product breadth of our lighting business.

But the rapid growth has created inefficiencies that we target to begin to recover in FY16.

To date, our strategy has been to aggressively price our LED lighting products to compete head to head with traditional lighting technology.

However, as LED lighting becomes the standard, we should retain more value as we bring next-generation lighting products to market.

We see a lot of upside in our lighting business and target the combination of improved factory efficiencies and greater value leverage to deliver lighting gross margin improvement over time.

Our third priority is expand our work with manufacturing partners to enable growth in LEDs and lighting, and allow Cree's factories to focus on the newest technologies that are not otherwise available in the market.

We've qualified additional manufacturing partners for our lighting products which will supply some of the targeted growth in our lighting business for Q4 and into FY16.

This transition should also help us to further reduce days of inventory over time.

We've also qualified several LED chip partners to complement our internal capabilities.

Although LED chip supply is not currently a constraint for our business, we are well-positioned to support the targeted future growth in volume for both our internal and external LED customers.

Our fourth priority is to generate incremental operating margin through revenue growth and incremental operating leverage across the business.

Fiscal Q3 was forecast to be a seasonally lower quarter and the bottom of the cycle for our LED business.

Margins were lower than forecast due to further inventory reductions in product mix, but overall the business is heading in the right direction.

It has been a challenging transition for our LED business over the last year, but we continue to see signs that our demand has stabilized.

We have significant operating leverage potential built into our current LED factory, and now turn our focus to delivering the additional demand to take full advantage.

With the external LED business stabilized over the last two quarters, and inventory levels moving back towards our target range, we are well-positioned to deliver incremental operating leverage in Q4 and in FY16.

As I mentioned earlier, Q4 total Company backlog is slightly ahead of this point last quarter, which is in line with our targets for fiscal Q4.

Our customers and distributors continue to operate on short lead times.

LED factory utilization is targeted to remain low in Q4, while lighting factory utilization remains high and execution continues to be a critical factor in meeting customer expectations and our financial targets.

Based on our current backlog, forecast, and trends in the business, we are targeting Q4 revenue to increase to a range of $420 million to $440 million, driven by strong growth in lighting, incremental growth in power and RF, and LEDs in a similar range.

We target Q4 non-GAAP gross margin to increase to 32% plus or minus.

We plan to continue to closely manage inventories in Q4, which may create some additional near-term margin headwinds, but we believe it also better positions Cree for margin leverage in FY16 and supports our strategy of continuous innovation and rapidly bringing new products to market.

We target non-GAAP earnings in the range of $0.24 to $0.28 per diluted share.

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

We've continued to lead the market by driving LED adoption, and have grown our LED lighting business to create a nearly $1 billion lighting company while managing the market challenges in LED components.

We have good new product momentum and a solid pipeline of products scheduled for release in our fiscal fourth quarter.

Although the LED components market is likely to remain very competitive over the next year, we believe we are well-positioned for the growth in our lighting business to drive overall growth in the Company.

Our power and RF business also continues to make good progress, commercializing our market-leading silicon-carbide and gallium-nitride device technology and building customer momentum.

We continue to believe that the best way to predict the future is to create it, and we're focused on building a technology company that continues to redefine what is possible in lighting, and shape the future of the industry.

While that vision guides our strategy, we are equally focused on converting the tremendous market opportunity for LED lighting into value for our shareholders, which comes down to growing our lighting business and operating profits.

As we said last quarter, we know there are going to be some near-term challenges, but we are confident that we're on the right track, and optimistic about the future growth in lighting and potential upside from our power and RF product lines.

That is why we continue to repurchase shares in Q3 and target additional purchases in Q4.

We will now take analyst questions.

(Operator Instructions)

Brian Lee, Goldman Sachs.

Hi, guys.

Thanks for taking the questions.

The first one I had was just on the impact that you mentioned on LED margins this quarter.

Can you elaborate on how much that was?

And was that just sell-through on legacy products, or did you have a bigger shift to mid-power outsourcing this quarter than you might have originally anticipated?

And then the second question I had was also on the gross margins.

What are you embedding into the view for June on LED factory utilization quarter on quarter, because unless mix is changing a lot, it seems like you're implying similar levels to what you had in March.

Wondering if that means you're targeting another round of inventory workdowns over the course of the quarter.

Thank you.

Yes, Brian.

On the LED margins, I think where you're going on the first one is what was the pricing piece of the margin impact.

What I would tell you is that the majority was actually the lower utilization.

I'd say of the margin decline in LEDs, a fraction of it was pricing, so it was a very incremental piece.

And it's really just older product that was in the channel that we are working with our distributors to help them move that a little bit faster.

So, I think that's a relatively healthy long-term decision.

The bigger one is really what we did in terms of slowing the factory down, the underutilization.

The question I think is what is in the June numbers.

I would expect utilization to get a little bit better in June, but we're not targeting it to recover quickly.

And then, second, is we've got a little over 90 days of inventory, so with having 90-plus days of inventory, whatever benefit we might get from speeding the factor up, we'll have a lag effect.

I think if the Lighting business continues on this trajectory and LED business does this well or even gets incrementally better, I think the first chance we could see some of that leverage is in Q1.

But, again, there's a lag effect because of the inventory.

Harsh Kumar, Stephens.

Hi, guys.

Chuck, I just wanted to again go back to the question that was just asked.

We're trying to understand how this inventory affects margins.

Is this inventory at an inherently higher price?

Is that why you're taking a big chunk -- is that why you're taking a big hit, or is it just all factory utilization related and the inventory costs are the same as the new product?

Harsh, the way to think about it is this.

Essentially, we have an inventory reduction.

Obviously, we targeted some.

We made more progress than we had intended.

That affects Lighting more than LED, but when it affects Lighting, if we're not building inventory on Lighting or, frankly, reducing it, that also reduces LED consumption.

So, what you have is, even though the LED business, from an external customer standpoint, was relatively stable, internal shipments were significantly lower to the Lighting division.

So, you have the same fixed costs on less overall shipments.

You're going to have a significant margin impact in the quarter.

So that's what you see in LED.

That was the bigger factor.

It also, though, affects Lighting because in Lighting, while the revenues were similar from a Commercial Lighting standpoint, we were reducing inventory.

So, we also have an under-utilization or under-loading phenomenon in Lighting.

And that was especially true early in the quarter when we have our inventory reduction and weather-related project delays, so the factory is very lightly loaded early which also is an overhead spreading phenomenon that affected margins there.

Chuck, I appreciate the color as always.

And then my other question was on OpEx.

I was surprised to see the $5 million OpEx increases, given the numbers and the results.

Curious if, as your Lighting business grows, if you think you can attain some leverage where these kind of variations simply go away and become meaningless.

In other words, I'm trying to get to the operating margins of the Lighting business.

Are they meaningful enough or can they go up meaningfully enough once you achieve scale?

Yes.

Harsh, first off, keep in mind that OpEx came in significantly lower than what we had planned for the quarter.

I think it was $3 million to $4 million lower.

Some of that just happens with the scale of the business and some of that is things we did to slow it down.

When we have it going back up $5 million, that's not significantly different than what we had budgeted last quarter.

The big drivers there are there is variable costs associated with higher sales drives higher costs from a sales comps standpoint and some other areas.

We do have higher litigation, as well.

I don't have any concern with the long-term operating leverage of the Lighting business, but we have a couple of compounding factors going on right now.

I think we will be fine in the long run.

I think we've got to get through this litigation phase, which is a pretty expensive choice, but we knew that when we started it.

If we're going to make an investment in IP, then we need to work to make sure we get paid for it.

I think long term we still believe there's a return on that investment but we've just got to get through that phase.

And then I think over time the Lighting revenue should drive leverage, both for Lighting and, frankly, even for our internal LED factory.

Edwin Mok with Needham & Company.

Great, thanks for taking my questions.

The first question on the LED components side, you said you expect stabilized in the fourth quarter.

But historically you get some seasonal uptick in your fiscal fourth quarter.

Do you have any pull in of demand?

That's why you have the stronger 3Q and maybe just flattish on 4Q -- or any color you can provide on that?

What I would say is that 3Q was a little better than targeted, so, Edwin, we did get that benefit.

I think what you're looking at, if you look at the two quarters together, demand is about what we expected.

Keep in mind that behind the scenes the other thing we are doing is we're making some incremental reductions in channel inventory.

We did that in Q3.

We target that again in Q4.

Now that the business has stabilized at these revenue levels, we're looking at what the optimal inventory is, so we are making some adjustments there.

And then the second thing we are doing is, I think it would be a good time to refine what's in the channel because we are getting ready for SC5 to start ramping up and going into production volumes as we get into next quarter.

So, I think it's a good time for us to lean out the channel a little bit and get ourselves in position for the new products.

That's actually great color, thank you.

And then on the Lighting product gross margin, you talk about partially the results are the seasonal related affect on that on the quarter.

Does the mix of light bulbs have an effect on that, as well?

And how is the new light bulb coming along and should we expect that to have a positive effect on your gross margin?

If you think about the seasonal, really it was the weather, and, honestly, it was worse weather than we had expected.

I think if you spent any time in New England, you know what I'm talking about.

If you look at the mix of commercial versus consumer, that's really what's driving that mix.

Honestly, if the weather doesn't happen, the revenue probably comes in pretty close to what we are targeting.

As far as mix of bulb, that's actually tracking about what we had targeted for the quarter.

I'd say that bulbs, plus or minus, was pretty close to what we had built into our targets.

It was really more of a phenomenon of commercial, which, without the weather, we estimated would have grown enough that you wouldn't have seen that significant mix shift.

Keep in mind, the weather did a second thing, as I mentioned in my comments.

It also hurt the mix even within Commercial Lighting.

So, we had a double factor that we would expect to get those benefits this quarter and that's what we built into our Q4 targets.

(Operator Instructions)

Sven Eenmaa with Stifel.

Thanks for taking my question.

I just wanted to clarify the LED product gross margin commentary for the next quarter.

With the Lighting utilization improving and you presumably having reduced some of the inventories already, why is that margin expected to be sequentially flat?

With LED gross margins, remember that while we won't have the inventory reduction effect, while the factory will start to incrementally ramp back up, it is about 90-plus days of inventory are in the factory today, so those costs are essentially here.

So, you have to essentially -- there is a lag effect of roughly about as many days of inventory, plus or minus -- it's not an exact science -- that we think will impact that as we go into next quarter.

And keep in mind that while Lighting is going up, it's going to drive some incremental utilization but we are not moving the volume up significantly in the short term.

So, really, I think this is one of those things that we have to build the volume back over time in LEDs.

How should we think about the SE5 impact on margins on LED on the product side as we go into the next year?

Right now it's, as much as anything, I think, an opportunity to drive new design wins and drive revenue.

What that does to the overall mix it's a little hard to predict right now.

We would expect SC5, it's a newer generation, our high-performance stuff usually is on the higher end of our mix within high power.

But with that being said, we are really a quarter away from getting any production volumes to see how that settles out.

So, I think, if anything, it's an opportunity to drive some revenue on one side of it.

At the same time, as I said earlier, the LED business is pretty darn competitive and we would imagine that the supply-demand phenomenon in LEDs is going to be similar here for the next year.

I don't want to get too far ahead of ourselves.

We feel pretty good that the business is stabilizing at this level and we're going to work from there at this point.

Paul Coster, JPMorgan.

Thanks for taking my question.

The first one, in respect to incremental operating margin, Chuck, you talked about being at the bottom of the cycle.

Is it a cycle that's specific to Cree or is it an industry cycle that you're referring to?

Then I have a quick follow-up.

Yes, Paul, I wish I knew on the industry.

I think for Cree this will be the third quarter with similar revenue levels in LED.

So, that's how I come to the bottom of the cycle.

I think the LED business overall, it's going to be a pretty tough market for the next year.

As long as supply is ahead of demand, it's pretty hard to claim that you can see the other side of the swing.

I think we feel pretty good that if it stabilizes here, we can at least manage around these boundary conditions for right now.

What we are hoping is that the new products offset the other factors in the near term.

Obviously, longer term, getting that Lighting revenue to drive our own demand and, frankly, trying to find some incremental LED demand, those are the levers we are working on.

But, again, I think it would be premature for the LED business to call the cycle.

Although it doesn't seem to be getting any worse, I'm not sure it's getting any better yet either.

So it's in the LED Lighting segment, how next-generation products will move you up the value chain, in some respects.

I'm not quite sure how I'd get there.

It seems that your products are still in the high-power category and thus far that's proven to be a tough segment of the market.

Can you explain what's happening there in terms of value creation?

Yes, Paul, what I'm trying to describe there is if you look at how Cree goes to market today, we have a fairly aggressive approach to pricing.

So, Cree, when we enter a business is, essentially only LED Lighting.

And we're competing for projects typically against companies that offer both LED lighting and traditional lighting.

One of the ways we do that is we push performance really hard.

So, we tend to be the performance leader.

But we also tend to price pretty aggressively to make LED the compelling value proposition.

Other companies may let the customer go -- hey, we've got both options -- and play both sides, traditional or LED.

I think that, that takes away some of our margin leverage in the short term, but I think as the market evolves and it becomes more and more LED-centric, as those new products come out, I think we get to keep a little bit more of that margin.

That's essentially what we are trying to model.

Jed Dorsheimer, Canaccord.

Hi.

Thanks for taking my question.

Maybe just stepping away from some of the details, maybe higher level.

About a decade ago, Chuck, you and I spent a considerable amount of time talking about the benefits of vertical integration, which in hindsight has certainly helped you through the second cycle between 2009 and 2011.

As we're seeing more and more companies -- I think Osram today announced that they will be looking to possibly spin out or break up the components in the bulbs business, Phillips with Lumileds divestiture divestitures -- or spin out, I should say.

Could you maybe elaborate on what the benefits are to Cree, and why you see the need to continue to have or operate the components in the Lighting business, as they seem to be diverging more and more over time?

Thanks.

Yes, Jed.

As you know, if you're in the semi business, vertical integration looks really good as long as your factory's full.

And if it's not, it looks like a bad idea.

So I think it depends.

There's really two factors.

I think where you are at in the semi cycle will affect people's opinions, both directions.

And clearly when the factory's underutilized, people don't like it as much.

If we really step back -- and you gave an interesting analogy, a 10-year view of the world -- if product innovation is our key strategy -- and it is for our Lighting business -- what we see today is a benefit of having that internal LED capability to drive new products and new technologies to market faster.

So, it gives us a marketing advantage for how we go to market.

Right now, with the fab being underutilized, it costs us a lot to get that advantage, so, you can make an argument on both sides.

To give you a recent example, the new rural utility light that we came out with, that's a great example of a product that has a very different approach to the market.

And it has an LED that if we were trying to sell that LED on the open market, it's a pretty radical different approach.

So, by being vertically integrated, we are able to go after a segment and start competing in a segment that I think would have been difficult without that.

So, there's pluses and minuses.

Clearly, the cost to Cree right now is pretty significant.

So, if you're measuring -- as you know, if anyone is measuring us in the short term, it looks like a less profitable way to do it.

I think as the market goes to the semi cycle, I think we will see incremental financial leverage that comes from having it on the other side of it.

And right now it's worth having that business because I think innovation is the most important factor to drive what we are trying to do.

Okay.

Thank you.

Mark Heller, CLSA.

Thanks for taking my question.

Chuck, I just had a question on the competitive environment in China.

I know that the leading player there is adding a lot of LED capacity.

So, I'm just wondering if you are seeing increased competition in the China market.

And, secondly, would you consider using Chinese-made LEDs within Cree?

I think the competitive environment of China remains pretty interesting.

You obviously have one very big player there that continues to make investments.

You also have the large Taiwanese player that's also talking about making capacity investments.

I think I'd keep that in a little bit perspective.

I do expect both of their capacity to increase, but it's probably not a one-to-one, because my sense is there's also some amount of retiring older generation equipment that just isn't competitive anymore.

So, it's a net add but probably not one-to-one as maybe it's projected sometimes.

I also think that with the new announcement of the company buying Lumileds, the investment group of China, I think it also creates an interesting competitive dynamic that we're going to have to see how that evolves over time.

So there's a new wrinkle that's coming because while you have Lumileds, it's really a Chinese-based investment group.

So, seeing how that affects the market will be a little harder to predict.

I don't know if that answers your question, but that's my sense on the two pieces that are going on there right now.

Colin Rusch, Northland Capital Markets.

Thanks so much.

Can you guys just expand a little bit more on your thought process, your luminaire product expansion.

It seems to me like there's a big opportunity here, still, with commercial construction growth to take a bit more share there.

Can you see yourselves accelerating that product development in the near future?

I don't think we've slowed down the product development.

The business is growing at a pretty healthy rate year-over-year.

One of the challenges in commercial fixtures is it's not just how fast can you invent the products, but how fast can you scale up the business to sell them and support them and all the pieces that go through it.

Lighting is not a straightforward distribution or sales model or support model.

We're pretty happy with the rate of growth in Commercial Lighting overall.

I think that we have quite a good product pipeline.

And it's really a matter for us of picking applications where we can add value.

Lighting is a huge business with many different applications.

Really, the key for us is finding the ones where our innovation solves the problem that's most worth solving at this time.

I don't think anyone was expecting us to come out with a light to go after rural utility lights, but that's an example of something that solves one problem.

At the same time last quarter we also announced a very high-end fixture for commercial buildings that is, essentially, a field-programmable LED troffer, which is probably the extreme opposite end of what's possible.

So, we're exploring all parts of the market.

I think that there is definitely room for more products and more applications to serve, but there's a finite rate at which we think it's practical for us to scale up the business right now because it's really about adding infrastructure as we go.

Great.

And then just a quick follow-up.

On the marketing spend, historically, you've given some updates in terms of the effectiveness of those campaigns.

Can you just give us your quick thoughts on how those things are going at this point?

Yes.

In the metrics we use, we saw a nice uptick in the spring.

What we had in the spring is it's a combination, really, of three things.

There's a marketing spend piece.

We had a pretty big program that was focused on NCAA basketball.

That give us some nice lift, but it's in combination with some of the products.

We had great response to the Cree smart-connected bulb as well as some of the things we're doing on the Commercial Lighting.

It's really how do we blend those three pieces together that drives the activity.

The advertising certainly is important but it's really the combination of those three pieces.

I'd say right now in terms of the metrics we're going after it's having the desired effect.

It seems funny that it was only two years ago that pretty much no one in the Lighting business had ever heard of Cree.

And I don't think we have that problem.

It's a long-term investment but one we still feel like is positioning us for success not just next quarter but hopefully over the next several years.

Krish Sankar, Bank of America Merrill Lynch.

Thanks for taking my question.

I've a two-part question and let me ask both of them up front.

First, Chuck, within the Lighting segment, can you give us some color on what the split is, either qualitatively or quantitatively, between the consumer bulb and the Commercial Lighting fixture?

And also a follow-up either for you or Mike.

It looks like you would have $160 million left on the share buyback.

And I think the buyback has to be used by June, but based on the share count guidance it looks like you don't plan to fully complete the buyback.

So, curious on what the thought process is on using the rest of the buyback by end of the quarter.

Thank you.

Let me take the Lighting one.

I think in the split -- we don't break it out exactly but the majority of that business is fixtures.

I'd say the overwhelming majority.

If you go back to the 10-Q, you can get an idea of the ratio of consumer to commercial.

I don't remember what that was, but you can see what the Home Depot sales were.

I'd say since then commercial is growing faster than consumer and I would expect that to be the trend over time.

High level on the buyback, I can tell you philosophically we said we'd plan to continue buying shares.

In terms of how does that work versus our share guidance, I'll let Mike give you some color on that.

Obviously, we got it that we would be buying some shares back, but it's really an assumption of where do we think the pricing goes within the quarter.

So, it's a rough estimate.

What I would tell you is, even if the share count was down to 2 million more, on average, the EPS range doesn't change.

And remember that it's a weighted average, is what we are using.

It depends on when they get bought and how that goes into the calculation and any dilutive effects of other shares that might be outstanding, like options.

So it's not just buyback.

It's buyback plus assumptions about share price.

(Operator Instructions)

Hans Mosesmann, Raymond James.

Hi, guys.

It's Melissa [Fairbanks] for Hans.

Thanks for taking my question.

I just had a quick one.

I'm not sure if you covered different trends that you are seeing by geography.

I believe that some of the big downturn in Lighting business a couple quarters ago is related to big projects in China being pushed out.

Just wondering what you're seeing on a geographic level, if you could give some more detail on that.

When it comes to Lighting, Lighting is really only a North American business, so there's really no international geographic trends.

Last quarter what I would tell you is that if you want a look at it within the US, the weak spot was the northeastern US directly related to weather.

You might be referring to our LED business, and in that, what I would say is the geographic trends did not change significantly last quarter.

So, Q2 to Q3 was pretty similar.

If you look at it on a year-over-year basis, the largest decline in the LED business on a 12-month basis is the China business, is what changed year-over-year.

That was the same as we gave last quarter, similar this quarter.

So, I'd say it's not changing relative to Q2 but year-over-year that's the place where I would say on a geographic basis the business declined the most.

Okay, great.

Thanks so much.

You're absolutely right, I was confused -- the LED business.

Thanks very much, guys.

Mike Ritzenthaler, Piper Jaffray.

Good afternoon.

Sorry to join late here.

I know you don't break out pricing specifically with any of your businesses, but I'm wondering if you could at least qualitatively comment on pricing within Lighting and the competitiveness that you're seeing as you work on bids within the C&I channel in particular.

Lighting C&I, I would say that there's some trending.

I don't have any specific numbers, but I would say that last quarter was pretty much as expected.

There's a mix shift.

The margins have some mix changes.

So, when the weather slows down some projects versus others, there's a mix within our product families.

But I don't have a good number.

It's down slightly, but it's a relatively modest decline quarter over quarter.

It's very unlike the LED business, which can have more significant erosion.

We haven't seen a significant change in pricing trends in the stuff we are bidding on for at least the last few quarters.

Okay.

That's helpful.

And then more of a philosophical question around R&D.

Does progress year on year in any given quarter in revenue growth color what types of R&D projects Cree engages in or how much is allocated to R&D?

I know historically it runs 10% to 12% of sales.

But as you look out, investing in projects now for revenues a year from now, how does that philosophically change what you're working on today?

I would say our history over the last 20-plus years is we've got a pretty long-term view about R&D.

We're going to invest in things we think change the business.

More than next quarter.

We're looking at things, some of the technologies you're not going to see for two to three years.

I think you will see, occasionally, quarterly trends.

For example, this quarter R&D is down a little bit but that's more of a function of how much we ran our factory.

We slowed things down to burn inventory.

One of the things we also do in the same factory is run R&D, so when we're slowing things down you're going to see potentially incremental R&D.

But I'd say the general philosophy hasn't changed.

I would imagine it will stay a similar percentage as it has been.

With that being said, it typically takes less dollars of R&D in Lighting to drive the business than it does in LEDs.

So, the mix will slowly shift because the LED rate hasn't changed significantly, and the Lighting rate is not changing.

But as Lighting becomes a bigger percentage of the business, you'll see that mix shift a little bit.

What's interesting is it doesn't change overall OpEx because Lighting tends to be a little lighter, R&D a little heavier sales and marketing investment versus the LED, so it works out.

Thank you.

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 results on August 11.

Good night.

Good night.

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

This concludes the program.

You may all disconnect.