Wolfspeed Inc (WOLF) 2015 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Cree Inc., FY15 quarter-four earnings conference call and webcast.

(Operator Instructions)

As a reminder, this conference is being recorded.

I would now like to turn the conference over to Mr. Raiford Garrabrant, Director of Investor Relations.

You may begin.

Thank you, Abigail, and good afternoon.

Welcome to Cree's fourth-quarter FY15 conference call.

Today, Chuck Swoboda, our Chairman and CEO, and Mike McDevitt, our CFO will report on our results for the fourth 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 presentation includes forward-looking statements about our business outlook and we may make other forward-looking statements during the call.

These may include comments concerning trends in revenue, gross margin and earnings, plans for new products, and other forward-looking statements indicated by words like anticipates, 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'll be limiting our comments regarding Cree's fourth quarter and FY15 to a discussion of the information included in our press 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 web casting our conference call and a replay will be available on our website through August 25.

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

Thank you, Raiford.

FY15 was the year of good progress in expanding our lighting and power and RF businesses mixed with the challenges in the LED industry.

Revenue was similar to FY14 at $1.63 billion as growth in lighting mostly offset the decline in LED.

Non-GAAP net income declined to $72 million or $0.64 per diluted share as profit growth in lighting and power and RF was not enough to offset the significant decline in LED profits and the related restructuring costs.

As we announced previously, we decided to restructure the LED business in fiscal Q4 to adjust capacity, reduce overhead, and increase LED reserves.

This resulted in $84 million of restructuring charges in our fiscal Q4 and we target $18 million of additional charges in FY16 as we complete the consolidation of our LED factories.

We believe this restructuring, once fully completed in our fiscal Q2, will better position the LED business to focus on our new market leading high-power products with a reduced cost structure moving forward.

Fiscal Q4 revenue decreased 7% sequentially to $382 million as solid growth in commercial lighting was offset by lower LED revenue related primarily to restructuring and lower consumer bulb sales.

This resulted in Q4 non-GAAP net loss of $20.5 million or $0.19 per diluted share.

However, cash flow improved in Q4 with free cash flow reaching $35 million, the highest quarterly level in a year and a half.

Q4 non-GAAP gross margin declined to 21% due primarily to the LED restructuring.

Power and RF margins were in line with our target while lighting was slightly lower than targeted due primarily to year-end items related to commercial lighting and lower consumer margins due to lower volumes in the quarter.

Commercial lighting margins were in line with fiscal Q3 if you exclude the year-end items that Mike will discuss in a few minutes.

Company backlog for Q1 is tracking to our targets for the quarter.

We made progress on several of our key objectives in FY15.

We continue to drive innovation across our product lines to lower customer cost and further improve payback.

We grew commercial lighting 37% for the year which drove overall lighting growth of 28% for the year.

Even though consumer lighting revenue increased only 2% for the year, the Cree LED bulb continues to build the Cree brand and enable awareness across all product lines.

We successfully added manufacturing partners for LED chips and LED lighting which should provide long-term cost leverage and enable Cree's factories to focus on new product introduction and technology.

The objective that we did not achieve was our goal to grow Company revenue and increase operating margins.

While we made progress in lighting and Power and RF we decline in our LED revenue and profits as a result of LED industry challenges and our restructuring more than offset the gains in the other businesses.

Growing revenue and operating margin will be our primary focus in FY16, and the actions we undertook at the end of FY15 underpin this goal.

I will now turn the call over to Mike McDevitt to review our fourth quarter and year-end financial results in more detail, as well as our targets for the first quarter of FY16.

Thank you, Chuck.

I will be providing commentary on our financial statements on both the 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 FY15, revenue was similar to FY14 at $1.63 billion.

We had a GAAP loss of $64 million or a loss of $0.57 per diluted share and non-GAAP earnings were $72 million or $0.64 per diluted share for FY15.

Non-GAAP earnings excluded $136 million of expense net of tax or $1.21 per diluted share from restructuring costs, amortization of acquired intangibles, asset retirement charges, net changes associated with our Lextar investment, and non-cash a stock-based compensation.

Regarding the restructuring of our LED business, we recognized $84 million of costs in the fourth quarter of FY15 which includes $27 million of LED revenue reserves, $11 million of LED inventory reserves, and $46 million of factory capacity and overhead cost reductions.

The revenue in inventory reserves are included in both our GAAP and non-GAAP results while the capacity and overhead charges are included in our GAAP results only.

We now target total restructuring costs to be approximately $102 million, which includes $18 million of additional charges in the first and second quarters of our FY16 primarily related to additional capacity and overhead cost reductions identified during the factory consolidation process and refining the estimated fair values on certain equipment being held for sale.

FY15 revenue and gross profit for our reportable segments were as follows.

Lighting products revenue grew 28% to $907 million and gross profit grew 19% to $236 million for a 26% gross margin.

Gross margin was lower year-over-year due primarily to lower LED bulb margins due to a more competitive pricing environment.

LED products revenue declined 28% to $602 million and gross profit decreased 50% to $191 million for a 31.7% gross margin.

The decrease in LED revenue and gross profit was due to a much more competitive market environment during FY15 and our decision to restructure the business to reduce excess capacity and overhead.

Power and RF products revenue grew 15% year-over-year to $124 million and gross profit grew 12% year-over-year to $68 million for a 54.7% gross margin.

These increases were driven by growth in our power products.

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

These non-allocated costs totaled $20 million for FY15 and are included to reconcile to our $475 million GAAP gross profit.

For the fourth quarter of FY15 revenue decreased 7% sequentially to $382 million which was slightly above our revise target of approximately $375 million.

We had a GAAP loss of $88 million or $0.83 per diluted share for the fourth quarter of FY15 and a non-GAAP loss of $21 million or $0.19 per diluted share.

The non-GAAP loss excludes $67 million of expense net of tax or $0.64 per diluted share from the amortization of acquired intangibles, non-cash stock-based compensation, restructuring costs associated with our capacity and overhead reductions, and our net changes associated with the Lextar investment.

FY15 fourth quarter revenue and gross profit for our reportable segments were as follows.

Lighting products revenue grew 2% sequentially to $229 million and gross profit declined 2% to $56.9 million for a 24.8% gross margin, which was 120 basis point decrease quarter-over-quarter.

During the quarter we had double-digit commercial lighting product revenue growth which was mostly offset by a larger than targeted seasonal decline in consumer lighting products.

The gross profit and margin were slightly lower than target due primarily to commercial lighting product year-end true-ups on inventory and warranty costs and lower consumer margins due to lower volumes.

LED products revenue declined to $122 million and gross profit declined $8.5 million for a 7% gross margin for the quarter, which was in line with the updated targets we provided on June 24.

Power and RF products revenue was $31 million in gross profit was $16.2 million for a 52.5% gross margin which was similar to last quarter in line with our target.

Non-allocated costs totaled $4.6 million for the fourth quarter of FY15 and are included to reconcile to our $77 million GAAP gross profit.

Q4 GAAP gross margin was 20.1% and non-GAAP gross margin was 21%, which excludes $3 million of stock-based compensation.

Both our GAAP and non-GAAP gross margins were impacted by the revenue and inventory reserves related to our LED restructuring.

Operating expenses for Q4 were $173 million on a GAAP basis and $108 million on a non-GAAP basis, both of which were within our revised targeted range after accounting for the restructuring costs.

Non-GAAP operating expenses exclude approximately $46 million of capacity and overhead restructuring charges, $12 million of stock-based compensation expense, and $7 million of charges for amortization of acquired intangibles.

Our non-GAAP operating loss was $28 million.

We ended the year with $713 million in cash and investments, a $449 million decrease year-over-year.

The year-over-year decrease was primarily due to spending $550 million to repurchase 16 million Cree shares and $226 million of capital expenditures which was partially offset by $181 million of cash provided from operations.

Free-cash flow was a negative $44 million for the year, and we ended the year with $200 million outstanding on our line of credit.

For the quarter, cash from operations was $88 million and capital expenditures were $53 million, including $5 million related to patents which resulted in free-cash flow of $35 million.

For FY16, we're targeting property, plant and equipment spending to be lower than FY15 at $150 million plus or minus, which will primarily occur in the first half of the fiscal year to complete certain existing infrastructure projects and provide lighting and power and RF incremental capacity.

Overall, we currently target FY16 free-cash flow of approximately $85 million.

Days sales outstanding was 44 days as compared to 48 days at the end of March and lower than our 50 day plus or minus target range.

Inventory days on hand decreased to 83 days as compared to 95 days from the end of March, also lower than our 90 day plus or minus target range.

Both ratios are in line with our target ranges after excluding the impact of the restructuring charges.

At this time, we target Q1 revenue to increase to a range of $410 million to $430 million, which is comprised of solid growth in lighting sales led by higher commercial sales; LED sales in a similar range to Q4 after excluding the impact of the revenue restructuring reserves; and incrementally higher power and RF revenue.

We target Q1 non-GAAP gross margins to be 32% plus or minus and GAAP gross margins to be 31.3% plus or minus.

We target incremental gross margin improvement in all of our segments along with some benefit from a recent patent license agreement.

These Q1 targets are based on a number of factors that could vary, including overall demand, product mix, factory execution, and a competitive environment.

Our GAAP gross margin targets include stock-based compensation expense of approximately $3 million while our non-GAAP targets do not.

We are targeting Q1 non-GAAP operating expenses to be approximately $107 million as core spending reductions are partially offset by higher IT litigation spending.

We are targeting Q1 GAAP operating expenses to be approximately $142 million, which includes approximately $50 million of restructuring charges, $14 million of non-cash stock-based compensation expense, and $6 million for the amortization of acquired intangibles.

Non-GAAP net interest income and other is targeted to be approximately $1 million for Q1.

Q1 GAAP net interest income and other is targeted to be a loss due to the significant decline in Lextar stock price quarter-to-date.

The amount of the loss will be primarily a function of the Q1 change in Lextar stock price on our 83 million Lextar shares.

We target our Q1 and FY16 tax rate to be 25%.

The Q1 of FY16 tax rate is higher than Q4 as we target a higher percentage of US earnings for FY16 due primarily to a higher percentage of lighting sales year-over-year.

As a reminder our Q1 in FY16 tax rates will fluctuate based on our overall earnings, tax jurisdictions in which our income is actually earned, tax credits and other tax benefits that may or may not become available to Cree in future periods.

We target a GAAP net loss for Q1 to be between $16 million to $22 million due to the additional restructuring costs and the estimated fair-value loss based on Lextar's current stock price.

Based on an estimated 103 million diluted shares outstanding, our GAAP EPS loss target is between $0.16 to $0.21 per diluted share.

Non-GAAP net income is targeted to between $19 million to $24 million or $0.18 to $0.23 per diluted share.

Our non-GAAP EPS targets exclude restructuring charges, amortization of acquired intangibles, net changes associated with our Lextar investment, and non-cash, stock-based compensation in the amount of $0.39 per share.

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

Thanks, Mike.

We are focused on several key priorities in FY16 to take advantage of the growing market opportunities for all of our products while responding to the competitive environment.

Our first priority is to build financial momentum.

We target overall Company revenue growth of approximately 10% in FY16 with operating margins increasing for the year.

We target our commercial lighting business to drive revenue and profit growth from the combination of new product sales momentum and improved product margins.

Consumer lighting is targeted to be lower for the year, but at a similar run rate as our fiscal Q4 as we focus on our premium product position and building brand value that translates to our commercial products.

We're focused on stabilizing the LED business and executing the previously announced restructuring.

We believe the LED market will remain very competitive for at least the next year, but target the combination of design wins for our new SC5 LED products and lower cost structure to help offset the competitive challenges in the market.

We target growth in power and RF to also contribute to our overall growth goals for the year.

We believe that we can generate operating leverage as we start to see benefits from our investments across the business over the last several years.

We're targeting lower legal expense in the second half of this fiscal year as some of the current patent litigation comes to a conclusion and have adjusted our brand spending lower to better align with the targeted levels consumer business for the year.

We recently announced a worldwide patent cross-license agreement with Epistar for LED chips designed to further advance the growth of the LED lighting and LED bulb markets.

This agreement resulted from our strategy to more aggressively enforce our LED intellectual property and our decision to file several patent lawsuits over the last year.

Each party receives a license to the other's nitride LED chip patents and is granted certain rights to non-nitride LED chip patent.

Over the lifetime of the agreement we will receive license and royalty payments from Epistar.

Our second priority is to continue to innovate in each of our business segments.

We have established ourselves as the innovation leader in LEDs, LED lighting, and wide-bandgap power, and RF.

We continue to develop new products that deliver fundamentally more value to our customers and build our brands.

We have a tremendous pipeline of new products and technology and target a steady stream of new innovations in 2016.

Our third priority is to promote future growth in power and RF and allow Cree shareholders to better realize the full value of this business.

This is a unique business with world-class IP and technology into exciting growth markets, energy efficient, high-powered switching, and next-generation wireless.

Our silicon carbide power device technology and gallium nitride RF technology are both likely to reshape large markets that today are primarily served with older silicon and gallium arsenide technology.

We announced our intent to spin off our power and RF business with an initial public offering in FY16 to raise capital to invest directly in the business to support targeted future growth.

As part of our increased focus on this business, we recently acquired APEI to extend our leadership position in advance power electronics and accelerate the market for high-performance best-in-class silicon carbide power modules.

As I mentioned earlier, Q1 total Company backlog is tracking with our targets for the quarter as commercial lighting orders are ahead of Q4.

The LED business remains very competitive and we are taking a cautious approach to this market with our distributors.

Our targets for FY16 include managing LED distributor inventory to increase their turn and further reduce our exposure to changes in pricing going forward.

Factory utilization is improving in LED as we execute the restructuring plan and is targeted to reach 85% plus or minus by the end of the December when our factory consolidation is completed.

Factory execution continues to be critical to achieving our targets.

Based on our current backlog, forecast, and trends in the business, we are targeting Q1 revenue in a range of $410 million to $430 million, which is comprised of solid growth in lighting sales driven by strong growth in commercial lighting and LED bulbs flat to slightly higher, LED sales in a similar range as Q4 if you exclude the effect of restructuring costs in the previous quarter, and incremental growth in power and RF.

We target Q1 non-GAAP gross margins at 32% plus or minus.

This target includes margin improvement in all three segments.

We target non-GAAP operating expenses to be lower than Q4 at $107 million.

As a result, we target incremental non-GAAP operating leverage in Q1 and higher operating margin.

Our tax rate is projected to be 25% and as a result we target non-GAAP earnings in the range of $0.18 to $0.23 per diluted share.

The actions we took last year position us for solid revenue growth and margin expansion in FY16, driven by the strength of our commercial lighting business.

We remain focused on leading with innovative technology to deliver better products and value to our customers and more profits to the bottom line.

We remain on track to raise the focus on our power and RF business with an IPO later this fiscal year which should provide additional capital to fund growth in that business and enable Cree shareholders to realize more value.

We're confident we can deliver revenue and profit growth in FY16 and we plan to utilize our stock repurchase program this quarter and across the fiscal year.

We will now take analyst's questions.

Thank you.

(Operator Instructions)

Paul Coster with JPMorgan.

Thanks for taking the question.

So, you're looking for 10% revenue growth I think it was in next fiscal year, Chuck.

And is it reasonable to assume that we should see operating leverage given the restructuring actions that you've taken like with a 15% EPS growth is a reasonable expectation or thereabouts?

Yes, Paul, so the target we put out there is 10% revenue growth plus or minus for the year and operating margin increasing and the number we put out is approximately 8% for the year.

So that gives you some idea of what the math looks like.

8%, sorry I don't understand.

8% operating margin for the year is our target.

I see.

My bad.

Got it.

And in the 10% revenue growth forecast that you've laid out there, can you just give us some sense of what your assumptions are about high-power, low-power mix, and whether there's any sort of heroics really around the sort of Cree sweet spot or whether you can see that the market may go against you and yet still can post those kinds of numbers?

Yes, the 10% is for the overall Company, Paul.

The real growth driver next year is the commercial lighting business.

We're actually targeting consumer lighting be flat to maybe even down a little bit for the year on a year-over-year basis.

And then you've got power and RF growing and then within LEDs we're targeting it to be within a similar range.

So the idea is that the combination of new products and lower costs from the restructuring are really -- the way we're modeling the year is that that would be offset by the continuing competitive LED environment.

So that's kind of the sensitivity to the target.

Brian Lee with Goldman Sachs.

Thanks for taking the questions.

I have two of them.

First, and forgive me, I think you did cover this but I missed it.

The capacity utilization that you're running at on the LED front end currently and then how that compares to last quarter?

And then the follow-up was around your gross margin guidance, Mike.

It's the same as what you had originally targeted for fiscal Q4 before the restructuring was announced, and I believe that at that time you cited lower-than-expected ASP's accounting for about an $8 million impact to top line.

So wondering how you're getting back to this similar margin level?

Has pricing actually improved or is this all about cost now being down or reduced enough to completely offset the ASP environment which is unchanged?

Thanks, guys.

Yes, Brian, let me take those in reverse.

On the gross margin guidance, it's really a combination of incremental improvement in each of the segments.

So we're targeting some improvement in lighting, LEDs, in power, and RF.

The LED one, we do get some benefit from the restructuring, but it's also a combination of targeting that that business would stabilize.

And then some incremental benefit in the quarter from the recent license that we announced.

So it's really those things driving the short-term guidance.

In terms of capacity utilization, we don't have a specific guide number for you for where we're at.

It has improved but the restructuring has actually started, it's not finished.

So the factory consolidation, the one that will drive the number the most, is our LED fab here in Durham.

The consolidation of those two fabs into one will take two quarters and so I would expect that really won't be fully implemented until the end of our December quarter and, at that point, we currently target for our plan for the year that we would be running at that point at about 85%.

So right now we're not at that level of efficiency just because we have a lot of moving pieces to get to the two fabs consolidated.

But that is where we should end up by the end of December.

Jed Dorsheimer with Canaccord Adams.

Thanks, Chuck.

Just a follow up to your last answer.

Based on the calculations, if I assume pricing is relatively static quarter to quarter it would look as if the restructuring resulted in a reduction of about 40% of the available capacity.

Is that the right way to look at the bounce back in, I guess sort of asking Brian's question a different way, the bounce back in margins quarter over quarter?

Yes, so, Jed, the challenge is that we will end up somewhere there is obviously some pricing reduction quarter to quarter over the year.

So when we get to the end you'll be in the right neighborhood, maybe not quite as much as you're putting out there.

But remember right now we still -- the process of consolidating those factories doesn't happen at once, so we're actually taking some equipment off line, we're moving equipment.

So we're not actually -- we will end up at a number that gets us back to 85% utilization but it's a little lumpier than that just given the fact that I've got two fabs that have to be put into one.

So that's why some equipment has been written off, some has to be used this quarter until we get the rest of it ready to move and re-consolidated.

So, you're in the right ballpark.

I'm not sure the 40% is exactly right, but if you've got the order of magnitude that's probably close enough.

Okay.

And then just as my follow-on, as I look at the 10% revenue guidance for the 10% growth in revenue for the year.

Given it's out there that you'll be spinning out the power and RF, that's roughly about $150 million of business, is that included in the 10% or are you netting out that $150 million coming out -- or are you netting out the power and RF coming out to get to that 10%?

No, we're describing the whole business, Jed.

So the IPO as we laid it out at this point, Cree would still remain a majority shareholder and so it would still be consolidated in to our numbers.

So, when you think about 10% for the Company think about all three segments combined.

Mike Ritzenthaler with Piper Jaffray.

Good afternoon.

By how much does the devaluation overnight of the Yuan affect your view on pricing and competitiveness in LED products in 2016?

Yes, I don't -- I think obviously that's a very recent move.

I think if you look at the likely effect that China's already a tough market, that's been the biggest change in our business over the last couple quarters.

That was one of the pricing changes we even saw in the quarter.

So, I'm not sure that it moving by that amount is going to be a dramatic change frankly on us right now.

I would assume that the LED business is already very competitive.

So I think it's something to keep an eye on, but my short-term view is it's not a significant effect, at least not in the near term.

Okay.

All right.

Fair enough.

I guess my followup I was curious about -- on the call in June you kind of laid out a bit of a different retail strategy around going after more premium light bulbs.

I'm just wondering how that channel has embraced that shift toward more premium light bulbs?

Yes, so I think that, effectively, there is -- what happened and what we mentioned in June is that a number of the other companies have basically traded off some of the features and tried to just chase price down and we don't think that obviously works for our customer base and certainly not for our brand.

And what I would tell you is that our sales, although not what we originally targeted, actually were pretty solid in the quarter.

So, if you just factor in normal seasonality they've pretty much tracked and as we are six weeks into the new quarter and they are tracking as well.

So I think we're doing fine.

We're not -- it's likely there will be other people with more volume, but I think we're on the right path to getting the ball positioned to where we need it to do -- where it needs to do the premium brand work for us.

And so I think so far the reaction from our partners has been fine.

We obviously have to keep innovating into new products and I think it will be up for us to show that here over the next couple of quarters and over the next year, but that's with the R&D investment is for.

Harsh Kumar with Stephens.

Hey, Chuck.

Let me ask you an interesting question.

When you get to your 85% stated goal by December, what can margins be at that point in time for -- you can answer it either as part of your chip business margins what they could be or even for the whole company?

Just any color would be great.

Yes, so, Harsh, the way to think about it is so we have some benefit that we're going to see in Q1 in terms of cost.

We will see additional cost benefit in Q2 and it's really not until we start Q3 we'll have that full consolidation.

I

I think as we get there, the way we built the model for the year is this.

We're going to get some benefit from cost reductions due to the restructuring.

We should have some benefit from our new products.

So the SC5 continues to get traction, so we're getting design win momentum on that side.

So the combination of focusing on our higher-end products, cost reduction and our model is really designed to offset what we think is going to remain a pretty competitive environment.

So we're really not targeting any big gains one way or another.

What we're saying is the progress we make on one side will generally be offset by the market at least in the near term and that's how we're thinking about it.

Okay, so let me ask you another question.

For as long as I've covered Cree, I've noticed that most of your fluctuations in business and vibrations around your business come from the chip side.

It seems like your commercial business is on pretty steady growth pattern.

So why be in an outside sales LED business, chip business, at all?

Why not just completely think about making that [captive]?

Yes, so the external part of that business, Harsh, while we have a very successful commercial lighting business the fact is that it's primarily focused in North America, so we have a tremendous investment in R&D and capacity for LEDs that if we just serviced our internal customer you would end up with something that's very small scale and probably long-term not a very practical approach.

So I think if you're going to make the investment in LED and capacity, I think you want to participate both as a supplier to the internal division, as well as the external market.

The other thing that happens is, when you're in the external market competing every day, it keeps you a lot sharper.

And so I think it continues to help us figure out where's our technology at, what our costs need to do and then frankly just makes us a better overall LED company.

Vishal Shah with Deutsche Bank.

Thanks for taking my question.

Chuck, you mentioned reduction in spending on the Consumer segment in order to improve your margins next year.

Can you provide some color on what you're spending run rate has been in that business over the last couple quarters and where you think it's going to go down to?

Yes, what I'm trying to guide to there is, I don't have a specific target, but maybe I can get you directionally correct on that.

We have had a very strong brand investment and, with the repositioning of the bulb really to premium, we know that the volumes are going to change a little bit.

And so really what we're going to do, when we think about operating leverage for the year, obviously part of that is to try to make improvement at the gross profit level.

But the other thing we're looking at is how do we balance our investment on some of the brand and make sure that it tracks a little better with the consumer business.

And I think by doing that we can still have success with the work we've done building the brand for the broader company.

But, at the same time, by getting it a little better aligned I think gives us some operating leverage for the year.

So, it's really just adjusting that spend to be more in line with the actual revenue of the consumer business.

Okay.

And just somewhat longer term question around the profitability of the lighting business.

I know it's a function of the mix, but how do you think longer term margins, operating margins, in the lighting business look like given the new pricing environment?

Yes, so what I would say in the new pricing environment there is really two pieces to that, right?

If you're talking lighting, there is really a consumer lighting business and a commercial lighting business.

Let's just put consumer to the side because, honestly, our strategy is that commercial lighting is the big growth driver here over the next several years and that consumer, while it's important, it's really core a brand strategy first.

So, I think our margins over time will merge towards our commercial margins and, if you look at that market, over the past three to five years, the commercial lighting industry, generally once you get to be about $1 billion, they typically have mid-30s gross margins and low double-digit operating margins.

And so that would be our near- to mid-term goal is to get the business to that level in terms of commercial lighting.

And then in the longer term if we're able to continue to innovate and lead, I hope we can at least be on the higher end of that range.

But that's kind of how we think about it.

Edwin Mok with Needham & Company.

Thanks for taking my question.

So, first question on the full-year target I know you laid out in terms of LED business being flat and lighting from commercial.

I am also wondering how much of that is baked into your guidance based on new product that you guys plan to launch this year or is it based on product you have launched (inaudible) customer base?

Edwin, so, look, one of our core strategies is to continue to lead in all of our segments with innovative products.

So inherent in how we build our model is that we'll continue to innovate and, as I mentioned in my comments earlier, we feel pretty good about our pipeline in all three businesses.

So some of it is assuming we will get some new business momentum from those.

The fact though is, is that whether it's LEDs, LEDs are typically looking at 12- to 18-month design cycle.

Even a new lighting product is typically two to three quarters before we see any momentum.

So, the majority of next year will be built on the momentum of products that are already in the market.

The key though is we have to keep innovating because that really builds the momentum for the end of FY16 and starts the momentum as we head into the next year.

So, I don't have an exact breakout, but the majority of our 16 targets are based on things that are already released and then really those new products will start to drive next year.

Okay, great.

That's helpful.

And then I have a question about capital structure.

I know that your debt has gone up partially because you had to buy back stock at this juncture and you plan to spend $150 million of CapEx this coming year.

Any way you can kind of think about capital structure and what -- where you think the capital structure goal or how much debt you guys can take on your balance sheet and kind of just [conduct] some guidance on that?

So as Mike mentioned earlier, we've got a free-cash flow target for the year of around $85 million.

And our CapEx, while it's sitting at target at about $150 million for the year, that's most of that's going to happen in our first and second quarter as we finish some infrastructure projects.

So, as you think about the second half of the year, the free-cash flow should increase in the second half versus the first.

So that's kind of the boundary condition of how we're thinking about the operating cash.

And then in terms of the buyback, given that we have still a very strong balance sheet, we have plenty of capacity available and debt if we want it, and I think we're going to continue to think about the stock buyback and be opportunistic because we have that flexibility from a capital allocation standpoint.

If we wanted to, we certainly have the ability to execute that full buy back and still be net cash positive for the year.

So I think at this point we're going to evaluate that as we go quarter to quarter, but I think you can see from how much stock we bought last year and the nature of the buyback we announced this year that, our current plan is that in not only this quarter but over the year we intend to use some of that because we think, given where we're at today, as we think it's a pretty good use of capital.

(Operator Instructions)

Sven Eenmaa with Stifel.

Thanks for taking my question.

My first question is on the commercial lighting side.

Could you discuss where do you see the pricing currently year over year change wise?

And what are your expectations for the year?

And the second question is, what are your expectations for the royalty and license revenues for the year?

Yes, so in terms of commercial lighting pricing, there hasn't been a big change.

I don't have a specific reduction.

It is going down a little bit year over year, but it's nothing like the LED business.

All things considered, commercial lighting is a relatively modest decline in terms of pricing specifically.

And frankly our mix of new products and what that blend is has more to do with what our ASP is year over year than the actual price declines, and I would say that hasn't changed a lot in the last year and we don't target it.

There will be some incremental price declines over the next year, but we haven't seen a big swing one way or another there and that's kind of what's built into our model.

In terms of licensing, we would target this quarter a little bit of incremental benefit from the Epistar license that we just announced, but overall I don't think it will be a significant change from what you've seen in the past.

There's some incremental benefit from it, but really at the end of the day it comes down to the core gross margins we can generate in each of the operating segments.

Steven Chin with UBS.

Thanks for taking the question.

Just trying to get an idea on the amount of ASP erosion in LEDs.

So if I assume units were flat and add back some of the channel in inventory reserve, I'm calculating ASPs were down about 15%.

So is that the right way to think about it?

Yes, Steven, we haven't broken out a number but I think if you're looking at that like a quarterly sequential number you're in the right order of magnitude on that.

It was definitely what we saw middle of the quarter is a fairly -- it was more severe than what we had seen and so I think you're directionally correct on that.

Got it.

Thanks.

And then just given where prices are, how have you thought about going out and buying chips, especially mid-power chips and high-power chips instead of making them?

And then how do you think that will impact your gross margin going forward?

Yes, so as we've modeled the next year with the restructuring, we would plan that our 85% utilization target for midway through the next fiscal year that assumes that we're making pretty much our high-power LEDs.

And frankly the reason we make them is that we can get performance we still can't buy on the open market.

We have been buying mid-power chips.

Part of our goal for last year was to qualify manufacturing partners not only in lighting but also in the LED chip and we are utilizing those partners.

And I would imagine that we will continue to maintain a pretty good balance between the two.

And so our factory utilization is really a function of how does demand fluctuate between the two categories.

But I would say that right now my expectation is we we'll have reasonably good balance between what we buy from mid-power and what we're making from high power over the next year and that's kind of what we built into our utilization target.

Jeff Osborne with Cowen and Company.

Good afternoon.

Most of the questions were answered.

Chuck, I just had a question on the premium bulb strategy.

Is that going to be using internal chips or would you be buying outside chips?

And then I also might have missed this on the call, but did you break out what consumer was for the quarter?

You had indicated that it would be running at a consistent run rate to the current quarter, but I missed the actual number for the quarter.

Yes, we didn't give you a specific number for the quarter.

So all I can tell you is that it was down from what we had originally targeted, but I don't have a specific number for you at this point.

In terms of chips, our bulb strategy is actually not changing, so about more than a year ago we had basically gone with dual sourcing.

So we initially launched, it was all our chips and we basically have both Cree chip-based LEDs in there, as well as chips we buy on the outside, and we're using that to kind of moderate demand or balance demand in our factory.

And so I think we're taking advantage of the external market it as it makes sense, but there's still occasionally some situations where our chips just work better or let us do something, so we're trying to use both of those.

Krish Sankar with Bank of America.

Good afternoon.

This is Andrew Hughes on for Krish.

Back to China really quickly.

Just curious, have you seen the macro situation significantly impact demand for LEDs there?

And then on the flip side, is the weakening there from a macro perspective, as well as some credit tightening, have you seen that impact your Chinese competitors ability to scale up or expand at all?

Yes, so I'll just take the back of the second one.

I haven't seen it affect the Chinese competitors yet.

I think in the LED space there's several large ones.

They're pretty well backed and when I say backed they both, whether they have access to their equity markets or they have access to what I will call some government-sponsored money.

I think they are able to access capital from what I can tell right now.

In terms of, has it changed in terms of demand, I think what we saw -- the first change we saw in our business last year in our second quarter was really a change in China.

I think that our third quarter it was relatively similar to what we expected.

Last quarter we definitely saw a change.

And so I think the data you're seeing out of China in my mind I think we've already seen partially in our business and I think that's what you're seeing reported by other LED companies.

So pretty much anyone in LEDs in Q4 had a pretty -- it was a pretty challenging environment and I think that the China market specifically was tough and I think that's a function of what changed in the backlighting demand.

So, I think those two pieces work together and I think China is probably the most obvious place you see it, it is broader than that, but to some extent I feel like we've already seen part of that and what we saw in Q4.

Melissa Fairbanks with Raymond James.

Sorry about that.

It's Melissa for [Hans].

I was wondering if you guys could give us a little bit more detail into the dynamics of the LED product segment for FY16?

We saw a pretty dramatic decrease in FY15 and then to expect kind of flattish trends next year.

Just kind of wondering what's shaping that expectation?

Thanks.

Yes, so it's the combination of the restructuring that we changed our cost structure, as well as new products.

Those two working together to help offset what we think will be continuing in a tough LED competitive environment.

So, keep in mind that by restructuring our factory we're starting at a fundamentally different base, and so it gives us a better ability to focus really just on the high-power LEDs and that's kind of how we built the model for the year.

So, the new products, lower cost structure to offset what we think is going to be a tough competitive environment.

Okay.

At what point could we expect to see year-over-year growth in that business?

Is the contribution from the higher-end new products going to offset -- pretty much balance out competitive issues going forward?

Well, we only have targets specifically for Q1 and our targets for the year are more directionally correct, so it's a hard market to predict.

But right now the idea is that the combination of the costs and the new products is going to generally offset the competitive environment.

But with that being said, I think trying to predict beyond what happens over the next quarter and over the next year I think given the dynamics within the LED competitive business -- we're not trying to put longer term targets out than that right now.

I'm showing no further questions at this time.

I'd like to turn the call back over to management for closing remarks.

Thank you for your time today.

We appreciate your interest and support and look forward to reporting our first-quarter results on October 20.

Good night.

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

This does conclude the program and you may all disconnect.

Everyone have a great day.