Wolfspeed Inc (WOLF) 2017 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Cree's first-quarter FY17 earnings conference call and webcast.

(Operator Instructions)

As a reminder, this conference call is being recorded. I would now like to turn the conference call over to Raiford Garrabrant, Director of Investor Relations. Please go ahead, sir.

Thank you, Abigail. Good afternoon. Welcome to Cree's first-quarter FY17 conference call. Today Chuck Swoboda, our Chairman and CEO, and Mike McDevitt, our CFO, will report on our results for the first quarter of FY17.

Please note that we will be presenting non-GAAP financial results during today's call and a reconciliation to the corresponding GAAP measures is 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. 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 first-quarter FY17 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.

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.

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

Thank you, Raiford. We delivered solid results in fiscal Q1, with total Company revenue the upper half of our target range at $371 million, with non-GAAP net income of $15 million or $0.15 per share. Lighting, LED and Wolfspeed all delivered revenue and gross margin that were in line with our targets, while operating expenses were lower than targeted.

We made progress improving lighting margins in both our commercial and consumer product lines in the quarter. Customer service levels improved with good on-time delivery and better lead times. This improved level of customer service, combined with the new products we released in Q4, has resulted in increased lighting project quoting activity, which is a good indicator of future demand. We know that rebuilding order momentum will take time but we believe we are on the right track.

We continue to make progress with our transition to Cree 3.0 and a more focused LED lighting company. It starts with improved fundamentals in our commercial lighting business. This, combined with our next-generation premium LED bulb family and solid execution in our LED business, puts us in a good position to begin to grow revenue and profits going forward. This is not a one-quarter transition but we are building a solid foundation to support a multi-year effort to build a larger and more valuable company.

I will now turn the call over to Mike McDevitt to review our first-quarter financial results in more detail as well as our targets for the second quarter of FY17.

Thank you, Chuck. I will be providing commentary on our financial statements on a 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 periods mentioned on this call is posted on our website or provided in our press release, along with a historical summary of other key metrics.

As a reminder, in July we announced an agreement with Infineon to purchase our Wolfspeed business. The Wolfspeed business includes the power and RF product lines that have historically been reported as a separate operating segment, plus the non-LED materials product line previously reported within our LED segment.

Beginning with this first quarter of FY17, we will report Wolfspeed as discontinued operations in our financial statements. As a result, I will be providing commentary on our results for our overall combined business, our continuing operations and our discontinued operations.

For the first quarter of FY17, combined Company revenue was $371 million and non-GAAP earnings were $15 million or $0.15 per share, which were at the upper end of our targeted ranges. For continuing operations, revenue was $321 million and non-GAAP earnings were $9 million or $0.09 per share, which were slightly above the mid-point of our targeted ranges. For discontinued operations, revenue was $50 million and non-GAAP earnings were $6 million or $0.06 per share, which were slightly above the upper end of our targeted range.

Our combined and discontinued operations include a $0.01 non-GAAP EPS benefit due to suspending depreciation and amortization on all Wolfspeed long-lived assets, as required under GAAP for assets being held for sale. The non-GAAP earnings above exclude non-cash stock-based compensation, acquired intangibles amortization, transaction costs related to the pending sale to Infineon, and other items.

For combined operations the excluded amount is $15 million net of tax or $0.15 per share. For continuing operations, the excluded amount is $12 million net of tax or $0.12 per share. And for discontinued operations the excluded amount is $3 million net of tax or $0.03 per share.

FY17 first-quarter continuing operations revenue and non-GAAP gross profit for our reportable segments were as follows. Lighting products revenue declined 7% sequentially to $184 million, which was in the middle of our target. Gross profit was within our target range at $49 million, for a 26.8% gross margin, a 100 basis point sequential increase.

Both commercial and consumer gross margins improved in Q1. LED products revenue was $137 million and gross profit was $42 million or 30.4% for the quarter, all of which were at the upper end of our targeted range.

Non-allocated costs totaled $2 million for the first quarter of FY17 and are included to reconcile to our $89 million non-GAAP gross profit for a 27.7% gross margin. Continuing operations non-GAAP operating expenses for Q1 were $80 million in at the low end of our targets for the quarter, primarily due to lower variable sales cost and the timing of IT litigation cost, some of which is expected to shift to Q2. Our non-GAAP operating income was $9 million, which was at the upper end of our targeted range.

We ended the quarter at $402 million in cash and investments net of line of credit borrowings, a $43 million decrease from Q4. At the end of the quarter we had $187 million outstanding on our line of credit.

For the quarter we generated $18 million of cash from combined operations and spent $21 million for combined capital expenditures, which yielded negative free cash flow of $3 million. The $21 million spent on combined capital expenditures includes $10 million spent for Wolfspeed.

During Q1 we spent $36 million to repurchase 1.5 million Cree shares at approximately $3 million for the year one earnout achieved from the APEI acquisition. For FY17 we continue to target lighting and LED capital spending of $55 million, plus or minus, to support our continuing operations.

Until the sale of Wolfspeed is completed we will continue to invest capital to support the Wolfspeed business. We target Wolfspeed capital spending to be $10 million, plus or minus, for Q2, which is in line with our previous guidance. Overall we continue to target FY17 free cash flow of $100 million, plus or minus, which may change depending on the timing of the Wolfspeed sale.

For continuing operations, days sales outstanding increased 4 days from June to 41 days at the end of September. Inventory days on hand increased 11 days from June to 112 days at the end of September. The inventory increased primarily relates to purchased commercial lighting finished goods, which are targeted to sell over the next few quarters. Our inventory days targeted 90 days, plus or minus, which we forecast being in line with by the end of the fiscal year.

For comparison to Q1, we target combined Q2 Company revenue, which includes both continuing and discontinued operations, in a range of $360 million to $380 million. We target combined non-GAAP net income for Q2 in a range of $13 million to $19 million, or $0.13 to $0.19 per diluted share.

For continuing operations we target Q2 revenue in a range of $310 million to $330 million, which is in a similar range as Q1. Both lighting and LED are targeted to be in a similar range as Q1 as we continue to rebuild commercial lighting order momentum and operate in a very competitive LED market.

We target Q2 gross margins from continuing operations to be similar to Q1. While we target incremental improvement sequentially for lighting, we anticipate this will be offset by slightly lower LED margins related to lower targeted production volumes in our LED factory to help rebalance our commercial lighting inventory.

We are targeting Q2 operating expenses from continuing operations to be $2 million higher than Q1 due to promotional spending related to our gen 4 bulb launch and incremental IP litigation spending. Additionally, our continuing operations operating expenses include approximately $1.5 million of shared service costs that also support the Wolfspeed operations. We will receive reimbursement for most of these costs for a period of time after closing under a transition services agreement with Infineon.

We target Q2 non-GAAP net income from continuing operations to be between $4 million to $10 million or $0.04 to $0.10 per diluted share. Our non-GAAP EPS target excludes acquired intangibles amortization, non-cash stock-based compensation and other items. The business fundamentals are improving in lighting as we see improved customer service levels, increased channel quoting activity and better gross margins, but it will take several quarters to see the full benefit in our financial results.

For discontinued operations we target Q2 revenue from Wolfspeed to be $50 million, plus or minus, which is similar to Q1. We target Wolfspeed Q2 non-GAAP net income to be $9 million, plus or minus. This non-GAAP net income target includes a $4 million net of tax or $0.04 benefit from the full benefit of not including any depreciation or amortization expense from long-lived assets.

Our Wolfspeed non-GAAP net income target excludes acquired intangibles, amortization, non-cash stock-based compensation, and transaction costs related to the pending sale to Infineon. Our Q2 targets are based on a number of factors that could vary, including overall demand, product mix, factory execution, and the competitive environment.

I will now turn the discussion back to Chuck.

Thanks, Mike. We are focused on the following goals to support the Company's transition to Cree 3.0 and our efforts to build a more valuable LED lighting technology company. First, we are working to complete the sale of Wolfspeed to Infineon. We continue to work through the process to get the necessary government approvals, while our team is engaged in a number of transition planning matters.

The process is progressing as expected but we recognize that the approval process can be unpredictable. Based on the feedback we have received to date, we continue to target closing the transaction around the end of calendar 2016, which will further strengthen our balance sheet to fund share repurchases in the near term and pursue inorganic lighting growth in the medium to longer term.

Our second priority is driving top-line growth for our LED lighting business. Over the next year we target growing core commercial lighting revenue from current levels and in line with the market, while potentially adding to that growth through product line expansion. Our corporate development team is working to evaluate lighting growth opportunities through potential M&A but we don't target any deals in the next few quarters as we give the new lighting leadership team time to build momentum for the core business.

Customer service fundamentals in commercial lighting have clearly improved over the last two quarters, which is the first step to rebuilding order momentum. The new products we released in Q4 are starting to gain initial project wins, but it typically takes nine months to accurately gauge market traction for new products.

Quoting activity by our channel partners is an imprecise metric and is subject to a number of market factors. However, it is also one of the better indicators we have for future demand, and the dollar value of quotes improved nicely in Q1, which is encouraging looking ahead to the second half of FY17.

The consumer product transition to gen 4 is proceeding as expected with the initial load in orders, combined with demand for our previous generation, a little higher than forecast. Our new gen 4 LED bulb continues to provide the premium light and quality that consumers expect from the Cree brand but at a lower price point and better value than our previous generation.

The new bulb is targeted to provide some incremental margin improvement for the consumer product line, which we're using in the near term to fund an expanded marketing program to support the new product launch. The new bulbs have been shipped to stores but are still in the process of being fully merchandised. Early sales numbers are encouraging and support our forecast, but we will need a full quarter of sales in lighting season to accurately judge the sell-through for these new products.

The LED business has performed well over the last year, and Q2 is targeted to be in a similar range as Q1, plus or minus. The market remains very competitive and we continue to focus our efforts on the applications where our technology can add the most value to the customer. We're also working on some mid- to longer-term programs that could expand the LED business in future years for both existing and new applications.

Our third priority is to improve operating margins. We target increased lighting gross margins to drive the improvement in operating margins over time. We made progress in Q1 and we target the combination of higher value new products and lower costs to drive improved gross margin opportunity.

We target LED margins in a similar range in the near term, as we work to continue to reduce product costs and increase performance levels to offset lower ASPs due to the competitive environment. While we forecast a short-term increase in Q2 OpEx, as Mike explained earlier, in general, we target Company operating expenses to grow slower than our revenue over the next year, which should drive some incremental margin leverage.

To enable our revenue and profit goals we must continue to innovate in all business segments to differentiate our products in the market and improve the customer experience and service levels across the Company. We made progress in lighting innovation during Q1 with the release of our gen 4 premium LED bulb family and our market-leading HXB LED industrial high-bay fixture, which utilizes our SC5 LED technology, a new 130 lumen per watt ZR troffer product, the new Essentia wrap product, and a higher performance version of our CPY canopy fixture.

In LEDs, we released our next-generation high-power XP-L2 LEDs, which have twice the lumens per area, a new high-performance sideview LED for gaming applications, and brighter MHB LEDs for commercial outdoor lighting applications. While we made good strides over the last two quarters, we are focused on further improving our ability to deliver innovative products that exceed customer expectations in terms of performance, value and quality, as we strive to set new standards for LED lighting.

As we look to Q2, the fundamentals in our business have improved. But this is not a one-quarter transition. We are still working to earn back share of mind with our lighting agent and distribution channel partners, and translate that effort to new projects and increased orders. The leading indicators are encouraging and we are making investments in people and systems to further improve commercial lighting performance.

We recently announced that Danny Castillo will be joining Cree as President of Lighting in early November. He will be responsible for both our commercial and consumer lighting business. Danny joins Cree from Eaton Corporation and brings many years of management and leadership experience from both the lighting and electrical products industries. David Elien, who is also a lighting industry veteran, has successfully led the commercial lighting business for the last two quarters and will continue to run this business as part of the new lighting organization, reporting to Danny.

We remain focused on building a larger and more valuable Company by bringing better light to our customers, light that makes their environment better and is intelligent by design; light that enables you to see better, feel better, and do more; light that is smart enough to not only improve the lighting environment but become an integral part of enabling smart buildings, thereby expanding the market and channel opportunity for Cree.

We're expanding our team bringing in experienced leaders who understand the unique aspects of the traditional lighting industry and sales channels and complement our strength and innovation. The transition to Cree 3.0 and the sale of our Wolfspeed business has created some challenges over the last year, but overall we are making fundamental progress towards our goal to build a larger and more valuable LED lighting company.

We will now take analyst questions.

(Operator Instructions)

John Quealy, Canaccord Genuity.

Good afternoon, folks. My first question, if we can go to Wolfspeed for a moment, the second request by some regulators, did you anticipate potential protracted process or is this all in line with your time frames?

John, I would say it's generally in line. You never know for sure that you're going to get a second request, but it's not outside the normal course. And I would say it still leaves us in track to get this closed sometime around the end of this year. So, I think we're still generally within the same boundary conditions as where we started.

Okay, great. And my follow-up, just on the commentary around a little bit better quotation activity in the lighting channel, can you provide a little bit more granularity? Is it existing agents doing a little bit more business, or is it maybe some new agents and some land-and-expand capabilities in the channel that are growing that pipeline? Thanks, guys

John, what we're really talking about there is it's our existing agents. And what we're just measuring is quarterly how much business new project, that quoting activity. So, we looked out over the last several quarters. As we fix the customer service metrics and really start to deliver better there, the first thing you would expect to see is starting to quote on more projects. And we saw a nice increase in our Q1 and that's why we believe it will lead to increased demand as we get into the second half of FY17.

Harsh Kumar, Stephens.

Chuck, a question for you. I think it was April that the ERP issue happened. Since then you have seen a pretty good -- you saw a decline, of course, in the March quarter, a bump up in the June quarter, and then a decline in the September quarter, you're talking flattish in the December quarter. I'm trying to put together your commentary about increased quoting activity and why we are not able to see growth, for example, six months after the issue happened, let's say, in the December quarter guide.

Harsh, the way to think about it is this. Really, we had the challenge that happened in our March quarter. We did have some increase in Q4. But, remember, most of those projects were already in the pipeline before we ever had the ERP challenges.

We are really in the mode now of rebuilding the project pipeline, which is what we talked about in our end-of-year call a couple of months ago. You start with get the customer service fundamentals right. I'd say for the last six months they have been as good as I have seen them since we've been in this business, so I think those are working very well.

And then the next thing you expect to see is getting the agents out there, spending more time with them to make sure the quoting activity is increasing. So, we are seeing more quotes for more dollars and more projects, and that would be the best indicator. The fact, though, is, from the time you get the quoting activity you are probably looking at two to three quarters before those projects would ship. They are quoting a job, that job has to get awarded and then it goes to construction and gets shipped.

So, the fact that there's a two- to three- quarter delay is not that uncommon. And I think what you are just seeing is the lag between when you cause the service disruption, you have to rebuild the fundamentals, and it just takes a while to build back that order momentum. I think the early indicators are there and now we've got to turn them into actual demand. But I'd say from a fundamental standpoint we are pointing in the right direction.

Understood. Thanks, Chuck, for that clarity.

And then the second question is about lighting growth. How fast do you think the lighting business is growing for the industry overall, the LED business, and how fast do you think you guys can grow at Cree?

Harsh, I don't have a good recent number for you on lighting industry growth. There's been some speculation that there's some Q4, is it slowing or not. I'll be honest, when we look at the industry itself, I think LED lighting is clearly growing, but I don't have a good specific number for you right now that would change what we've been thinking over the last quarter or two.

Part of that is, Harsh, because our business has really been focused, at least in our Q4 and our Q1, on our Company-specific things. For our standpoint, the industry is a factor but, really, just rebuilding momentum with our channel partners is probably the bigger factor in our business and has the most effect, at least in the near term. So, that's where our focus is.

I think at a macro level I am still confident that LED lighting is a growing industry and will grow next year versus this year. But as far as a specific number I don't have a good one for you right now.

Brian Lee, Goldman Sachs.

Guys, thanks for taking the questions. I had two of them and maybe a follow-up on the prior question. I'm a bit surprised, as well, that the guidance implies a little bit of a sequential decline in both the revenue and earnings. It's down a smidge, maybe flattish.

But how should we think about the impact of seasonality into December? I would imagine both your business segments, the continuing operations tend to historically have seen better sequentials into December.

And then looking ahead, do the new products offset that into March, or should we be expecting a bit of a two quarter flat to down trajectory as we look out into the early part of next year?

Brian, what I would say is, I would use our target range. It's basically, what we are trying to tell you is we think it's relatively flat quarter to quarter. All three businesses are in a similar range. I don't think there's a trend. I think it's relatively stable quarter to quarter.

And on the earnings, I think you have to look at the fact that we have two items in Q2. One is the launch of the new Cree LED bulbs, so we are going to see some incremental OpEx for that launch. That launch typically will happen this quarter and then we will manage that and we can balance that going forward.

The other thing is the IP litigation spending. That's just timing of that process. I think if you take out the Op Ex piece, I think actually the results are pretty similar quarter to quarter and it's really about how do we drive growth primarily in the short term in the commercial lighting business, and that's about turning those quotes into orders.

As far seasonality goes, I would say that, generally, if you just look historically, the business is usually, in our Q, what would be Cree's Q1 and fiscal Q2 are similar, maybe a little bit of growth in fiscal Q2, and then typically there's some seasonality in Q3. It's a little early for us to provide any guidance there, because one of the challenges is that we have seasonality on one hand and we have quoting activity on the other. And I think it's just too early for us to give you any specific targets.

If you ask me second half of this fiscal year, the first half of next year, I feel like we're going to see some growth. That just activity based on what we can see in the business. But as far as breaking that down to the third quarter, I think it's just a little early for us to make that call at this point.

Okay. Fair enough. Just a quick follow-up on the LED segment. Chuck, you alluded to some new and existing opportunities that you might be targeting for getting growth back into the segment longer term. Could you elaborate on that a little bit? And then just curious on how your product portfolio would need to change and over what time frame that might occur. Thanks

Look, I don't want to pre-announce any new products, but the way I would think about it is this. If you look at our LED business, we've had, really, a solid last year. We went through the restructuring really focused on the high-power high-technology side of our business. That business has delivered great results, consistent results, for four straight quarters in what's a pretty tough market.

So, what we're looking at is we're working on projects where you take our expertise, which I would call -- high power is probably a nice way to generalize it, but it's really more highly technical application -- and where we can use that expertise to extend it. So, I'd call them related high-performance high-reliability applications on one side.

And on the other side is where we can combine our knowledge on LEDs and our expertise on lighting and really come out with some more value-added products on the lighting side. One of those would be our CTA integrated lighting solution product that came out a quarter or two ago. This is a case where we add more than just the LED. We bring some of the knowledge around lighting and give a higher-value product.

I think there's an opportunity, both in the new application but also in higher-value lighting products that can give us some growth. Not necessarily in the next quarter or two, but if I look out over FY18 and FY19, I would believe, we are targeting to drive some incremental growth on LEDs from those two areas.

Craig Irwin, ROTH Capital.

Good evening and thank you for taking my questions. Chuck, the first thing I wanted to ask about was the transition that's going on with the consumer bulb to more commercial high-end consumer third gen versus fourth gen. Can you maybe update us on your target for full complete stocking of your fourth-gen product across Home Depot? And update us on the inventory position of the third-gen project that's being deemphasized, how far more do we have to go before that is complete?

What I would say is the primary load-in activity has happened. The store merchandising is, I would say, we are a majority of the way through, although my guess is, the last numbers I saw there's still some percentage of stores that have not been fully merchandised. So, we're really just starting to get into the point where we're going to have all the stores set up and we're going to get good numbers on gen 4.

I would say by the end of the quarter we will have a better read, but initial indicators are where the product is on the shelves it's selling as expected. So, I'm pretty encouraged about gen 4. And I'd say its stocking position in the majority of stores is in a good spot. So, it's really about sell-through and restocking at that point.

I'd say as far as gen 3 goes, we made some good progress in last quarter in having that wind down. It still is available in some stores. It's a clearance item that's moving out of the channel. And I'd say, while it's still out there, it's becoming a much smaller percentage. I'd say, generally speaking, already the majority of the business is gen 4, and I would say by the end of the quarter gen 3 should be only available in pretty limited places at this point.

Great. Thank you for that.

My second question is about the lighting products portfolio, the 11 new products and product lines that you have launched since the beginning of the year. Should we expect this portfolio to continue growing over the next couple of quarters? Do you have a number of things in the pipeline that have not been announced yet? From a relative standpoint, at this point next year would you expect the 11 products and product lines to be making a material contribution to revenues in this business?

Craig, what I would say is -- let me take those in reverse. We always target a fairly significant number of revenue from products we released in the last 12 months. That would be our track record over the years. That's how we built the business over a relatively short period of time.

Now, that's going to vary because not every product is the same size market opportunity. An architectural grade troffer is going to potentially have high interest but a fairly narrow category; whereas, you put out a high bay light that has a fairly broad industrial base, it can have a bigger application. It's hard to give an exact percentage, but, yes, we would expect any new product to contribute meaningfully within the first 12 months.

As far as the portfolio and how that looks over time, we will definitely continue to expand the portfolio. I would think of it as two ways. Some products -- and I'll give you two examples. The HXB, which is a new industrial high bay for very high, what I would call, high-temperature high-ceiling application, is a new market for us that we really didn't have a product for before.

And the other product would be our LN4, which is a suspended fixture, which is much more of an architectural product for a commercial -- typically, think of it as a commercial building application. Those are markets where we really didn't have products to address, so that would be expanding markets and selling into new places we haven't participated in the past.

If you then compare that to the Essentia product line -- and those are important products, those can drive significant revenue, but those are not a lot of SKUs. Each one of those is a fairly limited products set. At the same time we launched Essentia earlier this year and Essentia is over 1,000 new SKUs. I forget what the exact number is. But it crosses a wide range of products. And that's really about creating product that fill parts of the portfolio that we just didn't have enough offering.

I'd say we're going to continue doing both of those. Rough numbers I'd say we're shipping on average about 100,000 active SKUs in a quarter. And I would expect a year from now that number to grow fairly significantly because as those new applications and that product choice is part of the ways you grow the business and give your channel partners more to sell from Cree.

So, I think the portfolio will grow but it will grow in two different ways. It's a bit of a, we have a plan for what that looks like over the year. You should expect us to continue to innovate on one side and also look for portfolio extensions on the other. And I think we're going to plan to do both.

Vishal Shah, Deutsche Bank.

Hi. Thanks for taking my question.

I just wanted to clarify a comment you made on the industry activity in the fiscal second quarter. Last quarter you were talking about growth in the lighting business, were expecting the impact to be fully behind you. Is the flattish guidance more a function of industry slowdown, do you think? Or you just feel like you need another quarter or two to fully recover from the impact from the ERP implementation?

Vishal, I would say that's more Cree specific. What we're looking at is we get into some of the details and really look at quote levels and things like that. While the customer service metrics have been really strong for six months, it's taken longer. It took us longer in Q1 to drive some of that quoting activity that will then ultimately lead to new projects.

So, I would say it's more of a timing on our part of how fast does it recover versus an industry-specific dynamic. I am sure there are some industry things going on, but I think ours is more Cree specific at this point.

Okay, that's great. And your guidance for LED product margin, down slightly as you work down inventory, are you still assuming the LED revenues for the FY17 to be flattish, or do you think the market could slow down, as well?

We haven't really changed our view of the overall LED business. And if you look at our revenue expectations quarter to quarter are pretty similar Q1 to Q2. I would say I haven't really changed my view on the second half of our fiscal year or the first half of the calendar year. Obviously keep in mind there's likely some seasonality in Q3, but overall I don't see the industry demand changing significantly and LED.

And, honestly, the only real change in the margin guidance is that it's incrementally down, and that's really utilization for the internal customer as we rebalance that. I haven't seen a competitive shift one way or another. I'd say the market continues to be very competitive and our team continues to do a pretty good job executing to maintain ground with that.

Tom Sepenzis, Northland Capital.

Yes, I'm just curious as to how confident are you that you can grow the lighting margins faster than the LED margins decline over the next 3 to 12 months.

Tom, I would say that I don't expect a significant shift in the LED business in the next six months from the last six months. Obviously we have some internal utilization that is affecting it. But I would say right now our target for LEDs is to continue to maintain it in a similar margin range, plus or minus.

On the lighting side, we're certainly targeting to make some incremental improvement there. You can see even last quarter, the revenue in our commercial lighting business was actually sequentially lower in Q1 and Q4, and at the same time we made some incremental improvements.

There's a lot of work ahead of us. We've got to continue to work the execution side of that. But, as we do that, we would target improvement in lighting margin incrementally here over the next year. What that timing is quarter to quarter I don't have a specific target for you, but I think year over year we'd expect to make progress by LEDs. At least at this point we would forecast it to be in a similar range.

Great. Thank you.

So, the competitive pricing pressure, it sounds like maybe from an industry perspective has mitigated somewhat?

I would say LEDs has been -- we have actually had a relatively solid margin. If you take out the quarters over the last year where the IP licensing was coming and going, LEDs have actually hung in there pretty well over the last four quarters, and we're just targeting it to remain in a similar range. So, I would say the LED business hasn't gotten better but it hasn't really gotten any worse. I'd say it's highly competitive, but something that, at least over the last four quarters, we have demonstrated a pretty good ability to be able to compete in.

Edwin Mok, Needham & Company.

First, I want to clarify. Your LED revenue was down 4% sequentially. I just want to understand if that comes from lowballing, which is the pricing pressure you see in the marketplace. And I think you mentioned on answering Brian's question that you expect some of the new product to drive growth in the fiscal second half of this year. Is that correct?

No, let me clarify, Edwin. First of all, LED revenue in Q1 was within our target range. It is down but, remember, we had the benefit of IP license revenue in our fiscal Q4. So, it was relatively the same quarter to quarter if you take out the effect of the licensing revenue that we had in Q4.

As far as longer term, what I talked about is there are things we are working on in LEDs that could drive incremental growth, but they are not in the next couple of quarters. I would say they are more in the mid to longer term. We are working on activities that we think can expand us into new applications on one side and really expand our value-add within lighting. But those are not one or two quarter things. Those are things I would expect to see some benefit in in our FY18.

Okay, great. Thanks for clarifying that.

And I actually have a question on cash flow. I think you guys have laid out a cash flow target for the year of $100 million, I think. That's factoring how it's slower this year versus last year. But given where you're at right now, do you still think you can hit those targets? That would imply you expect some growth in the back half to bring that cash flow in. Or is there some growth in capital improvement you can expect to get on the model?

Edwin, this is Mike. We have the target of $100 million that we put out there for the year. And, really, the negative cash flow in Q1 was based on some working capital investment that we expect to normalize. So, the $100 million still makes sense to us.

Krish Sankar, Bank of America Merrill Lynch.

Hi. Thanks for taking my question. I have two of them, Chuck.

The first one is, can you tell me the dynamics on how the pricing is going on in the lighting business, especially in the commercial, as compared to some of your consumer residential peers? Clearly there's much more pricing pressure in the residential side, the consumer side. I want to know how it is on the commercial side.

And the second question is on M&A. You guys have spoken about doing an M&A for the last three years or so, but nothing has really happened. And obviously that is feature of Wolfspeed. With the new cash infusion from Wolfspeed, do you think your M&A appetite is going to get increased, or the fact you haven't done an M&A in a while is more a function of you've not really found a suitable candidate, that you're going to do more buybacks until you find the ideal acquisition target? Thank you

Sure. Let me start with the first one. I would say that commercial lighting pricing dynamics are pretty similar. There is some more lumens per watt. So, so I guess there is some amount of decline there, but it's nothing like what we see in commercial. And I would say there's also an opportunity to add features and values to where you could actually increase the value of products.

I would say that customers are looking for more lumens per dollar. But, at the same time, given what's going on from an innovation standpoint, there's also an ability to extract more value with new features, new capabilities, smart lighting, things like that. I feel like commercial lighting, yes, there are competitive factors but nothing like what you see on the consumer side or on the LED side.

In terms of M&A, we haven't made any deals over the last few years. I would say that up until the last year, the last year was really focused on the Wolfspeed transaction, so that's where our attention was. I think that prior to that we had not found candidates that fit.

We are a year after starting the Wolfspeed project. And assuming we're able to get that closed at the end of the year, as we are targeting, then I think we are continuing to build a pipeline of candidates. I think there are some people out there.

But what I would tell you is, and I made this comment in my prepared remarks earlier, our first priority over the next few quarters is going to be to give the new lighting leadership team some time to deliver improved execution in the core lighting business. I think that's priority one. And as we continue to build a pipeline of some potential targets that could fit in our lighting portfolio.

If there was something to happen, we're looking at something that's the second half of calendar 2017 at the earliest. And, again, that will depend on if we find the right candidates. But I do think that our interest -- the ability of using M&A to complement our lighting strategy is going to increase as we get into next year. But first we want to make sure we give the new team a chance to really get the core business running at a little bit better level and then we will look at adding some pieces to that.

Thanks, Chuck.

(Operator Instructions)

Neal Burk, UBS.

Hey, guys this is Neal on for Steven Chin. Thank you for taking my question. My first question is, during the December quarter what impact does daylight savings have on the seasonality of that quarter?

What I would tell you is daylight savings is actually the start of what is typically on the consumer side known as lighting season. So, you typically see higher consumer lighting sales in that quarter. Now keep in mind, that sales at the retailer.

We actually go through a process of loading in the retailers in our Q1. So, we tend to see more level demand Q1 to Q2 because we've already done part of the loading for what's called lighting season. And that generally drives the consumer bulb side of the business.

I would say that there's less of an effect of daylight savings time on the commercial lighting business, because that's more driven by projects and the construction activity or remodeling activity. It's more of a bulb phenomenon and more consumer-driven.

All right, thank you. One more question -- in the news recently was talk of a potential acquisition of [offbrand]. I'm wondering if you have any view on whether this would be a positive or negative for your lighting business, or your LED chip business, rather?

Neal, we don't comment on any rumors or speculation, so I really can't say anything at this time on that.

Colin Rusch, Oppenheimer.

Thanks so much. As you guys start to see some of this growth with the lighting business, how do you think about incremental operating margins on those increased sales?

Colin, what I would tell you is, step one, I think the operating margins come from gross margin improvement first. As we're able to drive growth in our commercial lighting business, we're going to see some scale benefits in that business, as well as some benefits likely on the supply chain. So, I would say that's where we'll see it first.

But if you look out a little bit beyond those first steps, there is some incremental operating leverage coming. Sales is relatively variable in the commercial lighting business, so it's really going to be more, over time, do we get some leverage on primarily the R&D side of that.

But think about the next year as a gross margin drives operating leverage in the near term, and then longer term I would expect that we can grow revenue faster (inaudible) overall.

And then looking at your pipeline, is there any real movement in terms of the average ticket size that you guys are bidding on? Are we going to see a meaningful increase in the dollar volume per order? Or are you expecting something similar to what we've seen the last few quarters?

Colin, I would say that, obviously if you expand the number of products, I think in some applications there is an opportunity. So, in applications where we are bidding both the Cree products and the Essentia brand, there's an opportunity to get a little bit bigger part of the project.

But, on average, even with 100,000 SKUs we tend to be experts at certain applications within those. So, our primary driver is about getting more share at the agents themselves to make sure that the Cree -- getting them to spend their time on Cree-driven projects versus other things they could be doing.

Thank you. That concludes today's question-and-answer session. I'd like to turn the call back to Mike McDevitt for closing remarks.

Thank you for your time today. We appreciate your interest and support and look forward to reporting our second-quarter results on January 24. Good night.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program and you may all disconnect. Everyone have a great day.