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Cree (NASDAQ:CREE)

Q3 2013 Earnings Call

April 23, 2013 5:00 pm ET

Executives

Raiford Garrabrant - Director of Investor Relations

Charles M. Swoboda - Chairman of the Board, Chief Executive Officer and President

Michael E. McDevitt - Chief Financial Officer and Executive Vice President

Analysts

Paul Coster - JP Morgan Chase & Co, Research Division

Brian K. Lee - Goldman Sachs Group Inc., Research Division

Andrew Huang - Sterne Agee & Leach Inc., Research Division

Vishal Shah - Deutsche Bank AG, Research Division

Satya Kumar - Crédit Suisse AG, Research Division

Jonathan Dorsheimer - Canaccord Genuity, Research Division

Jagadish K. Iyer - Piper Jaffray Companies, Research Division

Stephen Chin - UBS Investment Bank, Research Division

Edwin Mok - Needham & Company, LLC, Research Division

Colin W. Rusch - Northland Capital Markets, Research Division

Benjamin Schuman - Pacific Crest Securities, Inc., Research Division

Mehdi Hosseini - Susquehanna Financial Group, LLLP, Research Division

Operator

Good afternoon. My name is Saeed, and I'll be your conference facilitator today. At this time, I would like to welcome everyone to the Cree, Incorporated Fiscal Year 2013 Third Quarter Financial Results Conference Call. [Operator Instructions] As a reminder, ladies and gentlemen, this conference call is being recorded today, April 23, 2013. Thank you. And I would now like to introduce Raiford Garrabrant, Director of Investor Relations of Cree, Incorporated. Mr. Garrabrant, you may begin your conference at this time.

Raiford Garrabrant

Thank you, Saeed, and good afternoon. Welcome to Cree's Third Quarter Fiscal 2013 Earnings Conference Call. By now, you should have all received a copy of the press release. If you did not receive a copy, please call our office at (919) 287-7895, and we will be pleased to assist you.

Today, Chuck Swoboda, our Chairman and CEO; and Mike McDevitt, our CFO, will report on our results for the third quarter for fiscal year 2013. Please note that we will be presenting both GAAP and non-GAAP financial results in our remarks during today's call, which are reconciled in our press release and financial metrics posted in the Investor Relations section of our website at www.cree.com under Quarterly Results in the Financial Information tab.

Today's presentations include forward-looking statements about our business outlook, and we may make other forward-looking statements during the call. These may include comments concerning trends in revenue, gross margin and earnings, plans for new products and other forward-looking statements indicated by words like anticipate, expect, target and estimate. Such forward-looking statements are subject to numerous risks and uncertainties.

Our press release today and the SEC filings noted in the release mention important factors that could cause actual results to differ materially. Also, we'd like to note that we will be limiting our comments regarding Cree's third quarter fiscal year 2013 to a discussion of the information included in our earnings release and the metrics posted on our website. We will not be able to answer any questions that would involve providing additional financial information about the quarter beyond the comments made in the prepared remarks.

This call is being recorded on behalf of the company. The presentation 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 1 hour, we ask that analysts limit themselves to 1 question and 1 follow-up. We recognize that other investors may have additional questions, and we welcome you to contact us after the call by email or phone at (919) 287-7895. We're also webcasting our conference call. A replay will be available on our website through May 7, 2013.

I would like to turn the call over to Chuck.

Charles M. Swoboda

Thank you, Raiford. Fiscal Q3 was a great quarter as revenue increased to a record $349 million of non-GAAP net income of $41 million or $0.34 per diluted share. Revenue and non-GAAP earnings per share were on the high end of our revised target range, primarily due to strong sales of lighting products and our ability to continue to reduce the cost per lumen at the LED chip, package and systems levels. Our results continue to demonstrate the benefits of being vertically integrated from LED chips through lighting systems, which has enabled us to drive LED lighting adoption, with industry-changing product innovation of delivering strong financial results.

The revenue trends in Q3 were as follows: Lighting sales increased almost $8 million or 6% from Q2, as strong sales of commercial indoor fixtures and the Cree LED bulb more than offset seasonally lower outdoor lighting sales; LED sales decreased $5 million or 3% from Q2 ,which was in line with our forecast for the quarter; Power and RF sales were similar to Q2 ,which was in line with our target for the quarter.

Non-GAAP gross margin was 38.8% in Q4 which was within our target range for the quarter. We target company gross margin to improve in Q4 led by improvements across product lines due to cost reductions, increased volume and lower cost of new product designs. Overall, inventory levels increased slightly in Q3 to 82 days, to support the increase in the lighting business and the LED bulb product ramp. Overall, we continue to manage our factories to respond to short lead time expectations across our product lines.

Cash and investments increased to $937 million due to solid execution and focused capital spending. Free cash flow was $15 million in Q3 and our balance sheet continues to give us the ability to invest in growing our business and the flexibility to respond to new opportunities in the market. Overall company backlog for Q4 is ahead of this point last quarter. We are currently targeting strong growth in LED light driven by both our commercial fixture and consumer bulb product lines. The LED product line is also targeted to grow due to increased customer demand.

We are benefiting from the global growth in LED lighting adoption in our position as a market leader in both LEDs and LED lighting. We remain focused on using new product innovation to drive our growth by taking share from traditional technologies. The Cree LED bulb is the latest example of what is possible in terms of opening new markets to LED lighting, and creating opportunities for Cree to both increase revenue and build our brand.

I'll now turn the call over to Mike McDevitt to review our third quarter financial results in more detail, as well as our targets for the fourth quarter of fiscal 2013.

Michael E. McDevitt

Thank you, Chuck. I will be providing commentary on our financial statements on both a GAAP and non-GAAP basis, which is consistent with how management measures Cree's results internally. However, non-GAAP results are not in accordance with GAAP and may not be comparable to non-GAAP information provided by other companies. Non-GAAP information should be considered a supplement to and not a substitute for financial statements prepared in accordance with GAAP. A reconciliation of the non-GAAP information to the corresponding GAAP measures for all quarters mentioned on this call is posted on our website, along with the historical summary of other key metrics.

For the third quarter of fiscal 2013, revenue increased 1% sequentially to a record $349 million, which was at the high end of our revised targeted range of $335 million to $350 million. GAAP earnings increased to $22.2 million or $0.19 per diluted share for the third quarter of fiscal 2013. And non-GAAP earnings increased to $40.8 million or $0.34 per diluted share. Non-GAAP earnings exclude $18.6 million of expense, net of tax or $0.15 per diluted share from the amortization of acquired intangibles and stock-based compensation. Non-GAAP and GAAP earnings per share were on the high end of our revised targeted ranges of $0.31 to $0.36 for non-GAAP, and $0.16 to $0.21 for GAAP.

Q3 gross margins decreased 40 basis points sequentially to 38.1%, non-GAAP gross margins, which exclude $2.3 million of stock-based compensation, decreased 40% or 40-basis points sequentially to 38.8%, which was within our non-GAAP revised targeted range of 39.5% plus or minus.

Our LED products segment gross margin improved sequentially as we had high, higher LED volumes driven by LED bulbs. Our Lighting segment gross margin decreased sequentially due to the start-up costs related to our LED bulb launch.

Our fiscal 2013 third quarter revenue and gross profit for our reportable segments were as follows: LED products revenue was $195.6 million, with gross profit of $85.7 million for a 43.8% gross margin; lighting products revenue was $130.7 million, with gross profit of $40 million or a 30.6% gross margin; Power and RF products revenue was $22.7 million, with a gross profit of $12 million for a 53% gross margin.

In determining gross profit for our segments, we do not allocate certain employee benefit costs, stock-based compensation and acquisition-related cost. These non-allocated costs totaled $4.7 million for the third quarter of fiscal 2013, and are included to reconcile to our $133 million GAAP gross profit.

We ended the quarter with $937 million in cash and investments, a $51 million increase sequentially.

For the quarter, cash provided by operations was $46 million and capital expenditures were $31 million, including $6 million related to patents, which resulted in free cash flow of $15 million.

Our operating expenses for Q3 were $109.8 million on a GAAP basis and $90.5 million on a non-GAAP basis, which were in line with the revised targets. Non-GAAP operating expenses excluded approximately $11.6 million of stock-based compensation expense and $7 million of charges for amortization of acquired intangibles. Net interest income and other for the quarter were $2.5 million.

Our Q3 effective tax rate was 14% for the quarter with a cumulative benefit from the retroactive extension of the U.S. R&D tax credit and our revised target that a greater portion of our fiscal 2013 earnings will be in lower tax jurisdictions. Accounts receivable increased $37 million to $82 million and days sales outstanding increased to 47 days as compared to 38 days at the end of December. The days sales outstanding increase was a result of greater shipments occurring later in the quarter due to the business seasonality resulting from Chinese New Year in the outdoor lighting, plus the timing of our new product launches.

Inventory increased by $11 million to $196 million to support new product introductions, and days on hand increased 82 days as compared to 78 days at the end of December. Those days sales outstanding and days of inventory on hand were within our targeted ranges.

Property, plant and equipment additions were $25 million for the third quarter. For fiscal 2013, we're continuing to actively manage our capital spending. We're targeting fiscal 2013 property, plant and equipment spending of $90 million plus or minus, to support our strategic priorities to lead the market, drive adoption of LED lighting, accelerate cost reductions and support incremental capacity as needed.

At this time, we target Q4 revenue to be in the range of $365 million to $385 million, which is comprised of double-digit lighting revenue growth, driven by both commercial fixtures in LED bulbs, single-digit growth in LED revenue and Power and RF revenue up slightly. We target Q4 GAAP gross margins to improve to 39% plus or minus, and non-GAAP gross margins to improve to 39.5% plus or minus. We target gross margin improvement resulting from increased volumes, cost reductions and lower-cost new products. This target is based on a number of factors that could vary, including overall demand, product mix, cost reduction programs, factory execution and the competitive environment.

Our GAAP gross margin targets include stock-based compensation expense of approximately $2.3 million, but our non-GAAP targets do not. We are targeting Q4 non-GAAP operating expense to increase $5 million sequentially to support the LED bulb media campaign and sales of marketing expenses related to higher revenues. Our GAAP operating expenses targeted to increase to $4 million sequentially includes noncash stock-based compensation expense of approximately $10.5 million and charges for amortization of acquired intangibles in the amount of $7.7 million. Our non-GAAP operating expense growth is lower than non-GAAP due timing of noncash stock-based compensation expense.

Loss on disposal of assets is targeted to be similar to Q3. We target non-GAAP operating income to increase $8 million or 17% sequentially plus or minus, and GAAP operating income to increase $9 million or 37% sequentially, plus or minus, as we target generating operating leverage even with a significant near-term investment in marketing. Net interest income and other is targeted to be approximately $2.3 million for Q4.

We currently target our tax rate to be 20% for Q4 and 21% for the full fiscal 2013 year, plus or minus. GAAP net income for Q4 is targeted to be between $25 million to $31 million. Based on an estimated 119.6 million diluted shares outstanding, our GAAP EPS target is between $0.20 to $0.26 per diluted share. Non-GAAP net income is targeted to be between $41 million to $47 million or $0.34 to $0.40 per diluted share. Our non-GAAP EPS target excludes amortization of acquired intangibles and noncash stock-based compensation in the amount of the $0.14 per share.

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

Charles M. Swoboda

Thanks, Mike. We remain focused on our 4 priorities for fiscal 2013. Our first priority is to accelerate adoption of LED lighting and increase sales of our indoor and outdoor lighting products. The lighting product line grew 6% sequentially in Q3 due to the strong sales of commercial indoor fixtures and the Cree LED bulb. The sales growth offset seasonally slow outdoor fixture sales in the cold weather regions. The Cree LED bulb was the biggest new product announcement for Cree and the lighting industry in the last few quarters and probably, the last several years.

This product opens a new market for Cree to help us drive adoption and build brand. It gives Cree the opportunity to engage the consumer directly with an LED bulb that looks like a traditional lightbulb, works like a traditional lightbulb, only better, and is priced to give people a reason to switch to LED. This product follows our strategy of applying our innovation focus to large segments of the traditional lighting market that have been slow to adopt LEDs. In this case, we are partnering with the Home Depot and using the Cree brand to engage the consumer in a way that we believe will accelerate LED lighting adoption in the home.

While the commercial market is the biggest opportunity for LED lighting in the long run, there are currently more than 5 billion bulbs in people's homes across the United States, which could benefit from an upgrade to LED. We believe this product will also motivate the rest of the lighting industry to accelerate their efforts to bring new, cost-effective, high-performing LED-based products to the market. As part of the product launch, we plan to make a significant marketing investment in Q4, as we launch a national media campaign to promote the Cree brand and this new product. We believe this investment will drive sales of the LED bulb and further position Cree as the leader in LED lighting. Going forward, marketing spending is targeted to be incrementally lower in fiscal Q1 and more in line with our revenue goals.

In keeping with in our plan to accelerate adoption of LED lighting systems, we made good progress releasing several new fixture products. We released a performance upgrade to our LEDway series, LED Streetlights, which includes versions with up to 20% additional energy savings and versions with up to 15% higher output.

We announced the new high-efficiency CR Series LED troffer with an industry-leading 130 lumens per watt, and raised the efficiency of our standard CR troffers to 100 lumens per watt. We released the new AR Series architectural LED troffer, which builds on the success of our CR Series with new aesthetic options, while still delivering industry-leading light quality and energy savings. We also extended our KR Series of LED downlights with higher lumen options and a new 4-inch version. These new products continue to set new standards for LED lighting performance, while also improving the payback versus traditional lighting technology.

Our second priority is to drive growth in our LED component product line through innovation by leveraging the SC³ LED technology into a range of customer lighting products. This is the same technology being used in our own LED bulbs. The SC³ platform continue to demonstrate that LED innovation is a competitive advantage and an important differentiator in lighting system design. We recently released the XLamp XQ family of LEDs based on our SC³ technology platform, which are 57% smaller than our XB series of Power LEDs.

This new LED family uses a completely new package design that enables higher-density designs, novel optics and lower cost per lumen. We expanded our CXA series of LED arrays with a new higher-output versions from 5,000 lumens to over 10,000 lumens. We also set a new R&D record for LED efficacy with a prototype LED that delivers 276 lumens per watt. While today, this is an R&D result, our track record suggests that we should be able to bring this type of innovation to production LEDs over the next few years.

As LED lighting adoption increases, the industry is evolving into a range of customers who approach the lighting system design challenges in different ways. Our growing LED product offering reflects this evolution. We have high-power XLamp components for customers who value performance and want to control every aspect of their system design. We have CXA arrays for customers who want to utilize a more integrated product and simplify their supply chains. And we have customers that prefer to focus their engineering on the design and mechanical aspects of the fixture and use fully integrated lighting modules. This growing range of customer approaches is also expanding the opportunities to add more value to their designs.

Our third priority is to leverage our technology lead in Power and RF to open a new generation of applications for these products. In Q3, we released our second-generation silicon carbide MOSFETs, enabling systems to have both efficiency and a smaller size at cost parity with silicon-based solutions. These new MOSFETs deliver industry-leading power density and switching efficiency at half the cost per amp of our previous generation devices. We continue to work on new applications with our customers. But the design cycles typically take 18 to 24 months before we see production orders. In the near term, we target incremental growth in this business, driven primarily by increased demand for our gallium nitride RF devices in wireless infrastructure applications.

Our fourth priority is our ongoing effort to translate our product innovation into revenue and profit growth. We made solid progress over the last year, despite a very competitive market environment. Our goal is to continue to leverage our new products to drive revenue growth in LED lighting, LED components and Power and RF, and deliver incremental margin improvement across product lines through factory cost leverage, process improvements and lower-cost, new product designs. Our new LED bulb is a good example of this strategy. It is driving cost leverage in LEDs and is targeted to drive incremental profits for the company as the volume increases. We see a tremendous opportunity for further innovation to expand our product offering, reduce costs and increase profits.

As I explained earlier, Q4 total company backlog is ahead of this point last quarter. The LED and lighting sales forecast are trending higher in Q4, driven by strong growth in lighting and LEDs. The growth over the last few quarters has increased our factory volumes and execution has become a more critical factor to supporting the higher targeted demand. At the same time, the customer still expects short lead times, which adds variability to our forecast for the quarter. Based on our current backlog, forecast and trends in the business, we are targeting Q4 revenue to grow to a range of $365 million to $385 million, which is comprised of double-digit growth in lighting sales driven by commercial fixtures and LED bulbs, single-digit growth in LED sales and slightly higher Power and RF sales.

We target non-GAAP gross margins to incrementally improve to 39.5%, plus or minus. This builds on the momentum from the last several quarters as we target incremental improvement across product lines, led by gains in factory efficiency due to higher volumes, factory cost reductions and lower-cost new products. We target non-GAAP operating expenses to increase approximately $5 million in Q4, primarily to support the media campaign for the Cree bulb launch, seasonal trade shows and sales expenses related to the growth in the business. As a result, we target non-GAAP earnings in Q4 of $0.34 to $0.40 per diluted share. Please note that our non-GAAP targets exclude amortization of intangibles, stock-based compensation expense and the related tax effects.

The Cree LED bulb is off to a great start and has generated tremendous excitement. While the bulb itself represents a small piece of our financial results, strategically, it is an important element of driving LED adoption and building the Cree brand to drive sales for the rest of the company. We remain focused on driving adoption through innovation. Our new products have opened new applications, improved payback and fueled growth in LED lighting. We started the LED lighting revolution and now our focus shifts to driving mass adoption and our long-term customer goal of 100% upgrade to LED lighting.

We will now take analyst questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Paul Coster from JPMorgan.

Paul Coster - JP Morgan Chase & Co, Research Division

A couple of quick questions on the product strategy. Can you talk a little bit about the likelihood of you achieving a sub-$10, 60-watt equivalent bulb in the consumer segment this year? And on the commercial and industrial side, do you see any sort of products that are really going to capitalize a new tranche of growth in that segment? I'm thinking particularly of the troffers.

Charles M. Swoboda

Yes. So I would tell you, Paul, that there is lots of innovation left in the LED consumer bulb category. I'm not going to preannounce what we may do later in the year, but I can assure you that we're at the beginning, not the end, of what I think is possible. With that being said, we're going to respond to what's happening in the market and adjust accordingly to make sure we drive, really drive adoption at the consumer level. On the C&I side, boy, there is a series of products that we just came out with, 2 new troffer products, I think both of those start to open up some different applications for us, as well as really expand our ability to penetrate the current ones. I think we've got continued work coming on the outdoor side. So I think you'll see us continue to make progress on some new streetlights and other outdoor products. but don't think it's any one product. I mean, if you just look at what we did in Q3, the indoor product line grew pretty nicely, enough to offset the slowness in the outdoor business. So I feel like we've got good momentum and it's really just building on that and frankly, continuing to get in front of more customers. There's no doubt that the payback for LED lighting is getting better each quarter as we increase performance and lower costs.

Paul Coster - JP Morgan Chase & Co, Research Division

And follow-up question. Can you talk a little bit about capacity utilization now that you've launched the consumer product and what that means in terms of incremental investment?

Charles M. Swoboda

Yes. So as we exited, so earlier in Q3, we started kind of where we finished Q2. But as we got to the end of Q3, with the increased demand post-Chinese New Year for both the indoor -- our internal products, as well as the external products, we have been -- really done a good job of filling up our LED factory. So the utilization levels are much higher. You can see in our targets for Q4, we are looking at some incremental CapEx. To put that in perspective, the net for the year is still less than the previous year. So I still think it's a relatively modest level. As far as what it does going forward, I think it's going to be a function of what type of revenue growth we see and where it's at. So more LED-centric growth is going to probably require more capital than more LED systems or fixtures side of growth. And I think it's going to kind of depend on where that comes. We do have a number of levers. Obviously we can continue to do things, I think, to increase efficiency of our existing factory. And frankly, as we go to more 150, which will start to happen more, we increase in Q3 and it will happen more in Q4, there are some other things we can do at least over to the foreseeable future to hopefully reduce the capital intensity at least in the near term.

Operator

Our next question comes from Brian Lee from Goldman Sachs.

Brian K. Lee - Goldman Sachs Group Inc., Research Division

I had 2. First, Chuck, can you talk a bit more in detail about sell-through that you're seeing on the LED consumer bulbs, or at least the feedback you're getting from Home Depot? And then give us a sense for the proportionate impact to the top line in Q4 when you'll have had the product in the market for a full quarter versus Q3?

Charles M. Swoboda

Yes, so sell-through for the bulb, I would say that as of right now, it's actually doing slightly better than what we had targeted. So I think we are pretty optimistic and what we've seen is that it's at least that good and probably a little bit better. And so I think we're off to a good start. Most of that sell-through we've seen so far is a function of really what we did in the launch and really the PR activities and some of the initial Home Depot. We're obviously now into a much more broad-based media campaign. So I think we would expect that for our media activity to be successful, we should continue to see progress there over the rest of the quarter. As far as how it fits into the strategy, so -- or into the revenue profile, if you look at Q4, there's really 3 growth drivers. There is the Lighting segment which has 2 pieces: Commercial fixtures should grow, so that's one; the bulb is the other part of that. I think they're both important for the revenue growth, as well as we're targeting good growth in the LED product line. So it's really all 3 of those that are driving the growth. And maybe a different way to think about the bulb is, it is financially only a piece of this right? It's really a relatively small piece of the total revenue of the company and even in the lighting segment. But it gives us a much bigger strategic impact in what it can do to raise awareness for LED lighting generally, but more importantly, for Cree and the Cree brand. And I think what we would hope to see is that not only does these marketing activities help drive the bulb product line, but really translate across the lighting fixture business and even into the LED business.

Brian K. Lee - Goldman Sachs Group Inc., Research Division

Great. Then I had a follow-up for Mike on the OpEx. Just wondering how much of the increase that you're guiding in 4Q is the aforementioned media campaign and how much might be due to fiscal year and timing. Because if I recall in the past, you had bonuses and other top [ph] that can impact the fourth quarter. And also, I guess, you mentioned, Chuck, the Q1 OpEx should be down post the media campaign. Is that going to fall back to the just-reported Q3 levels?

Michael E. McDevitt

Yes, so let me take half of that and let Mike take half of that. In terms of -- I think you asked specifically about the media campaign. So there's 3 things really driving it and I'll let Mike break those out here in a second in terms of the Q4. But in terms of -- there's a fairly significant investment that's happening right now for the bulb launch and surrounding that. What I'm talking to is, as we get into Q1, we will continue to have some marketing activities related to that product. But they should be incrementally lower than what we're going to see this quarter. I don't think they'll be incrementally as low as they were in Q3, but it should be lower than with the level we see in Q4 when we get through this initial large push related to the launch. And Mike, if you want to handle the more broad question.

Michael E. McDevitt

Yes. And the broad, on the overall piece of it, the majority of that is related to the media push around the bulb launch. As you saw, we got -- we had some television ads that started over the weekend, we've had some online advertising on various things. We also have the -- in Q4, we have the trade shows, light fairs happening right now. And then since we're also guiding up in revenue, there's just a sales expense -- the incremental sales expenses in supporting that sales growth that are driving the OpEx.

Charles M. Swoboda

But not really anything end-of-year specifically.

Operator

Our next question comes from Andrew Huang from Sterne Agee.

Andrew Huang - Sterne Agee & Leach Inc., Research Division

So my first question is on LED component margins. It seems like you've make pretty good progress so far. Can you give us a feel for some of the levers you have going forward to help offset pricing pressure?

Charles M. Swoboda

Yes, Andrew. So we got obviously in the last quarter, we made nice progress on the LED side of that. So you see the benefit of continued factory cost reductions, the benefit of higher volumes. So we did things -- obviously, the overall business grew, but more importantly, we also had the benefit of the bulb volumes, right? So we're getting a benefit there and it shows up in the LED margins, as well as just the benefit of more of the new lower cost products being a larger percentage of the mix. So those will be 3 main drivers last quarter and probably, we'll continue to be as we head into Q4.

Andrew Huang - Sterne Agee & Leach Inc., Research Division

Okay, great. And then my follow-on question is on lighting subsidies by utilities. So I know that the Philips 60-watt equivalent gets a rebate of $10 per bulb in some regions. So my question is, when do you think you could get ENERGY STAR approval for your bulb, and is there any reason why you wouldn't get a $10 rebate for your bulb as well?

Charles M. Swoboda

So I would say that I think we will see, well, first of all, ENERGY STAR is ongoing, it should be completed sometime over the next quarter. I don't have the exact timing in front of me. However, we've already seen our first utility rebate for the product even without ENERGY STAR, and I would expect we'll get some additional rebate this quarter prior to ever getting that. The fact is, is that our bulb saves more energy than anything that's out there that's ENERGY STAR rated today. So if your utility is looking to save money, it's a pretty obvious choice in our mind. As far as the size of rebates, Andrew, I think that's going to vary. I honestly think the days of $10 rebates are going to go away because you don't need them to drive consumer adoption anymore. It's nice to have one, but that's only because someone was trying to sell an LED bulb for $30. At this point, at $10 for an LED bulb, then I think we will see some incremental contribution. But at the end of the day, the whole point of this product was -- we'd love to have rebates to help to drive demand, but with that being said, it's designed to be successful with the consumer even if there aren't rebates available. And that's the key point of this, is we want to be able to drive the market independent of that and then hopefully, the rebates would help on top of it.

Operator

Our next question comes from Vishal Shah from Deutsche Bank.

Vishal Shah - Deutsche Bank AG, Research Division

I wanted to just get a better sense of your gross margin drivers. You said you're going to have more 6-inch wafers in Q4. Is it fair to say that a bulk of the transition would be complete by the end of fiscal 2013, and then what do you think about the overall pricing environment as you sort of think about the competitive response from some of the other large incumbents in the consumer bulb market?

Charles M. Swoboda

Yes, so let me see if I get the first one there, and if I don't get the second part, you can remind me where I missed it. So In terms of cost drivers, 150-millimeter is a part of it, but it was up in Q3 about what we would have targeted, and it should incrementally go up in Q4. But we still have multiple quarters to go for that conversion. That's not a 1- or 2-quarter project. So I would expect that to continue to help us here over the next, at least, 4 or 5 quarters, potentially longer than that. The cost, what we're doing to reduce cost -- it's really more of what we've been doing for the last 2 years. So it comes down to there are things we can do to take cost out of our factory, there are things we can do to improve efficiencies within the factory. That would kind of be the first one. Second, with increased volume comes scale benefits, not just within our factories, but in terms of our supply chain in other areas. And then last, but certainly not least, is that we're able to do from an innovation standpoint, whether it is to design products that frankly have less processes that are fundamentally cheaper to make or just new lower cost designs that have lower building [ph] material or whatever the aspects are. So it's really all those things coming together, and it's bigger than just the LED factory, it really goes across our product lines and we're really trying to work all those levers, and then that's pretty much what it's been over the last year. I think on your second one, you asked me a bit about competitive response, but do you want to clarify what that question was a little bit?

Vishal Shah - Deutsche Bank AG, Research Division

Yes. I mean, it's a 2-part question. One is the competitive response to your consumer bulb and also just when we can expect the margin, the negative impact of that product margin to sort of go away and when can you see those margins sort of be more in line with profit margins?

Charles M. Swoboda

Yes. So if you look at what we're targeting for Q4, you can see from where we finished Q3, obviously, we have the startup costs in there. As you get to Q4, we're targeting growth in lighting fixtures, LED bulbs and LEDs, and the net result is our target is 39.5% plus or minus. So that's pretty good improvement and it's really driven by incremental progress in each of the major segments. So I think we can see progress starting here and that should continue to drive the business. If you look at how that works out, I mean, I think if you take the midpoint of our targets, it's something around a 7-point increase in revenue and even with that marketing investment that we're talking about, I think it's a 17% increase in op income or something along those lines. So I think we're getting good leverage on the model right now. As far as competitive response to the bulb, we have seen a couple of the name brand suppliers come out with announcements of their own. They tend to be directionally similar to what we're doing, although I would think say, I've yet to see an actual product that the performance level or actually in the price levels out there that's truly competing at this point. I think we've gotten their attention, that was part of the idea. We really want to move the industry. And so I think they are moving, I think it's going to be good for driving LED lighting adoption, but I think given what we've seen so far, I would say it demonstrates probably that we're a bit ahead on this curve on this one as well.

Operator

And our next question comes from Satya Kumar from Credit Suisse.

Satya Kumar - Crédit Suisse AG, Research Division

Chuck, I wanted to get back to the gross margin on the system business in the March quarter. System revenues were up sequentially, but gross margin dollars were actually down. And there's been a lot of, I guess, controversy on the gross margins on the bulb business, which I know was up in March. Is that a negative margin business or how should we think about the reason why dollars of gross margin was less in March when the revenues were up?

Charles M. Swoboda

Look, we obviously don't break out product-specific margins. But if you look at it, as we've said, we had -- the gross margins, you have to look at 2 pieces to see that. So within the LED segment, we actually made nice progress. Some of that is the activities within LEDs, part of that is the benefit from the higher volume for the LED bulb. On the lighting side, we actually made incremental progress, but as you can see, quarter-to-quarter those margins did decline, and really that's just a function of the startup cost. So as we look beyond what happened in Q3 and really get into a more high volume environment running in Q4, you can see that while increasing revenue in all those categories, we think we can make incremental progress on all the margins and the net result is -- gets you back to that target range of the 39.5 plus or minus. So we feel pretty good that we're on the right track to really have all the products contributing to driving not only the top line but also being -- adding to the bottom line as well.

Satya Kumar - Crédit Suisse AG, Research Division

I can see that in the June margin guidance, so that's helpful. And then on the system guidance, LED system guidance for June, you mentioned that you're seeing improvement in the bulb business with C&I, but you didn't mention outdoor and you didn't mention that outdoor was seasonally down in March, I was wondering why it's not recovering in June? Is that a timing situation or are there some problematic buying that are changing your competition, I was wondering if you could give some color on the outdoor business.

Charles M. Swoboda

Yes, that might be, maybe a bit of a misconception based on what I said. So in the March quarter, outdoor was seasonally down. It's very much in line with what we had targeted. In the June quarter, we're targeting the fixture business, the commercial fixture business to grow, and I use the word commercial, probably more -- I meant that in a more general sense, both our indoor and outdoor fixture businesses are targeted to grow in the June quarter. We're actually seeing good demand and good opportunities in both indoor and outdoor. So when I talk about growth in lighting fixtures, I really mean both the indoor and outdoor. And I did say commercial earlier, I meant it more in the broad sense of the nonconsumer lighting business. And so I probably made a -- maybe confused you a little bit on that one. So think about June as strong growth in both indoor and outdoor, commercial/municipal industrial lighting fixture products plus the LED bulb. Hopefully, that will clarify.

Operator

And our next question comes from Jed Dorsheimer from Canaccord.

Jonathan Dorsheimer - Canaccord Genuity, Research Division

Chuck, I guess, first question, just looks like on the component side of the business, you're getting some pretty nice margin expansion. I mean, congratulations on this SC³; it looks like it's that's really paying off. Where are you in terms of penetration versus the old -- versus the products that you're replacing? And then I have a follow-up.

Charles M. Swoboda

Jed, I don't have the exact percentage, but I bet you we're getting -- probably getting close to almost half the businesses on the SC³platform. I don't have the exact breakout for you, probably not quite there yet but it's definitely increased quarter-over-quarter. And then obviously, is a cost lever. One of the things I want to clarify is, and as we look of the new products, so the new product I talked about in my comments earlier is that is -- while it is based on that platform, it's actually a fundamentally different package design. So I think what we're going to get there is maybe not a completely new platform, but really a fundamentally lower cost product family. So I think we're starting to have another lever that will start to affect the business probably not here in the June quarter because it's brand new, but I think we can see other opportunities to create some cost per lumen leverage going forward.

Jonathan Dorsheimer - Canaccord Genuity, Research Division

Is that the package that we saw being used in the bulb? And then just as my follow-up, you mentioned that you're receiving a rebate. Congratulations certainly before the ENERGY STAR 2. Are you able to capture any service fee as part of that rebate? And then lastly, what's the capacity of the bulb business?

Charles M. Swoboda

All right. So let me see if I got all this. So in terms of the product question, what's in the bulb is an SC³-based product, but the next generation LED is not in the bulb at this time. So you can imagine that will happen at some point here in the not too distant future, but that product is not yet in there. In terms of rebates, there is -- we're not collecting any service fee on that. So that's really just a pass-through activity. And as far as capacity is, we're not breaking that out specifically. We obviously are in a ramp-up mode, so we ramped-up pretty fast, getting it going last quarter. I would imagine we'll continue to expand that capacity this quarter to meet the anticipated demand and then we'll adjust going forward.

Operator

Our next question comes from Jagadish Iyer from Piper Jaffray.

Jagadish K. Iyer - Piper Jaffray Companies, Research Division

Chuck, 2 questions. If you look at the 12 months ahead, how much headroom do you have in terms of the gross margins for the $10 bulbs? Directionally, any color will be great. And as a second part of the question, are you really concerned about the new -- and I mean, are you really concerned about the major brands starting to come out with their equal end to the $10 price points? What is the value proposition here against these competitors? And then I have a follow-on.

Charles M. Swoboda

Sure. So gross margin headroom, what I can tell you is that's going to be a bit of a function of what happens in the market in the price of the product. So what I can tell you is we think there are plenty of innovation opportunities to not only increase the performance of the LED bulb, but also to reduce the cost. And it's really no different than what we see when we look at our fixture products. We think we can do the same thing across both our indoor and outdoor fixtures. And we're trying to do the same thing in LEDs as well. So I think, we think there's enough cost leverage from the innovation standpoint. What the market price does is a little bit hard to call. So it's hard to give your prediction on that side of it. In terms of the major brands, we've seen some announcements, but keep in mind that there's a difference between a press release about a product that's coming in the future and actually making one, and there really isn't anyone else in the market with a product that competes with ours today. So at this point, there isn't anything else that looks like a bulb, works like one, and with the performance levels and has these price points. I have announced that they're going to do something similar and so I think we're going to have to see. In the grand scheme of things, it's a good thing, because as long as people were promoting LED bulbs for $20 or $30, this category wasn't going to move. And you can already see the momentum shifting. And at the end of the day, what this means is the traditional lighting companies stop promoting that old technology and get more serious about LEDs. I think it's good for the industry, I think it's good for Cree. And the nice part about Cree is we participate as an LED company and as a lighting systems company. So if it can move the market, that's the goal.

Jagadish K. Iyer - Piper Jaffray Companies, Research Division

I just have a quick follow up. What other geographies will have the appetite for a similar type of deal that you had with Home Depot? Is it going to be a similar type of deal or is it going to be something different that you've learned from Home Depot? Can you give some color on that?

Charles M. Swoboda

Yes, it's a little hard to speculate at this point. I think the U.S. market, obviously, that's where we're focused today, and that's really where all of our energy is getting this product launched, ramped up and responding to the many inquiries that we're dealing with there. As far as international, I think there is clearly markets for LED bulbs in other regions. Whether or not Cree will get involved with those directly or not at this time, like I said, we're focused on North America. I know that OSRAM announced a product for the European market, it was EUR 10 instead of $10, but where exactly that goes and how ready those markets are, at this point, I don't think I can answer that with enough data to really have a strong opinion one way or another. I think the point is, this LED bulb, if you use it in a normal mode, costs about $1 a year in energy versus $7 for a traditional lightbulb. If you use it in a high use application, you're looking at $2 versus $14. At those numbers, the thing pays for itself in a year. So I think anyone who has energy costs at the U.S. level or higher, you can make a pretty good argument that the math works today. Whether they'll do it or there's some other factor, I can't -- I just don't have enough information to speculate.

Operator

And our next question comes from Stephen Chin from UBS.

Stephen Chin - UBS Investment Bank, Research Division

Chuck, the question on the channel inventory, last quarter you had talked about channel inventory being quite lean. I'm just wondering if you could give us your assessment of channel inventory and lead times compared to last quarter?

Charles M. Swoboda

Yes, I'm assuming you're referring primarily to the LED product line?

Stephen Chin - UBS Investment Bank, Research Division

That's correct.

Charles M. Swoboda

Yes, I would say that the channel inventories are very similar in dollars to where they were at the end of last quarter. And lead times are also very similar. As demand, if demand continues to increase, I think at some point, we'll see lead times start to move. But in the short term, at least the customer is still expecting them to be short. So we'll have to see how that plays out.

Stephen Chin - UBS Investment Bank, Research Division

Great. And then a follow-up. A question on the new replacement bulb product, Chuck. Is there a seasonality associated with this new product line? And then second part, can you talk about this new platform, can you compare and contrast that with SC3? Is that as big as SC3 or is it like halfway through in terms of getting to a new platform as comprehensive as SC3?

Charles M. Swoboda

Yes. So the new bulb -- seasonality, too early to tell. Honestly, most people would tell you that the prime bulb season is actually the fall and the winter, not going into the spring and the summer season. So the demand we're seeing right now is probably working against normal seasonal trend. So that's actually a really positive statement. But honestly, it's a new product that's opening a new category that no one's been in before. So I didn't think we're yet at the seasonal -- seasonality phase. I think over time, as the business gets larger, there's clearly could be a dynamic. But the question is, how does that dynamic play versus the rate at which we can drive adoption? I think I said in my prepared remarks, there's over 5 billion traditional bulbs whether those be incandescents or CFLs in people's homes in North America today and we think each one of those is a good opportunity to upgrade to LED lighting. So clearly a tremendous opportunity sitting out there and we'll have to see what the seasonality is. The new platform, the way to think about the new platform is this, it is based on the same technology in SC³ in many respects, but it's a fundamentally new package design and so that gives us some significant cost leverage that kind takes SC³ to the next level. So I would say, it's not SC³, but it's certainly is a significant next step in the evolution of our LED product line.

Operator

And our next question comes from Edwin Mok from Needham & Company.

Edwin Mok - Needham & Company, LLC, Research Division

So my question on the lightbulb is, Chuck, you're making this marketing campaign, which is pushing the lightbulb and you basically have one distribution channel which is Home Depot. Any risk that Home Depot buy a whole bunch of inventory in this quarter and then your sell-through is not as strong as you guys have planned, that you may have a softness beyond this quarter?

Charles M. Swoboda

Look, in retail, and we've they've selling to Home Depot for the last few years now, not only do you want to sell to them but you got to make sure that they're generating demand with their customers. And so obviously, that's got to happen. Right now, what we can see from the actual sales is that's going as good or better than we had planned. And with the marketing activities that we're launching, as well as some of the stuff that Home Depot is doing, we're relatively optimistic. With that being said, it's a fair question. I mean, if for some reason, sell-through wouldn't be strong at some point, you would see demand slow to them. But it's in our -- our idea at this point is, is that if we've opened up the market as we have hoped to and only time will tell, that we think we can grow it -- grow these product line, as well as really hopefully energize the category.

Edwin Mok - Needham & Company, LLC, Research Division

Great. That's very helpful. And then a question on the LED component. Last quarter, you talked about pricing still pretty competitive and you still see industry being over supplied. Do you see any change from that?

Charles M. Swoboda

It still is competitive. So I'd say generally, no. I think the only question is, is that as I look at -- at some point, we will drive enough LED lighting adoption in these other applications that the fact that no one's been buying capacity for a couple of years should catch up with us. Do I think we're there yet? Obviously, from Cree's standpoint, we're doing many things to get more capacity out of our existing factory. But I think you would assume at some point there's enough demand that will start to drive that. But at least in the short term, it remains competitive and lead times are short and we're just going to have to watch it.

Operator

Our next question comes from Colin Rusch from Northland Capital.

Colin W. Rusch - Northland Capital Markets, Research Division

Can you talk a little bit about the visibility on cost reduction you have for the bulbs on a percentage basis and how should we think about cadence of those cost outs?

Charles M. Swoboda

We don't break it out in terms of specific actions. What I can tell you is what we're doing on the bulb is the same as we're doing on fixtures and everywhere else. So our levers are how do we make our existing factory more efficient, right? Second is getting some of the scale benefits both within the factory but also from the supply chain. And the third piece is to continue to innovate. This is our first consumer bulb design. We think there is plenty of opportunities to drive innovation, innovations that both increase performance, add new features but also ones that take cost out. And it's really a combination of those things that whether it be the bulb or our fixtures or other products that we're pursuing across the board to try to reduce cost.

Colin W. Rusch - Northland Capital Markets, Research Division

Great. And then on the luminaire design cycles, I guess the checks [ph] that we've been doing have design cycles as short as 6 months for some of the luminaire designers. When do you run into a problem with the chip development versus that luminaire design in terms of overlap and trying to match up those cycles? And do you see this XLamp really starting to potentially take off in early 2014 or could it be sooner than that?

Charles M. Swoboda

So the whole design cycle between luminaires and LEDs has been a challenge from the beginning. It's one of the reasons that we made significant investments in the luminaire side of the business, first indoor and then with Ruud. Because what we found is, is that the LEDs typically came out and despite the best efforts, there's a fairly significant lag in most luminaire products to get them in there. Now there are consumer products that move faster, and there are some lower spec products that move faster, but generally speaking, I would say that what we see in the market is luminaire design. Unless it's consumer markets, generally takes significantly more than 6 months. And so, frankly, we've benefited from the fact that we're generally running in parallel on those and hopefully, bringing those innovations to market faster, but it's an ongoing effort. The fact is, is that LEDs have changed so quickly that they changed the design rules on luminaires. What I see generally in the market today is most companies don't take full advantage of what's available in LEDs because by the time they get their product qualified and released, the LED has already changed. But it's not worth going back at least for some period of time. I think your other question was more about LED related, but frankly, I forgot what it was at this point.

Colin W. Rusch - Northland Capital Markets, Research Division

It's just on the uptake for the XLamp packaging.

Charles M. Swoboda

Yes, so look, we're targeting incremental growth this quarter, what will be over -- as we go forward, the challenge we've been facing is, is that with SC³, we got a significant cost leverage. So the units have gone up much faster in the last year than the top line. And while that's been good for margins, we haven't been able to grow the LED top line as fast. This quarter we're targeting some incremental revenue growth. What happens beyond that, I think, it's a little hard to say. Obviously, as LED lighting adoption picks up, there should be higher demand. At the same time, we continue to do things to reduce the cost per lumen. And so it's the right thing to do because it's important from a competitive standpoint and it's important from enabling the industry standpoint. But it tends to limit some of the upside. How that plays out over the next year? I think it's just too early to call other than if we keep making the LEDs more cost effective and we keep increasing the performance. I think it's likely that we'll see the market expand in terms of the amount of amount of LED lighting adoption.

Operator

Our next question comes from Ben Schuman from Pacific Crest Securities.

Benjamin Schuman - Pacific Crest Securities, Inc., Research Division

I guess, Chuck, we haven't heard too much about the China streetlamp market recently. Is that still a material driver of the component business? And if so, can you comment on kind of demand and competitive trends there?

Charles M. Swoboda

Yes, I would say in China that the streetlamp business is moving. It's not the boom or bust business it was a couple of years ago. I would say that in our current targets, we target incremental growth across the components business, Asia, China, specifically, as well as North America and in Europe. Streetlamp is one of those components, but it's not a component that's significantly bigger or more important than frankly all the other applications. Two years ago, it was kind of the first one to move. Now frankly, the indoor market is bigger than the outdoor market. And so while for Cree, it's an important segment, it's just one piece of a much bigger portfolio of applications we're working on.

Benjamin Schuman - Pacific Crest Securities, Inc., Research Division

Okay. Great. And then are you seeing any other disruptive players emerging in the lighting space as we move to LED, maybe as you walk the floor there at Lightfair, guys that weren't incumbents in the traditional lighting space? Or is it still the traditional lighting fixture folks that you're going up against in that space?

Charles M. Swoboda

I think -- so when Cree -- keep in mind, when Cree is talking about fixtures, it's really a North American-centric strategy, right? So there are lots of companies outside of North America, both incumbents and new players that are doing innovative things, and it's happening every day. We see that in our LED business. In North America specific, where we also have our fixture business and our systems business, I would say that for most big lighting projects, we tend to -- our products tend to be competing with products that come from the more traditional established brands. There are times when there's a newer player involved, but I would say the vast majority are the larger traditional players that are competing for those projects. It doesn't mean there isn't some innovation coming, I think the challenge is, and we learned this ourselves, that it takes a while to get scale as a new player. And so I think there will be other players that emerge. I just think it takes a while to build scale and so you don't see them as much at least in the near term. As far as any new news or a new players at the show, honestly, I spent my day getting ready for earnings release, so I'll be at the show tomorrow and I'll have a much better answer to your question after that.

Operator

Our next question comes from Mehdi Hosseini from SIG.

Mehdi Hosseini - Susquehanna Financial Group, LLLP, Research Division

Chuck, how should we think about the mix of your LED manufacturing capacity that is used to support your lighting business segment?

Charles M. Swoboda

I don't have a specific breakout. Clearly, the majority is still for external customers by a significant margin. But it did increase last quarter. Obviously, with the growth at our own fixture business and the growth and the additional of the bulb, it's a larger percentage, but still the significant majority of that business is for external customers.

Mehdi Hosseini - Susquehanna Financial Group, LLLP, Research Division

Got it. And then as a follow-up, you have done a great job accumulating a ton of cash, that has gone above $8 per share, at the same time, add to the U.S. more stuff that big players are going vertically integrated or they're changing their strategy to go vertically integrated. Is there opportunity for you to deploy some of this cash as you rethink your strategy for outside of North American market?

Charles M. Swoboda

I think we're going to evaluate that. Honestly, if I look at where we're at today, we are working very hard to take advantage of all the organic opportunities we have in front of us right now, whether that be growing the LED business with the growth in the market or probably the thing that most people are noticing is just the growth in our North American lighting systems business, whether it be fixtures for indoor or outdoor or the bulb. And so, we'll look at that, but in the near term, really our focus is on the organic growth that's in front of us. And frankly, I think it's the best use of our energy and focus. We've shown year-over-year some pretty significant, not only revenue growth numbers, but profit growth numbers, and so I think we want to continue to do that. With that being said, I'm sure there will opportunities that will emerge over time. But we're pretty picky when it comes to that because frankly, when you're essentially almost exclusively focused on LED lighting, it allows you to approach the market in a different way than if we were looking at the many companies that have all the traditional assets that they have to deal with. And so I think that's an advantage to let us keep moving fast at this time.

Operator

This concludes our question-and-answer session. I would like to hand the conference back over to Mr. Mike McDevitt for any closing remarks.

Michael E. McDevitt

Thank you for your time today. We appreciate your interest and support, and look forward to reporting our fourth quarter results on August 13. Good night.

Charles M. Swoboda

Good night and thank you.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes our program. You may all disconnect and have a wonderful day.

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