Cree's (CREE) CEO Chuck Swoboda on Q4 2014 Results - Earnings Call Transcript

| About: Cree, Inc. (CREE)

Cree, Inc. (NASDAQ:CREE)

Q4 2014 Results Earnings Conference Call

August 12, 2014, 05:00 PM ET


Raiford Garrabrant - Director, IR

Chuck Swoboda - Chairman & CEO

Mike McDevitt - CFO


Brian Lee – Goldman Sachs

Vishal Shah – Deutsche Bank

Jed Dorsheimer – Canaccord

Edwin Mok – Needham & Company

Harsh Kumar – Stephens

Colin Rusch – Northland Capital

Sven Eenmaa - Stifel, Nicolaus

Krish Sankar – Bank of America Merrill Lynch

Mark Heller – CLSA

Paul Coster – JPMorgan

Hans Mosesmann – Raymond James

Andrew Huang - Sterne, Agee

Mike Ritzenthaler – Piper Jaffray

Avinash Kant - D.A. Davidson


Good day ladies and gentlemen, and welcome to Cree fiscal year 2014 fourth quarter earnings call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference call is being recorded.

I will now turn the call over to your host Raiford Garrabrant, Director of Investor Relations.

Raiford Garrabrant

Thank you, Patrick, and good afternoon. Welcome to Cree's fourth quarter fiscal 2014 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 fourth quarter of fiscal year 2014. Please note that we will be presenting both GAAP and non-GAAP financial results in our remarks during today's call, which are reconciled in our press release and posted in the Investor Relations section of our website at under Quarterly Results on the Financial Information tab.

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

Our press release today and the SEC filings noted in the release mention important factors that could cause actual results to differ materially. Also, we'd like to note that we will be limiting our comments regarding Cree's fourth quarter of fiscal year 2014 to a discussion of the information included in our earnings release.

We will not be able to answer any questions that would involve providing additional financial information about the quarter beyond the comments made in the prepared remarks.

This call is being recorded on behalf of the company. The presentations and the recording of this call are copyrighted property of the company, and no other recording, reproduction or transcription is permitted unless authorized by the company in writing. Consistent with our previous conference calls, we are requesting that only sell-side analysts ask questions during the Q&A session.

Also since we plan to complete the call in the allotted time of one hour, we ask that analyst limit themselves to one question and one follow-up. We recognize that other investors may have additional questions and we welcome you to contact us after the call by email or phone at (919) 287-7895. We are also webcasting our conference call, and a replay will be available on our website through August 26, 2014.

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

Chuck Swoboda

Thank you, Raiford. Fiscal 2014 was another great year as revenue increased 19% to a record $1.65 billion and non-GAAP net income increased 31% to $203 million or $1.65 per diluted share.

All three product segments grew year-over-year led by 43% growth in lighting. The growth in non-GAAP net income was driven by higher revenue and a 26% increase in non-GAAP operating income due to improved operating leverage across the business.

Cash and investments increased $139 million to $1.2 billion for the year, due to increased profitability and solid execution that more than offset $300 million in capital spending and share repurchases.

The combination of our earnings momentum and strong 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.

Fiscal Q4 revenue increased 8% sequentially to a record $436 million with non-GAAP net income of $51 million or $0.42 per diluted share. Revenue and non-GAAP earnings per share were within our target range for the quarter.

The sales trends for Q4 and fiscal 2014 were as follows. Q4 lighting revenue increased 18% sequentially to $208 million and increased 43% for the year to $706 million. Q4 led revenue was flat sequentially at $200 million and increased 4% for the year to $834 million and Q4 Power and RF revenue increased 4% sequentially to $28.6 million and increased 20% for the year to $108 million.

Q4 non-GAAP gross margin increased slightly to 37.9%, which was on the high end of our target range for the quarter. LED and Power and RF margins were in line with our targets while lighting was slightly better due primarily to cost reductions and productivity improvements for LED fixtures.

Q4 non-GAAP operating margin was similar to Q3 at 13.1% and operating expenses were on the upper end of our target range due to higher R&D spending to support increased development activities in both LEDs and lighting.

Company backlog for Q1 is slightly behind this point last quarter, due primarily to lower LED bookings. Lighting and Power and RF are on track for Q1 and despite the current booking trend in LEDs we target overall growth in Q1.

We made great progress in all four of our key objectives for fiscal 2014. We continue to lead with innovation across our product lines and drive closer to cost parity with conventional technology by delivering next generation products that are 30% to 40% lower cost than the previous generation.

We demonstrated technology innovation that set new benchmarks for performance such as the first 200 lumen per watt LED lighting system and the first 300 lumen per watt LED component. We released breakthrough lighting products including the CXB High-Bay, OSQ Parking, LED TA replacement and our SmartCast light fixtures.

The Cree bulb has become the best selling LED bulb in the U.S. and established the Cree brand as the leader in LED consumer lighting. We made good progress with focused effort on targeted applications like automotive dealership lighting and we are building the capability to better serve existing lighting owners across a range of applications with complete solutions to upgrade their lighting.

We delivered good revenue growth in our operating leverage for the year while making significant investments for the future. We are well positioned to continue growing our business in fiscal 2015 as LED adoption increases.

I'll now turn the call over to Mike McDevitt to review our fourth quarter and yearend financial results in more detail as well as our targets for the first quarter of fiscal 2015.

Mike McDevitt

Thank you, Chuck. I'll be providing commentary on our financial statements on both the GAAP and non-GAAP basis, which is consistent with how management measures Cree's results internally.

However non-GAAP results are not in accordance with GAAP and may not be comparable to non-GAAP information provided by other companies. Non-GAAP information should be considered a supplement to and not a substitute for financial statements prepared in accordance with GAAP.

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

For fiscal 2014 revenue increased $262 million or 19% year-over-year to a record $1.65 billion. GAAP earnings increased 43% year-over-year to $124 million and $1.1 per diluted share and non-GAAP earnings increased 31% to $203 million and $1.65 per diluted share for fiscal 2014.

Non-GAAP earnings exclude $79 million of expense net of tax or $0.64 per diluted share from the cost of amortization of acquired intangibles and stock-based compensation. Fiscal 2014 revenue and gross profit for our reportable segments were as follows.

LED products revenue grew 4% to $834 million and gross profit grew 11% to $381 million for a 45.7% gross margin, which was a 270 basis point increase year-over-year. Our fiscal 2014 gross profit and margin growth was due to a combination of higher sales, lower cost new products, cost reductions and higher factory utilization.

Lighting products revenue grew 43% to $706 million and gross profit grew 32% to $197 million or a 27.9% gross margin. We had strong growth in both LED fixtures and LED bulbs. Gross margin was lower year-over-year due primarily to changes in product mix as we had a full year of lower margin LED bulb sales.

Power and RF products revenue grew 20% year-over-year to $108 million and gross profit grew 26% year-over-year to $61 million for a 56.5% gross margin which was a 270 basis point increase year-over-year. The gross profit and margin growth was due to a combination of higher sales, cost reductions and higher factory utilization.

In determining gross profit for our segments we do not allocate certain employee benefit cost, stock-based compensation and acquisition related costs. These non-allocated costs totaled $20 million for fiscal 2014 and are included to reconcile through our $619 million GAAP gross profit.

For the year, while we invested $198 million in capital expenditures and $100 million to repurchase Cree stock, we still increased our cash and investments by $139 million to $1.2 billion. Cash provided by operations was $319 million and free cash flow was $121 million for the year.

For the fourth quarter of fiscal 2014, revenue increased 8% sequentially to a record $436 million, which was within our targeted range of $430 million to $460 million. GAAP earnings increased 6% sequentially to $30 million or $0.24 per diluted share for the fourth quarter of fiscal 2014 and non-GAAP earnings increased 8% sequentially to $51 million or $0.42 per diluted share.

Non-GAAP earnings exclude $21 million of expense net of tax or $0.18 per diluted share from the amortization of acquired intangibles, stock based compensation and the write-off of an acquired trade name. Revenue, pretax income and GAAP and non-GAAP earnings per share were all within our targeted ranges for the quarter.

Q4 GAAP gross margins were 37.2% and non-GAAP gross margins were 37.9% which excludes $3 million of stock-based compensation. These were on the high end of our target ranges as our lighting segment gross margin was slightly better than targeted.

Fiscal 2014 fourth quarter revenue and gross profit for our reportable segments were as follows; LED products revenue was flat to the third quarter at $200 million and gross profit decreased 2% to $90.1 million for a 45.1% gross margin, which was in line with our target for the quarter. Lighting products revenue grew 18% sequentially to $208 million and gross profit grew 25% to $60.6 million for a 29.1% gross margin, which was 170 basis point increase quarter-over-quarter.

We had double-digit revenue growth for both LED, fixtures and LED bulbs. Gross profit and margin growth was due primarily to cost reductions and productivity improvements for LED fixtures.

Power and RF products revenue grew 4% sequentially to $28.6 million and gross profit grew 4% to $16.3 million for a 56.9% gross margin, which was similar to last quarter in line with our target.

In determining gross profit for our segments, we do not allocate certain employee benefit cost, stock-based compensation and acquisition related cost. These non-allocated costs totaled $4.7 million for the fourth quarter of fiscal 2014 and are included to reconcile to our $162 million GAAP gross profit.

Operating expenses for Q4 were $130 million on a GAAP basis and $108 million on a non-GAAP basis, both of which were on the higher end of our targeted range. Non-GAAP operating expenses exclude approximately $12 million of stock-based compensation expense, $7 million of charges for amortization of acquired intangibles and $3 million for a write-off of an acquired trade name.

Our non-GAAP operating income grew 7% sequentially to $57 million and our operating margin was similar to Q3. Net interest income and other for the quarter was $3.9 million. Our Q4 GAAP and non-GAAP tax rate was 16.3% for the quarter which was less than the 21% target for Q4, primarily due to the impact of tax benefit true-ups for the year and the acquired trade name write-off in the quarter.

Day sales outstanding was 46 days as compared to 49 days at the end of March and in line with our 50-day plus or minus target range. Inventory days on hand increased to 94 days as compared to 89 days from the end of March, also in line with our 90-day plus or minus target range. Our inventory growth is primarily due to the factory ramp to support our targeted lighting growth.

For the quarter, cash from operations was $91 million and capital expenditures was $64 million including $5 million related to patents, which resulted in free cash flow of $27 million.

For fiscal 2015 we're targeting property, plant and equipment spending to be similar to fiscal 2014 at $200 million plus or minus to support our new product priorities, provide incremental capacity and add infrastructure to support longer term forecasted growth. The amount we invest will vary based on forecasted revenue demand and the degree to which we expand the use of third party manufactures to support our growth in lighting and LEDs.

Additionally, we entered into $150 million unsecured revolving line of credit facility that our Board of Directors previously authorized the company to secure. As we announced back on May 8, 2014, this facility provides the company short-term flexibility to optimize a net investment return on our cash and investments, while funding working capital, capital expenditures, acquisitions or other general corporate needs.

At this time, we target Q1 revenue to increase to a range of $440 million to $465 million, which is comprised of solid growth in lighting sales, LEDs flat to single digit growth and single digit growth for Power and RF. We target Q1 non-GAAP gross margins to be similar to Q4 at 37.5% plus or minus and GAAP gross margin to be 36.9% plus or minus.

This Q1 target is based on a number of factors that could vary including overall demand, product mix, factory execution and a competitive environment. Our GAAP gross margin targets include stock-based compensation expense of approximately $3 million while our non-GAAP targets do not.

We’re targeting Q1 operating expenses to be similar to Q4 as we start to see some incremental operating leverage from the investments we've been making over the last two years. As a result GAAP and non-GAAP operating profit to grow faster than revenue sequentially. Our GAAP operating expense targets include approximately $14 million of non-GAAP stock-based compensation expense and $6 million for amortization of acquired intangibles.

Loss on disposal of assets is targeted to be similar to Q4. Net interest income and other is targeted to be approximately $3.3 million for Q1. We target our Q1 tax rate to be 21.5%. The Q1 tax rate is higher than Q4 as we target a higher percentage of U.S. earnings for fiscal 2015 due to a higher percentage of lighting sales and lower discreet tax benefit year-over-year.

As a reminder our Q1 and fiscal 2015 tax rates will fluctuate based on our overall earnings, tax jurisdictions in which our income is actually earned, the potential reinstatement of the U.S. R&D tax credit and other tax benefits that may or may not become available to Cree in future periods.

GAAP net income for Q1 is targeted to be between $30 million to $37 million. Based on an estimated $122 million diluted shares outstanding, our GAAP EPS target is between $0.25 to $0.30 per diluted share. Non-GAAP net income is targeted to be between $48 million to $55 million or $0.40 to $0.45 per diluted share. Our non-GAAP EPS target excludes amortization of acquired intangibles and non-cash stock-based compensation expense in the amount of $0.15 per share.

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

Chuck Swoboda

Thanks Mike. We're focused on four priorities to drive our growth in fiscal 2015. Our first priority is to drive innovation to lower upfront customer cost and further improved payback. The LED lighting market has been enabled with tremendous innovation over the last decade with technology improvements and LEDs and LED lighting systems.

We see many applications today where LED lighting offers a clear payback over conventional lighting products, whether it is for new construction or providing retrofits installed in existing buildings.

Part of the challenge is to enable further growth and simply the time it takes to change old habits and build awareness for LED lighting, but we believe we can also accelerate options by continuing to innovate to lower the upfront cost and make the paybacks even more compelling. This means LEDs and LED lighting system designed for specific applications with more lumen per watt and more lumen per dollar at the system level.

The same idea applies to our Power and RF product line when today our technology has tremendous technical benefits, but a higher upfront cost. We need to continue to develop the next generation devices that improve payback and expand the market for these products.

Our second priority is to continue to drive LED lighting growth and build the Cree brand in both the consumer and commercial markets. We are targeting strong growth in both the LED fixture and LED bulb product lines, driven by the new products we've released over the last year and continued innovation in the year ahead.

Consumer purchases of the Cree LED bulb were significantly higher year-over-year, but only slightly higher sequentially due to traditional slower summer lighting sales trend. We continue to innovate and add new bulb products as we prepare for targeted increased consumer demand in the fall lighting season.

We have made tremendous progress creating awareness for the Cree brand with consumers over the last year, and need to continue to drive awareness for Cree and LED lighting in the market. Despite our success, much of our consumer research suggests that one of the challenges for LED bulb adoption is consumer apathy towards the lighting category, which we need to continue to address in our market. We are also focused on extending our consumer brand success for the commercial markets.

Our third priority is to expand our work with third-party manufacturers to enable growth in LEDs and lighting. These partners are a key piece of our growth strategy as they enable Cree's factories to focus on the newest technologies that are not available in the market. As we have said in the past, we see strong growth in LED lighting, and believe this will drive growth in both high power and mid power LED-based lighting applications.

To serve growth in both of these lighting markets, our internal LED chip team is focused on the high performance, high power LED chips that differentiate Cree LEDs in the market. And we are working with LED chip partners on mid power sapphire LED chip. In both cases, we currently utilize Cree's packaging technology to meet our LED performance requirements for the lighting market.

We also have LED lighting manufacturing partners, which are focused on building some of the higher volume products, which gives us the flexibility to utilize our internal factory to support the many new product ramps and shorten the time to market for new technologies.

This approach gets Cree additional financial flexibility to optimize Cree's internal factory utilization and focus capital spending on higher value products. We target expanding production of both our internal factories and manufacturing partners over the next year to better leverage our sales and brand investments to support the targeted growth in our business.

Our fourth priority is to generate incremental operating margin to revenue growth and incremental operating leverage across the business. We made good progress growing revenue and delivering operating leverage in fiscal 2014, and our goal is to do this again in fiscal 2015.

We target revenue growth in all three product segments with LED lighting being the biggest growth driver. We target incremental revenue growth for LED components with our primary focus on high power, high value applications, but also some incremental revenue from lighting applications that are currently served by high-end mid power LEDs.

We plan to continue to invest in R&D and SG&A to support our growth and other strategic initiatives, but not at the expense of operating margin improvement for the year. Revenues targeted to increase faster than OpEx as we start to get incremental benefit from the investments we have made over the last several years.

As I mentioned earlier, Q1 total company backlog is slightly behind this point last quarter, due primarily to lower LED bookings. Lighting and Power and RF bookings are on-track for Q1. Our LED component customers and distributors continue to operate at short lead times, even though the merchant sapphire LED chip market is reporting stronger demand and longer lead times.

We believe the increased demand is primarily driven by mid power LEDs for consumer lighting and lower end indoor commercial, which is aligned with the trends we see in our own lighting business. If this trend continues, it is possible this could benefit high power LED demand and lead times at some point over the next several quarters. But there is likely to be a time lag based on lighting system design cycles.

Factory utilization remains high and execution continues to be a critical factor to supporting the growth in all three product lines. This adds variability to our forecast for the quarter.

Based on our current backlog, forecast and trends in the business we are targeting good Q1 revenue growth in a range of $440 million to $465 million, which is comprised of solid growth in lighting sale driven by strong growth in LED fixtures and LED bulbs in a similar range as Q4, flat to slightly higher LED sales and single-digit growth in Power and RF sales.

We target non-GAAP gross margins to be similar to Q4 at 37.5% plus or minus, even with an increased lighting mix. We also target non-GAAP operating expenses in a similar range as Q4 plus or minus. As a result, we target incremental non-GAAP operating leverage in Q1 and higher operating margin.

Our tax rate is projected to increase to 21.5% due primarily to the targeted increase percentage of U.S. profits. And as a result, we target non-GAAP earnings in a range of $0.40 to $0.45 per diluted share.

Please note that our non-GAAP targets exclude amortization of acquired intangibles, stock based compensation expense and the related tax effects. As a technology company, we remained focused on fundamentally changing the customers lighting experience for the better. To our customers this means better light that pays for itself and makes it easier to switch to LED, which applies to both LEDs and LED lighting systems.

The strength of our operating model gives us the flexibility to make investments to support our goal to grow the business and increase operating margin. Our new product pipeline, brand momentum and strong balance sheet put us in a great position to enable our long-term customer goal of 100% upgrade to LED lighting.

We will now take analysts' questions.

Question-and-Answer Session


(Operator Instructions) Our first question comes from Brian Lee with Goldman Sachs. Your line is open.

Brian Lee - Goldman Sachs

Hi guys, thanks for taking the questions. First one I had was just around the near-term trends. Last quarter you mentioned backlog was actually ahead of the same point versus the prior quarter. And this is the first time as I look at the modelling, two years at your top line has come closer to the low end versus the midpoint in the range.

So just wondering what transpired over the last two months of the quarter that you lost some momentum versus your outlook, and if the weakness was all concentrated in LED products. And then I had a follow-up.

Mike McDevitt

Yeah. So Brian, the weakness is LED driven, at least what we saw last quarter. And as I said, that revenue was relatively flat with the previous quarter at one point. When we gave our targets we would expected there to be some incremental growth in that business. As we said in April, we have very short lead times in that business which adds variability.

The other thing to keep in mind is that at the high utilization rates that our factories are running because we have to keep in mind that our internal lighting demand has been going up. That high utilization limits our ability to react to some of the short lead time business in LED. So I think there is incremental downside in the quarter from that as well.

So I think those major factors is what's driving the business right now. Given our position going forward, I still see good growth overall in LED lighting. I think there's going to be both mid power and high power base growth. And at the end of the day where we have the most values and high power and I think we're well positioned to benefit as that part of the market grows and we still believe that will happen here over the next year.

Brian Lee - Goldman Sachs

Okay. That's helpful. And Chuck, you mentioned the utilization rates may be impacting your ability to service short lead time demand. But if I look at the inventory days, they've been up here for about five straight quarters.

I know some of the drivers; maybe the major driver is in the lighting business. But wouldn't that position you to be able to service some of that short lead time demand given the inventory build. And also, given the build, is there any risk that we should be budgeting for that. This could actually impact your utilization rates in future quarters if you needed to start drawing down. Thanks a lot, guys.

Chuck Swoboda

Yeah. In the near term I would expect our factory to remain highly utilized. In terms of the inventory if you look at where we came in last quarter, it's little over 90 days and our target was 90 days plus or minus. It's primarily lighting driven, so we're having to make decisions of where to focus that capacity.

And so, we've essentially been focusing; essentially have better visibility to our own lighting business. That's where our internal factories focus, so we have the build not only in lighting, but also in LEDs for those lighting customers, which does inherently then while inventories going up it does limit our ability to react to some of the short term demand in the external market. We're trying to get that better balanced right now, but that's just the nature of having a fairly long vertical supply chain within the company.


Our next question comes from Vishal Shah with Deutsche Bank. Your line is open.

Vishal Shah - Deutsche Bank

Yeah, hi. Thanks for taking my question. Just wanted to follow-up on the inventory situation, I mean if you look at where your target will be. I mean if you consider the prior calls, I mean you've made some comments about where your targets will be. Can you update us as to how you should think about inventory levels on a go forward to going forward basis with the new lighting mix?

And also, I mean considering the impact of some of the demand trends in the lighting business, I mean how should we think about the operating expense and operating leverage in 2015? I mean can you assume similar kind of leverage or leverage improves in 2015? Thank you.

Mike McDevitt

Yeah. So, on inventory our target remains 90 days plus or minus. But I think you'll see some variation quarter-to-quarter as we ramp up factory product mix. So there's going to be some variation. But we still believe that's the right target for the business even with an increasing mix of lighting. Obviously, it adds some complexity to what we have to manage internally, but that remains our target.

In terms of OpEx and operating leverage with the growth in lighting, we believe that we are going to be able to grow revenue faster than operating expenses. We have been making significant investments over the last several years. And we think that although we're going to continue to invest, there is an opportunity to start to get some benefit from the investments we have been making. So it's really a ratio of where we think that while we'll assess the rate will be able to flow lover than the revenue growth which gives us operating margin for the year.

Again, likely quarterly variation in our business with some changes, but if I look at the business year-over-year, our target or goal for the year is to actually increase operating leverage and operating margin percentage for the year.


Our next question comes from Jed Dorsheimer from Canaccord. Your line is open.

Jed Dorsheimer - Canaccord

Hi. Thanks for taking my question. I guess, first, Chuck, I think you alluded to this, but I just wanted to confirm and may be ask it different way. The change in LED gross margin, it was down sequentially. I'm wondering is that attributable to a mix between merging versus captive? I know you are talking about sort of your high utilization in your captive limiting some upside there. More specific I guess is gross margin ticked down a direct function of that.

Chuck Swoboda

No, Jed. Actually the LED margins came in very much about what we were planning for the quarter, and it's really a product mix related within the LED business that's not internal chip versus external chip. Mike, I don't know if there's any other color you have to add to that.

Mike McDevitt

No, that's best color there.

Chuck Swoboda

So it's not a -- this is not a function of the use of sapphire or not at this point.

Jed Dorsheimer - Canaccord

Okay. And then, as my follow-up, two parts to it. I know this is your year end, so would you be kind enough to provide Home Depot as a percentage of sales, or do we have to wait for the K. And then my second part, Home Depot on the bulb impose the cost down, are you agreed to the cost down in the March timeframe? And I think that with a headwind last quarter. I'm just curious if you had achieved that running change and how that -- how much did that affect the margin increase in the lighting products business?

Chuck Swoboda

Yeah. Jed, I think the way -- we have to wait until the KP to see what the percentages of the 10% customers are that will obviously be in the case. As far as Home Depot goes, it is a -- that price change which was implemented in the spring time. By the way, we were very willing participant in that because we agree it's one of the ways to drive the market.

But with that price change you saw the impact, a bit of a negative impact in our Q3. And one of the reasons you see lighting margins getting better in Q4 is we have time to implement some of the cost reductions that we were anticipating.

Although I would tell you that most of the margin benefit in the quarter was lighting fixture driven. We did get the benefit of the timing of having time to work through the cost reductions that were planned on the bulb side.


Our next question comes from Edwin Mok with Needham & Company. Your line is open.

Edwin Mok - Needham & Company

Hi. Thanks for taking my questions. First question I just wanted to dive into the lighting revenue for the quarter and of your guidance. I think on our comment you mentioned that bulb may be growing less that fixture on the June quarter. Can you confirm that? And on your guidance I think you said you expect solid growth and that's in the similar trend for both fixture and light bulb where you expect light bulb growth necessary in the September quarter?

Mike McDevitt

Yeah. And let me see if I can help you out there. The -- what we broke out is, we don't give the specific numbers, but what we said is that we had sequential growth in fixtures and bulbs in our fourth quarter. And for our Q1 targets, we are targeting bulbs to be relatively flat with Q4, and most of the growth to be -- the growth in lighting to be coming from the fixture side of the business.

Edwin Mok - Needham & Company

I see, okay. Thanks for clarifying. That's very helpful. And then, Chuck, going back to the margin discussion there as well, right. We started to see, if I come back on your commentary on the light bulb, it sounds like your fixture margin has been expanding over the last few quarters. So is that mostly just come from stable price cost improvement, and do you expect that trend to continue? I think firstly you guys have talked about fixture can potentially be in a mid-30 gross margin. Is that the target that we should be shooting for in the next few quarters? Any kind of color you can provide on that.

Chuck Swoboda

Yeah. So I think it's accurate to say the fixture business margins have been improving over the last few quarters. I would say it's a combination of things. As we release new products, I think we get the benefit of new products that are designed inherently to be lower cost. I think we have a lot of cost reduction activities and a lot of productivity work within our factories to try to -- to gain incremental cost leverage on our whole portfolio of products. And I think that's what's the biggest driver of it.

As far as going forward, we don't break out a specific target, but what I would say for the year, one our goals would be is to continue to increase fixture margins year-over-year. So our goal is to continue to do things to improve those margins. I think we don't want to break it out into specific quarterly targets, but on an annual basis that would be right goal.


Our next question comes from Harsh Kumar with Stephens. Your line is open.

Harsh Kumar - Stephens

Yeah. Hi guys. Just had a couple of quick questions. First of all, on the LED business, Chuck, it was up 4% year-over-year, and also it looks like it's flattish in September, also June. Those have been traditionally sort of up quarters in that business. I'm curious if you could shed some light on. Maybe you're using more of your internal capacity and limiting the outside sale, or is there something else going on?

Chuck Swoboda

Yeah, Harsh, what I would say is, is that there's some incremental business that when it's a short lead time market and utilization is high, we're not getting. But I don't believe that as the major driver. I think what we're seeing in our LED business is we're primarily in the high power segment. And if you actually look at the commentary from other LED companies that are talking about high power, what we've actually seen recently that the positive growth signal we saw was merchant LED chip manufacturers who make sapphire started to report higher utilization.

From what we see in our lighting business and what we've read from other people, this is primarily being driven by consumer in low-end commercial markets. I believe that that is a near-term trend. I think that over time we will see growth both in high power and mid power. And frankly, our focus is on the high power side because that's where we add the value. What we want to do is better time on LED is that really help make a difference on the customer, and frankly that's also reflect in the profitability of that business for us.

Harsh Kumar - Stephens

Thanks for the color, Chuck. And as my follow-on, your OpEx was sort of you said sort of flattish in September, will -- is that the level Mike or Chuck that we should think about for the rest of the year, or just maybe some color on how we should think about OpEx for the rest of the year.

Chuck Swoboda

Yeah. So, think about as we will continue to invest, so there will be some growth throughout the year, but the goal for the year is to have revenue growth faster than OpEx, so we should be able to deliver for the year incremental operating margin improvement. And if you think about it Harsh, this is similar to what we did last year. So what we accomplished in fiscal 2014 we have a goal to try to drive operating leverage again in 2015.


Our next question comes from Colin Rusch with Northland Capital. Your line is open.

Colin Rusch - Northland Capital

Thanks so much. Can you guys talk a little bit about your lighting fixture road map, areas that you're targeting as we look out over the next 12 to 24 months?

Mike McDevitt

Yeah. So Colin, we don't breakout specific products that we're working on, but what you shouldn't assume is that we complete in several market segments. We have a fairly important outdoor lighting business that is both a street municipal lighting business. We have, I would call, a kind of an outdoor canopy parking garage business. And then in the indoor we have kind of these area lights as well as the down light business.

If you look at those major fixture areas, we will continue to innovate next generation products in those areas. So those are areas we want to continue to focus on. In the last year we added the industrial segment, so we came out with a high rate fixtures. So we will look for incremental market opportunities, but I would say most of our effort is next generation or products to better serve the markets we're already in.

And then the third piece to keep in mind is that within the lighting segment we have the bulb, so we have things like DTA replacement lamp that's just came out that really allows us to keep it in the indoor space, but much more from a retrofit standpoint and then the consumables are also something we can bring into the commercial market.

So it's really where the bulbs are focused and those five kind of major areas just how we think about the lighting market has potential to go after another segment, but we wouldn’t want to put that out there until the time we're ready to announce that.

Colin Rusch - Northland Capital

Okay. And can you just give us a sense of the TA payback periods that you are seeing out there right now?

Chuck Swoboda

Yes, it's widely a function of where they are located and what they are replacing. So it's a function of electricity rates. So here in North Carolina, it's going to be relatively long and I think if you go to places where you have a T-12 system that's up there today or you have a higher electricity rates, we're seeing people in the two to three year range I have seen numbers on. So it's fairly rapid payback for a product that comes with a 10-year warranty.


Our next question comes from Sven Eenmaa with Stifel. Your line is open.

Sven Eenmaa - Stifel, Nicolaus

Thanks for taking my question. First of all in terms of the growth metrics in the current quarter, what does the growth in any indoor versus outdoor applications?

Mike McDevitt

We don't break out the growth in indoor versus outdoor, but I can tell you both segments grew in the quarter, but I don't have the specifics for you.

Sven Eenmaa - Stifel, Nicolaus

Got it. And the second question I had is in terms of cross margin dynamics from June quarter to September quarter, is that kind of purely mix driven or is there -- do you expect sequentially lower margin in one of these segments?

Mike McDevitt

No, really what we are talking about is we are just looking at the fact that lighting will increase as a percentage of the total. That's really the driver in those targets.


Our next question comes from Krish Sankar with Bank of America Merrill Lynch. Your line is open.

Krish Sankar – Bank of America Merrill Lynch

Yes, hi, thanks for taking my question. Chuck my first is a longer term question, you guys have done a great job on the high power LED business, so look at longer term and if there is more of the opportunity in indoor, is the industry converging towards medium power and if so, do you think it makes sense for you guys to have a footprint in that longer term and then I also had a follow-up?

Chuck Swoboda

So I don't think the industry is converging. I think there are applications involving on both sides and I think I recognize that when the quarterly numbers move around, people get -- they vary between -- we are really excited about high power and then we are excited about mid power.

While I understand that the reality is both applications I believe will grow over time. We've relatively low adoption levels in all market segments and I would expect we are going to see not only outdoor, but what I would call focused and directional lighting, which is very high power centric and then you are going to see the indoor/area lighting, which is going to be more mid power centric, although they will clearly be crossovers in both segments and I would expect both to grow over time.

We believe that we can address -- we add value in the high power. So that's why we want to focus there and frankly when there is growth in mid power, that's part of the reason for the increased emphasis on our partner strategy, which is we can access the appropriate shifts in the market to service that as we need to and I would rather spend people assets and financial assets investing in parts of the business where we add the most value and buy what we can for the rest of the market.

Krish Sankar – Bank of America Merrill Lynch

Got it. That's very helpful and just as a follow-up either for you or Mike, how much of your cash is on share and do you have any updated thoughts on M&A either in terms of it doesn’t make sense to look more vertical, horizontal. Any of that would be helpful. Thank you very much.

Chuck Swoboda

Yes, so on the cash, most of our cash is onshore. We have -- it's accessible to us and then from a strategic opportunity we evaluate opportunities, but nothing specific to talk about at this time.

Mike McDevitt

Yes, the way to think about what we would think strategically is we have a list of priorities for the company and if we would look at something ideally would somehow be focused on one of those priorities that we've already laid out for you.


(Operator instructions) Our next question comes from Mark Heller with CLSA. Your line is open.

Mark Heller – CLSA

Thanks for taking my question. Chuck, just sort of high level question, for the past I guess three fiscal years the company has grown around 18%, 19% per year topline, I am just wondering do you think there is an opportunity to grow the company faster than that? Are there any roadblocks to keeping the company and now that we are getting to the inflection point for LED lightings, should the company grow faster than what we've seen?

Chuck Swoboda

You know Mark, obviously over Cree's history, we've seen years where we have grown faster than that. It doesn’t ever extend the work out to be quite as smooth as it works, but yes, I think there is opportunities at the same time in many cases we are talking about scaling up a manufacturing business which is people centric, where is there is inherent time constant to that.

I do think as we are able to build up our capabilities in terms of working with partners that will give us some flexibility to enable our growth. I think it's both a financial and manage to be able to put our assets on where we have the most value, but I also think it gives us some flexibility in terms of supporting growth by leveraging the activities of the partner.

So I think in the mid to longer term, there is opportunities, in the near term, it's really -- there is a lot of a piece by piece approach to the growth right now.

Mark Heller – CLSA

Okay. And then back on the M&A theme, but we've seen some consolidation within the component sector recently. I am just wondering what your view is on the merits of maybe acquiring another LED component company.

Chuck Swoboda

So from Cree's standpoint, we are a bit uniquely positioned. Obviously we always have a big focus on being vertically integrated kind of being a market leader driving innovation and I think that's worked out real well and most recent example, the LED bulb, the Cree bulb that's kind of changed that market here in North America and really gained momentum for the whole industry.

With that being said, I think we also see and as I laid out in my earlier comments, the opportunity to work with partners to access technologies that are frankly are available in the marketplace and so we don't comment on specific ideas. If we were going to do something, it would be more focused I think on our key priorities, but at this point, no specific insight to offer you other than kind of general view of the world.


Our next question comes from Paul Coster with JPMorgan. Your line is open.

Paul Coster – JPMorgan

Yes. Thank you. I think we all agree that we are an inflection point and would be expecting this market to perhaps even accelerate, but you sound like you are just a little bit more cautious and I can't quite figure out if it's to do the mid power LED guys have done a better job of ramping up supply and getting into your space or whether it relates back to your prior comment earlier on in the presentation around doing a better job of reaching and combing the message, can you sort of talk to us a little bit about all of those factors and am I right in assuming that things have slowed a little bit relative to your expectations?

Chuck Swoboda

I think I wanted to talk about the LED segment specifically I think one of the things you have to unwrap is that what is happening in the mid power space in terms of the growth without profit and what I would say if you look at the segment over the last couple of years, a lot of capital was invested, there wasn’t a lot of customers and so those companies were willing to sell it extremely low margin and in many cases at a loss.

So it changed -- it created an artificial price value dynamic on the mid power side, which I think we did a good job of actually getting some applications moving there.

I think high power actually is being going first and it actually stands and it's done a little bit better in terms of for the applications, we're trying to make money selling -- inventing and selling LEDs as well as helping our customers and so I think we had a slightly different dynamic there that's a function of markets like -- semi markets like open supply and demand.

I think if you look out over a longer period of time, there is merits in some applications to use high power, there is merits to use mid power and if you neutralize it to what the short-term supply and demand/pricing dynamics are, I think we really will see both grow and from a Cree's standpoint it would be great if high power would grow faster, but I think we're still positioned in the best place to get a return on the investments we're making in terms of inventing products and getting paid for in the marketplace and so I like where we are at. It's just not giving some of the short-term growth that I think a lot of people had expected in LEDs, but our strategy is enabling I think what continues to be a very successful lighting strategy.

I think we sometimes lose sight of the fact that this LED has enabled one of the more successful LED lighting businesses out there and it helped us create a market and drive a lot of growth here over the last few years.

Paul Coster – JPMorgan

Okay. You expect the markets to come around to you in the high power space in the next several quarters, I think you said what is it that you would be watching -- what's the proprietary lead indicators that you have that will allow -- give you the confidence so that it's finally there?

Chuck Swoboda

Yes, it's not only come around. I think they are expected both to grow. So if I look at activity the number of customers doing designs and overall market adoption rates, I would expect the applications that are primarily high power based to grow over the next year and I would expect the applications that are mid power. So I would think demand for both of those would grow.

On a quarter-by-quarter basis, it's a little hard to predict that, but I would think we will see both of that in the year ahead.


Our last question comes from Hans Mosesmann with Raymond James. Your line is open.

Hans Mosesmann – Raymond James

Thanks. Hey Chuck, a couple of questions, can you give us a sense on the retail dynamic besides Home Depot, are you getting some news guys lined up and I have a follow-up?

Chuck Swoboda

Yes, our main focus is still with the Home Depot. What we found is that in the work we've done and others with Home Depot, they’ve really established a very successful LED lighting business and so it remains where the majority of our focus.

We have looked at some complementary things. We recently did bring on a small online partner that will access some different customers, but in terms of scale hunt, Home Depot, their volume and their capability is just at a different level than what we're seeing in some of the complementary channels.

So while we're going to develop them, the numbers are going to be driven by what we do there for now.

Hans Mosesmann – Raymond James

Okay. Thanks. And then for modeling purposes, and how you guys look at the world going forward, what the growth rate of the lighting industry from your perspective?

Chuck Swoboda

Hans, I don't have a great number for you right now because the lighting industry itself is not growing. It's LED in at least not significantly, it's LED lighting that's really growing, conventional lighting shrinking and the net result is some incremental growth and as far as LED lighting goes, I don't have a good industry number because it's really a function of application.

So what's happening in outdoor street versus canopy, those segments move differently than what we see for example in indoor troughs and even there, there is different dynamics whether you are in a retrofit business, long of a low end new construction or kind of high end architectural.

So I don't have a one good number for you. What I would say is they are moving at different rates in the grand scheme of things. What we see overall is good growth pretty much across the segments, but in terms of timing quarter-to-quarter, it's very hard to predict right now because a lot of it is project based.

Hans Mosesmann – Raymond James

Thank you.


Our next question comes from Andrew Huang with Sterne, Agee. Your line is open.

Andrew Huang - Sterne, Agee

Thanks. So when I look at my model, LED components have been up sequential for the June quarter, I think every year since 2007, so normally you should see a sequential improvement, so maybe you could give us some additional color on what happened here? Is it share loss? Is it ASP pressure or is it market shift to mid power?

Chuck Swoboda

What I would say right now Andrew is it's more of a market dynamic. I think the high power business is relatively flat. I think you probably see that same dynamic is some of the other companies that have reported in this segment recently.

So I think that high power -- we haven’t seen the same kind of growth there recently, but again I think that is a timing dynamic. I do think that we have seen mid power have success in the consumer in the low end commercial markets, but frankly that's not surprising given that those markets are the ones that those companies focused on with extremely aggressive pricing.

I think it works itself out over a longer period of time, but there are definitely short term dynamics that work here. So the business relatively flat with last quarter. I still like our position because the goal here is not just to sell LEDs, it's to actually sell LEDs and make some money and I think what we've proven is that focusing on your products and value is kind of a key long-term strategy.

Andrew Huang - Sterne, Agee

Okay. And then here is my follow-up, I guess this is the first quarter in your history that lighting is bigger than components, so that may be a mixed blessing, should we assume that overall gross margin pressure for the overall company is going to get worse going forward or do you have enough cost on opportunities and letting to offset that?

Chuck Swoboda

Yes Andrew I don't have a longer term gross -- company gross margin target for you. I think lighting growing is actually -- there is no mix blessing, that's the great thing. As we stated out in this thing seven eight years ago, trying to create an LED lighting business and what we've done is -- we've done and it's quite successful I think we have to continue to do things to reduce cost in those products to hopefully add incremental cost leverage as that mix goes up.

I think if you look at what we did over the last year, we've been relatively successful, there is clearly going to be quarterly variation, but I think that at least year-on-year we can do things to make some incremental progress in lighting margins and how that mix works out is going to be a little bit of function of demand and I just don't have a good enough crystal ball right now to tell you how that mix shapes out.

At the end of the day thought, our core goal is revenue growth in these market segments with operating margin growth or operating profit growth that's at a faster rate and I think if we do that, we are going to be successful at creating overall value for the business.


The next question comes from Mike Ritzenthaler with Piper Jaffray. Your line is open.

Mike Ritzenthaler – Piper Jaffray

Yes, thanks. Just one question for me that hadn’t already been asked on the cost reduction side of things, it sounds like there is some positive impact of what you’ve been able to accomplish so far and my question is if you have a sense at this point of how much of that might be eaten up in the marketplace by erosion, price erosion versus what's a little bit more sustainable?

Chuck Swoboda

Yes I think that there is a blend in the answer there. So we are always coming out with products that are fundamentally lower cost. What we have primarily done until now in LED lighting is we generally pass most of that roll over cost to our customers in terms of lower price.

Our strategy going forward is as LED lighting becomes much closer to -- conventional technology because more competitive is to make incremental progress in terms of gaining some incremental profit leverage there, but still doing things to open the market.

I think one of the challenges we have is, is that LED lighting is still pretty early stages and that we want to continue to be aggressive in terms of driving market adoption. I think we're still in relatively low percentage adoption rate and we still need to get the market to really make this crossover.

It is great that the business is growing, but the fact is the majority of lighting today is still not LED, the vast majority and so I think we still have some work to do, but we don't want to slow down the adoption rate while we have this momentum.


Our next question comes from Avinash Kant with D.A. Davidson and Company. Your line is open.

Avinash Kant - D.A. Davidson

Good afternoon, just two questions actually. Could you talk a little bit about your utilization of six-inch wafers where are you -- are you 100% six-inch by now?

Chuck Swoboda

So 150 millimeter is increasing every quarter. We will be about as close to 100% as we're going to try to get to in the short term by the end of the fiscal year. So there is still some incremental conversions going on. What I would tell you we'll keep some percentage of older products we won't bother to convert. There won't be a payback on that.

The primary cost leverage actually in the LED side now is not just conversion, but so much of it is new products and innovations and the cost of actually -- the process cost that is where we think the bigger leverage here is over the next year or two.

Avinash Kant - D.A. Davidson

Do you mean end of fiscal year '15 right.

Chuck Swoboda

Yes, ending of fiscal '15 will be mostly converted to 150 with a small percentage left on some of the older products just because we're not trying to cover them. I would not overestimate that -- that is only one of many cost drivers in the business right now, I think is important to know.

Avinash Kant - D.A. Davidson

And could you give us a depreciation amortization number for the quarter?

Chuck Swoboda

Mike might have that. I don't have that in front of me.

Mike McDevitt

I don't have it off the top of my head, so we'll get back to you on it.


Ladies and gentlemen, this ends the Q&A session for today. I will turn it back to Mike McDevitt for closing remarks.

Mike McDevitt

Thank you for your time today. We appreciate your interest and support and look forward to reporting our first quarter results on October 21. Good night.

Chuck Swoboda

Good night. Thank you.


Ladies and gentlemen, thanks for participating in today’s program. This concludes the program, you may all disconnect.

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