Cree's (CREE) CEO Chuck Swoboda on Q2 2016 Results - Earnings Call Transcript

| About: Cree, Inc. (CREE)

Cree, Inc. (NASDAQ:CREE)

Q2 2016 Earnings Conference Call

January 19, 2016 5:00 p.m. ET

Executives

Raiford Garrabrant - Director of IR

Chuck Swoboda - Chairman and CEO

Mike McDevitt - CFO

Analysts

Paul Coster - JPMorgan

Brian Lee - Goldman Sachs

Vishal Shah - Deutsche Bank

Jed Dorsheimer - Canaccord Genuity

Harsh Kumar - Stephens, Inc.

Edwin Mok - Needham & Co.

Tom Sepenzis - Northland Securities

Krish Sankar - Bank of America Merrill Lynch

Colin Rusch - Oppenheimer & Co.

Mike Ritzenthaler - Piper Jaffray

Sven Eenma - Stifel Nicolaus

Operator

Good day, ladies and gentlemen, and welcome to the Cree, Inc.'s Second Quarter Fiscal Year 2016 Conference Call and Webcast.

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

Raiford Garrabrant

Thank you, Abigail. Good afternoon. Welcome to Cree's second quarter fiscal 2016 conference call.

Today, Chuck Swoboda, our Chairman and CEO, and Mike McDevitt, our CFO, will report on our results for the second quarter of fiscal year 2016.

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.

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 second quarter of fiscal year 2016 to a discussion of the information included in our press release. We will not be able to answer any questions that would involve providing additional financial information about the quarter beyond the comments made in the prepared remarks.

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

Also, since we plan to complete the call in the allotted time of one hour, we ask that analysts limit themselves to one question and one follow-up. If you have additional questions, please contact us after the call by email or phone at 919-287-7895. We're also webcasting our conference call and a replay will be available on our website through February 2nd.

Now I would like to turn the call over to Chuck.

Chuck Swoboda

Thank you, Raiford.

Fiscal Q2 revenue increased 2% sequentially to $436 million, which was in the middle of our target range for the quarter, led by growth in commercial lighting and a solid quarter for our LED business, which offset lower power and RF revenue. Q2 non-GAAP gross margin was in line with our target at 31.7%, led by gains in lighting, as our strategy to better balance lighting revenue and profit growth has started to deliver results. The LED business continued to execute well and delivered slightly better margins than the core business if you exclude the one-time license benefits from Q1. Operating expenses were lower than targeted, and our tax rate was also lower due to the reinstatement of the R&D tax credit. This result in Q2 non-GAAP net income increasing 38% sequentially to $30 million or $0.30 per diluted share, which was above our targeted range for the quarter.

Company backlog for Q2 is behind this point last quarter, which is in line with normal seasonal trends and our targets for the quarter. Our commercial lighting business continues to grow and delivered good margin improvement in Q2. The LED business has stabilized. We completed the factory consolidation and successfully made the transition to higher-channel turns. Our Wolfspeed division was able to work through some near-term softness in RF while still delivering strong margins. Overall we delivered a solid first half of fiscal 2016 and we're well-positioned for a strong second half.

I will now turn the call over to Mike McDevitt to review our second quarter financial results in more detail, as well as our targets for the third quarter of fiscal 2016.

Mike 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 measures for all quarters mentioned on this call is posted on our website along with a historical summary of other key metrics.

For the second quarter of fiscal 2016, revenue increased 2% sequentially to $436 million, which was in the middle of our targeted range of $425 million to $445 million. GAAP earnings increased 159% sequentially to $14 million or $0.14 per diluted share for the second quarter of fiscal 2016, and non-GAAP earnings increased 38% sequentially to $30.5 million or $0.30 per diluted share. Non-GAAP earnings exclude $16.5 million of expense net of tax or $0.16 per diluted share from restructuring costs, amortization of acquired intangibles, previously deferred IPO costs, net changes associated with our Lextar investment and non-cash stock-based compensation.

Non-GAAP and GAAP earnings per share were above our targeted ranges due primarily to lower OpEx spending and the retroactive reinstatement of the U.S. R&D tax credit that reduced our effective tax rate for the quarter. Our GAAP earnings also benefited from an increase in the Lextar's share price for the quarter, which provided a $7 million non-cash gain. Excluding the impact of the R&D tax credit reinstatement and the Lextar share price increase, our non-GAAP and GAAP EPS would have been $0.27 and $0.07 per diluted share respectively, which was still above our targeted ranges.

During the second quarter we completed the restructuring of our LED business. We recognized $3 million of costs in the quarter for factory capacity and overhead cost reductions. These capacity and overhead charges are included in our GAAP results only. Our total LED restructuring charges were $102 million and were aligned with our target.

Fiscal 2016 second quarter revenue and gross profit for our reportable segments were as follows. Lighting products revenue grew 11% year over year and 3% sequentially to $255 million and gross profit increased 12% year over year and 5% sequentially to $73 million, for 28.5% gross margin, which was a 60-basis-point increase quarter over quarter.

LED products revenue increased 1% year over year and 3% sequentially to $153 million and gross profit was similar sequentially at $53 million, for a 34.7% gross margin for the quarter. Wolfspeed Power and RF products revenue declined 12% year over year and 6% sequentially to $28 million, and gross profit was similar sequentially at $14 million, for a 52.2% gross margin, which was a 320-basis-point increase quarter over quarter.

In determining gross profit for our segments, we did not allocate certain employee benefit costs, stock-based compensation and acquisition-related costs. These non-allocated costs totaled $5 million for the second quarter of 2016 and are included to reconcile to our $135 million GAAP gross profit.

Q2 GAAP gross margin was 31% and non-GAAP gross margin was 31.7%, which excludes $3 million of stock-based compensation. Both our GAAP and non-GAAP gross margins were in line with our targets for the quarter.

Operating expenses for Q2 were $126 million on a GAAP basis and $103 million on a non-GAAP basis, both of which were below our targeted range for the quarter, primarily due to expense management and operational efficiencies. Non-GAAP operating expenses exclude approximately $3 million of capacity and overhead restructuring charges, $2 million of previously deferred IPO costs, $11 million of stock-based compensation expense, and $7 million of charges for amortization of acquired intangibles. The $2 million of IPO costs were expensed this quarter due to a delay in the anticipated timing of the plan Wolfspeed IPO, consistent with SEC guidance on -- regarding these costs.

Our non-GAAP operating income was $35.5 million and at the upper end of our targeted range. We continue to make excellent progress delivering operating leverage as operating income increased to 8.1% of revenue for the second quarter of fiscal 2016, a 120-basis-point increase sequentially.

Our Q2 GAAP tax rate was 20% and our non-GAAP tax rate was 16%, which was below our 25% target. The lower tax rates were primarily due to the retroactive reinstatement of the U.S. R&D tax credit. Our Q2 non-GAAP tax rate was lower than our GAAP tax rate to yield a 20% year-to-date non-GAAP tax rate, which is in line with our revised fiscal 2016 tax rate target.

We ended the quarter with $617 million in cash and investments, a $50 million decrease sequentially. The sequential decrease was primarily due to spending $62 million to repurchase an additional $2.5 million Cree shares and $35 million of capital expenditures, which was mostly offset by $77 million of cash provided from operations. Free cash flow was $42 million and above our target for the quarter.

For fiscal 2016, we are targeting property, plant and equipment spending at $135 million plus or minus. We spent $89 million during the first of the fiscal year, primarily on existing infrastructure projects. The remaining $46 million targeted to be spent during the second half of the year will be to finish the infrastructure projects and provide incremental capacity for lighting and Wolfspeed. We target approximately $100 million in free cash flow for fiscal 2016. Additionally, we ended the quarter with $205 million outstanding on our line of credit. Through the second quarter we have spent $132 million and repurchased 5.2 million Cree shares.

Days sales outstanding were 38 days, as compared to 41 days at the end of September. Our Q2 DSO benefited from more linear revenue shipments during the quarter. Inventory days in hand improved to 84 days as compared to 89 days at the end of September. The decrease was primarily lighting related and is in line with our 90-day plus or minus target range.

At this time, we target Q3 revenue in a range of $400 million to $430 million, which takes into account the lighting and LED markets, typical seasonal decrease of 5% plus or minus, which is partially offset by incrementally higher Wolfspeed sales. We target Q3 non-GAAP gross margins to be similar to Q2 at 31.7% plus or minus and GAAP gross margins to be 31% plus or minus. We target incremental gross margin improvement in our commercial lighting sales due primarily to factory cost improvements that will be offset by the seasonally lower LED margins, with Wolfspeed power and RF margins in the similar range.

These Q3 targets are based on a number of factors that could vary, including overall demand, product mix, factory execution and competitive environment. Additionally, this quarter we are implementing a new ERP system for our commercial lighting business. There is a near-term risk to our commercial lighting business if we do not execute the ERP implementation successfully. Our GAAP gross margin targets include stock-based compensation expense at approximately $3 million, while our non-GAAP targets do not.

We are targeting Q3 non-GAAP operating expenses to be approximately $100 million, a $3 million sequential decrease due primarily to variable sales costs associated with seasonally lower sales. We are targeting Q3 GAAP operating expenses to be approximately $119 million, which includes approximately $12 million of non-cash stock-based compensation expense and $17 million for the amortization of acquired intangibles. Q3 non-GAAP net interest income and other is targeted to be $0.4 million.

We target our Q3 and fiscal 2016 tax rate to be 20%. The Q3 and fiscal 2016 tax rate is lower than our previous targets primarily due to the impact from the permanent reinstatement of the U.S. R&D tax credit. As a reminder, our Q3 and fiscal 2016 tax rates will fluctuate based on our overall earnings, the tax jurisdictions in which our income is actually earned, tax credits and other tax benefits that may or may not become available to Cree in future periods.

We target GAAP net income for Q3 to be between $4 million to $11 million, excluding any net changes associated with our Lextar investment. Based on an estimated $101 million diluted shares outstanding, our GAAP EPS target is between $0.04 and $0.11 per diluted share. Non-GAAP net income is targeted to be between $22 million to $29 million, or $0.22 to $0.29 per diluted share. Our non-GAAP EPS target excludes amortization of acquired intangibles, net changes associated with our Lextar investment, and non-cash stock-based compensation in the amount of $0.18 per share.

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

Chuck Swoboda

Thanks, Mike.

We're focused on several key priorities in fiscal 2016 to take advantage of the growing market opportunities while responding to the competitive environment. Our first priority is to build financial momentum, which we're demonstrating through better-than-expected operating margin improvement, even though revenue is tracking slightly below our original targets.

Lighting revenue grew 3% sequentially in Q2 and 11% year over year, led by growth in commercial lighting, which offset lower year-over-year consumer lighting sales. Lighting gross margins improved 60 basis points sequentially due to better factory execution and our more balanced approach to revenue and profit growth. Consumer lighting revenue was similar to fiscal Q1 and in line with our targets.

LED revenue improved 3% sequentially in Q2 as demand was in line with our targets for the quarter. This allowed us to further reduce channel inventories to a level that should enable a higher turns model in the second half of the fiscal year. Core LED margins also improved as we saw additional benefits from our LED factory consolidation. The overall LED market remains very competitive, but our business has become more manageable in the near term as we continue to focus on high-power applications where SC5 technology drives system cost advantages.

Wolfspeed power and RF revenue declined about 6% sequentially in Q2 due to the continued lower RF demand. We target higher revenue for both power and RF in the second half of fiscal 2016.

Operating expenses were lower than our targets for the quarter, which enabled us to increase operating profits 21% to $35.5 million, and increased operating margin 120 basis points to 8.1%.

Our second priority is to continue to innovate in each of our business segments. Cree is a lighting technology company, and we believe that the world deserves better light. Our development and new product pipeline is focused on making this possible. In Q2, we released our breakthrough IG Series parking structure lights to volume production. This is the first product family to utilize our new cutting-edge WaveMax technology, which features a revolutionary combination of control, uniformity and efficiency to deliver a superior visual experience and new form factors that are intelligent in both design and function.

We target several additional new WaveMax-based product families to be released over the next few quarters as we apply this technology to both existing applications and utilize it to expand our product line in the new market segments. There are numerous companies working on variations of connected lighting and controls, and we continue to work with our partners to support demand for these more traditional solutions.

However, as part of our commitment to better light, we continue to build momentum for our SmartCast product line. Our development efforts remain focused on going beyond connected to deliver truly smart lighting where the intelligence and key functionality is built into the light. This is where we believe we can deliver innovation and real value to the end-users.

As our lighting business approaches a billion in revenue, we are working on a series of complementary lighting products to help fill some gaps in our existing product line. These products provide incremental growth opportunities and enable our channel partners to meet more of their customers' needs with high-quality products from Cree. We continue to win new designs with our SC5 high-power LED products. Our development efforts remain focused on expanding the SC5 product line and extending our leadership position in high-power LEDs for lighting and other complementary applications.

Our third priority is to promote future growth in our Wolfspeed Power and RF business and allow Cree shareholders to better realize the full value of this business. As I mentioned earlier, there were some near-term revenue softness in RF due to macro headwinds in the quarter. The bookings have improved for fiscal Q3 and we target good growth in both product lines over the second half of our fiscal year. Based on the near-term revenue softness and market conditions for IPOs, the IPO would likely not occur before the second half of calendar 2016. In the near term, we're focused on growing the business as we have the flexibility to be patient and get the timing right.

We target seasonally lower Q3 sales in line with normal trends and total company backlog is tracking with our targets for the quarter. Factory execution in all three businesses continues to be critical to achieving our targets. Based on our current backlog forecast and trends in the business, we are targeting Q3 revenue in a range of $400 million to $430 million, which is comprised of lighting and LED sales incrementally lower than Q2 and in line with seasonal trends and Wolfspeed sales incrementally higher than Q2.

We target Q3 non-GAAP gross margins in a similar range at 31.7% plus or minus. This target is driven by incremental margin improvement in lighting, Wolfspeed in a similar range, and LED slightly lower due to seasonally lower factory volume. We target Q3 non-GAAP operating expenses of $100 million, primarily due to lower variable LED and lighting sales costs. We exceeded our operating margin targets in Q2 and target maintaining most of these gains in Q3 adjusted for seasonally lower sales and LEDs in lighting. As a result, we target non-GAAP earnings in the range of $0.22 to $0.29 per diluted share.

We made good progress in the first half of fiscal 2016 and we're well-positioned for an even better second half. As we look beyond this quarter, we target the overall North American LED lighting market to grow 20% plus or minus in calendar 2016. We target our commercial lighting business to grow in line with the market and we have a healthy pipeline of new products to support this growth goal. We target additional growth over the next year from both organic and inorganic product line expansion to fill some of the gaps in a couple of key market segments.

The LED and lighting markets continue to evolve. Our LED business has benefited from our factory consolidations and narrowing our focus on the high-power segment. But the market continues to work through challenging competitive dynamics caused by excess capacity. Our commercial lighting business is building critical mass and has improved execution. The traditional lighting companies continue to shift their business to LED technology with the big players as well as a number of the midsize lighting companies all now more than 50% LED. However, most of these lighting companies are focused on simply delivering an LED version of traditional fixtures. The more knowledgeable specifiers and end-customers are starting to recognize that LED technologies can do much more. They want more than just lower costs and energy savings from the LED lights. They want better light.

Our mission is clear. The world deserves better light and we have the game-changing LED technology to deliver it.

We will now take analysts' questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions]

Our first question comes from the line of Paul Coster with JPMorgan. Your line is open.

Paul Coster - JPMorgan

Yes, thanks for taking my question. I think in the context of weak LED demand in Asia Pac, the LED module business stood out for me. Chuck, I'm wondering if you can give me a little bit of color around end-customers, end-applications, end-regions?

Chuck Swoboda

Yeah, Paul, I don't know that there's any one region or end-application that stands out for me. You know, I think we're probably seeing something a little different than others, but that's, you know, with our focus, very much on the high-power segment and those applications, you know, we probably -- what you're probably seeing, from our standpoint, is a subset. But I think if you look at what we plan for the quarter, Asia, U.S., Europe all came in kind of like we expected, and within the applications, you know, it's mostly lighting, but even the other applications all kind of tracked as expected.

So, Q2 for us was pretty much as-expected quarter on the LED side.

Paul Coster - JPMorgan

No exposures to backlighting, which seems to be in the trough here?

Chuck Swoboda

Yeah, correct. We haven't had any backlighting exposure in a couple of years. So we're really, you know, those trends sometimes can be a bit misleading because our business is a little bit more a function of more specifically the lighting segment as the biggest theme [ph].

Paul Coster - JPMorgan

Sure, got it. And the utilization rates for the module business?

Chuck Swoboda

Yes. So the LED business, as we exited Q2, we were somewhere in the mid to upper 80s, is what I would say, as we finished. You know, we've got the factory consolidation completed in the quarter. And so I think this quarter it'll be a little lighter in Q3, just will be a little seasonally slower. But overall I think we're kind of tracking to the range we expected to. And you can see in the numbers that we actually got the core LED business, if you take out the license benefit we got in Q1. Core LED margins were actually up a little bit quarter over quarter. I think that's just a function of, you know, combination of good execution and getting the restructuring completed.

Operator

Thank you. Our next question comes from the line of Brian Lee with Goldman Sachs. Your line is open.

Brian Lee - Goldman Sachs

Hey guys. Thanks for taking my question. First off, I guess, Chuck, on your comments around the lighting growth for the market this year, I appreciate that color, 20% you guys are not quite growing at that rate in your commercial business right now but you are targeting to get to 20% for calendar 2016. It does imply that I guess M&A is moving up the capital allocation priority list, and that is focused in lighting. Is that the right read? And if that is the case, what's sort of prompting the shift here a little bit from what it seemed like had been more of a priority around buybacks recently?

Chuck Swoboda

Yeah, Brian. So let me see if I can kind of peel -- put that together. So I would say that if you look at the first six months of the year, our lighting business is actually growing in line with the market. Keep in mind that, you know, the commercial lighting business is tracking, but you have the consumer lighting business actually smaller year over year. So I actually think we are tracking pretty much at that rate.

And frankly, you know, we have -- there's a series of new products that -- platforms -- that as they come online, I think put us in a good position as we head into the next year. So that's kind of my thought is the base business can grow with the market, we have some new products that open up some new applications.

And then what -- the other piece I added is, as the industry -- so as there are more lighting companies that cross over that 50% LED threshold, I think there are more opportunities for us to start to look at, are there complementary pieces that could add to the portfolio, to really kind of fill out the product line and really give our channel, you know, more opportunities to sell Cree.

And so that's just -- I think it's a -- the industry is changing. I think we're becoming a larger-scale business, and so I think it becomes a more viable opportunity. Nothing imminent but really just as -- it becomes a piece of the strategy. And also, it doesn't mean we won't still continue the buybacks. So I think that's also another viable option we'll continue to pursue. Because when we're thinking about these ideas, they're more incremental than really big deals at this point.

Brian Lee - Goldman Sachs

Okay, that's helpful. And then just one follow-up, I'm sorry if I missed this, but given the fiscal Q3 guidance, if we just take the midpoint of the range, it seems like the top-line target for 10% this year is maybe a bit more challenging. I didn't know if you were updating your views there. On the flipside, you're obviously tracking to already at that 8% operating margin view [ph]. So, wondering on both accounts whether or not there's any shift in your thinking for the target for this year. Thank you.

Chuck Swoboda

Yes. So, Brian, you know, if I look at where we're at for the first six months, really if you -- it is really the three businesses. Power and RF, as we talked about, the RF side, that business has been pretty slow the last couple of quarters, if you just pull that out, LEDs and lighting combined are riding [ph] pretty close with what we thought was in a few percent in the first six months, and I'm still tracking generally to where we're planning for the year. But obviously, you know, with the slow start on power and RF, that kind of took us off on the top line. As you mentioned, you know, the good news is we're still tracking to the overall profit growth goals. And the other thing I would say is, is that I do think we're going to see a nice -- some nice growth here in the second half of the fiscal year on the power and RF, and that really just comes from, well, RF was slow in the first half, we see increasing orders right now, so we're targeting a better Q3. And if that trend continues, we should see some incremental growth again in Q4.

So, net-net, probably not going to hit our overall revenue growth targets for the year. We'll still hit the profits. And I think the three businesses are in a pretty good spot as we head into that second half of the fiscal year.

Operator

Thank you. Our next question comes from the line of Vishal Shah with Deutsche Bank. Your line is open.

Vishal Shah - Deutsche Bank

Hi. Thanks for taking my question. I knew you guys talked about a weakness in the LED product margins in the next quarter. Can you talk about, you know, where you think the margins can stabilize and where you think utilization rates will be exiting next quarter?

Chuck Swoboda

Yeah. So I don't have an exact utilization rate for you. We'll be a little lower utilization just because of the seasonality, so I, you know, my guidance earlier was it'll be incrementally a little bit lower. I would expect that, you know, what margins do is really a bit of a function of what happens in the market. So if volumes hang in there where they're at and if trends continue, then I would expect that it's possible to get that incremental decline back in Q4. But it's a little premature there. As you know, it's a pretty competitive market and there's a lot of moving pieces. So, a little early for Q4 targets.

So I think all things considered, should be an okay shape here in Q3, and depending on what the market does, we'll give that Q4 guidance as we get there, so.

Vishal Shah - Deutsche Bank

And in terms of OpEx, you know, how low can it go? And I think you've done a good job in operating margins this most recent quarter, but how much more cost you could cut there as well?

And finally, on the free cash flow guidance, I mean, you talked about $100 million of free cash flow, how should we think about the uses of capital between buyback and M&A? Thank you.

Chuck Swoboda

Yes. So, OpEx, we're targeting this quarter $100 million plus or minus. That's down a few percent again from the previous quarter. Most of that is just variable OpEx. So with the seasonally lower sales in LED and in lighting, we'll get some lower variable costs there.

I think going forward our goal would be, is, as we build scale on the business, that while we'll have to invest in OpEx, we should be able to incrementally get some operating leverage. That was the target we laid out for the year and that remains the goal through the rest of this fiscal year. And, you know, as we build scale, we will attempt to do that again as we head into the next year.

As far as free cash goes, I think that as the free cash flow picks up, we have both the buybacks still out there, as well as we do see some incremental M&A opportunities. And so I think that we will continue to look at both of those, and just kind -- and see what opportunities arise over the next couple of quarters. The nice things is, is with the balance sheet where it's at, we have lots of flexibility to pursue both as we want or focus on or more than the other if needed.

Operator

Thank you. Our next question comes from the line of Jed Dorsheimer with Canaccord. Your line is open.

Jed Dorsheimer - Canaccord Genuity

Hi. Thank you and thanks for taking my question here. Chuck, I guess the first one is, is you restructured the LED components business and Cree lighting has become a larger proportion of -- as a customer in terms of sourcing the LED components. Do you see that as more of an insulating property given the dramatic price reductions in the overall market as we look out at the next year for your LED business?

Chuck Swoboda

You know, Jed, I think actually probably what the dynamic is, as much as anything, is, you know, the internal stuff, we don't -- that's not what's flowing through the numbers we're reporting. So when we're showing the numbers, we're really showing just the external sales part of the LED business.

I think the bigger benefit is when we really get focused down on where the high-power wins and, you know, when we -- by resizing the business, we gave ourselves the flexibility to really only focus there, put all the R&D there, put the sales effort. I think that's what's helped us in the short term.

As we go forward over the next year, it's probably more of a function of, you know, do the market segments we're focused on, you know, is that balance right? So, you know, I think there's, as you know, there's lots of competitive dynamics out there, the biggest one being there's still so much supply versus overall demand.

But if the high-power segment hangs in there and we keep doing the innovations and we keep winning the new designs, I think we can maintain the business, hopefully in a similar level. But again, lots of variables ahead of us, and a little too early to put any longer-term guidance on the LED business until we see how the market shakes up.

Jed Dorsheimer - Canaccord Genuity

Fair enough. And just with respect to the bulb business, you know, we're seeing a lot of your competitors looking to monetize their branding efforts in bulbs and dispose of those business segments largely going to Indian and Asian potential buyers. I'm curious, you feel as if Cree has built that brand with your depot efforts, that that will be a possibility for you guys as well?

Chuck Swoboda

I think our brand will be quite valuable for someone. I think that problem is, is that I would not want to do that to our brand. So I think the challenge you're going to have is, is that if you're putting your brand on some of these low-cost bulbs with inferior performance, you're risking the brand for the commercial lighting business in the long run.

So the incremental gain there I think is a very, for us right now, that will be way too shortsighted, I think. We're actually -- the reason we're focused on premium bulbs is we want to make sure that the idea of better light is true whether we sell a consumer bulb or we sell a commercial lighting fixture. And I think the risk of putting it out there and letting someone cheapen the brand would, you know, really hurt the value we've created over the last couple of years. So I don't see that, at least, not an option over the next couple of years.

Operator

Thank you. Our next question comes from the line of Harsh Kumar with Stephens, Inc. Your line is open.

Harsh Kumar - Stephens, Inc.

Yeah. Hey, guys. First of all, great results and guidance. Second, question from me was, Chuck, on the operating expense side, it's been pretty good progress here. I'm curious, what did you end up cutting in the December quarter? Where did the savings come from? And how sustainable is the -- so I know you said that's variable comp, but what should we think as we look out over the next year or two as the number for operating expenses?

Chuck Swoboda

Yeah, Harsh, the -- you know, it's actually a -- there is no one big area. So really what I would tell you is the core R&D investment is still going on, we're still making core investments in doing the sales and marketing capabilities of the business. What I would say it's more the -- the more corporate side and more some of the overhead sides where we're just getting leverage. As we get scale in the lighting business, you know, we're able to do things more efficiently on one side, and frankly, on the other side, you know, the team's just doing a good job of managing expenses where they can.

So it's -- the core is still being invested in. I think we're just, as we get to -- when you get to a certain size, you have some flexibility there to manage it a little tighter.

Harsh Kumar - Stephens, Inc.

Got it, understood. And for my follow-up, if I can hit upon the margin side. Your commentary suggests the LED chip business is settling down, the lighting business is growing, your margins are sort of flattish, 31.7%. How should I think of that margin as again time rolls on and we talk, let's say, 12 months or 24 months out, what should be our bias towards that gross margin number?

Chuck Swoboda

Yeah, Harsh, it's really going to -- so if you think about the business going forward, we've, you know, we said that lighting is the primary top-line growth driver. Obviously there'll be growth in power and RF, but it's a smaller piece of the business. So, lighting will be the biggest revenue growth driver, and we're targeting to make incremental progress there on improving the margins. That's not a one-quarter thing, that's an over time. It's a combination of operational efficiencies, it's, you know, new products. It's all those things.

And so it's really a function of, how does that roll out versus what happens in the LED business? And while definitely I think we're in a better position now in LEDs, you know, the future is a little hard to predict there, so I think that's a bit of a variable that it depends on which assumptions and it would be too early for me to give any longer-term guidance on LEDs. I think we feel good about where we're at today, but there's a lot of variability left in the market and a lot of dynamics that, you know, until those shake out, it'd be a little premature.

So I think what we can do is make progress in lighting, and I think we'll have to see how LEDs affect that going forward.

Operator

Thank you. Our next question comes from the line of Edwin Mok with Needham. Your line is open.

Edwin Mok - Needham & Co.

Hi. Thanks for taking my question. So I want to focus on lighting. I think, Chuck, you mentioned during the call that you're preparing or you developed some products that is expected to hit the market. How do you kind of think about that? Is there a way you can kind of quantify that, the number of new products in your market, or maybe a better, just directionally, should we expect acceleration of more products hitting the market? And what kind of impact that would have on operating expenses, those products out in the market, in terms of sales, you know, maybe sales and marketing expenses?

Chuck Swoboda

Yeah. So, Edwin, the way to think about it is, you know, we're always working, you know, our core lighting strategy is to be a technology company in the lighting business. So we want to be very innovative. And we have several new platforms coming out all based on our WaveMax technology.

And so the first product that was just put into production is something we call our IG Series Parking Structure Light. And it allows us to deliver a look at light quality and a performance at a price that we just couldn't do before. So, you know, it solves both the better light and it also provides better value. So I think that's kind of the first example. That just started shipping in the month of December. And we have other products along those lines that are coming out.

It is -- so there's basically, you know, several major platforms based on that. In addition to those, we're working now to try to bring what I call complementary products to market, to kind of fill some gaps in the portfolio. And so these things may not be revolutionary, but they do, you know, broaden the product line and frankly give the channel, you know, more to sell out there. And so I think there's a combination of these two things that you'll see over the next year.

Probably the most important subtlety to that is these platforms are actually products that took us probably two to three quarters longer to get into the market than we normally would have tried. So, frankly, you know, the growth we've seen over the last year, we've done that without as much new product. And so, you know, I become more optimistic about the next year just because, as these platforms come online, typically two to three quarters after they're in the market, then we can start to see some of the revenue growth momentum coming from them.

So that's kind of how I think about, it's a series of products, both kind of platform breakthroughs as well as complementary ones, but there's about a two to three-quarter lag to when you see that hit the market. And so as we head into the big lighting trade show season, it'll be important to get them out and start to build that momentum.

Edwin Mok - Needham & Co.

Great. That's great color. Just a quick question on the bulb. You mentioned it was down year over year in the quarter but in line with your expectation, right? Is that the trend that we should continue to expect, almost deemphasizing the bulb business, and what are you seeing on pricing and general inventory on the bulb side or business?

Chuck Swoboda

What I would say is we're probably -- I think what we started two quarters ago is -- deemphasize is probably the wrong word. I'd say reposition it. That's when we made the decision that, to chase people down to the low end on price, you had to reduce some of the performance and capabilities, and we weren't willing to put the Cree brand on those. So we said, you know, saw the opportunity to reposition as a premium brand. And I think the fact that we are able to sell that product at a premium price in the stores over the last couple of quarters shows that there is a market for that product and that's I believe a viable strategy.

Now that being said, we will have to continue to add features and capabilities. People always want something better. And so we'll have to move with the market. But I think, you know, over the next couple of years, that it can continue to be an important part of building that brand, but in a way where it's positioned more at the premium side versus the other guys, so that while doing that, it's not really the growth driver, it's probably, if anything, the revenue a year from now is probably similar to where it's at today, plus or minus. But the commercial business will continue to become a bigger percentage of that. And its bigger role becomes, you know, helping people get introduced to the Cree brand for the first time and understanding that better light is something they want to pay for.

Operator

Thank you. Our next question comes from the line of Tom Sepenzis with Northland. Your line is open.

Tom Sepenzis - Northland Securities

Hi, congratulations on the results. Just wondering if you could give us a little bit of color on, you know, the Wolfspeed light, you think the revenue is going to actually increase here in March, that's traditionally a pretty weak quarter seasonally for RF. So is this -- the strength you're seeing coming from power? Or any color you could provide there would be helpful. Thank you.

Chuck Swoboda

Yeah. I think what you're seeing is that, because the first six months, you know, we saw RF slow down in both our Q1 and our Q2 on our -- within Wolfspeed. And I think what you're seeing is those projects that were delayed, and these were both commercial projects as well as on the Milaro [ph] side, those projects are now starting to turn on. And so where we're getting the benefit of is, you know, gallium nitride is really a revolutionary technology and some of the major projects that drive that start to move ahead, that's what we're seeing as the incremental growth. So I'm not sure you can track this to a broader RF trend, it's really more gallium nitride getting designed in and those projects starting to become a bigger piece of business.

Tom Sepenzis - Northland Securities

Thank you. And then the tax rate at 20%, is that something we carry forward now? Is that the target number beyond the March quarter or is that just 20% from March and then back up to 25% moving forward?

Mike McDevitt

Tom, the 20% is the tax rate for the target for the year. So you can use, model that for the rest of FY16.

Tom Sepenzis - Northland Securities

Thanks very much.

Mike McDevitt

Yeah.

Operator

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

Krish Sankar - Bank of America Merrill Lynch

Yeah, hi. Thanks for taking my question. I had two of them.

First one, Chuck, you kind of emphasized you want to be the technology driving Cree. I'm curious, have you seen or heard of any other disruptive technologies that are happening in the space? I was reading about something called recycling light, which is to improve efficiency of incandescents. I'm kind of curious, have you seen any disruptive technologies out there beyond the core LED or do you think most of them are really in like, you know, concepts and feasibility stage that is not a real threat at this point? And then I had a follow-up too.

Chuck Swoboda

Yeah, Krish, I would tell you there's always people playing with different ideas. You know, you still have people talking about OLED lighting. There's a lot of different variations.

What I would say is, given what we can see in the marketplace, I don't -- I believe the LED is going to be a -- that part of the market will grow; the innovation though is around all kinds of things you couldn't do with it. So what no one's actually thought about is that, you know, we spent the last seven years trying to convince people that they want a light that lasts longer and saves energy, and that's mostly what the standard is in LED lighting. What you're going to see is LED lighting can do a whole lot more. And so what's possible in terms of light quality, how it's used, the fact that it truly can have smart features added to it and built in, I think that's where you're going to see tons of innovation from Cree and others.

And so I think we're really still in the early days of even the LED lighting piece of this, because from an efficient, cost-effective light source, I don't see something better than it right now. And we haven't really tapped those, the capabilities to do things that go beyond what normal lights do today.

Krish Sankar - Bank of America Merrill Lynch

Got it, got it. That's very helpful, Chuck.

And then as a follow-up, are you hearing or seeing any of your competitors actually kind of consider going more vertically integrated the way you guys are? If so, do you think it would be an advantage, disadvantage to them? Or the fact that you have a very unique technology with IP around silicon carbide, that, you know, the other applications either in sapphire or vertical integration doesn't matter?

Chuck Swoboda

Are you talking more within the LED side or in the lighting side or both?

Krish Sankar - Bank of America Merrill Lynch

Both, like the lighting guys doing more vertical integration, including equipment, or buying equipment.

Chuck Swoboda

Yes. I don't see other lighting companies looking to vertically integrate down into LEDs. I don't see that as a trend. I think unless you're a semi company and you want -- that you've already been in that business, I think going from there and adding lighting is hard enough, I think trying to go backwards probably doesn't -- that wouldn't make a lot of sense for people because it's a radically different business model and skill set.

I think within the LED segment, there clearly are some of the LED guys who use sapphire that also have, you know, strategic relationships to source sapphire differently and other things. Given the substrate costs, I'm not sure it makes a significant difference in that side of the business today. Obviously we have a bit of a unique approach on LEDs because we're the only major player using silicon carbide. And I think that plays into some of the unique things we can do on the power LED side that makes us a bit different.

But overall, I don't see a big push to increase vertical integration yet in either side of it today.

Operator

Thank you. Our next question comes from the line of Colin Rusch with Oppenheimer. Your line is open.

Colin Rusch - Oppenheimer & Co.

Thanks so much. Guys, can you talk a little bit about the cost reduction potential coming from the WaveMax series, and how we should think about the cadence of that over the next several quarters?

Chuck Swoboda

Yes, Colin, I wouldn't -- so, WaveMax is really a technology platform that adds capabilities. So while in some cases it will let us design a product that is lower cost, I think what you -- more importantly, I think it's going to give -- allow us to do things from a performance standpoint. And so this is less about trying to -- I think we'll get some ability to improve performance, and hopefully also some ability to increase value which hopefully leads to incremental margin improvement in our lighting business.

But at its core, what WaveMax is, is a -- it's a platform to let you engineer the light in a way that will fundamentally improve the performance. And performance could be described as efficiencies. But as much as anything, it's about how you use the light, where you put it, and how you manage it.

And so, to me it's less of a cost play and more of a performance capability play to allow LED lighting to go places it hasn't been before.

Colin Rusch - Oppenheimer & Co.

Okay, great. And then as you think about expanding the geographic footprint for the fixture business, how do you think about that and where do you make investments as you go forward?

Chuck Swoboda

Yes, the near term, it's very North American focused. That's just because, you know, we're getting close to a billion dollars but there's still more things we need to do to really solidify, I think, that business over the next couple of years, things we can do to grow organically but also things we can kind of solidify around that.

I think if you look out beyond the next couple of years, I think there is some geographic expansion opportunities. It'd be a little premature to target any one of them. I think, you know, we're going to look at the dynamics where we think that, you know, our technology fits with the market and that play kind of works. And so we got to be -- it's not just picking a geography but also looking at where some of the things we do unique fit into those markets. And there's, you know, significant customer value we can generate.

Operator

Thank you. Our next question comes from the line of Mike Ritzenthaler with Piper Jaffray. Your line is open.

Mike Ritzenthaler - Piper Jaffray

Yes. Thanks. Chuck, in your prepared remarks, you'd referenced higher margins in the retail lamps business. Just one follow-up on that comment. It was based on manufacturing efficiencies, if I understood you correctly. And I guess it's a bit counterintuitive to the lower volumes that one might expect from a niche strategy. I was just wondering if you could provide a bit more color on how those manufacturing efficiencies are being realized, if I did hear you correctly.

Chuck Swoboda

Yes, Mike, I may have -- you may have misinterpreted what I'd intended. We are seeing improved margins in the commercial lighting business and in lighting overall, but there hasn't been a significant change within the consumer lighting segment. We are promoting a premium pricing strategy within that business, but when I talk margins, I'm really talking about primarily the commercial lighting business and the improvements we've been able to make there from an operational efficiency standpoint.

With that being said, there is -- a premium strategy does not necessarily hurt the margins either, right? What you're really asking is, is trying to position the products with people that want to pay for the better light and the longer lifetime and a better warranty. You just try to get that positioning right.

So it actually -- premium supplier, it hasn't driven -- it hasn't hurt the margins either. But the real improvement you're seeing in lighting are being driven by the commercial lighting side of the business.

Mike Ritzenthaler - Piper Jaffray

Okay. Thanks for clarifying that.

Mike, on ERP system implementation, is there anything in terms of scope that you can share and, you know, how historically a project like this has been tackled with the same magnitude?

Mike McDevitt

Yes. So it's -- the ERP system is focused on our commercial lighting business, so, really confident on the long-term benefits. Just you have to manage through some of the short-term things that you have to deal with any implementation. We have done other ERP implementations in the past and we've been able to manage those successfully. But each implementation carries its own risks and uncertainties, and we're going to work through that, so.

Operator

Thank you. [Operator Instructions]

Our next question comes from the line of Sven Eenma with Stifel Nicolaus. Your line is open.

Sven Eenma - Stifel Nicolaus

Yes. Thanks for taking my question. First, I wanted to ask about the sequentially lower guidance you provided in terms of seasonality. Could you clarify kind of trends you're seeing in indoor versus outdoor lighting versus LED products? It looks like in your lighting business, last year the seasonality was sequentially down only 3%. So, a clarification would be helpful.

Chuck Swoboda

Yes. So what we're guiding is LEDs down roughly 5% plus or minus, and same thing on lighting. I think LEDs, that's within our normal range, and I think lighting. If you look at -- remember, the business is a lot bigger than it was a couple of years ago. So if you just look at lighting, we're using the industry target as kind of our target right now. We have almost a billion dollar commercial lighting business. And when we look at the last several years, 5% down is -- plus or minus is roughly what the typical seasonality is.

There's obviously going to be variability in the market. It's a -- this quarter is one that's typically affected by weather and other dynamics. So, you know, there's going to be a range. But I think that, you know, we're not targeting anything different than what I would think is the normal industry trend in this quarter. And again, that's plus or minus.

Sven Eenma - Stifel Nicolaus

That's helpful. And the second question I had is, in terms of LED product side, your customers, are they feeling a little more confident, is there visibility with them the same as it was last quarter, or what drove the kind of sequential improvement in volumes in the December quarter?

Chuck Swoboda

Yes, the business wasn't, you know, it was -- if you look at December, it was pretty much in line with what we targeted. I don't know that there was a significant growth in the business. It was a little bit up. And then it's just a dynamic of I think the places we're focusing on, getting the restructuring a little bit further behind; this is really what you see.

I think from a customer dynamic, they're feeling about the same now as they were a quarter ago. I think, you know, the other thing to keep in mind is, as we head into Q3, one of the things that's helping us a little bit is that, you know, we've kind of made the transition to the higher turns model. So I think that helps us a little bit as we head into the new quarter. We were actually working through that over the last couple of quarters. And so, you know, when you get that behind you, that actually makes it a little easier to run the business.

Operator

Thank you. I'm showing no further questions at this time. I'd like to turn the call back to Mike McDevitt for closing remarks.

Mike McDevitt

All right. Thank you for your time today. We appreciate your interest and support and look forward to reporting our third quarter results on April 26th. Good night.

Chuck Swoboda

Good night.

Operator

Ladies and gentlemen, this does conclude today's program. Thank you for your participation. You may all disconnect. Everyone have a great day.

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