Raiford Garrabrant - Director of Investor Relations Charles M. Swoboda - Chairman of the Board, Chief Executive Officer and President Michael E. McDevitt - Chief Financial Officer and Executive Vice President.

Brian K. Lee - Goldman Sachs Group Inc., Research Division Andrew Huang - Sterne Agee & Leach Inc., Research Division Vishal Shah - Deutsche Bank AG, Research Division Jonathan Dorsheimer - Canaccord Genuity, Research Division Jagadish K. Iyer - Piper Jaffray Companies, Research Division Brandon Heiken - Crédit Suisse AG, Research Division Daniel L.

Amir - Lazard Capital Markets LLC, Research Division Tony Grillo - Needham & Company, LLC, Research Division Craig E. Irwin - Wedbush Securities Inc., Research Division Mehdi Hosseini - Susquehanna Financial Group, LLLP, Research Division Richard Sewell - Stephens Inc., Research Division Mark J. Heller - CLSA Limited, Research Division.

Good afternoon, ladies and gentlemen. My name is Huey, and I'll be your conference facilitator today. At this time, I'd like to welcome everyone to Cree, Inc.'s Fiscal Year 2014 First Quarter Financial Results Conference Call. [Operator Instructions] As a reminder, ladies and gentlemen, this call is being recorded today, Tuesday, October 22, 2013.

I would now like to introduce Raiford Garrabrant, Director of Investor Relations for Cree, Inc. Mr. Garrabrant, you may begin your conference..

Thank you, Huey, and good afternoon. Welcome to Cree's first 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 our results for the first 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 financial metrics posted in the Investor Relations section of our website at www.cree.com 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 on certain trends and revenues, 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 first quarter of fiscal year 2014 to a discussion of the information included in our earnings release and the metrics posted on our website.

We will not be able to answer any questions that would involve providing additional financial information about the quarter beyond the comments made in the prepared remarks. This call is being recorded on behalf of the company.

The 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.

[Operator Instructions] We recognize that other investors may have additional questions and we welcome you to contact us after the call by e-mail or phone at (919) 287-7895. We are also webcasting our conference call, and a replay will be available on our website through November 5, 2013. Now I'd like to turn the call over to Chuck..

Lighting sales grew 11% sequentially to $148 million, led primarily by growth in LED fixtures; LED sales were slightly higher and in line with our target at $218 million; and Power and RF sales increased to $25 million. Non-GAAP gross margin increased to 39.2% in Q1, which was in line with our target range.

The margin increase was driven primarily by improvements in lighting as we realize the benefits from LED bulb cost reductions and higher fixture sales, as well as LED-related license revenue. LED product margins and Power and RF margins remained strong and in line with our targets.

Non-GAAP operating profit increased 14% sequentially in Q1, which demonstrates the strength in our vertically integrated product portfolio and our ability to leverage our technology to drive growth and create differentiated value in a wide range of applications.

Cash and investments increased $65 million to $1.1 billion due to higher profitability and solid execution of our strategy to increase operating leverage. Company backlog for Q2 is similar to this point last quarter as we see good order momentum in our LED lighting product line, and LEDs are tracking in a similar range.

Based on our current sales activity and project forecast, we are targeting growth in all segments in Q2 driven primarily by LED fixtures and LED bulb. As the leader in LED lighting, we continue to be in a great position to drive and take advantage of the global shift to LED lighting through both our lighting and LED products.

While there are many approaches to this market, we remain focused on our strategy to use new product innovation to drive our growth by taking share from traditional technologies. This approach is a reflection of who we are, what we are passionate about and what we have demonstrated that we are good at.

The tremendous success of the Cree LED bulb at The Home Depot is the most recent example of why we believe this is a winning strategy for Cree. I'll now turn the call over to Mike McDevitt to review our first quarter financial results in more detail as well as our targets for the second quarter of fiscal 2014..

Thank you, Chuck. I'll 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 as 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 historical summary of other key metrics.

For the first quarter of fiscal 2014, revenue increased 4% sequentially to a record $391 million, which was in line with our $380 million to $400 million target range driven by strong sales of our lighting products.

GAAP earnings increased to $30.5 million or $0.25 per diluted share for the first quarter of fiscal 2014, and non-GAAP earnings increased to $47.3 million or $0.39 per diluted share. Non-GAAP earnings excluded $16.8 million of expense, net of tax, or $0.14 per diluted share from the amortization of acquired intangibles and stock-based compensation.

GAAP and non-GAAP earnings per share were in the middle of our target range of $0.36 to $0.41 for non-GAAP and $0.23 to $0.28 for GAAP. Q1 GAAP gross margin increased 110 basis points sequentially to 38.6%, while non-GAAP gross margin increased 100 basis points to 39.2%, which excludes stock-based compensation of $2.4 million.

This was in line with our non-GAAP target of 39%, plus or minus. Fiscal 2014 first quarter revenue and gross profit for our reportable segments were as follows. LED products revenue was slightly higher sequentially at $218 million, and gross profit grew 2% sequentially to $102 million for a 46.6% gross margin.

The gross profit and gross margin increase was due primarily to higher license payments received in the quarter. Lighting products revenue grew 11% sequentially to $148 million, and gross profit grew 19% sequentially to $40 million for a 26.9% gross margin.

The revenue growth was driven primarily by higher LED fixture sales, while our gross profit and gross margin growth was due primarily to the higher LED fixture sales and the benefit of the LED bulb cost reductions. Power and RF products grew 5% sequentially to $25 million, and gross profit grew 5% sequentially to $13 million for a 53.7% gross margin.

The revenue and gross profit growth was due to higher sales. In determining gross profit for our segments, we do not allocate certain employee benefit costs, stock-based compensation and acquisition-related costs.

These non-allocated costs totaled $4 million for the first quarter of fiscal 2014 and are included to reconcile to our $151 million GAAP gross profit. Operating expenses for Q1 were $114 million on a GAAP basis and $94 million on a non-GAAP basis, both of which were within our targets.

Non-GAAP operating expenses exclude approximately $13 million of stock-based compensation expense and $7 million of charges from amortization of acquired intangibles. Net interest income and other for the quarter was $2.8 million. Our Q1 GAAP and non-GAAP tax rate was 23% for the quarter, which was in line with our target.

We ended the quarter with $1.1 billion in cash and investments. Cash from operations was $69 million. And capital expenditures were $38 million, including $5 million related to patents, which resulted in free cash flow of $31 million. Depreciation and amortization for the quarter was $39 million.

Days sales outstanding were 48 days as compared to 46 days at the end of June. Inventory days on hand were 81 days as compared to 76 days at the end of June. Both metrics are in line with our target range of 50 days plus or minus for days sales outstanding and 80 days plus or minus for inventory days on hand.

Our September ending inventory includes increased raw materials and FGI to support our targeted growth in lighting revenue. Property, plant and equipment additions were $33 million for the first quarter.

For fiscal 2014, we continue to target approximately $120 million of property, plant and equipment spending to support our new product priorities and provide incremental capacity as needed.

At this time, we target Q2 revenue to be in a range of $400 million to $420 million, which is comprised of strong growth in lighting driven by LED fixtures and LED bulbs and slightly higher LED products and Power and RF sales.

We target Q2 non-GAAP gross margin to be 38.5%, plus or minus, and GAAP gross margin to be 37.8%, plus or minus, as LED lighting fixture and LED bulb products become a greater percentage of our total sales.

This Q2 target includes incremental product margin improvement and is based on a number of factors that could vary, including overall demand, product mix, factory execution and the competitive environment. Our GAAP gross margin targets include stock-based compensation expense of approximately $2.8 million while our non-GAAP targets do not.

We target -- we are targeting Q2 operating expense to increase approximately $5.5 million from Q1. The targeted increase is primarily for higher marketing spend to promote the Cree LED bulb and take advantage of utility rebates, as well as higher sales commissions from the higher targeted revenue.

Additionally, we target incremental R&D spending to support new product development and cost-reduction programs and increased G&A cost. Our GAAP operating expense targets include noncash stock-based compensation expense of approximately $13 million and charges for amortization of acquired intangibles in the amount of $7 million.

Net interest income and other is targeted to be $2.7 million in Q2. We target our tax rate to be 23% for Q2 and fiscal 2014. Our fiscal 2014 and quarterly tax rates will fluctuate based on our overall earnings, the tax jurisdictions in which our income is actually earned, the expiration or extension 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 Q2 is targeted to be between $26 million to $32 million. Based on an estimated 123 million diluted shares outstanding, our GAAP EPS target is between $0.21 to $0.26 per diluted share.

Non-GAAP net income is targeted to be between $44 million to $50 million or $0.36 to $0.41 per diluted share. Our non-GAAP EPS target excludes amortization of acquired intangibles and noncash stock-based compensation in the amount of $0.15 per share. Thank you, and I will now turn the discussion back to Chuck..

Thanks, Mike. We are focused on 4 priorities to drive our growth in fiscal 2014. Our first priority is to continue to lead with innovation across our product lines and drive to cost parity with conventional technologies. In lighting, we're making great progress on both fixtures and bulb.

The industry's first $99 street light has enabled Cree to, again, redefine customers' expectations for LED street lighting. And the introduction of the industry's first TrueWhite high-output area light has set a new bar for LED lighting in applications such as auto dealer lighting.

We are seeing a similar reaction to the entire range of new products that we introduced last quarter, although it will take a few quarters to work through the bid process and build momentum for these products.

I had a chance to attend the annual supplier meeting at The Home Depot a couple of weeks ago where the Cree LED bulb won the Home Depot 2013 Innovation Award.

Cree was compared against some of the top new products and consumer brands in the world and was chosen as the best, which says a lot about our understanding of customer expectations for LED lighting products. One year ago, the Cree LED bulb was still an R&D idea, and Cree had never sold a branded consumer product.

Today, we are setting the standard for consumer LED bulb. Working together with The Home Depot, we have changed the lighting category and changed consumer perceptions about LED bulb.

How do we know it is working? I believe the proof is in our sales growth and how other big retailers and product companies have reacted with their own lower-priced LED bulb. Does this worry us? Not really, because we are not standing still.

These other companies are under pressure to respond to Cree's innovation and appear to be making the same mistake the CFL industry made over the last 20 years, by trying to convince consumers to buy compromised products that are not as good as traditional light bulbs.

LED bulbs should work better and cost less to own, delivering a no compromise solution. That is why the Cree LED bulb has been so successful. It looks like a regular lightbulb, it works as good or better than a regular bulb and it pays for itself.

I believe the other guys will eventually realize that consumers are a lot smarter than they give them credit for and will have to come out with higher quality, no-compromise LED bulb. By then, we plan to continue being 1 or 2 product generations ahead, having raised consumer expectations even higher.

We recently received ENERGY STAR qualification for the soft-white Cree LED bulb. This means these products can be purchased with an instant utility rebate, delivering consumers a high-quality LED bulb for under $5 in some markets.

We target these rebates, combined with seasonally higher lighting sales, to significantly increase sales of the Cree LED bulb at The Home Depot in Q2. The number of utilities offering rebates, the size of the rebates and the amount of the money available for rebates will affect sell-through.

We are seeing some early local rebate examples which have caused a significant spike in sales but it will be difficult to accurately forecast store sales in the near term.

We're adding capacity and building some flexibility in our factory to respond to potentially increased sales to The Home Depot as we target bulb sales moving to another level in calendar 2014 based on our ability to bring on additional utility rebate.

In LEDs, our SCQ technology has opened new applications for LED lighting to compete head-to-head with traditional incandescent, HID and fluorescent products. We continue to set a higher standard with new products like the XLamp XQ-E and high-density XLamp CXA array products.

The high-density CXA array utilizes Cree's proprietary chip technology to double the system intensity of spot lights, and the XQ-E family redefines what is possible in terms of very small footprint power LEDs.

Our success over the last year and the clear gap in our LED margins versus what the other companies report has validated the strength of our technology and our strategy to focus on lighting applications where our LEDs truly add value and make the customers' products better.

This means that there are some low- and mid-power applications where we choose not to participate and instead, focus our R&D and sales resources where LEDs make a difference.

In Power and RF, we continue to make incremental sales progress while we continue to invest in the technology and systems expertise to enable our customers to realize the full benefits of this technology platform.

Our second priority is to build the Cree brand in both the commercial and consumer lighting segments by expanding our product offerings and continuing to invest in marketing the value of the Cree LED bulb and LED lighting directly to the end user.

While we are making traditional marketing investments to build the Cree brand, I think it is important to point out that the Cree bulb is the foundation of the brand strategy.

We see the process of selling the Cree bulb and what it means to consumers to be as important and valuable to building the brand as it is to driving incremental revenue and profits.

While some may point out that consumer LED bulbs are a lower-margin category than are lighting fixture products, which is accurate, they are missing the point of our strategy. The Cree LED bulb is not a low-margin product strategy. It is a high-margin brand strategy.

The success of this product category for Cree is more than sales growth and incremental profit contribution. It is also the tremendous long-term benefit of building the Cree brand. I think it is clear that the strategy is working.

We are planning another significant media investment in Q2 to further raise awareness for the Cree LED bulb, take advantage of increased buying activity during lighting season and promote lower-price points due to ENERGY STAR rebates from utilities in certain markets.

These media investments will vary from quarter-to-quarter as we adjust to seasonal trends and specific product opportunities. Our third priority is to focus on select market segments where we can upgrade existing lighting and drive adoption.

We are currently working on both new product offerings and testing some new channel approaches to support this activity over the next several quarters. Our fourth priority is to build on the product momentum of FY '13 and continue to grow revenue and profits.

We target revenue growth from new products and increased LED adoption and profit growth from the combination of higher sales, lower cost products and operating expense leverage. Our Q1 results demonstrate that we are on the right track with good revenue growth and even better operating leverage.

We've proven that we can build the consumer bulb business and increase profits at the same time. We remain focused on the applications so we can provide a better value than traditional technology and drive LED adoption.

While this may vary from quarter-to-quarter with product mix and the timing of marketing investments, we target incremental improvement in gross margins across our products, combined with operating leverage and R&D and G&A to drive the bottom line.

As I mentioned earlier, Q2 total company backlog is similar to this point last quarter, but based on our current sales activity and project forecast, we are targeting growth in lighting, LEDs and Power and RF. Factory utilization is very high and while we are expanding capacity, execution is a critical factor supporting the higher targeted demand.

At the same time, our LED and lighting businesses operate with short lead times, which adds variability to the accuracy of our forecast for the quarter.

Based on our current backlog, forecast and trends in the business, we are targeting Q2 revenue to grow to a range of $400 million to $420 million, which is comprised of strong growth in lighting sales driven by LED fixtures and LED bulbs and incremental growth in LED and Power and RF sales.

We target non-GAAP gross margins to be in a similar range at 38.5%, plus or minus, as we increase the mix of lighting fixture and bulb products as a percentage of our total sales.

We target a significant increase in our marketing investment this quarter to promote the Cree LED bulb and take advantage of ENERGY STAR qualification and associated utility rebate to drive increased sales momentum.

As a result, we target non-GAAP operating expense to increase approximately $5.5 million in Q2, and we target non-GAAP earnings in Q2 of $0.36 to $0.41 per diluted share. Please note that our non-GAAP targets exclude amortization of intangibles, stock-based compensation expense and related tax effects.

It's important to keep in mind that Cree is a technology company first and one that is passionate about fundamentally changing the customer's lighting experience for the better. This translates to breakthrough products like the $99 street light, our entry into the consumer market with the $10 Cree LED bulb and our partnership with The Home Depot.

This means we are less focused on the traditional approach to lighting sales, and we are shifting even more of our resources and attention to opening new markets to LED lighting and creating opportunities for Cree to both increase revenue and build our brand.

Based on a recent Department of Energy report and despite our recent success, LED lighting currently represents less than 1% of all U.S. sockets.

LED lighting remains a largely untapped opportunity, and we plan to continue to make significant investments in new products, new channels and building the Cree brand as we remain focused on driving mass adoption and our long-term customer goal of 100% upgrade to LED lighting. We'll now take analyst questions..

[Operator Instructions] And it looks like our first question from the phones will come from Brian Lee with Goldman Sachs..

First off, can you quantify how much of the OpEx increase for Q2 is not related to the consumer bulb efforts and how we should think about the split of the OpEx increase that will need to flow through into calendar '14? And then I have a follow-up..

Yes, Brian, I don't have the specific breakout, but I would imagine it's roughly at least 80% is bulb-related, maybe even more than that. So there's a little bit of OpEx for higher sales commissions to just higher fixture sales, a little bit R&D.

But the vast majority is bulb-driven, and that's a combination of some media spending that we had always planned to do because this is lighting season.

But really, with ENERGY STAR happening sooner than we had originally targeted, there's also an opportunity now to go out and really make people aware, not only of the bulb generally but of the fact that these rebates are out there and available. So we've chosen to be opportunistic.

We want to take advantage of the fact that we're -- we got the ENERGY STAR sooner. And so part of the increase was planned and part of it is really just trying to take advantage of that opportunity that's available to us..

Okay. And my follow-up was kind of on the same topic.

Given that most of the higher OpEx is due to the consumer segment, and it seems to be pulling forward due to the ENERGY STAR qualification happening a bit quicker than you thought, can you give us some sense of how quickly you would imagine higher volumes from that increased spend? And it seems like the recent operating leverage is reversing in Q2.

So I'm just trying to get a better feel here for timing of when that might come back?.

Yes, Brian, I wouldn't read too much into some of the quarterly variations. Obviously, with the bulb business and some of the consumer activities, we're making some fairly significant investments. Our target for the year continues to be that if you look at it year-over-year, we would still target both margin and operating leverage for the company.

In terms of the volumes, what we're seeing is that originally, the plan was, is that we launched the bulb about a little over 6 months ago.

I guess it's about 7 now, and we spent a lot of time really -- a lot of our shipments so far have been not only to support demand, but also to put Home Depot in a position to take advantage of the lighting season. So there was a lot of product that had to be sent to Home Depot just to get it in position.

We've actually, now with ENERGY STAR rebates and some of the increased initial sales that we're seeing, we are now planning to actually ship higher volumes of the bulb this quarter than we were planning just a few months ago. So I think we're seeing some of the early returns.

Obviously, it will take a little while to see exactly what that sell-through is, but we're already reacting even in the targets for this quarter to that..

Our next questioner in queue will come from the line of Andrew Huang with Sterne Agee..

My first question is on capacity for LED products. Obviously, some of your LED products are sold externally and some are used internally for your lightbulbs.

So given the steep ramp you're seeing in lightbulbs, when do you think you might get capacity constraint? And if that does happen, will you scale back on external demand? Then I have a follow-up..

Yes, Andrew, I would say that we are currently running a very full factory, but we are not restricting external demand. The plan right now is to be able to service both the internal demand from higher fixture and bulb sales, but also continue to support our external customers.

We're committed to both businesses, and that's the plan for the -- that's the plan going forward. So right now I would say that it's tight, but we're making investments. We're bringing on new capacity this quarter. The key for us is continued good execution to be able to service the increased demand on both sides..

Okay. And then my second question is on the Cree branded bulbs. Clearly, you've seen a lot of success with your retail partner to address the channel, the retail channel.

I was wondering if your exclusivity with your retail partner prevents you from selling bulbs through commercial distributors?.

The current arrangement we have with The Home Depot is really focused on the consumer markets and Big Box retail. We obviously have some flexibility in some of the commercial markets right now.

But the main focus has been -- really, Andrew, with the growth in the bulb we've seen over the last couple of quarters, the vast majority of our energy right now is supporting the consumer side of that market in the short term..

Our next question in the phone queue will come from the line of Vishal Shah with Deutsche Bank..

Just wanted to follow up on The Home Depot exclusivity. I think it ends some time in April. Should we assume that, that allows you to go out and talk to other retailers and increase the sales channel in that market? And then also, we were picking up data points on, at Home Depot trying to reduce the price of the 60-watt bulb.

Is this part of the sales strategy? And then can you talk about the success you're seeing in the different types of bulb segments that you've sold with Home Depot?.

Yes, well, so I think I'll get the question here. I would say that right now, our energy is 99% focused on how do we support the ramp-up and the fact that we have ENERGY STAR and really responding to the increased demand in the market place. So -- and that activity is really Cree and Home Depot working together.

So we're -- I think people don't appreciate that we have 2,000 Home Depot stores with an end cap with this product. We have an online presence with them and really have a great, I think -- together, we've really changed the consumer bulb category. So really, the energy today is how do we expand the business that we have with the current platform.

And so really, I think it's premature to talk about any speculation of what might happen beyond that because we're really still in growth mode and taking advantage of that. As far as what we're seeing, I think you were poking at maybe what we're seeing with different bulbs and different categories.

What I would say right now is, is that obviously, the 40- and the 60-watt warm are the 2 biggest selling products, but we're seeing good success with the BR30 as well and some of the daylight products. Right now, the rebates are really on the soft -- warmer soft-white products.

So that's really what we've seen the incremental sales growth on with the addition of the rebates..

Our next questioner in queue will come from the line of Jed Dorsheimer with Canaccord Genuity..

Congratulations, Chuck, on again, the ENERGY STAR in that bulb.

I guess maybe just a follow-up-on Andrew's question but asked a little bit differently, as we look at the capital intensity for bulb expansion and as you expand that capacity, have you thought about looking at external supply in terms of low-power, mid-power components for those bulbs? Is that part of your strategy? Or do you still feel that the internal Cree components is really inherent to the -- for even the bulb side of the business?.

Yes, Jed, we've had a -- I think it's probably been the last couple of years, we've had an ongoing activity to basically see what's possible in terms of adding some external supply. I would view it more of a second sourcing strategy, and it typically applies more, I would call it, to slightly older generation products than it does our newer stuff.

I think we'd be open-minded. But honestly, right now the main focus of the bulbs, because we're making generational improvements pretty fast, we've gone from Gen 1 to Gen 2. We've changed the LED.

And so there's lots of activity around how do we keep generationally improving that product and how do we use the fact that because we're vertically integrated, we have insight into what the next-generation LEDs are likely to be and looking like.

And so I would say that on the new products and the ones that are moving very fast, they tend to be very much focused on the Cree technology and our R&D. But we are always looking at using some second source capability, but I'd say it's more what I'd call slightly older generation products is where that would apply more than on the new stuff..

Okay. And then as my follow-up, I've got a couple of parts to it that -- but kind of get at the core, which is really on gross margins. So in the LED component, I just wonder if you could comment on pricing. It seems like pricing is pretty steady.

And the reason I ask that question is, as we look at the lighting products in the non-Home Depot part of that channel, you introduced probably I think the lowest-priced street light that I've seen out there.

And I'm just wondering if that's what we're seeing in the non-bulb side in terms of why we're not seeing a greater rebound in margins, particularly because as we look at fiscal Q2, we're getting a full month of that Gen 2 bulb which has the lower cost structure..

Yes, so Jed, let me peel that apart, and if I get this wrong, you'll just have to come back and see if I clarified what you're looking for there.

So if you just -- let's -- if we go back and look at a -- maybe take a slightly longer look, a 2-quarter look, if you go from Q4 to Q -- through Q1 to Q2, so a 6-month outlook from our Q4 results to what our targets are for Q2, we have pretty significant growth. It's almost all in the lighting segment. There's a little bit in LED.

There's a little bit in Power and RF, but it's probably 90% roughly in the lighting segment, and that's a combination of fixtures and bulbs. And so if you actually just look at that, you can actually see that we're making fairly significant improvement.

And even with that very big increase in mix, we're actually seeing incremental corporate gross margin improvement. Regarding your specific question, I think, about the bulb, we ran the Gen 2 bulb pretty much the whole quarter last quarter. So our Q1 numbers have the benefit of going from Gen 1 to Gen 2 in it.

And so if you look at the lighting segment gross margins and you look at that improvement, one of the significant drivers to the improvement was going from Gen 1 to Gen 2 last quarter. In Q2, we're targeting running Gen 2 pretty much the whole quarter.

So you don't see the -- it'll still be -- it'll be as good as it was last quarter, but you won't see the incremental change that you saw Q4 to Q1. As far as things like the street light and the other fixture areas, what I would say is we continue to be very aggressive, pushing the limits on some of the new products.

But honestly, in a lot of cases, those are really still in the ramp-up phase. So when we introduce a fixture, there's a fairly healthy lag, especially in any of the business that has to go out through a bid process before that new product makes its way through and becomes a significant part of the fixture business.

So a little bit there you have, I think, is a lag effect of how fast we're pushing the market. But again, I think you point out, we're being pretty aggressive in terms of what we're trying to bring to the market to turn on those applications. So part of that's timing, and part of that's just how we're managing our strategy.

Hopefully, I got all of that question..

Our next questioner in queue is Jagadish Iyer with Piper Jaffray..

So Chuck, 2 questions.

First, how should we think about in terms of your response and given some of your competitors very recently announced that they are going to be positioning at major retail outlets at price points which are very attractive? And how should we think about your profile of bulb margins? I know you had mentioned in prior quarters that it will approach some level of lighting margins at some point.

So is there any more clarity that you can provide? And then I have a follow-up..

Yes, so I'll take that backwards. So bulb margins, what I -- I think the expectation we've laid out is that they are going to start out lower and that they should improve. And that they will be within the range of lighting products but probably on the low end.

And that's what I was trying to point out earlier, especially in the consumer bulb segment, just given the nature of how aggressive we're trying to be to open up that market.

That's really how we've kind of built that strategy in the near term because in addition to the fact that we're getting incremental revenue and profit, I think we can't underestimate the ability to build the brand using that product.

As far as our response to other people getting into the bulb business, what I tried to lay out in my prepared remarks is, is that I think first, it's an acknowledgment of the success Cree and The Home Depot have had in opening up this category that other people are trying to respond.

And obviously, one of the things we did with our product was offer a lower price. But I think more importantly, it's not just price. Our products -- the Cree LED bulb has as good or better performance than not only an incandescent, but pretty much anyone else's product on the marketplace, and it has a low price. And I think that's the combination.

I think it's critical -- our sense of the market and what we've seen from consumers is, if you want them to go to new technology, you cannot ask them to have a lighting product that is not as good as what they had before.

And so I think what I've seen from most of the announcements since we announced the bulb is, generally speaking, the lower-priced products also are lower performance and frankly, they're not as good as the bulb they're replacing.

So I think it's not how we view the market, and I don't think that's -- we don't think that's what really drives adoption, but that doesn't stop other people from wanting to try different strategies, and we'll see how they play out..

Just as a follow-up, I just wanted to understand, how should we think about the component gross margins as you kind of complete the transition to 6-inch over the next, say, 2 quarters?.

Component gross margins are not just 6-inch, they're not just SCQ. There are actually a lot of different factors. And so we'll be increasing the percentage of 150-millimeter not just in the next quarter but probably for the next several quarters.

Right now it's pretty much, as we add capacity, it's all 150, but we still not have the chance to go back and convert the 100-millimeter. And that probably won't happen for a while just because we're running at very high utilization rates. When I think about the opportunity in LED products, the things we control are really on the innovation side.

We believe there are ways we can reduce the cost further. So we think there's generational improvement in LED design that is both a -- that is a cost lever. And we also think there's things we can do on the technology to increase the performance, lumens per watt, which also then leads to other opportunities.

What we don't know for sure is, is obviously the market dynamics of what is going on exactly with supply and demand, what are the competitive dynamics. We don't control that piece. So as I look at it, we definitely have levers to reduce cost and increase performance.

And I think if we keep doing those 2 things, we're going to enable a larger market, and it gives us a relatively good opportunity to keep being successful in that business. Exactly what that means to margins, we don't control all the factors. So it's kind of hard to give you an exact prediction of what that looks like over the next year or so..

Our next question in queue comes from Brandon Heiken with Crédit Suisse..

I was wondering if you could clarify, you mentioned some expansion strategies. Could you elaborate further on what that maybe? And then I have a follow-up question.

And more specifically, are you considering any type of international expansion in lighting?.

Yes, when I was talking expansion earlier, I was primarily talking factory expansion to support the increased demand. So we're at high utilizations, we got to continue to invest.

Part of that is near term, right, the demand we can see just in the lighting business, both fixtures and bulb, as well as some of the targeted demand for the rest of the year. And also, trying to put ourselves in position that with products like the Cree LED bulb, it's a little hard to predict exactly what the uptake will be is.

We're only a few weeks into ENERGY STAR read [ph] -- in ENERGY STAR. We've only got us some relatively small number of stores that have rebates right now.

So exactly what that dynamic is, not only this quarter but more importantly as we get into calendar 2014 when we believe there will be additional pools of utility dollars that could be applied, we're trying to put ourselves in position there. As far as expanding the markets for our products, the LED strategy of selling components is global.

We're not changing that. As far as lighting, it's primarily a North American strategy, and I think we're going to continue to stick with that. We obviously have good growth opportunities here and right now, we want to stay focused on those.

And we will continue to do some things internationally on a much smaller scale with both fixtures, and we may even test the bulb internationally. But right now, really, the majority of that business and the focus is going to be in North America..

And do you think this OpEx increase, is this a temporary increase to take advantage of the ENERGY STAR certification? Or how do you project the OpEx to trend here over the next year or so?.

Well, so if you think about the next year, we've made a pretty significant investment. If I had to guess, we don't have targets for Q3 yet. But I would imagine it's a similar dollar, not increase, but similar actual dollar amount that we're going to spend this quarter. Now that could be up or down a little bit.

That's really the variability of what some of the opportunistic things are. And what will affect that is, if there is good utility rebates come online next quarter, we'll probably spend a similar amount as this quarter. Depending on the timing of how those things happen, it could slow down a little bit.

But I would say in the near term, similar dollar amount that we're spending in Q2. Longer term, what I would expect is, is that the revenue growth should outpace this OpEx growth.

But given the opportunity, we're in -- if you'd asked me a few months ago if we could have ENERGY STAR sooner, would I take it? And the answer is absolutely, even if we did need to spend a few more OpEx dollars to take advantage of that. So I think strategically, we're in as a good position as we could have hoped.

It's just it changes some of the things we need to do from a near-term OpEx standpoint..

Our next phone question will come from the line of Daniel Amir with Lazard..

So a couple of questions here.

First of all, in terms of the gross margins here, what should we look at really as the most important factors in the next few quarters in terms of changing of the gross margins? Is it really the product mix? Is it really the cost downs? Is it really moving to Gen 2? Is it certain product mix? And then I have one follow-up..

Yes, boy [ph], I would say that there's really, the gross margin is going to be really 3 things, right. Product mix is going to affect it.

I think at least from Q4 to -- through Q1 to our Q2 targets, I think we've demonstrated that we can add a lot of lighting business pretty fast and still deliver pretty -- actually from Q4 to Q2, I think that's actually incremental gross margin improvement and operating leverage. I think that gives you a sense of what we think is possible.

Now with that being said, there's a lot of moving pieces. But generally speaking, if we look out beyond just Q1 to Q2, because you have to keep in mind that in Q1, we had some incremental benefit in margin from licensing.

And so if you take that out, we're really doing -- I believe we're doing a pretty darn good job of adding a whole lot of lighting, both fixture and bulb, to the overall mix and actually delivering a very similar or incremental improvement in margins there. A cost down is a big thing. We have to keep doing that. I don't know if it's just generational.

We'll obviously keep working on that. But there's -- we're pretty early in these product cycles. So there's lots of cost activities that we're working on there. The third piece is the environment we are in. And then I think we're obviously rightly so focused a lot on lighting.

But what happens in lighting and what happens in the LED components business, those dynamics can affect the market either way. We've been, essentially for 2 years now, entering in a more supply. We had a -- let's see, it was a buyers market for the last couple of years in LEDs.

And I think that with the growth in the industry, we've seen that stabilized a little bit over the last few quarters; still competitive, but at least not like it was 2 years ago. And I think depending on what happens in that dynamic, it's going to have an effect on the margins as well..

Great. And the other question is just the usage of cash, another solid cash quarter here. You have more than $1 billion in cash now.

I mean, any thoughts there in terms of usage of cash?.

Well, obviously, it puts us in a great position to be able to fund the growth, whatever that would look like here. So obviously, there's the internal use. I think it's strategically. We keep our eyes open.

The challenge for us is, is that given the product pipeline and the business opportunities we've been able to generate internally, it feels like the best near-term strategy is to stay focused on taking advantage of those instead of going out and trying to buy some other opportunity in the open market.

It doesn't mean we won't look at strategic things and that's probably as the industry keeps evolving, there's likely to be some things that come along the way. But at least in the near term, the real focus is on executing the opportunity that's right in front of us..

The next phone question will come from the line of Tony Grillo with Needham & Company..

I'm calling on behalf of Edwin Mok.

So I guess to start off, focusing on the LED component business, what kind of drove growth in this segment? And then also, do you see growth coming from the Pacific region, such as China? And is there any growth here kind of baked into the next quarter's guidance?.

Yes, so if you look at -- we had significant growth in Q4, very modest growth. I think it was up only incrementally this quarter. So it was pretty similar. As we head into Q2, we have a little bit of incremental growth built in again. And what I would say right now is the unit growth is far higher than what we see at the top line level.

But we have a dynamic where there's been so much innovation from Cree and others that -- and the customer basically needs less -- or they can get a lot more LEDs today than they could a year ago for less money, right. So we're basically really increased the lumens per dollar, and so that's changed the dynamic.

So I think we're on the right track there, and you can see the health of that business in the margins. As far as the top line opportunity comes from -- we've focused on a subset of applications where we really think our LEDs, not only our high-powered but even our mid-power, our array products, where they play.

As we're able to have success in some of those applications, I think those are the growth drivers to the business. And so that's what we're focused on right now, and it's really about, keep pushing the design activity.

What I would say is that while we've had a lot of success growing the LED business, there's a whole lot more designs out there that we've won that haven't yet fully commercialized. And so I'm cautiously optimistic but again, the timing of that is hard to tell.

And so I think right now, we're just going to keep a safe strategy, keep innovating on one side and keep working new designs with the customer on the other. And, I think the market, as it grows, will eventually bring top line growth to that as well..

Okay.

And I'm sorry, did you mention growth from specific regions?.

Yes, in the region side, I would say it's been fairly -- I don’t know there's any one region that's really stood out over others. We've had some growth. If I look at -- again, this quarter, it wasn't a lot. But the previous quarter, we saw growth in North America, Asia primarily.

I think Europe for us has been probably the -- it's grown a little bit, but not as much as the other 2 regions. And I think that's just a dynamic of where we've had success with customers of really winning the design battles..

Our next phone question will come from Craig Irwin with Wedbush Securities..

Other LED bulb providers have talked a little bit about channel set reset costs as they go from first-generation to second-generation product.

Could you maybe give us a little bit of color on whether or not this has impacted your margins, your change in the channel with your key retail customer?.

No. So I think the difference is, is that when we went from Gen 1 to Gen 2 as a running change, that had an internal affect on Cree. In other words, it gave us a lower cost profile. It also made the bulb able to meet ENERGY STAR -- full ENERGY STAR specifications.

But in terms of the channel, we just rolled through the first generation and into the second. So we had kind of a -- we probably went into this knowing this was -- probably there was a lot more intentionalness [ph] to this.

And so it did not have any significant effect on our business going from Gen 1 to Gen 2 because it was really behind the scenes, other than the recent ability for Gen 2 to actually be ENERGY STAR-qualified..

Great. My second question is related to the external sourcing capacity. So it's been reported pretty widely out there that you've been buying chips from another third-party provider.

Was wondering if you could walk us through potentially how this impacts your margins, whether or not you see this as a material impact to margins, or if this is something that helps you sustain margins in some of the legacy products that are decreasing as a portion of your overall mix?.

Yes, what I would say is, one, it's not a change in strategy. I think there may be some reporting, but we've been talking about evaluating external suppliers for at least the last couple of years. So -- and it's really a second-source strategy. It's relatively incremental piece of the total.

And it's just an opportunity for us to utilize our capacity on the more high-end products and leverage suppliers where it makes sense, especially as we get into what I'd say products that are maybe wasn't had release for a while where we can access chips that now solve that problem versus pushing our chips to kind of that next-generation place.

So there is not a significant new change in our use of external suppliers. It's something we've been doing for a while. It's just something that I think people have recently become more interested in. What does it do to margins? It's part of the overall mix. It's not a big swing factor one way or another.

It's more -- I think Jed mentioned earlier, it's more of an opportunity for us to -- it's some capital avoidance and flexibility in supply, honestly..

Our next questioner in queue comes from the line of Mehdi Hosseini with SIG..

Chuck, it seems to me that there is a material change in the strategy with you putting more focus on the consumer segment, especially given The Home Depot and the like channel.

Can you please help me understand, how do you see the overall LED market mix between commercial and consumer? Because I'm still under the impression that commercial still accounts for the majority of the market?.

Yes, so the market opportunity has not changed. And we've been pretty clear about that probably for the last 5, 6, maybe going on 7 years. The biggest market for LED lighting is commercial lighting. It's just the biggest market for lighting. It's 75%, 80% of all lighting is in a commercial, industrial, municipal-type application.

The consumer is a much smaller segment of the market. As far as our change, we've been talking since we launched the bulb, one of the things we said is the bulb is a means not only to sell to consumers but also to build a brand.

And what we've found, and this is something we said last March when we announced the product and it's proven to be very true, is that while we were able to move some of the commercial markets, because the consumer wasn't involved, with the bulb, we've been able to engage a much broader part of the population into a conversation about LED lighting and getting people to think about why do you still use that old energy wasting, frankly, money wasting technology.

And so the bulb has become and the consumer market has become both an incremental revenue and profit opportunity. But really, and as well as a brand opportunity for Cree, it's also become a way to really drive the conversation about LED lighting generally in adoption.

So I think you can see not only in our consumer sales but just an overall awareness of LED lighting, as the consumer becomes more involved, we're shifting that dynamic, which I think is very healthy for Cree and others. But if you want to look at the big picture, at the end of the day the bulb is -- I mean, it's funny.

The bulb is a relatively small part of the overall market. Yet at the end of the day, there's 5 billion sockets, I think, in North America alone. So it's relatively small, but it gives you some sense of how big the lighting opportunity is.

And that's why earlier, and it may have been when I was -- it was -- having trouble talking during the prepared remarks, but today there is -- I think the DoE just came out and looked at in the United States, despite all the commercial fixtures and all the bulbs that have been sold by Cree and everyone else, less than 1% of the sockets in are currently LED-based.

And so what I think you've got to keep in mind is, is that the 2 parts of the market work together. It's part of our strategy to drive adoption, be a leader, build brand. But both of them are big opportunities given where we stand today..

Got it. And then my second question has to do with the leverage. When I look at midpoint of the Q2 guide and compare it on a year-over-year basis, it seems like revenue and SG&A growth was pretty much similar. And you said a few minutes ago that eventually, the leverage come in.

Can you please elaborate on the timing, what does eventually mean? Is that going to take more than a year to see revenue growth faster than SG&A, or is it a matter of quarters? Help us understand what you mean by eventually..

Well, so -- I mean, I -- I'm not sure what comparison you're doing because if I look at what the operating income was a year ago to today, I see pretty darn good operating leverage. I want to say -- and Mike maybe has the numbers in front of him. But I think last quarter, we came in right around 15%.

What was it a year ago, Mike?.

So a year ago, it was under 14%. 13.7%..

The operating income?.

Yes..

So I think we have seen some year-over-year. And so I think we are seeing it even though we're making pretty darn big investments, right? So the thing to keep in mind is, is that we are building a branded consumer business and growing revenue and trying to get operating leverage at the same time.

We're having, essentially, 2 big investment strategies at the same time, and I think what we're showing is you can do both. So I think we are making good progress and getting those other benefits, which are top line and frankly, are some of the things, I think, will pay off later, which is brand..

Our next questioner in queue comes from the line of Harsh Kumar with Stephens Inc..

This is Richard in for Harsh. So I think you touched about it earlier, but just kind of wanted to get a sense and some more color on the competitive landscape and how your outlook on the supply and demand dynamics going forward..

Are you speaking about LEDs or the lighting business more?.

More on the component side..

Yes, so what I would say in components is the competitive dynamics there have -- yes, I would say they've been pretty similar for the last few quarters. It has not changed dramatically up or down, and the words I like to use are it's competitive but not the point it was maybe going back 1.5 years ago.

So pricing continues to -- and there's lots of bidding, so it continues to trend. But at the same time, it seems to be a little more rational than it would've been 4 to 6 quarters ago. So I think that a -- it's a dynamic that we and the rest of the industry has kind of built into their model.

As far as what that means going forward, it's kind of hard to tell right now, I'd say. I think that's a function of what happens from a technology standpoint and also what other people do from an investment standpoint..

Great.

And then my follow-up is looking at gross margins, looking more on the lighting side, what initiatives are underway in order to get the lighting gross margins more in line with the corporate average?.

Well, it's a combination of some things we're doing from a cost reduction standpoint. You saw pretty good progress last quarter, I think -- I forget what it was. But it was probably 180 basis points, maybe close to 200 basis points quarter-to-quarter.

That's really a function of getting cost reductions in some products like the bulb, but also getting some of the new fixture products starting to ramp up. Those are the 2 kind of levers we have. And so it's more of the same. We're going to keep working on cost reductions.

But really, as we introduce new products, getting the next-generation product out into the market is where we see the opportunity to get some additional leverage there on that side of the business..

And presenters, we do have time for one additional questioner. Our final question in queue will come from the line of Mark Heller with CLSA..

Chuck, I just had a question on growth. We are approaching the theoretical demand inflection point for LED lighting. Growth, though, in the calendar fourth quarter, midpoint of guidance about 5%. Looking out at the previous 2 years, we've always seen double-digit growth. December 2012, we saw 10%. December 2011, 13% growth.

Why isn't growth accelerating at this point?.

Mark, so 2 things. One is, is the LED business, the component side of the business, that is something we're not seeing a lot of top line growth in right now. So we have to keep in mind, the biggest product line right now is growing in units but not in revenues.

So while that it's very healthy from an overall financial standpoint, we're not seeing the top line there. As far as the fixture business, we're seeing pretty solid growth both in bulbs and in fixtures this quarter. I think we're also seeing some of the dynamics of how fast do big chunks of business turn on.

And so in bulb, that's a function of getting the product launched, getting it out in the market and building that momentum. And in fixtures, it's really -- we have a pretty unique strategy. We pick certain product categories and try to do really innovative things there.

And we tend to sell them both through the traditional but a lot of nontraditional channels. So that business tends to come in chunks when those applications turn on. And I think the dynamic we're seeing there is that it's essentially a rate of new products being designed to those new applications.

But from a lighting standpoint, we're pretty pleased on the sequential growth that we're seeing there on both sides of that business right now..

Okay.

And as a follow-up, in terms of the gross margin improvement in the lighting segment in the September quarter, can you just give us some -- or quantify how much came from the bulb redesign versus mix from higher fixture sales?.

I don't have the breakout. I'd say that the 2 big drivers, but I don't have a specific percentage breakout. But if you attribute most of it to those 2 things and assume they're both fairly sizable, you get the right idea. But I don't have a specific breakout for you..

Thank you, presenters. And that does conclude our time for questions. I'd like to turn the program back over to Mike McDevitt for any additional or closing remarks..

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

Good night. Thank you..

Thank you, presenters, and thank you, ladies and gentlemen. Again, this does conclude today's call. Thank you for your participation, and have a wonderful day. Attendees, you may now all disconnect..