Raiford Garrabrant - Director, IR Chuck Swoboda - Chairman and CEO Mike McDevitt - CFO.

Mark Strouse - JP Morgan Jonathan Dorsheimer - Canaccord Genuity Mike Ritzenthaler - Piper Jaffray Edwin Mok - Needham & Company Jermaine Brown - Deutsche Bank Mark Heller - CLSA Harsh Kumar - Stephens Sven Eenmaa - Stifel, Nicolaus Jeffrey Osborne - Cowen and Company Andrew Charles Hahn - Bank of America Merrill Lynch Mehdi Hosseini - Susquehanna Financial Group.

Good day ladies and gentlemen, and welcome to Cree Fiscal Year 2015 First Quarter Earnings Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference call is being recorded.

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

Thank you, Patrick and good afternoon. Welcome to Cree's first quarter fiscal 2015 earnings conference call. By now you should have all received a copy of the press release. If you did not receive a copy, please call our office at (919) 287-7895 and we will be pleased to assist you.

Today, Chuck Swoboda, our Chairman and CEO; and Mike McDevitt, our CFO, will report on our results for the first quarter of fiscal year 2015.

Please note that we will be presenting both GAAP and non-GAAP financial results in our remarks during today's call, which are reconciled in our press release and posted in the Investor Relations' section of our website at www.cree.com.

Today's presentations include forward-looking statements about our business outlook, and we may make other forward-looking statements during the call.

These may include comments concerning trends and revenue, gross margin and earnings, plans for new products and other forward-looking statements indicated by words like anticipate, expect, target and estimate. Such forward-looking statements are subject to numerous risks and uncertainties.

Our press release today and the SEC filings noted in the release mention important factors that could cause actual results to differ materially. Also, we'd like to note that we will be limiting our comments regarding Cree's first quarter of fiscal year 2015 to a discussion of the information included in our earnings release.

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

The presentations and the recording of this call are copyrighted property of the company, and no other recording, reproduction or transcription is permitted unless authorized by the company in writing. Consistent with our previous conference calls, we'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 analyst limit themselves to one question and one follow-up. We recognize that other investors may have additional questions and we welcome you to contact us after the call by email or phone at (919) 287-7895.

We're also webcasting our conference call, and a replay will be available on our website through November 4. Now, I would like to turn the call over to Chuck..

Thank you, Raiford. Fiscal Q1 revenue increased 9% year-over-year to $428 million, but declined 2% sequentially as strong growth in LED Lighting and Power and RF was more than offset by 13% sequential decline in LED products.

Non-GAAP net income decreased 42% sequentially to $30 million or $0.24 diluted share, due to lower LED revenue which resulted in lower gross margins. These results were below our original targets for the quarter.

The sale trends for Q1 were as follows; Lighting revenue increased 51% year-over-year and 7% sequentially to $223 million, driven by strong growth in LED fixtures and LED bulbs.

LED revenue decreased 20% year-over-year and 13% sequentially to $174 million, due primarily to lower global LED demand from both direct and distribution customers with our China business declining the most. Power and RF revenue increased 24% year-over-year and 8% sequentially to $31 million driven by higher sales of power devices.

Q1 non-GAAP gross margin decreased to 32.4%, due primarily to a lower mix of LED sales, a higher mix of lighting sales, and lower gross margin within these two segments.

The gross margin trends were as follows; Lighting segment margins declined to 24.9%, driven by a higher mix of LED bulb products, a less favorable mix within LED fixtures and lighting factory execution challenges related to our growth.

The mix is targeted to shift more favorably back to fixtures in Q2 while lighting factory productivity is forecast to improve over the next several quarters.

LED segment margins declined to 39%, driven primarily by weaker LED demand which resulted in higher revenue reserves to reflect the more aggressive LED pricing environment and higher inventory reserves related to the factory over build. Power and RF segment margins decreased to 57.6% due to a more favorable product mix.

Q1 non-GAAP operating expenses declined sequentially, but not enough to offset gross margin. As a result operating margin declined to 8.2% in the quarter. During the quarter, we spent $68 million on capital projects and $54 million on share repurchases which was partially offset by $13 million in operating cash flow.

We target lower inventory levels and reduced capital spending in Q2 as we reduced the LED factory production rate which should support higher free cash flow over the next several quarters. Company backlog for Q2 is similar to this point last quarter as continued weakness in LEDs is offsetting higher lighting backlog for the quarter.

The LED competitive environment is currently very challenging, especially in lighting applications where mid-power and high-power LEDs compete for designs. There is a lot of available mid-power LED capacity chasing customer designs at very low LED margins.

We believe this market will rationalize over time as the LED semi-cycle matures and capacity is more fully utilized. When that will happen is difficult to forecast, however, we believe that our LED technology delivers fundamentally more lumens per wafer which positions Cree for long-term success.

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 2015..

Thank you, Chuck. I will be providing commentary on our financial statements on both the GAAP and non-GAAP basis which is consistent with how management measures Cree's results internally. However, non-GAAP results are not in accordance with GAAP and may not be comparable to non-GAAP information prepared by other companies.

Non-GAAP information should be considered a supplement to and not a substitute for financial statements prepared in accordance with GAAP. A reconciliation of the non-GAAP information to the corresponding GAAP measures for all quarters mentioned on this call is posted on our website along with a historical summary of other key metrics.

For the first quarter of fiscal 2015 revenue increased 9% year-over-year and declined 2% sequentially to $428 million which was below our targeted range of $440 million to $465 million.

GAAP earnings decreased 64% year-over-year and 63% sequentially to $11 million or $0.09 per diluted share and non-GAAP earnings decreased 38% year-over-year and 42% sequentially to $30 million or $0.24 per diluted share.

Non-GAAP earnings exclude $19 million of expense net of tax or $0.15 per diluted share from the cost of acquired intangibles, asset retirement charges, and stock-based compensation. Q1 GAAP gross margins were 31.8% and non-GAAP gross margins were 32.4% which were below our target ranges.

Non-GAAP gross margins exclude $3 million of stock-based compensation.

Fiscal 2015 first quarter revenue and gross profit for our reportable segments were as follows; Lighting products revenue grew 7% sequentially and 51% year-over-year to $223 million and GAAP gross profit decreased 8% sequentially to $55 million, for a 24.9% gross margin which was a 420 basis point decrease from last quarter.

LED products revenue declined 13% sequentially and 20% year-over-year to $174 million and gross profit declined 25% sequentially to $68 million for a 39% gross margin which was a 610 basis point decrease from last quarter.

Power and RF products revenue grew 8% sequentially and 24% year-over-year to $31 million and gross profit grew 10% sequentially to $18 million for 57.6% gross margin which was a 70 basis point increase from last quarter.

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 $5 million for the first quarter of fiscal 2015 and are included to reconcile to our $136 million GAAP gross profit.

Operating expenses for Q1 were $124.5 million on a GAAP basis and $103.5 million on a non-GAAP basis. Non-GAAP operating expenses were $4 million lower sequentially and $4 million lower than target due to lower LED sales commissions and lower discretionary spending.

Non-GAAP operating expenses exclude approximately $14 million of stock-based compensation expense, $6 million for amortization of acquired intangibles and for asset retirement charges. The asset retirement charges relate to early retirement of certainly building and building and equipment as part of our planned infrastructure expansion.

The non-GAAP adjustment represents incremental depreciation expense related to the reduced asset used for lives. Our non-GAAP operating income declined 39% sequentially to $35 million, and our operating margin decreased to 8.2%. Net interest income and other for the quarter was $2.9 million.

Our Q1 GAAP and non-GAAP tax rate was 22.5% which was slightly higher than our 1.5% target for Q1 primarily due to higher mix of U.S.-based profits in the quarter. We ended the quarter with $1.1 billion in cash and investment, a $58 million decrease sequentially.

The sequential decrease was due to $68 million of capital expenditures and $54 million for the repurchase of 1.2 million Cree shares which were partially offset by $13 million provided by operations and $35 million drawn on our line of credit within the quarter.

While Q1 free cash flow was negative $55 million, we target positive free cash flow for Q2 due primarily to reducing our working capital balances and lower capital spending. Our targeted working capital improvement will be primarily driven by reducing our LED factory production to reduce our inventory levels to a line with near-term LED demand.

Days sales outstanding was 50 days compared to 46 days at the end of June, and in line with 50-day plus or minus target range. Inventory days increased to 96 days as compared to 94 days at the end of June, which was on the high side of our 90-day plus or minus target range.

Our inventory growth is primarily due to the factory overbuild in LED products due to the weaker than forecasted LED demand in the quarter. Property, plant and equipment additions were $63 million and patent additions were $5 million in the first quarter. The capital additions were primarily capacity related to projects started in fiscal 2014.

With our revised LED products outlook, we're reducing our LED factory capacity investments, however, we target continued investment for infrastructure projects to support our longer term forecasted growth for fiscal 2016 and 2017. As a result, we target property, plant and equipment spending to be $200 million plus or minus for fiscal 2015.

The amount we invest in -- fiscal 2015 will vary based on actual demand. At this time, we target Q2 revenue in the range of $400 million to $420 million which is comprised of single-digit growth in Lighting sales with strong LED fixture growth partially offset by lower LED bulb sales.

LEDs, they owned approximately 12% sequentially due to lower overall demand and channel inventory reductions and Power and RF are in a similar range to Q1. We target Q2 non-GAAP gross margins to be 33.5% plus or minus and GAAP gross margins to be 32.6% plus or minus.

The Q2 non-GAAP gross margin target represents 110 basis points increase sequentially due primarily to more favorable mix of LED Lighting sales and Lighting factory execution improvement. This Q2 target is based on a number of factors that could vary including overall demand, product mix, factory execution and a competitive environment.

Our GAAP gross margin targets include stock-based compensation expense of approximately $3 million, while our non-GAAP targets do not. We’re targeting Q2 operating expenses to increase approximately $2 million plus or minus from Q1 due primarily to incremental sales experienced associated with higher fixtures revenue and incremental legal spending.

As a result, we target Q2 operating profit and margin slightly lower sequentially. Our GAAP operating expense targets include approximately $14 million of non-cash stock-based compensation expense, $6 million for amortization of acquired intangibles and $1 million of asset retirement charges. Loss on disposal of assets is targeted to be similar to Q1.

Net interest income and other is targeted to be approximately $2.7 million for Q2. We target our Q2 in fiscal 2015 tax rate to be 22.5%. The Q2 tax rate is the same as Q1 as we target a higher percentage of U.S. earnings for fiscal 2015 due to a higher mix of Lighting sales.

As a reminder our Q2 and fiscal 2015 tax rates will fluctuate based on our overall earnings, the tax jurisdictions in which our income is actually earned and the potential reinstatement of the U.S. R&D tax credit and other tax benefits that may or may not become available to Cree in future periods.

GAAP net income for Q2 is targeted to be between $6 million to $10 million. Based on an estimated 120 million diluted shares outstanding, our GAAP EPS target is between $0.05 to $0.09 per diluted share. Non-GAAP net income is targeted to be between $24 million to $29 million or $0.20 to $0.24 per diluted share.

Our non-GAAP EPS target excludes amortization of acquired intangibles, asset retirement charges and non-cash 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're focused on four priorities to drive our business in fiscal 2015. Our first priority is to leverage Cree technology to lower upfront customer cost and further improved payback. As we have demonstrated many times in the past, innovation is the key to leading the market, creating new value for our customers and driving growth.

While we can't control the competitive environment, we can certainly shape it to our advantage by developing LED technology that sets new performance standards in the market and shift the balance towards high power lighting application.

The semiconductor business has been defined for almost 50 years by a principle of innovation known as Moore's law that led to doubling transistors per wafer every two-year. The same principle applies to the LED industry in the form of increasing lumens per wafer.

We believe lumens per watt will dictate which companies will win over time as they are able to continue to invest in the capacity and R&D to compete instead of just filling their factories in the short term.

With our relentless commitment to the long term success of LED Lighting, we have been investing in LEDs like the XLamp XP-L which is 50% brighter than our previous generation. This investment is starting to pay-off in new customer design.

Looking ahead, we are developing the next generation LED technology platform that will enable Cree to redefine high power LED performance. This new platform more than double the lumens per LED incorporating significant advancement in epitaxial structure, chip architecture, and an advanced light conversion system.

The first products based on this platform are targeted to be announced in the near future with initial samples available later this quarter and the first production devices shipping in fiscal Q3.

While it will likely take a few quarters to work through the design cycle with these new products and rebuild momentum in the LED business, we are confident that we will continue to win with our market leading family of high power LEDs. We are also continued to lead and innovate LED Lighting system.

We have recently announced the ZR high efficiency troffer which is the first commercially available 150 lumens per watt LED troffer in the market. This product utilizes Cree TrueWhite Technology and reduces energy consumption by 70% when compared with traditional fluorescent troffers and is fundamentally more efficient than competing LED products.

We are also developing a next generation consumer LED bulb that delivers even better light, looks even more like a regular light bulb and at a price that gives even more people a reason to switch to LED. Our second priority is to continue to drive LED Lighting growth and build the Cree brand in both the consumer and commercial markets.

The LED Lighting business grew 7% sequentially and 51% year-over-year in the first quarter which was on the upper end of our target range for this segment. Lighting fixture revenue was in line with our growth expectations as we saw good progress in multiple sales channels driven by the success of our new products.

Our goal for the past several years has been to get customers to consider LED Lighting instead of energy wasting traditional lighting products that often contain toxic hazards like mercury found in many fluorescent lamps.

Now we're shifting our focus to educate customers on Cree's ability to fundamentally improve their overall lighting environment often at price parity with conventional lighting.

We are focused on continuing to innovate and set new performance standards for LED Lighting which we believe is key to driving our Lighting growth and broad LED adoption over the next several years.

LED bulb shipments were higher than our targets in Q1 as our retail partner shipped some demand from Q2 into our fiscal Q1 to support their stocking requirements for the fall lighting season. We forecast that our partner will start to reduce their inventory to normal levels towards the end of the calendar year as lighting season slows down.

LED bulb and customer sell-through is trending higher in Q2, however demand is subject to consumer buying trend, rebate availability, competitive pricing trends, and the success of our next generation bulb release.

Our third priority is to expand our work with manufacturing partner to enable growth in LEDs and Lighting and allow Cree's factories to focus on the newest technologies that are not otherwise available in the market. We announced last month that Cree has entered into an agreement to make an investment in Lextar for the supply of mid-power LEDs.

While there is currently available supply in the market, we believe this relationship will be important to support the longer term needs of our Lighting business. This approach also provides the operational and financial flexibility to help Cree achieve the best returns on our people and invested capital.

Lextar shareholders recently approved this investment and we expect the transaction to close by the end of our fiscal Q2. Our fourth priority is to generate incremental operating margin to revenue growth and incremental operating leverage across the business.

The Lighting and Power and RF product lines are growing, but this has been offset by the decline in sales of LED products. While we remain optimistic about the long term growth prospects for LED driven by increased LED Lighting adoption, we are going to have to manage through the near term challenges in our business and the overall LED market.

We reduced operating expenses in Q1, but remain committed to making investment in sales, marketing and R&D to drive long term growth. Cree has been through these cycles several times over the past decades and we believe we can manage the business to similar levels of operating margin over the next few quarters.

Longer term, we believe growth in the Lighting business will offset the slowdown in LED revenue to deliver incremental operating profit. We have built the tremendous IP portfolio over the last 27 years and we recently filed two patent lawsuits against LED suppliers.

We believe the near-term investment in legal cost will support future revenue and earnings growth from a combination of incrementally better LED product margin and LED licensing income.

These cases typically take one or two years to run their course, but we believe that they will be important in n reaffirming the value of our intellectual property in the market and in our financial results.

As I mentioned earlier, Q2 total company backlog is similar to this point last quarter, as stronger Lighting backlog is being offset by lower LED booking. Our LED component customers and distributors continue to operate on short lead time. Facility utilization has declined, which hurts margins, but improves our ability to respond the customer needs.

Execution continues to be a critical factor as we adjust to the changing demand requirement. The low LED visibility adds variability to our forecast for the quarter.

Based on our current backlog, forecast and trends in the business, we are targeting Q2 revenue in a range of $400 million to $420 million, which is comprised of Lighting sales up single-digit as higher LED fixture sales are partially offset by lower LED bulb shipment.

LED sales down approximately 12% due to lower overall demand and channel inventory reduction, and Power and RF in the similar range. We target non-GAAP gross margins to increase in Q2 to 33.5% plus or minus, due primarily to Lighting margin improvement from a more favorable product mix and factory productivity improvement.

We target non-GAAP operating expenses to be slightly higher as we fund our IP licensing strategy and have incremental sales expense associated with the targeted fixture sales growth. Our tax rate is projected at 22.5% and as a result we target non-GAAP earnings in a range of $0.20 to $0.24 per diluted share.

Please note that our non-GAAP targets exclude amortization of acquired intangibles, stock-based compensation expense, asset retirement charges and the related tax effects. The challenge facing our business in the near-term is lower LED revenue and margins.

However, lower LED revenue combined with recent productivity improvements and innovations in our chip factory have created available capacity to support future growth and significantly reduce our capital equipment needs for the balance of fiscal 2015.

With the upcoming release of our new LED technology platform, I believe we'll see good design win momentum in LEDs later this fiscal year. At 39% gross margin, we still have one of the most profitable LED businesses in the industry and a significant competitive advantage to win over the long term.

Revenue growth is on track in Lighting and up 51% year-over-year and I am confident that we will able to make factory productivity improvement over the next several quarters. As a technology company, we continue to innovate to enable growth in each of our business segments.

The market for LED Lighting is still in the early stages and largely untapped in terms of installed lighting sockets. We believe we are on the right track as evidence by our continued share repurchases in Q1 and we target more significant repurchases in Q2.

The strength of our balance sheet gives us the flexibility to buyback shares and continue to make investments to support our goal to grow the business and increase operating margin over time.

Our game changing technologies and new product pipeline are set to once again raise the bar for the industry and combined out brand momentum gives us great confidence in achieving our long-term customer goal of 100% upgrade to LED Lighting. We will now take analysts' questions..

(Operator Instructions) Our first question comes from Paul Coster with JP Morgan. Your line is open..

Yeah, hi. This is Mark Strouse for Paul. Thanks for taking our questions. So I think we just wanted to talk about the visibility that you guys have. Just I think this is the first quarter at least since we've been covering the stock, that you have come in below your initial guidance expectations.

I was just wondering if there is anything that is changing in your -- in your modeling approach, your forecasting approach, and really, if you look at the range for next quarter the 20 million -- yeah, $400 million to $420 million range, historically t has been $20 million to $30 million or so, so what kind of gives you the confidence to go out kind of towards the low end of your historical end spread there.

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Yeah, Mark, so in terms of target, if you look at what happened last quarter, the big delta to what we expected is in LEDs and that really came from general softness in demand that we did not see at the beginning of the quarter.

And if you look at some of the other commentary in the industry, it was really an evolving story as you got to the middle or later parts of our fiscal Q1. In our case the primary decline was in China. Although, we saw it in all of our segments, that's where we had the biggest delta to what we originally forecast.

So I would say that as we look to this quarter, we are targeting right now. We have revenue targets that are lower than what we had for last quarter. We have similar bookings to this point last quarter. So from that standpoint, we have positive view of the Lighting business and still low visibility in LEDs.

And the other thing in LEDs is we also are targeting that. We would expect there may be some channel inventory reduction as well on the LED side this quarter. So we are trying to factor that in. So I think given our backlog, we have tried to factor in all the different variables for this quarter.

And so I think it’s our best estimate to what we think is likely to happen and given the fact there is low visibility at LEDs factoring some of that risk into it as well. .

Got it. Excellent. Okay. Thanks, Chuck. .

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

Hi. Thanks for taking my question.

I guess with respect to the Lextar deal, Chuck, you know, I hear you in talking about how you want to maximize the lumens per wafer, but it would almost seem like the decision or the actions to make the investment, whether this is strategic or merely a hedge between high power and mid-power, doesn’t really support what you are saying or may be you could help clarify because it doesn’t seem to me support what you are saying with trying to drive the lumens per dollar, I guess with your high power solution.

.

Yeah, Jed, the way we look at is really two separate parts of the market. So there is one that is technology driven where we think that lumens per wafer is a factor. Things we are working on with our new platform, we think we can really redefine high power.

So we are high power LEDs overall optical system performance, system costs are driving factors, we think there is absolutely a place for that drive. I think on the mid-power side what we are saying is that we recognize there is some applications today especially ones where the light is relatively spread out. That is an appropriate solution.

I think the subtlety that maybe isn’t coming through in my commentary is that I think both markets will be driven by lumens per wafer in the long run, but the fact is that as long as there is excess supply there is a mid-power market that makes it more appropriate to address it.

So I think we are actually trying to invest for the future in high power where it matters today and recognize that with excess mid-power capacity there is a way to access some fairly low cost short term capacity.

I think that where the risk hedge that we are making is, is that I don’t think long term that companies that sell at the current margin will have the capital to reinvest in their business. And so I think that's why when you look at the business over a five, 10-year period or we have been measuring lumens per wafer for the last 12 years.

It will be that long trend will be defined by those that can make enough money to reinvest and that's why I think. In the end when we look back on this industry that metric will be one of the key drivers. .

That's helpful. Thank you for clarifying. I guess just as a follow-up.

So with that in mind, in this transitional phase, it would seem then that barring a major pickup in high power in the marketplace, that the LED business -- LED segment of your would largely be contracting to the point where it’s primary a captive supplier to Cree for your Lighting product, is that correct way to look at that?.

Not at all. I think that we are seeing even with some of the products like the XP-L those are having good success in the external market.

I would -- right now, if you see our targets for Q2, I would imagine that there is still a significant market for high power LEDs that will be important not only for Cree internal customers, but for our external customers. And so when spoke of design win, those are actually at external customers right now.

That's what I think is the -- I think there is a significant portion of the market where high power will continue to be a better design option for the foreseeable future. It may not be the whole market. It’s a subset of overall Lighting. And now with the LED business has, you know, fundamentally it’s about a third of the size it was six quarters ago.

I think we are in much better position to focus on those high power customers. .

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

Yes. Good afternoon.

How poor is the visibility in the LED products business right now compared to the recent two or three quarters? And I guess, you know, the spirit of the question what gives you the confidence that gross margins could be 100 basis points higher sequentially given that visibility challenge?.

So, as we mentioned earlier our targets were built around LED being down around another 12% in Q2 from Q1 plus or minus. So that gives you an idea that we are factoring in the lower visibility into lower LED targets.

When you add that up and combine it really on the Lighting side with what we're targeting within a better mix within Lighting and better execution, that's why we believe, we can even with the lower LED revenue deliver incremental gross margin improvement for the company and its really coming out of the Lighting segment..

Okay.

And then how does -- this is more of a philosophical question is how much does Cree's valuation influence the decision-making process on things like M&A in terms of what you're targeting and valuations that you're looking at?.

Well, I'm not sure -- I think it probably affects how you would do M&A more than what we would do, right? So, depending on valuations you're going to look at a different mix of equity debt, cash and other vehicles.

I think right now we continue to think there's going to be good opportunities over time here, but it's more likely that we'll probably be more focused at these price levels on cash or debt-based deals than we would using our equity at least in the near-term..

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

Hi, thanks for taking my question and sorry about noise.

So, first question I guess on the Lextar deal, was the deal expected to close end of this year? How much incremental revenue you expect to generate from using LED chips? And I guess if you look longer term like a year or two, how do you kind of think your mid-power to high-power mix could become as we look longer term..

We're not targeting any increment revenue from Lextar. We really view Lextar as a manufacturing partner to support really our internal needs within our Lighting business for mid-power. So, it's more of a supply partner, manufacturing partner approach, than it is to really change our overall revenue.

So, we've been, as I mentioned last quarter, we've had programs to work with partners in the past, but in this case, we wanted a more strategic relationship with Lextar to really build on that for the long-term.

Obviously, the deal won't close until the end of the quarter and I think over time, they will become one of the key partners as we look to focus our factory on the high-power LEDs where we really differentiated and utilized Lextar and other manufacturing partners for LEDs that are available in the market..

Great, that's helpful. And then question on LED gross margin. Actually if I look at your guidance, you kind of imply that your LED gross margin probably get to kind of say the high 30's percentage, right? And if I went to look at the last two cycles, it top bottom at mid to high 30s, right.

So, you're not that far away from what we've seen on the bottom of the last two cycles.

Is that the right way to think about where your margin can trend, as in we’re approaching the bottom, or do you think that the industry has fundamentally changed because of this increased demand in mid-power, any kind of color you can provide around that?.

Well, first in keep in mind our gross margins aren’t like the rest of the industries. They're fundamentally higher than most people out there. So, we're already operating in different segment than the most typical suppliers in LEDs.

So, -- but what I would say is that our Q2 targets what we would estimate is that the margins in Q2 will be similar plus or minus some variability with Q1 assuming that the revenue comes in where we're targeting. As far as what that looks like beyond Q2, it's pretty hard to give you any further guidance.

We don't have any great order of visibility right now. So, I think the key to that business over time is the new technology platform coming on line and driving those next generation designs.

What we've seen in the past is when we're able to bring a new platform to the market, if you give it about over the next three to six quarters, we should see some fairly good momentum and if what we do is make our customers' product better, we tend to win a lot more designs..

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

Hi, this is Jermaine in line for Vishal. Thanks for taking our questions.

You were the -- just talking about some new product introduction on the Lighting side, particularly for the consumer bulb, how much of the incremental margin improvement would you expect to pass along to the consumer versus keeping and hope to raise second margins?.

Yeah, I think in Lighting most of the improvement that we're targeting is actually coming out of the fixture business both from mix and from a better execution. I think within bulb -- we have a next-generation bulb that's coming. That really will only start to ramp up in Q2. It will have a bigger effect on Q3.

And what I would say right now is, is it's somewhat in the short-term margin neutral. It's getting a better product to drive more adoption and trying to get to a price point that expands the market right now. So, we're still in build the market mode. I do think over time that that starts to shift, but probably not in the next few quarters..

Okay, that's helpful.

And also on the CapEx side, as you guys have changed your investment plans, do you see that as longer term something that as you can maintain given the improvements that you're seeing, or would you expect to have to add a lot of capacity maybe next year?.

Yeah, so obviously with the current visibility, it's hard to give you specifically for next year, but just generally speaking, we've already shifted the CapEx for this year, anything that's LED or lighting or lighted, is primarily long-term. So, we're planning for FY 2016, FY 2017, infrastructure type investments.

As far as equipment goes, I think we have with both technology improvements and the investments we have in place now, we have bought ourselves a bit of headroom to grow especially on the LED side and support -- revenue growth with relatively low CapEx at least for the foreseeable next -- probably four to six quarters and maybe beyond.

The other thing is that with our strategy of using partners we'll probably also buy ourselves some additional flexibility, but it will be a little premature to give you guidance.

I think generally speaking, at least for the next few quarters, I think we're in a good position and I do think that what we're building is a business model that lets us be less capital-intensive as we grow going forward..

Our next question comes from Mark Heller with CLSA. Your line is open..

Thanks. Quick question, can you just tell us what the chip utilization levels were in the third -- the September quarter, and what you're thinking for the December quarter.

And also when do you expect inventory levels to sort of normalize?.

Yeah, so, Mark, I don't have specific numbers. They came -- they were down in Q1 and they were -- they are currently planned to be down further in Q2. That's what we've built into the model that will -- but I don't have a specific capacity utilization. Let's leave it as we got some reasonably upside right now to support good customer demand.

And -- but if you think about what happened in Q1, while we built more inventory than we wanted, we also had a higher inventory reserves so that offset whatever gain would have got from that. That's why our targets are similar in Q2.

The idea is that although we had more volume in Q1, we also had higher reserves and as we slow the factory down, we’ll reduce the inventory -- start to reduce the inventory dollars which will also reduce the reserve impact we saw in the previous course. So, it's a wash between the two quarters..

Okay.

And back on your China-related comment, do you think this is -- sort of indicates a broader demand issue or do you think it's more Cree-specific?.

So, what we're seeing in outdoor demand in China we're seeing a demand problem. So, I think that as I look across the applications and I look at the business that we targeted that didn't happen, its business that just didn't happen. The projects didn't happen as were expected.

This is not -- at least in the examples we've gone through to look at last quarter, it's not a share gain in China, it's more of a high-power outdoor business that we were targeting didn't happen because those projects weren't there.

And I do think there's a general -- if I look across Cree, if I look beyond Cree to some of the other suppliers that are out there that are more on the mid-power side, they're also having a fairly conservative view.

I think most people that I've seen recently that are reporting and targeting, especially if you look at the chip side which is probably the leading indicator, they're targeting lower demand, and what is calendar Q4, our fiscal Q2, than they did in the previous quarter.

So, I think the broader demand trend is something we're seeing from several other companies right now, so I would put it more on the market..

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

Hey Chuck I think you sort of just touched up on the question I was going to ask about what happened in the quarter. So, if the projects didn't happen I would have expected your revenues to take a hit, which they sort of did. But I'm also trying to triangulate on the sudden decrease in gross margin on the chip side, or the LED side of the business.

Is there a competing product that's out there that's pressuring you, or what happened suddenly to make the margins go down so much..

So, Harsh, what happens is that essentially when you have lower demand, then what we do is we get more aggressive and so you end up with a lower pricing environment, and at the same time, you also now have an inventory build.

So, it hurt revenue from a demand standpoint, but also with the pricing environment and the inventory we had higher reserves to take into account the lower pricing and we had higher inventory reserves to adjust for the fact that we overbuilt in the factory.

So, those two things kind of basically -- those adjustments, while the correct given the current demand situation is what moved the margins that quickly..

Okay. Fair enough. That's helpful.

And then in terms of the factory production issue that you're talking about on the -- I believe it's on the fixture side, Chuck, could you maybe talk about what is going on there, what happened that you're trying to fix this -- so you're hoping to fix this quarter?.

Yeah, Harsh, so -- we got a Lighting business that the entire business is up 51% year-over-year and I think that simplest way to say it is growing pains. So, you have -- we're trying to expand labor, we're trying to add shifts.

We're getting into various supply chain challenges as we scale up that business and I think we've done a really good job over the last year keeping up with it. And last quarter I think the execution on average we had too many things that didn't happen that we were planning on.

So, there are things we have seen before, things we dealt with, we just have to go out now and fix them. So, I think they're pretty straightforward execution issues. We just got to go do it..

(Operator Instructions) Our next question comes from Sven Eenmaa with Stifel. Your line is open..

Yes, hi. Thanks for taking my question. First, I wanted to ask in terms of the incremental margins in the Lighting business, how should we think about that? I understand there is a factory efficiency component and results of scale component.

Could you quantify please?.

Yeah, so what I would think is there's actually a mix, so we're going to get a benefit by having more fixtures, less bulbs. So, you get a margin improvement on that. You obviously get a productivity improvement on the factory execution and then even within lighting fixtures, we're targeting a better mix of product.

So, the -- there is a variation from quarter-to-quarter and if I look at the demand we're targeting in Q2, it should help us in all three of those areas..

Got it.

And the second question I have is in terms of -- if I look at the next quarter's gross margin guidance, what kind of -- does that imply similarly inventory provisions in the current quarter or how should we think about that?.

Yeah, so what we're doing is we’re actually instead of having to take the inventory provisions, we're slowing the factory down. And so effectively we'll be making less LEDs this quarter than we made last quarter which takes the dollar value of inventory which then reduces the need to have the reserves. So, that's really how we offset that.

The way to think about it is Q1 we built more but we took higher reserves to offset that. This quarter we’re just going to build less and we won't have the reserve effect or at least that's the target given the current demand we have..

The next question comes from Jeff Osborne with Cowen and Company. Your line is open..

Great, guys. Thanks. Just two quick ones from me. I was wondering Chuck, you mentioned a next-gen bulb, can you talk about the time on that and some of the attributes it may have? And then a second question I had was if you could touch on what you're seeing in terms of mix shifts on the Lighting product side between C&I business as well as outdoor.

I got your commentary about the Chinese outdoor market, but I was just curious about just from a broader perspective on how your agency force is doing on C&I side relative to some of the outdoor RPs out there..

Yeah, so next generation bulb I'm not going to be able to reveal too much. That product is -- obviously, there will be a fairly significant announcement when that thing hits the stores. What I could say is three pretty simple ideas, it's going to be an even better -- we believe it will be even a better lighting experience for our customers.

We think it will look even more like a light bulb, which we know they like. And we think we'll be offer it to them at a price that gets more people the ability to buy it. Probably any more than that and I'd be killing the marketing launch. So, we'll just leave it at that for right. Stay tuned.

And then the mix shift in Lighting in terms of what's going on C&I, we're actually seeing broad -- we're seeing good growth across the channels, everything from the agency and distribution side of the business, to the national accounts side. There is, obviously, some mix shifting between them, but it's really pretty broad based.

So, indoor and outdoor, across the segments is moving. The mix is a little different each quarter, but I'd say right now we have good momentum pretty much across the Board..

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

Good afternoon guys. It's Andrew Hahn for Krish. One question, Chuck, you mentioned the -- sort of the available capacity that's opened up internally again in challenging the LED market.

Just curious if there has been any consideration given to changing some of that internal capacity around to mid-power for, you know, captive use in bulbs?.

So I can tell you that we are working -- doing things to optimize the balance between our factory and supply chain. You can assume that we are doing some things along those lines. There is obviously a lag in doing that. But I think we will get that balance.

We will use those levers to improve the balance for Cree, but also respecting the fact that we want to help the supply chain. So we are doing that right now. .

Great. Thanks. And then understanding that next quarter's revenue guidance is impacted significantly by some challenges in the LED segment. But for the longer term, do you expect -- should we expect -- sorry -- the seasonal revenue trends in the business to change as Lighting becomes a larger component of revenue over LEDs..

I am sure Lighting will affect these trends more than LEDs. However, they both tend to have a relatively soft calendar Q1, our fiscal Q3. So you have typically LEDs is a little lower in that quarter and you have outdoors a little tougher for Lighting just because of the weather in North America in that quarter.

So I think that will continue to be similar. As far as the rest of year goes, you know, I think long term it becomes more Lighting dominated than LED, but I am sure both of will affect the business. .

Our next question comes from Mehdi Hosseini with Susquehanna. Your line is open..

Yes. Thanks for taking my question. My first one has to do with the operating cost. When I look at your September quarter revenue is up 9% on a year-over-year basis, but OpEx is up 10%.

Should I expect -- and looking forward Should I expect OpEx to grow similar to revenue or the trend of the last year should sustain into next year OpEx growing at a faster rate?.

Yeah, the challenge is that it’s going to be mix dependent and it is mix-depend pent in the different segments. So -- and given the fact that we don’t have great long term visibility. Right now, it’s hard to give you that guidance. I would say in the short term what you are seeing, for example, on our Q2 target is, you are seeing some incremental OpEx.

One of those is related directly to the growth of the business. Higher lighting fixture sales has incremental sales cost. One of those, something we are choosing to do which is to increase some legal spending to really, I think, get a little more aggressive with our IP portfolio and our licensing strategy in the market.

So some of those are going to be more flexible with time. I would say that it’s hard to give you better short term guidance on that. I would say that in the long run we still believe we can grow revenue over the long run faster than operating expense and we get some leverage.

But exactly how that's going to play over the next few quarters given the visibility, it’s just -- I don’t have any good specific targets for you in the near term. .

Sure. And then on the CapEx of $200 million for FY 2015, is it still about 10%, 12% higher compared to FY 2014. But you have some excess capacity and underutilized asset.

How should I think about your capacity decision especially as you try to manage stabilize utilization rate and margin profile?.

Yeah, so think about that investment is very different than in the past. About 65% to 70% of this year's capital is for long term infrastructure that will not turn on necessarily until probably, some of it will start to turn on in fiscal 2016 and fiscal 2017.

So that is less about incremental capacity even more, you know, a building that we need long term and things like that. So I think that we are managing the variable CapEx much tighter right now. And I think we'll get aligned pretty well here over the next couple of quarters. .

This ends the Q&A session today. I turn it back to management for closing remarks..

Thank you for your time today. We appreciate your interest and support and look forward to reporting our second quarter results on January 20th 2015. Good night..

Good night. Thank you..

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