Wolfspeed, Inc. (WOLF) Q1 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to Cree’s First Quarter Fiscal Year 2017 Earnings Call and Webcast. 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. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference call over to Raiford Garrabrant, Director of Investor Relations. Please go ahead, sir.

Thank you, Abigail, and good afternoon. Welcome to Cree’s first quarter fiscal 2017 conference call. Today, Chuck Swoboda, our Chairman and CEO; and Mike McDevitt, our CFO, will report on our results for the first quarter of fiscal year 2017. Please note that we’ll be presenting non-GAAP financial results during today’s call, and reconciliation to the corresponding GAAP measures is in our press release, and posted in the Investor Relations section of our website. Today’s presentations include forward-looking statements about our business outlook, and we may make other forward-looking statements during the call. 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’ll be limiting our comments regarding Cree’s first quarter of fiscal year 2017 to a discussion of the information included in our press release. We will not be able to answer any questions that would involve providing additional financial information about the quarter beyond the comments made in the prepared remarks. Consistent with our previous conference calls, we’re requesting that only sell-side analysts ask questions during the Q&A session. Also, since we plan to complete the call in the allotted time of one hour, we ask that analysts limit themselves to one question and one follow-up. If you have additional questions, please contact us after the call by email or phone at 919-287-7895. Now, I’d like to turn the call over to Chuck.

Thank you, Raiford. We delivered solid results in fiscal Q1 with total Company revenue in the upper half of our target range at $371 million, with non-GAAP net income of $15 million or $0.15 per share. Lighting, LED, and Wolfspeed, all delivered revenue and gross margins that were in line with our targets, while operating expenses were lower than targeted. We made progress improving lighting margins in both our commercial and consumer product lines in the quarter. Customer service levels improved with good on-time delivery and better lead times. This improved level of customer service, combined with the new products we released in Q4 has resulted in increased lighting project quoting activity, which is a good indicator of future demand. We know that rebuilding order momentum will take time, but we believe we’re on the right track. We continue to make progress with our transition to Cree 3.0 and a more focused LED lighting Company. It starts with improved fundamentals in our commercial lighting business. This, combined with our next generation premium LED bulb family and solid execution in our LED business, puts us in a good position to begin to grow revenue and profits going forward. This is not a one quarter transition, but we are building a solid foundation to support a multi-year effort to build a larger and more valuable Company. I will 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 2017.

Thank you, Chuck. I will be providing commentary on our financial statements on a non-GAAP basis, which is consistent with how management measures Cree’s results internally. However, non-GAAP results are not in accordance with GAAP and may not be comparable to non-GAAP information provided by other companies. Non-GAAP information should be considered a supplement to, and not a substitute for, financial statements prepared in accordance with GAAP. A reconciliation of the non-GAAP information to the corresponding GAAP measures for all periods mentioned on this call is posted on our Web site or provided in our press release, along with a historical summary of other key metrics. As a reminder, in July, we announced an agreement with Infineon to purchase our Wolfspeed business. The Wolfspeed business includes the Power and RF product lines that had historically been reported as a separate operating segment plus the non-LED materials product line previously reported within our LED segment. Beginning with this first quarter of fiscal 2017, we will report Wolfspeed as discontinued operations in our financial statements. As a result, I will be providing commentary on our results for our overall combined business, our continuing operations, and our discontinued operations. For the first quarter of fiscal 2017, combined Company revenue was $371 million, and non-GAAP earnings were $15 million or $0.15 per share, which were at the upper end of our targeted ranges. For continuing operations, revenue was $321 million and non-GAAP earnings were $9 million or $0.09 per share, which were slightly above the midpoint of our targeted ranges. For discontinued operations, revenue was $50 million and non-GAAP earnings were $6 million or $0.06 per share, which were slightly above the upper end of our targeted range. Our combined and discontinued operations include a $0.01 non-GAAP EPS benefit due to suspending depreciation and amortization on all Wolfspeed long-lived assets as required under GAAP for assets being held for sale. The non-GAAP earnings above exclude non-cash stock-based compensation, acquired intangibles amortization, transaction costs related to the pending sale to Infineon, and other items. For combined operations, the excluded amount is $15 million net of tax or $0.15 per share. For continuing operations, the excluded amount is $12 million net of tax or $0.12 per share; and for discontinued operations, the excluded amount is $3 million net of tax or $0.03 per share. Fiscal 2017 first quarter continuing operations revenue and non-GAAP gross profit for our reportable segments were as follows: Lighting products revenue declined 7% sequentially to $184 million, which was in the middle of our targets. Gross profit was within our target range at $49 million for a 26.8% gross margin, a100 basis point sequential increase. Both commercial and consumer gross margins improved in Q1. LED products revenue was $137 million and gross profit was $42 million or 30.4% for the quarter, all of which were at the upper end of our targeted range. Non-allocated costs totaled $2 million for the first quarter of fiscal 2017, and are included to reconcile to our $89 million non-GAAP gross profit for a 27.7% gross margin. Continuing operations non-GAAP operating expenses for Q1 were $80 million and at the low end of our targets for the quarter, primarily due to lower variables sales cost and the timing of IP litigation cost, some of which is expected to shift to Q2. Our non-GAAP operating income was $9 million, which was at the upper end of our targeted range. We ended the quarter at $402 million in cash and investments net of line of credit borrowings, a $43 million decrease from Q4. At the end of the quarter, we had $187 million outstanding on our line of credit. For the quarter, we generated $18 million of cash from combined operations and spent $21 million of four [ph] combined capital expenditures, which yielded negative free cash flow of $3 million. The $21 million spent on combined capital expenditures includes $10 million spent for Wolfspeed. During Q1, we spent $36 million to re-purchase 1.5 million CREE shares at approximately $3 million for the year-one earn-out achieved from the APEI acquisition. For fiscal 2017, we continue to target lighting and LED capital spending of $55 million, plus or minus, to support our continuing operations. Until the sale of Wolfspeed is completed, we will continue to invest capital to support the Wolfspeed business. We target Wolfspeed capital spending to be $10 million, plus or minus for Q2, which is in line with our previous guidance. Overall, we continue to target fiscal 2017 free cash flow of $100 million, plus or minus, which may change depending on the timing of the Wolfspeed sale. For continuing operations, day sales outstanding increased four days from June to 41 days at the end of September. Inventory days on-hand increased 11 days from June to 112 days at the end of September. The inventory increase primarily relates to purchased commercial lighting finished goods, which are targeted to sell over the next few quarters. Our inventory days target is 90 days, plus or minus, which we forecast being in line with by the end of the fiscal year. For comparison to Q1, we target combined Q2 Company revenue, which includes both continuing and discontinued operations in a range of $360 million to $380 million. We target combined non-GAAP net income for Q2 in a range of $13 million to $19 million, or $0.13 to $0.19 per diluted share. For continuing operations, we target Q2 revenue in a range of $310 to $ 330 million, which is in the similar range of Q1. Both lighting and LED are targeted to be in the similar range as Q1 as we continue to rebuild commercial lighting order momentum and operate in a very competitive LED market. We target Q2 gross margins from continuing operations to be similar to Q1. While we targeted incremental improvement sequentially for lighting, we anticipate this will be offset by slightly lower LED margins related to lower targeted production volumes in our LED factory to help rebalance our commercial lighting inventory. We are targeting Q2 operating expenses from continuing operations to be $2 million higher than Q1 due to promotional spending related to our GEN4 bulb launch and incremental IP litigations spending. Additionally, our continuing operations operating expenses include approximately $1.5 million of shared service costs that also support the Wolfspeed operations. We will receive reimbursement for most of these costs for a period of time after closing under a transition services agreement with Infineon. We target Q2 non-GAAP net income from continuing operations to be between $4 million to $10 million or $0.04 to $0.10 per diluted share. Our non-GAAP EPS target excludes acquired intangibles amortization, non-cash stock-based compensation and other items. The business fundamentals are improving in lighting as we see improved customer service levels, increased channel coating activity and better gross margins. But it will take several quarters to see the full benefit in our financial results. For discounted operations, we target Q2 revenue from Wolfspeed to be $50 million, plus or minus, which is similar to Q1. We target Wolfspeed Q2 non-GAAP net income to be $9 million, plus or minus. This non-GAAP net income target includes a $4 million net of tax or $0.04 benefit from the full impact of not including any depreciation or amortization expense from long-lived assets. Our Wolfspeed non-GAAP net income target excludes acquired intangibles amortization, non-cash stock based compensation, and transaction costs related to the pending sales to Infineon. Our Q2 targets are based on a number of factors that could vary, including overall demand, product mix, factory execution, and a competitive environment. I’ll now turn the discussion back to Chuck.

Thanks Mike. We are focused on the following goals to support the Company transition to Cree 3.0, and our efforts to build a more valuable LED lighting Technology Company. First, we are working to complete the sale of Wolfspeed to Infineon. We continue to work through the process to get the necessary government approvals, while our team is engaged in a number transition planning matters. The process is progressing as expected, but we recognized the approval process can be unpredictable. Based on the feedback we’ve received to-date, we continue to target closing the transaction around the end of calendar 2016, which will further strengthen our balance sheet to fund share repurchases in the near-term and pursue inorganic lighting growth in the medium to longer term. Our second priority is driving top line growth for our LED lighting business. Over the next year, we target growing core commercial lighting revenue from current levels and in line with the market, while potentially adding to that growth through product line expansion. Our corporate development team is working to evaluate lighting growth opportunities through potential M&A. But we don’t target any deals in the next few quarters, as we give the new lighting leadership team time to build momentum for the core business. Customer service fundamentals in commercial lighting have clearly improved over the last two quarters, which is the first step to rebuilding order momentum. The new products we released in Q4 are starting to gain initial project wins. But it typically takes nine-months to actually gauge market traction for new products. Coating activity by our channel partner is an emphasized metric and a subject to a number of market factor; however, it is also one of the better indicators we have for future demand and the dollar value of codes improved nicely in Q1, which is encouraging looking ahead to the second half of fiscal 2017. The consumer product transition to GEN4 is proceeding as expected with the initial loading orders combined with demand for our previously generation a little higher than forecast. Our new GEN4 LED bulb continues to provide the premium light and quality that consumers expect from the Cree brand, but at a lower price point and better value than our previous generation. The new bulb is targeted to provide some incremental margin improvement for the consumer product line, which we are using in the near-term to fund an expanded marketing program to support the new product launch. The new bulbs have been shipped to stores, but are still on the process of being fully merchandised. Early sales numbers are encouraging and support our forecast, but we’ll need a full quarter of sales in lighting season to accurately judge the sell-through for these new products. The LED business has performed well over the last year, and Q2 is targeted to be in a similar range as Q1, plus or minus. The market remains very competitive and we continue to focus our efforts on the applications where our technology can add the most value to the customer. We’re also working on some mid-to-longer term programs that could expand the LED business in future years for both existing and new applications. Our third priority is to improve operating margins. We target increased lighting gross margins to drive the improvement in operating margins over-time. We made progress in Q1, and we target the combination of higher value new products and lower cost to drive the improved gross margin opportunity. We target LED margins in a similar range in the near-term as we work to continue to reduce product costs and increase performance levels to offset lower ASPs due to the competitive environment. While we forecast the short-term increase in Q2 OpEx, as Mike explained earlier. In general, we target Company operating expenses to grow slower than our revenue over the next year, which should drive some incremental margin leverage. To enable our revenue and profit goals, we must continue to innovate in all business segments to differentiate our products in the market and improve the customer experience and service levels across the Company. We made progress in lighting innovation during Q1 with the release of our GEN4 premium LED bulb family and our market leading HXB LED Industrial High Bay fixture, which utilizes our SC5 LED technology; a new 130 lumens-per-watt ZR troffer product; the new Essentia Wrap product; and a high performance version of our CPY canopy fixture. In LEDs, we released our next generation high power XP-L2 LED, which have twice the lumens-per-area; a new high performance side view LED for gaming applications and brighter MHB LED’s for commercial outdoor lighting applications. While we made good strides over the last few quarters, we’re focused on further improving our ability to deliver innovative products that exceed customer expectations in terms of performance, value and quality as we strive to set new standards for LED lighting. As we look to Q2, the fundamentals in our business have improved. But this is not a one quarter transition. We’re still working to earn-back share of mine with our lighting agent and distribution channel partners and translate that effort to new projects and increased orders. The leading indicators are encouraging, and we’re making investments in people and systems to further improve commercial lighting performance. We recently announced that Danny Castillo will be joining Cree as President of Lighting in early November. He’ll be responsible for both our commercial and consumer lighting business. Danny joins Cree from Eaton Corporation and brings many years of management and leadership experience from both the lighting and electrical products industry. David Elien, who is also a lighting industry veteran, has successfully led the commercial lighting business for the last two quarters and will continue to run this business as part of the new lighting organization reporting to Danny. We remain focused on building a larger and more valuable Company by bringing better light to our customers. Light that makes your environment better and is intelligent by design. Light that enables you to see better, feel better, and do more. Light that is smart enough to not only improve the lighting environment but become an integral part of enabling smart buildings, thereby expanding the market and channel opportunity for Cree. We’re expanding our team, bringing in experienced leaders who understand the unique aspects of the traditional lighting industry and sales channels and complement our strength and innovation. The transition of Cree 3.0 and the sale of our Wolfspeed business has created some challenges over the last year, but overall, we’re making fundamental progress towards our goal to build a larger and more valuable LED lighting Company. We will now take analyst questions.

Thank you. [Operator Instructions] Our first question comes from John Quealy with Canaccord Genuity. Your line is open.

My first question, if we can go to Wolfspeed for a moment. The second request by some regulators, did you anticipate potential protracted process or is this all in line with your time frames?

John, I would say, it’s generally in line. You never know for sure that you’re going to get a second request, but it’s not outside the normal course. And I would say it still leaves us an attractive -- get this close some time around end of this year. So I think we’re still generally within the same boundary conditions as where we started.

And my follow-up, just on the commentary around a little bit better quotation activity in the lighting channel. Can you provide a little bit more granularity? Is it existing agents doing a little bit more business or is it maybe some new agents in some land and expand capabilities in the channel that are growing that pipeline? Thanks guys.

John, what we’re really talking about there is it is our existing agents and what we’re just measuring is this quarterly how much business new project quoting activity. And so we looked out, over the last several quarters, and as we fix the customer service metrics and really started deliver better there, the first thing you would expect to see is starting to quote you on more projects. So we saw nice increase in our Q1 and that’s why we believe it will lead to increased demand as we get into the second half of fiscal ‘17.

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

Chuck, question for you. So it was about, I think, it was April that the ERP issue happened. Since then, you’ve seen a pretty good -- you saw a decline of course in the March quarter, a bump up in the June quarter, and then a decline in the September quarter. You’re talking about flattish in the December quarter. I’m trying to put together your commentary about increased quoting activity and why we’re not able to see growth. For example, six months after the issue happened, let’s say in the December quarter guide.

Yes, Harsh. So, the way to think about it is this. So, really, so we had the challenge that happened in our March quarter. We did have some increase in Q4. But remember most of those projects were already in the pipeline before we ever had the ERP challenges. So, we’re really in the mode now of rebuilding the project pipeline, which is what we talked about in our end-of-year call a couple of months ago. So you start with, get the customer service fundamentals right. I would say for the last six months, they have been as good as I’ve seen them since we’ve been in this business. So, I think those are working very well. And then the next thing you expect to see is, getting the agents out there, spending more time with them to make sure that the quoting activity is increasing, and so we’re seeing more quotes for more dollars and more projects, and that would be the best indicator. The fact though is from the time you get the quoting activity, you’re probably looking at two to three quarters before those projects would ship, right. They are quoting a job, that job gets awarded, and then it goes to construction, and it get shipped. So the fact that there was a two to three quarter delay, it’s not that uncommon. And I think what you are just seeing is the lag between when you cause the service disruption, you have to rebuild the fundamentals, and then it just takes a while to build back that order momentum. So I think the early indicators are there, and now we’ve got to turn them into actual demand. But I would say, from a fundamental standpoint, we’re pointing in the right direction.

Understood, thanks Chuck for that clarity. And then second question is about lighting growth. How fast do you think the lighting business is growing for the industry overall, the LED business, and how fast do you think you guys can grow at Cree?

Yes. So, Harsh, I think I don’t have a good recent number for you on lighting industry growth. There has been some speculation that there’s some Q4, is it slowing or not. I’ll be honest, when we look at the industry itself, I think LED lighting is clearly growing, but I don’t have a good specific number for you right now that would change kind of what we’ve been thinking over the last quarter or two. And part of that is, Harsh, because our business has really been focused at least in our Q4 and our Q1 is really focused on our Company-specific things. For our standpoint, the industry is a factor, but really just rebuilding momentum with our channel partners is probably the bigger factor in our business and has the most effect at least in the near term. So that’s where our focus is. I think at a macro level, I am still confident that LED lighting is a growing industry, and we will grow next year versus this year, but as far as a specific number, I don’t have a good one for you right now.

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

Thanks for taking the questions; I had two of them, and maybe to follow-up on the prior question. I am a bit surprised as well that the guidance implies a little bit of a sequential decline in both the revenue and earnings; I guess it’s down a smidge, may be flattish, but how should we think about the impact of seasonality into December? I would imagine both your business segments, the continuing operations tend to -- historically have had seen better sequentials into December. And then looking ahead, do the new products offset that into March or should we be expecting a bit of a two-quarter flat to down trajectory as we look out into the earlier part of next year?

Yes. So, Brian, what I would say is that I would use our target range, it’s basically -- what we are trying to tell you is we think it’s relatively flat quarter-to-quarter, all three businesses are in a similar range. So, I wouldn’t -- I don’t think there is a trend; I think it’s relatively stable quarter-to-quarter. And on the earnings, I think you have to look at the fact that we have two items in Q2, one is the launch of the new Cree LED bulb. So, we are going to see some incremental OpEx for that launch. That launch typically will happen this quarter and then we will manage that and we can balance that going forward. And then the other thing is the IP litigation spending. That’s just timing of that process. So, I think if you take out the OpEx piece, I think actually the results are pretty similar quarter-to-quarter and it’s really about how do we drive growth, primarily in the short-term in the commercial lighting business and that’s about turning those quotes into order. As far as seasonality goes, I would say that generally if you just look historically, the business is usually in our Q -- what would be Cree’s Q1 and fiscal Q2 are similar, maybe a little bit of growth in fiscal Q2 and then typically there is some seasonality in Q3. So, little early for us to provide any guidance there because one of the challenges is that we have seasonality on one hand and we have quoting activity on the other. And I think it’s just too early for us to give you any specific target. If you ask me second half of this fiscal year to first half of next year, I feel like we are going to see some growth. That’s just activity base from what we can see in the business. But as far as breaking that down to the third quarter, I think it’s just little early for us to make that call at this point.

Just a quick follow up on the LED segment. Chuck, you alluded to some new and existing opportunities that you might be targeting for getting growth back into the segment longer term. Could you elaborate on that a little bit? And then just I guess curious on how your product portfolio would need to change and then over what timeframe that might occur? Thanks.

Look, I don’t want to preannounce any new products but the way I would think about it is this. If you look at our LED business, we had really a solid last year. We went through the restructuring really focused on the high power, high technology side of our business. And that business has delivered great results, consistent results for four straight quarters in what’s a pretty tough market. So, what we’re looking at is we’re working on projects where you take our expertise which I’ll recall high powers, probably a nice way to generalize it, but it’s really more highly technical application and where we can use that expertise to kind of extend it. So, I’d call them related high-performance high-reliability applications on one side. And then the other side is where we can combine our knowledge on LEDs and our expertise on lighting and really come out with some more value-added products on the lighting side, and one of those would be our CTA integrated lighting solution product that came out a quarter or two ago. And this is a case where we add more than just the LED. It would bring some of the knowledge around lighting, give a higher value product. And I think there is an opportunity both of the new applications but also higher value lighting products that can give us some growth, not necessarily in the next quarter or two, but if I look out over fiscal ‘18 and ‘19, I would believe that we’re targeting to drive some incremental growth on LEDs from those two areas.

Our next question comes from the Craig Irwin with ROTH Capital. Your line is open.

Chuck, first thing I wanted to ask about was the transition that’s going on with the consumer bulb to more sort of commercial high end consumer, third gen versus fourth gen. Can you maybe update us on your target for full complete stocking of your fourth gen product across Home Depot and update us on the inventory position of third gen product that’s being deemphasized sort of how far more do we have to go before that’s complete?

Yes. What I would say so, the primary loading activity has happened. The store merchandising is I would say we’re majority of the way through. Although my guess is last numbers I saw, there is still some percentage of stores that have not been fully merchandised. So, we’re really just starting to get into the point where we’re going to have all the stores set up and we’re going to get good numbers on GEN4. I would say, by the end of the quarter, we’ll have a better read but initial indicators are where the product is on the shelves is selling as expected. So, I am pretty encouraged by GEN4 and I’d say stocking position in the majority of stores in a good sport. And so, it’s really about sell-through and restocking at that point. I’d say as far as GEN3 goes, we made some good progress in last quarter and having that wind down, it still is available in some stores, it’s a clearance item, it’s moving out of the channel. And I’d say while it’s still out there, it’s becoming a much smaller percentage and it’s -- I’d say, generally speaking, already in the majority of the business GEN4 and I’d say by the end of the quarter GEN3 should be only available at pretty limited places at this point.

So, then, my second question is about the lighting products portfolio, the 11 new products and product lines that you’ve launched since the beginning of the year. Should we expect this portfolio to continue growing over the next couple of quarters? Do you have a number of things in the pipeline that have not been announced yet? And from a relative standpoint, at this point next year, would you expect the 11 products and product lines to be making a material contribution to revenues in this business?

What I would say is -- let me kind of take those and reverse. We always target a fairly significant number of revenue from products we released in the last 12 months; that would be our track record over the years. That’s how we’ve built the business over a relatively short period of time. Now that’s going to vary because not every product is the same sized market opportunity. So, an architectural grade troffer is going to potentially have high interest but a fairly narrow category whereas you put out a high daylight that has a fairly broad industrial basics and have a bigger applications. So, you got to be -- it’s hard to give an exact percentage but yes, we’d expect any new product to contribute meaningfully within the first 12 months. As far as the portfolio and how that looks over time, we will definitely continue to expand the portfolio. And I would think of it as two ways. Some products -- and I’ll give two expands. The HXB, which is the new industrial highway for very high what I’d call for -- high temperature, high fueling application is a new market for us that we really didn’t have a product for before. And the other product would be our LN4, which is the suspended fixture which is much more of an architectural product for a commercial -- typically, I think of it as a commercial building application. Those are markets where we really didn’t have products to address. So, that would be expanding markets that -- and selling in the new places we haven’t participated in the past. If you then compare that to the Essentia product line -- and those are important products, those can drive significant revenue but those are not a lot of SKUs, each one of those is a fairly limited product set. At the same time, we launched Essentia earlier this year and Essentia is over a 1,000 new SKUs. I forgot what the exact number is but it crosses a wide range of products. And that’s really about creating products to fill parts of the portfolio that we just didn’t have enough offering. And I’d say we’re going to continue to do in both of those. Rough numbers, I’d say we’re shipping on average about 100,000 active SKUs in a quarter. And I would expect a year from now that that number to grow fairly significantly because as those new applications and that product choices part of the ways, you grow the business and give your channel partners more to sell from Cree. And so, I think the portfolio will grow, but it’ll grow in two different ways. And we’ll be -- it’s a bit of a -- we have a plan for what that looks like over the next year. You should expect us to continue to innovate on one side and also look for portfolio expansion on the other. And I think we’re going to plan to do both.

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

I just wanted to clarify the comment you made on the industry activity in the fiscal second quarter. Last quarter, you were talking about the growth in the lighting business and were expecting the impact to hopefully behind you. Is this flattish guidance more a function of industry slowdown you think or you just feel like you need another quarter or two to fully recover from the impact from the ERP implementation?

Vishal, I would say that’s more Cree specific. I think what we’re looking at is we get into some of the details and really look at quote levels and things like that. While the customer service metrics have been -- really have been strong for six months, it’s taken longer -- it took us longer in Q1 to drive some of that coating activity that will then lead to new projects. So, I would say that it’s more of a timing in our part of how fast does it recover, versus an industry specific dynamic. I’m sure there’re some industry things going on, but I think ours is more Cree specific at this point.

And then your guidance for LED product margin to be down slightly, as you work down inventory, I mean are you still assuming the LED revenues for the fiscal year ‘17 to be flattish, or do you think that market could slow down as well?

We haven’t really changed our view of the overall LED business. And if you look at our revenue expectations quarter to quarter are pretty similar Q1 to Q2. I would say, I haven’t really changed my view on the second half of our fiscal year or the first half of calendar year. Keep in mind, there is seasonality in Q3 but overall, I don’t see the industry demand dynamic changing significantly in LED. And honestly, the only real change in the margin guidance is that it’s incrementally down and that’s more of an internal -- that’s really utilization for the internal customer as we rebalance that. So, there is no -- I haven’t seen any competitive shift one way or another. I’d say the market continues to be very competitive and our team continues to do a pretty good job executing to maintain ground for that.

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

I’m just curious as to how transparent are you that you can grow the lighting margins faster than the LED margins decline over the next three to twelve months?

Tom, I would say that I don’t expect a significant shift in the LED business in the next six months from the last six months. Obviously, we have some internal utilization that’s affecting it. But I would say right now, our target for LEDs is to continue to maintain it in the similar margin range plus or minus. On the lighting side, we’re certainly targeting to make some incremental improvement there. You can see it in last quarter; the revenue in our commercial lighting business was actually sequentially lower in Q1 and Q4 and at the same time, we made some incremental improvements. So, there is a lot of work ahead of us. We’ve got to continue to work the execution side of that. But I think as we do that, we would target improvement in lighting margins incrementally here over the next year. What that timing is quarter to quarter, I don’t have a specific target for you. But I think year-over-year, we would expect to make progress there by LEDs. At least at this point, we would forecast it be in a similar range.

Great, thank you. So, the competitive pricing pressure sounds like may be from an industry perspective is mitigated somewhat?

I would say LED has been -- we’ve actually had a relatively solid margin. If you take out the quarters over the last year where the IP licensing was coming and going, LEDs have actually hung in pretty well over the last four quarters and we’re just targeting to remain in the similar range, right? So, I would say the LED business hasn’t gotten better but it hasn’t really got any worse. I would say, it’s highly competitive but something that at least over the four quarters, we’ve demonstrated a pretty good ability to be able to compete in.

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

So, first, I want to clarify, your LED revenue actually is down 4% sequentially, just want to understand if that’s coming from low volume, which is the pricing pressure you see on the marketplace And I think you mentioned on answering Brian’s question that you will expect something, was that potential product to drive growth and then the fiscal second half of this year; is that correct?

No, let me clarify Edwin. So first of all, LED revenue in Q1 was within our target range. It is down. But remember, we had the benefit of IP license revenue in our fiscal Q4. So, it was relatively the same quarter to quarter if you take out the effect of a licensing revenue that we had in Q4. As far as longer term, when I talked about is there are things we’re working on in LEDs that could drive incremental growth. But they are not in the next couple of quarters; I would say they are more in the mid to longer term. So, we are working on activities that we think can expand us in the new applications on one side, and really expand our value-add within lighting. But those are not wanted one or two quarter things, those are things I would expect to see some benefit in, in our fiscal 2018.

Okay, great. Thanks for clarifying that. And then on -- I actually have a question on cash flow. I think you guys have laid out cash flow target for the year of $100 million I think right that’s factoring how CapEx is slower this year versus last year. But given where you are at right now, do you still think you can hit those targets and that would imply you expect some growth in the back half to bring that cash flow in or is there some working capital improvement you can expect on the model?

Edwin, it’s Mike. So, we have the target of $100 million that we’ve put out there for the year. And really the negative cash flow in Q1 was based on some working capital investment that we expect to normalize. So that’s still -- the $100 million still makes sense to us.

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

Thanks for taking my question. I had two of them, Chuck. First one is, can you tell us the dynamics on how the pricing is going on in the lighting business, especially in the commercial as compared to some of your consumer residential peers? Clearly there is much more pricing pressure on the residential side of the -- consumer side, I want to know how it is on the commercial side? And the second question is on M&A. You guys have spoken about doing an M&A for the last three years or so, but nothing has really happened and obviously doing a divestiture of Wolfspeed. With the new cash infusion from Wolfspeed, do you think your M&A appetite is going to get increased or the fact that you’ve not done an M&A in a while is more a function of not really found a suitable candidate that you are going to do more buybacks until you find the ideal acquisition target? Thank you.

Sure. So, let me start with the first one. I would say that commercial lighting pricing dynamics are pretty similar. There is some -- I would say there is some more lumens per watt. So, I guess there is some amount of decline there but it’s nothing like what we see in commercial. And I would say that there is also an opportunity to add features and value to what you could actually increase the value of product. So, I would say that customers are looking for more lumens per dollar but at the same time giving what’s going on from an innovation standpoint, there is also an ability to extract more value with new features, new capabilities, smart lighting, things like that. So, I feel like commercial lighting is -- yes, there are competitive factors but nothing like that you see on the consumer side or on the LED side. In terms of M&A, we haven’t had made any deals over the last few years. I would say that up until the last year -- last year was really focused on the Wolfspeed transaction; so that’s where our attention was. I think that prior to that when we had not found candidate to fit, I think we’re year after starting the Wolfspeed project and assuming that we are able to get that closed at the end of the year, as we are targeting, then I think we are continuing to build a pipeline of candidates. I think there are some people out there. But what I would tell you is and I made this comment in my prepared remarks earlier, our first priority over the next few quarters is going to be to give the new lighting leadership team some time to deliver improved execution in the core lighting business. I think that’s priority one and as we continue to build a pipeline of some potential targets that could fit in our lighting portfolio. And I think so if there was something that happen, we are looking at something that second half of calendar ‘17 at the earliest, and again that will depend on if we find the right candidates. But I do think that our interest or the ability of using M&A to complement our lighting strategy is going to increase as we get into next year but first we want to make sure we give the new team a chance to really get the core business running at a little better level and then we’ll look at adding some pieces to that.

[Operator Instructions] Our next question comes from Neal Burk [ph] with UBS. Your line is open.

My first question is, going to December quarter, what impact if any daylight savings have on seasonality of that quarter?

What I would tell you is daylight saving is actually the start of what is typically on the consumer side known as lighting season. So, you typically see higher consumer lighting sales in that quarter. Keep in mind, that’s sales at the retailer; we actually go through a process of loading in the retailers in our Q1. So, we tend to see more level demand Q1 to Q2 because we’ve already done part of loading for what is lighting season. And that generally drives the consumer bulb side of the business. I would say that there is less of an effect of daylight savings time on the commercial lighting business because that’s more driven by projects in the construction activity or remodeling activity. So, it’s more of a bulb phenomenon than more consumer driven.

One more question, in the news recently, it was talk of a potential acquisition of offbrand. [Ph] I am wondering if you have any view on whether this’d be a positive or negative for your lighting business or your LED chip business rather?

We don’t comment on any of those the rumors or speculations. So, I really can’t say anything at this time on that.

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

As you guys start to see some of this growth with the lighting business, how do you think about incremental operating margins on those increased sales?

Colin, what I would tell you is step one, I think the operating margins come from gross margin improvement first. As we are able to drive growth in our commercial lighting business, we’re going to see some scale benefits in that business as well as some benefits likely on the supply chain. So, I’d say that’s where we’ll see it first. But if you look out a little bit beyond those first steps, there is some incremental operating leverage coming; and sales is relatively variable in the commercial lighting business. So, it’s really going to be more over time do we get some leverage on primarily R&D side of that. But think about the next year as a gross margin drives operating margin leverage in the near-term and then longer term, I would expect that we can grow revenue faster overall.

And then looking at your pipeline, is there any real movement in terms of the average ticket size that you guys are bidding on? Are we going to see a meaningful increase in the dollar volume per order or are you expecting some things similar to what we’ve seen in the last few quarters?

Yes, Colin, I would say that obviously if you expand the number of products, I think in some applications, there is an opportunity. So, in applications where we are bidding both the Cree products and the Essentia brand, there is as an opportunity to get a little bit bigger part of the projects. But on average, even with the 100,000 SKUs, we tend to be experts at certain applications within those. And so, our primary drive is about getting more share at the agent themselves to make sure that the Cree that they’re spending -- getting them to spend their time on a Cree driven projects versus other things they could be doing.

Thank you. That concludes today’s question-and-answer session. I’d like to turn the call back to Mike McDevitt 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 24th. Good night.

Ladies and gentlemen, thank you for participating in today’s conference. This concludes the program and you may all disconnect. Everyone have a great day.