Wolfspeed Inc (WOLF) 2003 Q1 法說會逐字稿

Good afternoon. My name is Elizabeth, and I will by your conference facilitator today. At this time, I would like to welcome everyone to the first quarter fiscal 2003 conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer period. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you, Barsky, you may begin your conference.

Thank you, Elizabeth, and good afternoon. Welcome to Cree's first quarter, fiscal 2003 earnings conference call. By now, you should have all received a copy of the press release, and if you did not receive a copy, please call our office at 919.313.5300 and we will be pleased to assist you.

Today, Chuck Swoboda, our President and CEO, and Cindy Merrell, our Chief Financial Officer, will report on our first quarter of fiscal 2003. Today's presentations include forward-looking statements about our business outlook, and management may make other forward-looking statement during the call. These may include comments concerning trends in revenue, gross margins and earnings, plans for new products, and other forward-looking statements indicated by words like anticipate, expect 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. We note also that this call is being recorded on behalf of the Company, that the presentations and the recordings of this call are copyrighted property of the Company, and that no other recording or reproduction is permitted unless authorized by the Company in writing. Consistent with our previous conference calls, we are requesting that only analysts ask questions during the Q&A session. Investors may continue to contact me directly at 919.313.5397 or via e-mail. We are also Web casting our conference call to allow more flexibility for our conference call attendees. The Webcast will be available through October 21st.

Now I would like to turn the call over to

.

Thank you,

.

For our fiscal first quarter, revenue increased 29 percent over our prior sequential results to $38,811,000, and was the second highest sales level in our company's history. We also announced net income of $3,883,000 for .05 per share for the most recent three months' period. LED revenue was reported at record levels, and improved 54 percent over our June quarter results. The majority of the increase in LED sales was generated by new design wins, particularly in the handset market. Most major manufacturers now offer blue or white backlight designs, many of which include Cree products. As a result of these new design wins, we have ramped quickly and continue to accelerate as we move into our second quarter. We have also seen an increased demand for LEDs for automotive backlighting, and Cree began shipments for new, high-volume European and Asian designs for the 2003 model year. LED revenue was robust for the quarter, and our unit shipments increased 50 percent sequentially, and marked the highest quarterly volume sales by a wide margin in our history. For the first quarter, LED average sales prices increased 4 percent sequentially due to product mix. As Cree continues to deliver a high-quality product to our customers at a competitive price, we believe that we have continued to expand our market share. Despite the strong customer's demand, we still plan for average sales price reductions of 25 percent per year, but we will reevaluate this plan depending on market conditions for fiscal 2003.

During the quarter, our

chips, which we define to include our MegaBright, UltraBright, and High Brightness devices, showed the strongest demand and made up 89 percent of our LED revenue as compared to 88 percent in our fourth quarter. These products serve the handset market and the majority of our automotive business other than the Volkswagen product. Our Standard Brightness and

products were nine percent and two percent of LED revenue respectively during our first quarter. We continue to sample our redesigned

chips to our customers as demand is quite strong. We intend to focus on ramping these products and target them to provide a greater percentage of our LED revenue in the second quarter.

Overall, our LED business has shifted dramatically during our first quarter. We have moved from a low-demand environment to being capacity constrained in our factory over a period of less than two quarters. The mix of our customers and applications for our products has also shifted over the same period. During our first quarter, we estimate that 48 percent of our LED revenue was generated from handset applications, 24 percent from automotive lighting, 11 percent from display and traffic signal signage, and the remaining 17 percent from general indicator lights, entertainment devices such as Sony Playstation II, a growing gaming business, white lighting, and other applications.

In addition, during the first quarter, we had five 10 percent customers for our overall business as a result of the strong demand for our products. We target these trends to continue throughout fiscal 2003.

Revenue from Cree Microwave was $700,000 during the first quarter, which was in line with our target. Of the $700,000 in reported revenue, only $190,000 of product was sold to Spectrian. We indicated in our last call that per our contractual arrangement with this customer, they were not required to purchase product from us during our first quarter if we did not complete our qualification of our

products prior to the end of the quarter. We announced that the qualification of these devices was completed in late September, and we are still working with this customer to gain acceptance of these devices. All of our revenue for our first quarter was from

devices.

Silicon carbide material revenue was stable sequentially.

opted under our agreement to purchase more LED chips rather than wafers. Therefore, silicon carbide wafer volume decreased 21 percent, but was offset by a 28 percent increase in average sales prices. In addition, sales to

continue on an upward trend, but are still not significant to overall revenue.

Contract revenue rose 19 percent sequentially due to work that began on two new significant awards that is targeted to add more than $42 million in contract revenue over the next three years.

Gross margin for the September quarter was reported at 38 percent. However, cost of sales included a $185,000 write down for early generation

devices and inventory and a $522,000 inventory reserve for

devices due to the continued weakness in Spectrian's business. Without these charges, gross margin from operations would have been 40 percent.

For the first quarter, average LED costs increased three percent, including the write down discussed above. While we continue to produce record through-put in our factory, these productivity gains were impacted by costs associated with ramping up capacity in a rapid mode to meet customer demand. However, the major impact to our

cost was a challenge to meet tighter product specifications from our customers. As we shifted our production to meet these specifications, our yield was slightly lower. As a result, our overall LED gross margin was flat quarter-over-quarter. As we continue to add capacity during our second quarter, we may encounter some more challenges. However, capacity additions and yield improvements will be our highest focus.

For the three months ended September 2002, gross margin in Cree Microwave was negative due to the low utilizations of factory as the LDMOS 8 parts were being qualified. Without the impact of Cree Microwave, our overall gross margin would have been 45 percent for the first quarter. Contract gross margin was 25 percent in the September quarter compared to 27 percent in June. Operating expenses as a percentage of sales were significantly lower at 30 percent for the first quarter compared to 41 percent reported for the June quarter. These expenses are comprised of research and development and SG&A costs. During the September quarter, spending for research and development decreased $1.3 million, or 16 percent sequentially, to 13 percent of revenue as resources continue to be rotated from R&D to production due to the significant LED volume increase. The September quarter results also included a $1 million charge for costs associated with early generation

chips that were made over the last several quarters and were never qualified by our customers. We determined during our first quarter that these parts would not be sellable as we are now qualifying a newer generation device. In addition, $417 thousand of R&D chip costs associated with LDMOS 8 development was also incurred. We plan to focus more heavily on research and development in the second quarter and, as a result, we

that expenses will increase. SG&A costs were flat sequentially. Our non-operating expenses included a $400 thousand charge during our first quarter for severance costs at Cree Microwave. We reduced our workforce by one-third in order to lower our costs and we have now positioned Cree Microwave to focus on new customer development and support over the next several quarters.

During the first quarter of fiscal 2003, interest income increased 16 percent sequentially as more of our cash was invested in longer term securities throughout the quarter, which improved the average interest rate received on our investments. At the end of our first quarter our balance sheet remains strong, with cash and investments at $164 million, down from 170 million in June, as our capital spending was higher than cash from operations. We did not repurchase Company stock in the first quarter. We believe that the best use for our cash at this time is in our capacity expansion plans, but we'll continue to evaluate additional share repurchases based on market conditions.

For the three month ended September 2002, cash flow from operations was $10.2 million, despite a $10 milli0n increase in accounts and interest receivables, mostly attributed to our 29 percent sequential growth in revenue. Our days sales outstanding was at the lowest point since June 2001 at 52 days, down from 69 days reported in June 2002. Inventory balances declined $2 million during the quarter. Due to the strong growth in our business,

was reduced to 48 days from 74 days in June.

For the first quarter, capital spending totaled $16.9 million, which was primarily for capacity additions in Durham.

We continue our optimism about the outlook for

LEDs. Our customers indicate a strong demand for our devices for handset and other applications, and we are, therefore, planning to ramp capacity at our factory in Durham.

We believe that during the second quarter, our challenge will be to deliver significantly higher LED volumes. At this time, we have limited visibility for LED devices into the March, 2003 quarter.

For our second quarter, we targeted revenue to grow by at least five percent over our first quarter results. We believe that much of this growth will come from LED demand for handset and other applications. This target includes

sales of less than $1 million at CREE Microwave, as we continue to work with

to agree on the qualification of our parts.

We plan to aggressively target new customers for this business, as we now offer a competitive part to Motorola devices. We expect that customer qualifications will take at least six months, but we are focused in our efforts to gain new design wins.

During the first quarter, our gross margins were 38 percent, due to write-downs taken in our inventory. We were also challenged by a 50 percent ramp up of our LED business, and increased customer specifications.

We hope to overcome these issues in our second quarter, and are targeting gross margins in the low 40s for the quarter.

We intend to increase our focus in R&D in the December quarter, including further spending on higher-brightness LEDs, blue lasers,

products, microwave devices, including silicon, silicon carbide, and

, and further

development. Therefore, we target Q2 spending to increase slightly over results from our first quarter.

We believe SG&A spending will be relatively flat with September results. Therefore, operating expenses for the second quarter are targeted at just under 30 percent of revenue.

We estimate our tax provision will remain at 26 percent for fiscal year 2003, and earnings per share for the second quarter is targeted in a range of seven to eight cents.

While we have not increased our public or privately held investments, as of September 29th, 2002, the market value of our public investments is $3.4 million less than at the close of our fiscal year 2002.

If market conditions do not improve, we will likely have to write these investments to their market value at the end of December, and this adjustment is not factored in our earnings target.

For our third quarter fiscal 2003, we target sequential revenue growth over our second quarter. Capital expenditures for our fiscal year 2003 are targeted to remain in a range of 50 to $60 million at this time.

CREE has remained focused on our plan. Our revenue improvements have allowed us to map a return to higher profitability. Our management team is committed to grow our business, and we plan to do so by continuing to expand our capacity, and investing in R&D.

Our team is dedicated to our goal to ship record levels of product from our Durham facility during this quarter. We will focus on innovative yield improvements in our factory, and ramp up capacity to meet our customer demand.

We also plan to aggressively pursue new customer opportunities for our CREE microwave business, now that we have our LED

parts qualified.

Simply stated, we feel that our business is back on track for higher growth.

Thank you and I would now like to turn the discussion over to Chuck.

Thank you, Cindy. We have just completed a solid first quarter, and we are off to a strong start to the new fiscal year. Revenue increased 29 percent sequentially to 48.8 million, and earnings increased 300 percent to $3.9 million, or .05 per share, which exceeded our targets for both revenue and earnings. The results were driven by continued strong LED sales, which increased by more than 50 percent from the previous quarter, and were the highest in the history of the Company. Gross margins were 38 percent, which was slightly lower than the fourth quarter, as the improved productivity in our LED and Materials business was offset by the short-term losses at Cree Microwave. Gross margin excluding Cree Microwave was 45 percent. Cree's R&D expenses were 6.6 million, or 13 percent of revenue, which was a decrease from Q4, as we diverted R&D resources into production to support the surging demand in our LED business.

Our Development teams continued to deliver strong results in a number of areas, which included improved

designs, our first 30 mW laser prototypes and qualification of our LDMOS 8 process. R&D investment remains a high-priority as we continue to strive to create technologies that create solutions for our customers. As we bring in additional capacity over the next quarter, we are targeting R&D spending to return to the 7 to 8 million range per quarter. We are benefiting from the investments we made over the last year, and our core business is at its highest level in the history of the Company. As LED demand continues to grow, we must remain focused on a number of challenges across the Company. We need to continue to increase LED capacity to better serve our customers' delivery requirements, while improving yields and developing new LED product features to support the next generation application requirements. We have to build on our LDMOS 8 progress and finish the qualification of higher power devices, while securing designs with new customers to reduce our dependence on a single customer. Our development team must expand our silicon carbide product offerings for both microwave and power products, and we need to continue to make rapid progress on laser development. It is critical that we respond in these increased LED customer requirements so that we do not lose the momentum that we have gained over the last two quarters, while making sure the other areas of our business continue to execute on both the sales and product development fronts.

As we look toward the second quarter, we remain optimistic that we can continue to grow the business. We are targeting overall revenue to increase the more than 51 million in sales driven by strong demand for our LED products and the number of applications. Earnings are targeted to grow to .07 to .08 per share. These targets are based primarily on the growth of our LED business, and a conservative assumption of no sales growth in the second quarter at Cree Microwave. We currently have more than 75 percent of our revenue target booked for Q2, and we're starting to get visibility into Q3. Although we are not providing specific guidance for Q3 at this time, our current outlook is for continued sequential revenue growth. In the short term, the LED and Materials business growth is limited by our ability to increase capacity and improve yields, not by customer demand.

The LED business was strong in the first quarter. We set a new chip shipment record in Q1, and we are targeting to exceed that level again in Q2. Average sales prices were slightly higher in Q1, while shipments increased more than 50 percent. We have orders in forecast which exceed our current capacity for the second quarter, and we are striving to ramp up our factory as rapidly as possible. Our traditional large LED customers are targeted to be at record levels in Q2, and we are working to bring online additional large customers in the second quarter.

The demand increase in Q1 was driven primarily by our mid-Brightness products, which includes our MegaBright chips. We made good progress with our

products and started shipping the first production volumes at the end of Q1. We believe that we have addressed the primary

packaging issues with several key customers, and we look to expand the product rollout to additional customers in the second quarter.

continues to be an important piece of our strategy to migrate our customers to higher efficiency chips. Our future demand is being driven by strong new customer orders for

and additional growth for mid-brightness products.

We see continued strength in the mobile phone market for blue and white LEDs in both keypad and full-color screen backlights. Although our visibility to the end customer is limited, we believe that the majority of our mobile phone success in the last quarter was for blue keypads in phones with blue displays and phones with blue keypads and full-color displays. We also had several wins in Q1 for the white LEDs which backlight the full-color screens, and we are targeting to build on this success in Q2 and increase our light penetration in full-color phones.

Although mobile phones are a major growth driver, we are also seeing increased demand across a number of applications which include automotive interior lighting with colors ranging from blue to green to white. We're having success with our LEDs in a number of entertainment applications which are using more blue and white LEDs as the pricing becomes more competitive with traditional color LEDs. The video screen market seems to be improving after a slow first half of the calendar year. Our traffic signal business remains steady, and we target an increase in this area as our improved

chip enters the market in the second quarter.

We continue to work in R&D on a number of technical improvements that should enhance our LED competitive position. In addition to expanding our product line for current applications, we are continuing to invest in developing longer-range technology for the lighting market. We remain convinced that there is an even greater potential for LED technology in this market, and it remains a high priority and an important long-term business opportunity for the company.

On the laser front, we made tremendous progress in Q1 on a 30-milowatt device, and we are far ahead of the goals we set for ourselves last quarter. Our development team has been able to produce sample quantities of a 30-milowatt device which we have already shipped to one of our key packaging partners. Although these are only prototype devices, the lifetimes are already in the hundreds of hours, and we target releasing a 30-milowatt product in the first half of calendar 2003. Our development activity is focused on further improvements and increasing the lifetimes of these devices to the 10,000-hour level. We are monitoring the competitive landscape and although we are aware of several other companies working on blue laser diodes, we feel that we are still in a strong competitive position.

As the blue laser market evolves, it appears the first commercial applications for these devices are going to be read/write video recording systems based on the blue ray disk standard. Although some consumer electronics companies have indicated that they will release their first system in the first half of calendar 2003, it appears that high-volume consumer blue ray systems are still two years away. We are very excited about the progress we have made in the last three months, and we look forward to launching a product in the first half of calendar 2003.

Our Cree Microwave team has done a great job over the last quarter solving the technical issues to get our LDMOS8 process qualified. We have released our 30 and 60-watt devices to production and we are targeting to have our 85 and 125-watt devices released in the next few weeks. We plan to ship LDMOS8 to Spectrian this month, although we currently have some contractual issues with this customer. We are working with them to resolve the open issues and we intend to enforce the current contract.

Our Q2 financial targets assume that we will not be able to quickly resolve these differences and that revenue from this segment will be less than one million for the second quarter. We have taken additional steps over the last quarter to reduce our expenses at Cree Microwave while still maintaining the expertise and capability to pursue new business.

We are encouraged by the progress we are making in developing new tier one customers. We're working with several large customers and expect to be shipping qualification samples during the second quarter. Although the potential new business will take several quarters to ramp up, we are targeting more than six hundred thousand in

business in the second quarter and a sequential increase in revenue at Cree Microwave for the next several quarters as we maintain our current level of resources and work to offset the investment we are making to build this business.

Our current sales activity gives us confidence that we can bring value to the major amplifier manufacturers with both innovative designs and our LDMOS 8 products in the short-term and work together with these same customers to make our silicon carbide and gallium nitride technology an enabling feature over the long term. Although this has been a challenging year for Cree Microwave, we still believe in the long-term potential of this important piece of our overall business plan.

The power device business continues to move ahead as we expand our product offering while working with a number of customers on designs for our 600 volt

products. The majority of our design activity is for the power factor correction stage of high power switch mode power supplies. Our silicon carbide

diodes are enabling a dramatic increase in power density. We are working with customers on designs where power capability has been doubled within the same footprint. The first small volume shipments from these applications are targeted to begin in Q3. We are also seeing interest in other areas for 300 volt devices and 1200 volt devices. Our development activities are currently focused on getting the 1200 volt product released over the next quarter. As our product line grows, we are also working to expand our sales activity with the addition of sales representatives and distributors, both internationally and domestically. And we intend to have the first phase of the sales network in place in the second half of fiscal 2003.

In the first quarter, we delivered strong growth and solid financial results. We continued our development success with the release of our LDMOS 8 process and improved

chip and our first 30 milliwatt laser samples. With the dramatic increase in our LED demand over the last two quarters, our challenges have expanded and we must manage the ramp-up in capacity to meet customer demands while not losing sight of our development priorities. We delivered good operating results in Q1 with revenue growing almost 30 percent to 48.8 million and earnings increasing to more than five cents per share. Our balance sheet remains solid with cash and investments of 164 million. Demand remains strong for LEDs and customer orders in forecast exceed our current capacity. We are targeting revenue to grow to more than 51 million in Q2 with earnings of seven to eight cents per share.

Our outlook remains positive for the second half of fiscal '03 and our business is the strongest it has been in several years. We are looking forward to the challenge of ramping up our factory and building on our momentum from the first quarter.

I'll now take analysts' questions.

At this time I would like to remind everyone, in order to ask a question, please press star, then the number 1, on your telephone keypad. We will pause for just a moment to compile the Q&A roster.

Your first question comes from the line of Dale Pfau.

Yes, good afternoon, Chuck, Cindy. Great quarter, congratulations.

Thank you.

A few questions, here. A couple of housekeeping. When we look forward, Cindy, you said low 40s gross margin in the next quarter. Is that including negative gross margin at Cree Microwave again?

Yes. Yes, it does, Dale. Basically includes

a million in sales at Cree Microwave for next quarter.

And so the implication there is that you're going to improve your efficiency and your gross margins and the LED business would be over 45 percent?

It would definitely imply that those are going to go up, correct.

This is another housekeeping. Cindy, you said that in the R&D in Q1, there was effectively a $1 million charge included in that

. Did I hear that correctly, or did I write that down wrong?

No,

. There was a $1 million in expenses related to

, and then also about a half a million dollars related to

. So, both of those were in our R&D numbers for last quarter. But, if you factor those in -- you know, those are real expenses of getting those products to the market place. So, we're looking for that number -- our total R&D to even go up next quarter.

OK. And the next clarification -- you said that you are capacity constrained in the current quarter, and then you said something about 75 percent booked. Help me with this. Do you, indeed, have more demand than you can currently ship with your current capacity?

Yes. Basically,

, you know, we do work with some of our customers on rolling forecasts, so I don't include those in my book number. But, basically, if you take our firm customer orders, our shipments, and then what we're -- you know, basically our demand that we can count on from customer forecasts. It exceeds the capacity that we think we'll have in place for the next quarter.

Great.

popped up to two percent of revenues. What is the plan for Q2?

I'm not sure I have a percentage number, but you should assume it's gonna be the fastest growing segment of the business. I'm not sure we'll get to double digits next quarter, but over the next several quarters -- you know, I can see by the end of the fiscal year,

being in the 30 percent range of our overall LED demand.

And the primary application for the

?

You know,

, it goes into similar applications that we're already in. But, probably the most important thing is

seems to be getting a lot of interest for white LEDs, so I think it's gonna have a big impact in the light market.

Great. Things are going well.

And now for kind of a generic question. There was a report out by WBS or somebody suggesting that someone else

out there has the highest bright products on the market, and then suggesting talking about some market share losses in your comparison with

and the

. Can you give us a couple of comments about your thoughts on the brightness of the market place, and then what your belief is in market share, vis-à-vis your competitors out there, Chuck?

Yeah. So, the first question is on brightness. I have no idea how they would come up with that. Based on published information, based on our measurement on our parts and the

parts, and based on our own customers giving us direct feedback, I'm pretty confident that

is the brightest chip available in the market place. So, not sure where that comes from.

As far as market share goes -- you know, I saw that same report I think you're referring to, and I can only say that I think that one of comments was that they thought

business had grown by, you know, a little over 100 percent over the last six months. And I can tell you that our LED volume has grown more than that in the last six months.

So, I think that would imply we're not losing market share.

And one final question. We saw ASPs go up in the quarter. That's the first time in quite a while we've seen that. With demand and capacity being constrained -- and I would assume that there is some capacity constraints across the industry -- could we actually see ASPs go up again next quarter?

You know,

, we're modeling for the year, still, our historical 25 percent rate. And, you know, that's subject to change. But, at this time, our fundamental business strategy is still to drive this market. I feel like, you know, over the last six months with some of the aggressive moves, we're in the driver's seat, and I don't think we want to sit back on our accomplishments. I think we're gonna continue to push price performance and try to drive market share.

So, I wouldn't -- I don't have a good projection for you in exact numbers, but you should still assume we're gonna try to lower that ASP and improve price performance over the next nine months.

And one final question,

, could you give us the top--the 10 percent customers please?

No, we only provide that at year end, I'm sorry.

Thanks anyway. I appreciate everything guys.

Thanks.

Your next question comes from the line of

.

All right, thank you. Hi Chuck, Hi

.

Hey John.

Hi.

Okay, I was wondering if you could help us size the growing new handset markets that you are seeing so much growth in. What penetration rate is the market right now in terms of migrating over to the blue backlit--blue LED usage, and where do you see that growing over the course of the next 12 to 18 months? Then I have a follow up. Thank you.

Yeah, John, I think, if you look at that marketplace, it is in tremendous flux, so giving you a number is a pretty tough thing to do. I think if you look at the latest information from Motorola or Nokia or any of them, they are seeing the whole full-color segment grow pretty quickly, and I think it's surprising just about everyone. You know, from our standpoint, it's probably less than 20 percent of the market today, and if you--over the next 12 months, based on--based on other forecasts from other people, I've heard numbers as high as, you know 50 percent of the market could be full-color, whether, you know using blue or full color displays, so, you know if I look at that, that says that from an LED standpoint, that could be a half-billion dollar market.

No, well see, what I'm trying to get at is the growth cycle that we're in, so in other words, we're still in the early stages with much more growth ahead?

Yeah.

For the marketplace?

Yeah, I would say that we're probably still less than a quarter of the market is converted to either blue or full color, based on what we know.

Okay. And I have a follow up; given that you're at capacity limits and you're ramping up as quickly as possible, could you give us the utilization rate of your new building that we had seen the last time, and do you have to start a new infrastructure shell in the near future? Thank you.

Yeah, the good news is, John, is that we're ahead of the curve a little bit. I think we have enough overall space to continue our growth; we don't have to build a building in the short term, so we are starting to fill up pieces of all that, but I think it can take us through he next, oh, should be the next 12 months we should be fine. I think though, in that time, and depending on what the second half the fiscal year does, if the business continues to grow, you could see us being in position to having to break ground on new buildings here within the next 6 to 12 months. It really depends on the second half of '03.

And finally, it's been a while since the capacity supply-demand dynamics has shifted over into your favor; in terms of the new technology that's out there for

ovens and things like that, has there been a new improvements there that will allow you to continue to drive the unit cost down in terms of throughput volume of the newer ovens that you are putting in?

Yeah, I'm not so sure there has been any significant improvements in the

reactor business. I think though, that as a company, we've become much better at using these systems and figuring out how to make them do what we need them to do, so you know, as we've always said, while we do purchase some systems on the outside, when we get t hose systems, we modify them fairly significantly, and I think our experience over the years has improved, and if anything, I think we're better at using them as much as anything.

Okay, so--and the final question then, if I may phrase in another way; are you still considering that in terms of your yield

work, you still have room--headroom to go up in terms of yields that you can obtain from the wafers that you're using?

Yeah, John, we still have tremendous yield improvements. I would say that, you know we're still looking at high double-digit improvements in yields that are obtainable within the next several--you know, over the next year or so. There's a lot of headroom to go, because every time we introduce new technology, we generally give ourselves new opportunities on the yield front.

Great, thank you very much.

Sure.

Your next question comes from the line of Hans Mosesmann.

Hi. This is actually

for

. Congratulations on the great quarter.

Thank you.

Thanks.

I just had a quick question - could you give us an update on the progress that you've made in improving

yields and perhaps give a little more color on some internal milestones that have been set in targeting other than production in the first half of '03?

Yes, well, let me talk about

first.

You know, really what we focused on the last quarter was not as much yield but really working through the qualification issues of getting our product to perform the way our customers needed it to in their package. So, most of our effort was really modifying and optimizing the design to work better in our customers' packages. And that's what we spent last quarter doing. We had some success, and as you can see, we had enough success that we actually shipping in the last month of the quarter and making progress. So, that's

out there.

What was the second question?

Just some internal milestones that you're targeting.

For

?

The milestones you're looking for - are you looking for

milestones or something related to that?

milestones.

Yes, so I think that right now we've got a couple customers that we're shipping to and we have several more that we're in the qualification stage. I would hope that by the end of the second quarter, you know, we have quite a number of customers and you should expect to see us in good volume production and that increasing over the course of the quarter.

OK, great. And I just had a separate question - what are some expectations or goals that you have for margins in terms of gross margins, SG&A, and R&D?

Our goal - our targets that I have for gross margins would be in the low forties for the second quarter and, you know, that would produce - we gave a range of seven to eight cents for net margins, so it would be just slightly above 10 percent for net.

And for SG&A and - we expect SG&A to be similar to last quarter and R&D to be in the $7 million range.

I didn't specify, but do you have long-term goals

?

You know what? Our business right now is for the - for the rest of the year, we have previously said that we're looking for R&D to be in the $7 to $8 million range, and I don't think you'll see any significant change in our SG&A unless there would be a change in our lawsuit. Many - much of that cost today is driven by our litigation with

.

OK, great. Thanks.

Your next question comes from

.

Very nice quarter.

Thank you.

Thank you,

.

Wanted to hear a little bit about, you know, the - you said that the yields

because you know the specifications became tighter. Could you say a little bit about, you know, what was the - what's so different about the specs now?

Yes,

, so one of the things that's happened is as our business has picked up, we've added several new major customers. And so I think that any time you bring on large new customers, you go through a stage of where they have the product they need in a certain way, and so the specifications are slightly different than what we might have done for other customers. So, we're in the process of really, you know, kind of adjusting our production to meet some of their needs. So, we had a - we didn't see the improvement we would have liked to seen last quarter, but, you know,

focus on here over the next quarters and really try to

that in going forward.

But the specs - I mean would that be like lower forward voltage? Is it, you know, more uniformity in the brightness? What are - what are the specifics?

Yes, no, it's more a combination of things. You know, what we typically do is we sell bin products, so customers want certain bins one way, certain bins the other day, and it's really a matter of optimizing our factory to meet the distributions that they're looking for.

I see. It's mostly distribution type of thing.

Yes, it's really a distribution of wavelength brightness - those are the two biggest factors.

OK. In terms of your forward voltage, that's kind of an important thing for the handset, correct? I mean have you been able to lower that voltage?

You know, we made some improvements several quarters ago that really led to some success we're having today in the handset market. And, you know, we don't see that as a limit to our business right now and I think our--the strength of our sales in handsets kind of says something to that point.

What type of voltages do you have now?

You know, it ranges. We actually have different specifications depending on the type of product. We also sell them at different current ratings, so there's actually a wide range. It varies.

But is there like a lower number that you have because, I mean, that's a very important number, isn't it?

Well, I think the answer is is that we actually sell different specifications to different customers because they use the parts in different manners. So some customers use them at higher voltages, some use them at lower voltages. I think, you know, I think the easiest way to answer your question,

, is that we are growing our business in handsets in just about all the major manufacturers. So I think the easiest way to answer that question is--at least, not an issue at this point for the growth of our business.

OK. In terms of the capacity, how is that you're planning to increase that? Are you going to be buying more machines that, you know, that basically produce the same number of wafers per run or are you--you know, what type of strategy do you have?

There's really three main factors that will drive our capacity increase. The first and the most obvious one is to physically buy more capacity. As you can see from our capital spending last quarter it was almost $17 million, so you can see the first effects of that. And, you know, we're adding capacity throughout our production line there.

The other two things that we'll get more focused on is our productivity improvements and also yield improvements and there's probably more leverage in those two than there is just in buying more equipment. And that'll be an important focus as we go forward. And, you know, it's really something that at the last time we went through a tremendous growth phase, those really are the two larger levers because they not only give you more capacity, but they really give us some upside on our gross margins.

OK. And finally, the

contract, that's--if you could remind me as to what quarter does that go to?

The

contract goes through our June quarter.

OK. OK, great. Thanks.

Sure.

Your next question comes from Alex Gauna.

Yes, this is

for Alex. A question on the automotive end market. Could you just give a little more color as to how that end market is doing? We understand and the Honda Accord are there any other new, you know, Big Three manufacturers coming on and is there any new content, you know, besides the Dash. I mean, anywhere else LEDs are being designed that you can talk about.

Yes, I can't comment on specific designs, but I can tell you that even though our business grew very rapidly last quarter, automotive stayed the same percentage that it was at the end of the year. So it's still about 24 percent of our business. So, we're actually seeing pretty broad demand from a number of manufacturers, but it is mostly on the interior of the auto. There are some advanced projects being done for some exterior lighting, but those aren't in the short-term plans. What we see is just increased content, either in models we're already in or--we really last quarter saw more of an increase from new models adding LED content to their cars. All of it pretty much goes on the inside of the car.

Your next question comes from Audrey Snell.

Hi, I have a couple of questions for you. Just to pick up on that automotive question, have you been sampling for any manufacturers in auto outside of existing auto manufacturers, thereby potentially gaining share? And the second part of that question is moving outside of interior, could you talk about the movement in the industry toward exterior LED lighting?

Yes, so, you know, our efforts to sell our chips to packagers is broad and I'm pretty confident that just about every major manufacturer is at least considering LEDs and I think we have pretty good penetration in that market through our customers. So, I don't really think there's one specific, you know, manufacturer or another. I think they're all considering that technology and it's--you know, I would imagine it's a matter of time before we see LEDs in just about every vehicle out there.

In terms of exterior content -- you know, the red tail lights of cars have had LEDs in them probably now for almost 10 years. So, this is actually a well-known market. There has been some talk about doing some things, you know, in terms of the white lighting, but I still think we're probably a couple of years away from other volume application for that.

OK. If you had to project, would you anticipate that by the June yearend, automotive would still be roughly 24 percent of sales? Or do you anticipate a growth, there?

I think automotive will continue to be a good business for us. But, given what we can see today, I think the handset business is growing the fastest. So, I would imagine that handsets will continue to increase as a percentage of sales, and I think automotive will be steady. I don't think it will be able to grow that fast over the next few quarters.

And who are your principle competitors? Or, who were they this quarter as you anticipate in handsets?

Well, I think it's the same competitors we have in all of our markets. I mean in the handset business, there's basically a -- you know, as a chip supplier, we pretty much compete with

and some of the Taiwanese manufacturers. And then, some packaged LEDs, and they end up competing with people like

for business around the world.

But, you know, the chip business -- our competitors aren't really different in the handset market versus our other markets.

Have you seen additional LED capacity coming on line in Asia, Chuck?

Yeah. I think that -- I do know the Taiwanese continue to supply LEDs. They have -- I think they have some share of the lower end of the market place. And, you know, we have to continue to watch them. You know, they're a competitive threat. But, you know, our business has been a competitive business since we've been in it. I think it's just one more place we have to keep an eye on that. And keep our activities moving, and really keep our product development, and really from a yield standpoint, that's a huge leverage we continue to have.

You know, I feel pretty good that we still have one of the best, or if not the best cost structure in the market place, and I think that's really the

we're at today.

So, Taiwan's a factor; we've got to keep watching it. But, at least in the short term, our business is more constrained by our ability to add capacity, than it is by the Taiwanese.

So, you're competing on price performance. Are your LEDs -- is the line of LEDs you're selling on a higher brightness overall to the cell phone market, versus, let's say, the Taiwanese?

We actually compete in all segments of the handset market. So, I think we compete in the low-brightness, the mid-brightness, and the highest-end brightness of the segment. So, we compete across the board.

OK. And the

the Nokias of the world is to increase the backlighting and the color displays and the size of the screens as greater

functionality is incorporated, isn't it, over the next 12 months?

Yes. I think Nokia had a conference call in the last day or so, and one of the things they talked about is they see a large growth in their full-color phone business. And I think we're hearing similar things from the other handset manufacturers. And I think it's -- you know, our perspective is from what we can see today is it is a trend that, from what we can see, should continue to grow for the next several quarters.

Right. Like color TV -- you never go back to black and white.

I know I'm not going back with my phone.

Are you taking additional customers from others in the market? Are any of these 10 percent customers new customers for you?

You know, we talked about last quarter how, you know, we've added a couple of new 10 percent customers, and those guys remain strong. And I think we're actually in a position where we have several more customers coming on line. So, I think we're doing pretty good.

I wouldn't call them new customers. We've had pretty good relationships with just about everyone in the industry over the last several years. I just think what we're seeing is a broader base of our customers all having success.

As the price point in these handsets rises, does the average selling price going into these higher priced handsets increase for you as well?

No, typically, the way this works is that no one ever pays as much this year as they did last year for the same component, so we pretty much build in a model to keep being able to reduce our cost so we can offer price reductions, and you know still hit our profit targets.

Well let me ask it a slightly different way; are your--is the dollar content of your LEDs rising in the handset?

I think the answer to that is today, you know, if you look at a full-color phone, you have a four to six white LEDs and probably somewhere around eight blue LEDs in them. I think that for a full-color phone, that content is not rising, but it's a lot of content, so it's really more of an issue of not--it's how many phones use blue or full-color displays, not increasing number of dollars in a phone that's already using them.

Okay. And any new products on the horizon you're prepared to talk about?

Well, I already talked a little bit about our 30-mW laser, so I think that's an exciting point, and we still have some more work to do, you'll see additional products based on LDMOS 8, and you know, we continue to have a lot of R&D activities across the business area, so I gave you a little idea in my comments earlier, and I think you--best thing to do is stay tuned. We've got a large amount of R&D to do; it's going to be an important piece of our strategy going forward.

And the initial blue application you mentioned is a read-write--what was it, read-write what?

Basically, a read-write video recording systems, you know basically the next generation of what we call today a DVD player.

Oh, okay. Thank you.

Sure.

Your next question comes from Ram Kasargod.

Hey, Chuck, congratulations. that was a good quarter. I've got several questions for you, let me start off by--you know when you look at this number that you reported, you took off a five-cent

after tax on Cree Microwave. I know that

talked about some cost cutting that you've done there; can you talk about second quarter, is it going to be the same four to five cent loss that you are going to take at Cree Microwave, and what you are doing with that break even there?

Yeah, I think, you know, you're not going to see a dramatic improvement but I still--I think we will make some progress in the second quarter Ram, but you know, it will--that business is something that we intend to invest in, it is a important piece of where we want to go, not only with our silicon technology, but really with the silicon carbide and gallium nitride, so I think we're making the right investment that's going to give us a very strong business here over the next couple of years, and you know we got to keep executing. We did take additional cost reductions last quarter, and in addition to that, we should start to see some additional revenues from the non-

customer base, so I think we'll make some progress, but I think it's going to be steady progress, and it's going to be each quarter hopefully we get a little bit closer there, but I think we're putting ourselves in a good position to really benefit from some of the technology that we're developing, both in the silicon and the

side.

But what is the break even at Cree Microwave now? I think earlier on you were targeting $4 million run rate for break-even. Where is that right now?

Yeah, actually Ram, it used to be about 5 million was the break even there, and I think now it's right around 4, maybe a little less.

Okay, so as far as modeling goods, we are still talking about this negatively impacting your results?

Yes.

And then secondly, you know you touched on it very briefly, the issue on litigation. Can you talk about, you know how much is this litigation costing you? There have been some attempts within the industry to resolve litigation issues If you were to resolve your litigation issue, how much earnings leverage does the company have?

Yes, you now, probably the best answer I can give you - we don't give out specifics, but you can assume it costs us a few million dollars a quarter related to the litigation. And you know that is a complicated process I think you know from how we're doing, I think we're doing pretty well. We feel pretty pleased with our results. But, you know, that's a long road and it's an important road because I think it's important that Cree stake its position from an IP standpoint in the marketplace. So we will continue to pursue that and we'll see what happens in the future, but you know I - at this point in time, you know, we're still forecasting it to be a part of our expense structure.

I have a question here for Cindy. You talked about capital spending you know how you increased capacity in the first quarter. What are your targets for capital spending for the year as a whole based upon what you're seeing in your markets today and what does that do to your operating cash flow or free cash flow for the year?

Ram, I said in my script that I'm looking for $50 to $60 million in cap ex at this time, but of course that's subject to revisitation depending on what happens in the second half of our year with customer demand. In terms of cash flow from operations and free cash flow, we still believe we will be cash flow positive for our year based on that forecast build of $50 to $60 million.

Chuck, this capacity expansion, you know, that you're talking about, does any of that include, you know, a shift toward three-inch or are you going to focus on yield improvement?

You know, I think short-term, we're trying to ramp up the two-inch - you know, the two-inch products, but I'm sure that you'll see over the next few quarters three-inch become a part of our production line. And I think, you know, we'll probably end up running a mixed production line here for the next few quarters. So, it'll be a combination of both.

I have a - have a question for you, Chuck. You know, last year, the industry went through an inventory down cycle. You saw the negative impact for that. You came into this upturn with the turns business picking up and that made the business a little bit more difficult to predict. Where are we right now I mean with this shift to blue LEDs and brighter screens and full-color screens coming on. Where are we in terms of predictability or demand for your business? And at what stage in the game will you see at least your business shift from turns to maybe more long-term contracts to some of these larger - some of these new 10 percent customers, you know, go more long-term in their contracting?

Yes, I think you have to look at our business. You know, we're in a different place than we were two years ago. Our business has matured a lot, and this is a lot more of a traditional semiconductor model now. I mean as far as when we're going to get, you know, better visibility or firmer orders from our customers, you know,

, if you look at the last two quarters, last quarter, we - last quarter and this quarter we've got about, you know, 75 percent or more of our business booked, you know, and we're not even out of the first month.

So I think our business has firmed up tremendously. And if you add in the forecasting system that we're working with on our customers, you know, I've got enough visibility now to be pretty confident to say that we got more orders this quarter than we're going to have capacity to fill. So, I think we are getting that visibility.

But, you know, I really don't expect we're going to go back to where people sign up for annual purchase agreements any more than - you know, we have some of those. Our backlog is still strong. But I just don't think that's the nature of our business going forward, and, you know, we're going to have to manage it the way we are right now.

kasargod Chuck, I promise you I'll ask you maybe one or two more at the most. In terms of the inventory cycle - OK? - where do you think we are in terms of your markets at least? I think I'm reading in "Electronic News" that they're starting to get shortages on

devices once again in the electronics markets. Can you give us your thoughts on that? How it's impacting your business?

I can at least say, you know, I really can't comment on the rest of it, but I can say from an LED standpoint, we probably--today there's the lowest amount of inventory in the market--or in the channels than there has been in, I don't know, a couple of years. I mean, the inventory out there in the marketplace, from what we can see, is very low.

OK. Like I said, this will be the last one. There's a lot of talk now about the

standard, you know, conference is going on in Japan and people like Sony coming out and being perceived as leaders in this business. My perception is they're all still using Sapphire as the substrate. Any thoughts on how you guys are going to get positioned in the market with silicon carbide substrates in the

diode market?

Yes, I'll tell, you

. The substrate doesn't matter to how good is your laser diode and how well does it work in the system. I think if we execute on our R&D front and deliver the, you know, the 30 milliwatt product that we're targeting right now I think we're going to have access to that market. It's going to be probably more important to develop the customer relationships than a technical issue. And so, you know, our focus is get the product developed, get it out there, and then we're going to work with our partners, you know, various packaging partners to try to go get ourselves designed in. So, you know, I don't see it as a--it's not a technology question, it's who can build the best laser diode and that's what we're focused on doing.

Thank you, Chuck. Congratulations.

Sure, thanks,

.

Your next question comes from Chris Versace.

Good afternoon, everybody.

Hi, Chris.

Hi.

Just a couple of quick questions, here. I know we're a little long in the tooth. Just to skip back real quick, Chuck, to the automotive market. You know, you mentioned European and Asia. Anything on the radar screen in terms of the, you know, domestic automotive market?

Yes, we've actually mentioned previously that, you know, we have some content in things like the Lincoln Navigator so there is some stuff happening in the U.S. market, but, you know, I think I said probably, you know--I keep

I'm repeating myself, but it's fair to say the U.S. automotive market is about the last to adopt any new technology and I think that, you know, what you're seeing is Europe went first, we're now seeing some success in Asia and, I think, you know, the domestic auto makers will follow behind that. So, I just think, you know, it's not a very quick moving industry and I think you'll continue to see the trend, though, to add LED content.

So would--I mean, you're seeing the '03 model you already saw. That sounds like maybe it's an '04 event?

Oh, no. We have, I mean--for example, there's a few things going on in '03, but, you know, I think it'll continue to happen. Every year there's new models and I think you'll see the domestic guys finally start to catch up here over the next year or two, I think.

OK. And then you said before that you guys are, you know, planning on further increasing your capacity, yet you plan on bringing--adding on additional new customers. But you said that, you know, with each new customer there's certain specifications. So, I'm trying to understand, you know, the ability to really improve your margins on the LED business dramatically from here. Or is that something we should see, maybe, in the second half of the fiscal year?

No. I mean, we've already targeted, you know, a reasonable increase next quarter and, you know, I think if we continue to add volume--and again, we've got to execute on the, you know, productivity and yield

. But if we do both of those things, you know, there's opportunity for us to continue to drive those margins up. You know, the customer challenges are going to be with us, you know, it's the nature of our business. We have a much more diverse customer base than we've had in the past and those customers are buying quite a number of part numbers and different types of products, so, you know, it's a matter of us also getting better at just managing a more diverse mix of products.

OK. And then one, then, for Cindy. The question was asked, Cindy, are you guys going to be, you know, cash flow positive from operations. You said yes. Do you plan on being free cash flow positive in '03?

Yes, that's what I mean. I'm sorry.

That's OK. Alright, thank you.

Yes.

Sure.

You have a follow-up question from Pierre Maccagno.

Yes, I meant to ask you, what is your backlog at this point?

You know, Pierre, we don't update our backlog except annually, but I think it's fair to say it continues to be pretty strong.

Tell me, most of your LED growth -- does this come from those two new customers that you have been talking about?

The two new customers were definitely a part of it, but I would say that it's actually broader than that. It's a number of customers. It's both a combination of the new customers -- our traditional customers -- and, you know, that continues to expand at this time.

Can you give any color on the geography of these customers? Or where these LEDs are going in terms of geography?

Well, Pierre, almost every LED packager in the world is in Asia, so you can assume it's coming out of Asia.

And lastly, what is the LED content per

, coming from you -- I mean the blue and the green?

You know, Pierre, that's really hard to estimate. It varies dramatically. You know, one of the examples we've given in the past is if you just look at Volkswagen -- you know, the low-end cars might have 20 or 30 LEDs, and the high-end ones might have 70 or 80. And I think it just depends on the car, how many places they use it. It's really hard to give you a good number on that. It's just too diverse.

OK. Thanks.

Sure.

Thanks.

You have another follow-up question from Ram Kasargod.

Cindy, this is a question for you. I'm not even sure if I should be asking you this, but I'm just curious. I knew the fourth quarter -- the third quarter you

down the goodwill, and took some charges on CREE Microwave. What is CREE Microwave sitting on your balance sheet at right now? You know, I mean, you know,

expense run rate of a couple of million dollars per quarter. I mean, how much assets, you know, on your balance sheet are now tied to CREE Microwave?

A total of $15 million is shown is shown as a CREE Microwave asset at this time.

OK. Is there any expense run rate that you have there?

Well, as Chuck said, the breakeven level of CREE Microwave right now is around $4 million dollars per quarter.

And you can assume that those assets are being depreciated on, you know, a

basis.

Absolutely.

So, they're a piece of that. But, we can't break that out for you.

OK. Thanks a lot. I really appreciate that.

Uh-huh.

Your next question comes from Nathan Churchill.

How are you doing? Could you give us some more detail on what, exactly, Spectrian is bound to under the contract that you have with them?

Yeah. The Spectrian contract calls for $5 million of product this quarter, next quarter, and I think it's about just under two million in the June quarter. So, that's our agreement. But, there's a variety of terms based on qualifications and other things that we're currently working through.

OK. So, they are not fully qualified yet, and I guess, it's safe to assume you don't expect them to be fully qualified during this current quarter, or maybe late in the quarter.

I think we're taking a conservative position in our guidance regarding Spectrian. I think -- I mentioned earlier that we intend to ship to them this quarter, and that -- but, you know, we're in the middle of a contract dispute and we need to work that out.

OK. As far as the LEDs -- how interchangeable are your LEDs that are used in the handsets with those of your competitors? Once one has

, can they just basically shop around?

You know you have to remember that we don't actually sell to the handset manufacturer. We're selling to packagers. But, you know, there are LEDs -- someone can buy an LED for a handset that uses a CREE shipped from one packager, and then can also buy an LED from a different packager with a different chip from another manufacturer. So, it is a competitive market.

OK.

You have a follow-up question from Audrey Snell.

now that I guess it's only fair to ask why --- how do you win handset or auto or signage customers? Is it an overall evaluation of price performance, is it particular colors, brightness, wavelength?

Yeah, it's a combination of price performance and things we can do to meet specific customer requirements, so one of the things we do is by being more flexible, being able to do some things that meet exact customer requirements, I think we are able to differentiate ourselves and really make our packaging customers more successful so that they can win more business, but you know, it's a pretty traditional sales approach other than the fact that I think we have more flexibility from a price-performance standpoint to make our customers successful.

How do you guard in the future against defection from one OEM going from you to another supplier without a whole lot of visibility because the annual contract type of booking is just kind of going by the wayside?

And it's a--you know it's an ongoing battle. I think you should assume that most packagers have multiple sources already. It's about who provides the best product. The other thing to remember is that you know there are competitive products at certain places in the market. Today you get a higher brightness product, like our

and our

, now you start to get into places that there really aren't many people who compete at that level, so one of the things that happens is, as more people design an

or a higher performance product, it really creates a barrier, so it's a combination of competing for the one end of the business, and at the other end, it's really about giving them better value proposition with brighter products, and that becomes a barrier in and of itself.

Is it also fair to assume that you're working with current customers on future generations of brightness products?

We--there are--our customers do get to see early versions of our new products, and we typically let them help us spec out what they need, and it's fair to say they probably have a large say in our roadmap of what we're working on right now.

One last question, does the association with OEMs in handsets provide any sort of marketing synergy on power amplifiers?

No. They're really two totally distinct marketplaces. We're--in our LED business, we're selling chips to LED packaging companies, who sell them to handset manufacturers, and in our RF business, we're selling packaged RF transistors directly to infrastructure, and they don't tend to be the same groups of people.

Okay, thank you.

Sure.

You have a follow-up question from Nathan Churchill.

Is there some sort of threshold on the size an LCD screen can be that you can no longer backlight it with LEDs? If it were color, maybe it would be too dim in the center or something?

The answer to that is that right now, LEDs are being used in handsets, they're being used in PDAs, and they've been demonstrated in everything up to a full-color LCD screen for a computer--or a personal portable computer, so I think the answer is technically, the answer is no, I'm not sure, as you get larger, you know we need to continue to make improvements in performance to make it a price-competitive game, but you know, it is technically possible to do it all the way up through a portable computer.

Okay, thank you.

Operator, I think that we've closed our Q&A for this time.

Thank you, this concludes today's conference. You may now disconnect.

Operator?

Yes Ma'am.

I had some closing remarks. Fine, operator, thank you.