Wolfspeed Inc (WOLF) 2003 Q2 法說會逐字稿

Good afternoon. My name is Sandra (ph), and I'll be your conference facilitator today. At this time I would like to welcome everyone to the second 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. Ms. Barsky, you may begin your conference.

Thank you, and good afternoon. Welcome to Cree's second quarter fiscal 2003 earnings conference call. By now you should have all received a copy of the press release. If you did not receive a copy, please call our office at 919-313-5300 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 second quarter fiscal 2003.

Today's presentations include forward-looking statements about our business outlook, and management may make other forward-looking statements during the call. These may include comments concerning trends in revenues, 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 SE filings noted in the press 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 presentations and the recording 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 Webcasting our conference call to allow more flexibility for our conference call attendees. The Webcast will be available through January 23rd.

Now, I'd like to turn the call over to Cindy.

Thank you, Fran.

Cree has just completed a historic period, posting record revenue of $56,727,000 and $105,539,000 for our second quarter and first half of fiscal 2003, respectively. Revenue for the quarter grew 16 percent sequentially and 38 percent over the same period last year. Much of this increase resulted from the continued strong demand for our LED products for handset and automotive applications and our ability to improve capacity as LED revenue increased 18 percent over the September quarter.

To date, we reported net income of $8,996,000 for the most recent three-month period, which more than doubles earnings from the prior sequential quarter. Earnings per share grew 140 percent to 12 cents per share from 5 cents reported in the September quarter. Gross profit improved 26 percent sequentially to a gross margin of 41 percent, while net margins were the highest in five quarters, at 16 percent of revenue.

For the first half of fiscal 2003, net income was reported at 12,879,000 or 17 cents per share, which compares to a net loss of 15 cents per share in the comparable prior year period. LED revenue maintains strong growth, and as a result, our unit shipments increased 15 percent sequentially and 89 percent over the same period in the prior year, and marked the highest quarterly volume sold in our history.

For the second quarter, LED average sales prices increased 3 percent sequentially, while our high volume mid-brightness prices increased 2 percent on average. Blended average sales prices were 7 percent lower as compared to the second quarter of last year.

Cree continues to evaluate and adjust its pricing strategy to draw up long-term demand and increase its relative market share. As a result, we target lower average sales prices during the second half of the year; however, average sales price reductions for fiscal 2003 may be slightly less than our 25 percent historical average.

During the quarter, our mid-brightness chips continued to command the largest portion of our revenue at 91 percent of our LED sales as compared to 89 percent in our first quarter, due to an increasing demand for our MegaBright devices. Our standard brightness and X-Bright products were 7 percent and 2 percent of LED revenue respectively.

In the December quarter, we estimate that 46 percent of our LED revenue was generated from handset applications, 27 percent from automotive lighting, 11 percent from display and traffic signal signage, and the remaining 16 percent from general indicator lights, entertainment and gaming markets, white lighting, and other applications. We target these trends to continue throughout fiscal 2003.

Revenue from Cree Microwave Sunnyvale was $753,000 during the second quarter, which was in line with our target and slightly higher than our first quarter results. Approximately $183,000 of this amount was sold to Spectrion (ph) and Remic (ph). In November, we agreed to terminate our remaining supply agreement with Spectrion in exchange for a $5 million one-time cash payment that was recorded as non-operating income on our statement of operations. As a result of the settlement, we have been able to focus our efforts on new customer development, (inaudible) devices, and we now target new design wins each quarter for the remainder of our fiscal year.

Silicon carbide material revenue was stable sequentially. Weight for volume decreased 21 percent during the second quarter, offset by a 23 percent increase in average sales prices due to product mix. In addition, sales to Charles (ph) and Covard (ph) increased to 27 percent over the September quarter, but still makes up a small percentage of total revenue.

Contract revenue rose 13 percent sequentially due to heavy work performed on materials contracts. However, this revenue was targeted to decrease to first quarter levels in our third quarter. Gross margin for the December quarter improved from 38 percent to 41 percent sequentially. However, cost of sales for the second quarter included a $1.3 million net write-down for Cree Microwave inventory as a result of the termination of the supply agreement with Spectrion. Without this charge, overall gross margins from operations would have 44 percent.

During the second quarter, we also reduced our reserve for accounts receivable by $515,000 due to collection improvements of over 90 day accounts. However, the gain was more than offset by a $784,000 increase to inventory reserves for LED and wafer products.

During the second quarter, the most notable margin improvement occurred with our LED products, as our average sales prices increased 3 percent, while our average costs declined 8 percent. Our costs were significantly lower as we produced record units in our factory, and as a result, we benefited from productivity gains that lowered our costs per unit.

As we continue to add capacity during our third quarter, we may encounter challenges. However, capacity additions and yield improvements are our highest focus. For the three months ending December 2002, gross margin at Cree Microwave Sunnyvale was negative due to the low utilization of the factory, but was in line with our expectation. In addition, our pretax loss, without the payment from Spectrion and a related inventory write-down, was $3.3 million in December as compared to $5.2 million in the September quarter. We are now operating Cree Microwave at a quarterly expense level of approximately $4 million.

Contract gross margin was 24 percent in the December quarter compared to 25 percent in the three months ended September 2002. Operating expenses as a percentage of sales were lower at 27 percent for the December quarter compared to 30 percent reported for the September quarter. These expenses are comprised of research & development and SG&A costs, and in the December quarter, we recorded a $1.4 million write-down for fixed assets associated with a novel Epitaxy (ph) equipment project that we discontinued. Without this asset write-down operating expenses would have been 25 percent.

During the December quarter, spending for research and development increased $1.1 million, or 17 percent sequentially, to 14 percent of revenue. That's (ph) greater resources were focused on laser diode, LED yield, and productivity improvements at other projects. SG&A costs dropped $1.4 million or 17 percent to 11 percent of revenue due to reduced legal fees associated with the settlement of litigation with the Nachia (ph) Corporation that was announced in November.

Other non-operating income included the one-time $5 million settlement payment from Spectrion that was partly offset by losses on the sales of multiple securities of $2.1 million. Cree has now sold its entire position and public company marketable securities as of the end of December. Overall, the $5 million payment received from Spectrion was offset by the $2.1 million loss sustained on the sales of marketable security, the $1.4 million write-off of fixed assets, and the $1.3 million inventory write-down at Cree Microwave.

During the second quarter of fiscal 2003, interest income declined 10 percent sequentially due to lower rates received on our investments. As of December, our cash and investments stood at $177 million, up from $164 million reported in September. For the first time in Cree's history, we were cash flow positive by $7 million for the quarter. For the six months ended December 2002, cash flow from operations was $41.2 million, despite an $8.8 million increase in accounts and interest receivable. Our days sales outstanding, which was calculated on a monthly revenue profile, was 55 days, and our accounts receivable balance declined by $1.1 million sequentially.

Inventory declined $780,000, while days sales on hand was reduced to 42 days from 48 days in September. For the first half of fiscal year 2003, capital spending totaled $40.2 million, which was primarily for capacity additions in Durham. In addition, we did not repurchase company stock in the second quarter, but we will continue to reevaluate purchases based on market conditions.

For our third quarter, we target revenue to grow to approximately $59 million to $60 million, with a majority of the growth coming from LEDs. This target includes slightly higher sales at Cree Microwave as we continue to work on new customer design wins. During the second quarter, our gross margin would have been 44 percent without the write-down of Cree Microwave inventory. Based on our shipment estimates for the March quarter, we are targeting an increased gross margin and a range of low to mid 40s.

In December quarter, our spending for R&D increased, with our continued focus on higher brightness LEDs, blue lasers, solid state elimination products, microwave devices, and further Shocky (ph) diode development, we target Q3 spending to remain even with Q2 results in a range of $7 million to $8 million. We believe SG&A spending will be slightly lower in Q3 due to further savings in legal costs resulting from the mid-quarter settlement of litigation with Nachia (ph). We target SG&A expenses in a range of 9 percent to 10 percent of revenue. Therefore, operating expenses for the third quarter are targeted at 20 percent to 25 percent of revenue.

We estimate our tax provision will remain at 26 percent for fiscal year 2003, and earnings per share for the third quarter is targeted in a range of 13 cents to 14 cents. In addition, we are planning to increase capital expenditures by approximately 30 percent for our fiscal year 2003 to a range of $65 million to $75 million.

I am very pleased with the results of this period, and I'm confident that Cree is well positioned to continue its growth strategy. Our reported revenue has reached record levels, and our customer demand has continued to expand. As a result, we are committing additional resources to capital expansion. Our profitability has increased, as gross margins improved and our operating expense as a percentage of revenue has declined. In addition, our business is now free cash flow positive for the first time in our history, and we have a very strong balance sheet with no debt.

Our team is committed to a goal to ship record levels of product from our Durham facility this quarter, and we believe that our momentum and excitement will help us meet the challenges of the coming quarter.

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

Thank you, Cindy. We have just completed a great second quarter, with the highest revenue in the history of the company, as we exceeded expectations for both revenue and earnings. Revenue increased 16 percent sequentially to 56.7 million, and earnings more than doubled to $9 million or 12 cents per share. These record results were driven by continued strong LED demand and our ability to maximize capacity due to productivity improvements and a more favorable mix.

Overall, LED revenue increased 18 percent from Q1, while other business areas grew more than 10 percent. Gross margins improved to 41.5 percent. SG&A expenses declined to 6.5 million as we started to see the benefits of reduced legal expenses as a result of our settlement of litigation with Nachia. This was an important milestone for Cree, as it will not only reduce our legal expenses going forward, but more importantly, allow us to focus more resources on developing products to drive the market.

R&D spending was in line with our target range at 7.7 million and is targeted to remain in the $7 million to $8 million range over the next several quarters. We made progress on a number of technology fronts over the quarter, with continued performance improvements in LEDs, higher yields, and the release of our LDMOS 8 product family.

Our performance over last quarter not only sets Cree apart from most other technology companies, but it continues to demonstrate the strength of our business model and ability to convert our R&D investment into products that drive growth.

As we move into the second half of our fiscal year, we need to stay focused on a number of challenges. We need to continue to ramp up capacity to meet increased demand through both the addition of physical resources and also productivity and yield improvements, which drive down costs. This ramp-up is not only important to achieve our financial targets, but also should improve customer satisfaction through improved deliveries and responsiveness.

X-Bright development remains critical, as we need to expand on our initial success and qualify a broader customer base. We need to expand our LED product offerings to meet the evolving needs for both current applications and new markets, such as solid state lighting. We have to get customer wins on both the power and RF front while continuing our product development efforts to enable new applications.

Managing these types of challenges is not new for Cree. These are things that motivate us to keep pushing the boundaries of technology and conventional wisdom as we look to create solutions and build on our past success.

Based on the strength of our LED business and incremental growth across the rest of the company, we are targeting overall revenue to increase again in Q3 to approximately $59 million to $60 million. Earnings are targeted to grow to 13 cents to 14 cents per share. These targets are driven by plans for continued growth in our LED business of more than 5 percent sequentially. We currently have more than 80 percent of our revenue target booked for Q3, which is better than at this point last quarter. We made investments in additional capacity over the last two quarters, and need to continue this effort into Q3.

Although we are not providing guidance beyond Q3 at this time, I am optimistic about LED growth in Q4 as we foresee the continued adoption of white LEDs in a number of applications ranging from backlighting color LCDs in cell phones to automotive lighting and to a number of emerging niche light source applications.

The LED business remains strong, with revenue increasing 18 percent as we set another chip shipment record in Q2, and we are planning to raise this bar again in Q3. We exceeded our targets for LED shipments in Q3 as we were able to expand capacity faster than we expected through productivity gains. And ASPs were better than we had planned, as they increased slightly from Q2.

The ASP trend was driven primarily by a change in our product mix to a higher volume of MegaBright products. Our LED factory is currently fully utilized, and we are working to increase capacity during Q3 to support the increased revenue target and improve our lead times.

Q2 demand was driven primarily by growth in demand for our mid-brightness products and especially our MegaBright products. Although we have had some delays with X-Bright, in many cases this has been offset by improvements in MegaBright.

As part of our ongoing effort to continuously improve our products, we have been able to make incremental improvements in the brightness of our MegaBright chips, which has allowed our customers to use them in a number of high performance applications that were originally planned for X-Bright. This has driven the growth and demand over the last quarter as MegaBright shipments more than doubled to almost 40 percent of our total LED sales. We see continued strength of this product in Q3, with X-Bright positioned to take our customer product performance to the next level as it comes online.

LED development continues to be one of our highest priorities. We are work on X-Bright and several new chip designs which are being optimized in terms of size, shape, and optical electrical performance for very specific applications. We have made good progress over the last few months on X-Bright and have several customers who are using the product in small production volumes.

However, we still have some customers who need a more robust chip design to meet the reliability requirements for their products. We are learning that the reliability performance of the chip varies between customers due to package design and application requirements. We continue to make improvements to the chip which should increase the robustness for all applications, and we are learning many things which should improve our ability to help our customers with their package design.

We have recently seen promising results with the improved design on our internal reliability tests, and we are in the process of starting full qualification of these improvements. Customer interest in X-Bright remains strong, and we are targeting to have this product qualified and in volume production with several additional customers during the third quarter.

On the laser front, we are working to increase the lifetimes of our 30 millowatt chip for optical storage applications. We are making progress, and although we have a number of technical challenges to overcome, we still plan to launch a 30-millowatt laser diode chip product in the first half of calendar 2003. We are adding resources and focus to this project within Cree, and have begun to ramp up the technical coordination with our packaging partners. Our ability to work closely with the laser chip packagers is a critical piece of getting this exciting technology into volume applications.

At Cree Microwave, we are successful in getting our LDMOS 8 family qualified, with 30, 60, 90, and 125 watt products released and sampled to customers. We achieved our goal of increasing our new customer business during the quarter with 750,000 in revenue, and we met our reduced expense targets. We made good progress with the Hitachi Kokusai and agreed to extend our development program for high-powered amplifier modules based on our LDMOS 8 technology. We resolved the Spectrion contract, and now have all of our focus on developing new customer design wind, and we target this to begin producing a profit by the end of calendar 2003.

We have increased our development efforts for both silicon carbide and gallium nitride microwave devices, and we are targeting the release of our next generation silicon carbide mesfet (ph) in the next several months. Although we still have a lot of development ahead of us for commercial gallium nitride devices, based on our recent progress, we believe we could have the first customer samples available by the end of calendar 2003.

In the power device business, market development and design activity has remained strong. We have started small volume shipments on our first design, and we are targeting additional designs to ramp up in Q4 for our 600 volt products. We have recently signed up sales reps in several European countries and plan to continue to expand our sales network for power devices over the next two quarters in both Europe and Asia.

The development team is making good progress on a 1,200 volt Shocky diode for motor control applications. We have sampled selected customers and are currently targeting the production release of the 1,200 volt product during fiscal 2003.

In addition to our Shocky diode products, the advanced development team is working on silicon carbide (inaudible) which would be used to complement our diode products. The team recently demonstrated a 10-KVMOSFET (ph) which is more than 100 times smaller than what would be possible with an equivalent silicon MOSFET (ph). Although we are still more than a year away from releasing commercial MOSFET products, this is another important milestone and reinforces the potential of our power device business.

On the personnel front, Todd Tucker, our executive Vice President for Operations, has asked to transition into a new role with Cree in order to allow him to spend $additional time with his family. Todd will continue in his current role as head of operations until we have his replacement in place to ensure a smooth transition, and then he'll move into a new role, leading improvement activities both within the factory and across the organization. We've already begun the recruiting process, and will be working to have this position filled over the next several months.

The second quarter marked a tremendous mile stone for Cree as we delivered 16 percent revenue growth to the highest level in the history of the company at $56.7 million. Earnings increased 140 percent to $9 million, which far exceeded expectations. We have done a good job managing the challenges of ramping our factory over the last two quarters and we need to stay focused on continuing this momentum and achieving our key product development goals.

We successfully resolved our patent litigation with Nachia (ph), which is enabling us to increase our focus on creating technology that creates solutions for our customers. Our balance sheet got stronger, as cash and investments increased to $177 million from $164 million last quarter. Demand remains good for LEDs in our other businesses where (ph) targeting revenue to grow in Q3 to $59 million to $60 million, with earnings increasing to 13 cents to 14 cents per share.

In economic time when many companies are struggling, we are delivering record results. As we look forward, I remain optimistic about the second half of our fiscal year and tackling the challenges of developing the products that can continue to drive growth in our business.

We will 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 one on your telephone keypad.

We'll pause for just a moment to compile the Q&A roster.

Your first question comes from Dale Pfau of CIBC World Markets.

Congratulations. Spectacular quarter, guys. Knocked my socks off.

A couple of quick housekeeping things here, Cindy. On the $5 million that came in from our friends at Spectrion, it looks like there were two offsets, but there was also another write-off in the other revenue category. Could you detail all of those again for me?

Yes. We had the $5 million coming in from Spectrion that was a direct offset to a 1.3 million charge we had to take on our inventory because we didn't have a future sale for those products. So that was directly associated with the Spectrion settlement. In addition to that, we also had two unusual charges. One was a write-down of fixed assets of $1.4 million because we decided to abandon a project we had been working for on Epitaxy (ph) reactor technology. And the other charge, we finally exited our marketable securities positions in public companies, and that resulted in another $2.1 million charge.

Okay. And so that's all the charges in the quarter?

Yes. Well, we did have two offsetting charges, but yes.

What were the other two?

We took an additional $800,000 reserve on inventory in Durham for wafers and LEDs, and it was offset by $500,000 benefit by reducing our reserve on accounts receivable.

Okay. Great. Chuck, you said that you were -- I think I heard you say you were about 80 percent booked for the March quarter as of now?

Actually, we're more than 80 percent booked.

You're more than 80 percent booked for the quarter. And your customers out there, are they giving you pretty tight shipment schedules, fixed price, and could you tell us how you're doing in -- relative to their expectations for deliveries?

Yeah. I think that -- you know, we've gone through a tremendous ramp up. You know, our LED business grew more than 50 percent in Q1 and grew another 18 percent last quarter. So as we've ramped up the factory, we have had to work real hard to try to meet customer expectations. I think, now that a lot of that capital investment we made is coming on line, I think we're doing a much better job meeting those expectations.

At the same time, as you can tell from the amount of our quarter that's booked, demand remains pretty strong for us, and so we still are working real closely with our customers, and in some cases, we continue to be expedited.

Now, to your X-Bright product, which was only two percent of revenues, do you have any kind of expectation what you could possibly do on that in the March quarter?

Yeah, I think that - you know, what we're targeting is that, sometime during this quarter we're going to start to get some traction with additional customers. Based on the results we're seeing now, I feel pretty good about getting a couple of other customers on line.

The other thing to remember is we do have some people running with the version we have, and we have some people working on - waiting for the new one. So, I would think, later in the quarter, we'll start to see X-Bright pick up more than the current rate, and then I think we'll see the bigger impact in Q4.

The other thing to note, though, is that MegaBright continues to be pretty strong. As it continued to make improvements, it's really fulfilling a portion of what we originally had targeted for X-Bright demand.

As far as ASPs, if X-Bright ramps good, is it possible we could see another improvement in blended ASPs, Cindy?

You know, Dale, I think where we're at on that is that we always give that traditional number of about 25 percent a year, and clearly, after the first six months, our ASPs are actually up slightly. So we're not going to be in the traditional range anymore. At the same time, I think -- we want to remind you that we're going to use cost savings and other things to keep trying to drive market share.

So, you know, it's going to have -- you're right, if X-Bright becomes a higher percentage quicker, that's going to offset some of the traditional erosion that we're going to see, but we're going to continue to be aggressive and go after market share as well.

And then, on -- you're saying in the quarter that your gross margin on your LED business was about 44 percent, and you're saying that next quarter you're guiding to, you know, roughly low, mid-40s percent gross margin. I assume that gross margin for the March quarter is a blended, including a loss continuing in Cree Microwave. Is that correct, Cindy?

Dale, let me qualify. We did not give out gross margins specific for LED business. What I said was that gross margins would have been 44 percent if we did not have the 1.3 million write-down of inventory that appears on the cost of sales line at Cree Microwave this quarter. So, yes, in general, as LEDs are the largest percentage of our business, you might gain some inferences about our LED margins, but we did not give that specific number.

And yes, I am guiding up gross margins for Q3 to low to mid-40s. That would be accurate, and that would include a negative margin situation at Cree Microwave.

But that's for the whole company for all product lines.

Great. Now, on just a couple of points, whether you -- I'm sure you're aware, Samsung made some pretty bullish comments regarding the uptake of color screens last night on their call. Are you still seeing demand come out of primarily Asia Pacific, or have you seen demand pick up in other segments of the world for handset applications?

You know, the thing you have to remember is that our customers are really oriented towards Asia Pacific, but their reach is really worldwide in terms of the various manufacturers. So it's a little hard for us to gauge, you know, where -- which cell phone maker is driving demand. I can tell that you, in general, though, overall our demand from all of our customers remains pretty strong right now. So, it was good to see their announcement, because I think it makes sense, given the fact that our demand continues to be strong.

And could you enlighten us a little bit on the competitive position out there, particularly since you have settled your patent litigation with Nachia, and if there's any way you can extrapolate a little bit on what that means -- what your cross-licensing means to our models going forward?

Yes. I think that, for your models going forward, I don't think it should affect the financial models that you have. I think from -- in terms of what does it really mean to our business, you know, it's a tremendously defocusing and expensive thing to go through IP litigation. And in addition to the financial savings, which we've already started to see, the fact that we have the organization refocused back on developing new products is really where we're going to get the benefit. I also think that, you know, it removes any concerns that some customers may have had, although I really don't think that was a significant drag in our business previously.

And the competitive position?

Yes, I think that, you know, we still feel pretty good. We feel like X-Bright is still setting the standard out there. We feel like, if anything, our business has been more limited by our capacity than any other competitors over the last six months. And as we get additional capacity on line here, you know, we want to be -- continue to be aggressive and continue to try to drive market share.

And I promise this is my last question. Could you talk a little bit about what your expectations are for blue ray and when we might see the first inklings of any kind of drive to use the blue lasers in the next generation of products out there?

What we're hearing now is that, sometime in calendar 2003, there will be a -- one or two of the manufacturers are targeting to have a system in the market place. They describe the system as a very high-end professional system, really targeted more for the broadcast side of the business than anyone really using it in what you and I would consider to be a volume application. So the first -- that's really kind of the benchmark for the next calendar year.

As far as higher volume commercial applications, our best estimate is you won't start seeing those sometime until calendar 2004, but I'll be honest, it will get a lot better feel once these first professional systems hit the market, and I think they'll give us a lot better visibility. So we're continuing to push forward, still targeting to get our product out here by the end of the fiscal year, and we think that that will position us pretty well to try to push this market forward.

Great. Thank you very much. Keep up the good works, guys.

Thanks.

Your next question comes from Ram Kasargod of Morgan Keegan.

Congratulations -- a great quarter in a difficult market. A lot of questions got asked, so I'll try and keep it brief. I'm kind of wondering, you had a strategy to gain market share. Based upon your results in the second quarter, do you have an assessment of where you stand in market share?

You know, Ram, that's really hard to figure out. You know, if you look, our LED business in six months is up over 70 percent. So, you know, we've pretty much grown as fast as our capacity would let us during that time. But the whole market has been going through changes as demand's picked up for these color phones and blue keypads and a number of other applications. You know, I think -- I feel pretty good that we've held our own or gained share at the same time. It's pretty hard to give you any real numbers, because we've been growing as fast as our capacity would let us.

Secondly, outside of the handset market, I was watching the news the other day, where they were talking in California about these intelligent color screens or color displays that are being pulled out to specifically target advertisements at people on the highways, you know.

Yes.

Can you give us a thought on that and the automobile market, what that's doing for you in the LED business?

Yeah, well, handsets, as we talk a lot about, and everyone knows that continues to be strong. Actually, automotive was strong last quarter. It actually continued to grow even slightly faster than handsets from the previous quarter. So that business looks real good for us. The signs and signal business that you referred to remains steady, and we're also seeing just a tremendous diversification, Ram.

I think one of the things that's happening is, over the last six to nine months, as we've really pushed up performance and been able to really push to some new price points, we're opening up really a diversity of new applications, whether it be entertainment devices, whether it be different types of the portable electronics, or whether it's architectural lighting or other types of - you know, new niche lighting applications, it's really expanding -- while cell phones is definitely the biggest, it's really expanding to a much broader base. And to us, that's a really good sign, because that shows us that there's a lot of markets that, frankly, probably even haven't factored into much in the past to give us some growth opportunity.

And then finally, Spectrion finally got acquired by Remic -- that's completed right now. Any thoughts on what that might mean for Cree Microwave and LDMOS 8?

You know, we had a little bit of sales to them last quarter, and at the same time, you know, as a result of kind of settling the whole supply agreement, we really shifted our focus to, you know, really a broad base of tier 1 customers. And while we're happy to support those guys, our focus is really on some of the larger players and really trying to get new designs and applications with them with our LDMOS 8 technology.

When would you expect that business to pick up? Because it looks like there is some improvement in wireless infrastructure sales right now.

Yes. Actually, I would say that, from what we're seeing, infrastructure is maybe a little bit better, but really still pretty flat from the various announcements I've seen recently. What we've seen is we had a small incremental improvement last quarter. We're targeting to have that happen again in the upcoming quarter. And we would hope that, over the next four quarters, we'll get to the point where that business is profitable by the end of calendar 2003. I think that - you know, it will -- it's going to take a little while to get some traction, but we would hope that, really, by the second half of the calendar year, we'll start to get more wins there.

And then finally, Chuck, where are you on head count right now, and where do you plan to take that by the end of the year?

We're a little over 1,000 employees worldwide. Most of those are here in the Durham location. We are continuing to hire. At the same time, we're also really pushing productivity and yield improvements and trying to find a balance between additional head count and really driving, how do we get more out of the factory we already have. Hard to give you a target for the end of the year, although you will see some incremental growth this quarter.

Thank you.

Your next question comes from John Lau of RBC Capital Markets.

Thanks. Chuck, Cindy, I do have a question. I found one, thank you.

All right.

Okay. On a macro level, longer term, I was wondering if you could give us your visibility on the handset demands for the OED back light (ph) market. Is that going to continue through 2003 on, and what is the forecast, and against that forecast, are you still capacity constrained for the balance of this year? And I have a follow-up quickly on the cap ex expansion (ph) also.

Yes. I would say -- the best numbers I can give you are some of those things we're starting to hear from Nokia and the Samsungs of the world. And, you know, I'm seeing numbers for 40-plus percent of all the phones being color-screened phones. So I would say that gives us a good amount of growth here over the next six to 12 months, and that makes sense, given the demand we're seeing in the short-term.

In terms of capacity constraints, I would say that this quarter, I think we're in a position to add capacity to kind of keep up with demand. That's at least our goal. I think it will be tight, at least in the short-term, from what we can see, but our focus is, how do we take these investments we've made in the last six months, we're looking at additional investments over the next six month, but at the same time, we're really hoping to even drive even more capacity out of the factory we already have. While we made some yield improvements in the last quarter, we have a lot of opportunity there, John. And that's really where our focus has got to be, because that's what's going to continue to drive our competitive advantage going forward.

Over the course of the next -- forget about just the current quarter we're in, but over the next two quarters, against that forecast, is it going to be tight to try to reach those goals also, given your capacity expansion plans also overlaid on top of that?

You know, I think right now, I think we have a good plan for this quarter. The hard part to figure out, John, is exactly what does Q4 look like? As I said earlier, I'm optimistic. We think -- it continues to look positive. But, you know, depending on how fast they try to bring new models out, could we be capacity constrained again? Yes that could happen.

At the same time, hopefully we're getting a little momentum in our expansion here, and I would hope that we could continue to also ramp the factory at a fairly rapid pace. So it's a little hard to give you any firm numbers other than -- it's really a function of demand and some of the improvements we're doing internally.

And then finally, on your cap ex expansion, do you still have room in your new building for the remainder of 2003?

Yeah, we still have room. You know, we made some good investments here about a year and a half ago by building buildings that give us pretty good growth room. We're continuing to add equipment to fill up that space, but I still feel good about calendar 2003 and that we've got a lot of headroom in this factory.

The other thing to remember is that, not only do we have head room just from floor space for new equipment, but once again, yields is -- with yields alone, we could take the factory up several times more than it is today, and so we've got to keep focused on that.

Great. Thank you very much.

Your next question comes from Pierre Maccagno of Needham.

Congratulations on the quarter.

Thanks, Pierre.

I had a question on the X-Bright. Could you give us some comments regarding the yields -- the problems with the yields regarding the packaging of X-Bright, how those problems are being solved today?

We are -- what we have is really two sets of customers. We have one set of customers that is using the product and finding acceptable yields, and actually, we see increased demand from those customers. Then we have kind of a second group of customers that, as a function of their package and their application, we're still not at the point where they're ready to go into production. So we're continuing to make improvements for them, and our expectation is that -- we're pretty close to getting them something that we think we can qualified and online with later this quarter. But -- so it's really two groups, one that's on line and moving ahead, and one that we have a little bit more work to do, but should be on line this quarter.

So, I mean - so one of the packagers (ph) has good yields?

No, it's actually - there's actually groups of factors (ph). There's several companies that are using the current product and there are a number of other companies that we're working with on an improved version of the product that, just because of the specifics of their package or application, require a more robust chip.

I see. Could you specify a little bit of what's really meaning (ph) the main difference?

It's hard to get into the technical details on this call. I think the easiest way to think about it is, the way they use the chip, that they're not getting the type of reliability performance they want to see from it. And so what we need to do is find a way, you know, frankly to make the chip more robust so that - you know, in their particular way of using it, that they get both the acceptable yields and their reliability testing.

Tell me -- I don't know if I had it right, but had you mentioned that you were expecting 10 percent of your AEDs (ph) being X-Bright?

Yes. If you go back to the September quarter, we said we thought X-Bright could be as high as 10 percent this quarter. What we saw is that, although X-Bright did not grow significantly, MegaBright actually grew higher than what we had expected. And that has a lot to do with the fact that MegaBright's brightness is up from where it was six months ago, and as we made those improvements, that's really addressed some of those applications we had already targeted for the XV (ph) chip.

Is this MegaBright being used in display now, or is it mostly used still in the keypads?

We're seeing it used for white LEDs to do LCD backlighting, as well as a number of outdoor applications.

A couple of more questions. So, if I understand where your capacity -- I mean, are you constrained for your guidance in the third quarter?

You know, right now, I think that we have a capacity plan that will allow us to achieve the targets that we've given. You know, if the revenue goes up significantly from there, we could be constrained again. At the same time, we're working hard to try to get ahead of that curve right now.

Okay. And finally, any mention on your customers? You had two new customers you had mentioned, was it last quarter, that really drove the LED revenues quite strongly.

Yes. What we had talked about, starting in June, is we were expecting a couple of new 10 percent customers that then ramped up in Q1 and drove a lot of that demand. They continue to be strong, and we also have added another one or two customers over the last quarter that are also driving. So what we're seeing is that, in addition to the traditional customers we've talked about, we're actually seeing some diversity of a number of other companies becoming much bigger pieces of our business, which we think is a real healthy sign, not only for our business, but for the market in general.

So how many greater than 10 percent customers do you have now?

We don't give that out until the end of the year, but you can assume it's more than we had at the end of fiscal '02.

Okay. Hey, thank you very much.

Sure.

Your next question comes from Alex Gauna of UBS Warburg.

Yes. Back with regard to those new 10 percent customers, can you specify maybe what areas of strength they're capitalizing, or are they general packagers benefiting, as you are, across the board?

Yes. It's interesting, Alex. What we're seeing is they're packagers that some of them (ph) are more focused on the handset business, and we've definitely got some that are doing real well there. But we also have other ones that are winning everything from automotive, entertainment, handset - it's really a diversity. And it really depends on the packagers, and I think that's kind of how that business works. There are some packagers that are more handset or what I would call really portable electronic focus, and then you have some that have a broader portfolio. And it's really a function of that packagers' normal business tendencies.

Okay. And you had mentioned the progress on the blue laser and multiple partners. We know you're working with Rohm (ph). There are others you can speak of? How many companies are working with you on laser development?

I can't give you their names, but I can tell you there's two others that we've been working with. Definitely Rohm (ph) is who we work the closest with and we've been the most upfront with. But there are other people out there that we have sampling, evaluating products with and making sure that we try to have a product that can really meet the general needs of this trend.

Okay. And Cindy mentioned targeting LDMOS wins in each of the subsequent quarters of this year. What gives you confidence on your progress, your qualification, that you can get a win in each quarter? Where are we, how are you benchmarking that?

Yes, we - obviously, to just say that, we are working pretty closely with a number of customers. I would say that, at least for the near term, we have a couple of places where we made a lot of progress in the last six months. And one example is just the Hitachi Kokusai agreement where we've continued to extend that and take the next step. And hopefully those development programs lead eventually to business, and there are other people we're working with. And it's really in an area where -- I think what we found is we can add a lot of value by taking some of our applications and PA expertise and working closely with the customer to really design LDMOS 8 products that do something better than what they can get today.

Now, these LDMOS 8s, you're talking about new designs. Is the design on their front, or -- because you had talked in the past about having qualified your LDMOS 8 to the point that you needed to. Is that design fixed now, or do you have further silicon spins that you need to do to get to the customer's needs?

No, these are not silicon spins. These are device or module spins.

Okay.

These are really applications. These are really tuning the fine product exactly for what the customer needs.

I got it. Okay. And I don't have access to a working model right now, but Cindy, operating income was a big part of this current quarter -- or this last quarter. In your guidance, what sort of other other - I'm sorry, not operating -- other income do you have dialed in for that 13 cents to 14 cents guidance?

Frankly the only thing we've got -- and you're talking about below the operating income line item.

Exactly, where we had 4.2 million this quarter.

Yes. The only thing we have modeled for that is interest income.

And that's about steady with where it was this quarter?

Yes, I would expect that to be sequentially flat.

Okay. And last question, in terms of your ability to add capacity, which has been pretty strong, how do we correlate that with new -- I know you talked some about yield. How many new reactors have you brought on? How many are you able to bring on? What is that dynamic in terms of bringing on capacity?

Yes. I think that, you know, we started making investments as early as late June and into the July time frame. So I can't give you specific numbers, but I can assure you that we've added a significant amount of equipment capacity. At the same time I think that, you know, if you just look at the nature of this business with the yields, as we keep moving through the yield curves and MegaBright and then getting X-Bright on line and doing the same thing, there's probably more capacity through yield available than just adding equipment.

But we really haven't been limited on the equipment. We were limited earlier in the last six months on the equipment side, but I think we'll get ahead of the equipment curve here over the next quarter or so, because a lot of investments we made are starting to come on line.

Okay, very good. Congratulations. Great quarter.

Thanks, Alex.

Your next question comes from Audrey Snell of Brean Murray.

Good quarter. Congratulations.

Thank you.

I had a question -- I think I missed the percentage of the revenue -- LED revenue going into handsets this quarter.

Yes, actually, I didn't give you specifics, but I will right now. It was -- the breakout by application was 46 percent was handsets, 27 percent was automotive, 11 percent was signs and signals, and 16 percent was in the other category, a variety of diverse applications.

Okay. Aside from the demand for MegaBright and future demand for X-Bright, based on price performance, how much of this do you think we should feel is a result of recovery in worldwide economies, given that you're seeing strength across the board, it seems?

It's interesting. I don't think we're seeing -- this is not an economic recovery trend that we're seeing. What we're seeing is that you take some fairly enabling technology like nitride LEDs and start being able to do things like white lights, and you see that you can touch a tremendous number of applications. You can go everything from the signals and the signage business to automotive to, you know, taking the cell phone business, which really isn't (ph) the cell phone business growing, it's white LEDs enabling color screens and new features within the same market that already exists. So I think what we're really seeing is a growth of our business because of what our technology can do, not really a function of an overall economic recovery at this time.

Are there particular LEDs in the product set that are going into autos or just outdoor displays and traffic signage that position you as strongly as your white light in the handset market?

Well, I think what you need to realize is that, just like in the handset market for white and blue LEDs, there's automobile applications that need white LEDs or various nitride color LEDs, and same thing in the other applications. I think -- what you'll see is there's pretty much parallels in a handset to a car (ph), because you're still, again, taking a white light source and replacing it with a white LED.

So I think there are parallels. And then, if you look beyond the traditional applications to some of the newer things, you have things like digital cameras with LED flashes. You have architectural lighting, where people are taking outdoor signage and reramping it with LED. So I think -- there's lot of things that are hard to put your finger on any one application; it's really a diversification of our business into a number of different things.

Chuck, why do you think pricing is holding up better than you thought?

I think that the conversion to the higher performance products was more than we expected. You know, MegaBright grew even, you know, probably as a faster percentage than what we had anticipated. So that clearly helps. You know, there's -- a mixed shift is always a benefit. At the same time, you know, when a market grows and people get - you know, (inaudible) capacity-constrained, that always does reduce the pressure, at least in the short-term.

And how would you assess that capacity constraint right now? We hear wild stories about all kinds of Asian capacity being brought on line, et cetera?

Yeah, you know, I hear those same stories. I think that -- but the numbers I hear is the same number of reactors that were in Taiwan two or three years ago. You know, so the number hasn't changed. People just like to talk about it a lot more right now. And, you know, while it's a real issue, and we take Taiwan and competition from there seriously; we compete with them every day. At the same time, part of that capacity is dedicated to other high brightness technology, like the high brightness red.

And while there are people working on high brightness blues, you know, at the end of the day, it's about making a high brightness, high quality product for a low cost. And that's a challenge we have to continue to face, and we're going to continue to go after it. But I think our results over the last six months kind of speak to our ability to compete with that capacity, and we've got to continue to face that challenge and make improvements and have success going forward.

Do you believe that the color screen demand for LEDs will eventually be 100 percent of shipments?

I don't know if it's 100 percent. I think that, though, it can become a very high percentage. And that's not just based on my opinion. That's based on what the handset manufacturers are saying. I think the practical way to consider that is that, you know, you're not paying much of a premium already for a color screen. It's already becoming something that people are starting to expect. And at some point, if you can have color for a similar cost to the black and white screen, you know, just people will -- I don't believe people are going to find a need to have the older technology.

Cindy, a question for you. Cash flow for the first time, free cash flow generation -- this the beginning of a new trend?

Yes. We are expecting, at this point in time, that we think we can generate $10 million to $30 million in free cash flow for the fiscal year 2003.

Great. What about as you add capacity in the coming year after fiscal '03? Can you size that quantity of capacity add that you'll need?

No. I think the best thing we can do is kind of give you our perspective for the year. We spent 40 million to date. Got a range of 65 to 70 for the year, which is up about 30 percent from what we were thinking at the start of the year. So, you know, we have raised our estimates for this - at least in the next six months for the fiscal year. As far as going forward, I'm sure we'll continue to estimate capacity investments; at the same time, we're going to continue to challenge ourselves to get a whole lot more out of the capacity we already have installed, because that's where we get tremendous leverage.

Okay. Thanks a lot.

Sure.

Your next question comes from Nathan Churchill of Sidoti & Company.

How you doing, everybody? I had some pricing-related questions. Give us an idea if there's more pricing pressure in any particular end market application, say handsets, automobiles, et cetera.

Oh, I would say that the most price-competitive market is handsets, and the segment that's the most competitive would be in the low to mid-brightness. And that's basically where we compete head to head with the Taiwan suppliers on a regular basis. So that's definitely the place that's most competitive, but it also tends to be low to mid-brightness. So it's a little bit on the lower performance end, but it is a place that we can compete pretty aggressively.

Okay. Also, you said that you're maintaining your guidance for ASP declines in the 25 percent or so range, along with historical average.

Let me clarify that. Actually, what we're saying is that, although we traditionally predict 25 percent for the year, given the strength in the first six months, we don't think it will be that much. I don't have an exact number for you, but we think it will be less than that for the year.

Okay. Do you have any sense as to if we could expect any erosion in the third quarter at this point?

Well, you know, we're going to continue to stay aggressive. We're going to continue to try to push price performance. We actually think that's one of our strengths. That's actually one of the reasons we've been able to grow the business so much in the last nine months. So I think we're going to stay aggressive. I don't have any real numbers for you at this time. But you can expect us to push that a little bit going forward.

One more thing. How about the sales breakout within the handset market? Do you have any idea where these LEDs are ending up, if they're going into displays or if they're going into keypads?

If I had to give -- I don't have been breakdown for you. I would say that you can assume that today pre-penetration is still stronger on the blue than on the white side of the market. But I would think that, over the next six months, you'll see Cree's growth -- you'll see more growth at Cree on the white side, because that's the place we have the biggest opportunity.

I guess one more thing. As far as penetration within the handset market again, you're saying roughly 40 percent display penetration of overall handsets?

By the end of 2003 was what I believe Samsung has said recently -- in a recent call. That's for the next year going forward. I think it's significantly less than that today. My guess is it's less than 20 percent today.

Okay. Great. Thanks a lot.

Sure.

At this time, I would like to remind everyone, in order to ask a question, please press star, then the number one on your telephone keypad.

Operator?

Yes, Ms. Barsky?

Well, I think we're completed with the call.

And we do thank you for participating in our conference call today. We do appreciate your interest and support, and look forward to reporting our third quarter of fiscal 2003 results on April 16th. Thank you.

Thank you.

This concludes today's second quarter fiscal 2003 conference call. You may now disconnect.