Wolfspeed Inc (WOLF) 2003 Q4 法說會逐字稿

Good evening.

Welcome to the Cree fourth quarter fiscal 2003 year-end Conference Call.

At this time, all parties have been placed in a listen-only mode, and the floor will be open for questions and comments following the presentation.

It's now my pleasure to turn the floor over to your host, Ms. Fran Barsky.

Thank you, Wayne.

Good afternoon.

Welcome to Cree's fourth quarter and fiscal year-end 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 CFO will report on our fourth quarter 2003 fiscal year.

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 the words like anticipate, expect, target, and estimate.

Such forward-looking statements are subject to numerous risks and uncertainties.

Our press release today and the SEC filings noted in the release mention important factors that could cause actual results to differ materially.

We will not be able to answer any questions regarding the SEC inquiry or litigation with Eric Hunter other than what Cree has previously stated in our prior press releases or provided during the narrative portion of this conference call.

Also, we'd like you to know that as a result of recently effected SEC rules, we will be limiting our comments regarding Cree's fourth quarter results to a discussion of the information included in our earnings release and the materials posted on our Web site which you can find at www.cree.com by clicking on "investor information" and then click on "financial metrics."

We will not be able to answer any questions that would involve providing additional financial information about the quarter or fiscal year.

We note also this call is being recorded on behalf of the company, that the 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 only that analysts ask questions during the Q & A session.

Investors may continue to contact me directly at 919-313-5397 or via email.

We are also Web casting our conference call to allow more flexibility for our conference call attendees.

This Web cast will be available through August 14th, 2003.

Again, for those who may have tuned in late to the call, we will not be able to answer any questions regarding the SEC inquiry or our litigation with Eric Hunter other than what Cree has previously stated in our prior press releases or provided during the narrative portion of this conference call.

Now I'd like to turn the call over to Chuck.

Thank you, Fran.

In the fourth quarter, we delivered the highest revenue in the history of the company with 64 million in sales and net income of $11.4 million, or 15 cents per share.

For fiscal 2003, revenue increased 48% to $230 million, while earnings grew to a record 35 million or 46 cents per share.

The continued growth in our business was once again led by LED sales, which grew 7% sequentially and more than 100% from the fourth quarter last year.

Gross margins were inline with our fourth quarter target at 45%, while R&D spending increased to 8.8 million or 14% of sales to fund our growing pipeline of new products, especially in LEDs.

We target R&D funding to continue at this higher level over the next several quarters to support our development activities in LED chips, microwave, power, lasers, and materials while positioning Cree to better participate in the emerging market for solid state Lighting.

This R&D pipeline is a critical element to our success as we demonstrated in 2003, when LED sales alone exceeded our total company sales from the previous year and more than 70% of these sales came from technology developed within the last 24 months. 2003 was a great year for Cree as we expanded our capacity, increased productivity, developed a range of new products, and grew our customer base to deliver record financial results.

As we start the new fiscal year, we are striving to build on our success from 2003 and the fourth quarter while managing a number of challenges.

From an operational perspective, we need to continue to execute in R&D, as our new LED products are a key piece of our financial targets for Q1.

We must continue to win new business, not only for our new products, but also our current products to keep our factory utilization high and help drive productivity gains and cost reductions.

Yield improvement is also critical to reducing costs so that we can continue to profitably compete in both the high performance segment and the low-cost, high-volume Asian markets.

In addition to these traditional challenges of running our business, we must now also manage the distractions created by the recent lawsuits.

I want to assure you that the entire Cree team is committed to executing our operating plan, and we will deal with the distractions and stay focused on delivering strong operating results, which at the end of the day is what really matters to us and our shareholders.

We remain optimistic about demand for our new products, and we have good visibility for Q1 for most of our large customers, while our turns business seems to be firming up.

We are targeting gross margins in a similar range as Q4 with higher expenses in R&D and SG&A.

As we saw last year, R&D spending is critical to provide the products to drive our growth and it is targeted to increase to approximately $9.5 million in Q1.

SG&A spending is targeted to increase to more than $7 million to support additional expenses related to the litigation, Sarbanes-Oxley compliance, and other matters.

We estimate our tax rate will increase in FY 04 from 26% to 31%.

Overall, we are targeting Q1 revenue in line with our Q4 range of 62 to $64 million, with earnings of 11 to 12 cents per share.

We currently have approximately 65% of our target revenue booked for Q1.

We target incremental revenue growth beginning in Q2, which we believe will enable us to grow both our top and bottom line financial results.

LED sales were strong again in Q4, with unit shipments increasing to record levels while margins were relatively steady as ASP declines were mostly offset by cost reductions.

The ASP trends by product were generally in line with our targets, although we continue to see aggressive pricing in Asia for the keypad backlight application on the lower end of our brightness range.

We are pursuing these opportunities where we believe the combination of price and volume makes sense from both a margin and factory utilization perspective.

Overall, MegaBright sales grew the most in Q4 and represented almost half of our total LED sales.

XBright revenue increased in Q4 to 5% of LED sales, while unit shipments more than doubled from Q3, as we sought effect of new design wins and some aggressive pricing for this product.

While demand for our high brightness blue chips remain strong, the XBright ramp-up has not been as fast as previous products.

We believe the combination of a longer learning curve for XBright and the recent introduction of MegaBright-Plus has resulted in some demand shifting to MegaBright-Plus while our customers improve their capability to work with XBright.

In Q4, sales to our large customers remained strong and provided most of the growth in all LED sales.

We saw a slight decline in turns business as we saw our Asian accounts struggle with issues including SARS and of all demand for the China market.

For the year our 10% LED customer Sumitomo, who is a distributor, was our largest LED customer and represents sale to approximately 20 LED customers including several top tier Japanese LED packagers such as Citizen, Rome, Sharp and Stanley.

Although there seems to be some shift in demand between mobile phone manufacturers and among our customers.

To give you some perspective, one of our large customers is projecting reduced demand in Q1 due to limited short-term visibility from their cell phone and automotive customers, while another large customer is projecting increased demand from a number of their cell phone customers in Asia.

As a result, we are targeting first quarter LED sales in a similar range as Q4.

Overall, we target we target demand for our chips to grow in fiscal 2004, although we may not see this impact until our second quarter.

LED development activity continued at a rapid pace in Q4.

The MegaBright-Plus product was brought on line and represented an important component of our LED sales growth in the quarter.

Blue XBright was released in two versions for use in surface mount and through hole packages, and we're in the process of expanding the product family with a new version for lower temperature die attached processes.

We are working to qualify green XBright chips, which are targeted to be available by the end of the quarter.

We announced last week we've announced our new razor-thin chip for applications, which require smaller LED packages.

This mid brightness product combines a new 95-micron thin design with a typical forward voltage of only 2.9 Volt at 5 milliamps.

As we transition our new XBright and razor thin products into production, our development focus is shifting to our next generation chip in which we plan to combine the brightness of an XBright with the size and lower voltage of a razor thin product.

We believe this product is important for the next generation white LED designs, and we are targeting to have customer samples available within the next few months.

In addition to our traditional LED chip products, which are designed for relatively low power applications, we continue to work on developing high powered chips for emerging applications such as LED lighting.

Our latest power chip design has demonstrated good performance and incorporates the recent improvements in our XBright technology, but our customers do not yet have packages that can adequately utilize such a high power device.

We've made internal investments over the last six months to improve our own capability to evaluate and qualify these chips, and we target releasing this new version during the first quarter.

On the laser front, our team continues to work towards the goal of a commercially viable 30 milliwatt laser chip.

We have demonstrated the ability to build some devices that last more than 1,000 hours, but to date, we have been unable to do this in a consistent production manner, and the current devices are not capable of getting to our 10,000 hour objective.

We believe we are making progress on a number of the key technical factors such as material quality, but at this point, we are still investigating the failure modes in an effort to find a way to eliminate them all together.

We are optimistic about our progress in this area, and we remain focused in pursuit of this important longer term market opportunity.

In microwave, we made progress in Q4 as we delivered on our operating plan with revenue and expenses in line with our targets.

We recently received orders from two of our target infrastructure customers, one for modules and the other for discreets.

All Although these initial orders are for small volumes, we plan to is that start shipping to these customers in Q1 and anticipate that these may lead to higher volume business in the first half of calendar 2004.

On the new product front we lost our new silicon healthy mass product for the Avionics and military market, released a new silicon carbide MOSFETand announced our Silicon carbide MMIC foundry service for domestic customers.

These products are designed to strengthen our portfolio for the Avionics and military markets and complement our commercial wireless infrastructure products.

Although the business is relatively small in terms of Cree's total revenue, we are making progress and target our combined microwave sales for silicon and silicon carbide products to increase by more than $300,000 sequentially in Q1.

In our power business, we've started to get some sales traction for our shot key diode products.

We have recently received the first production order for 600Volt (ph) product for sever power supply was designed to utilize some of the unique features of silicon carbide, and in this particular application, the customer determined that Cree's shot key product is more robust than what they were using previously.

We are also working with designs target today go into production in our second quarter.

Although we are in the early stage of this business, it appears that we are on the right track to realizing sales from this exciting technology.

From a technology perspective, we recently acquired ABB's portfolio of 44 patents and applications related to technology for silicon carbide-based power semiconductors.

ABB has been one of the leaders in silicon carbide research over the last 10 years and developed an array of intellectual property.

The combination of their patents and technology with our existing portfolio gives Cree an even stronger position from which to pursue this morning important market.

Regarding the recent lawsuits, I'd like to give you my perspective on the current status.

As you know, Eric Hunter, a Cree co-founder, and his wife, sued the company on June 12th for more than $3 billion based on their claims of deaf nation, defamation, harassment and securities fraud.

This suit was followed by a surety number of securities lawsuits related to the Hunters' claims.

We stated in a press release on June 13th that we believe the Hunters' claims were without merit based on our preliminary review.

Nonetheless, management asked Cree's board of directors to employ a special committee of independent directors to investigate his allegations.

The special committee of Bill O'Meara and Bob potter has hired the law firm of Latham and Watkins as independent counsel and is in the process of investigating the allegations.

As far as the lawsuit is concerned, the judge has scheduled the first hearing in the case for August 14th to hear arguments on the pending motions.

Cree does not intend to debate their allegations in the press, since the matter is in litigation and will ultimately be decided by the Courts.

But I can tell you that at this point, based on my knowledge and understanding of their allegations, I believe the Hunters' claims are without merit, and I look forward to the results of the special committee's investigation.

It has been a tremendous year for Cree from a financial, operational and development perspective.

We increased revenue 48% to $230 million, while growing our earnings to $35 million.

We more than doubled our production capacity for LEDs while meeting tougher customer specifications and made progress on yields and productivity.

Our development teams continue to deliver enabling new products including LEDs, microwave transistors, shot key diodes, larger and better quality wafers and epitaxes.

We invested in offices in Hong Kong and Japan which expanded our ability to service our customers and helped deliver increased sales across Asia.

In Q4, our balance sheet through to $199 million in cash and investments, while our revenue for the quarter was the highest in the history of the company.

At $64 million with earnings of $11.4 million, or 15 cents per share.

While we had success dealing with the many challenges in 2003, we must continue to focus on delivering the critical new products and executing in the factory while working with our customers to enable them to continue to win new business with our products.

We are optimistic about LED demand over the next several quarters, and we are targeting Q1 revenue in line with Q4 at 62 to $64 million, with earnings of 11 to 12 cents per share.

After comparing our results with a number of other public companies over the last 12 months I believe our performance sets us apart, and we are looking forward to tackling the challenges ahead of us to try and make 2004 another record year.

I will now turn the call over to Cindy.

Thank you, Chuck.

Before I begin my remarks on our earnings results, please keep in mind that the reference to cautionary statements made at the beginning of this call will also apply to my comments.

For our fourth quarter and fiscal year ended June 2003, Cree reported revenues of $64,061,000 and $229,822,000 respectively.

For our fourth quarter, pro grew 8% sequentially due to higher LED and material sales.

For the 12 months ended June 29th, 2003, our customer diversity increased over the prior year as customers comprising 10% or miles an more of our revenue included Sumitomo at 34%, Osram at 21%, and Agilant at 10% respectively.

Today we reported net income of $11,391,000 for the most recent three-month period, which reflects a 7% increase sequentially.

Our after-tax net margins were 18% of revenue, and EPS was in line with our targets growing to 15 cents per share.

For the 12 months ended June 29 June 29th, 2003, net income was $34,901,000, or 46 cents per share, which was the highest profitability reported in our history.

LED revenue for the fourth quarter grew 7% sequentially to $48,947,000, which marked a record for Cree and made up 76% of our overall revenue.

For the fiscal year, LED revenue was $172,339,000, or 75% of total revenue.

For the fourth quarter, our unit shipments increased 21% over the March 2003 quarter to a new record while our LED average sales price decreased 12% sequentially.

Compared to a year ago, the average sales price for LEDs has declined 7% due to normal price reductions offset partly by a shift in the mix of our customers' purchase towards orders for higher brightness products, especially our MegaBright chips.

On a product by product basis, we continue to target average sales price declines of 25% for our higher brightness devices during fiscal 2004, which is consistent with our historical experience as we have continued to work with our customers to improve the price and performance value of our products.

During the fourth quarter, our mid bright nis chips made up 84% of our LED revenues, while our standard brightness and XBright parts were 11% and 5% of revenue respectively.

We estimate mobile appliances including cell phones, PDAs and other handheld devices are still the largest end user application for our products.

Sales to display, gaming and consumer product applications remain steady, while our automotive volume declined slightly in the June quarter.

As we move into fiscal 2004, we believe that our ability to ramp up production and gain customer acceptance of our newer products such as razor think, MegaBright-Plus and XBright devices will be critical in meeting our revenue targets.

Silicon carbide wafer revenue increased 25% sequentially to $6,328,000, or 10% of our overall revenue.

For the fiscal year, wafer sales were $19,480,000, or 8% of total revenue.

For the fourth quarter, our wafer volume increased 21%, while our average sales price was 2% higher than the March quarter.

The increase in volume resulted primarily from higher sales to Ozram.

Our average sales price remained stable as higher prices received for our epiwafers offset the impact of the wafers sold to Ozram.(ph) material declined 25% in the june quarter to $1,574,000 or 2% of total revenue due to lower yields of usable material per crystal, which reduced our average sales price received from Charles and Kobart.for a fiscal year sales at (ph) was $7,421,000 or 3% of total sales.

Cree Microwave Sunnydale reported sales of $700,000 and $2,797,000 for the three and 12 months ended June 29th, 2003, which was approximately 1% of our total revenue for both periods.

Contract revenue declined 3% sequentially due to a slowdown on work per performed on certain contracts as spending was running higher than budgeted.

Contract revenues were 10% and 12% of total revenues for the three and 12 months ending June 29th, 2003.

Gross margin for the June quarter was 45.1% of revenue versus for the 46.6% reported in March 2003.

Our average LED cost decreased 9% sequentially due to higher throughput in the germ factory and higher yields.

However, this decrease in cost was more than offset by the 12% reduction in our average LED sales price.

The gross margin for our materials business declined in the June quarter as the average sales price for wafers increased by 2% while average costs grew 16% as inventory reserves were increased by $159,000 for slower-moving material, in addition to a slight mix shift to higher cost materials.

Margins on gemstone materials were reduced in the fourth quarter due to lower yields of useful material per Crystal, which reduced our average sales price.

Cree Microwave reported negative gross profit of $1,553,000, compared to negative gross profit of $1,735,000 in the March quarter.

Contract margin declined to 18% of revenue in the June quarter from 20% in the March quarter due to a change in mix to more cost share type contracts and at $255,000 prior quarter rate adjustment.

Gross margin for government contracts is targeted to be 18 to 20% of revenue for fiscal 2004.

Operating expenses as a percentage of sales were lower at 22% for the fourth quarter compared to 25% reported for the March quarter.

These expenses are comprised of research and development and SG&A costs.

During the June quarter, spending for research and development increased $696,000or 9% sequentially due to a greater focus on new LED products including our MegaBright-Plus, XBright, razor thin and other devices.

SG&A costs declined 21% sequentially due to lower legal fees as a result of the settlement of our patent litigation with Nichia and reduced bonus compensation and other costs.

During the fourth quarter fiscal 2003, we recorded a $488,000 gain as other non-operating income for favorable foreign currency adjustments per our contract with one of our large customers.

Interest income for the quarter was 79% lower at $254,000 due to a prior quarter adjustment that reconciled interest income for our fiscal year-end as well as lower rates being received on our cash due to the low interest rate environment.

We are currently reviewing our cash portfolio with our investment bankers in order to maximize our rate of return on available cash.

At the end of fiscal 2003, we believe our balance sheet position is strong.

Our cash and investments were $199 million, up from $189 million in March.

For the 12 months ended June 2003, cash flow from operations was $89.6 million despite a $13.3 million build in accounts receivable from June 2002 primarily due to our significantly higher revenue base.

Our day sales outstanding, which is calculated on our trailing monthly revenue profile increased to 57 days from 51 days in the March quarter as collections were somewhat slower from our customers in Asia.

Inventory days on hand were 46 days, down from 50 days reported in March.

Inventory balances remain flat year-over-year despite our growing customer base.

Our capital expenditures for fiscal year 2003 were $77.6 million, primarily for capacity expansion in our determine facility to support our ramp-up of LED production and to target higher volume for fiscal 2004.

For the 12 months ended June 29th, 2003, we generated free cash flow for the first time in our history of $12 million, despite the heavy capital investments made during the year.

We calculate free cash flow as cash flow from operations plus capital equipment expenditures.

Please visit our Web site for further details of this calculation.

We did not repurchase company stock in the fourth quarter, but we expect to continue to evaluate repurchases based on market conditions in the future.

As of June 29th, 2003, our backlog stood at $67.9 million, which includes only one quarter of Sumitomo's year-long commitment of their contract.

In addition, we are currently working with Ozram and aim to renew our contract with them over the next few months.

Our government contract backlog declined from year ago as we secured several multi-year contracts in fiscal year 2002 and we have continued to perform work based on funding from these contracts.

As we look to the new fiscal year, we target first quarter revenue to be in the same range as our fourth quarter target of 62 to $64 million.

We believe much of our success in meeting this target for the first quarter will depend on how well we can execute the ramp-up in manufacturing of our MegaBright-Plus, XBright and razor thin products.

In the first quarter of fiscal 2004, we are targeting gross margin in a similar range as Q4 mid 40s as a percentage of our revenue.

At this time, we are planning an increase in spending for research and development costs for fiscal 2004.

We believe it is critical for us to continue to fund new LED programs in order to stay competitive in the marketplace and create new designs that can enable or customers to develop more applications for our devices.

Therefore, we target R&D spending to increase in our first quarter to $9.5 million, and we target R&D expenses in the range of 14 to 15% of revenue for the fiscal year.

We believe this investment can help support our target for a record year in fiscal 2004 in terms of both revenue and profitability.

SG&A expenses are targeted to increase to 11 to 12% of revenue in the first quarter, primarily due to higher legal fees associated with the Hunter litigation and related matters, and Sarbanes-Oxley act compliance costs.

We also target interest income at approximately $1 million per quarter for fiscal 2004.

Our tax provision is targeted to increase to 31% for fiscal year 2004 as favorable tax planning strategies have benefited us in fiscal 2003 will no longer be available.

In addition, our tax provision is increasing due to our target for higher profitability.

Therefore, earnings per share is targeted in a range of 11 to 12 cents for the first quarter with an estimated $76.5 million fully diluted shares outstanding.

Capital expenditures for our fiscal year 2004 are targeted to decrease to a range of 50 to $60 million as we intend to focus more heavily on yield improvements during the year for our capacity needs as well as benefit from investments we made in fiscal year 2003.

On July 10th, we announced that after the filing of the Hunter lawsuit, we received a request from the SEC for information in connection with an informal inquiry.

At this time, we cannot determine a time frame for the completion of their review.

As we have said previously, we look forward to answering their questions and we are providing information to them as rapidly as possible.

As Fran mentioned earlier on this call, we will not be commenting further or taking any questions with regard to the SEC inquiry or our pending litigation.

In fiscal 2003, spending for R&D was $31.2 million, and when you add the cost of government contracts of $20.9 million, total gross expenditures for R&D were $52.1 million.

We believe this level of spending is critical to our business, and our goal remains focused on delivering exceptional products that will drive strong net profits.

We believe we can do this while continuing to generate positive free cash flow.

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

Thank you, Cindy.

Once again, 2003 was a great year for Cree and we are excited about the opportunities ahead of us in 2004.

We will now take analysts' questions.Wayne?

Thank you.

The floor is now open for questions.

If you have a question or comment, please press 1-4 on your touchtone phone.

We ask while posing your question to please pick up your handset to provide optimum sound quality.

Please hold while we poll for our first question.

Our first question comes from Earl Lumm from CIBC Oppenheimer.

Yes, good afternoon.

A couple of quick questions, Cindy.

You talked about average selling prices down 12% in the quarter and then cost down being 9.

For fiscal 04, I guess we're looking at the standard 25% ASP reductions.

As we go into Q1, has the pricing within the last weeks of exiting the fourth quarter and entering into Q1, has that changed at all in any direction or can you comment on that?

Earl, this is Chuck.

I think that, you know, you've got to kind of look back to, one, we are continuing to give our 25% annual guidance, which is really based on a historical rate.

I think the other thing to note is that if you kind of look back at Q4, one of the things I mentioned earlier is that, you know, generally speaking, most of our products, especially our high brightness stuff, was pretty much in line with our expectations, although we are seeing some pretty aggressive pricing on the low end of our mid brightness category, specifically for that keypad market.

So, you know, it's a little hard to give you any additional insight into there other than getting a feel for that one segment of our business.

If you look at the XBright in particular, you say that unit volumes had doubled from a revenue perspective on a sequential basis, can you give us an idea as to how much the revenues had increased on a similar level?

Yeah, XBright, the units more than doubled and the revenue went from 4% of our LED sales last quarter to 5% of our LED sales this quarter.

Ok.

And then what exactly are some of the issues that you're seeing right now in terms of really getting that product to ramp, or can you give us some insight into what is going on in terms of some of the feedback that you're getting from your customers on that product?

I think the fact that the volume more than doubled gives you some indication that it has had good success over the last quarter.

I want to make sure we don't miss that point.

In terms of some of the challenges, I think it's really two things.

It's a combination of we're trying to take an industry that's been manufacturing LEDs the same way for about 30 years, and trying to help them convert to utilize the benefits of the new XBright, primarily in the die attached process, and that's frankly taking both us and our customers longer than we originally anticipated.

Probably as much as anything, though, we also, with the introduction of MegaBright-Plus last quarter, I think we made it very easy for our customers to access a very bright blu chip quickly using a platform that was already qualified, and so that probably also had some effect on the ramp-up.

Ok.

And then one other follow-up question with regards to the lasers, it seems like you're trying to make a leap now from the thousand hour to the 10,000 hour.

Is part of the R&D increase devoted to tackling that issue at this point from what your guidance is for the first quarter?

Yeah, I think there's really two things.

One, while we can demonstrate a thousand, we haven't been able to demonstrate it on a consistent production-type bases.

The other piece is, one of the fundamental issues that keep us even on those devices getting to 10,000.

So we're really working on a couple of issues in parallel, and it's hard to give you any forecast for that, although I will say we continue to work through various technical hurdles, additional ones in front of us, and we have to keep going after them.

Thank you.

our next question comes from Nathan Churchill from Sidoti & Company.

Could you guys give us some idea of where you think you're at as far as market share in the handset market and what you think your overall penetration of color displays is in that market?

I'm not sure we have any updated good mention for you on exactly how far they are.

I think, you know, at one point a couple quarters ago, we were looking at 20% and there was estimates saying color screen could be somewhere near 40 by the end of this calendar year.

Where exactly we're at there, it's pretty hard for me to give you that insight because we don't have the data.

As a general trend, I would say that we've done pretty well.

I think we continue to have a lot of success, you know, especially in the keypad portion of the market, and some of our customers bring on additional white product, for example, things like MegaBright-Plus, that is increasing our penetration for white LEDs for applications including things like cell phones.

So I would estimate that our share is probably improving, but again, it's a pretty loose estimate at this point.

Ok.

Another question.

On the ABB patents, are there any particular areas of weakness that you are looking to solve by getting those, and how do you think that those are going to benefit you and what kind of time frame are we looking at?

I wouldn't say we had any weakness.

I'd say this is a very opportunistic business opportunity for us.

You know, over the last 10 years, we've been very familiar with the stuff they were dog, and it's really complimentary not really for our short-term products, but especially for some of our technology that might be helpful over the long term, and it gives us a much broader technology and IP base from which to build on.

So it wasn't us looking for a missing piece.

It was really the opportunity to acquire a very complimentary portfolio.

Ok.

Cindy, do you have the cash flow for option issuance for the quarter?

I don't think we can disclose any numbers that are not included in our financial metrics on our Web site and that is not a number that we have disclosed.

Ok.

Thank you.

Our next question comes from Hans Mosesmann with Sound View.

It's not clear to me if the issues are end demand related or your ability to produce this product consistently, so if you can explain what is going on with.

XBright once again?

I would say at this point, we can build XBright.

That doesn't concern me.

It's like any new product, it has its challenges and you will always face those, but I don't think we're Cree-execution-limited.

I tinge think that at this point, the demand for a brighter chip like XBright is still tremendous.

I mean, it's one of the reasons I think we had such quick success with MegaBright-Plus, for example.

You really have to sit down with each customer and work through the issues to really help they them develop a new die attached process that they haven't had to deal with over the past X number of years they've been in the business.

So it's really a learning curve-related issue, not from a manufacturing chip standpoint but with our customers and in their packaging operation.

You and you think that it is a one- or two-quarter issue or long ?

I think it's an issue that's the reason Xbright hasn't ramped up quite as fast as a lot of us anticipated earlier on.

It's hard for us to give you a guess as how fast it's coming along.

I think the fact that the volume doubled is a good sign, but I think it will take a little longer than our current products.

I remain pretty darn optimistic that the brightest -- if you can make the brightest chip out there and that you can do it at a competitive cost, we're going to be able to drive market share there.

It's just going to take a little longer.

And if we keep offering alternatives like MB plus, we don't force the customer's hand very quickly there either.

One last follow-up.

What specifically is different with XBright that it requires different die attach, if you can explain that very briefly?

So traditional LED is generally put inside an LED package with it be surface mount or through hole ramp and they use a conductive silver glue to attach it, so it is the mechanical attachment into the package and it's also the electrical.

Because XBright is basically an inverted chip where it's on the bottom, we cannot use that tech technique, so we're looking at different types of metal attach techniques for that, something more similar you might see in a laser than you would traditionally in an LED.

So it's that learning curve for the standard LED packager that we're working through.

Great.

Thanks a lot.

Sure.

Our next question comes from Dale Pfau from CIBC Oppenheimer.

Yeah.

A couple of questions here, Chuck and Cindy.

First of all, on the contract revenue, what are you targeting contract revenue at for the first quarter and for next year?

We didn't give any specifics of what we're targeting contract revenue as a portion of our reef knew, but you can kind of base, Dale, it's been running in a range of 10 to 12% of our revenue.

I don't see any changes in that going forward.

Ok.

And we've got margins going down on the contract side, margins going down a little bit on the materials side, but it looks like we're going to get the improvement in margins on Cree Microwave.

You indicated you had about a 5K pop, is that right, Cindy?

I said negative gross profits were lower.

In other words, we had improvement in the profitability.

Dale, what I talked about is I said our total microwave sales, we're targeting at more than a $300,000 increase sequentially in a revenue line, so clearly we would expect to have some benefit for us on the cost side.

But also we did give you margin numbers for Cree Microwave, and they're less damaging than they had been in the past.

Right.

Ok.

And back just to make sure I understood, Cindy, the lower interest income in the fourth quarter was specifically because you adjusted for some interest income in prior quarters?

Yes.

We had made a correction for our prior quarters in our fourth quarter.

So that's why we saw a lower interest income in the fourth , and you're targeting about a million dollars per quarter going forward?

Correct.

Ok.

Now, back to -- Chuck, back to this ASP issue on the LEDs, we saw ASPs come down about 12%, costs come down about 9%, but yet your mix was obviously skewed and it was skewed a little bit different than we had anticipated coming into the quarter.

Did you see the ASP erosion at 12% across the product line or, as you mentioned, primarily at the low end of your mid bright category, and could you talk about ASPs in your standard brights?

I would say in the low end of mid bright is where we saw the most aggressive pricing, all right, so I think that definitely skewed the numbers a little bit.

Also volume, you remember -- as we report the mid brightness number to you, remember the volume swings across that range that can have an effect on that blend blended A ASP number we're reporting to you.

As we look at our standard brightness products, that those were pretty much in line with our expectation.

So the ASP -- was not quite as strong in those segments?

that would be fair.

Would you consider the 12% you saw in the quarter anomalous?

Were you responding to market pricing or were you being a market leader in pricing in that low end of the mid bright category?

I think the best way to say that is I think we did pretty good on market share.

Ok.

You know, as we head forward here, first of all, it looks like your turns business in the fourth quarter was a little bit better than we expected.

Your revenues came in slightly better than what we were looking for, and your turns business, it looks like your modeling for the first quarter is consistent with the low end of what you expected last quarter.

Could you talk a little bit about anything you've seen in the first few weeks of this quarter supporting or not supporting those trends in turns business?

Let me back you up a little bit.

I'd actually say our turns business was a little off last quarter.

I think our major customers really led the LED sales growth in Q4, so I would say turns business, if anything, was a little weaker, and that was affected by some of the issues in Asia with SARS and some of the China slowdown issues.

As far as going forward, what we're actually --what I was trying to suggest earlier is that we're actually seeing the turns business firm up or get a little bit better, so we're actually being more optimistic about that business coming into this quarter.

But at the same time, you're getting mixed messages from some of your larger customers?

We have a large customer that's forecasting lower demand is what I was describing earlier, and that's really having an offset to actually what I would consider otherwise a positive signal we're getting from the rest of the market.

Ok.

And on your new chips, could you give us the price differential between the MegaBright-Plus and your XBright?

Let's see.

I can't give you exact, but on MegaBright-Plus, which has about a 12-milliwatt minimum specification, is very similar to the specification for the low end of the XBright, so they're priced similarly at the low end, but then XBright becomes more of a premium product as it goes up in brightness and XBright-Plus is probably a 20 to 30% premium, in that range, over the MegaBright-Plus.

But you've got to be a little careful because what happens is MegaBright-Plus starts to overlap the standard XBright end of the range, and then XBright goes above from there.

Ok.

But the pricing between those two chips is comparable, so if you had some cannibalization, it shouldn't affect your overall ASPs?

Correct.

What you really saw is really a -- it's a shift between are they buying XBright or MegaBright-Plus, but between the two products, they're fairly similar pricing.

How about on margins between the two?

Margins would be similar.

If anything, MegaBright has been around a little bit longer so probably a little farther down the yield curve, but generally speaking, with the exception of the low end of our mid brightness category, our --plus or minus a little bit.

Ok.

Thank you.

Sure.

Our next question comes from Harsh Kumar from Morgan Keegan.

Hi, Chuck.

Hi, Cindy.

Gross margins were down on a sequential basis.

Can you give us qualitatively maybe some color on yields or was there something else in the cost of goods sales there?

There were 46.5% last quarter and 45% this quarter, so while they were down a little bit, if anything, that's just a little bit of of function of the fact that you could look at our LEDASPs came down a little faster than our cost did by about that 1.5% net that you see there.

Although we did see a little lower margins, probably LED esss is the driver there.

SG&A this quarter was 5.3 going to $7 million sequential basis.

Is that pretty much all legal or are you ramping anything on the G&A side?

Actually I want to make sure I clarify.

I said I expect to be more than $7 million, and that the largest driver would be legal expenses but there are other expenses related to things like Sarbanes-Oxley act compliance and other things if N. there, but definitely legal is the large driver of that.

Ok.

And just one final question.

Talking about your long-term model here, you gave us some sense of what SG&A and -- R&D in the 14 to 15% range, SG&A in the 11 to 12.

This is valid, I take it, for the next year.

Question number one, and is that also pretty much what you're targeting your long term operating expense model to be?

Maybe you can provide us some color on that.

From an R&D standpoint I think over the next several quarters, 14 to 15% is part of our model.

At the same time, I think that SG&A, I would not model that in for the longer term.

At this point, we're reacting to some pretty new expenses primarily related to this litigation, and I think until we work through those issues and really which ones of those are ongoing, which I don't think a lot of them will be, then I think you would see that some of those costs would go away going forward.

Got it.

Thanks.

Thanks for the clarity.

Sure.

Our next question comes from Pierre Maccagno from Needham & Company.

Hi, Chuck and Cindy.

Could you comment on the industry and is if still capacity-constrained for the higher brightness LED products?

Yeah, I would say that right now on the high end of the market, if it's not capacity constrained, it's a very tight supply or, you know, I think that there's definitely, you know, a limited supply on the high end of the market.

It's really only served by Cree, Nichia and maybe some of the best of Toyota's upper end but not them as mch.

I think if you look at the lower end of the market, especially with what happened last quarter, there's definitely not a capacity constraint on the lower end of the market.

Ok.

Well, thanks.

Sure.

Our next question comes from John Lau from RBC Capital Markets.

Yes, thanks, Chuck, Cindy.

Circling back to the litigation issue, more specifically on the patents litigation, could you give us an update on the outstanding litigation versus the competition in the industry?

I think specifically there was a case in Korea and in the U.S. with AXTI, and I wanted to see if you could give us not only the specifics on the AXTI but the overall industry perspective of what's happening in terms of that litigation on patents.

Thank you.

So John, let me see if I can talk on the overall issue first.

It is -- Nichia did announce during the quarter that they had shut down an unnamed Korean LED chip manufacturer during the quarter due to IP-related issues, so I think, you know, what does that do to the industry?

I think what we're seeing is it really -- I think it reminds all the people out there in the marketplace that IP does matter and has a pretty significant impact on people's business model.

As far as Cree is concerned, that's probably a net positive since we have a pretty good IP portfolio and a cross license with Nichea.

So I think generally speaking for our business model, it's a positive for Cree.

As far as the U.S. issues are concerned with the AXT litigation, we filed suit against AXT for patent infringement and then they've recently filed a counter suit that's based on their feeling that we don't -- they don't ink infringe our patent and some related claims, and as far as that goes, I can't say a lot because the matter is in litigation.

Think the best thing I can tell you is that the patent we are suing them on, we have litigated before over a number of years, and I think we know the patent very well, and I can tell you that we're pretty confident in our position at this point.

As this continues to evolve, not only for the -- you mentioned this Korean issue and AXTI, they're beginning to exit the industry.

If you would take a look at the competition that's out there for the LEDs, especially from the competition that you're getting that's pressuring the low end of the mid brightness, are they also at risk for this litigation?

Are they in violation?

I mean, how many of these manufacturers out there specifically in Asia could potentially be infringing?

Well, that's a hard question to answer, John.

I would say that the companies that have been doing this the longest, Cree, Nichea, Toyota, some of the people that have been investing in this tech technology for 10 years probably have the strongest advantage out there.

As far as all the many company that is have entered over the last three or four years, you know, I think as a practical matter based on what I'm aware of out there, there's probably some risk out there, but it's really hard and you'd have to look at it on a case-by-case basis, but, you know, I think in the case of -- you can see the case where Nichea has gone after the one manufacturer and they basically exited the business.

It does point that there are issues out there in the marketplace.

As far as how many people out there may have them and where those issues are, it's really hard to give you a good number at this point, but it does really raise the awareness.

Ok.

Let me try to rephrase it another way.

It seems that with the issues of patent, whenever that's brought up, it is very successfully defended in the marketplace.

Now the question is, will Nichea have taken that next step, although it's a very difficult process to go to Korea to address those issues, I think -- is it your intention or Nichea's intention in that matter to continue to pursue that into the Taiwan market or China market?

I have no idea what Nichea's intention might be.

I think from Cree's standpoint, we're evaluating our IP portfolio and where other company's products may fall within that, and we're going to take measures to make sure that we addressed that appropriately as far as, you know, where we might go next or what other things we might do.

It wouldn't be appropriate for me to comment at this time.

I think, you know, as far as where companies are located, I think one of the practical matters that people have to keep in mind is that it's not just where you manufacture the product, but where those products end up generating value.

So it might be manufactured somewhere else but it may get sold later in Japan or other things like that.

So we really live in a global market and it pretty much is inner-connected, so we'll have to see how that plays out.

Great.

Thank you.

Our next question comes from Blaine Carroll (ph) from Adams, Harkness & Hill.

Thank you.

Chuck, if we can look at another piece of your business, if you'll look at the wafer revenue, you know, it's actually been increasing very nicely sequentially over the last couple of quarters, and I was wondering how much of that growth is being fueled out of some work you're doing on the defense side.

Boy, it's a little hard to give you any exact breakout by customer.

I don't have that in front of me.

But I will tell you that definitely as the government funds more research related to silicon carbide, whether it be at Cree or at other companies, that's generally a positive thing for Cree because as someone who -- having the wafer products that we have available, it generally helps us not only there but it can also benefit some things like our silicon carbide MMIC foundry services.

So I think generally speaking, there's always an upside, but I would argue that probably we've had more success in the last couple of quarters in really the commercial sales of wafers and that the military side has been pretty consistent.

Wasn't there some news out there about you winning a contract with the government for some radar products?

I'm trying to figure out exactly which contract you're talking about, but in the last year or year ago, we announced a couple of different contracts that we're still working on now, and they're related to various defense-related things, one of them which is radar.

Ok.

And then I guess just, you know, to back up a little bit, just from 20,000 feet, if we're looking for revenue, total revenue to be flat to maybe down a little bit sequentially into the quarter, and if the LED revenue, you know, you're saying is going to be roughly flat, you know, which pieces of the businesses are going to negatively impact the revenue growth?

I think we're guiding to the targets we gave you earlier are basically the same range we went into last quarter with, and we're really telling you is we have about the same ability to, we think, accurately predict what we're going to be able to deliver, so I wouldn't read into that one way or the other there.

I think obviously LEDs was over 70% of our sales last quarter, so that obviously is the major driver.

I think the other businesses are really just coming in a similar range.

Ok.

Great.

I'll pass on.

Once again, if you have a question or a comment, please press the numbers 1 followed by 4 on your touchtone phone.

I'm showing no further questions.

I'd like to turn the floor back over to management for any closing comments.

Thank you for participating in our conference call today.

We do appreciate your interest and support, and look forward to reporting our first quarter fiscal year 2004 results in mid October.

Thank you.

Thank you for joining today's Cree Conference Call.

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Have a wonderful day.