Wolfspeed Inc (WOLF) 2004 Q2 法說會逐字稿

Good afternoon.

My name is Derrick, and I will be your conference facilitator today.

At this time, I would like to welcome everyone to the Cree second quarter fiscal year 2004 financial results 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 and then the number one on your telephone keypad.

If you would like to withdraw your question, press star then the number two.

If you need operator assistance, press star zero.

I would like to turn the call over to Fran Barsky, head of investor relations.

Ma'am, you may begin.

Thank you, Derrick, and good afternoon.

Welcome to Cree's second quarter fiscal year 2004 earnings conference call.

By now you you should have received a coppy of the press release.

And if you did not receive a copy, please call our office at 919-313-5300, and we will be pleased to assist you.

Today, Chuck Swoboda, our President and CEO and Cindy Merrell, our Chief Financial Officer, will report on our second quarter 2004 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 and revenues, gross margins, 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.

Also, we would like to note that as a result of the SEC rules, we will be limiting our comments regarding Cree's second quarter results to a discussion of information included in our earnings release and the materials posted on our website, 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 questions that would involve providing additional financial information about the quarter or answer any questions regarding pending litigation or other legal proceedings beyond the comments made in the prepared remarks.

This call is being recorded on behalf of the company; that the presentations and the recordings of there call are copywrited property; 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 (INAUDIBLE) analysts ask questions during the Q&A session; however, we recognize that other investors may have additional questions, and we welcome you to contact us after the call by e-mail or phone at 919-313-5300.

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

The web cast will be available through January 29, 2004.

Now, I would like to turn the call over to Chuck.

Thank you, Fran.

For our second quarter, we delivered strong financial results with record revenue and earnings that exceeded analysts' consensus.

Revenue increases 10% sequentially and 28% over second quarter of 2003 to $72.7 million.

Net income increased 46% sequentially to $13 million or 17 cents per share.

The growth in revenue was led in LED sales, which grew 12% in Q1 to $56.5 million.

Gross margins rose strongly to 47% as we benefited from both an improved pricing environment and successful cost reduction activities.

R&D and SG&A spending remain flat with Q1 at $8.3 million and $7.9 million respectively.

Our R&D teams continue to have success with the introduction of high performance products like our brighter XThin LED chips while also making good progress on cost reductions through yield improvements and process simplification.

We target R&D funding to increase over the next several quarters to fund improvements in the cost and performance our LED chips, development of our XLamp power LED product family, and further advances in materials, microwaves, lasers, and power.

Our operating plan is -- has delivered record financial results and enabling new products, and we target an stronger second half of fiscal 2004.

As we build on our success from the last several quarters, we must continue to manage the challenges of growing our business.

From an operational perspective, we must leverage our success from Q2 and continue to drive cost reductions across our product lines through yield improvement and productivity gains.

We need to continue our sales success from the last several quarters and continue to win business for our new products while managing the challenges of ramping up volume production of these products in our factory.

We operate in extremely competitive markets ranging from our LED chip business and our Silicon RF business to our merging silicon carbide diode and power LED lamp businesses.

Our R&D teams need to continue to deliver higher performance and lower cost products, not only in LEDs but for all of our product families in order to maintain our technology leadership position, create barriers for the competition, and enable Cree to deliver superior value to the customer.

These changes are not new for Cree.

They have been part of our business since the mid-90s's when we entered the Nitride LED market, and we look forward to finding solutions to overcome these hurdles and build on our past success.

Looking ahead to Q3, we are optimistic that we can continue to grow our business.

We are targeting revenue to increase in Q3 to a range of 75 to $76 million driven by growth in LEDs and microwave.

The first calendar quarter is historically a down quarter due to Asian factory shut downs for Chinese new year and seasonal trends for the mobile phone business, which is the largest end market for our LED chip products.

However, based on current customer order patterns and forecasts, we believe that continued strength in the overall demand for mobile phones combined with increasing demand for white LEDs being used within the phone will enable our LED chip business to grow further in the third quarter.

We currently have more than 70% of our target revenue booked or under contract for Q3.

We were are forecasting gross margin in the mid to high 40s range as percentage of revenue, although this may fluctuate up or down depending on the product mix.

R&D spending is targeted to increase to approximately $9 million, while SG&A expenses for the third quarter should be at a similar level as Q2.

Therefore, we target Q3 earnings of 17 to 19 cents per share.

LED chip unit shipments grew 8% sequentially in Q2, while ASPs increased 3%.

Overall we saw good sales growth in both our mid brightness and high brightness product categories.

The ASP trend was better than our original forecast and driven by a favorable mix shift due to an increase in the percentage of our sales of our premium price products in both the mid brightness and high brightness categories.

We had good success in the quarter with our razor thin products as well as MegaBright green products, while our sales for the low cost blue key pad back light market remains strong.

In addition to the blue keypad market, we saw an increase in sales of our high performance blue chips used in white LEDs for LCD back lights, camera flashes, and keypad backlights for several major phone manufacturers.

We continue to work with our customers to develop and expand the X class products for specific markets in packaging applications.

Our efforts to make XBright a success appear to be paying off, as we have booked a significant amount of business for our XBright, XThin and power chip products for the third quarter.

With the recent introduction of our new brighter XT 15 and XT 18 chips, we expect the XThin product family to become a larger part of our business, especially for use in white LEDs for mobile appliances.

Overall, we continue to see strong demand for our high brightness products and expect that this category will drive our growth in future quarters.

Customer demand for high brightness LED chips appears to be increasing across application segments with mobile phones being the key driver in the near term.

We see the continued adoption of color screen and camera phones driving demand for blue chips used in white LEDs for use in the flash and back lighting LCD and key pad.

Based on the feedback we are getting from our customers, we believe there is real pull through demand for these high end mobile phones.

Demand for green LEDs has also increased recently for applications ranging from video displays to automotive and entertainment.

From an overall market perspective, the Nitride LED chip business appears to be separating into two market segments.

The Taiwan/China market, which appears less concerned with IP, and the Japan, Europe, and North American markets, which are more concerned with the recent IP claims against certain suppliers in Asia.

We are seeing increased demand from a number of LED packager across Asia ,including Taiwan, for their products targeted for end customers and markets where IP is valued, and believe that this trend is reducing the pricing pressure for these markets.

In general, our Taiwan competitors continue to be aggressive on pricing and several of these companies have recently start promoting brighter blue and green chip products.

While this something we must continue to monitor, competing with Taiwan is not a new challenge for Cree.

It is an ongoing part of our business, and our continued success comes down to being able to deliver a better value proposition to the customer as we have done over the last six consecutive quarters.

We remain confident in our competitive position and continue to focus on increasing performance and lowering costs.

During the second quarter, we extended our LED brightness capabilities with the development of the new XT 15 and XT 18 blue LED chip products.

These products build on the XThin platform and deliver brightness up to the 20 milliwatt level with a low forward voltage and thin design of our other XThin products.

We made progress on our lower temperature of Diatest versions of XBright and XThin and expect to release the first product in this family in Q3.

For the high volume, price sensitive keypad market, we have developed a new lower cost market called the UT 230, which we have recently started sampling to select customers.

We target to have this product released by the end of Q3 and in volume production during our fourth fiscal quarter.

We also made product -- progress on yield improvements, which resulted in lower costs and increased capacity that was critical to supporting our strong results in Q2.

In the third quarter, our R&D priorities are focused on ramping up our new products, driving cost reduction for our current products, and further extension of these product families to support the evolving needs of our customers and the applications that they serve.

Our lighting product development team remains on track for the production release of our first XLamp power LED products in the fourth quarter.

We have recently sampled preproduction devices to a limited set of potential customers, and the preliminary feedback has been very encouraging.

We are in the process of qualifying the first production tools for our highly automated manufacturing line, which we estimate will be installed and fully qualified during the fourth quarter.

We currently target initial production samples to be available within the next three months.

In the laser area, we made progress on some fundamental material challenges to commercialize a 405 nanometer 30 milliwatt laser for optical storage applications.

We are in the process of incorporating these material improvements into laser structures and target improved laser results in the summer time frame.

In a related area, we are also developing even shorter wavelength laser diodes as part of the (INAUDIBLE) sponsored Sumas project that is targeting short wavelength lasers and LEDs for critical new applications such as bioagent detection.

We have recently demonstrated the shortest wavelength CW nitrade laser diodes at 348 nanometers, and we are making good progress on this longer-term project, which could have tremendous benefits for homeland defense applications.

Our Silicon microwave business delivered another solid quarter as revenue grew 90% from Q1 to almost $2 million as we saw increased demand for both our older LD [Moss] products as well as our new LD [Moss] 8 products from several different customers.

The new business is coming from both the cellular amplifier market as well as the [mill aero] market.

In the wide band gap area, we continue to win business for our 10 watt silicon carbide [MESFET] product, and we have recently begun sampling our 60 watt silicon carbide [MESFET die].

We continue to make progress in our gallium nitride and microwave development efforts as we recently demonstrated a record power density of 32 watts per millimeter with 55% power added efficiency for a gallium nitride hemp device at 4 gigahertz.

This is a 50% increase over what I reported just last quarter.

We believe that as we overcome the reliability challenges with gallium nitride microwave devices, we should be able to offer another disruptive technology for our high-power RF and microwave applications.

Overall, we are targeting our combined silicon and silicon carbide microwave revenues to grow to approximately $3 million in Q3.

In the power device area, our business continued to grow as shipments to our large power supply customers increased in the second quarter.

This the first volume design for our power device products, and we expect the shipments to remain in a similar level in Q3.

We have several new smaller volume design wins, but we don't expect significant growth in this product line until the summertime frame when we target additional volume projects to begin ramping up.

Our development priorities for the third quarter are focused on expanding our (INAUDIBLE) product offerings with a 300 volt 10 amp device for output rectification and a 1200 volt 20 amp device for motor control application.

Regarding the Hunter lawsuit, we announced a settlement which the Hunters on November 25 in which the Hunters dismissed all of their claims against all defendants.

Our agreement did not require any payments to either Eric or Joslin Hunter, and Cree accepted Eric Hunter's resignation as an employee.

While we continue to address the related legal proceedings that followed the Hunter suit, the resolution of that case has allowed us to again focus on growing our business.

In the second quarter, we delivered record revenue of $72.7 million with earnings of $13 million or 17 cents per share, which exceeded consensus expectations.

As we move into the second half of the fiscal year, we are looking to build on our success from Q2 while managing the challenges of growing our business.

Our balance sheet grew stronger to $218 million in cash and investments as we generated $52 million in cash from operations.

We are targeting continued growth in the third quarter with revenue of 75 to $76 million and earnings of 17 to 19 cents per share.

Our operating plan has delivered record financial results and enabling new products, and we target even stronger second half of fiscal 2004.

I will turn the call over to Cindy.

Thank you, Chuck.

Our second quarter results were outstanding as revenue increased to a new quarterly high of $72 million, 684 thousand, which was at the upper end of our revised revenue targets announced in December and represents a 10% increase sequentially.

For the six months ended December 2003, revenue also reached a record level for a six-month period at $138 million, 895 thousand.

Much of this increased business resulted from our customer's ability to gain new design wins for white LEDs and mobile phones.

LED sales for automotive applications also increased due to seasonal trends while Cree microwave revenues nearly doubled sequentially to $1 million, 983 thousand.

This higher level of revenue for our microwave business was particularly important, as it directly improved our profitability due to the fixed cost nature of our factory in Sunnyvale.

Today, we also reported net income of $13 million,7 thousand for the mont recent three month period, which was at 46% increase from the prior sequential quarter and our highest overall profitability in almost three years.

Our after tax net margin grew to 18% of revenue and earnings per share was 17 cents compared to 12 cents reported in the September quarter.

For the six month ending December 28, 2003, net income was $21 million, 886 thousand or 29 cents per share.

During our second quarter, LED revenue was robust as it increased 12% sequentially to $56 million ,500 thousand, which marked a record for Cree and made up 78% of our overall sales.

Our unit shipments increased 8% over the September 2003 quarter to the highest level in our history, while our LED average sales price increased 3% sequentially due to reduced pricing pressure and a more favorable product mix.

Our blended average sales price for LEDs has declined 19% compared to the second quarter of last year.

Cree continues to evaluate and adjust its pricing strategy to drive long term demand and increase its market share.

At this time, we target lower average sales prices during the second half of the year on a product-by-product basis in line with our historical trends.

We also target increased sales of our X class and other high brightness products which have more favorable pricing.

As a result, we believe that our blended average sales price may be more impacted up or down in the near term by changes in our product mix rather than our product-by-product pricing strategy.

During the December quarter, we saw stronger demand for mobile appliance in automotive applications, and we estimate that during our second quarter these end markets made up more than 50% of our LED sales.

In order to provide our shareholders with a more detailed information about our LED business, we are now breaking our LED products sales into three new categories based on brightness, which we believe will provide a better indication of the end markets being served with our products.

High brightness devices are a new category, which includes our MegaBright and X class product families.

While our mid brightness devices include our older HighBright and UltraBright products.

Our standard brightness category remains unchanged.

We believe this break down will provide more insight into the market trends of our products as our MegaBright products compete in the high brightness end of the market.

Our high brightness category will generally include chips sold for solid state illumination, outdoor displays, traffic signals, and white LEDs for LCD back lights in camera flashes.

Our mid brightness devices will target automotive dash boards, cell phone key pad back lights, entertainment, and indoor displays, while the standard brightness chips are used for automotive and indicator light applications.

During our second quarter, our standard brightness, mid brightness, and high brightness parts made up 8%, 46% and 46% of our LED revenue respectively. silicon carbide wafer revenue increased to 11% sequentially to $6 million, 3 thousand or 8% of our revenue.

During the second quarter, our wafer volume decreased 18% while our average sales price increased 35% over the September quarter.

The lower volume resulted from reduced sales to [OSRAM], which buys wafers in high volume and therefore they receive a lower average sales price.

Our average sales price also benefited from a greater volume of [Epi] wafers sold during the quarter.

Gem stone materials sales declined 20% in the December quarter to $1 million, 54 thousand or 1% of total revenue due to lower yields which reduced our average sales price.

Microwave sales were 3% of total revenue for the second quarter as Cree Microwave Sunnyvale sales increased 89% sequentially to $1 million, 983 thousand.

Over one-third of this revenue came from newer LD Moss 8 products that have been released in the past year and recently designed into new applications.

We target Cree's microwave business to increase by almost 50% in the March quarter based on customer orders.

Contract revenue decreased 13% to 8% of total revenue in the second quarter.

Although this a decline from the first quarter, the September quarter results included a $529,000 adjustment for additional funding that was awarded on older contracts.

And we had a shift in the second quarter to more cost share programs.

During fiscal 2004, we began recognizing shipping and handling costs billed to our customers as revenue in accordance with generally accepted accounting principles.

This revenue amounted to $26,000 and $52,000 for the three and six months ended December 28, 2003.

Gross margin for the second quarter was 47% of revenue as compared to 43% reported in the September quarter due to greater profitability on our LED products and at Cree microwave.

Our blended LED average sales costs decreased 7% sequentially due to higher productivity and improved yields in the Durham facility.

In addition, our LED blended average sales price increased 3% in the same period due to reduced pricing pressure and a favorable product mix.

During the December quarter, we were successful in reducing our costs through productivity gains, improved yields, and other measures.

Gross margin for the materials business was slightly lower during the second quarter as the average sales price for wafers increased by 35% sequentially while our average cost grew 49% due to product mix.

Margins on gemstone materials were reduced in the September quarter due to lower yields, which reduced our average sales price.

Cree Microwave reported negative gross profits of $806,000 for the quarter compared to negative gross profit of $1 million, 744 thousand in the September quarter, as revenue grew 89% sequentially due to new design wins.

The Sunnyvale facility has a high percentage of fixed costs, the majority of the $932,000 of additional revenue generated in the December quarter fell directly to the gross profit line.

Cree Microwave also experienced higher yields during the second quarter.

Contract margin decreased to 8% of revenue in the December quarter, which was lower than the September quarter due to shift in mix to more cost share programs and the receipt of funding on an older contract in a previous quarter.

For the next few quarters we target contract gross margin to fall in a range of 10 to 15% of revenue as we expect to work on a higher percentage of cost share programs.

Operating expenses as a percentage of revenue decreased to 22% for the second quarter compared to 25% reported for the September quarter.

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

During the December quarter, spending for research and development remained even with the September quarter at $8.3 million.

Our SG&A costs remain flat at $7.9 million, as legal fees associated with the Hunter and class litigation and related matters continued during the quarter.

During the September quarter, we incurred approximately $900,000 of expenses associated with special committee investigation that did not recur.

However, these costs were offset with higher costs for other litigations, Sarbanes Oxley compliance, and other expenses.

SG&A costs also included a higher level of funding for our employee profit sharing program during the second quarter.

During the December quarter, we recorded a $142,000 charge to write down equipment being held for sale at Cree Microwave to fair market value.

In addition, we also recorded a $379,000 gain as other nonoperating income for favorable foreign currency adjustments per our contract with one of our large customers.

Several years ago, Cree's Board of Directors established a stock repurchase program to enable the company to buy back up to 7 million shares of its common stock.

During the December 2003 quarter, we repurchased and retired 664,000 shares under this program for $11 million, 522 thousand, or an average price of $17.35 per share.

This repurchase is expected to be accretive to future earnings and bring the total number of shares repurchased since the inception of the program to 4,300,000 shares.

We will continue to evaluate additional share repurchases based on market conditions.

As for the end of the second quarter our balance sheet was strong.

Including our stock repurchase, cash and investments grew $23 million sequentially to $218 million.

For the three months ended December 2003, cash flow from operations was a remarkable $52.4 million due to higher profitability and an $18.5 million reduction in our accounts receivable balance.

As a result, our day sales outstanding, which is calculated on a trailing monthly revenue profile, decreased from 71 days to 44 days and marks our lowest point in nearly three years.

We target day sales outstanding in a range of 45 to 60 days going forward, as many of our customers in southeast Asia customarily pay with longer terms.

As of December 2003, our inventory balance remained low at $16.8 million and inventory days on hand were unchange from the September quarter at 39 days.

Our cash flow from operations also benefited from the $3.5 million reduction in deferred tax assets and a $2.6 million increase in the accounts payable due to timing.

Our capital expenditures for the second quarter and six months ended December 28, 2003 were $19.3 million and $37.4 million respectively.

These expenditures were primarily for capacity expansion at our Durham facility to support our ramp up of LED production as we continue to target higher volumes for the remainder of fiscal 2004.

Including these expenditures, we generated a free cash flow of $33.2 million during the second quarter.

We calculate free cash flow as cash flow from operations less capital expenditures.

For our third quarter, we target revenue to increase to approximately 75 to $76 million due to our estimates for growth in LED sales from mobile appliance applications.

We anticipate that these higher sales will be driven by the ramp up of our new products for use in white LED applications such as our X class products.

We also target Cree Microwave revenue to increase by $900,000 in the March quarter due to new design wins.

As a result of this increased revenue goal, we target the Cree Microwave will have positive gross profit in the March quarter and will return to overall profitability within the next few quarters.

We are targeting overall gross margin in the range of the mid to high 40s as a percentage of our revenue during our third quarter.

As we enter the second half of our fiscal year, we are planning to increase spending for research and development costs to fund new LED products including our X Lamp power LEDs.

As a result, we target R&D spending to increase in our third quarter to approximately $9 million.

SG&A expenses are targeted to remain in a range of 10 to 11% of revenue in the third quarter as litigation and Sarbanes Oxley compliance expenses are expected to continue into the March quarter.

Therefore, earnings per share is targeted in a range of 17 to 19 cents for the third quarter with an estimated $75.8 million fully diluted shares outstanding.

As our revenue and customer demand have continued to grow, we now anticipate that we will commit additional resources to capital expansion expansion.

Therefore, our capital expenditure targets for fiscal year 2004 have been increased to 56 to $75 million.

We believe that this was the strongest financial quarter at Cree in several years.

As we enter the third quarter, our balance sheet is robust and we target record revenue and increased earnings while generating positive free cash flow.

We continue to see strong demand for our LED products and mobile appliance applications.

We also remain focused on our cost reduction goals during the third quarter, and our success in this area is critical for us to compete in the full range of the market while generating strong profitability.

Thank you.

And I would now like turn the discussion back to Chuck.

Thank you, Cindy.

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 a moment to compile the Q&A roster.

Your first question is from Dale Pfau with CIBC World Market.

Good afternoon, Cindy and Chuck.

Good quarter.

Let's talk about a couple things.

First, I want to check my notes here.

From your new high brightness, mid brightness, and standard bright, did I get that right?

It was 46% in high, 46 in mid and 8% in standard?

That's correct, Dale.

Okay.

I had problems with my own note.

And on the ASPs, you said the blended ASPs actually increased 3%.

Headed for could be up or down pending more on mix than on a actual ASP decline by product type; is that what you said?

Yeah, Dale.

What we are seeing at this point is that while we probably will still see some partner by part number price erosion.

We are seeing a fairly significant shift in mix.

Last quarter it was in both the mid bright and the high bright categories.

It was really more toward the premium products.

It's that shift in mix that we think is lending to a lot of the price stability we are seeing.

And this price stability that you are seeing, how much of that is because of the shift to the higher demand products where you have less competition versus the shift toward those people out there that you are saying are somewhat IP conscious?

Can you give us the idea what is the shift?

I'm not sure I can break it out for you, Dale.

Both of them are clearly components of that equation.

I think that with the strong growth in the marketplace, that helps the pricing environment to start with.

Then we have, you know, the IP premium, if you want to call it that, or at least that's reducing the pricing pressure to some extent.

And then third component clearly is as you go to the higher end products it helps from an ASP standpoint.

It's really the combination of all three.

Can you give us an indication of the ASP differential between the high and the mid bright, Chuck?

Dale, I don't think I can break that out for you.

We obviously are getting some amount of a premium there.

I don't have the ability to really break it out for you.

You can assume that -- I will give you a rough number.

High bright is probably at least a 50% premium or more over the mid brightness category.

Okay.

And then on your new XThin product, did they account for significant revenues in the December quarter?

No.

XThin was not a large part of it.

Those will all roll up in the high brightness.

If you look at high bright, it was MegaBright drove the high bright in the last quarter.

Given our current bookings that we already have in place, we actually think we will see good growth in XBright and XThin as well as the power chip, which is an X class product.

All three we expect to see good growth and in Q3 based on the orders we already have.

And your packaged product, how are you going to define that going forward?

Will you give us a revenue or are you going to throw that into your high brightness product revenues?

In the near term over the next couple of quarters, we don't expect it to be a significant numbers.

So we will include it in our overall LEDs.

As it becomes more significant, I think you can expect that we will break that out for you.

I wouldn't expect that to happen until at this point September quarter probably at the earliest.

On your package products since you sampled, how does your composite brightness compare with those on the market?

Based on the feedback we are getting from customers, I would say that we are at the high end of what's available on the market today.

And congratulations on the microwave business finally getting some legs under it.

Could you talk a little bit about that for me?

We clearly know that the infrastructure wireless infrastructure market is doing better.

How much of this is market related versus how much are designed wins that are finally moving into production?

I'm not sure we can -- I don't attribute much of it all to the market getting better.

While I agree with you, we are seeing the same signs that the infrastructure market is improving.

As you know, this is a fairly long lead time business.

We are getting the benefit at this point of designs we are working on in the last three or four quarters.

That's the benefit we were seeing.

Obviously we were targeting to be up again in the next quarter.

And I think that as the infrastructure market gets stronger, that should definitely give us some assistance or help on that business.

At this point, it's really designs we have been working on.

How many customers do you have in that segment?

I would say that -- boy, I don't have the exact number, but I will tell you significant customers is close to about 10 right now, and then there is a large number of small customers below that.

There is probably ten relatively significant customers.

And are any of those revenues Silicon carbide power devices yet?

We do have a small amount of silicon carbide MESFET revenue that we are shipping at this point.

But it's not included in the Cree Microwave numbers, just so you know.

So when we show you Cree Microwave broken out, that's just the Silicon products.

We are getting additional business there, it's relatively small at this point.

Signs are encouraging there as well.

We are shipping the product.

And on -- you're upping your Cap Ex.

Could you tell us a little bit about your expansion plans there in Durham?

How much could you put in the current facility, and do you have to break ground there on a new section?

Yes.

At this point, our Cap Ex plan is in the 65 to 75 million range, which is higher than we were anticipating.

Clearly, as our business has grown a lot faster we will continue to make the investments.

From a floor space standpoint, we feel good that we have the floor space to get us the next 18 to 24 months, because part of our expansion has come from Cap Ex but frankly with the yield improvements we are making that's helping out on the cost side it's helping us on the floor space side.

You should expect or at least at this point we are targeting -- we will have to make a decision over the next three months about where to invest in some additional floor space, whether it be here, locally, in our current campus or whether we go out and look at some other campus opportunity.

We are in the process of evaluating that, and will have to make a decision in the next couple of months.

And one final question, if I might.

What are your plans now for some large format LEDs to get into say the auto headlight market and industrial lighting?

Can you talk a little bit about what you are doing there and what we might expect to hear from you in the next couple of quarters?

For the head lamp market we are probably several quarters away from getting any real firm visibility there.

There are a couple car companies talking about maybe some initial designs next year.

More likely the following model year.

We have are actively working with companies by selling our power chip product, and at this point the volume that we -- we do have orders next quarter for the power chip, but that's not yet targeted at automotive.

I would say that probably December quarter of next year is when we will first start to see some the demand auto motive related but it should be small in the beginning.

We are pretty encouraged that in the next 24 months that will become a fairly important segment for us and has pretty good growth potential.

Okay, well, congratulations and keep up the good work.

Thanks, Dale.

Your next question comes from John Lou with Banc of America.

Cindy, since there is brief classification of products in the different categories, I would like to focus on the high brightness category.

Was it XBright or MegaBright that grew the most?

And what was the major end product that was growing the fastest?

And I would like a follow-up question focusing on the handsets.

Thanks

Sure, John, this is Chuck.

Let me take that one.

Look at the high bright category, that was MegaBright driven.

Within the MegaBright category, it was the premium MegaBright products.

We saw growth really on the MegaBright, what we call the MegaBright plus family, and that was driven primarily by mobile appliance handsets, really, and that's things like keypads and as well LCD back lighting.

And so following that train of thought for a second, with regards to the handset market itself, you did gain a lot of traction on the MegaBright plus.

Is it the displays or the flash, and specifically as there been a market share shift from the competition that allowed you to gain traction in that area?

Or is it the overall market expanding?

Okay, let me back up.

The applications that we are seeing with the MegaBright plus family are LCD backlights, we were seeing keypad back lights, primarily white keypad back lighting, and we are seeing flash.

We had growth in all three of the segments last quarter.

As far as what do we think it is market share or is it the market growing?

At this point I would say it's probably both, because we know that high end phones, at least from what we can tell, seem to be increasing as a percentage.

That's definitely helping us grow.

But we also believe that we are winning designs that went to other companies in the past.

It's a combination of both at this point.

And when you go forward, we are looking at XBright with the orders we have, XBright and XThin will help drive that trend into the next quarter.

I think you asked a question about market share; that's a pretty hard thing to estimate.

I would tell you if you want to take a high level look at market share.

I think the LED business this year from some of the numbers that I saw recently is supposed to grow high brightness LED grow somewhere at 40% for the year.

And I think if you would break out our LED business you will see our LED business grew somewhere in the neighborhood of 70% for the calendar year.

So gives you an idea what we think our market share is doing.

Okay.

And then finally I will talk about the ASP in terms of the stability that you are seeing over there, would you characterize the supply as being constrained right now?

Is that one of the factors that had given you a pricing stability in the current quarter are things very, very tight in the marketplace?

Thanks.

John, I would classify them as tight, but I'm not sure we would say we were capacity constrained.

We have strong bookings, but we are trying to grow the business so we continue to expand.

And our lead times are not in one of those places where I would worry about double booking or things like that.

That's not the motor in.

I would say it's a strong environment, but we are able to react from the business we are getting and able to continue to kind of work with it from a growth standpoint.

I'm sure that any high demand market takes a little pressure off the pricing, but I'm not sure it's a lack of capacity that's doing that.

I would classify it more as really the phenomenon we described earlier, which is just a shift to some extent towards the higher brightness or more premium end of the market share and the IP factor.

Thank you.

Sure.

Your next question comes from Harsh Kumar with Morgan Keegan.

Hey, guys.

Congratulations.

Very good quarter; good guidance.

Just a couple of questions.

First of all on the cost reduction, gross margins ended up nicely.

You said part of the reason was cost reduction.

Is there any particular step or series of steps that you took that you can talk about that led to it?

Is this likely to repeat again in the next quarter from a cost angle?

Well, I'm not sure we can say it will repeat.

We are definitely going to try the same things.

I would classify it as a combination of yield improvements.

Basically we made improvements in processes which were able to drive our yields up.

We were also pretty focused on something -- a concept of process simplification, which I described a little last quarter, and this is looking at some of processes that we have been doing for awhile.

As the products mature, how do we simplify it and take the cost out?

I would say it's a combination of those things and both remain very high priority as we go into the next quarter.

Okay.

And, you know, how about on a longer term basis?

As you put these processes and yield improvement factors into place, let's say a year out, would it be fair to say you will be able to maintain margins in the high 40s?

Or is that too far out to see?

That's pretty far out.

I think at least over the next couple quarters we see something in the mid to high 40s as kind of a range we feel comfortable working in and that's always subject to change.

That's our best estimate at this point in time.

And the factors will be a combination not only a pricing environment but then, of course, as you are suggesting, on the cost reduction.

We still have tremendous opportunity in cost reduction across our facility.

And so I think we have a lot of upside there, and then it depends on that side how the pricing environment works out.

So we'll have to kind of see.

But at least in the near term mid to high 40s.

Got it.

You talked about the Xlamp market, Chuck.

Real quickly, you said you are putting an automated line in place to start manufacturing that.

Did you actually say you would be hoping to get revenues over the next three month time frame?

Or actually launch the product by then for sampling?

We are talking about a production release.

We were in the process now of bringing in the line.

We have the first step of process and over the next several months we had to bring the line in, get it installed and get it fully qualified for a full production release, which is targeted by the end of next quarter.

From a revenue standpoint we might see revenue next quarter, but it's targeted to get started in the September quarter because we don't expect to have a line really in place fully until next quarter.

And just real quickly, can you remind us the application for the XLamp product?

It will be these niche lighting applications.

Everything from putting LEDs in flashlight to decorative lighting applications, to over a little longer term that product will be targeted at the automotive segment.

I got you.

And just kind of a qualitative question, last quarter at this time how much booked were you?

This time you were 70% book.

Is it somewhere in the range or less than this?

I think it was closer to 80% last quarter, Harsh, and I think that at no point we still feel good about the 70, but it's not quite at that level.

Got it.

And I was doing your product breakout.

This is a question for Cindy.

I couldn't come up with about $1 million in revenue.

Could you explain to me maybe what I might be missing?

You are missing revenue that we generated from our power and silicon carbide microwave business in general.

I got it.

Thank you.

Thank you very much.

Great quarter, guys.

Thank you, Harsh.

Your next question comes from Blaine Carol with Adams, Harkness and Hill.

Nice quarter.

Thank you.

Chuck, couple things.

I guess if you look at the cell phone market, what percent of the cell phones sold in the December quarter would you say had the color screens and the back lighting on them?

What I'm trying to get at is the growth rate.

You obviously want to continue to grow greater than the 10 to 15% growth than we will see in the handset market.

How much headroom is there to expand and address that market within the phones themselves?

Well, I'll tell you, Blaine, we obviously spent a lot of time to figure that out here.

I can tell you that what we have is our best estimate, and there is quite a range on that.

If you want to put a number on, it I would say it's about 50% is our best estimate at this point.

And there are ranges, and we are reading a lot of the same data you are to figure that out.

That seems like about the midpoint of what the various things we are hearing.

That says -- and we expect the number to go up over the next 12 months.

Clearly we are looking for the opportunity to grow because we still see color and color screens, camera phones all driving increased demand.

And that's the other thing, I think, that some people are missing, Blaine.

We have got the potential to go to white key pads, we have got color screens, and in some cases we are now looking at more than one color screen in a phone.

And then the whole idea of a camera flash is another application within the phone.

So there is quite a number of variables that can drive demand, and we will have to respond to that over the year.

That's what leads to our optimistic expectation.

And the original statement was about 50%.

Where does that 50% tie back, to color screens?

That's what we would call the high end phones.

Color screens and/or color screens and camera combined are about 50%.

Okay.

But then again, cameras could be less.

I would expect cameras -- cameras would be a subset of that 50%.

Okay.

So there is plenty of head room here.

When do you negotiate pricing, Chuck?

Is it when you are shipping or come up with these 12 month pricing schedules?

How does that work?

Our business has evolved to where we feel like we are negotiating every day.

In reality though, we tend to work with our larger strategic customers with some visibility whether it be a three to six month horizon.

And then other customers for some our spot business they really are almost a monthly look at things.

But at this point, I would say we have good visibility for about three months looking forward on pricing, and we have a decent idea of what the trends are six months out.

Beyond that we don't have longer term -- well, we have longer term contracts.

They have pricing flexibility built in.

Because we obviously -- both us and the customers have to respond to the market.

Okay.

On the SG&A line, shouldn't we start to see SG&A drop a little bit now that we have the Hunter issue behind us?

We should see the Hunter issue cost go away.

We expect at this point we will see significant legal fees from all the related litigation, things like the securities class action of that nature.

The other thing we are seeing is that on the SG&A line we are seeing an increase just from the whole Sarbanes Oxley 404 compliance line.

At least in the near term we are having increase some of those fees to get ready for 404.

That is probably going to continue through Q3 and hopefully we will get relief maybe in Q4.

And then two more quick ones and then I will pass it on.

Cindy, any impact from the fact that the dollar has weakened against most currencies?

Actually, I will grab that because we were talking about that a lot lately.

There are a couple of things.

As you may have noted in Cindy's comments earlier, we got a $379,000 benefit from one of our customer contracts last quarter.

And that's because two of our large customer contracts have currency provisions that are really designed to buffer both of us from some the swings in the marketplace, but we got a benefit last quarter from that.

For the rest of our customers, we definitely would say that when the dollar is this weak, it's helping us in the China, Asia markets making us more competitive.

I would say at this point it's a combined benefit from those two things.

As far as going forward, with our large customer contracts, those tend to reset from time to time.

So I wouldn't expect any significant changes or benefits or changes in those in the next quarter or so.

Chuck, do you benefit on the weak dollar because you price in the U.S. dollars, and makes it cheaper in the local currency?

Or do you benefit because when you convert that foreign currency back into U.S. dollars it's a higher number?

Basically we are converting -- we are selling, for example, in the Taiwan/China market in U.S. dollars.

So when that gets converted with the weak dollar it effectively makes it cheaper against the guys selling in local currency.

Okay.

I guess just very quickly last one, with the DOSs being down, you being 80% booked going into the quarter, I'm assuming linearty was pretty good and that's the reason for it; is that fair?

Yeah.

It would be fair to say that we were extremely linear last quarter, which helped on that line a lot.

Okay.

Great.

Thanks.

Nice quarter.

Your next question comes from Tom Spenzis with Think Equity Partners.

Hi, guys.

Congratulations on the quarter and the guidance.

Most of my questions have been answered.

I just wanted to ask real quick, on the UT230 product that you mentioned coming out at the end of Q3, obviously this will come out with lower ASPs.

Is this going to be part of standard products?

Or how do you classify that?

I believe the UT230 will actually fall into our mid brightness category.

It will be kind of on the lower end of that marketplace as where it would be positioned in our product line.

It is designed to be in the very price sensitive applications.

It's also designed to be extremely low cost is how we come about it.

That should fall within the standard or close to the margins you are seeing right now?

Yeah.

I would say that it is designed to go after the most cost competitive segments and be able to compete with margins we like to see around here.

And that should be offset, I would suspect, in the June quarter by early XThin products in terms of ASPs?

Remember, the UT230 is probably not going to kick until the third quarter in any significant volume.

Between now and then we would expect to see the high brightness category grow as a percentage given the current order bookings we've got.

Great.

Thank you so much.

Congratulations again.

Thank you.

Once again, I would like to remind everyone in order to ask a question, please press star then the number one on your telephone key pad.

Your next question is from Nathan Churchill with Sidoti and Company.

I was wondering if you could expand on something.

I think you mentioned earlier comments that OSRAM material sales had declined.

I was wondering if you could you expand on that?

Yeah.

I don't have the exact numbers of what they declined last quarter, but they were down sequentially as I believe their internal demand for producing LEDs was down.

Is that to say across the board or a shift in technology that they are using?

Do you know?

I'm confident it's not a shift in technology.

It's a decrease in their internal production.

Can you give us a little bit of an idea what the customer reception of the XThin products are, particularly the newer higher brightness stuff?

At this point I think they are excited about it.

We already have some fairly significant bookings for that XThin next quarter, and some of those orders are already for the new XT 15 class products.

I would say at this point -- the product has been customer-defined.

Here is the application we want to go after.

We want to get into these key pads and displays, and this is what we need.

When we come out with the product, many have been -- they have been developed in parallel with the customer's feedback, so that is where they are targeted.

Okay.

Does it align better with keypads or displays or is it really indifferent?

It's more important for a keypad today than it is for a display.

Right now if you look at the LED specs for the packaged LED, thin is a more important factor in the new phones for the thickness in the key pad.

However, even the display, probably not in the near term, maybe a couple months out -- or I shouldn't say months, but a couple quarters looks like it will be looking for thinner LEDs as well.

Okay.

Do you know what your competitors may be offering for a competing product, thin product?

In the past, Sapphire products have been thinner than our silicon carbide.

From a thin standpoint, the product is proprobably in a similar range and maybe slightly different.

But I think that both products have the thickness specifications for the new thin LEDs.

We are taking the thinness and add our low VF and high brightness to it.

Okay.

Another thing, in the power chips, you were saying there were some orders booked for the third quarter.

What areas were those in?

Didn't get into specifics.

It's -- I would say it's more in the signaling business than anywhere else now.

All right.

Thank you.

Sure.

Your next question comes from Hans Mosesmann with SoundView Technology.

Great.

Three questions.

On the Cap Ex number of 65 to $75 million, what was the previous estimate and what's the additional number or dollars -- what's the reason for that increase?

Yeah, it was previously 50 to $60 million target, so we have increased it by $15 million primarily for equipment here in Durham.

It would be factory capacity for primarily to support LEDs.

LEDs and not for the lamp business?

No.

At this point the increase is not related to the lamp business at this point.

We have enough capacity coming in at least to get the line launched and should give us growth opportunity for the first half of our next fiscal year, which is the second half of calendar year.

We have brought a line in that should take us through there with decent growth numbers.

And, Chuck, I'm not sure if you addressed this.

I missed it when you talked about lasers.

What is what the update regarding the blue lasers and blue raid and that whole effort of regarding high definition down the road?

As you have probably seen, like i have, in the market, it sounds like there is some people -- additional companies throwing their hat in to support the blue race standard.

From the market standpoint it looks like it's getting a little bit of momentum.

I will tell you what we were hearing from an overall market place is until Hollywood decides which format they will support, it will be pretty hard to figure out which one will win.

There is two competing standards.

There is blue ray and the DVD forum.

At this point, there is excitement building, but it's still a wait and see from when we will get a market turn on there.

From a pretechnology standpoint, we have been working on the materials issues, really trying to get to the magic 10,000 or lifetime for the 30 milliwatt laser.

At this point, really focus on how do we get the key materials issues improved.

We had success, but now we have to basically put them in the lasers and drive those results, and that's really summer time frame to see where we were at there.

And then lastly, just a clarification.

When you said 50% of LEDs in color/camera, is that your LED split or the industry?

No, that would be my estimate of what we think the industry has done.

So, again, I have seen a range of numbers out there.

Again, these are our best estimates at this point.

We think it's about 50% are in these types of phones at this point.

Great.

Thanks a lot.

Again, if you have any questions, please press star one.

At this time, there are no further questions.

Are there any closing remarks?

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

Thank you.

Thank you.

That concluded today's conference call.

You may now disconnect.