Wolfspeed Inc (WOLF) 2007 Q1 法說會逐字稿

At this time, I would like to welcome everyone to the Cree Incorporated first quarter 2007 fiscal year financial results conference call.

[OPERATOR INSTRUCTIONS]

As a reminder, ladies and gentlemen, this conference is being recorded today, Thursday, October 19, 2006.

Thank you.

I would now like to introduce Raiford Garrabrant, Director of Investor Relations of Cree Inc.

Mr. Garrabrant, you may begin your conference.

Thank you, April, and good afternoon.

Welcome to Cree's first quarter fiscal 2007 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 Chairman and CEO and John Kurtzweil, Cree's CFO will report on our results for the first quarter of fiscal year 2007.

Today's presentations include forward-looking statements about our business outlook and we may make other forward-looking statements during the call.

These may include comments concerning trends and revenue, gross margin and earnings, plans for new products and other forward-looking statements indicated by 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'd like to note that as a result of SEC rules, we will be limiting our comments regarding Cree's first quarter and fiscal year 2007 to a discussion of the information included in our earnings release and in 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 beyond the comments made in the prepared remarks.

This call is being recorded on behalf of the Company.

The presentations and the recording of this call are copyrighted property of the Company, and 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 sales site analysts ask questions during the Q&A session.

However, we will 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 webcasting our conference call to allow more flexibility for our conference call attendees.

A replay of the Webcast will be available on our Web site through November 2, 2006.

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

Thank you, Raiford.

We got off to a good start in the first quarter with revenue of $104 million and earnings of $13.3 million or $0.17 per share, which was at the high end of our target range.

Although the near term market conditions for our LED chip products continue to be challenging, we made progress on our strategy to expand our business by leveraging our strengths in LED chip and silicon carbide materials technology to broaden our product line with higher value component level products for the emerging market in LED lighting and power.

During the quarter, we completed the INTRINSIC acquisition, which should help accelerate the development of high quality large diameter substraights for both power and LED products.

We released our new EZBright LED power chips and 160 lumen XLamp LEDs each of which is a significant performance upgrade from our current products and sets new standards for power LEDs with dramatically higher brightness and efficiency for lighting applications.

We announced an important license arrangement with [Whiton] that helps reinforce the breadth and strength of our IP and puts Cree in a stronger position to address the emerging notebook display backlighting market.

We also continued to leverage our technology beyond LEDs as we started shipping sample quantities of our gallium nitride HEMT devices for North American WIMAX applications..

I'll now turn the call over to our CFO, John Kurtzweil, to review our Q1 financial results and targets for the second fiscal quarter.

Thank you, Chuck.

For the first quarter of fiscal 2007, we reported revenue of $103.9 million with net income of $13.3 million or $0.17 per diluted share.

First quarter revenue was in the middle of the targeted range and rose 1% year-over-year but decreased 3% from Q4.

Earnings per diluted share were at the high end of the targeted range, as gross margin was at the high end and operating expenses were slightly below the targeted levels.

These results included stock compensation expense of $2.4 million net of tax or $0.03 per share.

Q1 LED revenue was $82.6 million or 80% of sales, declined 3% over Q4 and 2% from last year.

LED unit shipments increased 10% over Q4 and 32% from last year while our blended average sales price per LED declined 11% from Q4 and 26% from last year.

The decline in average selling price was due to increased competition and a higher mix of lower priced mid-brightness chips for the mobile keypad market.

LED blended unit costs declined 12% both sequentially and year-over-year.

Our mix of mid-brightness devices increased to 64% of LED revenue from 61% in Q4 and 58% last year, and was driven by increased demand for mobile keypad applications.

High brightness revenue decreased to 36% of LED revenue from 39% in Q4 and 42% last year, however, XLamp sales increased again to another quarterly high.

Q1 materials revenue, which includes wafers and gemstone products was $10.2 million, or 10% of sales, and increased 8% sequentially and 22% over last year.

Wafer revenue was $6.6 million increased 13% from Q4 and 28% over last year.

As lower wafer volumes were more than offset by a favorable shift in mix.

Gemstone revenue of $3.6 million was flat from Q4, but increased 13% over last year.

High powered products revenue, which includes Schottky diodes and wide band gap microwave sales was 5.4 million or 4% of Q1 sales and declined 9% from Q4, but increased 37% over last year.

Contract revenue was $6.5 million, or 6% of revenue for Q1 and decreased 9% from Q4 and 2% over last year.

Q1 gross margin declined to 41% of revenue from 42% in Q4 and 51% last year, but was at the high end of our target range of 39% to 41%.

Factory utilization was higher than expected during the quarter, leading to increased inventory of 59 days on hand.

This had the affect of incremental absorption of fixed costs that reduced cost of goods sold by approximately $1.5 million which benefited diluted EPS by approximately $0.02.

The gross margin decline from Q4 was primarily attributable to lower LED revenue as a percent of total revenue.

The decline from last year is a combination of lower profitability for LED products due to increasing price competition and a higher percentage of sales coming from new products, such as XLamp and Schottky diodes,which currently have gross margins below the corporate average.

However, gross margin for both products did improve quarter-over-quarter and still are in the early stages of the ramp-up.

Contract gross margins decreased to 21% of revenue compared to 33% sequentially in year-over-year as our mix of contract work has shifted towards projects that have a higher cost share component.

Q1 operating expenses were 25% of revenue, which is slightly better than our targeted 26% and compared to 25% in Q4 and 23% last year.

Research and development expenses of 14.4 million or 14% of revenue increased 0.4 million from Q4 and 1.6 million over last year.

Our research and development spending continues to be primarily focused on EZBright XLamp, Colorwave, and large wafer development.

SG&A expenses increased by 0.6 million from Q4 and 1.2 million from last year to $11.9 million or 11% of revenue.

These expenses reflect plant spending to build our sales team and launch new marketing programs focused on developing the Cree brand.

Other operating expenses, which were $97,000, related to the impairment or loss on the disposal of long lived assets which decreased from 1.5 million at Q4 and 568,000 last year.

Net interest income of $3.9 million decreased $0.2 million from Q4, primarily due to lower cash balances resulting from the purchase of INTRINSIC Semiconductor.

However, interest income increased by $1.5 million over last year, stemming from higher cash balances and higher interest rates.

Our effective tax rate for Q1 was 34%.

In June 2006, our Board of Directors approved the extension of our stock repurchase program through June of 2007.

During Q1, we repurchased 300,000 common shares for $5.4 million or $18.14 per share. 5.2 million shares remain authorized for repurchase as of September 24, 2006.

Our balance sheet remains solid, our cash, short-term, and long-term investments stand at $334 million, an increase of $38 million over last year.

Cash did decline by $42 million from Q4 and is primarily due to the closing of the INTRINSIC Semiconductor acquisition for $46 million with $43 million of the purchase price paid in cash and the balances for the assumption of stock options, transaction fees and other expenses.

Cash was also reduced by $5.4 million as a result of the share repurchase.

Cash flow from operations was $42.6 million in Q1 and capital expenditures were $33.8 million, resulting in free cash flow of $8.8 million.

We anticipate our capital expenditures will be in the range of $100 to $115 million for the fiscal year.

Accounts receivable were $72.2 million at quarter end, an increase of $3.9 million from Q4 and $20.7 million over last year.

Our day sales outstanding increased to 63 from 58 in Q4, and 45 last year.

We expect our DSO to stay in the 60 day range for the near future.

This quarter, we have changed the way we calculate DSO to conform to the conventional analyst practice of dividing quarter end accounts receivable by revenue for the quarter and multiplying by 90.

The financial metric section of our Investor Relations Web site reflects the new method of calculating DSO for the quarter ending September 24, 2006.

Inventory was $40.2 million at quarter end, an increase of $10.2 million from Q4 and $8.9 million over last year.

Our days of inventory increased to 59 from 44 in Q4 and 50 during the same quarter one year ago.

As was discussed on the August 10, 2006 conference call, the Company was targeting an increase in days of inventory to a level closer to our historical average of 50 to support new product ramps and position us to better respond to customer demand.

Finished goods inventory grew by 4.3 million as a result of better yields in the factory and the desire to build new product inventory of Schottky diodes, XLamp, and Colorwave LED units.

Until we get to the point where our distribution channel is more fully developed, we'll be carrying this higher level of finished goods inventory to support our customers.

Also during the quarter, raw and (inaudible) inventory increased by 6.1 million to support the broader product mix of our LED and power lines.

We expect inventory to be relatively flat at the end of December with a slight growth in finished goods for our new products.

Now I will give you an update regarding our outlook for the second fiscal quarter.

We are targeting revenue to be in the range of $105 to $109 million, with the increase from Q1 being driven by higher sales of XLamp, Schottky diodes, and RF products.

LED chip sales are expected to be roughly flat compared to Q1.

We target gross margins to be in the range of 39% to 40% of revenue as the near term market conditions for our LED chip products continue to be challenged and the new products are not currently contributing margins at the corporate average.

Operating expenses are targeted to be approximately 26% of revenue.

Research and development expenses will continue to be focused on EZBright, XLamp, Colorwave LED products and larger wafer efforts.

SG&A expenses will increase as we expand our investment to build our global component sales force and add tier 1 distributors to drive growth in our lighting and power products.

Based on an estimated 78.3 million diluted shares outstanding, we target earnings per diluted share in the in the range of $0.14 to $0.17, for the second quarter of fiscal 2007, which is consistent with the outlook that was provided on the August 10, 2006, conference call.

Now please note, these estimates exclude the amortization of acquisition related intangibles resulting from the acquisition of INTRINSIC Semiconductor.

The final valuation of the acquisition related intangible asset is expected to be completed by the end of December 2006.

Thank you and I will now turn the call back to Chuck.

Thanks, John.

The market for LED chips continues to be challenging, especially in mobile applications.

We have continued to increase unit volumes, but the growth has been offset by ASP declines stemming from mixed shift and increased competition, which is in-line with what we had forecast last quarter.

From what we see in the market, this is an industry wide challenge, not a Cree specific one.

We believe this market dynamic is a key factor driving the consolidation activity we are seeing in Asia among the Taiwan chip suppliers.

To succeed in this environment, we have aggressively launched new, higher performance LED chip products like the EZBright family while working to drive down costs.

We're expanding our reach beyond LED chips into exciting new growth markets for LED lighting and LCD backlighting.

To compete in these markets, we're developing higher value component level products, such as our new XLamp LED for lighting and Colorwave LED modules for LCD backlighting.

While this part of our strategy takes time to implement, it provides a tremendous opportunity to fully utilize the strength of our IP and technology portfolio and opens up a much larger market opportunity for our products.

As I outlined last quarter, we're focused on five key areas over the next year to enable this transition and drive revenue growth and profits.

Our first priority is to ramp up our new EZBright LED chip product family.

We made progress in Q1 with the initial ramp-up of the EZ290 and EZR products which provides the next level of performance for display and Mobile White applications.

A number of our customers have already qualified these chips in their products and are in the process of competing for new design wins in the market.

At the end of August, we released the blue EZ1000 Power Chip, which delivers almost twice the optical power of our previous XBright Power Chip.

This chip is setting a new performance bench mark in the industry and has already generated tremendous interest for applications ranging from high power camera flashes to general illumination.

We expect to see new customer products based on these chips begin to hit the market over the next several quarters.

We're currently focused on expanding the EZBright family to include several other form factors and additional green product versions.

The EZBright platform is an important part after of our LED strategy over the next few years, from both a chip sales perspective and as the engine for our LED component product lines.

Our second priority is to expand our component level product sales, for both LEDs and power devices.

In high power LEDs, we made progress in Q1 and with the introduction last week of our new 160 lumen white XLamp LED, we are targeting significant progress in the quarters ahead.

Although power LEDs have been available from Cree and other suppliers for several years, this new XLamp represents the first lighting class LED to be offered in the market with efficiencies of greater than 70 lumens per watt.

The product is getting good press coverage and the initial industry feedback indicates that we're enabling a new era of possibilities for high power LEDs.

New lighting designs generally take 9 to 12 months to get into production, however we're already getting volume orders for certain consumer lighting applications.

This new product is targeted to be the key driver of LED sales growth in Q2 and take the lighting component product line to greater than 10% of total LED sales for the quarter.

We continue to develop products and technology for LCD backlighting, which includes both our Colorwave RGB backlighting system for high color gamut TVs and monitors and our white LED component technology for backlighting laptop computer displays.

Our products for the LCD backlighting market are still in the development stage, but both should be released to the market in the second half of our fiscal year.

In power devices, we were able to resolve the capacity issues of our Schottky products in the first quarter by qualifying our RTP fab.

We're targeting incremental growth again in Q2 as we work to expand the number of designs using silicon carbide.

Since we are now competing with traditional silicon devices for new design slots, we need to manage our value proposition and continue to drive down the cost of these devices to enable new, higher volume applications.

We're also working to expand the product line to include the first silicon carbide moss fete, which is targeted for initial sample release over the next several months.

Our third priority is to accelerate our cost reduction efforts.

We're working to ramp up 4 inch substraight production and leverage the additional expertise we acquired from INTRINSIC to improve our 4 inch capabilities.

The Schottky product line has started the qualification process and is targeting to convert completely to 4 inch in the third fiscal quarter.

The LED product line is currently developing 4 inch process capabilities and is targeting to start converting the first products next quarter.

The LED conversion to 4 inch wafers is expected to take several quarters to complete.

We are also increasing our production volumes at our subcontractors for both our dye fab and packaging operations to further reduce costs.

Our fourth priority is to expand our sales, marketing and channel capabilities.

We have made some incremental sales additions over the last quarter and look to continue to build this team on a global basis.

We're working to bring in a new global head of sales from the components industry to lead this team and target further additions over the next months in the U.S., Europe, and Asia.

We are making progress in expanding our distribution capabilities and should have one or two additional channel partners in place within the next few months.

The investment we are making in this area is probably one of the most critical factors to our success in achieving our three year growth targets.

Our fifth priority is to identify and develop the strategic opportunities to expand our product portfolio.

This expansion is a natural evolution of an industry that is becoming more defined by bigger players who can deliver a combination of technology, IP, and scale to their customers.

In our case, we are looking to take these strengths and increase our capabilities at the components level.

This is an exciting time at Cree as we make investments to leverage our core technology in LED chips and silicon carbide materials to build momentum for our new product lines.

The LED chip market remains challenging and we must continue to differentiate our products with performance and IP.

We are working to lower cost through the 4 inch conversion and increase outsourcing of dye fab and packaging.

We made good progress launching new products in the first quarter, with brighter LED chips, the first lighting class XLamp LEDs and new RF devices for WIMAX.

We're investing in the sales, marketing, and distribution channels to enable Cree to compete as a global components company which will bring new opportunities and new challenges.

We have a strong financial operating model and balance sheet to support our growth.

We executed well in Q1 and although the next few quarters are difficult to forecast, we are on track with our strategy and target the new products to drive the growth of our business in Q2 and the second half of the fiscal year.

We will now take analyst's questions.

[OPERATOR INSTRUCTIONS]

Your first question comes from the line of [Patish Munshi] with Piper Jaffrey.

Good afternoon, guys.

First of all, congratulations to John on going aboard Cree and also congratulations on a good quarter.

Just had a couple of quick questions.

Can you tell us how the XLamp revenue is tracking as a percent of LED revenue?

I believe earlier the expectation was to exit the calendar year at 10% of LED revenue.

Are you guys still on track there, or anything noteworthy there?

I would say that based on what we're seeing right now and especially with the release of the new product, we would expect that we'll exit the calendar year Q2 with XLamp at 10% or greater of LEDs, so we're on track.

Great.

That sounds good.

And also, can you tell us on how you're tracking with the [Sumitomo] agreement?

I know it's only been a quarter, but are things on plan there?

And if you could give us a little more color on the situation in Japan.

Earlier it was a bit weak but are things getting better there or some more color there?

I would say on the Sumitomo agreement, it's just too early to call.

We're just after the first quarter of the year.

In general, what's going on in Japan is pretty similar around the rest of the world.

The chip business is extremely competitive and challenging and we're working through the issues.

Really the key for Cree is going to be taking the new products and using those to really drive growth in the second half of the year.

That's going to depend somewhat on what the market situation does around us, but we're going to get the new products out and see what we can make happen and we'll probably have a lot better insight as we get into the second half of the year.

At this point, what we're focused on, let's get the EZBright out there, get it qualified and try to get our customers to start winning some new designs.

One last question, if I may.

Earlier you had mentioned there were reallocating capacity.

It seems like you guys did a good job there and margins have improved, so how much do you think--how much more is left of that work is left or is that pretty much a done deal now?

We got the benefit from the utilization really last quarter and you can kind of see what our expectation is in the gross margin targets that John gave you earlier.

So we're going to--we won't get quite the same benefit because we won't have the same utilization rate this quarter, but I think overall we're still in line with what we set out last quarter.

Great.

Again, good job on a good quarter.

Okay.

Your next question comes from the line of Harsh Kumar with Morgan Keegan.

Hey, guys, first of all, welcome, John.

A couple of questions.

Your costs were down pretty hard, pretty significantly for the first time I think in several quarters.

Can you tell us what's going on?

Is there any one big factor driving it, or bunch of different reasons?

Harsh, one of the things to keep in mind is that we definitely got a benefit from the higher utilization in the factory as John broke that out for you earlier, but I think the other thing to keep in mind is we did have a mix shift as well to the mid bright and some of the lower costs keypad segments, so part of that is mix related as well.

Obviously we're pretty focused on what else we can do to drive cost down going forward and so the real focus here is , how do we get 4 inch online and how do we do additional things to drive costs down, so we did get some benefits, but keep in mind some of that was mix related.

Okay, fair enough, also, a similar question, ESP is down 10 or 11% also a little bit more than normal.

Is that also based on the mix, or are you just seeing greater competition all of a sudden?

I would say the primary driver to ASP, was the mix shift, it's the same mix shift issue.

I would tell you that obviously, the market is pretty darn competitive out there, but I would say the biggest driver of that number was mix shift during the quarter.

We had projected ASP declines and they pretty were much were within line with what we were thinking.

Fair enough, Chuck.

And you talked about EZ and XLamp in your press release, how long do you have to run a product in commercial situation before you start getting to normal yields?

And can you tell us where you are on that particular curve right now with those two products?

The time is going to vary, Harsh.

On the chip products, it generally takes a while to get the product fully ramped up.

That's going to take several quarters on EZ, and then so--I think we're a couple quarters away there.

At the same time, it's going to take a couple quarters to generate the new design wins to really drive that volume, so those two kind of go together.

XLamp's a little differently, we made good margin progress last quarter, we still have work to do, but I think that--we've been building that product for about a little over a year now, and I think that--I don't have a firm target for you, but I would expect to make additional progress each in the next few quarter there and hopefully sometime in the next year we'll be getting up close to where our targets are at the average.

Got it, and then you mentioned that you're ramping dye also at one of your subcons.

Are we to assume that that's Light-on or is that somebody else?

Can you give us some clarity on that?

Are you expanding capacity, silicon carbide capacity at a subcon?

To clarify, dye fab is really the back end of our current factory.

This is something we started over a year ago, we started transferring some of the sawing and sorting and inspection processes, that's what we call our dye fab, and we've really just expanded--we're just expanding that percentage, that's in Asia.

But it's really the same process we've been transferring for over the last year.

Fair enough.

Thank you, Chuck, very helpful.

Your next question comes from the line of Mike Burton with ThinkEquity Partners.

Hey, guys, thanks.

Can you talk a little bit about the high brightness LED sales being down in the quarter and how that relates with your XLamp sales, not only an increase in XLamp, but high brightness was down?

What we saw in the quarter is and I kind of alluded this on my earlier comments a little bit is that the high bright market has become increasingly competitive over the last few quarters, it's kind of indicative of what we're seeing in our overall in our Japan business and it's really just a combination of increased competition, you've got [Nachia] trying to keep market share, you've got TG trying to break into the market and Cree competing for a lot of the same slots.

So I think that business has gotten tougher.

The key for Cree there really is, it's--we really need to get the new product into the marketplace.

We still have success with the X products, but EZBright is going to real important to really get the momentum back there, and we really need the new products to really drive that side of the business again, and so the XLamp helped offset some of the chip side of the business, and hopefully we'll see more of that momentum this quarter, but last quarter, it just wasn't enough to offset the chip side.

Great, and can you actually--could you break out your LED revenues by end market?

I think you've talked about it a little bit in the past, mobiles marginally 50%.

Still about there and maybe some insight into some of the other end markets.

Yeah, we don't give a lot of detail.

I can tell you that I think mobile's still somewhere in the 40% to 50% range and I don't know that that's changed a lot in the last quarter or two.

And then I would say the other applications, whether it's entertainment, displays, some of the lighting stuff kind of make up the rest of it, automotive, but that hasn't moved around a lot.

It varies a little bit quarter to quarter, so we haven't seen a lot of shift.

I think, if anything, probably the biggest shift is we probably had a little more success in keypad last quarter, so within mobile, keypad grew faster than the other application.

That's probably the only shift we had.

Great, and then also, if you could talk a little bit about some of the decline you saw in your high power products business and the outlook there?

In high-powered products, you've got to keep in mind what's in there.

We have silicone carbide Schottky diode sales, we have RF component sales, but also RF foundry work.

The actual component side of the business, Schottky specifically actually grew quarter-over-quarter.

What was down is some of the foundry work, and that was really just a timing issue.

From a core component strategy, that business is still growing, although we did have a timing--we had less foundry work last quarter and that's just more of when our customers have contracts for that work.

Great, thanks for the insight.

Your next question comes from the line of [Steve Sneed] with Raymond James.

Thank you.

I was wondering if you could tell us what your (inaudible) price declines were as opposed to ASP?

We don't break it out on a partner by partner basis.

I can say that on average we're seeing--they're in line with our projections, but wedon't break it out on a part number basis.

I did say earlier the market is pretty competitive.

We have been planning for a fairly competitive pricing environment.

Okay.

With the new EZBright 1000, what sort of time lead would you estimate you guys might have on that before other competitors go out to similar brightness?

That's a great question.

It's interesting, that's where we have probably the biggest performance gap versus our competitors, as you make the chips larger, our technology scales real well.

That's hard to say, we've never--no one--we've never seen anyone announce results in a power LED even in R&D levels that compete with those.

I would imagine there's a lot of people working on them, and so it's hard to say.

I try to be pretty conservative about that.

I'm assuming the competitor is going to come out with something better tomorrow, but practically speaking, since there's no one in the market that's sampling something at that level, I would imagine it's probably, roughly at least a couple quarters.

It's hard to call, but since we really don't see anyone out there with chips at that level or package LEDs at that level, I would imagine that we're at least a couple quarters ahead at this point.

Okay, and could you walk me through the gross margin guidance a little bit more?

How much of the decline is from maybe running a little bit lower now that you've already built your inventory up versus price declines or other factors?

Yeah, the way to think about is we've got about $1.5 million benefit all things considered last quarter.

That was what you should basically assume, we're not planning on get that benefit in gross dollars this quarter, that's probably the single biggest change.

The other thing is that LEDs is projected to be fairly flat, so the additional revenues coming from the new product lines and although their margins are improving, they're still on average lower than the LED chip, so it brings the average down a little bit.

Great, thank you.

[OPERATOR INSTRUCTIONS]

Your next question comes from the line of Jiwon Lee with Sidoti & Company.

Hi, good afternoon.

I had other questions, but I kind of wanted to go back to this gross margin issue.

Chuck, you mentioned a $1.5 million benefit in the first quarter.

Can you highlight or clarify what that benefit came from?

One of the things we had set out to do in the quarter was to increase inventory in some of the areas, so we were trying to get the whip and the raw materials inventory up in some of the key places in the factory, as well as we were able to build some inventory in some of the new product lines.

Because of that, we were able to run the factory a little higher and that basically spread some of the fixed costs.

If you look at the net benefit for the quarter by building inventory, it basically gave us about a $1.5 million benefit to the gross margin line, that's an estimate.

But it's roughly that level of magnitude of benefit.

Okay.

And in terms of your XLamp, can you talk a little more about the current margin variation versus your LED chip?

I can tell you, it's increasing but still lower, we don't break that out specifically, and I don't think there's any reason we won't be able to get it over time up to the corporate kind of average level.

Really what we're fighting right now, and not really fighting, but it's a new product line, right, we just launched another new version, the lighting class one, and so that's just a matter of we've got to scale it up, we've got to utilize the capacity, we've got to get the yields ramped up, and so that takes us a few quarters usually to get those things under our belt.

Some of the work related to XLamp, you were outsourcing, right?

Ultimately, how do you see that work to be sort of kind of broken down between you and the outsourcers to drive the margin?

The idea is that generally the strategy would be when we have a new product, if it has unique technology or something that we think we have a lot of leverage on, we generally develop and ramp that up here first and then over time once we think we have a process that's transferable, then we look to transfer it to one of our subcontracting partners.

So for example, today, the products we released a year ago we make almost all of those today--have the ability to make those that are subcontractor and yet the new products are exclusively made here as we initially ramp them up.

It's really just a transition over time.

Invent it, get it going, get the process to the point where it can be transferred and then we move it and go to the next one.

Okay, so except for the chips, you could make the rest of the work overseas essentially?

We can over time, but even with the new XLamp, the new lighting class XLamp we just announced is actually made here, will be made here initially and then transferred over.

Okay, good enough.

So utilization, what was the utilization?

It just skipped me over in the first quarter?

We don't break out a specific number.

We're not at 100%, but we ran higher than target--higher than a normal level.

We just give relative guidance on that.

We're not running at full capacity these days and what we're suggesting is next quarter, because we won't be building inventory, we'll actually run the plant a little lighter, so that's where the gross margin guidance comes from.

Two more questions.

What can you tell us about your recent dispute with Bridge Logs, what can you tell us about that company?

Unfortunately, I can't say a lot more than kind of what is out in the press releases.

I think if you look at the press release, it basically says that we think they're infringing our IP and we fully expected them to counter sue us, that's a fairly normal strategy, and I think they're suits without merit, but beyond that I can't really comment a lot further because it's in litigation.

Okay, and the last question, your tax rate was a little bit higher than where I was looking for, how should we look at this going forward?

Yeah, I think the estimate--and I just want to make sure I check with John, I think we're looking for somewhere in the 34% to 35% range over the next year is that right John?

Yeah, 34% range.

So I think that's kind of what we're looking at over the next year, and obviously long term, we're going to look for opportunities to try to improve that.

Okay, thank you.

[OPERATOR INSTRUCTIONS]

Your next question comes from the line of Pierre Maccagno with Needham & Company.

Just a general question on major challenges for the LED backlighting of LCD displays.

Is there anything that has changed there or is the industry getting closer to the challenges?

Can you comment on this?

Yeah, Pierre, are you referring to the large screens like TVs and monitors with the direct view, or are you talking about more like notebook computer backlighting.

If you could comment on both.

Okay, so, and there really are two separate markets.

Our strategy on the notebook market is we're trying to work with companies that are in the business of building those backlights and really helping them to get high performance white LEDs that also have the IP requirements that they need to get into that marketplace.

There is definitely design activity going on there.

I think what we're likely to see is sometime here--I would imagine the first six months of next year, we're going to see some people put some products on the market.

I don't think we're talking high volume in the beginning.

I think we're going to see some test products get into the market and see, people will be testing the value proposition, finding out what people are willing to pay, how does that value drive it, but I do think we're going to see some additional models hit the market in the first six months of next year and it will really be--depend on what kind of acceptance there is to whether or not that's an exciting niche or that's a big market, it's too early to call that.

That's kind of in wait and see mode, but it's definitely technically feasible at this point.

One of the issues from my understanding is the heat is pretty high?

On the notebook computer application?

Yes.

The issue is is that the heat is high if you don't use high enough efficiency white LEDs.

So I think there's a trade-off there.

There's been some people trying to use relatively low cost white LEDs to try and use a lof them and what you end up doing is creating a lot more heat and battery draw.

So what we're seeing, at least the interest that we're working on tends to be higher efficiency LEDs that tend to balance out that side of the issue.

And then if we transition to the other side of the LCD backlighting market, now we're talking about RGB backlighting systems for direct view, these would be TVs or potentially very high end monitors.

We continue to work on some projects there, and we have one program that we have the ability, technically to build the system, I think it's a question of ramp--can we cost effectively ramp that up and will the end customer pay the premium it takes?

It's significantly more expensive than a traditional CCFL backlight system that's out there today.

The question will be, is there enough benefit with the high color gamut.

I can tell you that I've obviously seen many demos of what's possible there, and there's definitely a benefit, but the question is how big a market is there for that benefit?

I think we're going to find out next year, but at this point we don't have that product in the market and until we do, it's a little premature to call that one.

If I had to rank them, I'd say probably white backlighting on the notebook is likely to become a bigger market first although I think we'll see examples of both of those products hit the markets in the next year.

Do you think this could be significant probably in '09 or--?

As we get into calendar '07, I think that the large direct view systems are probably--we'll see some systems, but I don't know that those are going to be big next year.

I don't know that I would push it out to '09, it could be '08, but it's probably, we'll have to see, that one looks to me like high end could happen sooner, but whether mass market does I think that will take longer.

The notebook market is different.

That's really going to depend on where is exactly the premium, you're talking about a much lower premium to demonstrate LEDs there and there are some real benefits in terms of battery life, sport factor, things like that.

That one could happen by the end of '07, but it's too early--again, the products aren't in the market and I'm always a little hesitant to tell people we know the answers because we're really waiting to get those products out there and test drive that.

And regarding automotive, where do you see that market?

The major driver would be head lamps, correct?

In automotive head lamp, still lots of people doing design activity, still lots of talk about it.

I think the earliest we're going to see a product in the market is next model year and what we see right now is automotive--there's an interest, there's a design element to it, but there tends--there's a little hesitancy right now just from the standpoint that it's a new technology that they haven't really implemented yet.

The combination of that, specifications, regulations, it just seems to be taking its own time.

We're working on it with some customers at the chip--we're basically selling chips to some people who are working on it, but again lots of activity, but I think that one's probably going to take a little longer than the backlighting.

Other than the backlighting and the automotive, any other market you can foresee might take hold?

Absolutely.

We're already seeing it with the new XLamp product.

As we start to get truly the first lighting class LEDs in the market, and what we mean by that is there's the power LEDs out there, but the reality was they weren't much more efficient than conventional light sources.

So with the new XLamp we put out there, we're able to give customers a light source that's over 70 lumens per lot, that's a real different ball game, it's going to take a little while for that to develop, but I actually think you'll see lighting and not just the bulb in your home, but applications, whether it's commercial lighting in terms of parking garages or street lights or some industrial lighting applications.

I think you're going to see people start to push ahead with additional products in that area as well as on the personal lighting side.

To me, for when we look at the market, you have the big swing factors with things like LCD backlighting.

But lighting itself and some of those many applications that make that up are probably one of the more important growth drivers for us over the next 12 months, and the neat part is we get to address that not only as chips, but XLamp products.

Thanks.

Ladies and gentlemen, we have reached the allotted time for questions.

Presenters, are there any closing remarks?

Thank you.

We appreciate your interest and support.

We look forward to reporting our second quarter fiscal year 2006 results on January 18, 2007.

Thank you.

Thank you.

This concludes today's conference call.

You may now disconnect.