Wolfspeed Inc (WOLF) 2007 Q3 法說會逐字稿

Good afternoon.

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

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

[OPERATOR INSTRUCTIONS] As a reminder, ladies and gentlemen, this conference is being recorded today, Thursday, April 19t, 2007.

Thank you.

I would now like to introduce Raiford Garrabrant, director of investor relations of Cree Incorporated.

Mr.

Garrabrant you may begin your conference.

Thank you, Teprika, and good afternoon.

Welcome to Cree's third 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 third 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 in revenues, 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 note that, as a result of SEC rules, we will be limiting our comments regarding Cree's third quarter of fiscal year 2007 to a discussion of the information included in our earnings and the materials posted on our website, which you can find at www.cree.com, by clicking on investor relations and then clicking 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 is 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 [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 webcasting our conference call to allow more flexibility for our conference call attendees.

A replay of the webcast will be available on our website through May 3, 2007.

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

Thank you, Raiford.

For the third quarter of fiscal 2007, we delivered revenues of $90.3 million, with earnings of $21.1 million or $0.27 per share, which included a tax benefit of $0.23, which John will explain in more detail later.

The operating results were in line with our previously-announced targets for both revenue and earnings.

During the quarter we made tremendous progress on all five key aspects of 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.

Overall LED sales increased due to the combination of strong demand for our new lighting class XRE series of XLamp LEDs and stable LED chip revenue.

LED chip sales were in line with the previous quarter as increased EZBright sales help offset the normal seasonality in mobile phone-related LED demand.

We made tremendous progress in expanding our XLamp product line with the release of several new products that broadened our product offering and set new standards in terms of capability, performance, and value.

We continued to win new customer designs for portable lighting, as well as some of our first wins in general lighting for both municipal and residential application.

Our new LEDs are enabling our customers to produce LED lighting systems with capabilities that have previously not been possible.

These customers have started to confirm what we very been saying to the industry for the past several quarters, which is that the LED lighting revolution starts now.

With the increased XLamp sales, we have successfully reduced our dependence on the mobile phone segment, which declined less than 30% of total LED sales for the third quarter.

Although we still view mobile phones as an important part of our strategy, the improved customer diversity and more balanced application portfolio should be very healthy for our business.

The COTCO acquisition, which we closed on March 30th, will give Cree a strong presence in China and position us for additional component sales growth with very little conflict with our current chip customers.

Since COTCO has almost no exposure to the mobile phone segment, we should further improve our LED revenue balance among different market segments as we add COTCO sales to our revenue mix in Q4.

The combination of COTCO and growing momentum in our XLamp product line has put us in a strong position to grow the LED business in fiscal 2008.

Although it will take several quarters to fully integrate the product lines and channels, we are better positioned today for growth than we have been in the last couple of years.

I'll now turn the call over to our CFO, John Kurtzweil, to review our third quarter financial results and targets for Q4.

Thank you, Chuck.

For the third quarter of fiscal 2007, we reported revenue of $90.3 million, with net income of $21.1 million for $0.27 per diluted share.

Earnings included tax benefits totaling $17.9 million or $0.23 per diluted share related to the release of contingent tax reserves associated with the completion of our R&D tax credit study, and the expected resolution of Internal Revenue Service audits of fiscal 2003, 2004, and 2005.

Revenue increased 2% from Q2 and was at the high end of expectations, as we increased our XLamp component sales to offset the seasonal weakness in the mobile industry.

Q3 LED revenue of $67.2 million or 74% of sales increased 3% over Q2 and LED unit shipments decreased 5% from last quarter.

Our blended average sales price per LED increased 7% from Q2, but the increase in average selling price, partially driven by a richer mix of higher-priced, high-brightness products, as well as more stable pricing environment in the mid-brightness space.

LED blended unit costs rose 10% from Q2, as we built a higher percentage of high-brightness products and had lower factory utilization in an effort to minimize the inventory build.

For the first time our mix of high-brightness products increased to over 50% as mid-brightness devices decreased to 48% of LED revenue from 52% in Q2.

This shift was driven by increased demand of high-brightness products for lighting applications and seasonally lower orders of mid-brightness chips for mobile phones and other applications.

Q3 materials revenue, which includes wafer and gemstone products, was $10 million or 11% of sales and was down 6% sequentially.

High-power product revenue, which includes Schottky diodes and [Weiss] band-gap microwave sales was $5 million or 6% of Q3 sales and decreased 6% from Q2.

Contract revenue was $7.9 million or 9% of revenue for Q3, and increased 9% from Q2.

Q3 gross margin declined to 32% of revenue from 34% in Q2.

The decline in gross margin was primarily attributable to lower factory utilization and a higher mix of new products.

Contract gross margins increased to 24% of revenue, compared to 20% in Q2, as our mix of contract work has shifted towards projects that have a lower cost-sharing component.

Q3 operating expenses of $28.8 million were in line with previously-targeted levels and represented 32% of total revenue compared to 31% in Q2.

Research and development expenses of $15.8 million increased by $1.2 million.

Our research and development spending continued to be primarily focused on EZBright, XLamp, Colorwave, high power devices and larger wafer developments.

SG&A expenses increased by $0.5 million from Q2 to $13.1 million or 15% of revenue.

These expenses reflect planned spending to build our sales team, launch new marketing programs and increased legal expenses.

Net interest income of $4 million was flat with Q2.

We recorded a benefit of $9.8 million on taxes from continuing operations for the quarter, which was the result of our expected resolution with the IRS of our fiscal 2003, 2004, and 2005 audits, plus the effect of the completion of our R&D tax study that allowed us the ability to better estimate this credit.

We also recorded a gain of $7.1 million from discontinued operations, which included a tax benefit of $7.3 million that relates to the same IRS audit periods mentioned earlier.

,Our balance sheet has continued to remain solid with cash, short-term and long-term investments at $340 million as of the end of Q3, an increase of $9 million from Q2.

As a note, after the close of the quarter, we used $70 million in cash as a portion of the purchase price of COTCO.

Cash flow from operations was $22.6 million for Q3 and capital expenditures were $11.2 million.

We target our total capital expenditures to be $80 million to $90 million for this fiscal year, and were $71.8 million through the first three quarters of the year.

This is $10 million lower than we were targeting last quarter, as we continued to adjust your capital spending.

Accounts receivable were $61.3 million at quarter end, a decrease of $3.2 million from Q2.

Our day sales outstanding decreases to 62 from 66 in Q2.

Inventory was $50.3 million at quarter end, an increase of $1.6 million from Q2 of which raw and [whip] accounted for $1.1 million of the increase.

Our days of inventory were 74 and inventory turns were 4.6.

The increase in the base inventory has stabilized, although we expect the COTCO transaction will increase inventory in Q4.

I will now take some time to go over more of the financial details of the COTCO transaction that was announced on March 12th, and closed on March 30th.

We acquired all the outstanding shares of COTCO Luminant Devices, Limited, in exchange for 7.6 million shares of Cree's common stock valued at $126 million as of the closing date, and $70 million in cash, for a total purchase price of $196 million.

The cash portion of the purchase price is subject to a working capital adjustment that will be reconciled during this coming quarter.

Additional consideration of up to $125 million may be payable in the event COTCO achieves certain financial targets over the company's next two fiscal years.

We may elect to pay the additional consideration in cash, shares of common stock, or a combination of cash and stock within certain limitations.

We have commissioned a valuation analysis, and the acquisition will be accounted for under the purchase method of accounting as prescribed by FAS 141, Business Combination.

And all related goodwill and other intangible assets will be accounted for in accordance with FAS 142, Goodwill and Other Intangible Assets.

We target this valuation analysis to be completed by the end of June.

We are working on our fiscal 2008 targets at this time, and we will be in a position to give you more input on the base business at the next earnings call, but I want to give you some information regarding the financial targets that we will be driving for with the COTCO acquisition.

This acquisition is targeted to increase our fiscal 2008 annual revenues by $60 million to $80 million on a consolidated basis.

Please note that this is the net increase and includes the elimination of inter-company chip sales to COTCO.

We are also targeting the acquisition of COTCO to increase earnings per share on a consolidated basis for fiscal 2008 by $0.04 to $0.06, excluding the amortization of intangibles.

We forecasted if the business achieves the growth targets over the next two-plus years to trigger the additional consideration, the net result would be further accretive to earnings per share.

Now we'll give you an update regarding our outlook for the fiscal -- for the fourth fiscal quarter.

We are targeting revenue to be in the range of $110 million to $115 million, which includes the additional revenue from COTCO, incremental growth in XLamp LED components and a stable LED chip business.

We targeted gross margins to be approximately 32% of revenue and operating expenses are targeted to be 27% to 28% of revenue.

Research and development expenses are targeted to be in line with Q3, and will be focused on EZBright, XLamp, high-power products plus larger wafer development.

SG&A expenses are targeted to rise approximately $3.4 million, primarily as a result of the COTCO-based expenditures, COTCO -integration expenditures, and increased expenditures to support our new distributor.

Please take careful note, as I mentioned earlier, we have commissioned a valuation analysis on the COTCO acquisition and have not included any amortization of intangibles in our target for the fourth fiscal quarter or beyond at this time.

We will be able to provide this estimate beginning next quarter.

Interest income will be reduced in Q4 as a result of the $70 million cash payment as part of the COTCO transaction.

Going forward, we are estimating the effective tax rate to be 27%, which includes a favorable tax impact from the COTCO transaction.

Now, based on an estimated 84.4 million diluted shares outstanding and no amortization of acquired intangibles, we are targeting earnings per diluted share in the range of $0.05 to $0.07 for the final quarter of fiscal 2007.

Beginning with fiscal Q4 results, we will be revising our reported metrics to help provide you more meaningful information that will include the results from the COTCO acquisition.

Please see the metrics page on our investor relations website for the current data from fiscal Q3.

Thank you, and I will now turn the discussion back over to Chuck.

Thanks, John.

As we have outlined over the last year, our strategy is to continue to invest in LED and materials technology to provide higher performance capabilities for our core LED chip and materials product lines, while also enabling us to expand our component-level product lines.

We remain focused on five key areas to drive this strategy.

Our first priority to ramp-up EZBright LED chip production and expand the product family.

EZBright shipments continued to increase in Q3 and helped offset the expected seasonal slowdown in LED chips mobile phones.

Our standard EZBright LED chip product have started to ramp-up for gaming, mobile and signage applications.

Our high-power EZBright LED chips are driving our new XLamp LED products and enabling Cree to establish new levels of performance for LED lighting.

These same chips are also powering a number of our LED chip customers' new products in applications ranging from general lighting to mobile phone camera flash.

We are working to continue to expand this product family and further increase production over the next several quarters.

Our second priority is to expand our component level product sales.

We once again delivered double-digit sequential growth in LED component sales for the third quarter, as we continued to build sales momentum for our new XRE series XLamp LEDs.

During the quarter we made great progress in expanding our power LED component product line with the release of our XRC series XLamp LEDs for lower cost application, 1-Amp qualified XRE series XLamp LEDs for higher power applications, and our new Warm White XLamp LEDs for applications requiring warm and soft light color temperatures.

We believe that each of these products sets a new standard in the market for commercially-available power LEDs in their respective categories and builds upon our lighting-class LED leadership position.

We had good success in the third quarter in terms of sales momentum and design wins, but we believe that we are just getting started and target additional wins over the next several quarters from our expanded product line of XLamp LED products.

On the LCD back-lighting front, our LED chip customers continue to work on new designs for notebooks.

while our product plans for high-end RGB LED back-light, TVs and monitors has developed slower than previously targeted.

We have a technical solution that is ready to go, but our initial program has been delayed due to the high cost of the LED back-light..

This issue is not limited to our project, as there seems to be a general concern across the industry with the high cost associated with current LED solution.

Although we still believe that LCD back-lighting for TVs and monitors can drive a significant volume of LEDs within the next several years, we plan to focus our near-term efforts on supplying LED chips for the notebook application and developing XLamp LEDs for a range of lighting applications, including back-lighting.

High-power Schottky and RF power sales were in-line with the previous quarter.

We target power and RF product sales to remain at current levels in the near term, as it appears that it will take another several quarters before we are able to generate significant revenue growth due to the longer design cycle.

We continue to work on a number of mid--term projects to enable our customers to develop new products that can deliver higher levels of efficiency and more fully leverage the capabilities and value-added benefits of our silicone carbide and gallium nitride device technology.

Our third priority is to accelerate our cost-reduction efforts.

We produced a small percentage of LED and Schottky products on four-inch wafers in the third quarter.

Given the current utilization levels of our factory, the short-term cost benefit was minimal.

However, we believe that our four-inch program will put us in a strong position to support higher production levels and lower costs as the new product lines ramp-up in the year ahead.

In the interim, we plan to continue running a limited amount of four-inch to qualify the various products and target a more significant ramp-up in the second half of this calendar year as volumes warrant.

We increased our LED chip production in Asia over the last quarter and we continue to evaluate opportunities to further leverage lower-cost capacity.

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

In the third quarter we strengthened our global distribution capabilities with the addition of World Peace Industrial Company, who is the largest electronics components distributor in southern Asia and China.

We continue to add resources and expertise to our sales team and expect to continue to invest in this area over the next year.

On the marketing side, we have raised Cree's ability as a leader in the LED lighting revolution to an entirely new level with our LED City Initiative.

This project with the city of Raleigh is the first comprehensive commitment by a city to evaluate LEDs across its infrastructure.

The first installation in a Raleigh city parking garage has proven that LEDs save energy and deliver a financial payback of three years versus conventional lighting technology.

And a recent survey shows that the public feels safer in city spaces lit by LED.

As a result of the LED city announcement, we are now responding to inquiries from a number of cities from across the country and internationally.

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

We recently closed on a major strategic deal with the acquisition of COTCO Luminant Device.

This is a significant step forward in our strategy to build the Company with a more balanced portfolio of component product lines that leverage our LED chip and materials technology.

The addition of COTCO gives us strategic access to China, which is one of the fastest growing markets for high-brightness LEDs and a leader in the adoption of energy-efficient solid-state lighting.

The combination should also provide us with the opportunity to more fully leverage our investment in sales, marketing, and distribution channels.

The COTCO factory in China provides a low-cost manufacturing platform to further expand our global components business, while also supporting the local market.

Since the COTCO product portfolio is focused on high-performance LEDs for the display market, it is complementary to our XLamp product line and has minimal overlap with our existing LED chip customer.

As John reviewed earlier, the acquisition is targeted to be accretive to earnings in fiscal 2008.

The combination of growing XLamp LED sales, a more stable LED chip business, and the addition of COTCO has put Cree in a stronger position as we finish fiscal 2007 and prepare for fiscal 2008.

We have a broader LED product portfolio and better balance among applications than at any time in our history, with our exposure to mobile products targeted to decrease to approximately 20% of LED sales in Q4.

We will need to continue to manage challenges due to competition, changing market dynamics, and the integration of COTCO.

Our sales, distribution and marketing capabilities are improving each quarter, and we need to continue to invest in these areas to support our longer-term growth plan.

We have a strong balance sheet that gives us the opportunity to continue to invest in the critical technology, products and infrastructure to enable our future growth.

As we look ahead to our fiscal Q4, we target growth in LED components from both our XLamp product line and our COTCO acquisition to drive revenue for the fourth quarter to a range of $110 million to $115 million, with earnings per share of $0.05 to $0.07, which includes costs related to the COTCO transaction.

In summary, our LED business is growing, and we are focused on the key points of our strategy to drive the business into fiscal 2008, as we look to continue to maintain a strong LED chip and materials core business as we expand our LED component sales.

We will now take analyst questions.

[OPERATOR INSTRUCTIONS] Your first question comes from Jed Dorsheimer with Canaccord Adams.

Hi, guys.

Thanks.

Couple of questions for you.

Chuck, I was wondering if-- I guess as a follow up to your last comment, could you maybe separate out the core chip business from the COTCO and the XLamp and what type of growth assumptions are you assuming in that particular business as we look in to the following quarter or if you want to comment on the year?

Is that possible?

I can do that a little bit for you, Jed.

I think the way to think about the core chip business is we're projecting that it's stabilized in Q3.

We're thinking of that in a similar range in Q4, and kind of projecting that going forward.

So think of it as a stable core chip business at these levelings and really the growth coming from the two component sides, so that's a combination of further XLamp growth plus additional growth coming from COTCO.

Great, that's helpful.

And the COTCO business, is that about $20 million for next quarter?

You know, we don't -- we.didn't break it out that way on purpose.

The way to think about it is if you look at next year, where we -- what we have said is it's a $60 million to $80 million incremental for the year, and that includes the elimination of the chip sales which we previously told you ran about $25 million over the last year, so it kind of helps you put in to perspective about the size of that business.

All right.

And Chuck, I know we talked about it last week.

I was wondering if you could comment for everybody else listening as far as your thoughts on niches, provisional lawsuit with Sterling and what that means, how it -- what Cree's perspective on that?

I think that might be helpful.

Sure.

I think -- and I know you know this, Jed, but I'll just clarify for everyone listening.

The Chee has sued COTCO's customer, not COTCO, who is Sterling and it was for LEDs that were supplied, but it was for LEDs that were supplied prior to the acquisition.

And so since the acquisition, Cree has sent sub-licensed COTCO under our 2005 cross-license agreement that we have with [Nochia] for white LED technology.

So we're confident from a Cree perspective, and now a COTCO perspective as being sub-licensed, that we have the necessary IP to make and sell white LEDs, whether it be in Japan or anywhere else.

We view that as really Chee following up on a historical issue and not one that -- we don't see it having any major impact on our business going forward.

Great, that's helpful.

ne technical question and two housekeeping, and then I'll pass it on.

As you talk about the -- hitting some of the warm white lighting metrics, I was curious, the phosphor technology that you're using, could you comment on that and in particular could you comment on whether or not you're using the garnet-based structure or a silicon-based structure?

And then for John just two housekeeping questions.

Level of stock-based compensation you expect for Q4, and then did you buy back any stock during the quarter?

Thanks.

So Jed, unfortunately, I don't think we want to disclose which phosphor approach we're taking.

I don't think we want to explain to our competitors exactly which approach we're taking there.

I will tell you we have evaluated both and -- but I don't think we want to explain to our competitors exactly which approach we've taken there so I'm going to decline on that one And I'll hand the financial questions over to John.

Okay.

Jed, how are you doing?

In terms of the -- the stock, we did not repurchase any stock last quarter, and we don't have -- we were loaded up with the COTCO transaction.

And then as far as the stock-based compensation expense last quarter, it was $2.7 million pre-tax and $1.9 million post-tax.

But looking at Q4 do you expect it in the same level --?

I don't see it changes very much at all.

And then on the stock-based compensa -- sorry, on the share repurchase, what is currently open for -- or left in the current repurchase program, and -- that might be helpful, thanks.

There's approximately 4 million shares left in the current plan that's available to repurchase.

Great.

I'll pass it on and let somebody else ask.

Thank you, guys.

Thanks, Jed.

Your next question comes from Daniel Gelbtuch with CIBC Oppenheimer.

Hey, guys, I was wondering if you could just give us -- I know you talked about back-lighting for TVs being a economic non-reality, I guess, in the very near term, but can you give us an idea what the cost differential is in broad terms for TV, and then maybe move onto talk about the notebook market and how that compares?

Yes, so-- so I'll-- let me give that a shot, Daniel.

So if you think about the TV and even the high-end monitor, because they're really kind of a similar value proposition, you're really looking at the RGB approach, which is really pushing very high color fidelity, maximum color gamut, and so to do that requires not only the best possible LEDs from an RGB standpoint but also some pretty sophisticated control circuitry.

The net result is an impressive product but a fairly complicated and expensive system.

So to put it in rough numbers for kind of a -- let's just call it the 40-inch TV market, rough numbers you're looking at probably $1,000 incremental or more -- and that's a ballpark, but I think it'll give you want -- $1,000 incremental price adder to the price of the TV as it exists today, which I think you -- we all know is a pretty huge jump.

Now it doesn't mean that can't come down over time, but that's the state of the technology.

If you then separate that and say what about the notebook market you're really looking at doing something different.

Now you're basically leveraging off of still high-performance LEDs,but these are now white LEDs, so a blue chip plus a phosphor.

And instead of going for the really high color range, what they're really looking for is how to use the LEDs to really reduce the profile of the back light, reduce some of the heat issues, and also reduce the total energy consumption.

So if you look at the incremental costs there, there's varying numbers that are being flown around, but you're probably looking at something more -- and again, this is a rough number -- maybe in the $30 range, plus or minus 50%, but the incremental cost of a notebook.

So it's not a significant number and there's been estimates that it can be done down in the $10 to $15 range, depending on which combination and how many -- if you use the really bright LEDs or not, because obviously you need less of those.

So my point is to the relative price of the notebook it's a fairly small adder.

There is one but it's smaller, but you're really solving a different problem.

I think the implied question is which market is nearer?

And I think from what we see from the customer base, there is still a lot of momentum of trying to push forward and test drive some notebooks with these back-light systems.

And I think we'll probably hear them announced in the next quarter and see what happens then in the second half of the calendar year, so I think that's the one you are going to see further.

And as far as the high-end RGB stuff, we'll see where that ends up.

So within the notebook market we should expect to see penetration of -- would it be the ultra-portable market, would it be mainstream product, is it going to be across all areas of the market or it just going to be niche initially and then mass market in '08?

So there's two schools of thought.

I recently read some stuff coming out of Taiwan, which there's an argument being made that they'll test it across the product line.

I would tell you that I think that's a little optimistic.

I've rarely seen new brand new technology get broadly used in its initial adoption.

It could happen, but I would say it's by far the exception in when technology gets used.

think what we'll see is kind of a few premium model or two from the players to test it.

I think you'll see some people test it on ultra portable and I think you may see some others do the opposite, so I think it's really -- I would call it that early-stage niche test time.

'08 is the chance for it -- I mean, if it -- I think it's likely it will get some traction.

but I think we won't know the magnitude, really, until we get in to calendar '08.

And as far as dollar content per device on the LED side for average typical notebook, if there is one, it's a -- the incremental cost, is that mostly electronics or is that -- how much of it is LED?

Yes, I think the LEDs is run -- and this is -- again, I'm giving you some pretty ballpark numbers, but it's probably about $8 to $10 of LED content, something like that.

Okay.

And that's quote for the -- quote, typical one.

Obviously I'm not sure exactly what size that would be, but there's probably ones that could use less and clearly the bigger ones would use more.

I got you.

Thank you very much, very helpful.

Sure.

Kapur Your next question comes from Amit with Piper Jaffray.

Hi, thanks for taking my question.

This is [Pretesh Munchion] on Amit's behalf.

Can you tell us a little bit about the composition of inventory and how to model the inventory days over the next couple of -- over the next few quarters?

Yes, so if you look at it, it's probably -- of the inventory it's probably about -- I don't know, about 20% is raw and the rest is split between whip and finished goods on a rough basis.

And I think going forward, what we're looking at -- and that's really split between the businesses and it's more heavy wherever we have the new products, so it's more weighted to the newer LED chip products and it's more weighted to the new package component products, which is just part of the normal.

When we try to launch a product, we try to make sure we're in that position.

I think going forward, we would look at it as the bas inventory to stabilize -- potentially even coming down slightly over the next couple of quarters would be our estimate and that's definitely what we're going to be targeting.

And as long as the current rate of new products stays where we're projecting that would be pretty accurate.

The one thing to keep in mind is obviously when we consolidate COTCO, they will have inventory themselves.

But in terms of -- the trend would be stable to probably down slightly next quarter.

Does that --

Sure.

And just one more question actually.

Can you tell us how the Sumitomo [inaudible] is tracking, those sales there?

You know, last year you'd given kind of an indication there, so something similar would be helpful.

If you think about Sumitomo, obviously a year ago -- it's been almost a year ago when we announced the last deal that we were projecting the Japan business to be up actually year over year.

Clearly, as we have discussed over the last couple of quarters, the LED chip business has changed and Japan has been a part of that.

I don't have a specific projection for you.

I think probably the best way to think about Sumitomo is it's clearly going to down year or year, but that's not any different than what we were thinking three months ago.

I think the good news is that it actually appears that right now, kind of we were able to do in Q3 and what we're projecting for Q4, it really does appear to have stabilized and I would expect as we go in to fiscal 2008, it to be at current levels with some incremental growth as we get into the year from some of the new EZBright products.

So I'm pretty optimistic that we're worked through a lot of those challenges.

It's kind of -- I think is a micro -- it's a subset of our chip business, which has stabilized and now we feel like at these levels we can manage it here going forward.

And then in Japan specifically I think there's some opportunity as we get into next year, depending on how the new products are received.

All right.

Thanks a lot.

Sure.

Your next question comes from Harsh Kumar with Morgan Keegan.

Hey, John, Chuck and Raiford.

Couple of questions.

I guess coming back to one of Jed's questions, can you just tell us how much you're assuming for COTCO in the June guidance?

Well, we're not actually going break that out.

What we're going to be doing is when you see that it'll be consolidated.

And the way to think about that, Harsh, is this.

If you look at the -- if you look at what we're saying for June, there's really two drivers for the growth.

There's XLamp, which is going to grow again, but clearly the majority -- the vast majority of that's going to be coming from the addition of COTCO.

One of the reasons we're not breaking it out is as we look at that business, realize that although they have separate customer bases, one of the things we're going to be trying to do is sell XLamp through our COTCO branch in to China and then trying to leverage COTCO products through some of our other channels..

So it's really going to become a more combined component business as we go forward and so -- but clearly the big driver in next quarter -- the bigger driver of the two is COTCO, but we're still projecting XLamp to grow double digits again.

Okay.

So let me just -- just not to harp on the same question still again, but if I work the math off of $70 million, I got $5 million, $6 million worth of organic growth.

Is it fair to assume all that is LED-based growth?

The growth -- yes.

Yes, basically what I said earlier is that LED -- LED components are driving the growth and that's how you should think about the business.

That really is the driver.

Got it, thanks.

That's very helpful.

And then coming to gross margins 32% recently, you're guiding flattish again.

What point in time, with the CapEx that you're at and the the visibility you have on the 4X RAM coming up -- I'm sorry, four-inch RAM coming up, when do you think you start to make progress on that number?

Clearly we're doing things line pushing more of this back-end chip stuff to Asia; we've done it and we've gotten some benefits.

The problem is is the lower utilization has kind of offset that.

I think as we get -- as we get out into the second half of next year really two things got to happen.

Obviously we need the volume to come and really push the utilization back up.

And the other thing, though, is -- is that I think the component businesses, as they grow, will drive a piece of that.

So I think it's really going to depend on how fast those components businesses ramp up and can drive the growth into the year ahead.

We still believe we can make an opportunity.

The other thing to keep in mind, Harsh, is that that 32% is blended and the new product lines, while they are improving, are still actually not contributing at the corporate average, so those businesses as they make progress should help the overall margin.

Fair enough, that's helpful too.

And then ASPs, you said you got some benefit from the mix, obviously from XLamp and such, and some benefit also from the market stabilization.

Not to read too much into it, but could you clarify if there was one factor that was bigger than the other?

Actually I would weight them about the same.

I think that clearly a more stable chip environment helped, because it's obviously a large piece of our business.

But it doesn't hurt that -- and it's not just XLamp.

It's XLamp but also our EZBright high-power chips also contribute to that.

So our value-add on the chip side, whether it be as a chip or even selling it as an XLamp, obviously is going up, which helps that.

Great, that's it.

Thanks, guys.

Sure.

[OPERATOR INSTRUCTIONS] Your next question comes from the line of Mike Burton with ThinkEquity.

Hi, guys.

Sorry I missed it but what was XLamp as a percent of sales in the quarter?

And can we expect to see your combined package products broken outgoing forward?

We don't -- all we said on XLamp is that it grew double digits again.

I don't actually -- we have not broken that out and we're not planning on breaking out XLamp specifically.

As far as going forward, we're working through as we consolidate COTCO the best way to look at these things from an LED standpoint, and you're going to -- we will let you know as we get close to the end of the quarter, we're going to be revising the metrics and how we do that.

And I think we want to get through the consolidation and integration efforts first before we make that final call.

I think clearly we're going to try to give you visibility to the LED business and how it's growing, but we've got to work through that.

Okay.

And last quarter you spoke about working to reduce your inventory levels.

With the inventories still very high on a historical basis here, especially with COTCO coming on, where should we expect days inventory to level out, given your new product mix?

Excluding COTCO, I they we are -- \we're viewing our inventory to be able to maintain it at these levels or even make some slight improvement going forward, and given the fact that the business overall is stable or growing, then I would expect that days would probably get a little bit better next quarter.

I don't think it's going to be tremendous progress, but I would expect to start making some incremental progress over the next couple of quarters.

When we add COTCO in -- unfortunately I don't have that model in front of me -- it's going to add some -- obviously we're going to have to -- their days will get wrapped in to there and I don't have what that blended number's going to be.

Okay.

And as -- going back to the margin question, we've seen the margins come down, as you mentioned, as component sales have increased.

As you're working down inventories in the next quarter, can you talk how -- what's driving the gross margins to stay kind of flat for the next couple of quarters?

Yes, so think about the fa -- so in our component businesses, the components like the XLamp business, that's not about a utilization play.

That's really about launching -- I believe last quarter we launched four or five fundamentally new products into that line while we were ramping up the product we announced the previous quarter.

So we're managing just an incredible amount of product ramp ups in the near term.

That's really going to be about -- those margins are really about getting those new products through the learning curve, getting them stabilized, and getting the volumes to the level where we can really drive the cost reductions on those.

So I think when you look at the component product lines, it's really just about volume, scale and learning curve.

That drives their gross margins.

When you look at our chip and materials factories, that's where the utilization comes in.

So, if those businesses are sta -- relatively stable, then we think that if we get the cost reductions in the right place, we can hold those in-line with where they're at and hopefully make some progress, and they can be offset by some improvement in components in the short-term.

That's kind of our 32% target.

And then over time, the idea is those components should ideally start to push it back up.

Okay.

And then lastly, any 10% customers in the quarter?

Yes.

No, nothing -- nothing's changed from normal, obviously other than -- we only break them out at the end of the year and that traditionally has been Sumitomo and there's been a significant change there.

Okay.

Thanks.

Sure.

Your next question comes from Steve Smigie from Raymond James.

Great, thanks.

If you didn't, could you tell us what the difference in ASP change was for mid brightness versus high brightness?

We don't separate the ASP change between those two.

What we have is that the ASP overall was up 7% combined basis and, obviously, the mix went more high brightness so that high bright's driving that a little faster.

What I can tell you, though, just from a conceptual basis is that both the high brightness and the mid-brightness ASPs, while they -- they moved more in line with historical trends last quarter than they had been over the previous two, so that's where part of my comment that the business isn't stabilized has come from.

Okay.

I mean, were -- was there -- I guess, you are seeing annual price increases potentially on the high brightness as opposed to decreases?

No.

So -- no, what we're saying is that the mix is going more to high bright, so that drives the blended ASP up is really what I'm saying.

Both product lines are -- have generally speaking -- generally have ASP declines year over year and that's the trend we're seeing in both of them right now.

But what I -- my message is really more that I think that from a chip standpoint, those have stabilized more than they have previously, and then in terms of the why it went up 7%, that's really more high brightness -- both a combination of the high-brightness XLamp products, but really also the high-brightness chip products.

I think you had pretty good pricing a couple of years ago, and just curious if you could talk a little bit about what the environment looked like that lead to that, and is it possible to see that again with some of the newer products here?

I think it's going to vary, right?

I think obviously our products have different markets they attack and some of it's a fundamental of the end market.

If we just take out the market side of it and just generally where can we have some pricing power, obviously, on the higher performance end is where we tend to drive that, so those are the higher-end chips that we make.

And right now that would be EZBright product line, as well as our high-power EZBright product line, so these are the large power chips.

So we're having some success there.

And then on the other side, taking those same chips and putting them into our XLamp, we are able to drive a performance advantage.

So, these are competitive markets; we do have to compete for these pieces of business.

But where we're able to push the performance, which is the high end of both of those two markets, is where we tend to have the best situation.

That being said, we're not in the market we were in two years ago.

I think where we're at is the chip business has stabilized.

We're starting to get some growth and really it's going to take a few quarters to see what the trend's going to look like over the next year.

Could you talk a little bit about the lighting opportunities you have, say, relative to metal halide and if you're going to be going after that market any time soon?

So today, essentially where LEDs are going -- the markets LEDs are competing in are against incandescent for non -- what I'll call traditional bulb application.

So we're not really going after the bulb in the lamp, but things like down lights is a classic incandescent application where LEDs can compete pretty well.

Obviously the colored applications.

And all of those other things we talked about, whether it be emergency vehicles, personal lighting, things like that.

Realize those are traditional more of an incandescent market.

When you get into the commercial side, what we're seeing is any place that maintenance is a driver, we have an opportunity.

So, the parking garage was really a comparison against sodium vapor -- or high-pressure sodium, I should say.

But we're also seeing LEDs able compete against metal halide in certain markets where the combination of lifetimes for the maintenance and total output and really factoring that into the equation, plus fairly -- a good energy argument there.

as well.

although not as big as incandescent really is driving that.

And then, there's even a third market where you can actually go after things like compact florescent, because although that is kind of the hot thing for people to talk about, the hidden problem with compact florescent in a lot of applications, what it says on the bulb and what you get out of the fixture are radically different.

different.

The energy efficiency gain is not near what I think is perceived in certain applications.

And then the secondary effect is while you may be saving energy, we're now creating a mercury disposal issue to more fluorescent.

So it's really those three marks.

So metal halide is a piece of what I would call that municipal/maintenance market.

Last question is just on the -- back to the TV stuff.

Sounds like you're taking a break for a while.

When does that -- what has to be done to get the price down, because it seems like a pretty substantial market for you guys?

And is it just -- is it something that you guys can fix to get the cost down or is it something that has to be done elsewhere in the system?

The way I would think about it is a little different.

I don't think the mark -- given the cost of how we do it, I just think the market's not willing to pay what it takes today.

Obviously, as LEDs get brighter over time, that will reduce some of the cost from an LED standpoint, and that's also going to simplify some of the electronics.

That'll get us part of the way there.

I think part of it also is simply -- I think there are lots of new ways of looking at how to use these LEDs and as we get further down the road, those opportunities will creep up.

Really my point is that in the next year or so the markets that we can address that we want to focus on are going to be things like the notebook market on one side and then just lighting in general.

I.e., where we're driving this XLamp business is there is tremendous opportunity in lighting, and we want to take that momentum and realize that the same products we develop can be reapplied to markets like these TV or monitors.

I just think they're going to take longer to get there.

So, I think we'll see them.

I just think they're going to take a little longer to develop than people were -- that people were projecting and those people were not only Cree but, frankly, our customers thought that market was near, and I think now that we've got there, the reality is just a little further away.

Thank you.

Sure.

Your next question comes from Pierre Maccagno with Needham and Company.

Hi, Chuck.

If you could tell us at this point, what are the issues, if any -- are you seeing any with the LED lighting of notebooks?

What do you expect for the penetration -- how do you expect that to progress?

Hey, I think we're going to find out is -- my real answer is I think we're going to find out, right?

There are a umber of programs being worked on out there.

Pretty much every notebook company is at least evaluating.

Whether they actually go ahead and launch their models -- when they go ahead and launch them and how big that is I think is to be determined.

So it's a little hard to give you a penetration rate or how fast that's going to happen, because it's just not -- it's premature to guess, right?

I think we're going to see it.

They're going to put them into the markets and then we'll be able to evaluate it from there.

I think over a period of time it will be a significant market, but I guess I tend to be a little more pragmatic about these things.

New technology usually ramps up at the high end first and grow -- expands after that.

So I think we'll find out in the second half of this calendar year where we're at and then we can draw the line from there.

Any issues that exist at this point that have to be ironed out?

Well, I think there's -- the issues that the manufactures' are working on range from exactly what brightness level.

In other words there's been two approaches; high-performance LEDs because you really get the energy savings and you really get a simpler solution or going with a large number of a mid-brightness performance white LEDs.

The challenge there is now you start to offset whatever benefit you're supposed to get in energy savings on one side and now you start getting into debates about what of the real IP issues are not there.

I think it's likely they're going to go with the higher performance ones to start with, because these are meant to be premium models, and then we'll see where it goes from there.

The other issue then is if you have the right performance to get the benefits, it's going to be the life time of the LEDs and I think the packaging industry is going through a situation where they've got to improve the life time of their packages over what has traditionally been used for mobile phones to make them acceptable for those applications.

But I seen enough data that I think that we're coming through a phase where that should be something that's getting solved here over the next quarter or two.

[The attractiveness of using LED, then, is mostly driven by the lifetime would you say or in the factors?]

I think the lifetime in a notebook is a minor issue.

I think the biggest reason we're seeing an interest is the form factor of the notebook can actually be thinner with LEDs than it can with CCFL and there's a benefit also of having the energy savings.

There are designs out there where the LEDs flat out can use less energy than the CCFL, and I think those are the two driving reasons why we'll see people go to them.

Do you have an idea how much energy they're saving?

It's going to very dramatically by the type that's out there.

I think the best numbers I have seen are the -- Sony quoted some numbers in one of their designs where they were talking about something like 20%, roughly battery savings.

I have not validated that personally.

And then going on to the chip core business, when you say it's [inaudible], what explains that?

I mean, is it something that you can expect be the case for several quarters or what is the explanation for that?

Look, if you look at the past eight years of our chip business it goes through cycles, right?

There's growth cycles there's cycles where we go through technology transitions, and then there's cycles where the market recorrects.

We've obviously have been going through a time where the technology needs haven't been driving the new applications, so there's been a lot of competition for the same share.

I think what we're seeing is that we're obviously running the business at a different level than we were.

That takes some pressure off it, so we're able to focus on markets where we add more value.

We can really leverage our customer partnership relationship.

So I think we kind of got it to a place that makes sense for the current market and the current trends in the market.

As far as what it's going to look like over the next several quarters, what we know is that it has stabilized in Q3, similar to what it was in Q2.

Q4 looks about the same right now.

That makes us feel like we're at least -- that's what we can see.

I don't want to be too optimistic and saying I know what it's going to look like three quarters from now, but I don't.

But if the trends hold then this should be not a bad place to base.

But again, it's a little premature to call that since really is we've two quarters worth of data right now.

[inaudible] competitors are not pushing for lower pricing, is that what it is?

No, I think that there's a balance in the products and the technology that's available for certain applications, so I think where we're adding value, we're adding that value and that allows us to run our business in the way it is, and that we're not in the situation of fighting for market share in the applications that don't value our technology or our IP.

Thanks.

[OPERATOR INSTRUCTIONS] Your next question comes from Jiwon Lee, Sidoti and Company.

Hi, I just have a few quick questions for you, Chuck.

Would what'll be the currently biggest market for XLamps and where would that be geographically?

The biggest market is what we call generally lighting, so what segments are that?

The markets that are driving it today are a combination of architectural portable lighting and what we call vehicle lighting, that's everything from exterior of -- like marker lights to interior lights inside trucks and cars to -- the other piece would be emergency vehicle lighting.

Those would be three biggest markets today.

The geography there varies by those applications, but it's -- I would say the U.S., Asia, are probably the two biggest and Europe is just a little bit smaller than that, but also fairly significant.

It's pretty well spread out between the three.

Okay.

And with the COTCO you recently struck a strategic deal.

Is there anything qualitatively that you can further discuss?

Not other than what we said.

Obviously we think it's going to be an important chunk of business for us.

It gets us in to China, and we really think China is a place that -- LED consumption there from the projections we've seen, it's clearly an important market to be in.

And COTCO is probably the only true Chinese LE -- full-line LED company.

It puts us in a great position there to not only leverage their factory and low-cost manufacturing, but leverage their channels and their relationships with those customers.

So we think it's a going to be good for the COTCO product line, but also the XLamp product line by selling it there through COTCO.

So when you talk about that -- I would just ask you one more question -- COTCO's [inaudible].

When you say it's strategic, are you suggesting that it is a continuation of their core market or are you sort of talking about a little bit different market there?

I think when I look at what they do well, which clearly has been displays, and then they have other applications they service beyond that, but obviously displays has been what they're known for -- that's an important market for LEDs.

It's one that values high-performance LEDs.

The price performance is important there, but the quality of the LED and the capability to really drive performance is a big deal, so I think that fits great into our chip strategy, and it's always been an important market.

And I think we sometimes forget that those are sizable markets.

I don't have the strategies on limited data in front of me, but it's one of the major chunks out there, so for us that's a great place to be able to access and help COTCO be successful.

But realize, they also have a fairly broad portfolio so their other customers are everything from automotive to gaming to entertainment, and they even have an emerging lighting business there, as well.

So to me, while displays is what they've known for -- and I think that's a good segment -- it really gives us access to a pretty good range.

So one place they really don't compete is mobile, and frankly, given how high a percentage we've had there in the past, I think that's great.

It'll still be important but it really balances out our portfolio.

Yes, that's a good answer.

And one question for John.

What was the revised calendar '07 CapEx goal?

For this year it'll be between $80 million and $90 million.

And that's fiscal.

And that's for the fiscal year.

Fiscal year, okay.

And the fiscal year ends June 25th.

And that a $10 million decline from what we had projected last quarter.

So we're really trying to balance that capacity with the demand to really get the utilization back to where it should be over the next few quarters, hopefully.

Which leads to my final question, Chuck.

How important is the four-inch wafer transition and where are you now versus your earlier goal?

Four-inch wafer transition if you look on a mid to long-term basis is very important.

It gives us a cost structure, it gives us capacity leverage, it really allows us to do some things.

In the foreseeable few quarters, it's not that important, because until the utilization comes back up it's a fairly incremental benefit.

Because although I can get the four-inch wafers, until the utilization goes up you don't really see the big benefits there, so we're continuing to pursue it.

Our mid to long-term strategy and it's critical for, but right now it's more important to let's get it qualified on the various product lines and then we're just going to use it as a lever once utilization starts to come back up to really balance out the factory.

Okay, that's all for me.

Thank you.

Sure.

Your next question comes from Bennett Notman with Davenport.

Hi.

Can you just tell us, are you already generating revenue in the notebook business or is that something that's going to be more the next few quarters?

No.

The notebook business is -- we service that from a die standpoint, so while we don't have that direct -- we're not directly selling to the notebook companies.

We have pretty good visibility, and although there is probably some small amount of business out there through our packagers is being addressed on a sampling basis, I don't believe any of our packaging customers have any major notebook business at this time.

I think they're -- a number of them, probably four or five, are working on it and working on various projects, but I don't think it's a significant part of our business right now.

Great, thank you.

Sure.

There are no further questions at this time.

Gentlemen, do you have any closing remarks?

Yes, thank you, Teprika.

We appreciate your interest and support and look forward to reporting our fourth quarter and fiscal year 2007 results on August 9, 2007.

Thank you.

Thank you.

This concludes today's teleconference.

You may now disconnect.