Wolfspeed Inc (WOLF) 2007 Q4 法說會逐字稿

Good afternoon.

I'll be your conference facilitator today.

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

All lines have been placed on mute to prevent any background noise.

After the speaker's remarks there will be a question-and-answer session.

(OPERATOR INSTRUCTIONS) As a reminder, ladies and gentlemen, this conference is being recorded today, Tuesday, August 7th, 2007.

Thank you.

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

You may begin your conference.

Thank you, and good afternoon.

Welcome to Cree's fourth 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 fourth quarter of fiscal year 2007.

Today' presentation includes 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 revenues, gross margins 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 fourth quarter of fiscal year 2007 to a discussion of the information included in our earnings release and the materials posted on our website, which you can find at www.cree.com by clicking on Investor Information and then click on Financial Metrics.

We will not be able to answer questions that would involve providing additional financial information about the quarter 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 side analysts ask questions during the Q-and-A session.

However we recognize that other investors may have additional questions and we welcome you to contact us after the call by email or phone at 919-313-5300.

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

A replay of the webcast will be available on our website through August 21st, 2007.

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

Thank you Raiford.

For the fourth quarter of fiscal year 2007, revenue increased to a record $111.2 million with earnings of $6.4 million or $0.08 per diluted share.

Earnings included various benefits and expenses from several non-operating items that John will explain in his comments.

Excluding these benefits and expenses, overall operating results were in line with our previously announced targets for both revenue and earnings.

LED product line performance was better than expected, due to continued growth in XLamp sales, a strong quarter from Cotco and another solid quarter for LED chips.

The overall strength in LEDs helped offset slower sales in the fourth quarter for our silicon carbide wafers and high-power Schottky and RF products.

For the fiscal year we delivered revenue of $394 million and earnings of $57 million or $0.72 per share.

We made great 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.

We successfully ramped our EZBright chip product line which has set a new standard in high-power LED chip performance.

We grew our component product lines with XLamp high power LEDs delivering double digit growth each quarter since the introduction of our first lighting class products last fall.

We made progress in reducing costs through further expansion of our manufacturing activities in Asia and additional qualification of 4 inch wafers for LEDs and Schottky diodes.

We expanded our global sales team, signed two major distribution partners, extended our distribution arrangements with Sumitomo and launched a major marketing campaign for Cree as the first supplier of lightning class power LEDs and a leader of the LED lighting revolution.

We also took a major step to expand our LED packaging business and presence in China with the acquisition of Cotco.

The overall LED market continues to gain momentum.

The use of LEDs for backlighting notebook computers is gaining traction with the announcement of new LED-based models from most of the major computer players.

This should drive additional demand in the market for our high performance blue LED chips to support our customers making white LEDs for this application.

The recent announcement that Phillips intends to acquire Color Kinetics is further validation by the traditional lighting companies that LEDs are going to have a significant impact on the future of the lightning industry.

In addition to the expected financial gain from our investment in Color Kinetics, this move further establishes Cree as the lightning independent supplier of lighting class LEDs for this market.

It has been a challenging but successful year for Cree.

A year ago, Cree was an LED chip company with great technology that was heavily dependent on the mobile phone segment and facing tough market conditions while trying to build momentum for our fledgling LED component business.

Today we are one of the market leaders in total LED sales with a strong portfolio of LED products that includes chips, high-power lighting class packaged LEDs and now a broad line of high brightness package products for the display and gaming markets.

As we enter fiscal 2008, the mobile phone segment now accounts for approximately 20% of our total LED sales, as we have built a good balance across a variety of applications that include lightning, automotive, video display, gaming, backlighting and mobile.

After one quarter, Cotco is on track and although we still have a lot of work ahead of us, our transformation from and LED chip and materials company into a global leader of the LED lighting revolution is well underway.

I'll now turn the call over to our CFO, John Kurtzweil, to review our fourth quarter and end-of-year financial results and our targets for Q1.

Thank you, Chuck.

For the fourth quarter of fiscal 2007, we reported revenue of $111.2 million with GAAP net income of $6.4 million or $0.08 per diluted share, which includes $1.1 million or $0.01 per diluted share of expenses due to certain items as follows.

$7.8 million or $0.09 per diluted share of additional income from the sale of a portion of our investment in Color Kinetics.

$6.5 million net of tax or $0.07 per diluted share of additional expense related to the Cotco inventory valuation adjustments to finished goods that were sold through during the quarter, Cotco in-process R&D and amortization of acquired intangibles.

$1.6 million net of tax or $0.02 per diluted share of stock-based compensation expense.

And other incremental end-of-year tax expense adjustments in the amount of $0.8 million or $0.01 per diluted share.

On a non-GAAP basis, adjustments to exclude these items, net income for the fourth quarter was $7.4 million or $0.09 per diluted share.

When the first call estimate for the fourth quarter of $0.06 is adjusted to exclude stock-based compensation expense, as we do in our non-GAAP financials, the first call estimate would have been $0.08.

These non-GAAP results are consistent with one of the ways management internally measures Cree's results.

However, non-GAAP results are not in accordance with GAAP and may not be comparable to non-GAAP information provided by other companies.

Non-GAAP information should be considered a supplement to, and not a substitute for financial statements prepared in accordance with GAAP.

Please see the reconciliation of non-GAAP information to the comparable GAAP measures posted in the Investors Relations section of our website at www.cree.com under Financial Metrics, Quarter Ending June 24th, 2007.

Q4 LED revenue of $92 million or 83% of sales increased 37% over Q3.

Our results now include the revenue associated with the acquisition of Cotco, which was completed early in fiscal Q4.

I will speak more to the Cotco acquisition in a few minutes.

Also, contributions to this growth came from our XLamp product line, which grew at a double digit rate from fiscal Q3 to fiscal Q4.

LED chip sales were stable with last quarter and the average sales prices were in line with our expectations.

Q4 materials revenue, which includes wafers and gemstone products, was $8.8 million or 8% of sales and was down 12% sequentially, primarily due to the lower sales of high-power RF applications.

High-power products revenue, which includes Schottky diodes and wide band gap microwave sales, declined to $2.6 million or 2% of sales as compared to $5 million in Q3.

We are finding that, in the initial stages of the high-power business growth curve, there are relatively large contracts that come in stages.

And in Q3, we completed large RF build-up which was not duplicated in Q4.

A similar situation occurred in our power area.

We expect to see a small recovery in Q1, which I will talk more about later.

Contract revenue was $7.7 million or 7% of revenue for Q4 and was down slightly from Q3.

Q4 GAAP gross margin was 29% and non-GAAP gap was 32%, which included stock-based compensation of $0.5 million and $3 million of Cotco related inventory evaluations step-up charges that flowed through our income statement during the quarter.

Overall, LED margins were solid, despite the fact that the LED factory continues to run at sub-optimal utilization rates so as to keep the inventory build to a minimum.

Gains in LED margins were offset by power and RF products, which both took a step back in terms of revenue growth that resulted in a negative impact on gross margins.

Contract gross margins declined to 21% of revenue compared to 24% in Q3, as we are winding up some contracts and had to expend costs to complete that were not reimbursable.

GAAP R&D of $14.6 million included an in-process R&D charge of $1 million related to the Cotco acquisition and stock-based compensation expense of $0.7 million.

Non-GAAP Q4 R&D expenses for the quarter were $12.9 million.

When the above items are excluded, this is down from the previous quarter, as new products were moved into production this past quarter and out of R&D with the associated expense items now in our cost of goods sold.

GAAP SG&A expenses were $15.5 million for the fourth fiscal quarter and included $1.3 million of stock-based extension expense.

Non-GAAP SG&A expenses were $14.2 million when the above items are excluded, an increase by $2.4 million from Q3.

This increase reflects the plant spending from the acquisition of Cotco.

Also during the quarter, we recorded $3.7 million of charges for amortization of acquired intangibles, which we do not include in non-GAAP results and $1.2 million of obsolete asset write-offs, which we do include in our non-GAAP financials as a cost of running our business.

During the quarter, we sold a portion of holdings in Color Kinetics for $9.9 million and recorded a gain of $7.8 million.

We currently own 500,000 shares.

If the pending acquisition of Color Kinetics is consummated as planned, this remaining investment is expected to result in approximately $17 million of additional cash and an after tax gain of $9 million or $0.11 per share in Q1.

Net income -- net interest income of $3.1 million for the quarter was down from Q3, as we used $77 million in cash as part of the purchase price of Cotco.

GAAP tax expense for the quarter was $1.6 million.

When you take into account the incremental year-end tax expense adjustments and the effect of the other items previously discussed, tax expense would have been $2.9 million for an effective tax rate of 28%.

Our balance sheet has continued to remain solid with cash, short-term and long-term investments of $294 million as of the end of the Q4, a decrease of $46 million from Q3.

Please note, during the quarter we used $77 million of cash as a portion of the purchase -- for purchase price for Cotco.

Cash flow from operations was $26.7 million for Q4 and capital expenditures were $10.8 million.

For the year, our capital expenditures were $83 million.

We targeted our total expenditures between $35 million and $45 million in fiscal 2008, which is approximately half of what we spent in fiscal 2007.

These expenses are planned primarily for technology related items in capacity editions outside the U.S.

to help grow our XLamp and Cotco product lines.

Accounts receivable was $79.7 million at quarter's end, an increase of $18.4 million from Q3, which is related to our acquisition of Cotco and assuming the accounts receivable balances.

Our day sales outstanding increased to 64 from 61.

Inventory was $71.1 million at quarter end, an increase of $20.8 million from Q3 of which Cotco inventory was $19.8 million.

Our days of inventory were 81 and inventory turns were 4.1.

We believe that our base inventory before Cotco has stabilized.

I will now take some time to go over more of the financial details of the Cotco transaction that closed on March 30th.

We acquired all the outstanding shares of Cotco Luminant Devices in exchange for 7.6 million shares of Cree's common stock, valued at $127 million as of the date of closing and $77 million cash for a total purchase price of $204 million.

The cash portion of the purchase price was subject to working capital adjustment and during the quarter was reconciled and a final payment of $7 million was made and is included in the $77 million noted earlier.

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.

If the business achieves the growth targets over the next two years to trigger the additional consideration, we target the net result would be further accretive to earnings per share.

The acquisition is accounted for under the purchase method of accounting as proscribed by FAS 141, business combinations, and all related goodwill and intangible assets are accounted for in accordance with FAS 142, goodwill and intangible assets.

The valuation study has been completed and we have reported $104.8 million goodwill and $58.4 million of amortizable intangibles.

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

Please note that we are changing the manner in which we set targets.

We will not include amortization of inquired intangibles, stock compensation expenses or gains on the sale of investments in our targets.

This changes is based on numerous discussions with analysts and investors over the last several quarters and is intended to make it easier to compare Cree to other companies in our peer group.

Now on to the guidance.

We're targeting revenue to be in the range of $110 million to $115 million.

We expect XLamp LED sales to grow -- XLamp LED sales to grow double digits again in Q1, with Cotco and LED chip sales in a similar range as Q4.

XLamp shipments are expected to be capacity constrained in the near term as we qualify and ramp up production at our Cotco facility in China.

The Cotco business tends to have a high component of major projects for large outdoor display boards and gaming applications, which can drive sales fluctuations from quarter to quarter.

Although Q1 is targeted to be flat with Q4, our current sales forecast suggests good growth for Cotco products in Q2, due to new outdoor display business, gaming design, and capital projects related to the 2008 Olympics.

We are targeting flat sales in Q1 for LED chips, materials, and contract revenue with a slight increase in high-power devices.

For fiscal 2008, we are glad to be able to continue our long standing strategic relationship with Sumitomo and have entered into agreements to continue Sumitomo's exclusivity with respect to the distribution of both LED chips and wafer products in Japan for fiscal 2008.

The agreements target fiscal 2008 demand to be consistent with their rate of purchase for the last few quarters.

This is consistent with our strategy to maintain our LED chip business in its current range as we drive to grow our components business.

Gross margin is targeted to be 32% on a GAAP basis.

We target non-GAAP gross margins to increase to approximately 33% of revenue.

This target includes 1 percentage point of margin benefit when stock-based compensation are excluded and 1 percentage point of improvement when compared with fiscal Q4, coming from yield improvement activity in LEDs and better factory utilization for our high-power products.

GAAP R&D and SG&A are expected to increase by $1 million to $2 million over GAAP expenses from the prior quarter.

The non-GAAP R&D and SG&A expenses are targeted to be approximately $28 million to $29 million, excluding any noncash stock-based extension.

Interest income is targeted to increase to $3.4 million from higher cash balances.

We are estimating our effective tax rate to be 20%.

Our GAAP EPS targets for the first fiscal quarter of 2008 are expected to be in the range of $0.15 to $0.18 per diluted share when amortization of acquired intangibles, stock-based compensation and any impact from the gain on the sale of securities are included.

As mentioned earlier, our non-GAAP basis EPS targets exclude amortization of acquired intangibles in the amount of $3.5 million or $2.8 million net of tax, noncash stock-based compensation in the amount of $4.2 million or $2.7 million net of tax, and any impact from the gain on the sale of our remaining shares of Color Kinetics.

Based on an estimate 85.7 million diluted shares outstanding, we target our non-GAAP per diluted share in a range of $0.09 to $0.12 for the first quarter of fiscal 2008 as compared to non-GAAP earnings of $0.09 in the fiscal fourth quarter of 2007.

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

Thanks, John.

As we start fiscal 2008, we are focused on several key areas to continue to drive our transformation into a global leader of energy efficient LED components.

Our first priority is to continue to grow our XLamp product sales and enable the LED lighting revolution.

With our introduction of the world's first lighting class power LEDs last October, our customers have started using LEDs in a number of lighting applications that most experts thought were still five years away.

Although the momentum is building, this is generally a pretty slow moving industry and most of our early success is in niche lightning applications, such as personal lightning, emergency vehicles and architectural.

The first commercial LED based lightning fixtures were introduced only a few months ago and they are just now going into production.

Since many of these fixtures are for new projects, there will be a time lag before we can evaluate the real impact the market.

We also need to keep in mind that some of the traditional lightning fixture and bulb companies would prefer that the conversion to LEDs be slower, so that they can continue to sell their older, lower efficiency bulb products as long as possible.

Unfortunately for them, we don't have these constraints and we are moving ahead to enable the conversion to LEDs.

We increased our XLamp LED performance almost 70% in the last year and we still have room for improvement.

With the Cree LED City Initiative we demonstrated that real energy savings and payback are available now.

And those results were based on our older version of XLamp LEDs.

The energy efficiency should only get better with our latest generation of power LED products.

This is just the beginning and although it will take time to change perceptions in the lightning industry, we believe we're well on our way to enabling the LED lighting revolution.

Our second priority is the integration of Cotco.

We got off to a good start in Q4, with strong sales in the China market.

Since the Cotco product line is currently focused on large display boards and gaming, the sales tend to be major project driven and fluctuate from quarter to quarter.

We are focused on reducing some of this variability by expanding both the product offering and the customer base.

We recently launched our XLamp products into the Cotco sales channel for the China market and we're in the process of launching the Cotco products into Cree's sales channels outside of China.

The initial feedback has been quite positive, as Cree is the first company to offer customers a full LED component product line for high performance applications that includes both lighting class power LEDs and traditional high brightness LEDs.

These launches should be fully implemented by end of our fiscal Q1 and we target some incremental sales growth from these activities starting in fiscal Q2.

We are also working to further build the Cree brand across the combined product line.

In the near term, we're using Cotco, a Cree company, as our brand for the China market.

This interim step is designed to leverage the brand strength that Cotco has developed as the premium local supplier in China over the last several years, as we build Cree's brand reputation as an LED component supplier in addition to an LED chip technology and intellectual property leader.

Over the next year, we plan to consolidate all LED products under the Cree brand on a global basis.

Our third priority is to continue to develop our global sales coverage and drive growth with our distribution partners.

We made significant investments in our field sales force over the last year as we started to build a stronger component sales team for Cree.

We have built an exciting sales funnel for fiscal 2008, but we still need to add sales coverage where we have gaps in both Europe and Asia.

We also launched two distribution partnerships, with Arrow Electronics and World Peace Group, over the last several quarters which we need to continue to develop to drive sales across a very large target customer base.

Although most of our sales growth over the last year has come from direct accounts, we are starting to get sales traction with our distributors and target an increasing rate of sales growth from the channel in fiscal 2008.

Our fourth priority is to further expand our manufacturing capabilities in Asia to support increased packaged LED capacity requirements and reduce costs.

Depending on how fast some of the new applications turn on for our XLamp products, we could be facing a capacity crunch over the next few quarters.

To manage the capacity issue and reduce manufacturing costs, we are increasing production at our subcontractor and installing a new production line at our Cotco factory in China for lighting class XLamp products.

We currently target to complete qualification of the new production line this quarter and then start the additional production ramp-up at Cotco in fiscal Q2.

In the interim, we are working to maximize capacity in Durham and at the subcontractor.

Our fifth priority is to continue to develop our power and RF product lines to drive incremental growth in high value energy efficient applications.

We launched a number of products over the last year and we target some of the recent design activity to migrate into production applications during fiscal 2008.

We are working on several channel strategies to access customers and applications, ranging from server power supplies to solar invertor modules to broadband wireless transceivers.

These strategies include direct sales, distribution and a variety of cooperative efforts such as the one we recently announced with NIEC in Japan.

While some of these applications will take several years to develop, it seems clear that our power and RF products will eventually become an enabling technology for energy efficient next generation applications.

The combination of growing XLamp sales, a high brightness packaged LED product line in China and a stable LED chip business has put Cree in a good position for growth as we start fiscal 2008.

We have a broader LED product portfolio and better balance among applications than at any time in our history, with mobile products now accounting for approximately 20% of LED sales.

We will need to continue to manage a variety of challenges related to the integration of Cotco, changing market dynamics, a strong competitive environment and more complex sales channels.

We must continue to build our global sales capabilities and leverage our distributor partnerships around the world.

We believe that the LED business will continue to consolidate over the next several years and we plan to use our strong balance sheet to continue to build scale in terms of customers, technology, and manufacturing capability.

As we look ahead to fiscal Q1, we target continued growth in XLamp LED components, combined with Cotco and LED chip sales similar to Q4, to result in revenue of $110 million to $115 million with non-GAAP earnings per diluted share of $0.09 to $0.12, excluding amortization of intangibles, stock-based compensation expense and the gain we expect to realize on our remaining investment in Color Kinetics.

In summary, the transformation of our LED business is off to a great start.

And we believe we're building a company that can lead the LED lighting revolution.

We will now take analysts' questions.

Your first question comes from the line of Jed Dorsheimer with Canaccord Adams.

Thanks, I actually have a few questions for you today.

I'll try not to hog too much time.

First question, I was wondering, Sumitomo -- did I miss the details of this?

You said that you had resigned it, but I didn't get the details of the size of that.

I know in the past you've given that out.

Actually Jed, we didn't break that out.

What we basically said was is that we signed up Sumitomo again for next year, to continue to be our exclusive supplier and distributor in Japan for both chips and wafers and that the supply agreement calls for or targets purchases in a similar range as basically what we've been shipping for the last few quarters.

So it's pretty much a steady rate from where we exited the year.

As far as what they were for last year, it'll probably be down a little bit year-over-year but very similar to the rate we've been running over the last couple quarters.

All right, was there any shift in customer concentration within Sumitomo?

Not significantly.

I would say that we have -- Sumitomo makes up, still makes up about 20 different customers, but it's really four -- probably three or four, maybe five that make up the bulk of that business.

No significant changes in the last few quarters.

All right, and then the Cotco business, I was wondering, what is the exposure to -- you mentioned, or John actually mentioned the fact that the digital billboards are driving that business, and I assume that is primarily with Lighthouse.

I was wondering, what percentage of concentration in Cotco is indeed Lighthouse?

I don't have the breakdown of how much is Lighthouse, but I can actually tell you that they do more business for the sign board market, significantly more not with Lighthouse than with Lighthouse.

So they are one of their customers, but I don't believe they're even, I know their sign board business is far larger than that.

So they're a piece of the channel, but not the whole one out there.

It's interesting, although digital billboards are a part of it, there's still a lot of general purpose applications.

One of the things we're seeing, Jed, is that there's a lot of activities still, for things -- traditional video, replay boards and things like that, especially in Asia for basically capital infrastructure that wasn't in place previously and directly related to the Olympics.

All right, and then question, John on the $3.5 million write-off to get to the as adjusted in the cost of goods, I understand the options expense and actually writing that off, the $542,000.

But could you help me, just the thought process, the methodology as to why that would lower the cost of goods?

$3 million.

Yes.

The $3 million what it is is that under FAS 141, when you do acquisition accounting what you need to do is you need to value the inventory at basically the price you're going to sell it at less a profit on the selling expenses.

So we were required to do, with that accounting principle is to write up that inventory, and what we did is we backed off the $3 million of the finished goods and so you get a comparable margin from quarter to quarter.

It's just an acquisition accounting thing that is not going to be there quarter after quarter, so we thought the best thing to do was give you comparable numbers.

Sure, so if you sell that -- so are you writing off the inventory?

No it's not a write-off.

It's a writing up of the inventory to a lot higher value than what is cost us to manufacturer it.

So basically when you sell it you essentially get almost no margin on it.

That's part of the purchase accounting.

Got you and then--

Paragraph 37.

I could go through it with you at some point if you want.

No no, I read the footnote, I was just trying to -- I thought you were writing it off and it didn't make sense to me how that would actually lower the cost of goods--

No we understand.

It didn't make a lot of sense to some of us non-accountants as well.

And then just on the balance sheet, accounts receivable, you took a pretty good step up.

I was wondering, how much is organic and how much is inorganic related to the acquisition from that $18 million bump-up.

Almost all of it is related to the acquisition of Cotco.

All right.

I'm going to jump back in line here and let some other people ask, thank you.

Already, Jed.

Your next question comes from the line of Andrew Huang with American Technology Research.

I have two questions.

First I think a lot bears are focusing on you potentially losing customers on the chip side of the business, but I was wondering if you could give us some color or update on your customers on the packaged LED side of the business?

When you say on the package side, we're -- in terms of Cotco business or lightning business or both?

Cotco and XLamp.

On the Cotco side of the business, it's a fairly large array of customers.

The two biggest applications are the big video display boards.

And I would say, I don't have the sales numbers in front of us, but that's probably about ten major customers they sell to for the video display market.

And then you have gaming applications that makes up another -- that's another handful of customers.

So that's kind of what's driving Cotco.

They also have some amount of business for -- they have their own personal lightning products, they have some products for automotive and just kind of a wide variety of other general purpose LED applications.

That's kind of the Cotco product line.

As far as the lightning side of the business goes, that ranges everything from flashlight makers, to, I think people have seen our various press releases about different people using our LEDs for personal lightning.

We have architectural lighting customers.

So everything from what Color Kinetics does to much more simple type designs, from simpler ones to also more customized ones.

We have emergency vehicles, pool and spa lightning.

So it's really a diverse group of customers.

I would say that as we go more into components and packaging, we're actually increasing the customer number by a lot, probably by a couple orders of magnitude is what's happening right now.

So it tends to be very diverse, very quickly.

So I don't know if this is a fair question, but can you quantify the number of XLamp customers you have in the June quarter versus let's say two quarters ago in the December quarter?

So in terms, so one of the challenges is is that we now have significantly more customers through distribution and I don't actually have their numbers there.

I would say it's far more than doubled, but it could as much -- I mean, it could be 4X but I don't have those in front of me.

Because what's happening is there's a lot of new customers in the small to midsize category coming online through distribution.

Got it.

Next question is on the revenue guidance.

Sure.

It looks like, excluding the LED revenue, everything is going to be kind of flattish sequentially, except for maybe high-power.

Can you give a feel for why would -- I mean, what kind of revenue growth you're expecting for the LED side of the business?

Yes, the way to think about it is we came in at 111, and essentially, just to make it simple, although we're targeting a little bit of growth in high-power, that's not a significant number if you think about the size of the business, so it's really what's going on in LEDs.

Essentially, chips in Cotco we're targeting to be essentially roughly flat with the previous quarter and we're targeting some growth in XLamp.

Obviously, there's always some risk in those numbers so we give you a range, but that's why effectively going from 111 and giving you a range that moves the center of that upwards.

The other challenge we have in the short-term is that we are going to have some limitations this quarter on the XLamp side of the business and that's just due to the capacity constraints we talked about earlier.

So we're doing everything we can in the short-term.

But we won't have the additional Cotco capacity online until the next quarter.

So until then, we're going to be a little bit limited there.

So we've basically got flat chips in Cotco roughly and then you've got some growth in XLamp.

And that's how you get there.

Okay, great.

One last question for John if you don't mind.

I think you mentioned this in the call in your prepared remarks, but I missed it.

So just to help reconcile the difference between the GAAP and non-GAAP EPS guidance for the September quarter, how much are you expected get out of the sale from the Color Kinetic shares.

The gain on that is like $17 million or $9.9 million after tax or $0.11.

Thank you very much.

Sure.

(OPERATOR INSTRUCTIONS) Your next question comes from Amit Kapur with Piper Jaffray.

Great.

Thank a lot guys.

We've seen recently some more positive commentary coming out of Taiwan and (inaudible) LED backlighting in notebook computers.

Maybe can you talk about what the time table is that you're expecting and any OEMs you see out there that are more aggressive in adopting LEDs.

What we've seen is there's pretty much a program and we were kind of talking a little bit about this last quarter, but we've now seen the announcements come out.

All the major notebook computer makers, at least the U.S.

ones, have announced programs.

Obviously you've got Apple out there talking a lot about it, but also we've seen models come out from Dell and HP and those, at least they've been announced.

So I think there's generally a feeling that there's some momentum picking up on that side of the business.

Clearly that's a good thing.

It's a little hard to give an estimate on the uptake.

Because I think right now we're in that very early stage.

I think there's a lot of optimism.

I don't disagree with them.

What that means for us is that's really a chip business opportunity for us.

We do know that we have packaging customers that have indicated to us they have chips designed into some notebooks that are either out there are or coming out, and we're continuing to push that from a chip sales strategy for us.

So that kind of fits into our market where we've been going and that's how we want to attack that piece.

Okay.

So would it be fair to say maybe early to mid-2008 we'll probably see more traction in that market.

I think you're going to see incremental traction here over the next couple quarters.

I think the thing you have to keep in mind for us is we're not trying to drive significant revenue growth in the LED chip segment side of the business.

For us, LED chips, we're really trying to manage that business into a similar range as it has been the last quarter or so and really try to improve the quality of that business, I think focus on our partners where we can have a lot of value and then really drive growth through the component strategy and that's a combination of XLamp and Cotco.

In the short-term, we have to work through capacity issues on XLamp and with Cotco, that business is going to vary from quarter to quarter.

Keep in mind, that although I think we have a flat target for Q1, John indicated earlier that the sales funnel is looking pretty good for Q2.

And that just looks like the timing of different things.

So really the thinking is keep the chip business about where it's at today or in that range from external revenue.

And although the chip business will grow, it will grow to supply these component businesses internally.

Great that feeds into my next question, in terms of how should we think of gross margins going forward?

You talk about potential capacity constraints with XLamp coming up, looks like gross margins are still a little bit under pressure.

Is it a matter of industry pricing turning around or are there steps you're taking to improve your structure and in terms of some of the capacity that you're shipping out to your subcontractor, what impact should we expect on gross margins?

The way to think about that in short-term is is I think the LED chip business is relatively stable right now.

I think both pricing and cost trends are kind of in line with what we expected, no significant gains or losses one way or another there, it's facial stable.

I think when you get into the packaging businesses, realize that we are still introducing new products at an incredibly high rate.

So we're making progress on the XLamps we introduced six months ago, but we keep introducing new ones.

And so we're kind of in a -- right now, in a curve of ramping up a lot of products at the same time.

I think once we get out a few quarters and can get the XLamp business, really get the capacity into Asia specifically at Cotco, I think we can make some more head room, or some more headway there.

And that's really kind of the strategy to drive is.

So the way to think about it is we kind of -- I think our target for next quarter, if you go through all the numbers, is about, gross margins up on a company wide basis, about 1 percentage point.

So I think we're seeing a little bit of improvement there, looking at that from a yield standpoint and then as the business -- if we continue to get some sales growth traction, that should then drive it really in the second half the year.

Maybe one more question before turning it over.

More for you John, in terms of the inventory increase, what kind of drove that?

Is that mainly Cotco, what was the mix of finished goods in that overall number?

And then where would you like to see the inventory days trend in the long run?

In total, the majority of the inventory increase was in Cotco.

We had about $1 million dollars of inventory increase in the U.S.

out of our, our regular inventories and what we're seeing is that the finished goods inventory increased about $10 million quarter-over-quarter.

Our targets -- right now we're at 81 days of inventory.

We want to get that back down into the low 70s and as we integrate Cotco and get the processes in place, we think between there and here, we should be able to get that back down there by the end of the year, end of the fiscal year.

Great, thanks guys.

Sure.

Your next question comes from Harsh Kumar with Morgan Keegan.

Couple of questions.

First of all, I think you mentioned XLamp and Cotco are sort of capacity constrained, is there revenue that you're leaving behind on the table?

So XLamp and Cotco -- XLamp is capacity constrained, Cotco is not.

So what Cotco's role in XLamp is is we are building a new production line, theyr'e actually installing it now.

SO Cotco will bottom a major part of the production plan for the XLamp product line.

So the Cotco, traditional Cotco products aren't capacity constrained.

But the XLamp ones are.

Are we leaving orders on the table?

The answer is yes.

There are some deals -- we can't necessarily take everything that's coming our way right now.

I would say though that I think the industry in general is willing to accept some lead time.

So I think we're -- I don't think we're going to miss a lot right now.

I think we're doing everything possible to make sure that the customers that are working on longer lead time designs, we're trying to make sure we service them.

So next question is, can you just help us out with maybe the LED?

I know you said LED prices are stable.

I'm trying to understand, with XLamp growing and us being in sort of a seasonally strong handset timeframe, and I know that's diminished as a part of your business, with the ASP being sort of stable, how come you're having trouble growing on a sequential business despite the (inaudible) position.

You might have maybe misunderstood what I said or maybe I didn't say it clearly, Harsh, I said the margins were stable.

We're seeing LED pricing continuing to move in a fairly traditional range.

I would say, if I had to guess right now, based on the first six months of the calendar year, the LED chip business is moving at about the 25% ASP erosions a year, which is kind of the traditional level.

And cost reductions are kind of tracking.

So I don't know that's any one way.

I think what the difference in the LED business is is that up until the last couple quarters, that was moving a lot faster than that.

So I would classify the margins in chips as relatively stable.

I wouldn't necessarily classify the pricing as stable.

Fair enough.

That's actually very helpful.

You talked a little about Color Kinetics getting bought out earlier, I see you guys are sort of having some sort of -- basically having gaining technology, the only public company here in the U.S.

which does what it does very well.

Have you been, and I know you would be limited about what you can say about this, have you been approached by anybody, buyers and such.

Harsh, I couldn't -- even if we were, I could not comment on that on the call.

What I can tell you is that if you want my view on what does Color Kinetics mean for Cree, I think it does a couple things.

It's obviously a nice, at a very tactical level, it's a nice gain on our investment.

I think more importantly though, I think what Phillips has done is really raise the bar for LED and solid state lightning.

I mean here's a major player in the lightning industry and they're making a big bet that LEDs are a part of it.

So I think for all the skeptics that are out there, they're saying LED lighting may not be real or anything like that, well they must know something more that Phillips does.

Because Phillips has spent in the last year close to a $1 billion trying to make a play in this market.

So I think it's a good statement for the overall market.

The other thing it does, Harsh, and maybe most of you don't realize this is that it does put Cree in a pretty good position in terms of really reaffirming that we're really only one of the independent suppliers of lighting class LEDs.

And I think that can actually help us on the sales and marketing front in the year ahead.

Great, I knew you couldn't really answer that, but we still had to try.

Just an observation.

I think the data you guys used to provide in the past with LED breakdown and stuff of that nature was really helpful, is there any chance you guys would give us more -- help us better with our analysis?

Well, I think, one of the challenges you have to realize is is that our business is a lot different than it was a year ago.

We now have a significant portion of our businesses is XLamp and high brightness LEDs that are made at Cotco.

So I think the mix is so different, that those trends don't make a whole lot of sense.

I think we'll evaluate as we go forward over the next few quarters, is there's other things that may or may not make sense.

I think right now those trends are just, they're so irrelevant on a historical basis given the fact that our mix of our business is completely different now.

Got it, thanks guys.

Sure.

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

Hi guys, sorry if I missed it in the beginning, but did you break out what Cotco contributed in the quarter and what it is for your guidance for next quarter?

No we didn't break it out.

What I can tell you Mike, though, is it represents the vast majority of the growth.

Basically our revenue growth last quarter was Cotco plus some incremental growth from the XLamp business, which grew double digits again, chips were stable and then we had a decline which you can get from the metrics in some of the other product areas.

That's kind of how it shakes out.

We didn't break it out.

I can tell you that it's running pretty much in line with the rate as when bought it.

So it's kind of tracking to what we thought when we acquired -- when we made the announcement a quarter ago.

So no change to the guidance of (inaudible) for fiscal 08?

No.

We're pretty much looking at it at the level we provided the targets before.

I'll be honest with you, we're still learning.

I think that we have a pretty exciting sales channel there in China.

And I think the combination of two product lines, we're hoping there's more we can do.

But for right now, I think it'd be premature to change the targets we provided in the past.

Okay and you used to break out what your high brightness was, the mid-bright, the reason I'm asking, wondering if there was a mix shift within your chip sales at all or did you stay consistent with 48, 52?

I don't have the break out in front of me, but I don't know there was any significant shift, what you realize though, if you look at LED sales, there's been a significant shift in that a lot of it isn't chips anymore.

So it's obviously -- what we used to worry about in terms of high bright and mid-bright has significantly changed, given the fact we have XLamp on one side and Cotco, which has mix of both high and mid-bright products on their side.

I think that we're in a new period of time for Cree, we're selling -- our LED product line is much broader and much different group of customers than we had in the past.

It's changed a lot.

Okay and you did say that ASPs were relatively normal.

Did you provide an ASP number for the quarter?

No we didn't.

No because the challenge you've got now is that the LED number includes more XLamp and Cotco products.

So you have got basically three different levels of ASPs that -- the trend on a blended basis just doesn't make a lot of sense.

Because the mix is changing faster than the trend.

Okay.

And then outside of, so you gave mobile at 20%, could you perhaps help us with some of your other end markets and perhaps touch on an earlier question, of where we are for back lightning?

Sure, yep.

So I think in terms of markets that we're servicing today, I think on a blended basis, the top markets are going to be lighting, they're going to be gaming, they're going to be the large screen business and then probably after that, it's going to be mobile.

Those would be the top four.

There's going to be some automotive in there and some other smaller applications.

And backlighting, in terms of the notebook side of it, is just starting to gain some traction.

So there some winds there, but it's just starting to come up the curve.

And that's kind of how I'd put them.

So we kind of have four big applications and some -- with probably lighting growing the most on the high-power side and probably mobile is -- or not mobile but the notebook backlighting is probably the one with the -- that's the one I think everyone's pretty excited about.

We're seeing some of that as well, I think it's a little early to call exactly how much traction that's going to get.

Okay thanks.

And lastly I guess 10% customers and what percent of sales was Sumitomo in fiscal '07?

I'm going to ask John if he has got that handy here.

I don't have that in front of me.

So he's looking for the 10% customers for the year.

I don't have the whole list with me.

So that obviously, we'll have that out in a week or two in the K.

I don't have it in front of me right here right now.

Sorry about that.

Okay, thanks.

Sure

Your next question comes from Hans Mosesmann with Raymond James.

Thanks.

I have a few questions.

In terms of the metrics, there's a lot of things that you're taking out and I'm not sure that I understand at least for the June quarter why you wouldn't split out LED units from the core Cree business, since most of the analysts were modelling kind of like certain trend lines and you gave an outlook that was consistent with some assumptions there and you're also splitting out stock option compensation expense.

I want to understand why you're doing that all of a sudden.

I'll take a shot at these and maybe John can jump in.

I think on the LED business, I think the main thing we were doing is is that there's been a tremendous shift in terms of our LED business is really you know an integrated business now.

So to give you an example, we have chip sales that at a quarter ago that were calls chip sales, that this quarter we don't call chip sales.

They're eliminated, because Cotco is an internal customer.

We have a growing high-power packaged LED business, which is higher ASP, lower units, and then we have Cotco itself which adds a different level to the mix.

And so as we looked at all that, it just didn't -- the trend of Cree with the LED chip business, that was reasonable through March has changed dramatically.

So we felt like this was -- those trends weren't applicable.

And we decided that -- didn't think it was value add to sit around and explain things that didn't link to the past.

Understand that it's different.

And we think this makes more sense going forward.

As far as stock comp expense, really that was a function of a couple quarters worth of research.

And although I was in on a few of the conversations, that was mostly led by John and Raiford and when we went through and did a review of the companies that most of our analysts followed and most investors were comparing us to in the peer groups, I think with we found in nine out of ten cases almost all of them were excluding stock compensation expense from the numbers that they were using.

It seemed to be more a little bit more confusing to have Cree include it and everyone else exclude it.

So that's why we decided to make a change.

It was a result of a lot of people's inputs and so we decided to go for it.

Obviously, we break it out so you can see it either way, but we thought it was more appropriate to be in line with how most of the other companies are being looked at, at least in our peer group.

Okay, and then as a follow-up, what was the run rate of Sumitomo over the past several quarters?

I didn't catch that, maybe the others did.

But I'm not familiar with what the quarterly run rate was for Sumitomo over the past several quarters?

We don't break that out.

All I was trying to do, and we obviously didn't give out the specific terms going forward, what we really try to provide is more of a qualitative look at how the business is.

And so the business was running at a pretty high rate as we went into last year and obviously we talked a lot about, over the many quarters, how the business slowed way down on us.

The real message we're trying to get out is that, as we exited the year, the rate of the last couple quarters is kind of the rate going forward.

I don't believe we break them out on a quarterly basis.

I know we will be breaking them out coming up in the K, we'll be giving out what the numbers were for the year.

I don't know if we have those handy right now or not, but --

The number for the total year for Sumitomo was approximately $96 million.

Yes so, and the exact number we'll have the K, but so that was a little bit front-end loaded.

So that gives kind of gives you some sense of where that's at.

One last question and I'll leave it to the others.

There was noise coming onto Nichia early in the quarter, regarding potentially halting Cotco shipments into customers there, what's the outcome of that, if any, and what's the legal issues here, the challenges that you may have there in Japan?

So you know when we first made the announcement of acquisition of Cotco, we obviously had discussions and then shortly after the deal closed there was an announcement in Japan that Nichia had actually filed a law suit that was since -- that law suit was pulled and has gone away.

I'm not at liberty to discuss the nature of it but I can tell you that everything is happy again in the world of cross licensing partners between Cree and Nichia.

I think the good news is for us, frankly, I think it reaffirms our position and it does rehighlight the pressure that are on the people that don't have the IP in the marketplace, at least for certain markets.

I think we all know there's some low-end commodity markets where it doesn't matter.

But it's clear that Nichia still intends to hold people to -- hold their feet to the fire when it comes to markets where they think they have a good position.

But as far as Cree and Cotco goes, that's all been resolved, it's a non-issue at this point.

One quick follow-up.

I forgot to ask.

What's the stock options expense guidance for the September quarter?

I'm going to let John give you that one, Hans.

There's an option expense, above the line is $4.2 million in total and after tax it is 2.7.

Great, thank you.

Sure.

You have a follow-up question from Jed Dorsheimer with Canaccord Adams.

Hi thanks.

A couple actually.

I thought they'd probably be asked, but they weren't.

First, I mean, I'm glad you guys are definitely going down the path for the general illumination as we do believe it's going to be a pretty significant market, however, I am having trouble reconciling some of these numbers and I was wondering if you could help me.

If I look at Cotco as sort of $100 million run rate.

taking out the $25 million that was basically sales to Cree, I get quarterly about $17.5 million, maybe call it $20 million for the quarter.

So I'm wondering then, if mobile is now down at 20%, from a contribution perspective, your gross margins though continue to decline.

So that would imply that the actual core chip business has compressed or that as you move to these larger size XLamp LEDs, is there a yield issue going on?

I was wondering if you just could provide some perspective on that, thanks.

Yes, so a couple things, Jed.

Let me see if I can get you back to what's going on with the margins.

So what I can tell you is the core chip margins were actually pretty stable quarter-over-quarter.

What I can also say, is that within XLamp there's definitely room for improvement.

We made progress, we made significant progress on the XLamp products that were released six months ago in terms of the pool light products.

We also launched an entire new product line.

So what' happening is, we're making progress and starting new ramp-ups at the same time.

So we're not getting as much traction there as quickly as we can.

I don't think there's long-term concerns there, but I do think it's just the nature of trying to ramp up so many new products at one time.

The other thing to keep in mind is that our margins also took a hit because of the advanced device products, what we call the high-power products.

So remember, that's essentially a fixed cost of business and the revenue went down about 50% quarter-over-quarter.

So that's going to put fairly significant pressure on what happened there on that side of the business.

So really got a couple things working against us.

But in terms of -- Cotco margin's pretty much in line, I would say chip margin's in line, XLamp a little below, but not unexpected, given that that's mostly related to the brand new products we're ramping up and then you have the high-power products pushing it down, probably the single biggest factor.

That's very helpful.

Thank you, Chuck.

The -- John, in terms of Cotco, if Cotco was in for the whole quarter and the jump in the AR was from the Cotco, are the terms different?

Because we've dealt with a few other Chinese companies, I'm wondering do we need to get used to sort of 120-day or 100-plus day type of receivables on the Chinese business, as that business ramps?

I don't think you're going to have -- we're going to see it extended out that long.

Because we have larger products and you tend to get paid better because you're not dealing with as small of a customer, but typically it is just a little bit higher over there.

We expect to be running instead in the 50s and low 60s probably in the mid-60s for the near future here.

Got you and so -- actually Chuck, the lawsuit that Hans was asking about, that's the Sterling lawsuit, it's been resolved?

Yep, gone.

And lastly as the market is moving towards surface emission devices and the use of vertical gan structure, clearly there's some benefits with improving the external quantum efficiency and actual extraction ability of the photons and also improving the thermal resistivity.

I was wondering, on the silicon carbide side, are you going down the same path as well or can you give us any indication of what you have planned for -- to go against a fully ablated pure RP substrate?

I think if you look real close as to what we're doing right now, I think the EZBright chip technology that we launched is a classic vertical structure.

If anything, we probably, between the Osram Thin-Gan and the Cree EZBright, we kind of pushed this idea forward before most other people.

Remember that what we're doing there is, is we essentially remove the substrate as part of that process and so what we have then is a vertical emitter designed to operate that way.

Are there other ideas and tricks coming?

Absolutely, I can assure you that our R&D guys and I'm sure everyone's R&D guys have a lot of reasons to spend money over the next few years to try to continue to improve that.

I think we have some ideas right now.

That's why our R&D results are ahead of where we're at in production.

That being said, I think there's more to be learned.

So there is more coming, we have various things we're doing, but keep in mind, that we're essentially already in the business of using a substrate to grow the best (inaudible) possible and then engineering a chip structure to maximize it for the application.

I think we're already there, just in terms of Cree being on that bandwagon, I would put ourselves frankly as one of the leaders of the bandwagon, but we also have a lot of work to go.

I think there's just lots of innovation left.

That's helpful and last question, what do you think the optimal size of the LED chip is for lighting applications?

It varies from I think from -- I think you're going to see it vary from as big as a couple millimeters squared to as small as a couple hundred microns square.

I think what we're going to find is that lightning is not an application, it's a collection of hundreds of applications and that, depending on what people are doing, there's going to be different optimizations for different applications.

When we say lighting today, it's mostly a power LED business.

And I think a lot of the mainstream applications are going down the power LED path.

That being said, we're still seeing new ideas for some of the smaller chip applications in different packages, so I think it's way too early to call.

Thank you.

Sure

You have a follow-up question from Andrew Huang with American Technology Research.

Thank you, first a clarification on the gross margin.

If I look at the June quarter and I exclude the inventory adjustment from Cotco, was your GAAP gross margin for the quarter, 31.3%?

In there as well, there's the option expense.

I guess my point is that in the March quarter you were including options.

Yes that's right.

I think you got that right.

So then if I look at your September guidance in your prepared remarks, you said the GAAP gross margin for the overall business should be 32% correct?

The non-GAAP should be 32.

If you're doing a comparison, essentially what we're trying to tell you assuming the numbers all work out, we're looking for about a 1 point margin improvement quarter-over-quarter, all things equal.

Got it, that's what I thought.

And secondly, Chuck I was wondering if you'd give us your view of how the LED lighting adoption is taking place right now.

Just your kind of 30,000 foot view would be much appreciated.

Look, it's been an interesting year.

I think that you go back a year ago, and there's applications that people are working on today that they flat out weren't looking at a year ago.

I think the best example is the stuff that's connected with the LED City, whether it be a parking lot, parking garage, street lightning.

And a good example of that is the stuff we saw at the lighting trade show here this last spring.

So I think you're starting to see those products come on the market.

But as I said earlier, there's a time lag in terms of new product announcements, ramping them up into production and getting them design in.

And so I think we're going to see more as we go forward and it's a little early to call but I think we're on the right track.

The other application we're seeing is the down light market, there's company's like LED light fixtures.

Those guys are out there putting out a product that, I'll be honest with you, I've seen other companies who don't think what they're doing is possible.

And the reality is, it is.

And so I think the LEDs we're putting out now are really starting to change some perceptions.

But it's early.

And I think it's hard for anyone to put an exact trajectory on this, other than to say the signs are positives and the combination of what we're doing technically, getting the awareness up in the industry generally and Phillips and guys like that are certainly helping, and then the fact is there's a whole legislative angle that continues to reinforce that energy efficiency and environmental efficiency are going to matter.

And I think we're in the early stages of that.

As I look at LED lightning, I don't think there's -- I don't run into many people whether they're in LEDs today or they're in traditional lighting who don't think it's going to happen.

But again, it's a big slow industry and it's a lot of blocking and tackling ahead of us.

Got it.

Thanks for the commentary.

Sure

At this time there are no further questions.

Are there any closing remarks?

Yes.

Thank you.

We appreciate your interest and support and look forward to reporting our first quarter of fiscal year 2008 results on October 18th, 2007.

Thank you.

This concludes today's conference call.

You may now disconnect.