Wolfspeed Inc (WOLF) 2008 Q2 法說會逐字稿

Good afternoon.

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

At this time, I would like to welcome everyone to the Cree Incorporated second quarter 2008 fiscal year financial results conference call.

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

After the speakers remarks, there will be a question and answer period.

(OPERATOR INSTRUCTIONS) As a reminder, ladies and gentlemen, this conference is being recorded today, Tuesday, January 22, 2008.

Thank you.

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

Mr.

Garrabrant, you may begin the conference.

Thank you LaTonya.

Good afternoon.

Welcome to Cree's second quarter fiscal 2008 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 919-287-7895, 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 second quarter of fiscal year 2008.

Please note that we will be presenting both GAAP and nonGAAP financial results in our remarks today during today's call, which are reconciled in our press release which is posted in the Investor Relations section of our website at www.cree.com under financial metrics quarter ending December 30, 2007.

Today's 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 for revenue, gross margin and earnings, plans for new products, and other forward-looking statements indicated by words like anticipate, expect, target, and estimate.

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

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

Also we would like to note that we will be limiting our comments regarding second quarter of fiscal year 2008, to a discussion of the information included in our earnings release, and the metrics posted on our website.

We will not be able to answer any questions that would involve providing additional financial information about the quarter, beyond the comments made in the prepared remarks.

This call is being recorded on behalf of the Company.

The presentations and the recording of this call are copyrighted property of the Company, and no other recording or reproduction is permitted unless authorized by the Company in writing.

Consistent with our previous conference calls, we are requesting that only sell-side analysts ask questions during the Q&A session.

Also as we plan to complete the call in the allotted time of one hour, we recognize that others may have additional questions, and we welcome you to contact us after the call by E-mail, or phone at 919-287-7895.

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

The replay of the webcast will be available on our website through February 5, 2008.

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

Thank you Raiford.

We had a strong second quarter, as revenues increased to a record $119 million, with GAAP earnings of $6.6 million, or $0.08 per diluted share, and nonGAAP earnings of $12.2 million, or $0.14 per diluted share.

Both revenue and earnings came in at the high end of the target range for the quarter.

Gross margin increased to 35% in Q2, which exceeded our target range, due to yield improvements across several product lines, higher factory utilization in Durham, and increased production in China.

The revenue growth was driven by higher LED sales, r where both XLamp orders and shipments increased by double digits, as we made good progress addressing the XLamp capacity bottlenecks, and bringing on line additional capacity in China.

LED chips and Cotco sales remain solid, in-line with both our targets, and the previous quarter.

Our power and RF products grew sequentially in Q2, which offset lower sales for our silicone carbide materials products.

Overall, we continued to be successful during the second quarter in executing our strategy, to increase sales by growing our LED component product lines, while maintaining the current line of LED chip sales.

As we look ahead, we continue to target growth in our LED business, due to increased component sales, driven by the growing number of LED lighting applications.

Over the last quarter, the global momentum for sustainable energy efficient lighting products, has continued to build with the passage of a new Energy Bill, that will require the use of more efficient lighting technologies by 2012.

This legislation is important, and it will force the lighting industry, which has been relatively slow to adopt new technologies in the past to change.

Although the momentum continues to build, we are still in the early stages of adoption.

Until our lighting class LEDs were released 15 months ago, LED-based general lighting was simply not practical.

These LEDs enabled a few leading companies to release the first commercially-viable LED lighting products to the market last summer.

These products have now validated that LEd lighting is real, for both indoor downlights and outdoor parking and street lights.

We expect the success of these first installations to spawn a wave of new products this spring, from a larger number of the more traditional lighting suppliers.

This should expand the choices available for the end customer, and further accelerate the adoption of LED lighting technology.

We target that the cycle of new products will continue to fuel the growth of our LED product lines over the next several years.

I will turn the call over to John Kurtzweil, to review our second quarter financial results and our targets for Q3.

Thank you, Chuck.

For the second quarter of fiscal 2008, we reported revenue of $119 million, with GAAP net income of $6.6 million, or $0.08 per diluted share, which includes 5.6 million of net expense, or $0.06 per diluted share, from the amortization of acquired intangibles, stock based compensation expense, and a one-time property tax gain in D&A.

On a nonGAAP basis adjusted to exclude these items, net income for the second quarter was $12.2 million, or $0.14 per diluted share.

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

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

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

As Raiford mentioned at the beginning of the call, for a reconciliation of the nonGAAP information for all quarters mentioned on this call, are posted on our website.

Overall LED revenue increased 6% to $98.9 million in Q2, as compared to $93.4 million in Q1.

XLamp product line sales increased double- digits during the quarter, as we made significant progress increasing capacity.

LED chip sales and Cotco high brightness revenue were similar to Q1, and in our targeted range.

Q2 materials revenue which includes wafers and gemstone products was $7.5 million, or 6% of sales.

High powered products revenue, which include Schottky diodes and wide-band gap microwave sales, grew double digits to $4.8 million, or 4% of revenue.

Contract revenue was 7.7 million, or 6% of revenue for Q2.

Q2 GAAP gross margin was 35%, which included stock based compensation of $0.7 million, or less than 1 point of margin.

Overall, this is a 400 basis point improvement over the first quarter, due to better factory utilization, to support higher demand for our internal components growth, the initial contribution from a portion of XLamp production in our factory in China, yield improvements, and the transition of our power products to 100 millimeter wafers.

Included in gross margin is approximately 150 basis points, related to the inventory build above our forecast during the quarter, and we do not expect to occur in the third fiscal quarter.

This should provide you some indication of the potential cost leverage, as we continue to grow the business.

GAAP R&D expenses were $14.9 million in Q2, and included stock-based compensation expenses of $1 million.

Total R&D expenses were as expected.

GAAP SG&A expenses were $18.2 million for the second fiscal quarter, and included $2.2 million of stock-based compensation expense, and a one-time gain of $0.7 million related to a property tax audit.

NonGAAP SG&A expenses were $16.7 million, as compared to 15 million nonGAAP SG&A in Q1.

This increase primarily reflects the planned spending to increase the size of the sales force, patent related litigation expenses, and an extra week of expenses.

As Q2 was a 14-week quarter versus our standard 13-week quarter.

As a note, Q3 and Q4 will both will 13-week quarters.

Also during the quarter, we recorded $4 million of charges for amortization of acquired intangibles, which we do not include in our GAAP results, and $0.5 million of obsolete asset write-offs, which we do include in our nonGAAP financials.

Net interest income of $4.5 million increased from Q1, as a result of the increased cash balances, resulting primarily from our higher cash flow from operations, and the extra week of interest.

GAAP income tax expense for the quarter was $2.1 million for an effective tax rate of 24%, which is also our targeted tax rate for the balance of the year.

Our balance sheet has continued to strengthen with cash, short-term and long-term investments of $362 million as of the end of Q2, an increase of $29.5 million from Q1.

Cash flow from operations was $35.1 million, and capital expenditures were $9.9 million for a free cash flow of 25.2 million during the quarter.

As I mentioned last quarter, we plan to increase our targeted capital expenditures to a range of 45 to $50 million.

Accounts receivable were $90.5 million at the quarter end, an increase of $4.5 million from Q1, which is primarily related to an increase in revenues.

Our Days Sales Outstanding were flat at 68.

We targeted the Day Sales to stay in a similar range going forward, with a growth in receivables to match our growing revenue.

Inventory was $75.1 million at quarter end, an increase of 10.3 million from Q1.

Our days of inventory rose to 88, and inventory turns were 4.1.

The increase in inventory was primarily due to higher than expected yields, and we also utilized the extra production week to add work in process inventory for our component lines, to support the targeted growth over the next two quarters.

We are targeting our inventory to be flat for Q3, which would decrease our days of inventory, and increase our inventory turns.

Now I will give you an update regarding our outlook for what is typically a seasonally slower fiscal third quarter which ends on March 30th.

We are targeting revenue to increase to a range of 120 to $125 million dollars, primarily due to higher LED sales.

XLamp product revenue is targeted to grow double digits once again.

The Cotco High Brightness product line is targeted to be in a similar range with Q2, and the LED chip revenue is also targeted to be similar to last quarter, and in-line with our planned range.

Targeted increase sales of high powered products, which include our silicone carbide Schottky diodes and RF products, is expected to mostly offset lower sales of gem stone materials, and lower contracts revenue.

Gross margin is targeted to be in a range of 34 to 36% on a GAAP and nonGAAP basis, with approximately $700,000 of stock-based compensation.

This target includes continued yield gains in LEDs, increased XLamp production in Asia, and a slight increase in expense from the initial ramp-up of 100-millimeter wafers in our LED chip fabs.

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

This increase is primarily due to the nonrecurring property tax gains in the fiscal second quarter.

On a nonGAAP basis, R&D and SG&A are targeted to remain flat, and as a remainder, nonGAAP expenses exclude noncash stock-based compensation expense of approximately $3.1 million, and amortization of intangibles of approximately $4 million.

Interest income is targeted to be flat at $4.5 million, based on an increase in our cash balances, being offset by lower yielding investments, due to lower interest rates.

We are estimating our effective tax rate to be 24%.

Based on an estimated 87.3 million diluted shares outstanding, our GAAP EPS target for the third fiscal quarter of 2008 is expected to be in a range of $0.07 to $0.09 per diluted share, when amortization of acquired intangibles, and stock-based compensation are included.

We target nonGAAP earnings per diluted share in a range of $0.14 to $0.16 for the third fiscal quarter of 2008.

Our nonGAAP basis EPS targets exclude amortization of acquired intangibles in the amount of $0.04 per share, and noncash stock-based compensation in the amount of $0.03.

Thank you.

I will now turn the discussion back to Chuck.

Thanks John.

We remain focused on five key areas that 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.

We continue to make good progress in this area in the second quarter.

Orders and shipments for XLamp products grew double digits, and our distributors continue to report growing numbers of new business opportunities related to LED lighting.

We had good execution on our capacity ramp-up in Q2, and we exited the quarter with significantly higher production output, and an improved the ability to meet near term customer requirements.

We drove continued industry momentum as Ann Arbor joined the LED city initiative in early Q2.

We launched the first phase of our LED workplace, to promote the use of LED lighting to help meet the sustainability initiative across the commercial sector.

We target double digit order and shipment growth for this product line again in Q3.

Our second priority is the integration of Cotco.

Many of the integration items have been completed, and we are starting to operate as a global company.

We are in the process of transitioning the Cotco brand in China to Cree, which should be complete by the end of our fiscal year.

As we make this transition, we will start to refer to the Cotco product line, as High Brightness components instead.

High brightness Component sales in Q2 were in-line with Q1, despite lower sales pertaining to the application.

Our largest market for High Brightness components remains large video screens for the China market.

We are focused on expanding our sales and marketing activities, to serve a broader range of applications, and a more global customer base.

We target a similar level of High Brightness sales in Q3, despite a shorter sales and quarter production in China, due to the Chinese New Year Holiday.

We continue to work with our key packaging partners, and some of the major systems companies, to provide our new high performance small LED chips for backlighting applications.

This is a growing segment of our LED chip business, and has enabled us to shift some of our production away from the low priced mobile product, to new higher value chip products.

As a result our external chip demand has remained stable and in-line with past quarters, but we have been able to improve our margins to a more favorable product mix, and higher factory utilization from increased internal customer demand.

We target external LED chip sales to be in a similar range as Q2 over the next few quarters.

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

We continue to add incremental global sales ,resources we recently and filled a key position with the hiring of a regional Vice President of Sales in Europe.

Our investment and distribution continued to pay off, with strong order and shipment growth to our distributors in Q2 for LED components, and our distributors also reported a strong increase in their outgoing sales.

We are in the process of adding field application resources to our global lighting sales team, both internal and at our distributors.

We are working with our distributors to leverage their existing capabilities, to ramp-up our High Brightness LED sales outside of China over the next two quarters.

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

We made good progress in Q2, as we were able to get the first phase of our new XLamp line installed and qualified at our China factory.

This additional capacity was able to significantly reduce our major XLamp capacity constraints, and we are now in a better position to to support the planned growth of this product line.

We target additional XLamp capacity additions coming on-line over the next two quarters, and we are in the planning stages for further capacity additions for fiscal 2009, and fiscal 2010.

We saw the benefit of higher factory utilization, improved yields, and increased Asia production, that lended margin gains for both LED chips and components in the quarter.

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

Our power and RF businesses continued to grow in Q2, primarily due to increased orders for Schottky diodes in power supply applications, where energy efficiency is becoming a more important product requirement.

We are working on several new products to expand the range of applications that we serve, which are targeted to be introduced the next two quarters.

Our RF revenue also increased in Q2, and we are focused on continuing to expand our gallium nitride HEMT product offerings, for broadband wireless applications like Wi-Max.

We are starting to see the benefit from converting our power products to 4-inch wafers, we target additional revenue growth from power and RF in Q3.

I would also like to clarify some of the recent confusion regarding Cree's use of silicone carbide substrates to make our LEDs, instead of the sapphire substrates used by our competitors.

First the customer doesn't care what substrate the LED is grown on, they only care about the price and performance of the end product.

Keep in mind that we are uniquely qualified to assess the benefits and trade-offs, since we are one of only two companies that have produced LEDs on both platforms, we are the only volume producer of silicone carbide, and we are the first LED company to start converting to 4-inch.

We could use either substrate, but we choose to use silicon carbide, because it gives a lower substrate cost per chip than sapphire, and just as important, it provides us a performance advantage.

Although we believe we have the best solution for today's products, we haven't stopped inventing, and continue to research a wide range of substrates and other materials technology for next generation products, as we continue to look for ways to build on our leadership and high performance lighting class LEDs.

As I mentioned last quarter, we are also focused on expanding our management team to help us build a global business, and we made great progress in this area with the recent addition of two industry veterans.

Soo Ghee Lee brings more than 25 years of LED industry experience, with both HP and Avago, and has joined Cree as our Vice President and General Manager for Asia Pacific.

Wayne Nesbit who brings more than 20 years of global semiconductor manufacturing management experience, with both Motorola and Mindspeed, has joined Cree as our Vice President of Manufacturing.

We are very pleased that both of these industry leaders have chosen to join the Cree team, and help us lead the LED lighting revolution.

We believe this LED business will further consolidate over the next several years, and we continue to evaluate ways to leverage our strong balance sheet, with $362 million in cash and no debt, to build additional scale, in terms of customers, channels, technology, people, and manufacturing capabilities.

We are passionate about leading the LED lighting revolution, and we continue to look for new ways to drive the adoption of this technology faster than some of the large traditional lighting suppliers who don't want this to happen.

We view this resistance to change as a tremendous business opportunity, for both Cree and the LED industry.

As we look ahead to fiscal Q3, we target higher LED revenue due to double-digit growth in XLamp LED sales, combined with LED chips and High Bright component sales in a similar range as Q2.

In total, we forecast that the growth in LED combined with higher power and RF sales, will more than offset lower material product sales, to result in a revenue increasing to a range of 120 to $125 million, with nonGAAP earnings of $0.14 to $0.16 per diluted share.

These nonGAAP targets exclude amortization of intangibles, stock-based compensation expense, and related tax effects.

Although we are still in the early stages of the LED lighting revolution, the initial installations are proof that LEd lighting is real, and it is happening now.

We will now take analyst's questions.

Thank you.

(OPERATOR INSTRUCTIONS) We will pause for just a moment to compile the Q&A roster.

Thank you.

Your first question comes from the line of Amit Kapur.

Hi guys.

Chuck, you mentioned that you are working to fix some of the supply, some of the production bottlenecks for XLamp.

Can you maybe talk about exiting the quarter, did you have all of those bottlenecks fixed, and then to what extent might some of those bottlenecks carryover into your March quarter expectations?

I think we made great progress to be able to deliver on our revenue targets that we had laid out for the quarter.

I feel like we did the things we needed to do last quarter, kind of in-line with our plan.

More importantly, we got the Cotco factory up and running to support that product line.

So I think we are in pretty good shape as we head into Q3, it doesn't mean we don't have more work to do.

Obviously we are planning on adding additional capacity in Q3 and in Q4.

It is really more about capacity additions now, than some of the bottleneck issues.

You mentioned some of the strength coming out of China, are there any other particular end markets that are driving the strength, and given some of the obvious concerns out there about the macro economy, can you maybe talk about how you are seeing the market shape up for the next several quarters?

I think we all companies are affected to some extent by the macro factors.

The difference for us, and what we are seeing is that our growth drivers are really about getting our new LED technology into some new applications.

These are really not about further use of you know, this is not about the demand for cell phones, or the total demand for TVs, but it is really about adapting those technologies to use LED technology.

It is going to be more about how does general lighting adopt LEDs, and how does notebook computers and TVs use the technology.

So I think while we won't be immune, I think we are in a bit of a unique position, this is about really about technology adoption, and it will be the determining factor is whether or not we can hit our growth targets.

Okay.

Great.

Maybe one final question before turning it over.

Can you talk about some of the key growth, key drivers of your gross margins going forward, and how we should think of maybe the timing of returning to 40% gross margins?

If you look at last quarter it was factory utilization, it was yield improvements, it was getting 100-millimeter for the power business, and it was getting to China for XLamp.

Those were really the big drivers.

As we look ahead to the next couple of quarters, it is going to be about continuing to drive factory utilization, we obviously continue to have opportunities and yield improvements.

We are just getting started bringing up the China factory for XLamps.

So we look for opportunities there and you know, although I don't think we will see a big impact in Q3, we are also starting a 100-millimeter conversion for LEDs now.

Maybe not this quarter but as we get into Q4 and early Q1.

I think those are kind of, It is more of the same, what we have been doing.

It hasn't changed our targets going forward.

We will keep looking to try to make progress each and every quarter, that is the goal.

Great.

Thanks a lot, guys.

Sure.

Your next question comes from the line of Andrew Huang.

Hi.

Can you hear me okay, guys?

We can hear you great, Andrew!

Great.

You mentioned in your prepared remarks that it is still early in the adoption curve for LED lighting, I am just curious, when do you think the average consumer will walk into a Lowe's or Home Depot, and then maybe find a LED fixture that he can buy himself?

Today obviously you can walk into Lowe's or Home Depot and you can find some specialty lighting products, personal lighting, things like that.

In terms of more general illumination-type fixtures, I think what we are going to see Andrew, is that will come, but I think where it will come first is really the more value added channels, places where LED lighting is specified in, where people are actually out there trying to say, I want to do more energy-efficiency, it will come more from the commercial sector in the beginning, and then it will move to the retail or individual homeowner sector.

I think it will come, but I think it will start more commercial.

There is definitely a lot more attention to this idea of energy-efficiency and sustainability.

So it will more of the traditional lighting distribution channels that will thrive, at least in the beginning.

Okay.

Great.

Then I kind of have a separate question.

There may be confusion out there, about who the players are in power LEDs.

First, if you could help clarify, who are your major competitors for power LEDs, and then second, can you talk a little bit about the risks of commoditization for power LEDs?

Yes, I think that the answer to the first question, the majority of the time we are competing for power LED business, it is generally against Philips Lumileds, and they have been in business the longest.

It is reasonable for everyone to assume that they started and created the segment.

They are going to be the ones that kind of are in the starting position.

That is what we see most first.

Really where we are competing there is price performance.

To a lesser extent we are going to see Nichia and Osram, and they really have a different approach to the market.

I wouldn't really put them in the classic high power, they are coming at it from more of a little bit lower power, lower cost angle.

But I would say it is probably right now, Cree and Lumileds for the segment we are targeting, especially general illumination, and then as we get on to some of the other related segments, we are going to see Nichia and Osram coming in, but that is about it who we see in the marketplace today.

As far as commoditization goes, I think all markets are going to have people raising volume, investing in the technology, trying to get up the curve.

What we are seeing in the power LED segment today is, it is a lot of technology that is driving these things, it is pretty clear that not everyone has the same technical capabilities, and none of us are standing still.

So I think it will be a little while before we see some of those classic signs for two reasons, one, I think it will take time for everyone to try to catch up from a capability standpoint.

We are not done yet, and then second, really getting access, you know, being able to get access to the channel and end customer, and really be able to drive total solutions is not a simple part of the process.

I think there is a lot more barriers to driving this thing than in the traditional consumer-driven components business.

Got it.

Okay.

And then since you mentioned Lumileds, it looks like last week, they announced a major product recall, so it would seem to me that this opens a pretty significant opportunity for you.

So if you were to take a reasonable best case scenario for Lumileds, and then a reasonable worst-case scenario for Cree.

Can you assess the potential magnitude and timing of this opportunity, and then also just to clarify.

Did you see any benefit at all in the December quarter from this Lumileds hiccup?

All right.

The Lumileds hiccup was announced last week.

We did not see any impact last quarter.

I will take these in reverse.

Your next question, we have seen, so that has really only been within in the last seven days or so, is a pretty significant increase in inquiries.

One thing to keep in mind, is power LEDs are like analog semiconductor, they are not drop-in replacements.

We have a significant amount of increased activity, but you know, for someone who has a design with one, to switch to another, it is not only a board redesign, but an optics redesign, and a product requalification.

So there is going to be a time lag there.

When we look at the potential impact, one thing it will be is how fast can Philips Lumileds recover.

That is still to be determined on their side.

The other thing to keep in mind is that it is more about new design.

If you look at their business, the products that are affected, you know, from our understanding, are really their high end K2 and Rebel products that use a new chip design, so those are really not their mainstream business, but really what is primarily focused on their new design opportunities.

I think it impacts a fairly small percentage of their existing business, and it is much more about I think there are new designs, and there is going to be a lot of opportunity created on.

I am not sure we are prepared to give a magnitude yet, but I think it clearly, it should be a positive, at least in terms of customer activity it already is.

We have to see why where it goes.

That being said, I fully expect they will get they will get this resolved, and be back in the game.

We fully expect them to be in a real competitor in the long term.

Got it.

Okay.

One question, and then I will get back in the queue.

You mentioned a little about this in your prepared remarks.

With RUBICON having done their IPO in mid-November, it seems there has been a lot of talk on silicon carbide versus sapphire.

Can you just give us a little more color specifically on cost and technology?

Yes.

Look at the end of the day, the choice is what do you want to grow your EFFIE on, and as I said earlier, we choose to grow it on silicon carbide, but we are pretty uniquely qualified, we have to expertise in-house to do it on both, and we have done it on both.

That being said, at the end of the day our cost, the substrate contribution cost to our end LED chip is lower when we use silicon carbide, than when we use sapphire.

That is a pretty big reason for us to stick with our current approach.

Second we get better performance.

So it doesn't make a lot of sense for us to switch is we don't get any advantages.

The confusion comes from the fact that there are a lot of companies out there buying sapphire wafers, but the reality is we are not competing with most of them in the high performance end of the marketplace.

So there is a little confusion, the mixing of apples and oranges here.

And look we will keep evaluating different options.

But for right now we are confident about where with we are at.

At the end of the day, our customer cares about price performance and their application.

That is what we are focused on delivering.

Great, thanks a lot, guys.

Sure.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of Vijay Rakesh, Oppenheimer.

Hi, guys just a question on your gross margins, going forward is the 35% going to be a sustainable level here?

Our targets for this quarter are going to be 34 to 36.

We are in a similar range.

Our goal is that, you know, we are trying to drive increased throughput, more yield improvements, and additional Asia production.

Our goal is actually to drive it up.

Our mid- to longer range target is to get our gross margins in the low 40s.

That is going to take us a little while.

So the goal is try to make a little bit of improvement each and every quarter on our way to that longer-term goal.

Okay.

I know you listed a couple of reasons why your margins went up.

If you were to prioritize that, would yield improvements be the major one that helped you on the gross margin side?

Wow, you know what, when we look at the different factors, I would say I would equality weight it between additional throughput, yield improvement, and getting the initial XLamp production up in China.

Those three probably are the three bigger drivers, and we got a smaller benefit, but we got a benefit from getting the power devices on 100 millimeter.

They are obviously a smaller part of our business, so they contributed less than the overall, but I would say those three were pretty equality weighted to driving improvements.

Okay.

And here, when you look at your revenues, can you give us a split by end market between lighting and mobile or notebook blues, where is it today, and where do you see that, let us say by the end of '08?

Yes, right now, for the December quarter if we look at the LED business, lighting and the display back, not display back, but the video screen business, those are the two biggest markets, and they add up to a little over 50% of the total, with lighting being a little bit bigger than the video screen business.

Those are the two big ones.

That is over half, and then you get into the next segment, which is a combination of mobile is still important, but obviously a lot smaller than it used to be.

Gaming is still important, and automotive would probably be the next three, kind of that make up the rest, and then a lot of smaller applications after that.

Got it.

Do you see this kind of being the same split by the end of the year also?

No.

I think what you will see is that by the end of the year, lighting will continue to increase as a larger percentage of the total, and then the other application that will start to get a little bit more traction will be the notebook, kind of TV backlighting, but that is kind of second half of the year affect.

You still see notebook and TV start to pick up in the second half?

Yes.

I mean there is a lot of activity going right now, but in terms of what it is going to drive, be more of an effect on our business.

It is more second half of calendar '08.

Okay.

One last question, going back to, sapphire, Rubicon is moving to 6-inch sapphire, and you guys are going to 4-inch silicon carbide, does that, how does that affect your competitiveness, all of your competition here, I guess?

So the 6-inch sapphire business isn't the reason that people aren't making LEDs on bigger wafers using sapphire, it is the EFFIE technology, it uses a larger substrate.

Most LED companies are using 2-inch sapphire, and a few are using 3-inch.

Unless someone has recently changed, no one has acknowledged that they have even started to go to 4-inch in any kind of real volume production.

This is not about the source of the substrate supply, this is about who has the EFFIE technology to use those substrates.

I don't think anyone is particularly worried about having enough sapphire.

It is more about the EFFIE technology.

Great.

Thanks a lot, guys.

Your next question comes from the line of Bennet Notman of Davenport.

Hi.

Could you just talk a little bit about how the notebook opportunity has developed, in terms of your ability to get market share, or how you feel is your overall position in that space, and then also could you talk a little about whether or not intellectual property issues are popping up, either trying to sort of penetrate the notebook market, or just in general in the market these days?

Yes, on the notebook side, we are seeing that this is primarily, you know, for Cree this is really a chip, LED chip business opportunity, and what is happening is that the notebook guys are pushing pretty hard for high performance LED chips for these applications.

When I say high performance, these arern't the high power, these are the smaller chips, similar, basically an upgraded version of what you would use for backlighting smaller LCD screens.

There is a lot of push, and I will be honest, the notebook guys are probably the most stringent customers we have today, about having, wanting to discuss and review the IP situation as they go forward.

That is obviously helping drive some of the overall demand on the chip side for us, and we feel like we are in a pretty good position through our packaging customers to address customers in that market.

Could you just talk a little bit about how much work you might have left to do on building out your sales force for the general lighting opportunity, and then maybe what channels are proving the most successful for you in the various relations that you have created and focused on?

I feel, we feel like we are in a good shape here in North America, we feel like we have a good position in China, our Asia team is in pretty good shape as well.

We probably have got a little more work to do in Europe right now.

We just got our new VP of sales there.

We have a little bit more to do in terms of a Cree investment.

It is less it will be less about additional direct sales, and more about the applications and technical field sales support, is where you will see the investment shift to now.

I think when we are accessing the customer, it is really about helping the lighting guys work through the design process, to really make their end product work.

From a Cree channel and partners which are working better, you know, our distribution strategy is really focused around Arrow, as well as World Peace group, are really our two big distributors.

We also have regional distributors in most markets.

I would say that generally distribution as a whole is doing a nice job.

Obviously, you know, it takes a little while for us to get them up to speed on the product offering, and get that momentum going, but we are feeling pretty good about the rate at which they are identifying new opportunities, the rate at which we are starting to see some closure to them.

And then also, the fact that you know, even though we are getting new business, the funnel continues to expand.

That is pretty good.

And it is not just us supplying them, but also sell-through on their part, that is growing sequentially.

It feels pretty good, the distribution channel is working.

I will tell you that we still have a lot to do on the technical sales side, but overall it is working pretty well.

What are your thoughts or comments on the Philips [Gemlight] acquisition, and does that change the dynamic for you guys?

Yes, you know, what I see the Philips Gemlight is really just a further acknowledgement that if you are a traditional light bulb company, you have got to do something to compete in this market longer term.

From my standpoint they have made a lot of investments on the LED side, and now you see they are working on the fixture side, if you buy into the model, and I think Philips does, that the LED is going to just rub the light bulb industry, it is pretty clear to me they are positioning themselves as a fixture company, so that they have a long-term proposition.

So from our standpoint, it further validates what is going to happen out there.

Thank you.

Sure.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of Hans Mosesmann, Raymond James.

Chuck, a couple for you, and then for John.

Cotco, the business has been flattish for the past couple of quarters, you are guiding flat, was that within the expectations when you made the acquisition, and when do you expect it to resume some kind of growth?

When we made the acquisition, we had three objectives, one was that we wanted to access their China sales force, to drive the overall lighting sales strategy, which is really XLamp products.

We don't, when we are talking about Cotco, or High Bright, we are excluding the fact that they are actually growing their business if you include the growth of their power LED products, we are putting those in the XLamp numbers, so that part has gone well so far, that was really our first focus.

The second big focus was obviously to get their manufacturing capability brought up to speed for the XLamp, we really needed that, so that is going pretty well.

And then the third piece is how do we expand the overall breadth of the High Bright component product sales, and you know we have made progress in getting new customers, and really expanding primarily in the video screen application, unfortunately, we did that at the same time that we saw our gaming sales there slow down.

The gains we made in one, instead of growing the business really just offset the losses we had on the gaming side.

I think going forward, now that we have got the other two things done, as we expand that product line, and really take it outside of China, as well as bring on some additional packages that will service more than just the video screen market, I think we can see some growth, probably not a lot, obviously this quarter we are guiding relatively in-line.

That has a lot to do with the fact that it is also the Chinese New Year quarter, but I think as we get into Q4 and the new fiscal year, our target is to start to see growth as well in the High Bright component, but probably, you know, not really in Q3, more of an opportunity starting in Q4.

That is really a function of the time it takes, to get your parts out there, and get them qualified at the customers, and get the channel up to speed.

Okay.

One more for you, Chuck, then I will go to John.

On the LED chip business, it is going to be flat for some time, it has been.

Why wouldn't you outsource that, some of that business, that seems to be a little more commoditized, why wouldn't you go to OpenStar or something like that, there and then take, use your brand to sell these products?

For right now, I think our focus, it is the strategic vision of the chip business, is to kind of keep it in this range.

We feel like the resources to drive the growth are better focused at the components level.

It doesn't mean we don't want to continue to support the chip business, but really focus it on the more high value applications.

Frankly, one thing we see as we continue to drive chip performance and get new products out there, what we saw last quarter is we are able to, when we are able to grow things like our higher valued chip products, we are able to get out some of of that older business, which in effect from a mix standpoint, it is actually driving up our margins even in the chip area.

So, we feel like it is a good use of Cree resources.

You could argue we could re-sell or sub-contract out some other products, but I am not sure right now that we feel like that is the best use of our sales teams time or resources.

We really feel like we want to drive the growth at the components level.

I will not going to say never, but really not a near term focus for us.

Okay.

Thanks.

John, quickly, just two items, what was your, the stock-based compensation of your guidance for your Q3, and then some guidance for the interest income, how you see it going forward, since it jacked up here quite a bit?

You expect it to be 4.5 million or so for the next couple of quarters?

Let me take this stock-based compensation first, and then I will hit the interest.

What we had said, it will be about $700,000 of stock-based compensation in COGS, okay.

Then there will be approximately $3.1 million in R&D and SG&A, so for a total of about 3.9 million in total before you tax effect it.

As far as the interest income, what I see, we expect that being flat this quarter, but even though we have higher cash balances and we are generating cash, you can imagine the move by the Fed to lower interest rates over the last couple of quarters, and what they just did today, is going put a squeeze on that.

I would keep it in that similar range for the next couple of quarter, until we can sort out what is happening with rates.

Fair enough.

Thank you.

Thank you.

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

Hi, guys, just a clarification, when you spoke on the High Brightness component segment, is that just going to be an aggregation of XLamp and Cotco, and going forward, are you going to break that out, was that 10% of revenues in the previous quarter?

Let me clarify that.

What I am trying to say, we have been talking about Cotco as a product line, but also as a part of, you know, as a part of Cree.

They do more than just make High Brightness LEDs, obviously they sell high power components.

What I am talking about when I say High Brightness, we are not going break it out, but I want to make sure that investors have a change to get a sense for the trends whether it be chips, High Brightness components, which you should think of as the traditional Cotco product lines, and then separately, XLamp or high power or lighting components.

So we will still try to give you a qualitative view of those three sections within the LED, but it is not a combined.

It is really the old Cotco product line is the way to think about it.

Okay.

And 10% customers in the quarter?

We don't break out 10% customers except in the K, but no significant customer shifts in the quarter.

Okay.

And then lastly, nice job on the guidance for the OpEx being flat, and will soon be coming down as a percentage of revenue, how should we think about the OpEx going forward, are you going to be able to maintain this level, and bring it down as a percent of sales, or should we be modeling some modest increases toward the end of this calendar year and next?

Well, thanks for, we appreciate the compliment.

I think we are getting a little bit of benefit from the fact going from 14 back to 13 weeks.

We are growing it a little but as a percentage obviously it is starting to shrink a little bit.

What you are going to see, we will continue to invest in R&D.

I would imagine in total dollars that will grow in the future, but I think the SG&A line, G&A should definitely not grow as fast, and sales, while there is additional investment, we have been in a pretty high spend mode.

We will see incremental investments going forward, but I wouldn't expect it to grow at the rate that it has been growing over the last year, there will be some but hopefully, the biggest growth should be in R&D, and other areas hopefully will get a little bit more leverage.

Your next question comes from the line of Jed Dorsheimer.

Thanks for taking my call.

Yes.

First question, BridgeLux do you not see them as a competitor?

We don't see them as a competitor in any of our accounts today, although we do have a lawsuit against them at this point.

Why are you suing them?

For IP--

All right.

But they are not a competitor?

Not a significant one in our day-to-day business, no.

What about SemiLED, Citizens, Epistar, and SEMCO?

Do you see those guys as competitors on the power side?

So walk me through them one at that time again Jed.

SemiLED which is a private company over in Taiwan, making you know, 90 lumen per watt type of power chips, and then Citizens Electronics, which I think is a customer of yours, but they also have a light bar in the power chip market.

EpiStar which I think you are familiar with over in Taiwan, and SEMCO, which is Samsung's manufacturing arm.

I am just wondering if you see any of those four as competitors in the power chip business?

Power chips or power packaged LED business?

Power packaged LED business.

Excuse me.

So in the case of SemiLED, it would be they are not making the packaged LED, they are making the chip, which would sell to a packager, that would create a power packaged LED.

Yes.

Let me walk you through those.

Again, it doesn't mean these guys don't offer products in our segment, but I am telling you which ones we actually run into on any regular basis, that we would be competing with.

We know that SemiLED offer chips.

We don't view them as a significant threat to our business today, despite their claims.

Citizen, we view them as a potential customer for our chip products, and we know that they have components out there, but we really don't see them as a competitor to Cree, in the things we are doing.

EpiStar, yes, we see them on the low end of the chip business, they are obviously a very large supplier on gallium nitride LED products, but we really see them in the low to mid-end of the market, we dont see them at the high end for any of our big chip applications, and SEMCO as a packager is really focused, we know that they are pretty active at Samsung itself, but we don't sell components directly at Samsung, right, we are generally a chip supplier, We don't really see them as a chip competitor.

SEMCO may competing with our packaging customers, but we don't really see ourselves competing with them directly in any accounts out there.

Thanks.

That is helpful.

On the 4-inch, I think Osram and two companies in Japan, one in Korea, and then another one in the U.S.

that has manufacturing in Malaysia have some 4-inch capabilities that are processing products, are you not seeing that?

No, we don't see any significant amount of that volume mix in the market.

We know there are people working on it, but we don't see a significant impact on that from our marketplace, from the fact that, the people we are talking to.

All right.

And then on the, it looks like Toyoda Gosei has some aluminum gallium nitride patents that expire.

I think that there is a Japanese patent that expires March 1, and then there is a U.S.

patent that expires on the 16th.

Are you at all concerned that this may allow other or existing chip companies that are already operating using an aluminum gallium nitride buffer layer, to enter the market with IP Free technology, or are you not concerned about that?

When we look at [CV] patents, those have been around a long time, I don't think they have been a barrier to anyone getting in to the business so far.

I don't really think they have ever filed a suit against anyone on them.

So they are out there, I don't really view them as part of the, the big part of the portfolio, I do know that those are expiring, but I don't think most people consider them to be a major barrier.

Maybe they do, but I am not aware of it.

All right.

Just a follow up on the Hans' comment in terms of Cotco, if the Cotco business is staying flat basically on a quarter to quarter perspective, but the agreement that you have with Light Engine, I think requires, if I read the Addendum correctly, it requires to actually see a 10% sequential increase of purchases from Cotco.

Is that growing as a percentage of the Cotco, the question is Light Engine growing as a percentage of the Cotco business, and is it over 50% at this point?

The answer is no, it is not growing as a percentage.

It is about the same overall level as it was before we bought them.

It is not growing as a percentage.

If I look at the 10% from the 9.7 million back in June, sequential increase starting in September, gets to about 12 million, is that the right level to look at for Light Engine?

You lost me on the math there.

9.7 million was the amount you disclosed in your--

What?

9.7 million what?

In sales for Light Engine.

Yes.

I will be honest I would have to pull out the Q.

What I know is in total, the business hasn't grown really significantly since we bought it; right.

It has been basically flat for the last two quarters, they are running at about the same level of total business now as they were when we bought them.

I don't have the specifics in front of me.

All right.

The yield increase that you saw during the quarter, could you elaborate on that at all?

Well, we saw improvements in yields pretty much across the factory.

We saw improvements in dye production, we saw improvements in XLamp production, and even substrate production.

Generally a pretty good quarter overall.

All right.

And then so the XLamp, are those running at corporate averages at this point?

No, still a lot of room for improvement.

We definitely made progress, with we are on-track with what we were trying to do last quarter, but they are not the corporate averages, we still have got some opportunities there, and I think what we will see is that I am not talking about the yield, I am talking about it from a margin standpoint.

Yields are doing fine, but as we continue increased production in China, we will see start to see continued improvement there over the next couple of quarters.

All right.

And two last questions, and then I will jump back in the queue, although I think I might be last.

One, are you outsourcing any of your packaging for the XLamp at this point?

Yes.

We have had a subcontractor qualified for about a year now.

That is not Cotco.

Correct.

All right.

And I thought, so I guess I was confused I thought that Cotco was going be doing the packaging for you there.

They are, but remember before we bought Cotco, we had already qualified a subcontractor to support the additional capacity.

So they have been on line for probably 18 to 24 months now.

Before Cotco, we had already brought up a subcontractor, and we are continuing to work with them as well.

We think the multi-source is definitely the way to go here.

All right.

And John, depreciation, why was it down quarter-over-quarter?

We have been adding fewer and fewer assets, as you look at our cash flow statement when it comes out.

The increase in capital is not there, and older equipment is rolling off.

All right.

And then, last question, Chuck, just on the silicon carbide versus sapphire, I think a lot of the confusion has to do with, not the cost of the silicon carbide versus sapphire, but the processing.

Just to clarify, when you are doing your thinning, are you actually thinning from roughly 350-microns down to 100-microns, and using a lapping process, and I think that actually compares to what some of the sapphire manufacturers are doing with the laser ablation.

So I guess my question is, are you using lapping, a lapping process to thin, or are you using a laser?

Yes, Jed, as I mentioned last quarter, I think we discussed it then, we don't disclose the process that we use, since we are pretty sure that we are the only ones using it, and it is proprietary.

Cost is the only metric.

If the cost is lower, what other metric matters?

As long as the performance is high and the cost is low, what metric should we be using?

No.

So I mean I would argue that the overall cost, the end result is not lower than using an Osram process, that is using a laser ablation, or using the Philips Lumileds process to remove the sapphire.

I am not sure you want to benchmark Philips Lumileds process right now, as the standard we are going for.

But we feel pretty good.

Look I think we feel like not only our cost at the substrate, but our overall cost is pretty darn competitive out there.

We think our approach works, but I understand the perspective, but don't think, I think we probably have a more efficient process than maybe is perceived by some of our competitors.

Fair enough.

Thanks for letting me ask the questions.

I will jump back in the queue.

Sure.

Your last question comes from the line of Andrew Huang.

Three quick follow-ups, first, do you think you can comment in general, on whether or not your visibility has improved relative to let's say, two quarters ago?

Well, Andrew, I am not sure about two quarters ago.

We are sitting in about the same position now as we were about this point last quarter.

I don't, I am trying to remember what it was like in the July quarter, or in our Q1, but I can tell you relative to last quarter about the same point.

Okay.

Got it.

Then secondly with respect to your new XLamp line in China, I know it just got started in the December quarter.

So would you say that the yields in China are comparable to those in North Carolina?

Just directionally I am just kind of curious.

Yes.

Okay.

Great.

And then third, you know, given how quickly demand is accelerating here, do you think you can give us a little more color on your plans for additional capacity expansion beyond 2008?

We already announced what we are going to do for this year.

The plan for beyond 2008 is, you know, basically additional equipment in our China facility to support growth.

We are looking at that from a packaging standpoint, and we definitely have an opportunity to continue to grow there.

At some point in '09, '10, depending on what the overall growth continues to look like, but there is probably at some point in the not-too-distant future, we have got to look at a second factory for packaging, and then in parallel to that, the dye fab still has some capacity, but at some point here in the next couple of years, we will have to bring on-line Asian based dye fab.

We are looking at that as well right now, and we haven't made a final decision on which way we are going to go there, but it is likely we will have to make a capital investment in Asia, to also increase dye fab capacity within the next couple of years.

Okay.

Great.

Thanks a lot, guys.

Sure.

At this time, there are no further questions.

Okay.

Thank you, operator.

And in closing what I would like to do is thank you for your time today.

We appreciate your interest and support, and look forward to reporting our third quarter of fiscal year 2008 results on April 22nd.

Good night to you all!

Bye.

This concludes today's conference call.

You may now disconnect.