Wolfspeed Inc (WOLF) 2008 Q3 法說會逐字稿

Good afternoon.

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

At this time I would like to welcome everyone to the Cree, Incorporated, third 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, April 22, 2008.

Thank you.

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

Mr.

Garrabrant, you may begin your conference.

Thank you, Heather, and good afternoon.

Welcome to Cree's third 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 first quarter of fiscal year 2008.

Please note that we will be presenting both GAAP and nonGAAP financial results in all remarks made on today's calling which are reconciled in our press release which is posted on the Investor Relations section of our website at www.cree.com, under financial metrics quarter ending March 30, 2008.

Today's presentations include forward-looking statements about our business outlook.

And we may make other forward-looking statements during the call.

These may include comments concerning: trends in revenue, gross margin and earnings, plans for new products, and other forward-looking statements indicated by words like anticipate, expect, target and estimate.

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

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

Also we'd like to note that we will be limiting our comments regarding Cree's third quarter of fiscal year 2008 to a discuss 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 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 south side analysts ask questions during the Q&A session.

Also since we plan to complete the call in the allotted time of one hour, we recognize that other investors may have additional requests 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.

A replay of the webcast will be available on our website through May 6th, 2008.

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

Thank you, Raiford.

We delivered another good quarter in Q3 as revenue increased to a record $125 million with GAAP earnings of $5.7 million or $0.06 per diluted share and nonGAAP earnings of $12 million or $0.14 per diluted share.

During the quarter we took a bold step in leading the LED lighting revolution with our action assist of LED Lighting Fixtures which added approximately $700,000 in revenue and reduced earnings per share by approximately $0.01 for the third quarter.

Excluding this acquisition, revenue, gross margin and earnings were all within our target range for the quarter.

Revenue growth was led by another double-digit sequential increase in XLamp LED sales which enabled total LED revenue to exceed LED chip revenue for the first time in Q3.

LED chip and high brightness component sales were in line with both our target and the previous quarter, while power and RF products grew sequentially which partially offset lower sales for our silicon carbide materials products and lower government contract revenue.

Overall we continued to successfully execute our strategy to drive the growth of our business through higher LED component sales.

As we look ahead to Q4 we target growth from XLamp LEDs, high brightness LED components and our new LED lighting solutions.

All of these product lines are being driven by LED lighting applications where the global momentum continues to build for sustainable energy-efficient lighting products.

We recently participated in the Bi-Annual Light and Building Trade Show in Frankfurt, Germany, where LED lighting was featured prominently throughout the trade event and our XLamp LEDs were widely recognized as the gold standards for power LEDs in lighting.

Despite the high profile of LEDs at this lighting event it was interesting to note that the large traditional suppliers still seem to be trying to downplay the timing of LED lighting adoption which we see as a great opportunity for Cree.

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

Thank you, Chuck.

In January, we targeted the following financial results for the third fiscal quarter.

Revenue was targeted to be in the range of $120 million to $125 million.

Gross margin was targeted between 34% and 36%, with GAAP R&D and SG&A expenses targeted to increase by $1 million.

NonGAAP R&D and SG&A expenses excluding stock option expense was targeted to remain flat.

Interest income was targeted to be at $4.5 million.

Diluted average share count was targeted to be 87.3 million shares.

EPS for the quarter on a GAAP basis was targeted to be in a range of $0.07 to $0.09.

On a nonGAAP basis excluding amortization of acquired intangibles and stock-based compensation, EPS for the quarter was targeted at $0.14 to $0.16.

And finally in connection with the announcement of our acquisition of LED Lighting Fixtures we announced that we expected to add approximately $1 million to our revenue and reduce EPS by approximately $0.01 for the quarter.

Our financial results for the third fiscal quarter are: revenue of $125 million, which includes approximately $700,000 from our acquisition of LED Lighting Fixtures or, LLF.

LED revenue increased 7% to $105.5 million in Q3 as compared to $98.9 million in Q2.

The XLamp product sales again increased double digits in the quarter as we made significant progress increasing capacity to meet our customers' need.

LED chip sales and high brightness component revenue were similar to Q2 and within our targeted range.

This was the first quarter that the LED component product sales were more than half of overall LED revenue.

Q3 materials revenue which includes wafers and gemstone products was $6.3 million or 5% of sales.

[High power] products revenue which includes our Schottky diode and wide-band microwave sales increased to $6.2 million or 5% of sales and contract revenue was $6.8 million, or 5% of revenue for Q3.

GAAP gross margins of 35% included stock-based compensation of $.6 million or approximately one half of a point of margin.

GAAP R&D and SG&A expense was $36.5 million.

This was $2.4 million higher than targeted, primarily due to higher patent litigation costs, the acquisition of LLF, increased R&D and higher sales expenses.

NonGAAP R&D and SG&A expense was $32.9 million excluding stock-option expense of $3.6 million.

Interest and other income was down to $3.9 million from lower interest rates.

Diluted average share count increased 1.6 million shares above our target to 88.9 million from the shares issued for the LLF acquisition and the exercise of options.

GAAP profit was $5.7 million and GAAP EPS for the quarter was $0.06, which includes the impact of lower interest income and an increase in the share count.

And nonGAAP profit was $12 million with nonGAAP EPS of $0.14, which excludes stock-option expense and amortization of intangibles.

Please note that 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 a reconciliation of the nonGAAP information for all quarters mentioned on this call is posted on our website.

Moving on to the balance sheet.

It has continued to strengthen with cash and investments of $398 million as of the end of Q3, an increase of $36.4 million from Q2 and no debt.

Capital expenditures were $16.4 million for the quarter, and we have targeted capital expenditures in the range of $45 million to $50 million for fiscal 2008.

Accounts receivable were $116.6 million at quarter end, an increase of $21.1 million from Q2.

And our days sales outstanding increased to 80.

Inventory was $83.3 million at quarter end, an increase of $8.3 million from Q2, which included approximately $1.6 million for LLF.

Our days of inventory rose to 92 and inventory turns declined to 3.9.

More than half of the increase was in raw material and from LLF.

As we are becoming more vertically integrated and continue to ramp our component product lines the internal supply chain is no longer and we will inherently be carrying more inventory.

We are working to streamline the internal supply chain which will help us be more responsive to our customers requirements and improve our profitability.

I will now take sometime to go over more of the financial details of the LED Lighting Fixtures transaction which was announced on February 8th and closed on February 29.

We acquired all the outstanding shares of LED Lighting Fixtures in exchange for approximately 1.9 million shares of Cree's common stock valued at $58.8 million and cash of $16.5 million.

Additional shares -- additional consideration of up to $26.4 million in cash may be payable over the next three calendar years tied to new product milestones and key employee retention.

We have commissioned evaluation analysis and the acquisition will be accounted for under the purchase method of accounting as prescribed by SFAS 141, business combination, and all related goodwill and other intangible assets will be accounted for in accordance with SFAS number 142, goodwill and other intangible assets.

We target this evaluation analysis to be completed during the fiscal fourth quarter.

Now I will give you an update regarding our outlook for the fourth fiscal quarter, which ends on June 29.

We are targeting revenue to increase to a range of $129 million to $133 million, primarily due to higher LED sales.

XLamp product revenue is targeted to increase double digits along with growth of our high brightness LED components for both displays and lighting applications.

LLF revenue is targeted to be in a range of $2.5 million to $3 million in the fourth fiscal quarter.

LED chip revenues targeted to be down slightly quarter over quarter due to the slowness in mobile demand.

We targeted sales increase for a high power product which include our silicon carbide Schottky diode and RF products to offset lower sales for materials and lower contract revenue.

Gross margin is targeted to be in the range of 34% to 36% on a GAAP and nonGAAP basis with approximately $1 million of stock-based compensation.

This target includes the 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 fab.

GAAP R&D and SG&A are targeted to increase in the aggregate by approximately $2 million to $2.5 million over GAAP expenses from the prior quarter.

On a nonGAAP basis R&D and SG&A are targeted to increase by the same amount.

These targeted increases are expected to result primarily from increases from the acquisition of LLF and incremental legal expenses associated with patent litigation.

As a reminder nonGAAP expenses exclude noncash stock-based compensation of approximately $3.7 million and amortization of intangibles of $4.7 million.

Interest income is targeted to be down to $3.2 million based on a full quarter of lower interest rates on our conservatively invested portfolio.

We estimate our effective tax rate to be 24%.

Based on an estimated 91 million diluted shares outstanding which includes a full quarter of 1.9 million shares issued as part the of the purchase price of LLF and a full quarter of the 2.2 million shares added from the exercise of employee stock options in the third quarter, our GAAP EPS target for the fourth fiscal quarter of 2008 is expected to be in a range of $0.04 to $0.06 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 $0.12 to $0.14 for the fourth quarter of fiscal 2008.

In arriving at our GAAP and nonGAAP EPS target we forecast lower interest income, higher patent litigation expense and the dilution resulting from our acquisition of LED Lighting Fixtures, which together we estimate to account for approximately $0.04 per diluted share of our GAAP target and $0.03 per diluted shares of our nonGAAP target.

Our nonGAAP EPS target exclude amortization of acquired intangibles in the amount of $0.04 and non GAAP -- excuse me, noncash stock-based compensation in the amount of $0.04.

Thank you.

I will now turn the discussion back to Chuck.

Thanks, John.

We remain focused on five key areas to continue to drive our transformation and our global leader of energy-efficient energy component and solutions.

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

We continue to make great progress in Q3 as orders and shipments for XLamp products grew nicely and we target double-digit order and shipment growth for XLamp LEDs again in Q4.

On the broader objective of enabling the LED lighting revolution, we announced today that five leading universities in the U.S.

and China have joined the new LED university initiative and are deploying LED light to go save energy, reduce costs and help protect the environment.

The LED city initiative also gained support in Q3 with the addition of the tangent economic development area as the first LED city in China increased U.S.

participation with the addition of Austin, Texas.

In addition to these marketing activities we recently increased our ability to directly enable LED lighting with our acquisition of LED Lighting Fixtures, which gives Cree direct access to the lighting market, expands our total market opportunity and gives us a no compromise, retrofit LED down light that can enable LED lighting today.

Our second priority is the integration of our recent acquisitions, COTCO and LED Lighting Fixtures.

The integration of COTCO is essentially complete as the high brightness LED products are now part of the overall LED component product line and the COTCO team has become the Cree Hong Kong and China team.

High brightness product sales are on plan in Q3 and are targeted to increase in Q4 due to higher sales in China for both lighting and display applications.

We are also starting to develop new high brightness growth opportunities in North America and Europe that we target to start to come online in the first half of fiscal 2009.

The integration of LED Lighting Fixtures is well underway.

The business has been renamed Cree LED Lighting Solutions and we are working on a number of important test installations with large potential customers to demonstrate the energy savings, light quality and maintenance benefits of our LED lighting products.

The initial feedback for our products has been very positive including the recent comments from an IHOP franchise operator in northern Virginia who said, when comparing our LR6 down light to CSL, "LED light to more energy-efficient, generates less heat, has a longer life and it's just a better quality light." These comments are very encouraging.

We need to keep in mind that this business is still in the early stages and our focus over the next six months will be to build sales momentum for the LR6 product while we finish the develop of the LR4 and LR24 product platforms and get them fully released to production.

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

The distribution strategy continued to pay off in Q3 with strong order and shipment growth to our distributors for LED components.

Our distributors also reported a solid increase in their out going shipments for the quarter.

Based on the results from Q3, we are getting good traction in Asia and North America and we are now focused on working with both our global and regional distributors to increase our LED component sales momentum in Europe.

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

We made solid progress again in Q3 as we were able increase XLamp capacity at our China factory to support the double-digit shipment growth.

Based on the additions we made in Q3 we should be in good position to support the targeted growth for XLamp LEDs again in Q4.

Overall yields and productivity were on plan and in some cases slightly ahead of our targets for the quarter which enabled to us make progress on XLamp cost and meet our overall gross margin targets for the quarter.

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

Our commercial power and RF business continue to grow nice until Q3 led by higher sales of our Schottky diodes and commercial RF product.

This increase in product revenue help offset lower government contract revenue for the quarter as this business is starting to become less dependent on government funding.

We are also seeing lower costs in our Schottky products resulting from the conversion to four-inch wafers.

We target higher power and RF device sales again in Q4, which should offset a further decline in government contract revenue for the quarter.

Although our focus is on integrating LLF in the near term we continue to look for additional ways to lead the LED lighting revolution and drive the adoption of this technology faster than some of the large traditional lighting suppliers seem to want it to happen.

We view this resistance to change as a tremendous business opportunity for Cree, and we continue to evaluate ways to leverage our strong balance sheet with $398 million in cash and investments and no debt.

As we look ahead to the fourth quarter, we target revenue to increase to a range of $129 million to $133 million, driven primarily by the strength of our LED business.

We target the growth in LED to come from additional digit growth in excellent LED sales, the addition of LED lighting solution sales for a full quarter and increase high brightness LED component sales.

LED chip sales are targeted to be a little lower than Q3, due to softness in mobile demand, but still within our target quarterly range.

We also forecast higher power and RF sales that should mostly offset lower material sales and government contract revenue.

We target nonGAAP earnings in Q4 of $0.12 to $0.14 per diluted share, which includes approximately $0.03 per diluted share representing expected lower interest income, higher patent litigation expense and dilution from the LLF acquisition.

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

Our strategy to drive revenue growth by focusing on LED lighting is working.

For the third quarter our business grew 38% year over year, driven by the success of our LED components and we are on track for a strong finish to fiscal 2008.

The global momentum continues to build for sustainability and energy efficiency.

We see reports in the papers or on the news all every day about how a world built on the premise of abundant low-cost fossil fuel and unrelated carbon emission is being forced to find new alternatives.

The addition of the LED Lighting Solutions product line to our existing LED components platform has put Cree in an even better position to be one of the solutions to this global problem as we head into fiscal 2009.

We will now take analysts' questions.

(OPERATOR INSTRUCTIONS) Our first question comes from the line of Andrew Huang with American Technology Research.

Good afternoon, guys.

Can you hear me okay?

First question, XLamp has been growing at double-digit sequential for some time now.

Can you give us some color as to what's driving that growth?

Well, Andrew, the easiest way to answer that question is to say lighting generally it is actually a combination of general applications.

If you look at XLamp today, our top five application are probably: portable lighting, outdoor commercial lighting, indoor commercial lighting, architectural lighting and also then also some transportation.

Those would be the big five, and those are what's making up the current revenue growth over the last year.

Looking forward what you will probably see is that the indoor and outdoor commercial lighting segments are what I would expect to really be the bigger growth drivers going forward.

Okay.

And then since you mentioned the indoor and outdoor, when do you think that's really going to start to see some real sequential growth?

I think it's already been a part of it.

I think people may underestimate that both the indoor and outdoor segments have over the last year gone from really an idea to something that's starting to gain traction.

Now, they are not the largest segment yet but they are definitely the fastest growing, and I would expect that in FY '09 they would start to really drive the new applications, especially based on our current quoting activity which is the majority of them are in those two segments.

Okay.

And then kind of a detail question.

I was wondering, can you give us a sense of what the gross margin would have been if LLF was not part of Cree?

I'm not sure I can break that out.

I think given that it was only $700,000 this last quarter and it did cost us a little bit on the earnings side about $0.01, I don't think it would have affected it a lot, but I don't have that break out for you right here, Andrew.

Okay.

And then just one last follow up and then I will get back into queue.

I think there was some mention about additional patent litigation expense.

Can you comment on that?

Sure.

So, well, two things.

One, we saw higher expense in Q3 than we had originally expected.

So John mentioned that that in Q3, one of the reasons our SG&A was a little higher than we had originally thought was that.

And what we are forecasting is that it will go up fairly significantly again in Q4.

And what that is that's really just the timing of the patent litigation that's going on.

So we don't control exactly when the courts decide to schedule different parts of the process.

But it looks like in Q4 and maybe even into Q1, we are going to be in a little hotter spending time just because it's the nature of where those cases are in the court system.

And could you comment just in name which cases those are?

It's a combination of all of them, but the main one driving is are the Bridgelux cases which there are two of those and probably the biggest driver in the nearest term but in some time in the future will be the Newmark suit.

Got it.

Thanks very much.

Our next question comes from the line of Yair Reiner with Oppenheimer & Company.

Thanks for taking my questions.

A couple quick questions on the balance sheet.

Total cash was up $35 million in the quarter.

What was the source of the cash?

Okay.

The source of the cash was about -- primarily came from the exercise of options during the quarter, and then we had general cash from operations.

Okay.

But the cash from operations was $5.5 million?

Yes.

And --

So the majority of it came from the exercise of options.

So there's about $60 million in exercise of options, is that about right?

No, there was 2.2 million shares that were exercised during the quarter, and we received cash of about -- from that we received cash of about $30 million some.

Okay.

But the market value, I think you're driving the market value is somewhat closer to that, yes.

That's not the cash value.

But not the cash value to the company.

And I guess you haven't paid out the money to LLF.

Is that what happened?

No, we paid out -- we paid -- that's all net of the LLF transaction.

Okay.

Maybe I will follow up off line because I'm not understanding the math.

In terms of AR, can you explain what caused accounts receivable to kind of move up a little bit during the quarter?

Yes, I think if you look at the nature of our business we are shifting pretty quickly to a more components driven business, so we are really changing our customer mix and expanding the number of customers pretty quickly.

So in that situation we are changing the dynamic from a fairly limited number of big customers where we can drive payment terms pretty easily to one where, while the terms haven't changed, it's a larger collection exercise for us.

I would tell you that while it was up I don't think it's -- I think it's something that we would expect to make some fairly significant progress on in the quarters ahead, and I think John alluded to that in his comments.

I think it's really just the nature of us managing a more diverse customer base going forward.

Fair enough.

One final question in terms of the [BLU] market, are you seeing any progress there, what are some of the things that you think that maybe Cree could maybe do to increase its exposure to back lighting units both in laptop and in television.

Obviously that's an exciting market that is on the horizon.

I think it's still relatively small today in terms of the actual number of products in production, but there's a lot of design activity going on.

Our approach to that market is really one of as it primarily an LED chip supplier working with several partners to try to provide them the chips and help them go and win that application.

We have a number of projects underway.

None of them we can comment on at this time.

But I would expect that as we get into fiscal 2009 that it will be one of the growth drivers of the overall chip business.

And really it will become a larger percentage of our chip business next year.

Thank you very much.

Sure.

Our next question comes from the line of Amit Kapur with Piper Jaffray.

Thanks, guys.

I got disconnected for a bit.

I apologize if this connection was already asked but were there any supply constraints for XLamp during the quarter, and how has that affected your CapEx plans into 2008?

Yes, so I think that we were able to get enough capacity on line to pretty much meet it.

It was -- we were adding capacity throughout the quarter to meet the growth, but I think we got it pretty close to in balance by the end of the quarter.

From a CapEx standpoint, target is a finish of $45 million to $50 million, which is one more quarter and we are still working on our targets for next fiscal year at this point in time.

Okay.

And in terms of the -- what are some of the key drivers to your gross margins going forward and how should we think of the timing of returning to 40% gross margin?

Yes, the way we are looking at it right now is we have a fairly significant mix shift going within our businesses, the new product lines are obviously becoming a largest percentage of the business.

The focus is really how do we drive the yields up and reduce the costs there so that those gross margin get up closer to corporate average and then can help drive us higher beyond where we are at today.

I think in the near term we are kind of in a transition period where we are really working on improving the gross margins of the new products as they become a larger percentage of the total.

Don't have a target for you as to when we are going to get to 40%, but we are going to work on the same things.

It's really about continuing to scale up China at the component level, yield improvements, as well as we get more into fiscal '09, the fact that we have more of our chips built on four should give us a little bit of leverage on the chip side of the business.

Okay.

Great.

And maybe one final question kind of more big picture.

As you integrate LED Lighting Fixtures what's the feedback you have gotten from potential customers, and do you see any signs of revenue synergies now that there's more revenue coordination between your products and the fixtures out there?

I think so, when you say potential customers at the end customer level or at the fixture level?

At the end customer level.

Yes.

So, one of the things we are finding is that it's interesting to be able to to have direct access to them.

I think they have a much better appreciation of what's driving their decision process than we did even six weeks ago, and what we are finding is that there is a pretty significant pent up demand for people that really want to implement real sustainability programs.

And frankly, the biggest complaint we here is give me a real product that I can install so I can start moving forward.

Right now that real product for us is the LR6, which is the down light and we are getting some pretty great feedback.

I alluded earlier to the IHOP comments.

We have some interesting tests going on that we can't release yet, but I would tell you that generally people looking for energy-efficient lighting, we get positive feedback.

The challenge for us is those -- is that's one product and we really have to get the LR4 and the LR24 out there as well, because in most cases what we find is people want to use, they have more than one application for the technology and so generally what you are looking for is people who would like to use the LR6 and LR4 and LR24, which are products that are coming but not yet released yet.

It's good at this point, it's a lot of positive news, and as I said earlier really the focus out there is we have to get these other products out there in the market and released.

Okay.

Thanks, guys.

Sure.

Our next question comes from the line of Carter Shoop with Deutsche Bank Securities.

Hi, good afternoon.

Hi, Carter.

This is a quick follow up there.

When do you expect the LR4 and LR24 to be in commercial production?

Both of them should be in volume production some time over the next six months.

The LR4 will come first and then the LR24.

I don't have a specific date for you, but I think we are targeting LR4 some time here midsummer and the LR24 early fall.

Okay.

Thanks.

And with regards to future acquisitions, would it make sense to continue down the acquisition line here, possibly make another fixture acquisition down the road, or do you think that what you currently have with LLF is going to be sufficient for at least the next few years?

Well, right now our focus is on integrating LLF, and I think we have a lot of work to do there, and I think there are a lot of opportunities that we are just now -- I think there's more opportunities for some synergies there than we probably appreciated even through the process of deciding to make that acquisition.

And the challenge for us is LLF is pretty unique.

Right?

They are focused on a segment that's really about providing an LED lighting solution that is for existing infrastructure.

Most of our traditional customers are trying to design LED lighting solutions that are really new construction type things.

And so right now the way it's working is LLF is pretty complementary to what our LED component customers are doing and the kind of two are working hand in hand.

In the near term the goal is we want to obviously drive some incremental growth from the LED lighting solutions business, but really want to use it to drive LED lighting adoption, which what I think is what we are going to see next year is only going to help build momentum on the component side.

So it's kind of -- they really go together.

In terms of where we might go beyond that short term is to integrate what we have, we are going to keep our eyes open, but it will have to be something that truly gives us the synergy that drive LED lighting.

I think one of the challenges is we don't think the old businesses -- we think that model is changing pretty dramatically.

So the question is, are you better off trying to build it yourself like we are going to with the LED Lighting Solutions Group or are you better off trying to buy an existing business, and I don't think so we've made our mine up on what's best and we will try though drive the market and sell more components.

That's helpful.

When you think about the power LED market when do you think that market will start to commoditize a little bit?

Obviously it's in a very high growth period now, there's not a lot of competition, but given the rapid pace of change that we've seen in some of the other markets within the LED space, how do you guys envision this market developing?

Is it going to be two years down the road and we'll see a lot of Asian competitors in the marketplace with comparable products, or do you think it's going to be further down the road?

It's a little hard to figure out how fast they will come up the curve.

There's really a few several things with the power LED business.

You have to have access to the die technology and I think there's clearly -- we have a gap compared to whatever else is available in the marketplace today.

When we sell our power LED we really only see generally Phillips as one competitor and if there's a second competitor we see it's probably [Nichia], but that's about it.

That's a combination of access to the die technology and also access to some packaging technology.

And then the third piece is do you really have the IP to do it the way you want to do it.

What we see out there a today is and I think [Lumileds] is probably my best proof point right, here is a company that essentially invented the first power LED more than 10 years ago and we saw them stumble because the technology is extremely complicated.

Creating a high power LED and then packaging it, there's a lot of technology LED, and I think we are several years down the road to where there is a differentiator on the performance end.

That doesn't mean there are not people who won't come out in the mid to low end of the marketplace, and I think you are always going to see that, but I think there's a segment, as long as the lighting market is driven by lumens per watt and efficiency and performance, I think then we are in a pretty good position to really drive that segment for at least the near future.

That's helpful.

And the last question, just a housekeeping question here.

Can you tell us a little bit about the total distribution channel, maybe how that compared to the March quarter to the March '07 quarter?

Yes, while March '07 distribution was a pretty small part of our business, March '08 distribution is the driver of the LED -- power LED component side of the business, and it's a growing piece of the regular component as well.

Our goal as we came into the year was really to build up that channel to drive the market because we are talking about really trying to approach hundreds and thousands of customers.

And I would say that it's gone well.

It's a combination of both the big guys, the [arrows] and the world piece, but also a lot of regional distributors, and that combination is working well, and we definitely have work to do.

I would say today we've really got -- while we've had good success in North America and Asia, there is a lot of opportunity for us to have more success in Europe right now, and that's kind of where our focus is, but it will continue to be an important part of the growth strategy in '09.

Thanks.

Sure.

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

Good afternoon.

Just a couple of quick questions here.

Your four-inch wafer transition may lead to power devices.

Where do you stands in terms of translating that to your LED and other lighting business?

Yes, we are four inches at last quarter we got started and we did produce -- we were able to get some initial products qualified and then to a relatively small percentage of the total production, but it went pretty well.

We are now shifting our focus to starting to qualify some of what I'll call the more new products or the newer generation, which is a combination of both the very bright small chips, as well as the power LEDs.

That's going to happen here over the next couple of quarters.

So I think we are on track after one quarter, but you haven't seen a significant impact really to the big runners yet, and I think it's something that we will see more in kind of the first half of fiscal '09.

So it's going to take another quarter or two to get more of these products qualified and start to make it a significant part of the production.

So if you're looking for an effect on the business, it's really first half '09.

Okay.

And I missed the comment on your inventory growth quarter over quarter.

Was the inventory growth mainly on the raw material side including substrate, or what was that?

Not substrates, since we made our own substrates that would be WIP.

But the growth was on raw material.

More than half the growth in inventory was raw materials and the addition of the LLF acquisition.

So those two things were just the nature as we grow the supply chain out and add a bunch of new product lines.

The rest of it was in WIP and FGI split between the two of them, but it's less than half of it, and it's really the nature of we have a vertically integrated supply chain from wafers to chips to packaging in Asia, and as we extend that supply chain to Asia we are working through how we manage that, and the reality is that it's longer than it was six months ago.

But that's what we are working on.

Okay.

And then back to this litigation that you have, especially with the Bridgelux, I know you expanded the scope a little while ago, and I think a lawsuit has been going on as much as I can tell at least a year and a half.

So, I mean, does this thing typically drag out like this, or can you tell us a little bit more about where you are in terms of the stage and why you're projecting this lengthy sort of expenditure?

Well, so, I think whether you give an IP litigation you know at some point the expenditures are going to go up when they get near time, when you are going to start to actually the cases get beyond the discovery phases and actually get into the court phase.

We are starting to get close in part of the Bridgelux suit in get to go then the Bridgelux suit is more than one, there's a Texas case as well as a case in California.

So it's just the nature of where those are in their process and this is the time where it ramps up, and we get to pay the outside lawyers a lot of money to try to do their job.

It's not unexpected, but it's hard to predict because the courts really control the timing.

And until you get to a certain point they don't start scheduling these things firmly and you don't see these things in incremental expenses.

So I think in the short term we are in kind of a probably fairly heavy period for the next couple of quarters, at least at this point.

But again the courts can reschedule think change the timing, and we are just going to have to react to it as it happens, a little bit out of our hands.

(OPERATOR INSTRUCTIONS) Thank you.

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

This is Will calling in for Harsh.

Just a couple of quick questions.

Were there any 10% customers during the quarter?

We only break those out in the K.

There were no -- I can tell you there were no significant customer shifts in the quarter.

All right.

And then on CapEx, can we get a little color on that, are you all capitalizing some things that you previously didn't?

No, not really.

The $45 million to $50 million is the same target range we gave you last quarter.

So we are pretty much staying within that range, and it's pretty much the same as usual.

Your next question comes from the line of Bennett Notman with Davenport & Company.

Yes.

Hi.

A couple housekeeping items that I missed.

I know you gave guidance for gross margin in the coming quarter, but I missed the number.

What did you say it was?

The quarter, for Q4 it's 34% to 36%.

Okay.

And then on the LED chip business, you said that was flat sequentially pretty much?

Yes.

So I'm just trying to understand sort of what falls into the buckets of the component business, how much of COTCO is in that versus I guess other products?

Yes, so basically chips is in chips, and then basic components is the combination of our XLamp products and the former COTCO products, which we call high brightness components now.

Both of those combined are what we call LED components.

Our next question comes from the line of Hans Mosesmann with Raymond James.

Thanks.

Chuck, government contracts, you mentioned it's going to be much less of a factor.

How should we view that over the next several quarters?

What magnitude are we going to model there?

Yes, I think John gave you a sense it's going to be down a bit more in Q4.

I don't know, John, did you give them a specific number?

No, I didn't give a specific.

It's going to be down a little bit more and I think this is the level we will settle at for the next couple of quarters.

It doesn't mean there's not additional government funding out there and we continue to work on things.

It's kind of the nature of the timing right now.

So, I think my best estimate at this point is, is after we get to the Q4 level it will probably sit there for at least the next couple of quarters, and then there may be some opportunities to slightly increase it, but on a relative basis, Hans, as a percentage it's probably likely to continue to shrink on a percentage basis in either case.

Okay.

And two quick follow-ons, on inventory, I know they are going to -- you want them to come down a little bit, how should we view inventories with this new model or transitioning to more of a component company?

We now own our -- when we make components unlike most people in components business we own our whole supply chain, so we own the chips and the wafers.

I think at the current levels we're at, we are going to try to keep it at these ranges.

We are going to see if there's things we can do to squeeze it down a little bit.

I think we are not going to put a projection out there for you, because it's really -- this much business now the chips being made here and moving to Asia for packaging I think we are still putting in place some systems to really get a better handle on it going forward.

I would imagine our goal would be to not have it grow significantly from this point.

At the same time, I think we do have a different model and so we are still really

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

The LLF revenue expectations for Q2, can you give us a target gross margin for that segment?

Should we think in the lines of where (inaudible) was in the mid [50%s]?

What I would think is we don't break it out specifically, but I can tell you that it will start out below the corporate average.

So there is definitely some -- we have some opportunities there to reduce the cost and improve margin in that product going forward.

It is not at a mature product line level at this time.

Okay.

And then can you also following up with one of the Carter's question talk a little bit about your strategy as relates to perhaps licensing your IP to some of the Asian chip manufacturers?

There's been some rumors about that this morning out of Taiwan, that you were involved with the licensing deal.

Chuck, if you could just comment on that and if and going forward?

Yes, you know what, we generally haven't been very active in licensing out technology or IP to anyone in Asia -- I shouldn't say Asia, that's too broad, in Taiwan.

I think we have done some things in the past.

We have a fairly broad cross licensing arrangement with [Nichia], and we have more of approach to cross licensing than straight out licensing our technology or IP.

and I think that's kind of our approach going forward, does that mean we won't make an exception?

There's always a chance we can make some exceptions if the business case made sense, but as of right now our focus is more about, if we are going to do some licensing it will probably be more of the nature of cross licensing with some of the people with really deep IP portfolios.

Our next question comes from the line of Jed Dorsheimer with Canaccord Adams.

Hi, thanks.

My first question is, Chuck, you mentioned Bridgelux and Newmark in terms of litigation, but I didn't hear a Honeywell or a Honeywell intellectual properties.

Any comments on that?

And then I have a follow up.

Thanks.

Yes, Jed, no, on the Honeywell, I just didn't mention it because it's not a significant driver to the cost increase in the near term is the only reason I didn't mention it.

It's out there but it's still really early stage stuff.

So it's not what's driving our financial forecast from a patent litigation expense standpoint.

So, it's just early until that one that's the only reason I didn't mention it?

Alright.

And then my second question has to do with some of your related party transactions, specifically some of the ones that Mr.

[Lowe] is involved with.

As we look at Lighthouse, COTCO, LLF, United Luminous International and Light Engine, the $21 million sequential jump in receivables, could you provide any additional color on how much of that sequential increase was to any of those five companies?

So where -- so I'm a little bit confused in the five companies because I think --

So Lighthouse I think through Gold Peak is the --

Lighthouse and who else did you say?

Well, you've acquired COTCO and LLF, so count those out.

COTCO is us now.

Right, so --

Yes.

So you are not at Luminous, sorry.

So you're not at Luminous International and Light Engine, which I think is now a 10% customer of yours.

I think United Luminous and Light Engine are kind of the same company, but I would tell you that two things, one is that they are important customers, we obviously don't break out percentages at this point in the year.

That they are important customers to us.

I would point out to you, by the way, that they have actually been declining percentage wise from where they actual were, but they are still big important customers for us.

But the other parts of the business have actually been growing a little faster.

And from a payment standpoint I don't think they represent any of the increase in accounts receivable.

I don't have the specifics in front of me, but I don't think they make up any of the change.

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

Great.

Thanks.

One more was, I wanted to know a little bit more about the closer of the LLF acquisition, can you talk a bit about management teams roles there, in particular Neal Hunter, Cindy Merrell.

Are they have been given incentives to stay on or any insight into what their plans are?

Thanks.

Yes, Mike, they are definitely innocent advised to be a part of not only staying on in the near term, but really helping to grow that business.

It's actually part of we describe that there was the earn out is designed around some mile -- product milestones as well as employee retention and in terms of what their roles are, Neal is running that business.

So Neal is the President of LED Lighting Solutions, and he continues to drive their push into the lighting market.

Some of his key people: Mike Rogers, Cindy Merrell, Gerry Negley, Tony van de Ven, the founders of the company, those guys are still there, basically in very similar roles to what they had before the acquisition, and we are letting them run and we want them to make it successful.

It's part of one larger Cree company, we are all on the same team, but that being said we are really trying to let them continue to be aggressive and drive the market.

Okay.

Good to hear.

Thanks.

Our next question comes from the line of Hans Mosesmann with Raymond James.

Thank you.

That was the question I wanted answered.

Thank you.

Our final question for today comes from the line of Andrew Huang with American Technology Research.

Hi, just a couple quick follow-ups.

John, could you repeat the gross margin guidance on a GAAP and nonGAAP basis, please?

The gross margin guidance for next quarter is 34% to 36%, and that's the same for both GAAP and nonGAAP.

Okay.

Got it.

And then, Chuck, I think there was the press release out in the last couple of days talking about the Cree solutions provider network.

So I was wondering if you could kind of give us an idea of how that's going to work, and maybe then give us a sense of the traction they are getting?

I recollect the way to think about the solution providers is they are third-parties out there that basically understand our XLamp products and services pretty well, but more than just understanding XLamp they bring some design expertise from a lighting systems standpoint.

One of the challenges of making LED lighting happen is that a lot of our customers have frankly never designed with LEDs and don't understand a lot of the subtleties.

So their role is to bring expertise, whether that be thermal, optical, drivers or a combination of all that kind of bring that together for the customer.

So, the easiest way to think of them is they are kind of an extension of our sales force, and we really use them to complement not only our direct sales activity, but actually what the distributors are doing as well.

Got it.

Okay.

Thanks a lot.

All right.

Thank you.

Okay.

Thank you for your time today, and we appreciate your interest and support, and look forward to reporting our fourth quarter of fiscal 2008 results on August 12, 2008.

Have a good evening.

Thank you.

Thank you for your participation in today's Cree, Incorporated, third quarter 2008 fiscal year financial results conference call.

You may now disconnect.