Wolfspeed Inc (WOLF) 2009 Q1 法說會逐字稿

Good afternoon.

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

At this time, I would like to welcome everyone to the Cree Incorporated first quarter 2009 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 October 21st, 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, Jennifer, and good afternoon.

Welcome to Cree's first quarter fiscal 2009 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 2009.

Please note that we will be presenting both GAAP and non-GAAP financial results in our remarks 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 September 28th, 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 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 first quarter of fiscal year 2009 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 presentation and the recording of this call are copyrighted property of the company and no other recording, reproduction, or transcription 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, since we plan to complete the call in the allotted time of one hour, we recognize that other investors may have additional questions, and we welcome you to you 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 November 4, 2008.

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

Thank you, Raiford.

Fiscal 2009 started strong in the first quarter with record revenue of $140.4 million, and non-GAAP net income of $13.2 million or $0.15 per diluted share.

Non-GAAP gross margin increased to 36% for the quarter.

These results were on the high end of our previously announced target ranges.

The revenue growth was driven by LEDs, including another strong double-digit increase in XLamp sales.

High brightness LED components and LED chip revenues were in line with Q4 and LED lighting sales grew double digits.

The growth in LEDs more than offset a 14% decline in power, RF, and contract revenue, due mostly to lower demand for our silicon carbine Schottky diode products.

The strong increase in gross margin was primarily the result of higher throughput in our LED chip factory and improved XLamp yields, which resulted in higher XLamp product margins.

Working capital was in line with our target levels as inventory days on hand declined to 78 days and DSO declined to 66 days.

Cash flow from operations was a very healthy $42.1 million for the quarter and our balance sheet remains strong with $339 million in cash and investments and no debt.

As we start our second fiscal quarter, we continue to evaluate the impact of the recent turmoil in the global financial markets on our customers and our business.

We have seen some signs of lower demand for our power products and IT related applications, but current customer forecasts for LED products remain pretty solid.

We anticipate, however, that the economic uncertainty and lack of consumer confidence will eventually have some impact on the markets we serve.

At this time, our targets for Q2 indicate that we should be able to deliver sequential growth, but we are becoming more cautious about fiscal Q3, which is historically a seasonally slower quarter for Cree.

As a result, we are taking a more conservative approach to operating expenses and capital spending in the near term.

However, we still plan to make new investments to support the targeted growth in LED components and lighting product sales as the LED lighting revolution continues to gain momentum.

I will now turn the call over to John Kurtzweil to review our first quarter financial results in more detail and our targets for the second quarter.

Thank you, Chuck.

I will be providing commentary on financial statements on both the GAAP and non-GAAP basis, which is consistent with how management internally measures Cree's results.

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

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

A reconciliation of the non-GAAP information for all quarters mentioned on this call is posted on our website as well as a historical summary of other key metrics.

For the first quarter fiscal 2009, revenue was $140.4 million, which is within our targeted range for the quarter of $138 million to $142 million, a 24% increase over Q1 of fiscal 2008 and a 3% sequential increase over Q4.

GAAP net income was $5.9 million or $0.07 per diluted share and within our targeted range for the quarter of $0.06 to $0.08.

On a non-GAAP basis, net income for the first quarter was $13.2 million or $0.15 per diluted share, which excludes $7.3 million of expense net of tax, or $0.08 per diluted share from the amortization of acquired intangibles and stock-based compensation expense.

Non-GAAP earnings were consistent with the company's previously announced target range of $0.13 to $0.15.

This is a 50% increase of non-GAAP earnings per diluted share compared to the first quarter of fiscal 2008, which excluded similar items as well as the realized gain on investment and property tax expense adjustments.

Cash provided by operations was $42.1 million.

Free cash flow was $30.3 million, and we ended the quarter with $339 million in cash and investments and continued to be debt free.

LED revenue increased 32% when compared to the same period last year and 6% sequentially to $123.3 million, while non LED products and contract revenues were down 12% sequentially to $17.1 million and down 15% from the same period last year.

LED revenue was led by double-digit growth in both XLamp LED sales and LLS products.

LED chips and our high brightness products were in line with our target and in a similar range as Q4.

As we had forecasted at the beginning of the quarter, we saw a decline in our non-LED product lines in Q1, primarily due to lower silicon carbide power device sales and lower government contract revenue.

Q1 GAAP gross margin was 35.2%, which was an increase of 460 basis points year-over-year and 150 basis points sequentially.

Non-GAAP gross margin was 36.1%, which excludes stock-based compensation of $1.3 million or approximately 90 basis points of margin.

Non-GAAP gross margin was at the high end of our targeted range, primarily due to volume benefits from higher throughput in our LED chip factory and improved XLamp yields, which resulted in higher XLamp margins.

Operating expense was $44.7 million on a GAAP basis and $36.5 million on a non-GAAP basis.

Non-GAAP operating expenses exclude approximately $4.1 million of stock-based compensation expense and $4.1 million of charges for amortization of acquired intangibles.

This is higher than our targeted range, primarily due to increased R&D spending on new LED chip development and LLS products.

Net interest income and other decreased year-over-year to $3 million, but was above our targets primarily due to higher cash balances than we targeted.

Given the recent uncertainty in the debt market, and the most recent 50 basis point drop in the Fed funds rate, the average return on our cash is expected to decline in the second quarter.

The tax rate for the quarter was 22.8%, which is slightly higher than our 22.5% targeted.

This relates to closing out fiscal 2007 and earlier returns with the IRS.

The balance sheet strengthened during the quarter as we continued to make progress on working capital.

Days sales outstanding declined 9% to 66 days from 73 days in the prior quarter, as accounts receivable decreased by $6.9 million to $103.4 million on a $4.5 million increase in revenue.

We also decreased our inventory days on hand 3% to 78 days from 80 days last quarter as inventory declined by $0.9 million to $79.2 million.

Cash flow from operations was $42.1 million and capital expenditures were $11.9 million for a free cash flow of $30.3 million during the quarter.

We used $2.7 million in cash to repurchase approximately 130,000 shares of the company's stock at an average price of $21.18 per share during the quarter.

With the growing economic uncertainty, it has become more challenging to forecast the business and has increased the chance that our actual results could differ from our target.

We anticipate that the lack of consumer confidence will eventually have some impact on the markets we serve.

At this time, our forecast for Q2 indicates that we should be able to deliver sequential growth and we target revenue to increase to a range of $142 million to $146 million, driven primarily by double-digit growth in both XLamp LEDs and LLS products.

We target high brightness component sales to be in a similar range and LED chips slightly lower than Q1.

Power and RF are also targeted to be in a similar range while material sales and contract revenue are targeted to be a little lower than the previous quarter.

Gross margin is targeted to be in a similar range as Q1 with GAAP gross margin of 35% to 36%, which includes approximately $900,000 or 60 basis points of stock-based compensation expense.

On a non-GAAP basis, we target gross margin to be in a range of 35.5% to 36.5% when you exclude the stock-based compensation expense.

We are targeting slight improvements in gross margin from current products to be offset by slightly higher costs on the ramp-up of several new products during the quarter.

GAAP operating expenses are targeted to be approximately $45 million to $46 million and include approximately $4.3 million of noncash stock-based compensation expense and $4.1 million of charges for amortization of acquired intangibles.

We target R&D and selling expense to be flat quarter over quarter with an increase in G&A expense primarily related to litigation expense as we start to gear up for IP related trials scheduled for calendar 2009.

We target that litigation expenses will increase again in the third fiscal quarter when the Texas BridgeLux case is scheduled for trial, and remain at that level into the fourth fiscal quarter due to preparations for the Newmark case, which is anticipated to be scheduled for trial in the summer of calendar 2009.

Interest income and other is targeted to be approximately $2.7 million, based on lower returns from our investment portfolio and lower average cash balances than in the first fiscal quarter.

We are targeting our effective tax rate to be 22.5% for the balance of the year.

Based on an estimated 89 million diluted shares outstanding, our GAAP EPS target for the second fiscal quarter of 2009 is expected to be in the range of $0.07 to $0.08 per diluted share when amortization of acquired intangibles and stock-based compensation are included.

We target non-GAAP earnings per diluted share in a range of $0.15 to $0.16 for the second quarter of fiscal 2009.

Our non-GAAP EPS targets exclude amortization of acquired intangibles in the amount of $0.03 and noncash stock-based compensation the amount of $0.05 per share.

Receivables are targeted to increase in relation to our revenue growth while days sales outstanding are targeted to be in the current range or slightly higher.

Inventories are expected to also increase to support our growing XLamp and LLS product lines while days are targeted to remain in a similar range to slightly higher.

We are targeting capital expenditures in the quarter to be in the range of $15 million to $18 million primarily for additional capacity, new product introductions, and the continuing transition of LED chip production to four-inch wafers.

Thank you for your time and attention.

I will now turn the discussion back to Chuck.

Thanks, John.

As I stated last quarter, we are focused on four key areas in fiscal 2009 to continue to drive our transformation into a global leader of energy efficient LED components and lighting products.

Our first priority is to drive topline growth for Cree through higher sales of LED components.

In Q1 LED components continue to increase as a percentage of overall LED revenue, as XLamp sales once again grew double digits sequentially and high brightness LED sales were in line with the previous quarter.

We target LED components to lead the growth again in Q2 driven by another double-digit increase in XLamp LED sales, while our high brightness components are targeted to remain in a similar range as Q1.

Our second priority is to build upon market leadership in LED lighting by driving LED adoption through higher sales of our LED lighting products, continuing to develop new products that raise the bar for lighting class performance, and expanding Cree's brand awareness through our market development activities.

LED lighting product sales increased in Q1, but at the lower end our target range.

The sales in Q1 were limited by some delays in a ramp-up of several new products as orders increased faster than shipments.

In hindsight, we determined that we need to increase our finished goods inventory levels in North America to better serve this growing customer base.

Demand has continued to increase for our flagship LR6 product and we have already seen strong initial orders for our soon to be released LR24 product.

We are working to resolve the manufacturing bottlenecks and target double-digit revenue growth for these products in Q2.

We recently announced an important new strategic agreement with Zumtobel, who is one of the world's leading lighting fixture companies, where they will sell Cree's award-winning LED downlights in Europe through their extensive sales channels under both the Zumtobel and Thorn brands.

This agreement signals an important step for Cree and is targeted to accelerate the LED lighting revolution across Europe by providing Zumtobel's customers with energy efficient and long-lasting product that save energy, save money, and help protect the environment.

We also made great progress extending our leadership in lighting class LED components in the quarter as we released both our new XP and MC series of XLamp LEDs to initial production.

These products bring lighting class performance to new package form factors, which should enable our customers to address a wider range of lighting applications.

Initial production for both of these products is underway in Durham and we plan to transition them to high-volume production at our China factory in the second half of this fiscal year.

Our third priority is to increase new product margins and build operating leverage.

As we have stated over the last couple of quarters, improving our gross margins is key to driving operating leverage.

This starts with our new product lines.

We made nice progress in Q1 as gross margin increased to 36%, due primarily to higher LED chip factory utilization and higher XLamp LED margins as we were able to increase XLamp yields.

We remain focused on a number of activities to help improve margins over the next year, including further yield improvements at the chip and package level, capacity additions in Asia, volume benefits due to increased factory loadings, and the transition of LED chip production to four-inch wafers.

Our fourth priority is to continue to grow our commercial power and RF product revenue and transition this product line from the current level of a slight quarterly loss to adding to the bottom line in fiscal 2010.

As we had forecast at the beginning of the quarter, this business declined 14% in Q1 primarily due to lower silicon carbide power device sales as two of our major power supply customers reduced orders during the quarter in response to anticipated slower demand in the IT sector.

On a positive note, we recently received our largest order ever for commercial RF devices, which is expected to provide a solid base of RF business over the next year and should help offset some of the fluctuations in demand on the power side of the business.

Our goal over the next year is to begin to realize more of the potential for our Schottky diodes from a broader customer base and we are working to increase both our direct and distribution sales coverage to improve our customer reach.

Expanding our sales channel remains a high priority, as demonstrated by the recent addition of Digi-Key and Farnell to our global components channel.

Sales to distribution continue to increase as a percentage of total sales in the quarter, and we estimate that our distributors' days of inventory were in line with our targets for both LED components and LED chips.

Our market strategy of using our LED lighting product line to lead the industry is working.

Recently, some of the traditional lighting companies have reacted to our award winning LED downlight products and decided to introduce their own LED- based products.

While this creates competition for our LED lighting product line, that is part of the plan, because it also stimulates overall demand for LED lighting, which then fuels the growth in LED component sales.

Given the financial market issues and greater economic uncertainty, it has become more challenging to forecast the business, and increase the chance that our actual results could differ from our target.

We target revenue in Q2 to increase to a range of $142 million to $146 million, driven primarily by double-digit growth in XLamp LEDs and growth in our lighting products.

We target high brightness LED component sales to be in a similar range as Q1 and LED chips to be slightly lower.

Power and RF are targeted to be in a similar range, while material sales and contract revenue are targeted to be a little lower than the previous quarter.

We target non-GAAP earnings in Q2 of $0.15 to $0.16 per diluted share, as higher sales and similar gross margins are somewhat offset by higher G&A costs related to IP litigation and some near term execution risks in lighting and RF.

Please note that our non-GAAP targets exclude amortization of intangibles, stock-based compensation expense, and related tax effects.

Our strategy to focus on LED lighting to drive revenue growth has worked well over the last seven quarters, and we are targeting more of the same in the year ahead.

We are not immune to the economic cycle, but we are well positioned to take advantage of the growing trend for energy efficient lighting, and we remain focused on our mission to obsolete traditional light bulbs.

We will now take analyst questions.

Your first question comes from Harsh Kumar.

Hey, guys, first of all congratulations -- these are, I'd say, extremely good numbers in what I'd characterize as an extremely tough environment.

Couple questions.

Your product, inherently by nature, is sort of discretionary, and somewhat to the high end of the range.

Given this economy, first of all, I'm somewhat surprised you haven't -- you mentioned that you are seeing strong LED demand still, particularly in XLamp.

Can you help us put together all the parts and pieces in what's driving that, and why you haven't seen some of what the rest of the world is seeing?

Harsh, obviously it's -- as you listen to enough earnings calls you realize we're seeing something a little different than other people.

What I can tell you is what our customers are telling us right now.

XLamp continues to look pretty good this quarter.

Obviously we're targeting double-digit growth again.

The high brightness business looks solid.

Maybe we're a little different there because we have pretty good exposure in the China market itself, and although the export business looks like it might be under a little pressure in China, I think there's still domestic growth there, and so obviously we benefit from products that are sold in China that stay in China.

And then I think on the LED chip side, I think what you are seeing is that over the last couple years we have really reduced our dependence on the consumer side of the business.

And that's not to say that we don't have some exposure there.

We do.

But I think what you are seeing is the fact that lighting is the biggest driver has helped us probably weather this, at least initially, better than others.

What happens beyond Q2 and Q3, it's hard for us to forecast.

We don't have that visibility right now.

But I think the lighting markets, we're still seeing demand for more energy efficient products, and I think it's generally helping us across the business.

I will also say the other thing is that the conversion of back lighting for notebooks to LEDs is probably also helping a little bit on the chip side.

So I think we have two factors that are probably helping us at least in the near term.

We'll see how that goes as we get through this quarter and into next.

Hey, that was very helpful, Chuck.

Quick follow up for you.

XLamp, great job on the gross margins, by the way, increasing them very nicely.

How much room -- could you give us an idea of your XLamps margin?

Are they equal to or are they still below corporate average?

How much below do you think and long it will take?

XLamp is a name that we started out talking about one product and it's actually a whole family of high-power products now.

So if you look at our XR-E and XR-C products, which are the ones we've had in the market for a little over a year, we've got them to China, we've been working on the yields -- those are actually driving the gross margin for the company now.

Those are adding to it.

We made tremendous progress in the last couple quarters there.

At the same time we are now launching the new XP and MC series.

So we're going to have new XLamps also coming online.

So I think you would have to split that out.

If you look at the ones that have been running a while, those are now driving the company's gross margins, but I think the new ones are going to give us plenty of opportunity to increase yields and hopefully work those up.

It really goes beyond that, because when you look at the Cree overall gross margin, remember that high brightness, we have opportunity there.

I think we continue to have opportunity in chips as well as on the lighting product and power and RF.

So we have made good progress specifically in the XLamp area, but I think we've got room to improve in a lot of other ones.

That being said, this quarter is going to be obviously a little challenging because we've got a whole bunch of new products coming on line.

So that's why we're targeting a similar range as last quarter.

Very helpful.

Last question and I'll let somebody else get on.

Could you characterize for us if you are seeing revenues already from back lighting for laptops yet?

Or how much it was?

Any way to break that out?

What I can tell you is that our chip business is getting some business for the notebook back lighting market.

I would tell you it is not a big piece of business, but we are winning some chip business that segment.

I will jump back in.

Thank you.

Your next question comes from Dale Pfau of Cantor Fitzgerald.

Your line is now open, sir.

Good afternoon, gentlemen.

Let me add my congratulations.

Spectacular performance in these challenging times.

My first question has to do with your recent announcement about your new distributors that you've got out here, including Digi-Key and -- ?

Farnell.

Farnell.

Maybe you could give us a little overview on your distributor strategy and the overlap or nonoverlap of these various distributors out here.

Yes, so if you look at what we started with, obviously Arrow was the -- they're the big dogs, one of the two largest distributors in the world.

So they are core to our global distribution strategy and they are able to manage accounts, both small to medium size all the way up to those global companies.

We also have World Peace, which is also a very important player.

I believe they're now the third largest distributor in the world.

For our Asia strategy, they're an important piece.

So we have the big guys covered.

What we have been looking to do is there is -- because we are getting into new markets, especially from a lighting standpoint, there is just -- we estimate there's thousands of small companies out there designing with LEDs, trying to create new products and we really wanted exposure to what I'll call the catalog or the on-line distribution channel.

At the end of the day, Digi-Key and Farnell -- Digi-Key in North America, and Farnell probably everywhere else -- are the two premier catalog on-line sales distributors.

It's really an area that neither World Peace or Arrow puts much emphasis on.

So it was really important for us to build that piece out.

It's not a significant high-volume sales channel, but does it get to us lots of customers, so that's what we're trying to do there.

Okay.

And are you going to use those sales channels for all your products, including the variations on XLamp?

Right now we plan to use those channels for all of our LED components and also probably for, over time, most of our power components.

We'd see both of those product lines there.

LEDs are in those and power is currently in some of those distributors.

Okay.

One more quick question here.

As we continue through this worldwide financial crisis, as we call it that, could you maybe talk a little bit about the competitive dynamics and the advantages that maybe your balance sheet and your IP give you as we move through this?

Well, let's see.

We'll start at the balance sheet.

It's certainly nice to have $339 million in cash, and I will anticipate potentially the next question.

Very conservatively invested.

So we don't need to raise capital.

We can use that to drive our business, and at the same time -- I think, Dale, you've known us long enough to know we've run this place relatively conservatively.

I think it gives us lots of options to look at different ways to approach the market.

We are going to be able to drive the business the way we think we need to.

I think it will put pressure on people that are highly leveraged.

And so from just a pure balance sheet standpoint we have got a lot of options.

I think from an IP standpoint, I think what we've seen is the -- if you look at just some of the -- our Taiwan competitors, they are reporting pretty big declines, month to month and year over year, at least in the most recent data.

I think what you see is they're clearly having trouble either accessing certain markets, either from a performance or an IP standpoint, and it's probably in some cases one or the other, and in some cases both.

And so I think that's also helping us probably hold up a little better than others.

Again, we're all curious what happens in Q3, but at least at this point the early returns say that we're in a -- relative to everyone else we're in a favorable position.

Great.

Thanks.

Your next question comes from Yair Reiner from Oppenheimer.

Your line is now open, sir.

This is Michael [Smith] for Yair Reiner.

Can you hear me?

We can hear you.

Congratulations on the quarter.

Thanks.

Can you give us a sense of any revenue contribution by product segment or any proportion?

Like which applications are driving it, or more from a Cree product line standpoint?

I guess components or XLamp things?

I'll answer both of them pretty quickly.

If you look, the fastest growing segment, really what's driving the growth is LED components.

As I said earlier, the high brightness was fairly stable with last quarter, so most of that growth this quarter came from the XLamp side of that product line.

As we commented, chips was pretty similar to the previous quarter, so that's pretty stable.

And we got a little bit of incremental increase from the lighting products.

So I would say LED components is the growth driver, and then power and RF was actually down sequentially.

So that's from a product standpoint.

If you flip that around and ask the same question from a market standpoint, it's really what we would call lighting applications, and that's a fairly general term.

It's everything from architectural, portable, indoor and outdoor commercial, refrigeration, all that large group of lighting.

That would be -- if you combine our chips and all of our component products, you would actually see that that is by far the largest segment we're in now, and then followed by the display business would be the second.

So that's kind of what's driving it from an applications standpoint.

Very helpful.

Which parts of those end markets do you have the greatest degree of visibility, whether it's, like you said, China or specialty lighting or consumer?

I'm not sure that there's any one end market we have better visibility in right now.

If I look at where we are at this point -- at this point last quarter, we'll have about the same visibility, and it's pretty much spread pretty evenly across our business, whether it be high bright components is about the same, chips is about the same, XLamp about the same.

The one area that we probably have better visibility on is the LLS or lighting products.

Those are probably -- we have the most visibility on.

It's a relatively small part of business, but we clearly have pretty good order flow there.

That one is actually running ahead of the rate it was at this point last quarter.

But generally speaking, about the same.

Okay, great, thank you.

One more question.

Do you have any 10% customers, or I guess the add-on question is if you can talk about related party contributions?

So we don't break out 10% customers or related parties on a quarterly basis.

I can give you some color, though.

If you look at the related parties we disclosed in our K, they were Light Engine and Conway, and they're part of the high brightness LED business.

And we mentioned earlier that high brightness was pretty flat quarter to quarter.

So that business is pretty stable, and I don't have the specifics on those, but I think those guys were pretty close.

I think they were down a little from the previous quarter, but not a significant change, down a little bit.

And then I think the only other area that would probably be a big customer is Sumitomo and that's been the chip business, and they've been pretty stable for the last four, five, six quarters.

There's not really a big change one way or the other in that business.

Do you have any feedback on those guys on visibility or anything like that?

You know what, right now what we're seeing in the LED business is that the visibility from our customers is -- they're giving us the same visibility that we get last quarter.

When we ask them, they're seeing about same right now.

Obviously there's lots of uncertainty.

None of us -- we never have visibility into the quarter beyond, but I think right now we're all cautiously optimistic.

At the same time, we're not sure how Q3 is going to pan out at this point.

Thank you very much.

Sure.

Your next question comes from Daniel Amir from Lazard Capital.

Your line is now open, sir.

Thanks a lot and congratulations on the quarter.

Couple questions here.

First of all, follow-up on the LLS.

Can you highlight where the success is now, what's going on beyond the US?

It seems like you said your visibility I guess is improving there.

Yes.

On the LLS business -- that is primarily today a US business.

So from what we actually sell direct, that's all in North America.

What we do have the benefit of now is with the Zumtobel relationship, we now have business in Europe that will be starting up as well.

We'll make our first shipments to those guys this quarter, so that's really new business for us.

What it's really doing is giving us exposure to a whole other continent that we frankly weren't selling our product into.

In terms of the stuff driving the order flow, in North America what we are seeing is we're a little over a year into selling the LR6.

And what we're seeing is that in the whole retrofit market area where people are doing conversions, we continue to see uptake.

They're small to medium size customers.

I think what we see is this idea that spending a little money for LED lighting and getting a payback on both the maintenance and the energy savings at least for some segment of our customer base is working pretty well at this point.

Again, it's a relatively small business today, but the basic business theory we've been trying to prove since we bought that business so far is holding in there pretty well.

Okay.

And on the power RF business, it looks like near term still is a bit choppy.

Do you expect it to stabilize in the March quarter with its -- with this new order that you guys have gotten that will impact calendar year '09, or is it something that is going to see still a bit of lack of visibility in the near term?

Yes, the way I would look at that is I would tell you -- so there's really the two segments, the power and the RF side.

I think the power side is seeing some of that general economic weakness, because I think it -- I don't know if it's IT sector related specifically or not, but that's where we're seeing it there.

The good news is that with the RF order, it's helping offset that.

So we're targeting our power RF business to be fairly similar in Q2 as it was in Q1.

At this point, I don't have good enough visibility on what it looks like in Q3.

I would imagine because we have a pretty good base customer in RF, it will be pretty stable going forward and really be a question of what happens on the power demand side.

It's too early to call that, how that might look in the first half of the calendar year.

Okay.

And then last question is, where do you stand on the four-inch wafer side?

What's the update there in terms of what your plan is?

So we've been working to qualify additional products, made progress last quarter.

But in terms of a percentage of our production, we're mostly focused on the engineering in terms of getting the products and the processes qualified.

We have not converted a large percentage of the production yet.

That will happen over the next several quarters.

But one quarter in, we're on track and I would say that our target to have pretty much all the major product lines fully converted by the end of our fiscal year -- we should still be on track to do that at this point.

Okay, great, thanks a lot.

Sure.

Your next question comes from Mike Burton from ThinkPanmure.

Your line is now open.

Can you guys talk a little bit more about your progress with your two new distributors?

Obviously it takes time to get these channels up.

Are these distributors now pretty much online?

Are you comfortable with the level of inventory or is there still some more ramp ahead of us?

And when you say that, are you specifically talking about Digi-Key and Premier Farnell?

Primarily those.

If you have more to go on Arrow and World Peace, we'd love an update there too.

No problem.

Those guys are again broad but not high volume channels relative to the Arrows and the World Peace.

I would tell you that you've got some basic initial stocking orders into those guys last quarter.

It doesn't amount to much.

I think combined between both of them, it's less than a couple hundred grand.

So these are not big stocking distributors.

It's fairly small dollars.

It's more making it easier for the small customer to buy the ones and two pieces and get them quickly and overnight.

That's really the value add.

I would tell you that those guys are doing pretty good.

We still have work to do to get them fully trained on our products and do some other things, but from an initial launch I think we're satisfied with where that is after the first quarter, and I really think we'll see the impact there -- it will take to six to nine months to really see how broad we can go with those guys.

In terms of Arrow and World Peace, things have been running pretty well.

They've both been growing pretty well, and I said in my earlier comments that we feel like their inventory levels are about where they should be from where we're targeting -- maybe a little light, but that's all right.

That's probably a good place to be right now.

And the real challenge is how do we keep making sure that we can get the new products online fast enough to make sure they happen, because every time we introduce new products, it's definitely putting pressure on them to be able to deliver them.

But I think overall, what we tried to do in the last year with both of those guys, I'd say in both cases they're going pretty well.

Just to follow up with that -- so what is a comfortable range in terms of days, and then talk a little bit more about maybe by geography -- how is Asia versus Europe right now, and the US?

So we don't break out the specific days.

I can give you some flavor by geography.

I would tell you that North America, we're doing pretty well.

Arrow is really leading the charge there.

I think in Asia, Arrow and WPI are important players.

WPI is really driving the sales in that market.

They are doing pretty well there but WPI is probably a little ahead.

In Europe, I'd say that's the place we have the most work to do.

Arrow is trying to develop that for us, but we're probably a little behind in terms of both sales generation -- we've probably got the most work to do there at this point.

Any of these distributors approaching 10% of revenue?

I don't believe so at this point.

Maybe broken up, but I'm pretty sure it's because they're primarily selling XLamp today.

I don't think we're at that point yet.

Could you talk a little bit more about end market applications, automotive versus display and signage for last quarter and then the outlook heading into Q4?

Lighting is definitely the biggest, second is displays -- lighting -- it's funny, but lighting is probably twice as big as displays, and combine the two of them are significantly over 50% of the business at this point.

The next big three, and these are all going to be relatively small compared to those two, are going to be auto, gaming, and mobile.

And I would say that between those three -- they fluctuate from quarter to quarter.

All of them are less than 20% of the business and they move around quarter to quarter.

What we will see over time is -- I think the whole notebook backlighting segment start to come back up.

But again it's really just getting started at this point, so it's relatively small.

Last one.

A lot of discussion around some of the Asian competitors seeing pretty low utilization rates right now.

What have you seen so far as far as pricing?

Have you started to see some real pressure there in components or do you expect it to pick up going forward?

Well, so I think, two pieces to that.

Both the chip side and the component side.

I'd say on chips there's definitely excess capacity in Taiwan right now.

I was just there a couple of weeks ago, and it's pretty clear that their business -- because it's more linked to mobile and some of the consumer segments, I think they've felt -- they've seen the impact more than we have at this point.

So I think if you're in the low to medium end of the chip business, it's a tough business, but I don't know that it's significantly different than some of the signs we saw starting a couple of quarters ago.

So I think it's tough, but we're out there competing for that, and as you can see from our overall numbers, at this point the strategy -- because we're more on the higher end, more in lighting applications has held in pretty well.

I think on component side it's a little bit different.

We primarily compete in components in lighting and then the second biggest market for us is displays.

We are not a big player in the mobile or consumer markets in terms of our light -- our LED component-level products.

There's definitely some competitive things going on in terms of the component level business, in things like both mobile and in the notebook backlighting, but we don't have a big exposure to that at this point, and our whole challenge there is we have to keep developing chips that are bright and cost effective enough so our customers can win that business.

I said earlier we've had some initial success, but we've got work ahead of us, and we're hopeful that we can continue to win there, but I would imagine that will continue to be a very competitive segment.

But one we want to keep some exposure to, because it's important for our business.

Your next question comes from Hans Mosesmann from Raymond James.

Your line is now open.

Chuck, couple questions on LLS.

Can you give us a sense of how large that business is?

I know it's a small part of the business, but how big is it, and can you explain to give more granularity on the bottlenecks on the production side of that product group?

It's in the few million dollar range at this point, Hans, and in terms of the bottlenecks -- when the business originally was -- primarily a one or two SKU-type product.

I think when we completed the acquisition, it was primarily the 110 volt and had an Edison base and a GU24 base.

It was a fairly simple product line.

We right now have -- I think we're up to over 30 SKUs just on the LR6.

We have the LR4 and we're getting ready to launch the LR24.

And really what we're managing is as SKU proliferation goes up, it's a lot of engineering time and energy to get those products qualified ready for production, get the subcon qualified.

It's really what I would call new product introduction blocking and tackling.

And so we've redirected more resource to work at it, and I think it's just a matter of time and energy, and we will work through that.

But it is definitely -- the complexity of the product line has gone up and that's what we're working to manage.

Thank you very much.

Thanks, Hans.

We have a follow-up question from Harsh Kumar from Morgan Keegan.

Your line is now open, sir.

Hey, guys.

Quick question.

You mentioned that there's a lot of capacity in Taiwan.

Are you seeing them start to get really aggressive, perhaps on some of the markets you share on the border with them, and I've got one more.

Harsh, I would say they're already very aggressive.

They saw their capacity numbers start to move away.

It's been more than a quarter now.

I think they're already very aggressive on the mid to low ends of the marketplace.

I haven't seen a dramatic change in the last few months.

I think what's different is that I think they're complaining a lot more about their excess capacity than they were a few months ago.

Okay.

And then how much revenue do you think you left behind on the LR6, or the LLS business?

I'm not sure.

I think in terms of the orders we have, I'm not sure we left a lot behind.

I think what we're more worried about is as we sell those more integrated products, the customer expectation is that those are shipped from stock-type units.

I think one of the things we've realized is that we have to have more North American inventory so that whether it be a rep or a distributor, when they want a product, they're expecting one or two day deliveries on some of those things.

And that's more of a -- we probably lost some in North America there just because we didn't have stock, but I don't know that I can estimate how much that is.

We're at the pretty early stages of the market.

I don't know that we created any significant issues.

I think more than anything we've got to go ahead and address that so we can take advantage of the opportunity.

But I don't think it's been a big number so far.

Fair enough.

That's it for me.

Thanks.

Great quarter again.

Great guidance.

Thanks, Harsh.

Your next question comes from Carter Shoop from Deutsche Bank.

Your line is now open.

Good afternoon.

I wanted to touch base and try to better understand what investors should be thinking about in regards to normal seasonality for this business.

It sounds like for fiscal 3Q you are getting a little bit cautious about the seasonal factors there.

Maybe if you could walk us through about what kind of seasonality we'll expect in this business now that the overall mix of business has changed quite a bit over the past couple of years.

I'll give you some color.

I'm not sure it'll be as good as you might want.

We're still trying to figure that out ourselves.

I think we know that on the chip business, we know the parts of that that are consumer related, we know there's a slow quarter there.

We have seen that for a few years.

We have the most experience there.

In our high brightness business, which includes the high brightness products and the COTCO business in China, we know that Q3 -- the seasonality is not as much a demand issue for displays as much as a short quarter -- because of Chinese New Year, the domestic stuff fundamentally has lower demand.

Those we've got those two factors are the normal seasonality.

What we don't understand yet is XLamp has obviously grown a lot in the last year, and I don't know if we know enough about how to project what kind of seasonality there may or may not be.

So I think -- our caution comes from the fact that you've got these macro economic indicators.

We know that that's typically a quarter where we don't grow very much in chips and or the high bright business, and I think we're just trying to manage that.

So I think you're hearing us give caution but we don't have enough visibility to quantify it any more for you at this point.

Would it be out of the realm of possibility to see a down quarter sequentially, or is it not seasonal?

Is it feasible?

I think in this environment, anything is feasible.

I'm not sure -- we don't have enough visibility to give you that kind of guidance at this point.

That's helpful.

In regards to the guidance for the December quarter, wanted to better understand how much prudence you have put into that guidance, given the overall macro environment.

It didn't sound like you're seeing a material slowdown at this point.

Just curious on how prudent you are being, maybe accounting for some potential slowdowns later this quarter.

So that's obviously been a lot of discussion here internally.

What we have decided to do is we have a process that we've used now pretty successfully about the last seven or eight quarters that's been relatively accurate.

We went with that to provide our targets, which has a lot to do with what our customers are saying.

We checked.

We try to force them to make sure they're comfortable, things like that.

What I would tell you -- so I think our process is similar to what we've done in the past, and that's what led to our target.

Since our visibility is similar to where it's been the last couple quarters, that's where it came up with those targets.

I would also tell you, though, is that -- and we're making sure you understand this -- we think the data might be a little higher right now.

There's just so much other activity, we're concerned there may be higher variability than in the past.

Again, our best estimates are the targets we provided.

With that being said, I think we don't know what we don't know at this point, so we're using the process that's worked well and just trying to let people know that we think the variability could be higher.

That's helpful.

Some companies out there today are looking at their traditional process of how they provide guidance and maybe getting a 5% to 10% haircut just because of the increased uncertainties out there.

I can tell you we honestly looked at what a lot of other companies did, and I think where we came down was because, at least at this point, the LED forecast from all the major LED businesses are really looking relatively solid, we didn't feel like it was appropriate -- we didn't want to arbitrarily guide down there just because that's not the message we're getting from the customers at this point.

Two more quick ones here.

On the notebook backlit LCDs, or LEDs rather, how big of an opportunity is this for Cree over the next year?

Is this going to become a meaningful driver for the LED chip business, or is it going to be more of a nice benefit but not a huge driver?

Yes, I would call it an important driver for the industry and an incremental benefit for Cree from a chip standpoint.

So you know our focus is really been -- lighting markets has been a huge focus for us, but we can't ignore notebook back lighting, and obviously we want to be successful and at least participate in that.

So I think what you could see is more of our chip business could end up in that application instead of some other maybe lower to mid end applications over the next year.

At the same time, I don't think it's as big a growth driver for Cree specifically as, say, some of the lighting trends are.

So we want to participate, but it's not the number one driver of the business is the way I would look at it.

And again, it's at that chip level, not at the component level.

Absolutely.

Within the chip business, could this market represent roughly a quarter of the chip business within the year?

I don't think our chip business will see that high of a percentage there, but I do think it could become one of those segments when I talk about things like mobile, gaming, and auto -- it could be of that size.

Okay.

Last question on the litigation -- the commentary there about how some of the cases are unfolding are helpful.

Would you care to comment on the financial impact going into the first half of calendar '09 in regards to the impact of these two cases?

Well, we might be -- I don't know if we're prepared to give any targets on that at this point, John.

The way I would look at it is this.

You are going to see an incremental increase this quarter.

That is really prepping for what is expected to be a first calendar quarter trial in Texas.

There is not necessarily firm trial dates in all the other cases, so I think what we're basically saying is you could see another incremental increase in Q3.

It's hard for us to give you a number yet, but if that trial stays on track and all the other ones, depending on how they line up, there could be a second bump up in our Q3, but again, until we see exactly where those trials line up, it's hard to give you a number on that.

Okay.

Thank you very much.

Sure.

Your next question comes from Bennett Notman from Davenport & Company.

This is your last question, sir.

Thank you, and my questions were asked and answered.

Thank you.

All right.

Operator, are there any more questions?

There are no more questions in queue, sir, if you would like to go ahead with your closing comments.

Thank you, operator, and thank you, everybody who was on the call today.

We appreciate your interest and support and look forward to reporting our second quarter of fiscal year 2009 results on January 21st, 2009.

Good night.

Good night.

This concludes today's conference call.

You may now disconnect.