Wolfspeed Inc (WOLF) 2009 Q3 法說會逐字稿

Good afternoon.

I will be your conference facilitator today.

At this time, I would like to welcome everyone to the Cree Inc.

third 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 today, April 21, 2009.

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

Thank you, and good afternoon.

Welcome to Cree's third 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 third 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 and the financial metrics posted in the Investor Relations section of our website at www.cree.com under FY 2009 financial metrics.

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

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

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

Also, we would like to note that we will be limiting our comments regarding Cree's third quarter and 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 presentations 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 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 5, 2009.

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

Thank you, Raiford.

Revenue in the third quarter was $131.1 million with non-GAAP net income of $11.8 million or $0.13 per diluted share.

These results are within our previously announced targets for the quarter.

Overall, revenue declined 8% sequentially when one-time licensing revenues excluded from the previous quarter.

LED lighting sales increased double digits in the quarter but were offset by lower LED component and LED chip sales due to a more conservative inventory approach at our customers and distributors, a longer Chinese New Year's shut down for a number of our customers and lower sales for automotive, mobile, and consumer applications.

Demand for LED based lighting applications remains solid and we saw incremental growth notebook and TV back lighting application.

Power and RF came in higher than targeted while materials product sales were similar to Q2.

Non-GAAP gross margin was 36.9% in Q3, which is similar to Q2 when you exclude the benefit of the license deals last quarter.

This is on the high end of our target range for the quarter due to a beneficial mix and higher yields in LED components and a lower bill of material costs in LED lighting that more than offset lower factory utilization and a more aggressive pricing environment for LED chips and components.

Working capital was in line with our targets, and we strengthened our debt free balance sheet as cash and investments increased to $405 million.

Our fiscal Q4 backlog has improved from this point last quarter, and is in line with historical booking rates for the fourth quarter.

Although the global recession continues to impact near-term demand in mobile, automotive, and some consumer applications we believe this will be offset by forecasted growth in LED lighting and other applications.

We are planning to increase both R&D and capital spending in Q4 for several key LED product areas to support the targeted growth in our business.

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

Thank you, Chuck.

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

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 historical summary of other key metrics.

For the third quarter of fiscal 2009 revenue is $131.1 million, and within our targeted range for the quarter of 128 million to $135 million.

This represents a 5% increase over Q3 of fiscal 2008.

GAAP net income of $4 million or $0.05 per diluted share and a high end -- and at the high end of our targeted range of $0.02 to $0.05 per diluted share.

On a non-GAAP basis net income for the third quarter was $11.8 million or $0.13 per diluted share.

This was at the high end of our targeted range of $0.10 to $0.13 per diluted share and excludes $7.8 million of expense net of tax or $0.08 per diluted share from the amortization of acquired intangibles and stock-based compensation expense.

LED revenue increased 7% when compared to the same period last year and declined 11% sequentially to $112.4 million while non-LED product and contract revenues of $18.7 million were down 4% from the same period last year, but were up 22% sequentially.

Our power and RF business increased approximately 70% sequentially due to spot orders for silicon carbide Schottky diodes while materials and government contracts revenue were in line with expectations.

Q3 GAAP gross margin was 36.1% while non-GAAP gross margin was 36.9% which excludes stock-based compensation of $1 million.

These were at the high end of our targeted non-GAAP range of 35 to 37%.

Operating expenses were $44.4 million on a GAAP basis, and $36.1 million on a non-GAAP basis, which was in-line with our targets.

Non-GAAP operating expenses exclude approximately $4.2 million of stock-based compensation expense and $4.1 million of charges for amortization of acquired intangibles.

Overall, R&D and SG&A expenses were lower than our target as we implemented expense controls across the Company.

We did take a higher than targeted fixed asset impairment charge for a total of $2.3 million of which $1.2 million was related to an abandoned manufacturing project as we decided to pursue other lower cost options to support our long-term capacity needs.

Net interest income and other decreased year-over-year to $1.9 million which was close to our target.

Given the Fed funds rate, the average return on our cash is forecasted to decline again in Q4, given even with the higher average cash balance as we continue to emphasize cash preservation over yields.

The tax rate for the quarter was 16%, which is lower than the 24% targeted.

This benefit is primarily the result of recording the favorable impact of a tax holiday granted at one of our manufacturing locations outside the US during the quarter.

We expect our rate to be 23% for the fiscal fourth quarter.

Our debt free balance sheet got stronger during the quarter due to lower working capital requirements and a strong cash flow from operations.

We ended March with $405 million in cash, short term and long term investments and continue to be debt-free.

Accounts receivable declined by $5.6 million to $103 million while day sales outstanding increased to 71 days from 66 days at the end of December.

Inventory declined by $1.3 million and days on hand increased to 83 from 78 days at the end of December.

Inventories are expected to increase slightly in Q4 as we are planning to increase inventories in LED components and LED lighting products to be in position to take advantage of spot business opportunities.

Cash flow from operations was $49.9 million and capital expenditures were $9.3 million with free cash flow of $40.5 million during the quarter.

We are targeting increased capital expenditures for Q4 to be in a range of 10 million to $15 million, primarily for capacity increases in China and the continuing transition of LED chip production to four-inch wafers.

Year to date, cash provided by operations was $134.6 million and capital expenditures were $40.6 million resulting in free cash flow of $94 million.

We continue to make capital investments that support new product introductions and capacity expansion.

The uncertain economic environment continues to be make it challenging to forecast the business and increases the chance that our actual results could differ from our targets.

At this time, we target Q4 revenue to increase to be in a range of 137 million to $143 million.

GAAP gross margin is targeted to be approximately $1 million or 80 basis points less than our non-GAAP targets of 36 to 38% as our GAAP targets include stock-based compensation expense and our non-GAAP do not.

Chuck will give additional insight into our targets in a few minutes.

GAAP and non-GAAP operating expenses are targeted to increase by approximately $1 million plus or minus.

Our non-GAAP targets do not include approximately $4.3 million of noncash stock based compensation and $4.1 million of charges for amortization of acquired intangibles.

We target R&D to increase approximately 10% as we ramp up spending on LED components and LED lighting.

SG&A expenses are targeted to increase by approximately 5% to support new product launches and higher sales in both LED components and LED lighting products as well as higher year end internal and external auditing costs.

Interest income and other is targeted to be flat to down slightly.

We are targeting our effective tax rate to be 23% for the last quarter of the year.

Based on an estimated $89 million diluted shares outstanding our GAAP EPS target for the fourth fiscal quarter of 2009 is expected to be $0.05 to $0.07 per diluted share when amortization of acquired intangibles and stock-based compensation expense is included.

We target non-GAAP earnings per diluted share in a range of $0.13 to $0.15 for the fourth quarter of fiscal 2009.

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

Thank you for your time.

I will now turn the discussion back to Chuck.

Thanks, John.

We remain focused on four key areas to continue to drive our business and leadership in energy efficient LED components and lighting products.

Our first priority is to grow LED components.

As expected LED components declined single digits sequentially in Q3 as solid demand for indoor and outdoor commercial lighting was offset by lower demand for architectural and portable lighting applications as well as a shorter sales quarter due to a longer than normal Chinese New Year shutdown.

Sales to our distributors declined in the quarter while distributor sales to customers actually increased slightly from Q2.

This is a positive trend for our business and an indicator of growing end customer demand for LED components.

Our LED component distributor days of inventory remained within our target range.

For Q4, we target LED component revenue to rebound with double-digit growth in both our XLamp and High Bight LED component product lines driven by indoor and outdoor commercial lighting and incremental sales for LED video screens.

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

LED lighting product sales increased double digits again in Q3 led by sales of the LR6 down light and our new LR24 luminaire.

We target double-digit growth again in Q4, although the rate of growth in this product line has slowed down due to lower spending on new construction.

Our success in Q4 will be partially contingent on our ability to ramp up production and sales of several key new products.

We recently received commercial and residential Energy Star qualification for our best in class LED down light family which includes our LR6, LR5 and LR4 products.

This is an important step for Cree and the industry as the Energy Star program sets important standards and helps customers recognize high quality LED lighting products that can deliver on the promise of energy efficient LEDs.

We continue to set new standards for lighting class LED performance with the recent announcement of ANSI standard bidding across our entire white LED spectrum as well as a new tighter bin structure for warm white LEDs that are more in line with traditional lighting expectations.

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

Despite a challenging economic environment, and lower volumes, non-GAAP gross margin remained flat at 36.9% in Q3.

This is due to our favorable LED component mix and higher yields combined with LED lighting cost reductions that offset lower factory utilization and a more aggressive pricing environment for LED chips and components.

For Q4, we target higher factory utilization that should help offset a less favorable LED component product mix and a more aggressive pricing environment as competitors try to shift their focus from mobile and automotive to new applications such as LED lighting.

We continue to focus on several key activities to further reduce product costs including further yield improvements at the LED chip and component level, introduction of lower cost LED product designs, 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.

Q3 revenue increased more than expected due to some spot orders for silicon carbide Schottky diodes and continued strength in our RF product line.

We don't expect the spot orders to recur in Q4 but the base business is starting to gain some momentum.

Our focus over the next couple quarters is to continue to build on the -- is to continue to build the customer base for silicon carbide power products as we focus more on new products which should improve the operating margins for this product line.

As we look ahead to Q4, the uncertain economic environment continues to make it more challenging to forecast the business, and increases the chance that our actual results could differ from our targets.

Despite this environment, we see positive trends in LED components and target overall Q4 revenue to increase to a range of 137 million to $143 million based on the following factors.

Growth in LED product sales due to continued adoption, growth in LED component revenue for lighting applications, LED chips, materials, and contract revenue in a similar range as Q3, and power and RF revenue down approximately $2 million from the previous quarter.

We target Q4 non-GAAP gross margin in a range of 36 to 38% as higher factory utilization and increased four-inch production is partially offset by a more aggressive pricing environment.

As a result, we target non-GAAP earnings in Q4 of $0.13 to $0.15 per diluted share.

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

As we look ahead, we continue to be optimistic about the growth opportunities for LED lighting.

We remain somewhat cautious due to the potential impact on our customers' business from the recession, and we're closely monitoring design activity and sell-through in an effort to track the progress of the market.

LED lighting is in position to benefit from the Federal Government's focus on energy efficient products as part of the economic stimulus package, and we are seeing continued momentum in LED lighting adoption as evidenced by recent LED streetlight projects announced in both Los Angeles and Pittsburgh.

We're currently targeting our LED lighting and LED component product lines to grow next year, and we're planning to continue to invest in R&D, sales and marketing and capacity to enable and support this growth.

We will now take analyst questions.

(Operator Instructions).

Our first question comes from Harsh Kumar from Morgan Keegan.

Hey, guys, first of all congratulations.

That's pretty good guidance right there.

Had a couple, then I'll try to jump back in line.

First of all, Chuck, your cell phone business, as it relates to your LED business, could you talk about if you're starting to see a bottom there, maybe see a turn in that particular part of the business, and how much is it as a percentage of revenue?

Harsh, if you look at the application mix for our lED business today, mobile is a pretty small percentage.

I think lighting is by far the biggest.

It's probably half the business today.

Then when you add in video screens, that's probably three-quarters of the business.

So mobile is a relatively small percentage.

We continue to have some success on the high end of the market, but I'm not sure that we have enough business there to really give you the overall trends.

I can tell you that where you have high-end, high-value products, we continue to have some new design win success but it's a relatively small percentage of the total so I'm not sure I can give you an overall trend of what goes on in that market.

Our business has become much more lighting centric.

Got it.

Fair enough.

And Chuck now that you sort of hit bottom and starting to grow again, a little bit as far as your business is concerned, can I throw the question out to you again about your target financial model?

Could you remind us if anything has changed with this recent blip in the industry and the economy?

Our long-term models, as we've been talking about for probably the last year or so has been to get into the 40% plus gross margin range, then over time build to what we target is a 20% operating margin.

Now, with that being said, I think you can see the progress we've made in the last four quarters on the gross margin so that's pretty evident.

And some of that has dropped through on the operating margin line.

I would tell you that where we sit today the focus is really continuing to do things to drive down the cost and find areas where we can drive more value which helps on the margin obviously, then over time, we should see some of that leverage as we get more top-line growth.

With that being said, the focus right now is how do we take advantage of this emerging LED lighting market.

So you are actually seeing in our targets that we're actually making some pretty significant near term investments in both R&D and sales and marketing to really drive that growth.

So I think the operating margin goal is a little further out than what we think we can achieve on the gross margin side.

Fair enough.

And are your margins and your lighting products, as it relates to general and overhead lighting, are they up to snuff with your corporate margin goals, or in line with your corporate margin?

Better, worse?

Anything you can provide us would be helpful.

Harsh, are you referring to the system level, like the downlight products?

Yes.

Specifically for our LED lighting system level products, they have made improvement last quarter.

We did get some cost improvements on that but they are still trailing the corporate average, so there's still opportunity for improvement in that side of continues.

With that beg said, Harsh, components is what's really driving the majority of the revenue so it's really -- that probably is more of a driver to the overall number than anything else, and as I said last quarter, and it continued this quarter, components is actually running above the corporate average.

Got it.

Thanks, Chuck, I'll get back in line.

Thank you.

Your next question comes from Dale Pfau from Cantor Fitzgerald.

Your line is now open.

Good afternoon, gentlemen, again, congratulations, good quarter, nice outlook.

Could you talk a little bit about what's going on in China relative to the specific domestic markets over there, how far along you are and a follow-up to that is how far along are you on the four-inch conversion?

Yes, so when you look at the China business, Dale, there's really two parts.

You have China, domestic market, then China export market.

The China export market continues to still be weak.

That's pretty connected to the overall global economy.

But the good news is, is most of our business is actually China domestic consumption for projects there.

They have a stimulus package in China, and that's clearly -- it's clearly adding to the momentum for LED lighting.

I would tell you there was momentum for LED lighting before the stimulus package and I would say that it remains a healthy market for LED consumption generally and LED lighting specifically.

So we see that as a pretty good place.

Now, when you switch over to the export side of that business that's still lagging behind, but we have less exposure to that at this time.

On the four-inch question, we continue to make progress.

We got additional products converted on to four inch.

As of right now we remain on track that we should exit the fourth quarter with more than 50% of our chips made on four-inch wafers.

So more than a majority of them.

The as we go through the next couple quarters we should get that up to a very high percentage of the total.

So we've got probably a little bit of benefit in Q3.

We should start to see more benefit in Q4, then that should roll out more so in the first half of fiscal '10 when it's fully on line and we're getting the benefit in the fab.

Okay.

And spot orders for silicon carbide Schottky diodes, it seems like an odd time in the economic cycle to see a large spike in orders.

Could you give us a little color on what that was?

I would agree it was an odd time.

I think what you see there is that if you go back to our December quarter, we actually had a relatively weak quarter in that business, and that was a product line that's pretty connected to the IT side of the business, which from our standpoint, that supply chain slowed down for us in December.

So what we believe primarily happened is there was a bit of a catch-up there as we got into Q3 of really kind of overcorrecting and having to kind of refill the supply chain a bit on that side.

That's why we don't think it's going to recur again.

We were making some nice smaller progress on the base level business, but that was really a case of December was probably artificially low, and then the March quarter was artificially high to catch back up, and we should get back to a more normal rate.

Then on your lighting products, could you give us kind of an idea of the percentage of products there, how much are your revenues are coming from the LR4 and LR6 versus the LR24s there?

In that business the LR6 is still by far the majority of that business.

We did start to have some more meaningful revenue from the LR24, and then we're still having small revenue from the LR4.

So if you kind of look at that business today LR6 leads it.

That's both the same both domestically and internationally, then the LR24 would be a distant second, and the LR4 is coming along but really slow and the LR4 is much more affected by new construction design-ins.

Right?

It's really not a retrofit, it only is a new construction product.

Both the LR6, obviously the six-inch downlight 1 is a larger market to start for it and it was designed as a retrofit, so we kind of got the dual benefit of that and the products been out longer.

Then the LR24, obviously, it's got all the buzz from the Pentagon project.

I think there what we see is is that you do have the ability to fit into some more retrofit type applications with that product because it is a trough or a lay in.

And since you brought up the US stimulus, there's several potential different pockets of money there.

Where do you think people are targeting the most?

Would it be municipalities for streetlights, or is it the GSA for building retrofit?

What are you thinking what are you hearing?

So, boy, to give you specifics, I can give you some anecdotal evidence, because frankly, it's just not possible to create a specific answers to that.

I think we see it in both so I think the whole Federal Government side of it has clearly got some momentum for LED lighting so the combination of that program and the Pentagon project I think we're seeing LED lighting get bid more there.

Where those bids turn out, whey wins them and when that turns into real money and orders, we're not there yet.

I think that will play out jere over the next few quarters.

I think on the other side, the States we've seen, I think someone gave me an estimate this is a rough estimate, but I want to say somewhere around approximately 30 different municipalities, cities that had basically came up with streetlighting projects as part of the original stimulus proposal.

Who is going to end up with that money and how many get fully funded, I don't know, but I think it's still a sign of we've gone from LED lighting being a novelty, where you could have one or two examples to where there's quite a number of people starting to put it into real projects.

So it's a net positive but what those numbers are, Dale, unfortunately I just don't have a specific way to quantify it at this point.

One last question and I'll get back in queue.

In the overall environment out there, are your customers telling you that there's actual demand?

Are they saying some of this is just inventory rebuild?

How would you characterize the general demand, particularly, I guess, for LED chips and so on out there?

Yes, so if I would tell that you LED chips, components and the lighting product, all three of them, I would tell that you what we believe right now in terms of our direct customers is it's real demand.

So I can say that the backlog obviously has come back pretty well.

We're ahead of last quarter, we're actually in line with historical Q4 rates so that's a pretty quick correction.

What we believe is that's real customer demand.

As far as our distributors are concerned, we know that their Q3 POS was up, and the indications we're getting is that the inventory in our case never got way out of whack, so I think in this case what we're projecting and what we're hearing from both the customers and the distributors is this is demand base, not channel fill.

But we'll see.

But I think that's our best estimate at this time.

Great.

Thanks for your time, Chuck.

Sure.

Your next question comes from Yair Reiner, your line is now open.

Hello.

Operator, we can go to the next question.

Yes, sir.

Mr.

Reiner, your line is now open, from Oppenheimer.

Yes.

Can you hear me?

We can hear you.

So as you mentioned, competition seems to be increasing.

There's a lot of chip companies and component companies that have, now working up up to the idea of LEDs being used in general lighting.

Can you give us a sense of how that has been impacting your win rate and pricing, if at all?

Yes, I would say on the win rate, I don't see a significant change at this time.

I think what you have to remember is wanting to be in the business and thinking it's a good idea and having the products to meet the customer needs and the -- and that momentum is a radically different thing.

So I think it's clearly, in terms of win rate, I haven't seen a significant impact at this time.

I think what we are forecasting or at least building into our targets is, is that we would expect that when you see a slow down on things like mobile or automotive that some of our traditional competitors may put more focus on the lighting segment, just because they're obviously suffering in some of those other businesses that were more hit by the recession.

So that's what we're trying to project.

At the end of the day lighting is about having the right products to enable the application.

So I think we're trying to build into it our targets, but at this point, haven't seen it change the win rate dynamics yet.

Okay, very good.

Now, in terms of your customers, as you get more of the larger lighting guys moving into the space, do you expect that the percentage of sales you are selling as chips rather components is going to change or do you think you are still going to have components continue to increase as a percentage of your revenues?

I don't have any doubt.

Right now all of our plans suggest that components will continue to increase as a percentage.

The chip business, our strategy, frankly, is to service our critical customers.

We have a series of long-term important customers that we're continuing to work with and try tone able them for the markets they want to be successful in, but almost all the growth of our business is projected to come out of the LED components business, and that's just because we think we've done a pretty good job of getting ourselves connected to those customers and applications, and that's where our focus is.

Got it.

Final question from me is on back lighting.

I think that the opportunity for notebook back lighting has developed much faster than anyone predicted, now it looks like the TV opportunity is also going to ramp quite quickly.

Can you talk about your exposure there and whether we should think about that primarily as a chip or a component play from you?

I do want to clarify.

If you go back three years ago people thought the notebook business was going to happen then, so I don't think it actually happened faster than anyone thought.

I think it's finally happened, so, in other words, there was several false starts over the last couple years.

I think now it has truly got some real momentum and we're starting to see it have an impact at the chip business.

Again, we only service that market today as an LED chip supplier.

In terms of TV, that has some momentum but I will tell you that I think the people that are excited about TV, it's probably where notebook was, back lighting was, one or two years ago.

So I think there are some discrete wins that are going on.

There are some exciting new products, but in my mind I feel like the TV is running probably about 12 months behind the adoption cycle of the notebook market, but I would actually say that it's probably pretty much in line with what we were thinking, and it's probably almost took a little longer than what some people were estimating a few years ago.

Your next question comes from [Steve Mollenovich], from Merrill Lynch.

Could you repeat what you said about the impairment this quarter and any sense of impairments in future quarters?

What we said about the impairment this quarter is that about half of it, or $1.2 million, was for a manufacturing project that we abandoned.

We found other ways that we're going to be able to get our capacity needs.

The rest of it is our normal process of reviewing our assets, so that's about what it is.

Going forward it's kind of hard to say how you might review those assets but would you expect a little bit every quarter?

If you look at historical rates, Steve, you can see it's -- there's a small amount but you can kind of go back and look.

It's usually in the, I don't know, I think it varies somewhere between a few hundred thousands dollars, $0.5 million range.

This quarter was obviously a little higher than normal, mostly because of that manufacturing project that we decided not to pursue.

Okay.

And how should we think about capital spending?

It was a little light this quarter.

You said it's going back to 10 million to $15 million.

Does that over time grow with revenue, or how does the capital intensity change over time, are there step functions involved?

I think what you'll see is as we see the LED lighting momentum gain some traction here and the growth of the revenue come, you will see us start to increase that number back up.

I think originally we had much higher targets for this year, and we slowed them way down, and we saw the slow down coming in our business.

You'll see us now start to ramp that back up.

Most of that, though, keep in mind, will probably be -- some of that will be at the chip level to support the transition to four-inch wafers as well as some capacity.

There will also be a chunk of that in China for the component expansion.

That will be the two biggest chunks.

I think at this point if revenue continues to grow in the next year, would you see us probably continue to invest at this rate or potentially even higher rates.

Is that accurate, John?

Yes.

I think it would be a little bit higher than what we did this year.

Okay, that's great.

And one more.

Where do you think we are in the overall adoption curve here, and where are payback periods?

Because I know that you are very focused on trying to get those down.

I think LED lighting still accounts for significantly less than 1% of the lighting market, so I think we're at the very beginning still.

Obviously we've made progress from where we were a year ago but that being said, we're at the beginning of the cycle.

In terms of payback, I think it varies over time.

I would tell you the indoor lighting applications still somewhere, depending on the product, just depending on the application, you're probably looking at something in the -- maybe as good as a year, maybe as long as three or four years.

It just depends on the product.

I know we have some products where we have customers that have come up with numbers, down in the 12-month range.

It is going to also depend on their maintenance costs and their electricity rates.

I think those factors vary wildly.

On the outdoor side our customers are telling us they're hearing numbers from their customers, somewhere in the two to three-year range, sometimes a little longer, sometimes shorter, but those are the numbers right now.

And I think those will probably come down over time but it's going to be a function of how fast the system manufacturers can take the improvements in LEDs in terms of brightness and cost reduction and get them into their products.

It's a little hard for us to give you an estimate on that, what might happen here in over the next year.

Clearly we're trying to increase the value proposition so that should flow through.

In a recession does the lifetime cost of ownership argument become more powerful or less?

You could argue obviously that it potentially could be more powerful but I've always found that in a recession people are just hesitant to make outlays and that initial apparent higher cost might be a bit of a barrier?

If we were talking about large percentage of the market, definitely the recession doesn't help you.

Right?

Obviously construction spending goes down.

You obviously are shrinking some of the potential pool of dollars available for that.

We're so early though, I think what we're seeing now is that the people, like I said, we're less than #% of the market.

When we're at that early stage I think the people that are looking at LED lighting continue to look at it despite the recession.

They have motives that are payback, but they also have an interest in doing something, they're thinking longer term to start with.

With that being said, if your payback is in the one to two year range, that project has got a much better chance right now than the three to four years.

Great, thanks.

Sure.

Your next question comes from Carter Shoop from Deutsche Bank.

Good afternoon.

Hey, Carter.

Wanted to ask a couple questions here on the linearity of the business.

I guess first on the chip business.

Was that a very back end weighted quarter, the chip business?

I would actually tell you that both chips and components were more back end loaded.

Part of that was, with Chinese New Year, where it fell in the quarter, and the fact that in some cases it was a two-week Chinese New Year shut down instead of a one-week Chinese New Year shutdown.

The first, somewhere in, what was that, week three through week five, somewhere in the quarter, there was a big chunk of the world that wasn't doing anything.

So this quarter was back end loaded in both of those product lines and it was back end loaded to some extent because the customers just weren't there in the beginning of the quarter.

But definitely -- with that being said demand also picked up as we got into the second half of the quarter.

Okay, doesn't sound like demand picked up for the chip business quite to the same extent as some of your Taiwanese peers, based on the monthly results they've seen there.

That was a pretty dramatic acceleration there.

February over January, and March over February.

I think the reason for that, Carter, is that if you look at our numbers in December, they also didn't go down very much.

So we really have a very different chip business than they do.

If you look at our December numbers they were down dramatically and we actually had a very healthy December quarter.

I think we were down pretty much, almost exactly in line with what we expected in the third quarter, and that's kind of in line with our strategy, right?

We're focused more on the high value applications, and we're going to be a little less, probably, affected by some of the more mainstream mobile segments.

Mobile is not as big a market for us as a lot of other guys, neither is consumer, and we're more affected by some of the trends in terms of things like the video screen business, or, for example, the notebook back lighting or the lighting segment, which is probably -- I don't have the specific breakout, but it's probably also the largest piece of the chip business now.

Great, that's helpful.

In regards to the RF market, is that -- I mean, when you say it's mostly IT is that three-fourths of the business, IT?

And then also, are you shipping to distributors or directly to OEMs for that business?

I want to clarify.

So within power RF, there's really two segments.

There's the RF segment, which is much more military customer oriented.

So when I say power and RF, RF is military, the power side is IT oriented.

So the largest applications are things like server power supplies.

Most of those customers are direct, although we do have some distributors in that business as well but I think our largest customers there are direct customers.

We also have some consumer electronics and some higher end applications, whether it be solar or wind, things like that, but the biggest application of that business today is on the server power supply market.

Okay, that's surprising that you saw that big of a pickup.

In regards to LED components, sounds like you're expecting growth there in fiscal 2010.

Are you expecting growth in both the high brightness and high power components business?

Yes, we expect both businesses to grow in fiscal '10.

Lastly, when you think about the High Brightness business, are the margins there still materially higher than the corporate average by a factor of 2X, or have the two started to narrow a little bit?

Yes, not sure, so I don't know that we've ever broke out that High Bright was higher by 2X than the corporate average.

I think components is better than the corporate average.

And high power is actually better than the High Brightness segment, but I don't believe we've given out specific target on which relative percentage is.

I was just looking at that time pro forma cut to operating margins.

I think it was about 3X, 4X what Cree was when it was acquired.

You're talking about operating margins.

Yes, when I break out the corporate average, I'm describing gross margins, not operating margins.

Got it, okay.

Okay, that's helpful.

Thank you.

Sure.

Your next question comes from Mike Burton.

Your line is now open from ThinkEquity.

Thanks, guys.

You mentioned lighting is half of LEDs now.

I was wondering if you could give us a sense within that bucket what is components versus systems?

Components is the vast majority, chips would be second, and systems is the third piece.

Systems is still a relatively small percentage of the overall LED business.

It is growing nicely, but again, that's a business that, when we bought it a year ago, was a very small business, and while it's growing, it's still -- and gaining momentum, it's still single-digit percentages of our revenue.

Okay, and on the -- you spoke about double-digit growth for XLamp and High Brightness.

I was wondering if you could characterize that as a percentage of your LED sales flow?

When you say High Brightness, you mean components generally?

Yes, the comment from the prepared remarks, double-digit growth for XLamp and High Brightness.

So the XLamp and High Brightness business, what we call LED components, is -- it's running at -- well, it's over half the overall LED business.

I don't have the specific breakout, but it's well over half the LED business at this time.

Okay.

Then with the ramp and the video in the win there, can you talk about, do you have a new 10% customer?

Can you talk more generally about the ramp and what are the margins in that business?

Thanks.

Yes, so the video is part of the High Brightness business.

There's really not a significant ramp.

I think this quarter we are expecting some growth there, and that's just really seeing that we expect that China video screen business to actually pick up this quarter relative to the previous quarter.

So it's not as much a ramp as it is really just seeing that business which slowed down a little bit last quarter, see that strength in that business again this quarter.

In terms of the margins, we don't break out the different margins between those businesses, but the video screen business is similar to the rest of High Bright, which is part of components, overall is better than the average, and within those two, high power is a little better than High Bright.

Okay, thanks.

Sure.

Your next question comes from Jiwon Lee from Sidoti & Company.

Your line is now open.

Hi, thanks.

I'm not sure if I got an answer on that 10% customers.

Was there any 10% customers for the quarter?

We don't break out 10% customers except at the end of the year.

So maybe -- I didn't probably answer that correctly, but we don't have any updates for you.

Those will come at the end of the fiscal year.

Okay.

With some of your large customers, have you finalized annual purchasing commitment with them for the fiscal 2010?

If there are any large customers that we think are material we'll announce those, but actually if you look at our business it's actually becoming more diversified.

So frankly, while our customers remain very important I think you'll actually see less sensitivity to individual customers going forward but we don't have any updates for you at this time.

Lastly, on the notebook side how many design wins should we be expecting from you?

Well, I don't know that I can give you a design win number.

What I can tell sue that we saw that business grow last quarter, so again, this is LED chips.

So again we're selling the chips to a packaging customer of ours who then is actually getting the design win.

So I can't give you specific design win traction but I can tell you we did see nice incremental growth in tat segment last quarter.

With that being said, it's still a relatively small percentage of the total, but it is a growing percentage of that business.

Okay.

Thank you very much.

Sure.

Your next question comes from Harsh Kumar, from Morgan Keegan.

Your line is now open.

Hey, guys, thanks for taking my follow-up.

Chuck, at some point in time you talked about being maybe just a little bit conservative as you expect increased pricing, or tough pricing environment, as you put it.

Where exactly are you seeing that?

That's one part of the question.

And second, have you started to see, I guess some of the Taiwanese guys step up in what I would describe as high quality lighting, and started to see them or not yet maybe?

What I'm expecting is that our traditional competitors will put more focus on LED lighting.

We have not seen any significant inroads from the Taiwanese packaging competitors in the lighting market, and that's not what we're projecting.

In terms of pricing I think it's more of a projection of what we expect to happen given the outgrowth of what's happening in the industry.

So I don't have any specific data points for you right now.

I think it's just something that as we look out at the market and estimate what we see might happen, that's what we try to build into our targets, because it just seems to us that as you see those traditional markets slow down that's a likely outcome of some of the competitors that already are in the lighting market.

We just think we might see more focus from them in those markets.

Fair enough.

Thanks, guys.

Sure.

Your next question comes from Jed Dorsheimer from Canaccord Adams.

Your line is now open.

Thanks for taking my question.

Chuck, I was wondering, as we look at you transform the Company into more of a lighting Company, it seems very natural to combine the chip and the packaging through the Carclo acquisition.

Through that process we saw the components business really accelerate and the chip business come down a bit.

And as we look at sort of the next growth phase of the Company, as you start to sell more of the systems, I'm curious how we should -- do you think we'll see the same type of repeat in terms of -- see components sort of plateau and start to drive more of the systems?

Is that how we should look at the evolution of Cree?

And then I have a follow-up, too.

Actually, it's a very logical conclusion to draw, but it's actually not what we're trying to do.

So it is what happened in chips and components, but we knew that going in, and we frankly did things to allow that transition to happen.

We really focused our chip business just on our more strategic customers and the high value side of that.

And so we kind of -- we let and encouraged he that transition to happen, and I think we found a decent balance for us there.

The lighting business has a different role.

That business is really about driving the market, and, yes, do we want to sell products there and make a profit in that business?

Sure.

Is it our focus to be able -- to build a large lighting systems business?

It really is not.

We need to turn those markets on, but we think at the end of the day, Cree as a component supplier is where we can drive the majority of our growth.

That doesn't mean we won't keep investing in the system side of the business, and it will add incremental growth but if I look out over our plans over the next few years the vast majority of our growth is targeted to come from components.

System should grow, but is really key -- the key for us will be the winning components.

I think we can do some exciting things in components, and I think you will see us probably have some pretty nice niche businesses there but I don't think you'll see us trying to become mainstream all things in lighting because I think that's what it takes to be really successful in systems over time and I just -- at this time that's not our focus.

With that being said, I think you'll see us do some pretty exciting things there that should hopefully get the attention of the market and hopefully accelerate adoption even further, and it's going to be up to us to deliver on that but I think if we do that, that then leaves more people to go to LEDs which gives us more opportunity to sell to components.

So that's the strategy and remains it.

And so as we look at -- if we're judging Cree on milestones going forward, should we start to see your products end up in more of the traditional fixture companies that are going to be introducing products into the market, or do we see the tactics that Cree creates either its own distribution network, or how should we look at some of the milestones that we can judge you on in the lighting business going forward?

Yes, so I would say there's probably two pieces to that.

I think if you look at the systems business, which is really about enabling and getting the market moving, you should look to see are we able to come out with products that turn on new categories, that really get the market to react.

So if we can come out with an LR24, basically a 2 X 2 lay-in trougher, do the other companies move into that marketplace and do LED versions of those product?

Because I will tell you, a year ago most of them said it wasn't even on their roadmap.

So the question is does the LR24 to only generate some incremental sales but do the big guys get into that business and move down that road and does the next product we do spur the bigger lighting Company, not just in North America, but really around the world to take action.

So I would kind of -- if that happens, and that's kind of what we're trying to do on the system side.

And then what that means in components is, yes, I think you should look to see if we're designed into the traditional lighting companies but I would go beyond that.

I look to see how much traction are we getting in lighting broader than that.

I think any time you have new technology entering a market we absolutely want to work with the traditional players and make them successful but I also think it creates an opportunity for a lot of the more medium to smaller size players who are probably going to be a little quicker to market, a little more willing to try the technology, and so for us, absolutely winning with the big guys is important but we also want to make companies like beta LED successful because, frankly, they're helping create a category that before them no one was really working too hard on sale.

So I think you've got to look for both sides of it.

And again, I don't think we'll win every account, but we're hoping to just win our fair share or better, and that should drive the strategy.

That's helpful.

Two housekeeping questions.

CapEx for the capacity expansion, skewed to back end, front end, any color on that?

Then as a follow-up, it looks like dollar strengthening versus the yen and won, you have some exposure in the chip business in both of those regions, any hedging strategies going forward?

Thanks.

Yes, on the CapEx I would tell you that right now the investment is about 50/50 back in terms of chip versus components.

So we're investing into more component packaging capacity in Asia but we're also making some investments in our chip fab, and that's really a function of both as the volume comes back but also still making investments to support the 100-millimeter transition.

In terms of the other question, John--?

On the hedging, Jed, we're continuing to look at it, but it's not something I have in place today.

Yes.

And what I would tell you, Jed, is that clearly there was a fairly significant shift over the last, probably four or five months, in some of those exchange rates.

We think we've factored that into the business and we are managing through it in more of a traditional manner but at this point we don't have a hedging strategy to offset that one way or the other.

Your last question comes from Yair Reiner from Oppenheimer, your line is now open.

My question has been answered, thank you.

Sure.

I will turn it over to Mr.

Kurtzweil for closing remarks.

Thank you for your time today.

We appreciate your interest and support and look forward to reporting our fourth quarter along with total fiscal year 2009 results on August 11, 2009.

Good night.

Thank you.

This concludes today's conference call.

You may now disconnect.