Wolfspeed Inc (WOLF) 2010 Q1 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 Incorporated first quarter FY 2010 financial results conference call.

(Operator Instructions).

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

Mr.

Garrabrant, you may begin your conference.

Thank you, Sarah, and good afternoon.

Welcome to Cree's first quarter fiscal 2010 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 2010.

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 financial metrics posted in the Investor Relations section of our website at www.cree.com under FY 2010 Financial Metrics.

Today's presentation includes forward-looking statements about our business outlook and we may make other forward-looking statements during the call.

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

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

Our press release today and SEC filings noted in the release, mention important factors that could cause 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 2010 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 sales site 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 email or phone at 919-287-7895.

We are also webcasting our conference call and a replay will be available through November 3, 2009.

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

Thank you Raiford.

We got off to a very good start in fiscal Q1 as revenue increased 14% from Q4 to a record $169.1 million and GAAP -- and non-GAAP net income increased 64% sequentially to a record $27.4 million or $0.30 per diluted share.

Revenue and profits exceeded our targets for the quarter due to solid factory execution and strong demand.

The revenue growth on Q1 was driven by higher XLamp LED sales for lighting applications, higher LED chip sales due to increase demand in notebook back lighting and lighting and solid growth in LED lighting products and power and RF devices.

Non-GAAP gross margin increased to 44.1% in Q1, which was 380 basis points better than Q4 and higher than our target for the quarter of 40% plus or minus.

The better than expected results were due to a combination of factors, including additional cost leverage from very high factory utilization across the entire quarter and increased production scale, better than plan yields across our LED factories, a more stable pricing environment for LED chips and LED components and continued progress in our power and RF product line.

Working capital was in line with our targets and we further strengthened our balance sheet with a file on equity offering which raised $434 million in net proceeds.

So, why did we raise money now?

Because we believe we have an opportunity to accelerate our growth in LED lighting.

These funds are primarily intended to support higher capital spending and additional working capital needed to fund the targeted growth over the next several years.

With cash and investments now at $888 million, we are also in a good position to consider potential strategic investments that could strengthen our leadership position and help us accelerate the adoption of LED lighting.

Our Q2 backlog is higher than at this point last quarter due to increased demand across our LED product line and solid demand for our power RF products.

We have started to build Q3 backlog in several of our product lines while we continue to work on Q2 orders for the shorter lead time project business in LED lighting and components.

Our near term focus is on execution and capacity expansion at our US and Asia manufacturing facilities.

I will now turn the call over to John Kurtzweil to review our first quarter financial results in more detail as well as our targets for the second quarter of fiscal 2010.

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 summaries of our other key metrics.

For the first quarter of fiscal 2010, revenue was $169.1 million and above our targeted range for the quarter of $160 million to $166 million.

This represents a 14% increase sequentially.

GAAP net income increased 255% year-over-year to $21 million or $0.23 per diluted share and exceeded our targeted range of $0.14 to $0.16 per diluted share.

On a non-GAAP basis, net income for the first quarter increased 107% year-over-year to $27.4 million or $0.30 per diluted share.

This is above our targeted range of $0.21 to $0.23 per diluted share and excludes $6.4 million of expense net of tax or $0.07 per diluted share from the amortization of acquired intangibles and stock-based compensation expense.

The impact of the equity offering to EPS was $0.005 per share during the quarter.

I will go into more detail on the future impact in a few minutes.

Cash provided by operations was $62 million.

Free cash flow was $41 million and we ended the quarter with $888 million in cash and investments.

The gross proceeds from our equity offering were $449 million or $432 million net of expenses.

We issued 12.7 million shares at a public offering price of $35.50 per share in September with the proceeds primarily intended for capital expenditures to support accelerated growth with the remainder being used for general corporate purposes including working capital and potential strategic investments.

LED product revenue for the first quarter increased 14% sequentially to $156 million, while power and RF revenues increased 15% sequentially to $13.1 million.

Please note, that the power and RF revenue includes $3.6 million of government contract revenue and LED products revenue includes $0.5 million of government contract revenue.

Q1 GAAP gross margin was 43.6%, while non-GAAP gross margin was 44.1%, which excludes stock-based compensation of $0.8 million.

This was above our targeted non-GAAP range of 40% plus or minus.

The increase in gross margin versus our target was a result of a combination of factors which include additional cost leverage from high factory utilization across the entire quarter and increased production scale, better than planned yields across our LED factory, a more stable pricing environment for LED chips and LED components and continued progress in our power and our RF product line.

Operating expenses for Q1 were $47.1 million on a GAAP basis and $39.3 million on a non-GAAP basis, which were in line with our targets.

Non-GAAP operating expenses exclude approximately $4.8 million of stock-based compensation expense and $3 million of charges for amortization of acquired intangibles.

We achieved significant operating leverage during the quarter as our Q1 GAAP operating margin increased 810 basis points to 15.8%, while non-GAAP operating margin increased 680 basis points to 21.9%.

This was the result of a combination of factors.

Revenue increased quarter-over-quarter by 14% and provided significant factory leverage.

Gross margin increased 380 basis points and we achieved increased leverage out of our operating expenses which did not scale with the increase in revenue.

Net interest income and other for Q1 was $1.8 million, which was slightly above our target.

The GAAP tax rate for the quarter was 26%, which was in line with our estimate.

The balance sheet improved again with accounts receivable down to $93 million while days sale outstanding declined to 50 days from 63 days at the end of June.

This is a result of fairly linear shipment during the quarter.

Inventory increased $7.1 million and days on hand increased to 81days from 79 days at the end of June.

The majority of the inventory increase came in the form of raw and work in progress which is intended to support our sales growth targeted for the second fiscal quarter.

During the first fiscal quarter, we added $32 million of capital and in Q2 (lost audio).

We targeted capital additions to be between $150 million and $165 million.

At this time, we target Q2 revenue to be in the range of $180 million to $190 million.

GAAP gross margin is targeted to be 43% and our non-GAAP target is 44% plus or minus.

Our GAAP targets include stock-based compensation expense of approximately $1 million or 60 basis points and our non-GAAP targets do not.

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

For operating expenses, we are targeting non-GAAP R&D expense to be up slightly, while non-GAAP SG&A expenses are targeted to increase by approximately $2.5 million for increased sales, staffing costs for our new application centers and increased IP litigation expense.

We target (inaudible) impairments to be approximately $500,000 for this quarter.

Our GAAP targets include approximately $7.1 million of non-cash stock-based compensation and $3 million of charges for amortization of acquired intangibles.

Interest income and other is targeted to increase approximately $2 million based on higher cash and investment balances.

We target our tax rate to be 26%.

GAAP net income is targeted at $21 million to $23 million and based on an estimated 105 million diluted shares outstanding, which includes the full $12.7 million shares issued in our recent equity offering.

Our GAAP EPS target is $0.20 to $0.22 per diluted share.

Non-GAAP net income is targeted to increase quarter-over-quarter to $29 million to $32 million for a non-GAAP EPS target of $0.28 to $0.30 per diluted share.

The diluted EPS impact or the equity offering is approximately $0.035 per share on both a GAAP and non-GAAP basis.

Our non-GAAP EPS targets exclude amortization of acquired intangibles in the amount of $0.02 and non-cash stock-based compensation in the amount of $0.06.

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

Thanks, John.

We remain focused on four key areas to continue to drive our business in fiscal 2010.

Our first priority is to build on our leadership in LED lighting and further disrupt existing lighting markets.

Our strategy is to be a catalyst for LED lighting adoption by developing innovative new LED lighting products to lead the market and open up new applications for LED technology.

The growth in sales of LED components and our own LED lighting products suggest that we are on the right track and our challenge now is how do we go faster.

In terms of market leadership, Cree was once again named the American Lighting Association's Lighting for Tomorrow grand prize winner for our new deep recess 1,000 lumin down light, while our par 38 LED bulb and high efficiency LR6 down light each won special focus awards.

We also continue to work on raising the awareness for LED lighting by supporting new installations such as the recent McDonald's store that opened with 97% of all the lighting based on LEDs.

looking ahead, we are working to further develop our channels and products to make LED lighting products more accessible to a broader base of customers and applications.

Our second priority is to further enable our lighting customers to accelerate growth in LED component sales.

This starts with expanding our LED component product offering for the lighting market.

We recently announced commercial availability of our new XPG X-lamp LED, which is the industry's brightest and most efficient lighting class LED.

While, this LED is brighter, more importantly, it changes the game for a number of lighting applications by delivering up to 367 lumins from a single LED at 111 lumins per watts.

If the old benchmark for lighting class LEDs was 100 lumins per LED, we believe the new benchmark is 350 lumins.

We also now have the most lighting class LEDs for designing Energy Star compliant LED fixtures.

We've also started to staff our new customer design centers in Europe, California and Asia with the goal of having these centers online in the second half of our fiscal year.

Our third priority is to maintain the product margin levels we have recently achieved and to start to build operating leverage in the business.

We saw the benefit of strong execution and high factory utilization across the entire quarter in Q1, as well a more favorable pricing environment for LEDs due to increased demand and limited supply.

As a result, gross profit grew faster than operating expenses and our increase in sales and marketing which resulted in some incremental progress in operating margins.

We look to maintain these gains in Q2 as we add capacity and introduce several new products with the primary risk being factory execution in the near term.

We need to keep in mind that the overall LED market continues to be competitive as we invest in expanding our marketing and technical support capabilities and remain focused on both cost reduction and increasing the value of our products by providing new capabilities to the customer.

Our fourth priority is to build on the recent progress in our power and RF product line and refine our product offering and market focus.

We got off to a good start in Q1 as we built on the momentum from Q4 and delivered results that incrementally contributed to Cree's bottom line.

This product line is still subject to variability as demand fluctuations change the factory loading, but we seem to have achieved a new base level of business over the last several quarters.

The focus now is to build on this success and expand our customer penetration into new higher value applications for both power and RF, as we look to grow the power line over the next several years.

As we look ahead to Q2, we are expanding our LED factories to support increased demand.

We are targeting to add $150 million to 165 million in capital additions this fiscal year to expand our LED chip factory and more than double our LED component capacity by the end of the year.

Although, we are currently capacity limited in most product lines, we target overall revenue to increase to a range of $180 million to $190 million led by higher LED component sales for lighting applications, higher LED lighting product sales followed by some growth in LED chips to support notebook and TV back lighting and incremental growth in power and RF sales.

We target Q2 non-GAAP margins in a similar range as Q1 at 44% plus or minus as we look to maintain our recent gains in margin.

We target continued investment at R&D to support new product development in LEDs, as well as increase spending in sales and marketing to support our new global customer service and application centers.

As a result, we target non-GAAP earnings in Q2 of $0.28 to $0.30 per diluted share based on share count of 105 million shares which reflects the dilution from our recent offering.

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

We got off to a strong start in fiscal Q1 and we are well positioned for a solid Q2.

As a result of the recent equity offering, we have the balance sheet to invest in the growth of our business as we look to continue to lead the LED lighting revolution.

The macroeconomic environment remains a risk factor that we'll need to continue to monitor, but in the near term our focus is on managing growth and execution.

We are still in the early stages of LED lighting adoption and we must aggressively attack the traditional lighting markets and find ways to expand awareness, break down barriers and increase the value proposition for LED lighting.

We will now take analyst questions.

Operator, we are ready for questions.

(Operator Instructions).

Your first question comes from the line of Yair Reiner with Oppenheimer.

Thank you.

Congrats first of all on the nice quarter.

Thanks.

My first question.

Can you give us a sense, directionally of how the mix was in the quarter in terms of components, chips, and so forth?

Yes.

In the quarter what we saw is the two big growth drivers were components and chips and the applications that drove that were a combination of lighting and back lighting.

We definitely saw some benefit from back lighting, but actually overall I think lighting actually grew slightly as a percentage of the business.

So, if you look at the application mix, lighting is still the biggest, over 50%, the video screen business still hanging in there in second and then the next two big applications would be mobile and back lighting and they are similar size, but back lighting has come up to rival the mobile in terms of size, but again net -- net, lighting is still the biggest driver.

In terms of your design centers that you are building out, how should we measure the success of those moving forward and how do you think that will impact your geographical mix in the quarters and years ahead?

In the short term it will be difficult because obviously it will take us most of the year just to get these online.

The way we are going to measure them is design win rates, but we don't typically break that out.

I think the easiest way for you is going to be sales growth momentum and components and that will become more obvious in the year ahead in terms of fiscal 2011.

We are going to have to rely on the sales team we have in place right now to drive the current business, but I think it's really going to be in sales growth and then internally we will also look at design win momentum.

One more quick question and then I'll free the floor.

In terms of your capital investments moving ahead, clearly there's quite a bit of a bottleneck in terms of the major tool makers.

How do you intend to deal with that and how might your capital investments be different than a lot of the other players in the field?

I think we probably started investing earlier than most, so we started placing the first POS actually in our Q4 when we saw the business start to book up.

So, I think we are a little bit ahead of the curve and I think we have a little bit control over some of the key operations.

So, we obviously rely on outside vendors, we've become pretty good at adapting existing equipment for our processes.

So, I think it gives us some flexibility because in many cases we are able to use used equipment that exist versus necessarily having to go into the marketplace.

That doesn't mean we don't buy new equipment, but I think it gives us a little bit more flexibility.

With that being said, we were pretty much capacity limited in Q1 and we are likely to be that way in Q2.

That is why execution will be a big deal.

It will be the key to driving our revenue range for this quarter.

Thank you very much and good luck moving forward.

Your next question comes from the line of [Chris Lanfig] with JPMorgan.

Based on your comments earlier about the mix of the CapEx, is it fair to say that a lot more of your own chips will go into your own packages and that's a planned progression over the next twelve months?

I think what you'll see is a lot of the incremental investment and capacity for chips will go into our package.

We actually see the chip business keep staying in kind of a similar range.

It was up last quarter, but if you look at it on a year-over-year it's only up slightly from a year ago.

So, it's kind of in the right range.

We are not looking to shrink that business, but I do think most of the growth from the new capacity, the majority of that will end up in components, although we will probably take some incremental growth in chips as well.

So, I think -- I wouldn't look at it as much as taking existing capacity as much as the new capacity.

It will probably be more more for internal than external, but there would be a benefit to both.

Okay.

And then on your latest XLamp product, how do you describe the response from your customers and in general I guess demand trends for components versus chips of that same generation?

Yes.

I would say that chips has been benefiting a lot on the whole back lighting phenomena and I think everyone is pretty well aware of that and in lighting it's a little broader than that.

We have the new XPG, but the XPE product that came out only a couple of quarters ago, that probably has the most momentum because it has had time to be designed in.

With that being said, we have products like our MC, which is our multichip that's been out there long enough to start to get some momentum.

So, I would say it's pretty broad based across several of the new product lines.

XPG is probably -- it's probably the most exciting from the customer because it's the newest and you are letting customers do different things with LED.

This idea of being able to get 350 lumins plus from a single LED is really -- we think will change some of the design constraints.

So, it's probably more excitement than orders with the revenue being driven by the products that have been out six months.

One last one from me.

When do we see the XPG LEDs in your own lighting systems products?

Boy, I don't have a specific date for you.

I think right now we are focused on using, we use both the XR and the XP generation and a lot of that has to do with once you get a design approved there is quite a cycle to getting a new system approved through UL and all the other things, but I would imagine sometime in the next quarter or two you'll start to see some of the first Cree lighting systems that has XPGs in them, but that being said, we'll continue to use a lot of XP products in many of the applications.

Thank you very much.

Sure.

Your next question comes from the line of Jesse Pichel with Piper Jaffray.

Good afternoon, Chuck, John, Ray.

Congratulations on the stronger results on the guidance.

Thanks a lot.

Your utilization now, where is it and what type of quarterly revenue would a CapEx target of $150 million to $160 million support?

Yes.

Let me answer the first question.

We are probably for Q4, we ran as close to 100% utilization as you can run.

It's a -- there is some gap of underutilized capacity, but we were running pretty much full out based on bottle necks across the Company.

With that being said, we have a fairly good investment strategy that is giving us the growth we saw last quarter and we are targeting for this quarter and we would target into the second half of next year.

In terms of how much revenue do we get from that?

We don't have a revenue target out there for beyond Q2.

I think -- I don't necessarily have an exact number for you at this time.

I think it's a great question, but I'm not sure I'm in a good position to answer.

But, it's certainly up more than 100% year-over-year.

Could you think of somewhat doubling your quarterly revenue over the next couple of years?

Clearly it's going to give us a lot of leverage.

It will depend exactly on where we end up spending it.

Right now it's a combination of chip and components, so what we are having to do keep in mind, is we are investing in chip capacity that we then have to use in the components business which we also have to buy capacity for.

So, there's a little bit of doubling up there, but it clearly gives us some pretty significant growth potential.

I'm just not comfortable giving you a specific target.

Understood.

Regarding the growth of the lighting business, is the sequential growth you are seeing enough to offset potential seasonality in your third quarter?

Yes.

We are already seeing some bookings, solid bookings into Q3.

So, that is an encouraging sign.

I would put my current -- the tone you should read is cautiously optimistic.

I think it's clear that seasonality when it hits, it's typically a Q3 phenomenon for Cree and that is typically driven first by the customer electronics applications.

If we are going to see seasonality in LED chips we will see it in Q3.

It's too early to call that one.

The other thing we have to deal with is that, our third quarter, the March quarter also has Chinese New Year, which limits production in China.

Those are the two negatives.

On the other side LED lighting adoption ramped last quarter.

We are targeting more in Q2.

If that continues to grow, there's an opportunity to potentially grow through that seasonality.

I wish I had the answer.

We don't yet, but those are the variables and we'll see as we get closer to Q3 what is going to happen.

In your answer to a previous question you said that component sales would be an indicator there of design success and that would probably be in the dosti channel and I'm wondering how do you characterize the growth from the distributor channel because I noticed that Arrow was quite big for you over the last quarter?

Are you seeing growth in that channel?

Is that a good indicator of design success?

I would actually tell you that we are seeing success both direct and dosti.

One of the nice things about putting in these design centers is that we are able to also drive some of the major accounts ourselves.

Distribution is absolutely an important part of the strategy and we saw good growth both at Arrow and at World Peace last quarter.

I think both of them are having success and if anything right now our challenge is that, I think they are having success a little bit ahead of what they were expecting and so we have some challenges having enough inventory in the channel right now.

Do you think there's much legs left in the LED back lighting story?

You never hinged your growth or marketing effort toward the back lighting story.

We've all seen that Samsung is ramping its own LED lines internally.

I still think it's going to have a significant impact on the LED industry.

Obviously, Cree participates as a chip company.

It's obviously, it's not our primary focus, so we really get incremental benefit and we get that two ways.

A little bit of chip revenue we definitely get the factory loading benefit.

If you put that aside, I'll put my industry hat on, I think if Samsung has put out some pretty aggressive numbers on estimates for the number of LED TVs they are planning to build next year, I think it's almost a third of their demand, and then Sharp came out with a similar type of numbers.

If those guys are able to really convert that much of their production to LED back light, I think you will see -- I think the expectation in the industry is that there will continue to be supply constraints into 2010.

So, I think -- when I say calendar 2010.

If those guys go, I think the TV back lighting will continue to have a pretty significant impact on that side of the LED supply chain.

Thank you very much and congratulations.

Sure.

Your next question comes from the line of Dale Pfau with Cantor Fitzgerald.

Good afternoon gentlemen.

My congratulations also.

Great quarter, great outlook.

Thanks Dale.

Chuck, my question is about your transition to the 4-inch wafers.

Clearly, you are saying yields are better.

How far along are we on the transition to 4 and how much better were your yields than you were expecting in the quarter there?

I don't have a specific number, but I can tell you it's a couple of points of yield better is probably the right range.

I don't have the exact number in front of me.

In terms of how far are we along, we should have essentially all the products we intend to convert in the near term converted, which will be almost all of our production -- by the end of December is the current plan.

So, I don't know what the exact percentages are right now Dale, but we are well on our way to having the factory essentially converted by the end of December.

Would you say you are 70% through right now.

Yes, probably at least that much at this point.

Probably, maybe even a little more.

Great.

Could you maybe give me a little of indication here how much ASPs are being helped by the demand in the back lighting?

We typically have seen ASPs dropping about 20% per year for the same lumin output and you always shove higher lumin devices into the top end, but are we seeing some mitigation of those ASP pressures?

Two phenomenons going on.

You have LED chips and components.

I think in LED chips, we are definitely seeing the supply -- the increased demand that pushed out lead times definitely stabilized pricing a little more last quarter.

So, I think we have seen less price erosion than normal in Q3 and it's likely to continue a little bit here into Q4, although I think as we get near to the -- our Q3 which is the seasonal slower quarter, it may be a little more normal.

In terms of components, we also saw at least from what we were forecasting, it's been a little, I think we were probably a little conservative on our outlook there, but that being said, I think that we are continuing to model that the market will stay competitive in terms of pricing just because as you know there are a number of other competitors out there.

Although the market is very big, we are all focused on making sure we drive those new designs.

That frankly is a benefit because at the end of the day, as we drive the price for lumin down we are going to expand the market.

Okay.

And one other question.

Can you give me a little bit of -- well actually two more -- indication of your kind of mix.

How much are you shipping of your XP products relative to some of your older style products?

I would say that right now the older designs probably are still in the process of converting to XP, so we still have a significant amount of XR business, but I would say most of the new designs are on XP and they are probably -- I don't know if they are 50/50, but they are probably a similar order of magnitude at this point is what is driving the business there.

And a few of the other products mixed in there.

Then my favorite topic here, power and RF.

What is driving the demand there?

Is it just socket wins, the market moving in some of the servers, can you give us indication where you are picking up share and what do you see?

You have been following the story long enough.

We have been talking about this awhile.

It's great to see some success there.

What we are seeing is on RF I think, we started talking about some success there a couple of quarters ago and that is really driven on the military side of that.

The positive we are seeing right now is that the power side is also getting some traction and it's a combination of things.

It's more of the server power supply business and the other thing is we are seeing growth in the solar market.

Solar inverters.

So, we are starting to see that pick up and that is where our focus has been on the higher value type applications.

It's really a combination of those things that is giving us some, seeing the growth in the business.

How much revenue do you get out of the solar inverters?

It's smaller than -- I don't know what the exact numbers.

We don't break that out, but I know it's smaller than the power supplies, but it probably grew faster than the power supply segment.

So, it's growing fast, but it's coming from a smaller base.

Great.

Congratulations.

Keep up the good work Chuck.

Thanks Dale.

Your next question comes from the line of Andrew Wong with GC Research.

Hi.

I was hoping you could give us a little more color on three things.

First, can you say which performed better on a sequential basis, LED components or LED chips?

Andrew they were pretty similar.

Each had about a similar benefit in terms of the growth last quarter and then obviously we had some incremental benefit beyond those two in the lighting products and in the power and RF, but those two are similar impact.

Second, on general lighting, between the US and China, which is the bigger opportunity and where do you expect to see faster growth over the next 12 months?

Boy, I think the opportunity is large in both.

I'm not sure I can classify one or the other as better.

I think what we are seeing is the outdoor market in China has definitely got some momentum.

In the US, I think we are seeing a combination of outdoor and indoor.

So, maybe the scale of either one, outdoor isn't quite as large, but I would say similar scale and similar opportunity in both markets right now.

Got it.

Lastly, it seems like your new high efficient fixture has the highest efficacy out there by about 2 1/2 times.

I was wondering have you looked at anyway to get that up to market more quickly?

I think you are talking about the high efficiency LR6.

We actually had a couple of announcements there when we won the Lighting for Tomorrow Award.

We had the DR1000, which is our deep recess 1000 lumin product, that was the grand prize winner.

That one, we are targeting to get out here early in calendar 2010.

So, sometime next quarter.

The high efficiency product is behind it and it's behind it primarily because although it's a very exciting technical achievement, right now what we see is more demand of the 1000 lumin because there are existing sockets looking for that specific product in the LED version.

So, it's really a function of where we think there's more near term market demand.

It's clearly a great technical achievement.

You will eventually see that in our product line, but really just given the constraint of how much we can do sow fast that's how we picked the order of those.

Got it.

Thanks.

Sure.

Your next question comes from the line of Vijay Rakesh with Thinkequity.

A couple of questions here.

I was wondering what are (inaudible) running at now?

You probably have answered it.

We are running close to 100%.

I'm sure there's probably a few little pockets of underutilized capacity, but we are running pretty flat out right now and we did almost all last quarter.

On that, how do you -- how do you allocate to that?

So, we started purchasing additional capacity in our Q4.

So, that was the June quarter.

We continue to buy additional capital last quarter.

So, that capital starts to come online.

We got some of them online last quarter.

Additional capital comes online this quarter.

That will drive part of the growth and the other thing is we are continuing as we finish converting the 4-inch as well as yield improvements.

We're getting a combination of those three things that is really creating the additional capacity for the revenue.

By this capacity, does that -- is that beneficial to you?

Versus your in-house capacity?

When I say buy it, we are buying equipment and putting it in-house.

So, I think it is the same benefit as the existing --

Got it.

And just wondering on the customer concentration side, as you see the TV side pick up, the (inaudible) side pick up and the lighting side, do you have any customer concentration as you go out and do next year?

Although we are getting incremental TV business, I'll be honest, lighting is actually growing as a percentage of the overall Company's revenue.

So, it's anything.

That is not driving customer concentration.

What we are seeing is really it's in the component business that is driving, probably the bigger revenue driver, especially if you look into Q2.

What that is actually doing is that is decreasing our customer concentration.

Lighting is lots of customers and lots of different applications.

So, I think what you are actually seeing as we grow the business we are relying less on any one key customer.

Got it.

Last question.

On your gross margin outlook longer term, wondering what you are looking at and how that could change as this mix most in lighting and consumer?

Obviously, the near term target is that in Q2 we think we are targeting 44% plus or minus again.

So, I think it's pretty similar to what we did last quarter.

I think as we look longer term, we laid out a couple of years ago a goal of getting our gross margin in the low 40% range and our operating margins into the low 20%s and I would classify where we are at today is that we are in that range.

I'm sure there will be some variation quarter-to-quarter.

We know that.

As different things change in the market and utilizations change and on the other side, there are things we can do as we scale the business where we are targeting to still drive some operating leverage.

So, I think this is still the right range going forward that we are targeting.

Obviously some variability, but this is the model we were shooting now and from what we can see, we are going to maintain that target range.

Got it.

Thanks.

Your next question comes from the line of Steve Milunovich with Merril Lynch.

Great.

Thank you very much.

Chuck, just to clarify that for me so, you said in the past 40% was probably as good as it gets on gross margin.

You are now higher.

You are expecting that it would be higher in the near term.

Is this the new baseline or do you think over time as maybe supply comes up a bit more and competition hits up we hit back to 40%?

Yes.

So, near term, I think Q2 is similar to Q1.

I think going forward, the way I would classify it and just to clarify, what we did lay out in the past was we used the term low 40%s, low 20%s.

In my mind whether that is 40% or 44%, we are in the right range.

So, I think that right now I think that if the factory continues to operate the way it is and frankly as we get more components business I think that gives us the opportunity to maintain it at this level.

I think longer term obviously, as the market changes and capacity comes online and utilizations might vary, people always look to put pressure on gross margin.

And it might put some on it.

The counter balance to that is that our operating margins as we grow the business, we targeted some leverage especially in SG&A longer term as revenue grows and I think that is still to come.

So, I still think this is the right range going forward low 40%s, low 20%s plus or minus each quarter, but for now this is what makes sense.

What kind of decline are you seeing on your costs on a annualize basis?

Boy, I don't have if I have a specific number right now for you, Steve.

I haven't seen that, frankly, that specific analysis.

Typically what we target is about 25% a year and that is 25% a year ASP erosion.

Obviously, the costs are probably coming down as good as that much or more right now just because we are getting a combination of all the normal things and good utilization and ASPs are probably a little off.

That's why the margin you have seen some of the benefit, but I don't have a specific number for you.

Okay.

What's the headcount of the Company and where do you see that going over the next 6 to 12 months?

I want to say right now we are in the range of about 3300 employees.

We just announced a couple of weeks ago that we will be expanding in Durham over the next few years at 275 this year and then 575 I think in total over the next three years here in North Carolina and then we'll likely have to expand in Asia as well for the backend type operations and I don't have a specific target for you there, but you should expect there will be growth there, but no number for you at this point.

Okay.

And finally any update in terms of stimulus spending and sort of you get that indirectly, but are you seeing any change in the flow there?

Steve, I think we are seeing it in some incremental business.

I think it's definitely helped spur on some of the municipal lighting projects.

I think it got people interested.

What is interesting is that it got a lot of people working on LED lighting, whether or not they ended up getting the stimulus or not.

So, we are seeing some of that benefit, but I think it's very much incremental.

I would describe it as a similar way in China.

I was just there last week and I don't think there's direct dollars driving this program, but there's clearly an awareness and a real focus on energy efficiency projects, whether they are directly funded or not.

And so I think we are getting, the stimulus programs had the biggest effect on getting people to think different about some of this stuff.

Thank you.

Sure.

Your next question comes from the line of Lauren Silver with Lazard Capital Markets.

Thanks for taking my question.

My question might have just been answered, but I was going to ask about the Government stimulus and whether or not you've seen an effect from the stimulus plan and how that affected your revenue in the quarter.

Yes.

I think it's indirect.

I think there's probably some incremental sales in there.

I don't think it's a major driver of the revenue, but we have seen some incremental benefit.

I think really at the end of the day, I think stimulus, the biggest effect it had is it has changed the market's awareness for energy efficiency generally and LED lighting, specifically.

So, I'm sure there is some incremental benefit in our numbers, but I don't believe it's a significant piece.

We see LED lighting adoption happening independent at this point of stimulus dollars, although they clearly helped get the momentum started.

Okay.

Interesting.

So, that's a little bit of a change from what you guys were saying before, I believe.

No.

Actually what we said is the biggest impact in the past, is I think we said we thought we might see a future benefit, maybe some incremental positive to the Company, but it has the biggest impact to move the market.

When I say benefit, not to Cree, but to our customers who then buy LEDs from Cree.

Right.

Okay.

Then if you had to put a number on it, what would you say what would the percentage growth be for the industry in terms of supply over the next year?

How about we'll go for calendar year 2009 and calendar year 2010.

I don't think I have a great estimate for you.

I just spent last week with a bunch of people in the industry in China and I think it's kind of hard to put a number on what capacity growth is.

It's clearly growing.

It grew in 2009, specifically in the second half, but I don't think anyone has a good number on it and I think as far as 2010 goes, there are some people talking that have some capital purchases on the books, but there is so many speculation and rumor, I'm not sure anyone has a good handle on the real number even when I talk to my colleagues in the industry.

Interesting.

Okay.

Thank you very much.

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

Good afternoon.

First question on the lighting market.

Can you discuss where you see the largest opportunity for Cree over the next six months?

Is it more on the architectural lighting market, street lights or somewhere else?

Yes.

I think, Carter.

I would put it in three things.

I think the outdoor municipal lighting market, street lights, parking garages, that is one of the large drivers.

We are also starting to see some of the indoor lighting markets.

They would be whether we service those with our own lighting products, but even with LEDs we sell to other companies we are seeing that growth.

The third I would call, is the more indoor, but it would be the bulb market.

So, we are starting to see some traction whether they would be linear tube LED replacement lamps, which are quite popular in Asia right now to even some of the A lamp type products that are starting to appear in some of the stores here in North America.

If I had to put three things out there is those.

There doesn't mean there still aren't things going on in architectural, kind of colored lighting.

There is still the vehicle lighting.

There's still the specialty lighting, like refrigeration.

All those things are still happening, portable lighting, but in the end if I was looking at general elimination, it would be those three buckets would be the driver.

That's helpful.

Shifting gears to gross margins, can you help us understand which LED segments in the quarter were above or below the corporate average gross margin?

Yes.

The gross margin, LED components is above the corporate average.

LED chips is below.

Both of them improved last quarter, but they both kind of relatively speaking about the same.

The LED lighting business is lower than the corporate average, but if you think about that business it's about driving the market right now and it's still in a small scale stage.

And then power and RF is below the corporate average, but some incremental improvements there as well.

I think it's still components is the driver and the other three are in different positions below the average.

That's helpful.

Thanks.

In regards to lead times for LED chips, I think last quarter we were talking about or in the last earnings call we were talking about them being about three months for chips.

Have they come in a little bit or holding out for three months?

They are still pretty far out there.

I think Q3 is a little harder to get a handle on.

We definitely have backlog into Q3, but I think part of what happens there is I think even our customers are all trying to figure out what might happen in Q3.

So, I think while last quarter there was no concern with booking out pretty far in advance, I think everyone is wondering what we might see in Q3.

I guess the backlog is still good, but I would tell you that I think, the chip business has probably come in a little bit from last quarter at this point.

I don't have the specific number.

Okay.

That's helpful.

In regards to the distribution channel, you have World Peace and Arrow right now, I think in the past you suggested that that is enough of a distribution partnership both in Asia and North America.

Is that still the case and can you remind us what is the strategy in Europe?

Do you plan on continuing to use manufacturing reps or is there opportunity for a more involved relationship with a partner?

What we are doing is -- Arrow is our global distributor, and we work with World Peace, primarily in Asia, although we have some efforts with them in other markets, but their real strength is in Asia when it comes to our product line right now.

What we are doing in other markets is we also have then, the other side, which is we have both DigiKey and Farnel as the catalog slash online distribution.

So, we cover the small customer from that side and those guys have access to the markets around the world and then in addition, in specific regions we often times when it comes to LED components, we'll have a local distributor.

So, in Europe, I don't know what the exact number is, but we probably have eight or nine local distributors at this point.

In North America we have in some cases, some specialty value added resellers that we work with.

So, I think each market can be different and some applications require specific relationships.

So, we are pretty open to finding relationships that help the customer solve their problem and be successful with the design.

With that being said, clearly Arrow and WPR are the two biggest players.

but especially in some of the local markets the local distributors do a great job for us.

Okay.

Are the DigiKey and Farnel, were those established in the past year or have they been around for a while?

I want to say it was probably a year ago, maybe a year and a half ago.

Something like that.

Okay.

Last question for you guys.

Obviously the cash balance on the balance sheet is pretty attractive at this point.

Can you talk a little bit about what type of acquisitions the Company might be looking for without showing your hand too much?

Obviously, the primary purpose is to fund the growth so we can see from the product lines we already have.

That's the primary purpose of why we have that money.

Because obviously if the business is going to grow significantly it's going to take more capital to fund that growth.

With that being said, when we look out and think about strategic opportunities, there's nothing specific, but the way to think about it is we have a pretty -- we have a pretty well laid out strategy of driving the market with our lighting products and filling the demand with LED component and that continues to be the strategy.

If there's a way for us to accelerate LED lighting adoption or improve our leadership position related to the same strategy we have today, we would consider it.

With that being said, really nothing specific right now.

We are pretty focused on driving the growth that is in front of us with our current product lines.

Do you think there's an opportunity for possibly integrating into more of the fixture side, something similar to what you did LES or do you feel that the fixture opportunity as a company is sufficient?

I think our lighting business is doing a great job of getting the market going and I think if there was a big gap we didn't think we have a customer we were addressing, we would consider it, but with that being said, it's really, I think that's a lower probability idea at least in the near term.

I think it's more about how do we enable those types of customers, what can we do to make our components business more successful and make them more successful in the marketplace.

So, that's how I think about things.

Great.

That's very helpful.

Thank you.

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

Congrats on the quarter guys.

A few questions.

You mentioned Chuck or John that litigation expense will come up a little bit.

What is driving that?

Are those existing cases or is there an update there?

Thanks.

Hans, that's the [Newmark] case.

Right now it is scheduled to go to trial in our Q3.

So, that is just a ramp up for that trial.

Obviously, those things -- those schedules are subject to being changed, but it's really a function of the timing of that trial and that's been on the calendar for a couple of years now.

That's all it is.

Okay.

The issue, the greater issue here in terms of how the street is trying to understand demand and tightness, is this issue called double ordering and it's something that everybody is talking about.

What is your opinion just if you can put your industry hat on with the degree of tightness or shortage certain type of components or chips, what is going on and how are you guys dealing with it, if at all?

Thanks.

I think obviously we are always wary when lead times move out and that affected the LED chip business more than anything.

So, we have done a number of different things.

I am not going to get into specifics to test whether the market's demand was real or not.

Obviously, last quarter it was real and we think it's pretty solid for this quarter as well.

I think the question in everyone's mind is what type of seasonal effect could there be in Q3 and the opposite side of that if the TV back lighting guys really try to start converting, what is the offsetting fact and I don't think we don't know yet, but in terms of Cree's backlog, I feel pretty good about what we can see.

We have done a lot of things as you know from your industry days, there are some things you can do to see to see if you think the backlog's real or not.

At this point we feel pretty good about it through Q2 and at least what is on the books for Q3 at this point.

When it comes to LED components, we have done some things to try to ensure that we maintain some shorter lead times there.

So, our lead times are not as long when it comes to, especially some of the key lighting applications.

We know it's a project-based business.

So, though we get designs in, when that order comes into the design, the demand is not there until someone gives a contract to do, for example, a street light project.

So, we've been doing some things to try to maintain some relatively shorter lead times there.

So, I think we are less susceptible to that right now.

If I look at distributor inventories, they are pretty lean right now.

So, I think we are not there yet, but I think your concern is correct.

I think whenever demand is high, you have to look for that.

At least in the short-term we don't think it's there, but we are watching for it.

Okay.

And then a follow-up on the gross margin question.

Top line is going to grow let's say high single digits.

Why wouldn't gross margin pick up just a little bit?

What's keeping that from going up a little higher?

The way that target was developed, is if you think about the fact that we ran all of Q1 pretty much fully-loaded, the whole quarter, we are not going to get a loading benefit this quarter and so essentially if you are loaded for all 13 weeks you can't get any more loaded than that.

That's really, I'm sure there will be some improvements on one side and there is going to be some normal activity on the other.

The idea is there's no additional utilization benefit at least in our targets for Q2.

Fair enough.

Thanks a lot.

Sure.

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

Congratulations on a solid quarter.

Thanks Jed.

A couple of quick questions for you.

The 350 lumin, how many amps is that?

350 -- what do you call it?

That's a one amp device.

It's a one amp and how many watts?

It's 111 -- the device is 367, 111 lumins per watt, so at 350, you scale that down.

And any idea, do you have that product now or and then any -- I doubt you are going to comment on any pricing but do you have the product now?

No.

I won't give you pricing on that, but it is priced on a dollars per lumin basis.

I will tell you that.

In terms of availability, we do -- we don't have as much availability of it as we would like right now and that is just the nature of introducing a new product and having a pretty good initial acceptance for it.

So, we are in the process of ramping that up and hopefully as we get through this quarter we'll be able to get that to a higher level, but right now, it's in relatively short supply.

Alright.

Scott and Richard have done a great job with the COTCO integration.

I'm curious.

Two questions actually.

One, what are your thoughts of, since COTCO has been so successful for you, do you look for another COTCO out there in terms of that level of the supply chain in terms of strategic investments and then secondly, I was wondering if you can comment on what your exposure is geographically speaking to China?

I'll answer the second question first.

I think China, at the end of June was 28% of revenue and I think it's probably maintaining in a similar range at this point.

I don't think it got any smaller as a percentage of the overall, so it's a big market for us.

Back to your COTCO integration, I think obviously we didn't choose that business lightly.

We really thought that not only was it a good business and it had some strategic benefit, but we thought we could integrate the two teams and just to give you a perspective.

That COTCO name, we don't use anywhere in the Company because it doesn't feel like that.

We have gotten it to where it is just part of the components business now.

In terms of doing that again, I think it will depend on how fast we can grow the business on our own and what other opportunities might come up.

If there was something that would accelerate our existing strategy, improve our leadership position and help us make LED lighting adoption happen faster, we might consider it.

If not, I think we are in a good position to drive the growth with our own product lines today.

I think it's different than when we did that because at that time we had a gap in terms of both manufacturing.

We didn't have great access to China and we needed a broader product line to fill out the portfolio.

So, we kind of handled three things in one.

I think going forward it's going to have to meet those strategic criteria that I laid out, but if something comes up, we will obviously consider it.

And then lastly video screens, you noted that still hanging in there.

Curious is that mostly in Asia?

Yes.

Our biggest market in video screens is the Asia video screen business.

I think our biggest market is China and then other parts of Asia and then we have some business in US and Europe as well, but not the same level.

So, that's our best market for that and it's doing pretty well.

What's interesting, it's not growing as fast as the lighting so it's probably getting smaller as a percentage of revenue, but it's definitely hanging in there.

It continues to be a solid business for us.

Great.

Thanks.

Your next question comes from Ramesh Misra with Brigantine Advisors.

Good afternoon folks.

Thanks for squeezing me in.

First question was where were lead times at the end of the last quarter?

So, lead times on LED chips are still out there about three months, maybe slightly less than that in components.

Don't have a specific number for you.

It will depend on the customer and application and since a lot of that is in distribution we try to use them to handle the buffer in the project business.

Components would be less, but that's partially because we are managing it that way.

That's not a demand phenomenon.

That's how we are trying to manage the business.

Got it, Chuck.

In regards to asking the question of your expected capacity expansion, I wanted to ask it in another way, how did you arrive at your revised CapEx target?

Well, we looked at basically the rate of growth we had in Q1 and Q2.

Obviously, we've spent last quarter I think it was capital additions were $32 million.

We are looking at $50 million to $60 million.

If you look at that rate over the next couple of quarters, you get a sense for how much capital it would take to support that kind of growth going forward.

That probably answers your question.

So, basically with the $150 million to $165 million you expect to maintain the kind of low double digit growth rate sequentially through the year?

I think the idea is to give us the capacity to be able to support a growth that will allow us to grow in the second half similar to what we grew in the first half.

Okay.

Thanks.

At this time, there are no further questions.

Mr.

Kurtzweil, do you have any closing remarks?

Thank you, for your time today, and we appreciate your interest and support and look forward to reporting our second quarter of fiscal year 2010 results on January 19, 2010.

Good night.

Good night.

Thanks.

This concludes today's conference call.

You may now disconnect.