Wolfspeed Inc (WOLF) 2010 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 Incorporated third quarter 2010 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 20, 2010 at 5:00 o'clock p.m.

Eastern Time.

Thank you.

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

Mr.

Garrabrant, you may begin your conference.

Thank you, Amanda, and good afternoon.

Welcome to Cree's third 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 third 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 FY2010 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 in revenue, gross margin and earnings, plans for new products and other forward-looking statements indicated by words like anticipate, expect, target, and estimate.

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

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

Also we would like to note that we will be limiting our comments regarding Cree's third quarter 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 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 and a replay will be available on our website through May 4, 2010.

Now I would turn the call over to Chuck.

Thank you, Raiford.

Fiscal Q3 was another record quarter for Cree as revenue increased 17% from Q2 to $234 million and non-GAAP net income increased 28% sequentially to a record $51.4 million or $0.47 per diluted share.

Revenue and profits exceeded our targets for the quarter due to the combination of higher revenue from strong LED demand and solid execution on our capacity ramp.

The revenue growth in Q3 was driven primarily by strong growth in XLamp LED sales for lighting applications as well as incremental growth in LED lighting, power and RF.

Non-GAAP gross margin increased to 48.1% in Q3 which is on the high end of our target range for the quarter of 47% plus or minus.

The increase in gross margin was driven by several factors including very good execution in our factory ramp, cost leverage due to increased volume and scale, improved yields in LED chips which benefited downstream product margins, and continued improvement in our power and RF product line.

Cash and investments increased to $991 million and we remain in a strong position to continue to invest in our business and lead the adoption of LED lighting.

Our fiscal Q4 backlog is higher than at this point last quarter due to increased demand for our LED components, lighting products and power devices.

We still have some orders to book for the quarter primarily in the project-related applications.

Sales through our distribution partners continue to grow and our channel inventories are at target levels in terms of days on hand.

The capacity investments we have made over the last several quarters continue to come online which is starting to improve lead times and should enhance our ability to meet customer requirements.

I will now turn the call over to John Kurtzweil to review our third quarter financial results in more detail as well as our targets for the fourth 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 a historical summary of other key metrics.

For the third quarter of fiscal 2010, revenue was $234.1 million which is above our targeted range of $215 million to $225 million.

This represents a 17% increase sequentially and 78% increase year-over-year.

GAAP net income was $44.6 million, an increase of 32% sequentially.

GAAP diluted earnings per share were $0.41 and exceeded our targeted range of $0.35 to $0.37.

On a non-GAAP basis, net income was $51.3 million and non-GAAP diluted earnings per share were $0.47 which exceeded our targeted range of $0.41 to $0.44.

Non-GAAP net income excludes $6.7 million of expense net of tax or $0.06 per diluted share from the amortization of acquired intangibles and stock-based compensation expense.

We continue to strengthen our balance sheet and ended the quarter with $991 million in cash and investments which increased by $36.9 million since the end of December.

Cash provided by operations was $72.9 million which included $22.3 million of depreciation and amortization.

We spent $66 million on capital expenditures in Q3 which resulted in free cash flow of $6.9 million.

LED product revenue for the third quarter increased 16% sequentially to $211.8 million while power and RF revenues increased 27% sequentially to $22.3 million.

Please note that power and RF revenue includes $3.3 million of government contract revenue and LED products revenue includes $0.5 million.

Q3 GAAP gross margin increased to 47.9% while non-GAAP gross margin increased to 48.1% which excludes stock-based compensation of $0.5 million.

This was above our targeted non-GAAP range of 47% plus or minus.

The increase in gross margin versus our target was a result of a combination of factors including very good execution in our factory ramp, cost leverage due to the increased volume and scale, improved yields in LED chips which benefited downstream product margins, and continued improvement in our power and our RF product lines.

Operating expenses for Q3 were $55.7 million on a GAAP basis and $47.3 million on a non-GAAP basis which was approximately $3.6 million higher than our targets.

R&D and SG&A expenses were within our targeted range.

We continue to hire in both areas as we grow the business.

We did take a higher than targeted charge of $3.3 million for fixed asset disposals and impairments which was primarily related to a discontinued manufacturing project due to technology improvements.

Non-GAAP operating expenses exclude approximately $5.3 million of stock-based compensation expense and $3 million of charges for amortization of acquired intangibles.

Our Q3 GAAP operating margin increased 110 basis points sequentially to 24.2% while non-GAAP operating margins increased 20 basis points sequentially to 27.9%.

Net interest income and other for Q3 was $2.2 million.

The effective tax rate for the quarter was 28.5%, however, as a result of several discrete favorable one-time items the book tax rate for the quarter was 24%, which is below our target of 26%.

As I mentioned earlier, cash and investments increased to $991 million from $954 million last quarter.

Days sales outstanding were 48 days as compared to 51 at the end of December.

Net account receivables increased by $12.4 million from December.

Inventory days on hand were 79 days as compared to 80 days at the end of December.

Net inventory increased by $13.3 million during the quarter due to increases in raw and work in process.

Finished goods inventory was flat with the previous quarter.

This increases [intendence] for our targeted sales growth for the fourth fiscal quarter.

Our capital targets for the year are still within a range of $240 million to $260 million with cash outlay targeted in a range of $195 million to $215 million due to the lag between when capital is ordered and when it is paid for.

At this time, we target Q4 revenue to be in a range of $255 million to $265 million.

GAAP and non-GAAP gross margins are targeted to be 47.5% and 48% plus or minus respectively.

Our GAAP gross margin targets include stock-based compensation expense of approximately $1 million while our non-GAAP targets do not.

Operating expenses, we are targeting GAAP and non-GAAP R&D expenses to increase by approximately $2 million while GAAP and non-GAAP SG&A expenses are targeted to increase by approximately $3 million to $3.5 million.

The increase in SG&A is primarily due to higher marketing expenses for two major trade shows, staffing increases and higher legal costs in preparation for the [Newmart] intellectual property trial which is scheduled for July.

We target asset impairments to be approximately $1 million for the quarter.

Our GAAP targets include $5.7 million of non-cash stock-based compensation and $3 million of charges for amortization of acquired intangibles.

Interest income and other is targeted to be approximately $1.9 million.

We target our tax rate to be 28.5% next quarter.

The increase in the tax rate is primarily due to increased profits targeted to be earned in higher tax jurisdictions such as the U.S.

GAAP net income for Q4 is targeted to be at $46 million to $49 million and based on an estimated 10.7 million diluted shares outstanding, our GAAP EPS is targeted at $0.41 to $0.44 per diluted share.

Non-GAAP net income is targeted to increase quarter-over-quarter to $53 million to $56 million for a non-GAAP EPS target of $0.48 to $0.51 per diluted share.

Our non-GAAP EPS targets exclude amortization of acquired intangibles in the amount of $.02 and non-cash stock-based compensation in the amount of $0.05.

I'm now going to shift gears and talk about our operating model over the next several years.

With the growth in LED lighting adoption and our success in the market, we are revising our operating, our targeting operating model.

We are increasing our gross margin target to be in the mid to upper 40s.

We are also increasing our R&D plus SG&A targets to approximately 25% of revenue to enable continued business growth and maintain our competitive edge.

As a result, we are targeting operating margins in the low to mid 20s as operating expenses approach the targeted levels in the mid to long term, and finally, we target our tax rate to stay at approximately 28% plus or minus.

Thank you.

I will now turn the discussion back to Chuck.

Thanks John.

We 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.

We want to be a catalyst for LED adoption by developing innovative new LED lighting products to lead the market and open up new lighting applications for our LED technology.

At the recent Light + Building trade show in Frankfurt we unveiled our first LED module, the Cree LRM4, a new class of product intended to help accelerate the adoption of LED lighting at traditional lighting fixture manufacturers.

This product is an extension of our LED component product line and brings our patented TrueWhite technology to our component customers for the first time.

The LRM4 is a compact, easy-to-use module that is designed to speed time to market and give our customers access the same high quality, energy efficient award-winning technology that we use in our own lighting products.

Several European customers announced their first products at the show based on this new module.

We also continue to expand our business with Zumtobel which unveiled several revolutionary new LED fixture products at the Light + Building show with custom LED light engines developed by Cree using our TrueWhite technology that are twice as efficient as current CFL-based products.

Integrated LED products like these modules are part of our strategy to work with the market leaders and make it easier for the traditional lighting industry to design higher quality energy efficient LED-based products.

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

This starts with developing innovative new LED components.

We extended our technology leadership in Q3 as we broke the 200-lumen-per-watt barrier with the announcement of a record 208 lumens per watt from a prototype LED component.

This is a tremendous milestone for our industry as it was only a few years that many people still believed that 200-lumens-per-watt was the theoretical limit for LEDs and something we would probably never see in practice.

This breakthrough further establishes LEDs as the most efficient lighting technology.

Although 208-lumens-per-watt is an R&D result and production performance at this level is still a ways off, we recently announced our XLamp XM product family, a new component platform that has enabled the first 160-lumen-per watt production LED.

This new product is the most efficient lighting class LED and demonstrates our ability to take R&D results and turn them into real products for our customers.

We also announced our new XLamp MPL EasyWhite LED which offers the performance, color consistency and lumen density to displace conventional light sources.

This multi-chip LED component delivers 1,500 lumens at 250 mA of current and is optimized for directional lighting application including par or BR style light bulbs and it's designed to enable our customers to meet the Energy Star requirements for integral LED lamps.

We also continue to expand the resources in our design centers to provide the technical support to help our customers design products with our LEDs to solve specific lighting design challenges and accelerate their success.

Our third priority is to maintain the product and operating margin levels we have recently achieved as we continue to ramp-up the business.

In the third quarter, gross profit came in ahead of targets due to the benefit of increased scale, higher yields and strong execution on the factory ramp.

Operating profit was ahead of plan due to the combination of higher revenues and higher gross margins.

We target similar gross margin in Q4 as cost reductions are offset by normal price erosion while operating margins should also be in a similar range to slightly higher as new operating expenses are targeted to ramp a little slower than gross profit in the short term.

In the mid to longer term, we target R&D and SG&A spending to increase as a percentage of revenue as both areas are critical to execute our strategy and enable longer-term growth.

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

We did well again in Q3 and the growth has become capacity limited.

We are working on a number of operational activities to increase output in the short term and we have new equipment on order which is targeted to come online by the middle of fiscal 2011.

The demand for both power and RF products looks solid for Q4 and into Q1 of fiscal 2011.

We continue to balance resources between the power and RF product lines and we are evaluating how to increase our focus in this area on higher value products to serve the growing demand for energy efficient power switching technology.

As we look ahead to the first half of fiscal 2011, demand looks solid across our LED product lines and we are focused on expanding our LED factories to support the increased adoption of LED lighting.

Although we are still developing our capital targets for fiscal 2011, our preliminary estimate is that capital spending will increase next year to a range of $250 million to $300 million.

The investments are planned to further LED chip and wafer production capacity in Durham including our initial 150-millimeter production capability, additional capacity for power products, back end LED chip and component packaging capacity at our new factory in China and pilot production capability for our module and lighting products.

For fiscal Q4, we target overall revenue to increase to a range of $255 million to $265 million led by strong growth in LED component sales for lighting applications and incremental growth in LED lighting products and power devices.

The rate at which we can bring on line new capacity, factory execution and our ability to continue to drive adoption for LED lighting will once again be the important factors to achieving our targets.

We target Q4 non-GAAP gross margins at 48% plus or minus as we look to maintain our recent gains.

We target continued investment in R&D to support new product development in LEDs as well as increased spending in sales and marketing.

As a result, we target non-GAAP earnings in Q4 of $0.48 to $0.51 per diluted share.

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

The LED lighting revolution continues to gain momentum and we are well positioned to continue to grow.

We recognize that our competitors are also investing and new players are entering the market, so we are focused on extending our leadership position while we build the scale, cost structure and channels to win in the market.

We will now take analysts questions.

(Operator Instructions).

And we'll pause for just a moment to compile the Q&A roster.

Your first question comes from Steve Milunovich from Merrill Lynch.

Your line is open.

Thank you very much.

Good afternoon, guys.

First question is on Chuck's comment about the, well, both your comments about where the model is going.

Can you talk first of all about the gross margin and your confidence in raising your gross margin target over the next couple of years despite potentially greater competition, and then, second, Chuck, I thought previously you had talked about in your third goal operating leverage expenses coming down as a percent of revenue.

Now you are actually saying the opposite.

They're going to go up as a percent of revenue.

Is that a luxury you can afford because the gross margins will hold here and you want to go for R&D and keep your differentiation or how should we read that?

Yes, Steve, I think a couple of things have changed, right.

In the last year, we've obviously far exceeded the model we originally laid out, and what we have seen is that especially as we move more towards lighting products, we think there's an opportunity to continue to innovate and make differentiated products that will support the new gross margin target which is the mid to upper 40s.

That is kind of how we get there.

I think as we better understand the lighting market and what innovation does and the value that that creates, that's how we got there.

I think on the other side, we have created a tremendous amount of operating leverage in the last year.

As I mentioned, we exceeded the old target.

I think what we are looking at, though, is as the LED adoption continues, and we really want to drive significant growth over the next several years and want to continue to maintain our leadership position, we just see an opportunity to continue to invest in R&D to really continue to push that market very hard and at the same time, it is a very fragmented market.

We have thousands of customers in many different regions and we see that the investment both in the sales and the design centers and the marketing to drive that adoption to be real important to kind of maintain that leadership position.

So I think you can say it's a little bit of both.

We see we have an opportunity to do that and really try to extend that leadership position.

Okay.

If I can just ask about the factory ramp.

Your new plant in China as well as the additions in North Carolina, I thought China is supposed to come on maybe late spring, early summer.

So have you really added capacity at this point?

Can you elaborate on your factory ramp execution?

So what's happening is the new China factory will start to come online not really until sometime in our Q1, probably more towards the end of it.

We are continuing to ramp both chip production here in Durham as well as packaging capacity in our existing China factory.

That is where the ramp is coming from right now and that is what is giving us the ability to continue to grow the business at this point.

It;s new CapEx in the existing factories.

With that being said, we have made the investments for the new factory, those are starting to be installed.

We'll start to see the benefits a little bit in Q1 and really more as we get into Q2 of next fiscal year.

I think the existing factories have some additional upside in them and then really starting in Q2 we'll count on the new factory in China.

Thank you.

Sure.

Your next question comes from Brian Lee at JPMorgan.

Your line is open.

Hi, guys.

Thanks for taking my questions.

I guess just one point of clarification.

On the updated operating model, do you guys expect margins, gross margin to peak in the upper 40s or is this more of a normalized average so peak margins could actually be higher than this in any given quarter, I guess potentially into the 50s?

What we are trying to lay out is more of a longer term view of where the business settles out.

I think there's definitely, given the current demand environment and other things, it's hard to give you any kind of specific short-term target there other than what we've given you for Q4 which is 48% plus or minus.

Depending on what happens with supply and demand in the short term, I think there is some flexibility in the short-term numbers.

As far as the operating expense, I want to clarify.

That is not something that we think happens in the next one or two quarters.

That is, over several years we want to move towards that target and the reality is with the rate of revenue growth in the near term, it's unlikely we will see a significant change, at least in the next couple of quarters, assuming that revenue growth continues at similar levels.

Okay, great.

And then I guess my second question.

I was wondering if you could give us a sense for what percent of your sales mix today is related to multi-dye LED packages versus single-dye and how you expect that mix to trend, I guess, over the next several quarters?

I don't have that breakout for you.

I can tell you that the multi-dye packages are relatively new to the product line.

They are growing but the single-dye packages, especially the higher performance ones continue to grow as well.

So I don't have a good breakout for you.

I would say that single-dye would still be the larger percentage of the business, but it's too early on the multi-dye.

Those are really new products that are just starting to ramp up.

I think they will will become a larger percentage longer term, but it's hard to give you any specific numbers on that in the short term.

Okay, fair enough.

And maybe just as a follow-on to that, longer term can you talk about maybe any potential margin impact from, let's assume a growing mix of those multi-dye products in the overall sales mix?

Yes, I would expect the multi-dye products to have similar margins as our single-dye packages if not maybe even slightly better.

What we are doing is involving specific problems there.

So they tend to be more application specific.

I think the other thing you have to tink about is we also announced our new module product line and right now I would target both of those to be in a similar range as the components business is today.

Okay, thanks, guys.

Sure.

Your next question comes from Ahmar Zaman from UBS.

Your line is open.

Hi, Chuck.

Congratulations on a great quarter.

You didn't mention much about ASPs in your -- can you tell us how ASPs have been trending this quarter and how you foresee them trending in the second half this year?

And then I have a follow-up.

I would say that they are trending under a relatively normal condition.

Obviously in some of the spot markets like chips and others, the pricing pressure isn't very high right now.

But we actually continue to move pricing and specifically in the components business we are moving it on purpose.

So as we are able to drive cost reduction we are continuing to move our pricing because the goal is really how do we open up large new markets for lighting.

So we think that the up front cost ability is an important part of that.

Although, obviously, we've had a pretty constrained environment for several quarters in terms of our ability to meet demand, I think we are trying to act in a manner that is about driving the market.

So we continue to move that.

So I would say the best way to think about pricing last quarter was, at least in components was relatively normal pricing environment with the price reduction built into most of the products and maybe a little bit of benefit in some of the smaller product lines.

But generally normal.

And then you mentioned in the last call about capacity, that you expect to exit capacity at the end of this fiscal year at 3x level at the beginning of the fiscal year.

Can you provide us an update on that and in terms of your capacity expansion into next year, how should we think about that?

For this year we'll exceed our 3x target.

I don't have a specific number but we will have exceeded that for the year.

The ramp has gone.

We are ahead of where we thought we would be when I laid out that target nine months ago.

As far as next year, you can get a sense that the preliminary number, and it is preliminary because we really haven't finalized the capacity plans for next year, but we are looking at a $250 million to $300 million number.

So that gives you a sense that we are looking at increasing the CapEx number year-over-year.

As far as what exactly that does in terms of volumes, I think it's going, it's a little too early to give you any specific targets because it will depend on the mix.

Obviously, we get different leverage across the product line and it's just a little too early to give a number.

But I think you get a general sense.

It's a higher amount of CapEx year-over-year.

Okay.

And if I may sneak in one last one.

We've seen the LED revenues grow in the mid-teens range quarter-over-quarter in the past few quarters.

Is that how we should think about it going forward?

I think in the short-term, obviously, we are seeing pretty good adoption and lighting that is driving that.

It's hard to give a longer-term number.

There's obviously various people out there in the market throwing out different kinds of annual growth rate numbers.

I think it's going to depend on how fast we can turn on different market segments.

We are looking at top line another 11% next quarter.

So you get a sense that growth continues at a pretty good clip, at least in the near term.

As far as next year, it will be a function of can we keep the new applications to turn on.

I don't have a specific target for you yet.

Obviously, from what we can see demand, at least going into the first half of next year, looks pretty solid for the key markets we care about.

We are optimistic, but no specific number for you at this point.

Thank you very much.

Your next question comes from Dale Pfau from Cantor Fitzgerald.

Your line is open.

Good afternoon, gentlemen.

Hey, Dale.

Congratulations on raising the guidance.

Thanks.

For the long-term model.

That is a great thing.

A couple of specific questions here.

Chuck, you mentioned you are going to 150 millimeters next year.

Can you give us a little bit of hint about how you might see that breaking in to the production process?

Yes.

Let me clarify.

What we want to have is an initial production capability.

So we want to have qualified 150-millimeter capability.

I don't think you'll see it by the end of next fiscal year.

And to give you an idea, that's sooner than we would have thought six months ago.

With that being said, in terms of how it affects the model and the cut over, I really think that the ramp to, from 100 to 150 will start in fiscal 2012.

So it will mostly be engineering qualification.

A lot of the heavy lifting will be done next year.

We'll have the capability but at this point I would target that the ramp would be really an early FY 2012 target.

And in that same vein, can I assume that the equipment currently on order, and you will be ordering, will be 150 capable?

That would be correct.

And how about on your crystal, your growing equipment?

I would say that our entire factory is, we have the ability to do 150-millimeter today on an R&D basis, purely on a prototype basis.

So we are basically building a factory to support 150 across the line.

Okay.

And one quick question.

As to your commentary about being booked better at this point in the quarter than last quarter.

Can you give me a little bit of guidance?

Are you already booking then into, some into the first quarter of next fiscal year?

Can you give us a little bit of guidance about, or some sort of feeling how your customers are giving you production plans and so on?

Are you getting a little better visibility there?

Yes, I would like to clarify kind of what I mentioned in my earlier comments.

Where we are at is, we have more bookings at this point this quarter than we did at this point last quarter.

I'd say from an overall visibility standpoint, I would say it's relatively the same from where we were at this point last quarter.

We are booking products, some demand into Q1 across most of our product lines at this point, and with that being said, there's always some spot business that we still need to book to make this quarter happen.

I would say, Dale, relative to where we were at this point last quarter it's pretty similar given the targets.

Great.

Thank you very much.

Sure.

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

Your line is open.

Hey, guys.

First of all, congratulations on beating handily and raising numbers again.

Two quick questions for you.

Sounds like you are still pretty hand-to-mouth, whatever you make you are able to sell.

Did you have to leave any revenues on the table this past quarter and in end March, Chuck?

I think, Harsh, we are getting pretty close to being able to meet the requests, but I shouldn't say that.

It's a little heart to say.

We have relatively long lead times so we are setting expectations pretty far out.

I think our execution allowed us to meet or exceed those expectations.

With that being said, we obviously still have a strong backlog.

One of the things that is getting better is that we are pushing really hard to try to get the capacity ramp to the point where we can get the lead times a little better.

We were, in some cases, we were over 12 weeks.

We are getting some products closer to eight weeks which is real important, I think, right now because I don't think you can sustain the business in that other.

With that being said, we still have a number of parts that aren't there yet but that is what we are working toward.

I don't know if that gives you the color you're looking for?

That's very helpful.

My next question, I think you alluded in parts and pieces to this earlier.

In terms of China capacity coming on perhaps maybe the June to September timeframe.

Chuck, can you help me understand when your next large chunk of front end capacity will go down in terms of a fab or a line?

Is that also consistent with that time period of fiscal 1Q?

Right now, basically at the rate we are investing, it's coming on pretty much every month.

We pretty much started the ramp a year ago this time and we are seeing new equipment come on every month.

So I don't think right now you are going to see big, big chunks that change the numbers dramatically.

We are trying to ramp every month to grow with the growing demand.

So at this point even when China turns on, we are going to turn on a part of that factory, the entire factory doesn't turn on the first day.

We'll have some lines of equipment installed and then we'll be installing more over a period of time.

Similar to what to how we've been expanding.

I think maybe what you are going to is what about a wafer fab and I would say that right now we think we have enough space that we can grow through fiscal 2011 and we are really looking at fiscal 2012 as to what we are going to do then in terms of additional capacity beyond that.

Right now is really new equipment in the existing factories and/or our new China factory is how we see ourselves growing over the next fiscal year.

Got it, very helpful.

Thank you.

Your next question comes from Yair Reiner from Oppenheimer.

Your line is now open.

Hi.

Congrats on the quarter and the guidance.

Thanks.

This is actually Michael [Saw] calling in for Yair.

My questions are regarding product mix.

Can you give any kind of sense or color on the quarter-over-quarter or year-over-year growth in your product lines, say, XLamp or on the components?

So if you look at, I would tell you if you look at sequentially the growth last quarter was, the vast majority was LED components led by the XLamp product line.

If you are looking at our growth what you are seeing, the big driver there is XLamp.

We did see some incremental growth this both power RF and the lighting but overall XLamp was the big driver within the LED component segment.

That's really what's driving the growth.

I don't know if you are looking for color beyond that or something else there?

No.

That's very helpful.

In understanding your gross margin target, I mean, it sounds like you're even running pretty much on full for the past couple of quarters.

I wonder if this is the peak kind of, or do you see like further upside even going into FY 2011?

You won't give that kind of commentary, I guess, but is it very difficult or do you think it's just as you like double, triple in scale you can really even get better than this?

Look, clearly what we've shown over the last four quarters is that we've got some significant benefits from scale, yield improvements, wafer scale up.

So a lot of things from an execution and obviously if we continue to scale up the business we should continue to see some cost leverage and we're obviously working on lots of yield activity at the same time.

The variable in that is really what happens in the market environment.

It's a little hard to answer that beyond the quarter we are giving you and the reason for that is that we are going to try to increase scale.

We are going to drive down cost.

We will continue to try to open up new markets but the demand environment will have some effect on that and the rate of that growth lot have an effect, and it's just hard to give you better visibility than what we give you in the short term.

And the answer is there's probably variability in both directions next year.

Okay.

I guess as a quick follow up to that, would it be fair to say the increased confidence in raising your gross margin target would be, I guess, a lot stronger component orders versus more, I guess, volatile, more commoditized?

If you think about it we have already demonstrated we can achieve those gross margin targets.

What it is as we become more components oriented and frankly more lighting oriented, I think what it has allowed us to do is look at that market and what drives the differentiation and give you a different perspective on what we think is sustainable, at least in that mid to longer term, from really based on what we think is possible in components.

What we see is that technology and value-added solutions matter a lot in this market.

That is why we are driving so hard to continue to push those types of products.

Great.

Thank you very much.

Your next question comes from Bill Ong at Merriman.

Your line is open.

Yes, congratulations.

Nice quarter.

Thank you.

I'd like to get your thoughts on industry trends on what would be the next set of drivers that would bring LED costs further to increased adoption.

Can you comment on manufacturing trends, on when the industry will reach 90% [light] yields or 90% machine up time, or do you see the overall industry move the six-inch wafers concurrent with your plans and how will you stay ahead of the competition?

One, there are lots of people talking about 150-millimeter.

I would tell you that, though, I don't think most of them are very close to being able to go that route.

I feel pretty good where we are at, that we can continue to be one of the leaders in that.

And I think that is obviously a growth driver.

Frankly, I really see scale coming as we continue to drive the growth in the market.

You have two things happening.

You obviously have the whole backlighting market driving scale in the industry on one side, and we have lighting growing on the other side, and I think as we scale up both of those we will get the normal benefits of the market.

More volume, larger wafers, learning curve comes up.

I think the yields in some of the older products, we've already demonstrated we can achieve the types of yield you talked about, maybe not in the newer products or the really high end stuff, but we know that is possible based on having built blue LEDs now for, heck, I guess we've been building blue LEDs at Cree for 20 years now.

I think we see all those dynamics are available to us.

One of the keys is going to be, I think, people, well, moving the cost down is important from the up front.

I think people underestimate the fact that we are getting adoption at the cost today specifically in lighting.

We shouldn't underestimate the fact that there is a good value proposition to be made right now for LEDs, in outdoor lighting, in indoor lighting application, some of the bulb replacements.

And I think we get a little confused, or people tend to want to jump to that next step and, yes, we want to drive it down and we do think it opens up more applications but the reality is we are getting adoption today.

So I think there's growth even with what we have already achieved.

Great.

Nice job, gentlemen.

Thanks.

Your next question comes from [Al Skiana] from JMP Securities.

Your line is open.

Thanks very much.

I was wondering, Chuck, if you can give us an idea in the second half of the year what do you think will drive your biggest gains in the residential market?

Will it be new products like the EasyWhite or will it be the CR6 and what kind of mix should we anticipate maybe being able to hit in the near term from a residential perspective?

It's going to be an interesting swing factor.

We think outdoors is moving and that will continue togo pretty well.

And we see some of the indoor commercial growing.

In terms of the residential space, I will tell you right now it's a little hard to give you any specific insight there.

Components will drive more of that.

We'll have success with our own lighting products but the reality is our components business is at a different scale today.

It's likely to be a bigger factor and it's really going to come down to what kind of consumer uptake is there as some of these new bulb-type products come on the market.

There's been products out there for the last year.

But it's really only been in the last quarter or two that they've really seen the performance come up and the cost come down to the point where you can actually screw these things in and they work and start to fulfill what the customer expects from a lighting performance.

And then the question is what price point drives that.

And I'll be honest, we don't know for sure at this point.

The other thing that is happening is these are the same customers that pretty much every three months they are coming out with higher performance products using the latest LEDs and trying to drive their costs down.

They are moving the products pretty fast.

At this point we are supporting them.

We are seeing some initial interest in the products but it's a little hard to call where that uptick is at this point.

So we are in a wait and see mode.

Is part of your new operating guidance incorporate educating the residential market and help set, say, [binning] standards so that the customer actually has a sense of quality in what they are getting when they go to market with LEDs?

Not directly.

I would say when we look at our new targets is we think the commercial markets are still the big driver for LED lighting.

They are the ones that will drive the market.

I think what helps on the residential or the consumer side is as they start to see LED lighting it raises awareness that actually feeds back and drives the commercial market.

We will see some, I think we are going to see some uptake on the residential side.

I still think the commercial is the big driver over the next one to two years just because at the end of the day LED lighting is about cost of ownership and those are the people that get it better than anyone else.

So what I think we are trying to do on the residential side is really use that to drive awareness and that actually feeds back in overall adoption if that makes sense to you.

It does.

Thanks very much.

Congratulations, powerful quarter.

Thanks.

Your next question comes from [Avin Ashkent] at D.

A.

Davidson & Co.

Your line is open.

Good afternoon and thank you for taking my question.

A few questions.

First one is could you give us some idea about what percent of your LED sales came from the general lighting market?

LED, general lighting is over half.

I don't have a specific percentage but it's grown past the halfway point last quarter and it's roughly getting close, maybe not quite two-thirds but somewhere between half and two-thirds.

Okay.

And you talked about your CapEx budget for fiscal year 2011.

Can you give us some idea in terms of how would that trend through the year?

Would that be higher early on then start to come down, or would it keep going up throughout the year?

If you look at the current rate, we are ramping up to close to that similar rate as we exit Q4.

So I think it's really looking to kind of maintain that investment across the year.

Obviously, we think LED lighting adoption is a multi-year trend.

We think that this investment is not only necessary to grow at FY 2011 but to position ourselves for additional adoption beyond.

Right.

So maybe the next question will be once you get past this huge CapEx expenditures in fiscal year 2010 and 2011, where do you think your capacity is going to be in terms of revenues maybe?

So it's similar to the question earlier.

I think right now, I don't have a specific target for you.

I think the best thing I can do is if you look at what we spent last year, we are going to spend roughly, John, about 250, is that right?

Rough numbers, and that's not all going to come online, right, so a lower percentage will come online.

So you can see what we did in fiscal 2010 with that.

We are raising that number to 250 to 300 next year.

You can make your own estimates and the reason I don't want to give a target yet is we are still in the planning stages and the mix of that revenue will affect that somewhat.

So it's a little hard to give you any more specific target.

But it gives you a directional number.

And, of course, in terms of pricing what should we be expecting going forward at least in fiscal year 2011?

Look, we continue to expect right now in fiscal 2011 that we will need to continue to move prices down as we are able to drive costs down.

In a typical year in the LED business that's 20% to 25% ASP decline on a similar product year-over-year.

I have to tell you right now that we don't, again, we haven't finalized our FY 2011 targets but that is a good general guidance area to start with.

And the gross margin guidance that you gave for the longer term, that would take at least -- maybe you are talking a few years out?

Yes.

I think you can see that even, we are increasing our investment right now, but you can see even in our Q4 targets that even with increased investment revenue is also moving at a rate where you won't really see a change in the percentage in the short term.

Perfect.

Thank you so much.

Your next question comes from Hendi Susanto from Gabelli & Company.

Your line is open.

Hi, all.

Thank you for taking my call.

First, congratulations on your strong results.

Thanks.

And then back to your fiscal year 2011 CapEx and higher reinvestment in SG&A and R&D.

Can you give more color on what kind of revenue growth you can achieve?

In other words, is it reasonable to assume that you would be at six times the capacity at the end of 2009 by the end of your 2011?

No, I understand why everyone wants to know to the answer to this.

We are not ready to give out those kind of numbers at this point.

I think the best thing you can do is look at what we spent last year, what we did, what we're spending this year, what we are targeting for next year gives you a rough sense and we'll provide better targets as we get closer to starting our next fiscal year.

It's just premature for us to give you a specific target.

Okay.

And then my follow-up question.

You mentioned that your tax is expected to be higher in the fourth quarter due to strength in the U.S.

Can you elaborate more on where you see strengths in the U.S.

markets and other higher tax jurisdiction geography?

I think it's as much a product mix as well.

What we are seeing is different products are attacked at different rates because it has to do with where the products are invented.

What we are seeing is that different products are taxed at different rates as well as where we sell them because it has to do partially with where the products were invented and other things.

So I think what you're seeing is, we are actually seeing pretty broad demand across the market.

So at last quarter I think we saw solid growth in our China, Asia business.

We saw good growth in the U.S.

business.

We saw good growth in Europe, but what was happening is depending on the mix of those products they had different tax affect.

They affect the taxes differently.

Is that accurate John?

Yes, that's spot on.

Your next question comes from Daniel Amir from Lazard.

Your line is open.

Yes, thanks a lot, and congratulations on a good quarter.

A couple of questions.

First of all, can you elaborate a little bit more about how you view kind of the LED industry here going forward considering that you have a number of new entrants that came in in the past six, nine months and how do you think they will eventually look into the general lighting market and where Cree sees itself in the market there in the future?

Okay.

So obviously we are well aware of the new entrants and their investments and clearly today specifically some of the large Korean players have really focused on serving their own needs from the backlighting standpoint.

But they've all been pretty clear that they see lighting as another market opportunity for them.

We fully expect that they will build products and look at this market, if not in the short term over the mid-term.

And so with that being said, we think what we have seen so far in lighting is it very regionalized market.

There are thousands of customers in each region and the product differentiation required to solve specific problems tends to drive the dynamics.

So we take them very seriously.

I think that they are going to obviously try to drive the market in one direction and we are going to try to help the lighting customers solve their problem from the other direction.

We still think, we have a good competitive position in terms of not only the fact that we start out in a strong scale position and we continue to invest, but we have a great technology leadership role, good IP position and I think our investment over the last several years in channels and really helping the customer solving their problems will pay off for us in the longer term.

And that is kind of how we see the market.

Okay, and on the inventory side, can you just comment a bit on what you see, if any, in terms of inventory right now in the channel right now in LED?

In the channel for, for Cree specifically, we feel like our channel is in a pretty healthy position.

They are pretty much at target levels.

Maybe some of our distributors would complain they don't have enough because their lead times are still pretty long, but I would say we are in a okay position, with the distributors probably thinking they wished they had a little bit more.

I think the overall industry, beyond Cree, I think that will be a function of what happens with this LED backlighting rollout.

Most people who are involving are investing in that side of the market at least today, and I think that is where a lot of the capacity is targeted.

And it will be a function of, if the big consumer companies take a large percentage of their business over the next year, for example, in TV to LED back lights, I think we will continue to see a market that demand will run ahead of supply.

I think if that conversion doesn't happen obviously then we may see something different in the market.

But right now the consumer guys seem to remain, from what we're hearing they remain pretty optimistic about driving that conversion.

Great.

Thanks a lot.

Sure.

Your next question comes from Carter Shoop from Deutsche Bank.

Your line is open.

Great.

Thanks.

First question on the lighting division, the fixture business, can you help us understand the strategy there within Cree and then how you think about ASPs and that division over the next couple of years?

The strategy there is basically a lead to market one.

When we made that move a little over two years ago, there was essentially no one in the indoor lighting business and everyone was telling us it wasn't going to happen for another five plus years.

The idea was go out, show people what is possible and really try to cajole or encourage the rest of the market to embrace LED lighting and when I saw it at Light + Building in Germany last week was, we've definitely got it moving.

Our focus there is to find applications that are under served where the traditional industry isn't yet embracing LEDs and that's kind of where our product goes.

So we started out with a down light.

Other people started moving into a down lights from a commercial standpoint, so we went with a troffer when most people said fluorescents would always win.

That's why we did that.

Now that some people are talking about LED troffers, we went and did a PAR 38 lamp because everyone was thinking you couldn't do that.

And then after that everyone said, but LEDs will never work for the residential customer so we did a residential product.

It's really about finding products to open up new categories when we know the reality is that the big lighting guys are really an important part of this.

Their ability to build thousands of SKUs and really build fixtures in a lot of different areas is critical.

So it's really get the market moving.

We'll get some benefit from that but really try to then help the rest of the fixture industry get into those markets.

For example, that is why we introduced the module last quarter.

There's a technology where the customers are saying, hey, we would like to be able to do TrueWhite ourselves.

It's pretty complicated technology.

It's patented.

So what we said, it's fine.

We'll build you effectively a really high tech LED component called a module and now they can do their own fixture products there.

That's very helpful.

When we think as the LR6 product as an example kind of introduced three years ago, really haven't seen that price come down a whole heck of a lot.

Is the idea that now that we have introduced it and we have seen competitors coming into the market, that we've kind of de-emphasized those types of products and at some point kind of discontinue those types of products or are we going to have a cost competitive product also in the marketplace?

I think we look at it a little bit differently.

The price has come down a little bit since we first introduced it, but really it's out there and it's still winning most applications when it's in a product because frankly most people don't have a product that offers the efficiency with the color quality at that price point.

So there's other products, there's still not quite, one of the things we did with the LR6 is try to take away all the objections to LED lighting.

I think that product still has a healthy life because in a lot of applications is still solving the problem better.

With that being said, there are a lot of other new products for different applications that work real well or a different way to solve that and when they win, we are happy for that too.

I don't think the LR6 goes away anytime soon just because it really solves, where we focus today is really on high efficiency, very good color quality, and that is still a piece of the market where I think we distinguish ourselves from most everyone else.

That's helpful.

One quick follow-up.

In regards to the channel strategy in the U.S.

and internationally you mentioned that is something you want to continue to build out, can you help us understand if that is more on the chip side, on the package side?

Where do you see the kind of biggest holes right now with Cree's current channel strategy?

I think we have a lot of good partners in place.

What I am referring to there primarily is the LED components segment of the business, the big growth driver.

We like our partners.

We like what we've done.

What we are finding, though, is that there's still a lot of customer design support is the best way to think about it to really help them be successful designing their own products.

In some cases, we need to develop products that are easier to use like the MPL, like the module, like the new kind of more advanced products, and in some cases we frankly just need to provide the technical support like you see in a lot of other semi businesses where we've got to help them with their designs.

Because they are moving over from a different technology and our ability to help them out it makes a big difference.

So really more the breadth of this service rather than -- the actual expanding into new regions?

Yes, I don't know that it is new regions as much as it is design support, technical support, really, things you that you would see in some of the other semi businesses where you really have to help the customer with the design.

Great.

Thank you very much.

Sure.

Your next question comes from Jonathan Dorsheimer of Cannacord.

Your line is open.

Hi.

Thanks, and congratulations on the quarter and also getting out of Germany.

I wasn't as fortunate.

Are you still stuck there?

I am.

Hopefully, later this week I'll be able to get out.

Chuck, I guess my first question is in a lot of your press releases I am noticing that you are talking about drive currents a bit more.

I am just curious in the lighting business what your thoughts are in terms of do you think one amp or two amps is what is being (inaudible) and then what does that do to the lifetime side of the cost of ownership equation?

I think what we are finding is that depending on the application, all different drive currents can be a reasonable approach to the market.

We have, obviously a lot of customers have kind of focused around the 350 mA.

That was initially where we started.

And what we are seeing now is in some applications it's more beneficial for the customer to go to a more high current design.

That is why we have products qualified up to over an amp and obviously with the new XM platform will go up to 2 amps.

It really just depends on the customer's application, what problem they are solving and how they want to do their product design.

Some want to use an array of LED that works great for them because they need to move the light around in an area and others really want fairly large single-point light sources.

So what we are trying to do is give them the choice.

In terms of lifetime, we have products that at high drive currents can deliver the same lifetimes that we can deliver at the low drive currents.

It's a function of managing the thermal design around that.

And so I think, one of the things we worked a lot on in our development of our products is making sure that we can support these high current designs and we are not just taking the same LED and changing the drive current.

We are doing a number of engineering things to try to support that from a lifetime standpoint.

Great.

That is helpful.

My last question here is I know you haven't finalized the CapEx budgets, but I presume, or let me ask, is all of the Epi still staying in the U.S.

or will any of that be going over into China?

We have no plans to move the Epi technology in fiscal 2011.

That is what I thought.

So there's a $10 million R&B subsidy for a lot of the front end tools over in China.

I am just curious, are you able to capture any of that or any of the back end or if you can elaborate on maybe what China is helping in terms of subsidies?

I don't think we plan to break out specifically what kind of incentives we got as we've expanded our factory in China.

I agree there are a number of different subsidies.

I think they are broader than the just the one you referred to but I don't know if I have the same numbers but I heard something along the lines of what you described.

I think there is an incentive there to expand production in China.

From our standpoint, the way we look at that is, yes, those are nice things to have but at the end of the day it is about where is the most efficient place to put the production to serve the market.

Frankly, we are as interested in what markets we can serve when we're building these factories as we are those other pieces.

Not that we don't like those, and they are helpful, but it's really as much about what makes sense from a manufacturing logistic standpoint and serving the customer.

Great.

Thanks, and congrats on the quarter.

All right, Jay.

Good luck getting home.

The last question comes from Hans Mosesmann from Raymond James.

Your line is open.

Thanks.

Congrats, guys.

A couple of questions.

Can you tell us where your inventory levels could be in the June quarter if they are going up by how much?

Hans, I will throw that one to John.

I think they will stay at a similar level in terms of days.

John, do you have any better --?

That's our target.

Our target is to keep them hovering right around the 79, 80 days.

Okay.

And then as a follow-up, in terms of your sequential growth, a lot of my questions have been answered, you are saying the components will be driving the growth.

How should we think about lighting in terms of incremental growth through the power and RF side, is that low-single-digits or mid-single-digits?

Power and RF is capacity limited in the short term, Hans, so it can't grow very much.

The demand is solid but we have to, we have equipment on order.

We are doing some operational things but it will be somewhat capacity constrained.

We'll get some incremental growth, but it's probably single-digits in the short term.

In terms of lighting, it's actually still growing well.

The real reason I don't put that out there in terms of the lighting systems business is that it's just such a smaller base, right.

So the answer is that at the end of the day the main dollars of the growth are coming out of the components business but the lighting products is still growing in the double-digit level.

Great.

Thank you very much.

Sure.

There are no further questions at this time.

I will turn the call back over to the presenters.

Thank you for your time today.

We appreciate your interest and support and look forward to reporting our fourth quarter of fiscal year 2010 results on August 10, 2010.

Thank you and good night.

This concludes today's conference call.

You may now disconnect.