Wolfspeed Inc (WOLF) 2011 Q1 法說會逐字稿

Good afternoon.

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

At this time, I would like to welcome everyone to the Cree 2011 first quarter earnings release 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, October 20, 2010.

Thank you.

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

Mr.

Garrabrant, you may begin your conference.

Thank you, Amanda, and good afternoon.

Welcome to Cree's first quarter fiscal 2011 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 2011.

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 on the investor relations section of our website at www.cree.com under Quarterly Results in the Financial Information tab.

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

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

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

Also, we'd like to note that we will be limiting our comments regarding Cree's first quarter of fiscal year 2011 to a discussion of the information included in our earnings release and the metrics posted on our website.

We will not be able to answer any questions that would involve providing additional financial information about the quarter beyond the comments made in the prepared remarks.

This call is being recorded on behalf of the Company.

The presentation and the recording of this call are copyrighted property of the Company and no other recording, reproduction or transcription is permitted unless authorized by the Company in writing.

Consistent with our previous 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 also are webcasting our conference call and a replay will be available on our website through November 2nd, 2010.

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

Thank you, Raiford.

Fiscal Q1 was another record quarter for Cree as revenue increased 1.5% from Q4 to $268 million and non-GAAP net income increased 10% sequentially to $66 million or $0.60 per diluted share.

Revenue grew in lighting, LED components and power, but in total was on the low end of our target range of $270 million to $280 million due to an almost 20% decline in LED chip sales as a result of weakness in notebook and monitor backlighting demand.

The growth drivers remained on track with strong double-digit growth in LED lighting product sales for both our commercial products and the initial rollout of LED downlights for Home Depot, growth in LED component sales driven by outdoor lighting and LED bulb application, and growth in power products.

Net income exceeded our targets for the quarter due to solid gross margins, lower than planned operating expenses and a favorable tax rate.

Non-GAAP gross margins was 49% in Q1 which was on the high end of our target range for the quarter of 48% to 49%.

Gross margin was driven by solid execution across the factory, higher yields and a heavier mix of components which mostly offset slightly lower factory utilization and increased LED pricing pressure, especially in the LED chip product line.

Cash and investments increased to $1.1 billion and we remain in a strong position to continue to invest in our business and lead the adoption of LED lighting.

Our Q2 backlog is running behind last quarter's order rate, primarily due to soft LED chip demand as the business has shifted from a capacity constraint environment to short lead times and turns oriented business.

LED chips are targeted to be down about 10% in Q2 due to a continuing inventory correction related to backlighting applications.

As we have explained in the past, chip sales to backlighting are opportunistic and not part of our core lighting strategy.

This trend is in line with historical LED chip business patterns and we expect demand to increase again in the first half of calendar 2011 driven by lighting demand and renewed momentum in the conversion to LED backlit TVs.

Looking beyond the LED chip effect, LED lighting and power orders remain strong and ahead of last quarter, while LED component orders are booking a little slower.

We believe this is primarily a function of our customers and distributors using shorter lead times to manage their inventories.

LED lighting adoption continues to gain momentum and we continue to see strong design activity.

The growth rate at which new lighting applications are converting to LEDs fluctuates from quarter to quarter, but this is not surprising given the early stage of adoption and the disruption being caused by LED technology.

Our own lighting business, which is probably the best leading indicator for indoor commercial applications, is targeted to continue to grow at a strong rate again in Q2.

LED components is also targeted to continue to grow primarily in outdoor lighting and bulb retrofit in the short term, while we expect to start to see growth in indoor commercial applications over the next few quarters based on the trends we see in our own lighting product line.

The one area where we have seen a recent slowdown is in the China outdoor lighting market as new LED street light specifications have delayed some projects.

We believe this is a net positive for Cree as the new requirements raise the efficiency and lifetime standards which should favor higher performance LED design.

I'll now turn the call over to John Kurtzweil to review our first quarter results in more detail as well as our targets for the second quarter of fiscal 2011.

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 to the corresponding GAAP measures for all quarters mentioned on this call is posted on our website as well as the historical summary of other key metrics.

For the first quarter of fiscal 2011 revenue was $268.4 million compared to our targeted range of $270 million to $280 million.

This is a 1.5% increase sequentially and 59% increase year over year.

GAAP net income was $58 million, an increase of 10% sequentially, and 176% increase year over year.

GAAP diluted earning per share was $0.53 and exceeded our targeted range of $0.53 to $0.51 (sic - See 4Q10 Press Release).

On a non-GAAP basis net income was$66.3 million, an increase of 10% sequentially and a 142% increase year over year.

Non-GAAP diluted earnings per share was $0.60 which exceeded our targeted range of $0.56 to $0.59.

Non-GAAP net income excludes $8.2 million of expense net of tax or $0.07 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 $1.1 billion in cash and investments which increased $32 million since the end of June.

Cash provided by operations was $88.5 million which included $24.4 million of depreciation and amortization.

We spent $61.6 million on capital expenditures in Q1 which resulted in free cash flow of $26.9 million.

I will now provide more details on the results of the first quarter.

LED products revenue increased 2% sequentially to $244.4 million.

Power and RF revenue was essentially flat with Q4 at $24.1 million as growth in power product sales was offset by a decline in government contracts.

In total, this product line had capacity constraints during the quarter.

Q1 GAAP gross margin was 48.6%, while non-GAAP gross margin was 49% which excludes stock-based compensation of $1.1 million.

This was at the high end of our targeted non-GAAP range of 48% to 49%.

Operating expenses for Q1 were $51.7 million on a GAAP basis and $47.5 million on a non-GAAP basis.

R&D expenditures were on target for the quarter and increased to $2.8 million sequentially on a non-GAAP basis.

SG&A expenditures were approximately $3 million below our targeted range, and on a non-GAAP basis primarily due to lower legal expenses related to timing of IP litigation costs and lower compensation-related expenses.

On a sequential basis SG&A declined approximately $9 million from Q4 which included expenses related to an IP settlement in Q4.

When the impact of the IP settlement and other one time items was taken into account core SG&A increased about 4% sequentially from Q4.

Non-GAAP operating expenses exclude approximately $6.9 million of stock-based compensation expense and $2.7 million of charges for amortization of acquired intangibles.

Net interest income and other for the quarter was $2 million.

The effective tax rate for the quarter was 23%, which is below our target of 25%.

This lower tax rate was primarily due to a new foreign tax holiday we received during the first quarter.

Day sales outstanding were 41 days.

That's compared to 40 at the end of June.

Inventory days on stand were 82 days as compared to 76 days at the end of June.

Inventory increased by $13.7 million to $125.9 million during the quarter.

Half of the increase was raw and WIP as it is intended to provide more flexibility in the factory to meet customer requests in the shorter lead time environment.

The other half of the increase was in finished goods, where we had planned to increase inventory in LED components and LED lighting.

We also had an increase in LED chips due to the slowdown in revenue.

We target days of inventory to remain in a similar range for Q2.

Capital additions were $61.6 million in the first quarter.

We were actively managing capital additions to be in line with the growth targets of the Company.

We continue to invest in our strategic priorities such as the 150-millimeter production line in the US and building out our back end operations at our new factory in China.

Our revised capital commitment target for the year is between $250 million and $260 million as compared to $300 million that we previously disclosed.

At this time we target Q2 revenue to be in the range of $270 million to $280 million which is being driven by a number of factors including double-digit growth in LED lighting product sales, mid-single digit growth in LED components as we work through the transition to shorter lead times, power and RF at similar levels and lower LED chip sales due to a soft market for backlighting.

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

This is similar to Q1 but factors in a lower factory utilization due to a further decline in LED chip volume and the competitive pricing environment.

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

We are targeting non-GAAP R&D expense to increase by approximately $2 million while non-GAAP SG&A expenses are targeted to an increase by approximately $2.5 million.

The R&D increase is primarily related to the ramp in our 150-millimeter development program, new LED components and new LED lighting fixture products.

The growth in SG&A is primarily for an increase in sales and marketing to support growth in LED lighting and LED components, plus increased legal expense related to the Fox Group litigation along with the patent infringement lawsuit that Cree recently filed against SemiLED.

We target asset impairment to be approximately $500,000 for the quarter.

Our GAAP operating expense target includes non-cash stock-based compensation expense of $2.7 million in R&D, plus $7.6 million in SG&A, and charges for amortization of acquired intangibles in the amount of $2.7 million.

Interest income and other is targeted to be flat at approximately $2 million.

We target our tax rate to be 23% next quarter and for the full fiscal year.

GAAP net income for Q2 is targeted at $51 million to $55 million based.

And based on an estimated 110.1 million diluted shares outstanding, our GAAP EPS target is $0.46 to $0.50 per diluted share.

Non-GAAP net income is targeted to be $61 million to $65 million.

Our non-GAAP EPS target is $0.56 to $0.60 per diluted share.

Our non-GAAP EPS target excludes amortization of acquired intangibles and non-cash stock-based compensation in the amount of $0.10.

Thank you.

I will now turn the call back to Chuck.

Thanks, John.

We are focused on four key areas to continue to drive our business in fiscal 2011.

Our first priority is to build on our leadership in LED lighting and continue to be a catalyst for LED lighting adoption by challenging people's addiction to old energy wasting technologies.

Along these lines, we recently launched the EcoSmart LED Downlight with Home Depot and it is off to a great start.

The product was released first as a web product in mid-August and the initial sales had been strong with essentially no advertising.

The product has recently arrived in stores and the initial sales are ahead of plan and customer feedback is very encouraging.

The product was recently featured on the Home Depot homepage and as part of their weekly product promotion on Fox TV Saturday morning.

This product launch is an important part of our effort to fundamentally change people's perception about LED lighting.

While there are many companies currently touting consumer LED bold products that are cheaper, they generally make compromises that result in mixed consumer response and limited sell-through.

While we agree that initial cost is an important factor, our strategy is to focus on delivering no compromise LED lighting that is as good or better than what it replaces and what the consumer expects, and pays for itself in terms of long lifetime and energy savings.

I believe our success in creating the LED downlight category of the last three years and our initial success with the EcoSmart Downlight at Home Depot validates that we are on the right track with this approach.

Our second priority is to further enable lighting fixture companies to develop and introduce their own high quality LED system products to drive demand for LED components.

We continue to be reminded that ramping up new lighting applications does not happen overnight.

Our LR6 downlight, which was launched over three years ago and has set the standard for LED downlights, has continued to grow each quarter as our original value proposition that it is better than the CFL or incandescent alternative is validated and the project gets specked into more projects.

We have learned in designing our own lighting projects that the best system level solutions often require high performance lighting class LEDs that are optimized for specific lighting applications.

Our goal is to bring this concept to our LED component customers through application optimize lighting class LEDs.

We recently launched several new component products targeted at indoor lighting and bulb retrofit applications.

The XLamp MLE is a 1/2-watt lighting class LED optimized for linear lighting applications.

This product is already designed into several customer indoor lighting products.

The XLamp MX3S and MX6S are higher voltage LEDs that are designed to enable more efficient LED bulb products.

We also launched our first EasyWhite LED modules which enable our customers to quickly expand their product offerings by leveraging the same design as our our TrueWhite models.

Our third priority is to further invest in capacity expansion to drive sale and accelerate our transition to 150-millimeter wafer production.

We have chosen to build the first 150-millimeter line in our existing RTP wafer fab that currently produces silicon carbide power devices.

By locating this line in an existing facility near our current LED manufacturing and R&D centers, we can leverage our existing infrastructure to reduce costs and speed innovation.

We are on track with the first phase of the 150-millimeter expansion and the initial equipment is being installed.

R&D spending is planned to increase over the next several quarters to support this development which is critical to maintaining our competitive edge in the market.

We continue to target the first 150-millimeter products to be qualified by the end of the fiscal year with the first production volume to start in early fiscal 2012.

Our fourth priority is to further develop our silicon carbide power product line with investments in new products and capacity to drive growth.

We finished Q1 with another record quarter for silicon carbide Schottky diode sales as demand for solar applications has continued to grow.

We are working to qualify new equipment to support additional sales growth in fiscal Q3.

We target releasing our first silicon carbide switch product by the end of this calendar year which will be a significant milestone in the power market and should expand the market opportunity for our products.

We continue to see growing demand for energy efficient power switching technology and believe this product line is well positioned to grow over the next several years.

As we look ahead to Q2, we target revenue in a range of $270 million to $280 million.

These targets are driven by a number of factors which include double-digit growth in LED lighting product sales, mid-single digit growth in LED components as we work through the transition to shorter lead times, power and RF at similar levels, and lower LED chip sales due to a soft market for backlighting.

We target Q2 non-GAAP gross margins at 48% plus or minus as we look to maintain margins in a similar range as Q1.

Factory execution in yield improvement will be critical again in Q2 as we adapt to managing shorter lead times, lower utilization rates and a more competitive pricing environment.

We target increased investment in R&D to support new product development in LEDs including 150-millimeter development, as well as increased spending in sales and marketing to expand our ability to enable our customers and grow the market.

As a result, we target non-GAAP earnings in Q2 of $0.56 to $0.60 per diluted share.

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

We continue to be the leader in LED lighting and our lighting products are a good indicator of what is coming.

Design activity at our LED component customers is increasing.

Overall LED adoption is growing and the growth drivers for our Company remain on track.

Although we have seen a slowdown in some applications like the Chinese street light market, this should be a net positive going forward as the new specifications raise the bar in performance which is exactly where our product line is positioned.

The LED chip business is going through a normal cycle but is declining as a percentage of the total which further reduces our near term exposure to the backlighting market.

Our strategy is working.

We just have to remember that our biggest competitors are still the old incumbent energy wasting technologies, and the key to growing our business is to lead the market and drive LED lighting adoption.

Disrupting markets can be messy, but history suggests that the winners are those with the courage and conviction to drive the change, not those who wait for it to happen.

We need to keep innovating and enable our customers to deliver high performance, no compromise LED lighting products that save energy and save money.

Thank you and we will now take analysts' questions.

(Operator Instructions).

Your first question comes from the line of Steve Milunovich from the line of Bank of America Merrill Lynch.

Your line is now open.

Thank you.

Good afternoon.

On the backlighting side, I think you said total chip sales were down 20%, so could you review for us again how much of total revenue backlighting represents?

It seems like you've talked in the past about that being maybe 10% or less, and yet to get a 20% decline in chips assuming most of it's in back lighting it looks like it almost has to go to zero.

Were there other things in the chip side going on besides backlighting?

Is backlighting bigger than what you've told us in the past?

Just trying to get a little clarity on that.

No.

I think you got the right numbers, Steve.

I think maybe what surprised people is that the backlighting demand went down a little quicker than we had originally targeted when we put out our targets for the quarter, but it was a 20% decline in chips.

It was pretty much all backlighting related and it has significantly reduced our exposure to that market.

Now, we do have some exposure, but I think if you look at the list of applications now, backlighting probably falls number six or seven on the list, so it's becoming a very small percentage.

With that being said, we see Q2 for the backlighting market to continue to be pretty soft.

So that's why we've gone ahead and built in some additional decline in chips, and that's really primarily related to the rest of our backlighting exposure.

But I think if you work the math backwards, you'll see it is a business that represents less than 10% of the total and now it represents significantly less than that.

And then, second, could you just talk a little about the competition?

You mentioned pricing maybe increasing a little bit.

You said mostly on the backlighting side, but can you talk about it in the core general illumination side, what's going on there and which competitors you see today?

Yes.

Just let's get the chip piece out of the way.

Obviously it's a buyers' markets in chips, demand's soft, so it's been pretty significant price erosion there.

With that being said, obviously the net result is our margins still hold up pretty well.

So I think gives you an idea of how much leverage we have in our factory to drive costs down.

I think more importantly, though, is your question about what's happening in the larger market.

If I look at the LED component business, which is obviously the biggest piece, pricing continues to come down each quarter, but I would tell you that I think it's more of a purposeful thing that we're doing as well as our competitors.

One of the things we've shown over the last year is that we've been pretty successful bringing costs down and as a result, use that to drive up what I'll call the lumens per dollar.

So essentially improve the value proposition to the LEDs.

So we continue to be aggressive.

But I will tell you we were being aggressive six to nine months ago, as well, because as we look forward -- today LED lighting is probably a few percent of the total market.

If we want to drive that to 50% higher, then it's really going to come down to reducing the cost of LED lighting and I think we want to be one of the people pushing that, not waiting for it to happen.

So did it move?

Yes, but frankly, it was within what we had targeted for the quarter and the best way to see that is you see what happened.

The revenue is on the low side and the margins obviously still held in there.

Thank you.

Your next question comes from line of Chris Blansett from JPMorgan.

Your line is now open.

Hi, guys, a quick question related to the demand side on the backlighting consumer electronics.

You mentioned it's a buyers' market right now.

Is that really affecting the volumes in addition to the pricing or is it really just a pricing issue at this moment?

It's both and basically there's less total demand.

Effectively what we've seen is those guys basically got ahead of themselves, had too much inventory, who had hundreds of reports about what's going on in both the notebook and the TV market.

And as they go through that there's just less total volume, and so what volume is there, there's more pricing, Chris, one of the things I do want to point out though is, the net result is, from where we sit today looking forward, we have relatively small exposure.

The exposure of that market is getting pretty small.

So I think it's going to have even less of an effect on our business going forward.

It's really going to be more about how do we win in LED lighting.

Chuck, what I was trying to get at is, obviously you've had pretty strong demand for the general lighting side and I wasn't sure how much of your capacity this potentially opens up for lighting versus maybe selling into that opportunistic backlighting market.

I would tell you that we definitely have capacity.

We have opportunities now that we can grow faster in the lighting segment as applications turn on.

So I think we have shifted that.

With that being said, depending on how demand looks as we get into the first half of next year, I think our approach to backlighting is not going to change.

When it comes to chips, I think there are some applications where we can add value and that it makes sense to participate opportunistically, and if that helps us keep the fab loaded, great.

But at the end of the day obviously our priority is lighting first and then use that business really as a balance from a fab standpoint.

One quick last one for me is could you give an update on how much of your revenue for the quarter was for general lighting, just so we can keep track of how this is trending?

I can't give you a specific, but I can give you a pretty good sense.

I think if you look at the LED business, over two-thirds of it is now related to the lighting segment.

I think after that it drops a long way.

The next biggest segment, I think it's probably the video screen market, and then after that you're getting down into things like gaming, automotive, mobile.

And I think it's only after all those do you get to what's left of our exposure to the backlighting market.

But over two-thirds of it's now lighting driven.

Thanks, Chuck, appreciate it.

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

Your line is now open.

Good afternoon, gentlemen.

First of all, what is the specific reason for the slight down tick in the CapEx guidance for the year?

Dale, as we look out for the whole year you basically have two pieces of CapEx.

We've got our strategic CapEx, 150, getting really ready for where we're going.

We're still spending that money.

But I think if we look at right now where we're at in terms of just total revenue in the short term and really look at a slowdown in chips, I think what we realized is that we can back off that a little bit.

It still gives us opportunity to grow the business pretty significantly and I think we have a lot of flexibility.

One thing you should keep in mind is that although we've slowed that down a little bit, we are still going to try to stay a quarter ahead or two of where we're going to be.

I think it's just a recognition of we got further ahead than we had originally thought and it's an opportunity to go a little slower, what I'll call the variable capacity side of it.

Strategic capacity, we're not making any changes.

Could you just review for us again as you bring higher luminosity chips on, about how long before you see the big knee in the uptake, and then how long before you start seeing ASP competition in those product families?

Dale, where we're at today is the product line is pretty broad.

So we're basically bringing chips in a lot of different packages.

It's going to vary on the product and the application.

I think our XPE product probably competes most directly with a few other companies, but it really is only a few, and generally speaking, it's the mainstream and then there's the higher end.

I'd say in the higher end markets we still enjoy a bit of a performance advantage.

But really what we're seeing, Dale, is many applications are really about lumens per dollar.

Lumens per watt matters, but there's some applications where if we can get them enough lumens per watt, then what they're trying to do is use that to really optimize their design.

So there's really two pieces of the market.

There's the pure performance and then there's the performance with the lumens per dollar angle.

I'd say those are running in parallel.

Back to your specific question, XP-G is a product that came out well over a year ago.

It is in a series of designs.

But I would also tell you there is a whole other series of designs that will only start turning on here over the next few quarters.

So it went through an initial phase of conversion and now there's probably a whole other round of designs that will come around here over the next six to 12 months.

So it's a two phase in that product.

That being said, XP was different.

XP happened more together.

I would think with the XM, which is a product that should be coming out pretty soon, that's the one that takes the brightness up even further, I think XM will take a little bit longer just because it is a new footprint.

We've actually already been out sampling and shipping some small volumes to customers to get them ready for that, but that one will probably take a little bit longer just because it does change the footprint of the design.

One last question.

Power margins and your lighting products, Chuck?

By lighting you mean the systems business?

Yes, the systems business.

I would tell you that components continues to be a little over the corporate average and lighting is making some improvements, but both it and chips are running a little below the corporate average right now.

Okay, great.

Thanks, Chuck.

Your next question comes from the line of Yair Reiner from Oppenheimer & Co.

Your line is now open.

Good afternoon.

My question is about looking past December.

Seasonality for the business has been a bit hard to model, partly because last year has been so strong.

As you look out to the first half of calendar 2011, do you expect there to become negative seasonality in March or do you think the trend will continue to be up and to the right?

So, obviously if we were going to normally worry about seasonality, the traditional businesses that are more consumer driven, we tend to worry about March quarter a little bit because you've got that in Chinese new year.

With that being said, obviously, for example, the LED chip business is already going through a cycle now.

So I think that's a little harder to predict.

I'm not so sure we're going to see a normal trend there and frankly, it's too early to call.

A wildcard in all this is, the number of projects and designs that we're working on continues to increase and so a bit of it's a function of when do those designs and projects turn into business and when do they ramp up our customers?

And at the end of the day it's going to be that phenomenon that's going to drive Q3 more than anything and unfortunately we just don't know enough about Q3 yet to see what seasonality might do versus the new designs.

At a macro level we see adoption growing and we see the basic market growing, but in terms of what happens in Q3 specifically, it's a little hard to call right now.

Great.

Geographically, can you give us a sense of the degree to which China ticked down?

And then if you can also give us maybe a flavor of how you see the lighting market panning out in the US and Europe.

Thank you.

Yes.

So as I think about the three regions, let me go in reverse order.

Europe was basically flat and that was expected.

We built that into our targets.

China actually didn't go down.

It just didn't grow as much as we had originally targeted.

So I want to make sure that that's clear.

There was some slight growth there and what we saw is growth in a lot of applications that was offset by a little slower quarter in terms of the street light business.

And again we think we understand what happened there, and frankly, that should be a net positive going forward.

And then the US had some nice growth.

So Europe was flat, US grew and China was flat to up a little bit which is actually a pretty positive sign because it means that even with the street light thing the market in general is still growing.

Thank you.

Your next question comes from the line of Ahmar Zaman of Piper Jaffray.

Your line is open.

Hi.

Thanks for taking my question.

Historically we've seen almost double-digit growth in your components business and now we're looking at about mid- to high single digit growth in the lighting component business.

Is that the new normal in that business or how should we think about that going forward?

I think I wouldn't go -- I don't think we should take any new normals yet.

If we step back, the market, 3% to 4% of the market's LED today and the rest is conventional lighting.

So as we go through this adoption cycle, I think we're going to be able to see periods of fairly significant growth in the market and that's going to create lots of opportunity.

I think in the near term, obviously as we go through each quarter and you have lots of different applications moving in directions and it's not consistent, if it's in mid-single digits or if it's in the double digit area, I think anywhere in that range puts us on the right growth track.

And what I tried to bring out a little bit earlier is we're not dealing with "a" market, right?

So lighting is really a bunch of different markets and we're still, in so many cases, at the early stage of getting the market to turn on.

To me the fact that it comes in lumps or it's a little bit lumpy doesn't surprise me to much.

And frankly as long as adoption is low and we can see it growing in the future we're pretty optimistic we will have some quarters in the future that will be back to double digits and exactly what order they come in will be a little hard to predict.

Thank you for that.

And just on your operating margins, your operating margins continue to grow sequentially and there's been some concern in the past about operating margins, and you've guided them to be around the 25% range with increasing OpEx.

In the near term in the next few quarters should we continue to expect strong operating margin performance or with increasing OpEx should that start to slow?

I think if you look at where we're at right now, you've got the gross margin and you've got basically OpEx, and one of the things we've found is that OpEx, we can grow a certain amount each quarter, but fundamentally when revenue grows faster, it's hard to grow at that rate and it doesn't slow down.

It might catch up a little bit.

But right now we're still investing.

I think we're in the right range.

We're probably a little bit on the high end of the target range where we've been operating so we're going to continue to make some investments right now.

But that's really something we can choose to do going forward.

I think right now what we see is tremendous opportunity and from an R&D standpoint and from a sales and marketing investment standpoint to drive further growth we're going to make those investments.

And to some extent the revenue growth was so strong in the last few quarters we essentially couldn't make the investments as fast as we would have otherwise targeted.

So I think you'll see it balance out a little bit.

In Q2 our targets, we don't see any significant change there in Q2.

You can see it moves a little bit from last quarter just as OpEx grows a little bit.

But I think going forward it will move around a little bit, but I don't see any tremendous change one way or the other; at least in the next few quarters unless something we can't see changes.

In fact, just to clarify, I think Q2, if you run the targets, I think you'll end up somewhere in the high 20s, maybe somewhere around 29 plus or minus so, somewhere in there.

Great.

Thank you.

Your next question comes from the line of Andrew Wang from Sterne, Agee.

Your line is now open.

Chuck, how are you?

Just a couple questions.

First, there was an earlier question on general lighting pricing specifically.

My question, to be more specific.

is would you say that the ASP erosion in general lighting, is the rate of erosion accelerating or staying the same?

I would tell you that it's been going down probably faster than you had perceived over the last six to nine months but people don't necessarily talk about it when the margins keep going up.

So I would say keep in mind, Andrew, it's a little hard because the ASPs for last quarter, they're actually right in line with what we targeted.

Maybe even on average a little bit better.

That's one of the reasons the margins came in on the high end of the range.

But that being said, I think people confused that with what we're quoting on new business, and absolutely people are quoting on new business at prices that are more aggressive than what we're selling at today.

But those projects typically come online six to 12, and in some cases 18, months from now.

I think we're unlike some businesses where you quote a price and it instantly changes the whole business, that's not the nature of the lighting business which is project-based in a lot of cases.

So I think there's maybe a little bit of confusion out there in the market.

Is it accelerating?

No.

But we are continuing to being aggressive.

In other words, ASP is basically tracking according to the plan, but we are making aggressive prices, but I also think we have aggressive cost reduction road maps to make that happen.

That's why I'm not answering your question exactly because the ASP trend is different than what the quoting is, and the quoting is really being driven by Cree and others who are trying to open new applications.

Okay.

Now, it looks like you're scaling back your CapEx plans a little bit.

I think originally you were saying $300 million, and now you're saying $270 million to $280 million.

Is that correct?

No.

$250 million to $260 million.

Oh, $250 million to $260 million.

So my question is, at that level of CapEx, at $250 million to $260 million, will you still be able to double your XLamp capacity?

Yes.

We'll still have the ability to do that if we want to, yes.

We were probably trying to get further ahead of the curve than maybe was obvious to outsiders.

There's been a lot of talk about the ability of some of your competitors to transition from backlighting to general lighting.

And I was wondering if you could go back a couple years maybe to the late '90 s when Cree started getting into the general lighting market and maybe remind us of some of the biggest challenges that you faced to get into the general lighting market, and maybe specifically from the perspective of channel.

Let me work backwards.

First of all, what we see when we go out and compete for business each day, we're generally, I'd say, nine out of 10 times, and that's a rough approximation, we're going to compete with either Lumileds each year or Osram.

That is what we see every day.

I know there's a lot of other talk, but that's actually what's happening in the near term.

In terms of getting into the business, one of the things we find is that lighting is not like a traditional market.

It's not one application.

So selling an LED to the street light guy is not the same as selling one to a guy making a consumer A lamp which is not the same thing as selling it to someone who wants to make an architectural downlight.

I can go on and on because there's hundreds of lighting applications.

And so what we found is that the ability to do that one is it starts with thinking about your products and how to solve that specific application problem.

One of the reasons you've seen Cree's product line change so much in the last year in terms of the number of products is that we found the best way to solve those lighting problems is to optimize LEDs for those applications.

Once you do that, though, you've still got to get to those customers and help them through the design cycle and basically support that, which, we use the word channel, but it gets down to it's not just channel to the customer, it's the ability to actively support the customer.

There's a lot of design support as well as a lot of specialty requirements in terms of can you adjust this this way or can you optimize this that way.

And so I would tell you that when we first launched the XLamp, when Lumileds was in the market and we got in with our XLamp, even designs we won, or we thought we could win, we probably spent the first two years before we ever got any real traction and realized that it was more than just making widgets that were bright but also doing the other stuff.

Now, that being said, Andrew, there are going to be some applications that will probably be more consumer-like that I think will act like more traditional markets, but I would put that in the minority of things we're working on, not the majority.

Got it.

Okay.

One last question.

I think it was in the March quarter when you actually raised your long term gross margin goals to the mid- to upper 40s and then operating margins to low to mid-20s.

So then my question is whether or not your long term margin targets take into account these periods of where there might be some oversupply.

Well, they're long term targets, Andrew.

I think we're looking at where the market goes and trying to not look at what might happen in any one particular quarter.

I think one of the things, I think for us it's simply we've been chasing LED lighting for such a long time I think we've developed a different perspective.

But lighting market doesn't adopt in nice quarterly chunks.

It actually adopts over long periods of time and you're talking about an industry that has, in many cases, 18 month design cycles.

So as I look out there, we're not changing our model at this point in time, but I also think we probably shouldn't look at any one quarterly data point too much because, frankly, that's not what we're trying to do.

But to answer your question maybe in another way, we're assuming that we have to drive up the lumens per dollar which means we have to reduce the cost per lumen significantly to enable the market, and that's what we built into our plan and now it's up to us to figure out if we can develop the products to do that and execute on the operations side to make that happen, as well.

Okay.

Thanks.

Your next question comes from the line of Joshua Paradise from Morgan Stanley.

Your line is now open.

Hi, guys, thanks for taking the question.

You've talked a bunch about competing on a lumen per dollar basis.

Can you maybe give a little bit of color on are your prices at a price premium, but there's advantages on a system level to using Cree or are you pricing at parity with competitors?

How does that work in the search day, and then for the 6 to 12, 18 months out that people are quoting?

I would tell you that it works in different ways depending on different applications.

There are some applications where we have an LED that's very optimized to solve a problem.

So, for example, in our NC product or our NPL products, those work very well in certain applications to where it's going to be lumens per dollar, but it's the customers' lumens per dollar is what we're driving there because we solve several other problems in their application.

In other cases, the MX6 product, we have to go out and we have to compete against people like Nichia.

So there you have the more standardized form factor and it's going to be a much more near term view of lumens per dollar.

And then with some of our high performance products you're going to see a range of different things and it's going to depend on the application.

So I would tell you that the net result of most customers' choice is they figure out what gives them the best lumens per dollar.

In some cases there's a system benefit.

In other cases our product is more competitive straight up in lumens per dollar.

And so it's going to vary, right?

When you get into the higher performance applications, it's going to be more system driven and when you get into more of the medium performance applications, it's going to be more of a heads up kind of competition.

So I think we see all of that today and I would expect that to continue.

There's going to be some applications that you'll get above a threshold for performance that maybe both Cree and Lumileds and Osram can hit and then it's going to be who can deliver the best lumens per dollar.

In other cases, we're going to have an optimized LEd application that's going to change their business model and they're going to calculate the numbers differently.

There's no one answer.

It's just not that homogeneous of a market.

It's just too many different things.

Okay, thanks.

That's helpful.

And just one more, if I could.

It seems like you still have a lot of costs that you can take out of the system because as prices are coming down margins will stay pretty stable.

Can you give a little bit of color?

I know you don't give utilization levels or yield levels, but what are you doing that enables you to take cost out continually and rapidly?

I'll tell you what we have done over the last year and then give you an idea some of the things we're doing going forward.

So one of the things we've seen is a huge benefit in terms of scale, adding scale to our factories.

Yes, we also got a benefit of very full utilization, but what we've seen last quarter is we pulled that utilization down and we were able to offset that with yield improvements and other things that were going on in the marketplace.

So it definitely is a factor.

I would rather have higher utilization in any short period of time but I think right now we were running the business probably maybe almost too hot there in the first half of the calendar year.

With that being said where we're at now is with chips slowing down we'll have a little lower utilization, so that will probably put a little more pressure on the business.

But at the same time, there are still things we're doing from a yield standpoint to drive cost down.

And the other thing is, as we design new products we're not just trying to get the yield up on the existing one.

We're trying to continually look at how we make our products and then design the next one hopefully to take costs out of that.

And we don't just do that -- we look at that at the chip level, at the package level.

We also look at that at the lighting system level.

So, for example, the product we're selling at a Home Depot is an example of we did it at all levels.

We actually reengineered everything to be able to sell a downlight that works almost as good as the LR6 but at half the price.

And I think that's the piece people misunderstand.

We're so early in this game in lighting.

There's a lot of engineering optimization left that really can change the leverage and so that's what we've done.

Going forward we see continued scale driving benefit.

We still have yield benefits available to us in almost all our product areas.

And then the third piece is really we're making a big investment in 150-millimeter.

So as that product gets qualified and starts to come online next year, that gives us additional leverage, as well.

So I hate to say it's more of the same, but it is, and those are the things that allow us to keep driving the cost down.

We've been able to support very aggressive moves in this market in terms of bringing down the cost per lumen and still be able to deliver pretty healthy margins.

So we've got to keep executing, but I think we know what the levers are.

Okay, great, thanks a lot.

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

Your line is now open.

Hi, guys.

Can you talk about maybe what your utilization was in the September quarter?

And, Chuck, as you bring this another $250 million to $260 million of capacity out, when does a big part of that hit us?

How should we think about the timing of that and what will it do to your utilization in this kind of slowdown market that we're in?

And then I've got a follow-up.

Thanks.

Last quarter, Harsh, I don't have the exact number.

I think we came in a little under 90%.

That will drop a little bit more this quarter but that gives you an idea about where the fab's running.

You've got to be careful, though, because remember that since we're vertically integrated that's not an exact number, right?

I used the wafer fab benchmark just because that tends to be the most common one.

I would say going forward we are looking at how we bring that capital on and trying to make sure that we do that in what I would call a smart way.

This isn't like there's $100 million that shows up one day and we didn't know it was coming.

So I think we are trying to make those investments in places where we are supporting actual growth in these product areas.

I think we've got a fairly good handle on it.

Also, remember that a chunk of that capital is also for the 150-millimeter investment.

So that's really effectively like we're building capacity for next year.

In the short term that's mostly going to be R&D because we've got to develop the technology, but essentially we have an R&D program this year that frankly provides capacity as we get ready for next year.

So I think we're making an investment for 2012 and in the short term it's going to be mostly at R&D expense because we have to develop it first.

Got it.

That's very helpful.

And a lot of my other questions have been asked, but let me ask you this one.

With the CR6 product, obviously a great product, seems to be doing really well.

Could you discuss maybe the ideal price point to make that a mainstream product?

I still think at $50 maybe it's a little bit high, but I'd love to get your thoughts on it.

Yes.

So I would say that there's a group of people that think you have to have a $19.95 LED bulb, and there's some that think you can sell a $49.95 downlight replacement.

And I think what we've proven is if you sell an upgrade style product like our downlight, you can actually potentially drive different demand than you can.

So I think this market, I understand the idea that consumers respond to price point, and if you are selling a bulb that is nothing more than a bulb, I agree.

The consumer is going to think of it the same way.

But we're not solving the problem that way.

And I think what we're trying to explain is the value in what we sell and what consumers are responding to right now in the sales is that they can see the benefit of paying that and not having to mess with that light for the next 20 years.

And so I think that many people who are talking about consumer price points in this market -- yes, I understand if you're going to make nothing more than a bulb, I get where that comes from.

That's not what we're trying to do.

The value of LEDs is much more than that and we're going to spend the time to get people to understand that because I think what we've proven is the consumer is a lot smarter than people think.

But you've got to market it the right way.

And hopefully the initial success we're having at Home Depot is a proof point that if you solve real problems, they'll buy it.

So we're going down a different path.

That doesn't mean we don't sell LEDs to the bulb guys trying to do the other thing.

We will.

I just think that we're trying to solve a different problem.

And my sense is that what we learned in the LR6 business, Harsh, there's a much bigger market for products that last a really long time and save energy than people think.

You just got to take the time to sell the value.

Got it, Chuck.

Thank you very much, appreciate it.

Your next question comes from the line of Daniel Amir from Lazard Capital.

Your line is now open.

Thanks a lot.

A couple questions here.

First of all, on the LEE chip business, just to understand it better, if we assume that the market stays soft the way it is on the backlighting side from now on it's going to have a much more minimal impact.

Is that fair to say that?

Yes.

So we basically took the biggest hit last quarter.

Obviously we're targeting it down, rough numbers plus or minus 10% again this quarter.

So you can see it's diminishing as a percentage of the total.

Obviously what I'd like to do is have that business flat to growing a little bit, but right now that's about the impact.

Okay.

And then the second is on the China outdoor lighting side, can you give us an idea how much this really impacted you?

Has it been as big of an impact as the LED chip decline?

And also, when do you think that you're going to resume growth in that market?

If you take the chip decline, we just took the chip business out of the numbers, and I don't have the exact ones in here, but just to give you an idea, Daniel, I think the Company probably would have grown in probably the mid- to upper single digits quarter over quarter.

So that's what the core of the Company was growing if you just take out the backlighting issue.

If you look at it, that's a little bit slower than we were growing in the other areas in the last couple quarters.

But I think China, did it affect it?

Yes, it knocked down the growth rate a little bit, but the neat part was, and frankly the positive thing is, even though that's a big application for us, that market can be soft and even down a little bit and net China was actually flat to up slightly last quarter.

So I think it's showing that there's enough applications growing right now that I think we're seeing some -- I frankly am fairly encouraged that we can have the backlighting market move so fast and still deliver a little of top line growth, and know that the core is actually still growing at a reasonable rate, is the way I look at it.

Maybe that's glass half full but I'm in the business of trying to convince people to get rid of their old light bulbs.

So that's where I start each conversation.

Okay.

Thanks a lot.

Your next question comes from Jed Dorsheimer from Canaccord.

Your line is now open.

Thanks for taking my questions here, guys.

Two questions for you.

One, on the lighting side I'm glad you're talking about dollars per lumen.

Do you think that you can get to $0.005 to lumen sometime by the middle of next year?

The reason I'm asking, I'm just trying to get a better understanding of hitting the key inflection points in terms of the adoption.

Yes, Jed, I'm not sure you probably -- if you pick the right product and design the application to use our LEDs in some of the ways they're designed, you could probably get pretty close to that today.

I think it's possible.

And as you know, Jed, one of the things we're working to help people understand is if you take an LED that's designed to run at high currents and you run at low currents, you're wasting most of the benefit, but if I can deliver high enough efficiency at high currents and reliability.

A lot of this is working with the customer to think about their designs different.

Sure.

And then I just wanted to dig a little bit into some of the yields benefits.

You did a great job on gross margins this quarter, but inventories grew, it looks like, by about $11 million.

So if I keep days of inventory flat, it looks like gross margins would have been 45% range.

And so with that in mind it looks like the margin expansion is based on some yield benefits, as you mentioned.

As we look at the coming quarters, can you give us any indication on where the costs savings is coming from?

Is this mostly from the start of the transition to the 150-millimeter?

Although it sounds a little bit premature on that.

Or are you seeing some other area in the packaging?

Could you give us any better visibility into that?

Yes, Jed.

So first of all, on the inventory, remember about half of that is raw and WIP, so it didn't have really any impact whatsoever.

That's really a position-in-the-line phenomenon.

And if the rest, I'd say a couple million dollars of that inventory in the chip area, and I don't remember exactly what it was, that was probably more than we had originally targeted just because chips slowed town faster than we had planned.

But the rest of it, I don't know that it changed the margins too dramatically.

I think we probably got some small benefit on chips, but I don't think it's of the magnitude you said.

In terms of the cost leverage, one of the things we're seeing is that we still have pretty good yield leverage.

So on our products we're still making nice consistent yield improvements quarter to quarter.

And because of that, I think it's helping us more than maybe I think would be obvious from the outside.

And so, as we've had to support markets and go after new applications and really try to drive dollars per lumen or lumens per dollar, whichever way you want to look at it, I think we've really developed more leverage over the last year from a cost standpoint than maybe was obvious from the outside.

Great.

That's helpful.

Thank you very much.

And your last question comes from the line of Carter Shoop from Deutsche Bank.

Your line is now open.

Great.

Thanks for taking my question.

I just wanted to clarify a comment you made earlier, and make sure I'm understanding this correctly.

As it relates to pricing for the components business, it sounds like the rate of ASP erosion hasn't changed much for the business that you're shipping today, but you do expect it to accelerate going forward based on the design bids that you're putting in today.

Is that accurate?

Not exactly.

Think about it this way.

The ASPs we have targeted for a while to come down each quarter probably more significantly than might be apparent on the outside because we had more cost leverage on the inside.

So I think that's the first starting point.

But with that being said, it's a lagging indicator of what we were bidding in the past.

The second piece is that in terms of new designs we are quoting more aggressively, but we've also attempted to build that into the model, as well.

So the idea is that we're also trying to drive cost reduction that will hopefully keep us in a similar range.

Now, that's an execution challenge for us in a lot of different areas.

So is it going to decline faster?

I'm not so sure about that, but I do want you to understand we are quoting aggressively on new projects.

It's really a rate at how fast the new projects turn on relative to the existing business, and as those turn on, what percentage of the business do they become.

And so because this industry has a fairly long design cycle and there's a lot of business that wants your design in, I think the word they used in the Phillips call the other night was sticky, I think when you realize that, it tends to, the ASPs, while they move, they just don't change quite as fast as what we have seen in other businesses like chips or more consumer driven markets.

Does that make sense what I'm describing there?

Yes, that makes sense.

The newer business coming on is going to be a little bit more aggressive, but then you have the whole mix shift to factor into.

And there's a lag to it.

And so the point is, I might be bidding on something today that turns on in three months.

It might also not turn on for 15 months and I don't exactly control that.

Okay.

You made an earlier comment also that the business that you're shipping today in the components, you're competing primarily with Nichia, Lumiled, Osram, et cetera.

Can you comment about how the competitive dynamics have changed for the design business, and who are you competing against today for the design business that maybe you weren't six months ago on the general lighting applications?

That's actually what I was referring to.

For new designs it's those guys we see I would say, rough numbers, nine out of 10 times.

I'd say occasionally we might see a Citizen in one application or a Sol in another application, or a Samsung here, but really not very much.

In fact, I would say there's certain applications you might see someone who has a product design right for there, but on average for most of the designs we're working on it generally starts with the same guys we've been competing with.

And although we do see other guys occasionally in some specific areas, we don't see anyone broadly in the market right now.

So they'd be more focused on specific niches here and there.

So we take the competition seriously and we should.

That's what we're seeing.

That's very helpful.

I appreciate the clarification.

One last question, if I may.

Without giving too much information to competitors who might be listening to the call, can you help us understand the size of the chip business?

We've talked about the backlighting market, we've talked about general chip trends, but is there a way to comment on the overall merchant chip business?

It obviously declined from last quarter, but we don't break out specifically, Carter.

So I'm not sure I can give you a number around that since we don't break it out.

Fair enough, thanks.

I will now turn the call back over to the presenters for any closing remarks.

Thank you for your time today.

We appreciate your interest and support and look forward to reporting our second quarter fiscal year 2011 results on January 18, 2011.

Good-bye.

This concludes today's conference call.

You may now disconnect.