Wolfspeed Inc (WOLF) 2011 Q2 法說會逐字稿

Good afternoon.

My name is Amanda and I will be your Conference Facilitator today.

At this time I would like to welcome everyone to the Cree Incorporated second quarter earnings announcement fiscal year 2011 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, Tuesday, January 18, 2011.

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 second 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 second 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 in 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 second 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 other 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 ask that analysts limit themselves to one question and one follow up.

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 February 1, 2011.

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

Thank you, Raiford.

Fiscal Q2 results reflected continued growth in our LED lighting product line but revenue and earnings were lower than our targets for the quarter.

This was primarily due to lower sales to our LED component distributors in Asia due to inventory correction at their customers.

The inventory correction has been caused by a pause in the China LED street light demand and lower than expected growth in LED bulb applications.

Revenue was $257 million, or 5% below our target range, which resulted in non-GAAP earnings per share of $0.55, which was $0.01 below our targeted range.

Despite the lower revenue, many of our key LED product areas grew in Q2 and we continued to execute well with gross margins of 48%, which were in line with our targets for the quarter.

As I said during last quarter's earnings call, disrupting markets can be messy.

The opportunity in LED lighting has not changed and if anything, we are more confident we will see continued adoption over the next several years.

We remain well positioned to lead this market and drive the adoption of LED lighting which in the end is what puts us in a position to build a much larger Company and create a sustainable brand for Cree in the market.

Revenue declined 4% from Q1 to $257 million as growth in our LED lighting, power and our direct LED components business was offset by a 30% decline in sales to our LED component distributors.

The LED lighting product business grew double digits again and exceeded our plan for the quarter on the strength of sales to Home Depot, Zen Table and continued growth in our commercial downlight products.

Power product sales and LED chips were in line with out targets.

LED component sales to direct customers grew double digits, driven by new design wins and increased demand in Asia, while LED component sales to distribution declined in Asia, primarily due to an inventory correction at LED street light and bulb customers.

The China street light slowdown is related to a pause in the market as new specifications were being developed by the government.

The specifications were published last quarter and a number of companies were recently approved under the new guidelines.

We have design wins at the majority of these companies and expect new projects to start being awarded after the Chinese New Year.

The LED bulb slowdown is related to our customers working off inventory that was bought in Q1 ahead of end customer demand.

The application is growing but not as fast as our customers had anticipated which has resulted in the short-term inventory correction.

Net income was below our target range for the quarter, due to lower revenue and higher operating expenses.

R&D expenses were higher than our targets as we released a large number of new products and increased spending for 150-millimeter LED wafer development during the quarter.

We believe this near-term increase will pay for itself in fiscal 2012 with new design wins and lower LED costs.

non-GAAP gross margin remains solid in Q2 and was in line with our targets at 48%.

The gross margin was driven by solid execution across the factory in a very short lead time environment and improved yields across several product lines, which mostly offset LED component and chip price declines as we continued to be aggressive in the market to drive new applications.

Our Q2 factory plan was based on shipping more distribution orders for LED components which were shifted into Q3 very late in our quarter, so we ended with higher LED inventory than our original targets.

Cash and investments increased to $1.11 billion, and we remain in a strong position to continue to invest in our business and lead the adoption of LED lighting.

Our Q3 backlog is running behind last quarter's order rate and is the result of seasonality due to the Chinese New Year holiday, the current business cycle with very short lead times, and a more turns-oriented business.

LED lighting and power backlog is tracking for Q3 while LED component and LED chip backlog remains soft.

We have good visibility into our direct LED component customers and their business is targeted to continue to grow, while we expect that distribution sales will be flat to down as the inventory correction continues in Q3.

The LED chip product line seems to be bottoming and we are targeting Q3 in a similar range as Q2, although we have low order visibility and don't expect this to improve until after Chinese New Year.

We see some upside potential in Q4 for LED chips, but this will vary with growth in LED TV backlighting demand.

LED lighting adoption continues to gain momentum.

Our own lighting business, which is a good leading indicator for indoor commercial applications, grew strongly in Q2 and is targeted to grow again in Q3.

LED component demand is forecast to be in a similar range as Q2 as we work through the inventory correction in the channel.

We target increased demand for China street lights starting in Q4 as well as new designs for indoor commercial applications.

Although the China street light slowdown has affected our revenue growth in the short term, we continue to believe this is a net positive for Cree, as the new requirements raise the efficiency and lifetime standards which should favor higher performance LED designs.

I'll now turn the call over to John Kurtzweil to review our second quarter results in more detail as well as our targets for the third 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, along with a historical summary of other key metrics.

For the second quarter of fiscal 2011, revenue was $257 million, compared to our targeted range of $270 million to $280 million.

This is a 4% decline sequentially and a 29% increase year-over-year.

GAAP net income was $49.8 million, a decline of 14% sequentially and a 47% increase year-over-year.

GAAP diluted earnings per share were $0.45, compared to our targeted range of $0.46 to $0.50.

On a non-GAAP basis, net income was $60.7 million, a decline of 8% sequentially and a 51% increase year-over-year.

non-GAAP diluted earnings per share were a $0.55, as compared to our targeted range of $0.56 to $0.60.

non-GAAP net income excludes $11 million of expense net of tax, or $0.10 per diluted share, from the amortization of acquired intangibles and stock-based compensation expense.

We continued to strengthen our balance sheet and ended the quarter with $1.11 billion in cash and investments, which increased $12 million since the end of September.

Cash provided by operations was $57.2 million, which included $25.9 million of depreciation and amortization.

I will now provide additional details on the second quarter results.

LED product revenue declined 6% sequentially to $229.7 million.

Power and RF revenue increased 13% sequentially to $27.3 million, primarily from our power product line.

Q2 GAAP gross margin was 47.1%, while non-GAAP gross margin was 47.7%, which excludes stock-based compensation of $1.4 million.

This was in line with our targeted non-GAAP range of 48% plus or minus.

We estimate that there was a gross margin benefit of approximately 100 basis points from fixed cost absorption due to the inventory builds in Q2.

Operating expenses for Q2 were $65.7 million on a GAAP basis and $54.4 million on a non-GAAP basis.

non-GAAP operating expenses exclude approximately $8.6 million of stock-based compensation expense and $2.7 million of charges for amortization of acquired intangibles.

non-GAAP R&D expenditures were $2.1 million higher than our target for the quarter and increased $4.1 million sequentially.

This increase was primarily due to the release of a large number of new products and increased spending on our 150-millimeter wafer development project.

As Chuck mentioned earlier, we believe this near-term increase will pay for itself in fiscal 2012 with new design wins and lower LED costs.

SG&A expenditures were on target and increased $2.8 million sequentially.

$2 million of this increase was related to our investment in sales and marketing to drive LED lighting and LED component growth, and $800,000 was related to G&A expenses.

There was an increase in core G&A expenses of $2.5 million, primarily attributable to $1.1 million in higher legal expenses associated with the two active IP litigation cases, along with increased employee costs, partially offset by a $1.7 million benefit due to a nonrecurring recovery of a bad debt expense and lower employee bonus accruals.

Net interest income and other for the quarter was $2.2 million.

The effective tax rate for the quarter was 13.7%, which is below our target of 23%.

Five points of the lower tax rate was due to the extension of the R&D tax credit in December, as well as absorbing all of the calendar year 2010 benefits in the quarter.

The remainder of the benefit is primarily related to a greater percentage of our income coming from lower tax jurisdictions.

Both of these items will lower our effective tax rate going forward to 21%.

Days sales outstanding were 47 days as compared to 41 at the end of September, as the quarter's revenue was more backend loaded.

Inventory days on hand were 96 days as compared to 82 days at the end of September.

Inventory increased by $19.6 million to $145.5 million during the quarter.

This increase was primarily due to two factors.

First, we built and targeted shipping more distribution orders for LED components in Q2 that were rescheduled very late in our quarter into Q3 as our distributors and their customers worked through an inventory correction.

The product had already been built and therefore we ended with higher LED component inventory than our targets.

Second, we grew our LED lighting products inventory including raw materials, WIP and finished goods to support our higher revenue targets for the coming quarter.

We target to bring our days of inventory down to the upper 80s this coming quarter, as we adjust our build schedules to the current targets.

Capital additions were $64.7 million in the second quarter.

We are actively managing our capital additions in light of our near-term revenue targets while continuing to invest in the long-term growth 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 backend operations at our new factory in China.

Our capital commitment target for the fiscal year remains between $250 million and $260 million.

At this time, we target Q3 revenue to be in a range of $245 million to $265 million, which is being driven by a number of factors including seasonality due to the Chinese New Year holiday, growth in LED lighting product sales, increased direct component sales, offset by the continued inventory correction at our distribution component customers, incremental power growth offset by lower RF and material sales and LED chip sales in the similar range as Q2.

GAAP and non-GAAP gross margins are targeted to be 46%, plus or minus.

This target factors in a more price competitive environment and lower factory utilization, partially offset by yield improvements.

Our GAAP gross margin targets include stock-based compensation expense of approximately $1.1 million, while our non-GAAP targets do not.

We are targeting non-GAAP R&D expense to increase by approximately $3 million in Q3 primarily to support the ramp in our 150-millimeter development program, new product development in LED components and LED lighting fixture products.

We target non-GAAP SG&A to increase approximately $4 million overall from Q3.

This increase includes approximately $2.3 million in core non-GAAP SG&A expenses and a $1.7 million to account for the nonrecurring benefits from Q2.

The core SG&A increase is primarily in sales and marketing, to support growth in LED lighting and LED components to drive demand creation, while G&A includes an increase in legal expenses related to the timing of patent litigation and other employee-related expenses.

We target asset impairments of approximately $0.5 million for the quarter.

Our GAAP operating expense targets include noncash stock-based compensation expense of $2.2 million in R&D, plus $6.7 million in SG&A and charges for amortization of acquired intangibles in the amount of $2.7 million.

Net interest income and other is targeted to be flat at approximately $2.1 million.

We target our tax rate to be 21% for the third fiscal quarter.

GAAP net income for Q3 is targeted at $32 million to $40 million, based on an estimated 110.6 million diluted shares outstanding.

Our GAAP EPS target is $0.29 to $0.36 per diluted share.

non-GAAP net income is targeted to be $42 million to $50 million, or $0.38 to $0.45 per diluted share.

Our non-GAAP EPS target excludes amortization of acquired intangibles and noncash stock-based compensation in the amount of $0.09.

Thank you.

And I will now turn the discussion back to Chuck.

Thanks, John.

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

The EcoSmart LED downlight at Home Depot is selling well and ahead of our original targets.

Customer feedback has been very positive and this product has confirmed that consumers are willing to pay for no compromise LED lighting that is as good or better than what it replaces and pays for itself in terms of long lifetimes and energy savings.

On the new technology front, we believe the LED bulb market has been lacking a no compromise product for the consumer market.

I am pleased to announce that we recently demonstrated the brightest, most efficient LED based A lamp that meets ENERGY STAR performance requirements for a 60-watt standard LED replacement bulb.

This level of performance is the result of Cree's continued innovation and focus on improving LED brightness and efficiency, and the use of our award winning Cree TrueWhite technology and patented remote phosphor technology.

The dimmable prototype bulb delivers more than 800 lumens, consumes fewer than 10-watts and features a CRI of 90 at a warm white 2700K color.

Demonstrating a commercial 60-watt replacement at less than 10-watts is a significant milestone for the industry.

In the race to commercialize LED bulbs and reduce the cost the industry has forgotten that LED lighting is supposed to save energy and deliver a quality light that is as good or better than what it replaces.

With this combination of new technology we can deliver high efficiency, better light quality and a low cost.

We plan to use this product and the technology we have developed to enable our customers to accelerate LED lighting adoption.

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.

The module products, which we announced over the last several quarters, have now been released in the first customer products and we're working on a range of new customer applications for our TrueWhite technology.

Over the last quarter, our LED component new product momentum accelerated with a number of market leading new products.

The XLamp XML LED, which is the industry's brightest, highest performance lighting class LED, was released to volume production.

The XLamp XPE high efficiency light, or HEW LEDs, are the first high power LEDs featuring Cree's new Direct Attach LED technology, which enables fixture design that can use up to 50% fewer LEDs.

The XLamp CXA20 LED array is the first lighting class array that can enable a 60-watt A lamp equivalent.

And we also released new 80, 85 and 90 color rendering index options for our XLamp XPG and XPE warm white LEDs for color critical lighting applications.

Although these products don't turn on new applications overnight, we have continued to increase LED performance which should reduce system costs and enable our customers to expand the market for LED lighting.

We are also increasing our investment in field sales and application resources to put more emphasis on demand creation at both our direct customers and our distribution customers.

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

We increased R&D spending in Q2 to support additional wafer turns for both process development and new tool qualifications.

The new 150-millimeter tools for our RTP wafer fab are being installed, and although there have been some tool delivery delays, we remain on track to meet our target qualification goals.

R&D spending is targeted to increase again in Q3 as we increase development runs.

Although this isn't a significant short-term increase, the project is critical to reducing costs and maintaining our competitive edge in the market.

Once the development is complete, this short-term incremental spending is targeted to be reduced as much of this capacity will support production in fiscal 2012.

We continue to target the first 150-millimeter products to be qualified by the end of this fiscal year, with the first production volumes 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 Q2 with another record quarter for silicon carbide Schottky diode sales and yesterday we announced commercial availability of the world's first commercial 1200-volt silicon carbide MOSFET.

The product establishes a new benchmark for energy efficiency and enables design engineers to develop high voltage circuits with the combination of extremely fast switching speeds and ultra low losses that are simply not possible with silicon technology.

We believe this product can fundamentally change high voltage circuit design for energy efficient applications and expand the potential market for our power product line.

We are on track with the qualification of new capacity to support growth in this product line over the next several quarters.

As we look ahead to Q3, we target revenue in a similar range as Q2, at $245 million to $265 million.

These targets are driven by a number of factors, which include seasonality due to the Chinese New Year holiday, growth in LED lighting product sales, increased direct LED component sales, offset by the continued inventory correction at our distribution component customers, incremental power growth offset by lower RF and material sales and LED chip sales in a similar range as Q2.

We target Q3 non-GAAP gross margins at 46% plus or minus, as we factor in a more price competitive environment and lower factory utilization, which are partially offset by yield improvements.

Factory execution will be critical once again in Q3, given the shorter lead time environment.

Although revenue growth has slowed in the near term, we are still in the very early stages of the LED lighting revolution and we continue to invest in our business to drive LED lighting adoption.

We target increased investment in R&D to support 150-millimeter development, and new product development across our LED product lines, as well as increased spending in sales and marketing to expand our field sales and application resources to drive demand creation with both our direct and distribution customers.

As a result, we target non-GAAP earnings in Q3 of $0.38 to $0.45 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 the success of our lighting systems products demonstrates what is possible when high-quality energy saving LED lighting products are made available to the customers.

Our strategy is to drive the market faster with even more innovative products and more resources focused on enabling our customers to develop, market and sell their own innovative products.

Some applications have started moving but in all cases, we need to continue to knock down industry barriers and push the market to change.

Disrupting markets is messy but we're on the right track.

We will now take analysts questions.

(Operator Instructions)Your first question comes from the line of Chris Blansett from JPMorgan.

Your line is now open.

Good afternoon, everyone.

Chuck, I had a question about your comments about the China market.

You indicated that obviously there's a slowdown due to the standard setting, but you also indicated that you're qualified at the majority of LED light makers who already meet those standards.

Just wondering why we should see continued weakness there before you really see that pick up again if you already have a lot of products that already meet the standards?

Yes, so Chris what's going on is that effectively what's in the market is our customers were anticipating that the current pause would not be as significant as it was so they got ahead of themselves from an inventory standpoint so they're going through an inventory correction.

And two, the market hasn't really turned back on.

Although the new standards are out and most of the -- and a number of companies now have been basically, I don't know what the right word is, qualified under those standards.

But we don't expect most of those projects to really gain momentum until after Chinese New Year.

so I really think we'll see the benefit more in Q4 than we will in this quarter.

So it's really a timing issue.

They've got to work through their inventory and then I think as the new designs get- as the new projects get put out there then we'll see the market start to pick back up.

Okay and then my second question was tied to the lighting products business.

You said demand has been stronger than you thought and just wasn't sure if you could provide more color.

Was that really from the CR6 at Home Depot, continued growth in the conventional lighting channel with your LR6 type products, or where is it coming from?

It really was all three, Chris.

So Home Depot is ahead of our original targets.

The Zen Table business actually grew nicely, continued to grow nicely last quarter, so that's doing well.

As well as just the normal sell in our LR6 and our traditional products through our normal channel continue to gain momentum.

And I think that's a function of having those products out in the market long enough that they've really gotten designed in more places and they've become much more just broadly adopted by the traditional lighting industry in terms of general purpose lighting retrofits.

Okay.

Thanks, guys.

Appreciate it.

Sure.

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

Your line is now open.

Good afternoon, Chuck.

Hi, Dale.

Quick question on this distribution business that moved out here at the end of the quarter.

Based upon your outlook, can we kind of assume that whatever moved out, you're kind of moving that forward also into the fourth quarter?

And then could you give us kind of a magnitude of where you are right now with what percentage of your component business is going into distribution?

Yes, so let me give you the magnitude.

The distribution now is just-- it's a little under two thirds of the business so it's down a little bit from where it was a couple of quarters, so it's still an important part of our strategy and we'll continue to invest in that.

But the direct for the last couple of quarters has obviously been-- continued to grow, so the mix has changed a little bit there.

In terms of the demand, so we basically-- those orders moved into Q3 and then what I think you'll see is it's really a function of how much demand can we help generate at their customers and, frankly, in the end markets.

So at this point, with the lead times being pretty short, Dale, we mostly have visibility into Q3 so it's a little hard to speculate into Q3 at this point-- Q4 at this point.

But I would imagine that at least for Q3, we'll be going through this correction for this quarter and it really won't be until we get the demands going again, both in street light and some of the other bulb applications that we'll kind of come out of this on the other side.

And then as a follow up, could you talk a little bit about where you're seeing the demands for the technology and pricing?

Clearly, you're leading on the technology side.

I know you're pushing on the pricing side.

How do you see the competitive dynamic out there?

I don't think the market's changed a lot in the last quarter.

We came into our Q2 knowing that it was competitive pricing environment, and I think we said for a couple quarters, we've been being pretty aggressive to try to drive adoption.

That stance hasn't changed.

We continue to go aggressively after new applications.

With that being said, they're pretty much in line with our targets and I think the best example of that is if you look at our gross margin, it came in pretty much in line with our plan and the pricing assumptions we made were pretty much in line.

So it's essentially, for what we expected to happen, it's kinds of happening that way, other than the inventory correction in Asia.

So I think we're going to stay aggressive.

I think we're in a great position to drive the market.

It's a combination of technology and lumens per dollar.

And I think as we keep pushing here we are going to open up some new applications going forward.

Great.

Thank you.

Your next question comes from the line of Yair Reiner from Oppenheimer and Company.

Your line is now open.

Hello?

Operator, we'll take the next question.

The next question comes from the line of Harsh Kumar from Morgan Stanley.

Your line is now open.

Hi, it's actually Morgan Keegan.

Two questions.

China's street lighting, Chuck, you talked about you expect most of the impact in Q4.

Are you building anything into your guidance for this March quarter at all or are you just deferring all that to the June quarter?

Harsh, our expectation right now is is that we'll see some projects start to happen post Chinese New Year but in terms of driving growth for Cree, I would expect right now that that's really targeted for Q4 and the thinking there is is that we know the customers got a little ahead of themselves so we've really got to let them-- get them to work through some of their inventory this quarter and that puts us -- everyone in a better position heading into Q4.

And again, it's subject to the projects coming online as expected but it looks like those will start to happen here post Chinese New Year.

Got it.

Very helpful.

And then another question.

A Company came out, competitor, small competitor, a couple of days ago, talked about pretty significant pricing pressure.

Your gross margin guidance of 46%, how much of that is efficiency or yields versus pricing pressure?

I mean what part of your business I guess is experiencing where you go out and compete on the street and experience pricing pressure?

Any color will be helpful.

Yes, so Harsh, if you think about it, both LED chips and the component business, we knew that we were in a very competitive environment for a couple of quarters now and so we've been acting that way.

I think what you see in our gross margin is that despite the fact that it's a competitive market with short lead times that our cost structure is in a pretty good place to enable us to keep going after the markets.

And on the other side it's tracking how we would expect it to in a cycle like this.

So I think we remain competitive.

I think it fits within our business model that we're trying to accomplish and I think it's just a normal part of the business cycle right now.

So I'm not sure -- it's generally tracking with what we're expecting.

Obviously, the (inaudible) this quarter our gross margin targets have two things in there or really three elements.

We know it'll continue to be a competitive pricing environment.

We know that we're going to have a little less factory utilization because we are going to try to balance the factory a little better given that we built inventory last quarter.

And the offsetting factor is that we continue to target more yield improvements and it's really the combination of those things that kind of gives us the -- it really leads the targets we put out there for you.

Got it.

Thanks, Chuck.

Sure.

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

Your line is now open.

Hi, Chuck, can you hear me okay?

I can hear you, Andrew.

Okay.

First question is China's street lighting, can you give us a sense of how much of that goes direct versus [Disty]?

Yes, so although I don't have a breakout for you, Andrew I would tell you that our China business, we do have some direct customers but probably more of our business in China is Disty, but it's probably-- there's a relatively strong balance on both sides.

If I had to guess, I don't have the data in front of me, it's probably a little heavier Disty.

Okay.

And on cost per lumen, you've talked about 150-millimeter transition starting to have an impact in your September 2011 quarter, is that correct?

Production?

Yes, so the first -- our first fiscal quarter of 2012, that would be, yes.

Okay.

So can you give us a sense of some of the things that you're looking at to kind of cut costs between now and then?

So Andrew, we're going to do the traditional things.

Obviously we're always looking at productivity improvements.

As we come out with new products we try to design products that are lower cost to make and we have yield improvement that is an ongoing, never ending process and those would be the three things that are pretty much an everyday part of life at Cree and something we've been working on for a long time.In addition to that then, is major activities like 150-millimeter, which that's kind of the other piece and right now we're really in investment mode.

It's a large part of the increase you're seeing in R&D.

But again, I think that will be -- we'll get a-- we should get a nice benefit from that in 2012 once it starts to ramp up.

Okay.

And then just one last follow up.

Do you have any concerns about Phillips Lumileds starting production at 150-millimeter about a month ago?

No, look, we read all the stuff that people talk about their own capability.

I'm pretty confident given what we know about where the industry is and the market and our own capability that we should be in a really strong position, getting up the volume curve in 150-millimeter and I feel really good about our position there.

Okay.

Thank you.

Sure.

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

Your line is now open.

Hi, guys.

I'm wondering if you can talk a little bit about the market share that you have and whether you think it's increasing or decreasing, specifically maybe a little bit product-by-product, so the street lighting, the commercial lighting?

So, boy, we don't have great data for you.

I can give you what we do-- I can give you some anecdotal data from what we calculated internally.

I would say in street lights our market share remains solid.

Really the challenge we're seeing in street lights now is not a share issue, it's been a market pause.

So we feel really good about where we stand there.I think if you look at the indoor markets, I think in the bulb market we don't have as high a share but I don't know that it's changing.

I really think what we're seeing in LED bulbs is really just I think the customers had bet that the market was going to grow faster than it did, so they're going through an inventory correction.But we push pretty hard on share there and it feels like we're holding our own.

And then in some of the other commercial lighting applications, I think the ones that are really pushing lumens per watt and efficiency we're doing well and on the lower end ones we probably have less share.

But I'm not-- I don't see a significant change there.

I think that's kind of where we've been strong here over the last year.

But can you quantify the share at all, or give kind of a range?

We have some internal numbers but we don't break those out in terms of what the share is because they're just-- we don't have an independent way to validate them.

It's just not something we break out.

Okay.

Thanks.

Sure.

Your next question comes from the line of C.J.

Muse from Barclays Capital.

Your line is now open.

Hi, this is Olga calling in for C.J.A couple of questions.

Can you talk about where the inventory of your chips currently stands at your Disty customers and where it was exiting the September quarter?

So it's not chips, It was- I think you actually mean inventory of our LED components?

Yes.

All right.

So components.

I would tell you that the inventory from a dollar basis is pretty similar.

I think the dollar amounts plus or minus about the same as it was at the end of the previous quarter.

So we're really watching is actually inventory at their customers is where we think we need to work through it.

Obviously we'd like to have more turns at Disty, but at the end of the day their dollars of inventory is relatively flat quarter-to-quarter.

Got it.

And then on the OpEx side, is the March Q level what we should be assuming going forward or will there be some pulls and takes as you move through the year?

Yes I think what you've got to realize is, so if I think about OpEx at a high level we're going to invest in sales and marketing as we go through the year.

Obviously, we'll-- that'll -- exactly how much we invest each quarter is going to vary.

R&D we're in kind of a pretty high cost situation right now in terms of a significant investment to get the 150 qualified.

So we'll be -- R&D spending is up this quarter.

It will also be pretty healthy next quarter as well.

But then once 150-millimeter gets qualified and comes online, some of the costs you see today shouldn't be necessary once that product's qualified.

It doesn't mean we won't continue to invest in new products in all the other areas of R&D, that's going to be a part of our business.

But I think we're in a period of time where it's a little heavier than normal because of the 150-millimeter.

Got it.

Thank you.

Sure.

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

Your line is now open.

Thank you.

Hi, Chuck, I guess I can understand the put off in the Chinese street lighting.

Could you talk a bit more about you mentioned the bulb weakness out there?

I mean you guys have been -- you spent a good part of last year over sold.

Did these distributors you deal with there tend to only sell on to street lamps, or can't they find other applications to kind of put the product in?

And recalls a comment I think one of you guys made recently which is maybe you were getting ahead of our customers' ability to use our technology.

I just wonder if you could comment on what's going on in some of those non-street light applications?

Okay so in LED bulbs, specifically, Steve, net we've been looking at this really close this quarter.

And what we've seen is that if I go back to the -- our fiscal Q1 when lead times were still relatively long, I think a lot of customers, not the distributors, necessarily, but their customers were betting on a certain growth rate in LED bulb applications and although the application is growing, it's not growing at the rate that they were assuming.

And so they effectively when lead times were long got ahead of themselves and so all they know is the application's growing, now that it's not growing as fast, they have too much inventory that they've got to work through here.

Good news is I think bulbs is an application that will continue to grow because I think we're going to see better performance and lower cost going forward, but I think we've got to work through that and I think it's a function of the customer is speculating demand would be X, it's a little less than X.

And so they basically got caught when the lead times were long.

Okay.

And then one for John.

The 46% gross margin guidance next quarter, just wondering if you're very confident in that or if there might be some down side given that you're losing about a point due to that, correct me if I'm wrong, due to the nonrecurring, or maybe that was an expense, not gross margin.

But you've got a lot of inventory to work off.

And are you going to have to discount that and given your competitor's comment about your very aggressive pricing in one particular situation, do you feel highly confident in the 46%?

Yes, what we did is we think that there's a little bit of variability in the gross margin but in terms of our estimate, we have adjusted our build schedules, we've taken that into account.

We plan to bring our days of inventory down.

So we've taken all that into consideration.

So we think that that's -- that's our best guess at this time.

Okay.

Thank you.

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

Your line is now open.

Thanks a lot.

I was wondering if you can give a comment about how do you view kind of the big picture industry growth currently, considering where we are kind of in the market and the issues that you're facing?And how does Cree fit into that industry growth, considering you've had about three quarters here that it's been flat to slighty-- slight growth?

Well, look, Daniel, I think you've got to consider where we're at.

Our best estimate says that the-- we're somewhere in that roughly let's call it 4% of adoption in LEDs and the overall lighting market.

I think any time you're at that early stage of a market, you're basically counting on specific applications to turn on and ramp up and it's not one application.

It's lots of different ones.

So for example, there's obviously things that are going well because our direct business continues to grow.

But for example, in our Asia China street light business, which is a big chunk of our business, when that specific segment pauses, I don't think anyone believes that LED street lights aren't going to continue to be adopted but it does go through a two quarter pause when they're trying to redo the regulation.

So from my standpoint, I think any-- we like-- everyone likes to look at industry transitions in hindsight and think that they're a straight line.

I think they're a little bit-- always a little bit lumpy on the way up.

But I think when you're this early, I remain pretty optimistic, right?

I think we're going to be able to make LED street lights better than they are today with new LEDs.

They're going to become more cost effective, and I think that drives (inaudible) and I think the same things happens in bulbs, commercial lighting.

I just see lots of opportunity out there, I see lots of innovation required to make it happen.

But I think we're in the early stages of this thing and I think as long as we keep driving innovation that makes our customers' products better, that makes their value proposition better, then we should be in a good position to benefit as the market grows and frankly make it happen.

And I think if we make it happen that puts Cree in a pretty good position.

And one additional question.

How should we look at going forward kind of the impact of what goes on in China in terms of LED demand, if it's for street lighting or general lighting on Cree's business?

Well, look, China's a big part of our business.

I think if you look at through our fiscal year ended FY fiscal 2010, I think it was just under 40%, I think the exact number was 39%.

So look, it's an important part of our business.

We're going to continue to emphasize that market.

I think China is a country that sees the benefits of LED lighting and that I think we need to continue to focus there to be successful.

It doesn't mean it's the only market for us but it will be important and I think you'll see us continue to invest there to make that happen.

But I think we also see growth in all the other markets, right?

So whether it be the US, Europe or frankly some of the new developing countries that won't be a big impact in the next year, but I think over time you'll see LED lighting adoption become -- those conversations become more important.

Great, thanks a lot.

Sure.

Your next question comes from the line of Stephen Chin from UBS.

Your line is now open.

Great, thanks.

Hi, Chuck.

I was wondering, Chuck, if you could talk about how you think industry sapphire, raw material prices might trend in 2011?I know Cree doesn't use sapphire to make products, but your competitors do.

So I was wondering if Cree's move to the 6-inch wafers can fully offset any sapphire price decline benefits that your competitors might have?

So look, we've actually had for a long time a parallel program in R&D on sapphire and the reason we've never converted is that before-- a year ago when sapphire prices were relatively competitive before they went through the supply/demand phenomenon, even at that time for us we got a lower cost on silicon carbide than on sapphire because remember, we make it ourselves internally so our costs are probably less than what people think they are.

Two, the yield you get on that wafer from your FE process all the way through your line is a bigger leverage on your cost than the cost of the substrate itself.

So I think that I'm sure there'll be some effect.

If sapphire supply comes online and there's more availability, I'm sure it will have some effect on the market but I think it's a relatively minor number relative to what people's yields are and what they're able to do develop the high end lighting chips to go after the markets we're focused on.

Okay.

And then just a quick question for John on the inventory.

Now this was the second quarter that inventory's growing faster than sales.

So I was wondering if there's any concerns of any inventory write-downs, John?

Well we look at that every quarter and we make valuation allowances that are appropriate on it.

And what we're doing is as we're growing the business, we're putting it in place and we're targeting that our inventory in terms of days will actually come down next quarter into the upper 80s.

Next question.

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

Your line is now open.

Hi, thanks and thanks for taking my question here, guys.

I guess starting first, just on the last question, the inventory, getting it down into the high 80s is about ten days and so implying that the utilization will come down, do you expect that we're going to be in this, basically this margin bracket for the next couple quarters, sort of that 46% plus or minus, in order to work things down?

Yes Jed, so we don't -- look, I don't have a target for you for Q4 but I can talk about I think the fundamentals which I think is what you're asking about.

Right now, remember, that that inventory increase, a lot of that was on the lighting side of the business.

So that doesn't really effect factory utilization at all.

That's a lot of inventory in terms of piece parts unrelated to our LEDs and other things to build lighting fixtures.

So that's -- I think you have to take they out of the equation and it's really on the XLamp side where it's a smaller piece of that that we'll be balancing that.

So I think the utilization issue, we would hope that we can run the factory next quarter in the mid-80s and that's kind of what -- mid to upper 80s and that's kind of what we're targeting.

And that depending on what we see in terms of the street light business and some other things in Q4, we're not targeting utilization at least at this point to go a lot lower than that.

Obviously we'll see what demand does.

But at this point in time, that's kind of what we're thinking.

And then obviously if demand grows we'll look to see that number creep back up.

That's helpful.

Thanks, Chuck.

And then just maybe a bigger picture question as my follow up.

You talked a lot about China, China's clearly important and growing and it sounds like you're banking on the street light market primarily there with some bulb applications too.

In the US market, where do you see that growth engine?

Do you see it in a similar fashion to China or do you see it more of a bulb type application for replacement and retro in the US market?

And how would you categorize sort of the geographic growth engine if we look out over the next two years?

Yes, so I think in the US market there's also a large outdoor market, whether it'd be street lights or commercial outdoors.

So that'll be I think when it comes to the US, I think the bulb market is -- it's an interesting category.

I think obviously we're following it real closely and there is definitely some adoption happening there.

I think what will be interesting to see is that as new products come on, what kind of adoption can we drive.

And so I think-- I right now I think it's an incremental growth driver, not a big one for the US market.

Keep in mind, though, for Cree, most of our sales from a US bulb end market standpoint are really Asian-based LED sales.

So it'll show up in our China or other Asia sales because that's where the manufacturer of those bulbs is.

And then the third piece is I think we're going to see a commercial market, maybe not in the next couple quarters, but over the next few years, I really think the commercial lighting indoor market is a place that has a real opportunity.

It's going to take some innovation and get some better paybacks but I think that's a place that while street lights might be the easy one for people to see today, I would really look to see that application starting to get some traction here as we later this year, as we look out maybe over the next one to two years.

Thank you.

Sure.

Your next question comes from the line of Mark Heller from CLSA.

Your line is now open.

Thanks for taking my question.

I think you said that utilization would be in the mid-80s, I think it was the last question.

Can you give us just frame of reference what utilization was in the December quarter?

Yes, it's mid to upper 80s is what we're targeting for Q3.

And in Q2 I think it ran in the low 90s.

Okay.

And recently one of your major customers in Europe announced a supply agreement with L G Innotek.

I'm just wondering if you're seeing any increased competition from the-- some of the Korean suppliers?

Obviously that agreement we've looked at pretty closely because Zumtobel is a very important customer for us.

I think what it highlights is the complexity of the market.

So our business (inaudible) actually is growing and that's because you have to think about, Zumtobel is really two company, it's a lighting fixture Company, that's who we're selling to from an LED standpoint, that's where we're really cooperating.

And then they have their Tridonic division, which is really a component company for the lighting industry, and that's really where they're-- I don't see a lot of change in the market dynamics from the Korean suppliers right now.

They're clearly out there.

They've been sampling.

But I don't see a lot of traction in the what I'll call the main stream lighting applications.

Definitely we're watching on some of the more lower end consumer grade lighting applications but haven't seen it in any of the main stream commercial applications but it's something that we're watching.

Thanks a lot.

Sure.

Your next question comes from the line of Yair Reiner from Oppenheimer and Company.

Your line is now open.

Thank you, apologies for the earlier technical difficulty.

Just in second quarter, chip sales, were they down sequentially or were they flat?

They were down, Yair, but right in line with what we had expected.

So we had guided that chip sales would go down about 10% last quarter and they were right on our target for the quarter.

Got it.

And then when you think about R&D, can you give us a sense of what the normalized R&D level is if you take out what I think are largely one time costs associated with 150-millimeter ramp up?

Wow, that's a great question, Yair.

I have not-- I've been so focused on what we're doing here in the near term, I'm not sure I have that number for you.

We can work that out.

But I don't have something to throw out for you at the spur of the moment.

I don't know John, if you want to throw something out, we can get back to you Yair.

What we had said is that it can go up a couple million dollars this quarter, it go up a little in the fourth quarter and then we expect to see it come back down again in the first half of calendar-- or fiscal 2012.

So the idea, Yair is we'll still be investing in product development and other things.

I think those incremental dollars associated with 150 will go away.

I think on a percentage basis we're probably running at the high end from a percentage range over the next couple quarters.

And I think what we'll see is while the dollars may not -- we may take some of those same dollars and invest them in new product development, on a percentage basis we should get some benefit here starting in the first half of fiscal 2012 .

And it's really a function of when the 150-millimeter starts to convert from development into

Understood.

And then going back to the chip business for a moment.

First of all, what is your exposure in that business now to LCD backlighting?

And secondly, given the fact that a lot of capacity has come online specifically for that application, what is your level of confidence that that part of the business will come back when the LCD TV market presumably goes through its inventory correction?

Yes, so, it's a pretty small percentage.

It's way down there now.

I don't have a specific number for you.

But I would tell you, we continue to, in some specific applications, we continue to work on new designs.

Just because there are some places where our chip technology that has been developed from a lighting standpoint adds some value in some of the more high-end applications or ones where they're trying to use a higher power LED.

So our exposure is relatively small in the short term.

I think there's still an opportunity for us to sell [dye] there as the market makes sense and it's really a function of what happens to demand here as we get into later in this year.

Our current sense is is that what we see is the industry's projecting that backlighting demand starts to pick up and although there is capacity out there, I wouldn't be surprised if later in the year our backlighting percentage grows again a little bit just with the market.

Again it's too hard to give you any specifics because we don't know yet, but I-- that wouldn't surprise me.

Great, thank you.

Sure.

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

Your line is now open.

Hi, Chuck, John, thanks for taking my question.

Most of my questions have been answered.

I just wanted to know, I don't know if you addressed this, I apologize if you did, your accounts receivable they also saw a big tick up in the quarter.

Can you give us some color on that?

What was the question again?

Your accounts receivable.

You want the accounts receivable.

So Ahmar, what we had with AR, it was a little bit more backend loaded in the quarter than we had been in other quarters, where we had been pretty much on extended lead times.

Those lead times have been coming in, the demand has shifted a little bit.

So when we look at it overall, we don't see that there's much issues in terms of the collectability of that at all.

Okay.

So you expect that to trend back down into the low 40s over the next few quarters?

Stay about the similar range in terms of days.

I don't see much -- it coming down much right now.

Okay.

And then just if I may, sort of bigger picture here, you talked a lot about China and also some other market.

Looking outside of China, as the cost of LEDs comes down, continues to come down, what are some of the other markets that you think will begin to open up for the LED lighting opportunity?

Well look, I think where we've been focused, what's driving the business today, is we know about street lights, we know about LED bulbs but I think we're at the very early stages of the LED bulb application.

Today we're talking about a very premium product.

I think as costs -- not only costs come down but as performance goes up, I think many people miss the fact that it's not just about a cheaper LED bulb, the reality is we need 60-watt, 100-watt equivalents and they need to work as good as the light bulb that's out there.

And I think part of the reason I made my comment earlier about the product we've recently demonstrated, there isn't a 60-watt bulb you can go out that works just like the one you have today, it's just not out there yet.

And after that we've got 75, we've got 100, so there's a whole lot of innovation required to get the performance so that the customer gets exactly what they expect.

In parallel we've got to do some things to make these bulbs more cost effective.

So I think that's a big application.

And then in the end, I think commercial indoor lighting, which is lots of sub-applications, I think there's lots of opportunity there.

And it's not just about cost, it's about products that work better or as good as what they have been in terms of light quality and everything else.

And so we just see our-- I think we're at the beginning, right, it's 4% of the market.

I think there's lots of opportunity but there's lots of work ahead of us.

Thank you.

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

Your line is now open.

Great, thank you for taking my question.

Given the attention around the Chinese street lighting opportunity, I was hoping for you all to help quantify this opportunity both in regards to roughly how large it is for you today in the December quarter, or how large it was, and then how big could it be in the June quarter?

And I know that's a somewhat sensitive question, but if you can give us any kind of quantification there, I think that would be helpful given the heightened expectations around this market.

Yes, Carter, we don't break that out.

So I'm not going to be able to give you a percentage.

What I can tell you is that in total the actual sales into that application actually declined in the last quarter so it is actually an application that had been growing pretty consistently.

It is probably of all of our applications, I would say that street light of all the different lighting applications is the largest.

But I think you have to-- it's more than that, right?

If you add in bulb, architectural, commercial, indoor, you'd have to add into the portable and all those other ones to get to the full number.

But-- so it is the largest but its not the-- I mean it's not a lot larger than the other pieces.

So it's important, but what would change for us is that it actually declined because of the inventory correction.

Rough figures, could we think of it going to be a 10% end market for the Company, is that like a reasonable way to think about it without giving away too much information?

No, the answer is we're not going to be able to break that specifically out for you.

Okay, that's fair.

And then can you discuss your level of confidence about a rebound here in the June quarter with this market?

Look, right now, we know that the new specifications are out there.

There are projects that are out for bid.

It's a function of when they get bid and how fast that starts to happen and so for us it's -- I don't have -- I don't know yet.

Right now I think we'll know more as the quarter goes along.

I think there's not a lot that's going to happen between now and Chinese New Year.

So we'll have to see what happens in this market as we get later in this quarter.

I wish I had better visibility, I just don't.

I think we understand the basic trend.

We don't have a -- we just don't understand the exact timing at this point.

That's helpful.

And the last question, when we think about the distribution channel as you've brought new products into the market and expanded into new geographies, we've obviously brought on new partners, be it manufacturing reps or distribution partners, can you help us understand where we are in that process?

What areas can we continue to build out?

Are we starting on new distributors in emerging markets or is that build-out largely complete?

So look, our main distribution today is we have a pretty good Asian-based team.

We've got a China team.

We've got a US and a Western Europe.

I think they're emerging markets you'll see us invest in longer term, have not gotten a lot done there.

We have a small presence there today.

I think in terms of the distributors we're working with, we like the team we have.

I think we may look for very specialty people in some applications where we think we need some more specific access.

I think more important for Cree is we've had great success in driving our direct business and so we're looking for the things that are working there, how do we translate that to do more of that to help our direct business but also how do we bring that over to help drive demand on the distribution side.

So we're looking at both of those.

Great.

Thank you very much.

Your next question comes from the line of Alex Gauna from JMP Securities.

Your line is now open.

Thanks for taking my question.

Chuck, I was wondering if you could comment on some of this business that you anticipate coming back in June?There's been speculation out there that you got aggressive on the pricing front to win some of that business.

All else being equal, is there another shoe to drop in terms of gross margin pressure out there or have we felt the new pricing level in the market?

Well look, we've been aggressive for a few quarters right now.

I can-- we've given you our targets for Q3.

I think it's hard to give guidance for Q4 when it's going to be a function somewhat of what happens in demand, what happens in the other dynamics around the market.

So I don't have great target for you there.

I think right now we're focused on how do you increase the performance on one side, that obviously gives us leverage, drive down the cost on the other side and drive up the demand.

And we're going to work on all those but it'd be premature for me to give you any guidance on Q4 targets right now.

Okay.

One more question about Q4, though.

You did say there isn't a solid 60-watt replacement, some of your key customers and I believe based on your technology, plan on having some of those 60-watt products out in the spring time.

I'm wondering if you can comment on where you think price points are going to come out in that time frame and where you think they need to go to really ignite that market?

For the LED bulb applications specifically?

Correct.

Yes, so, look, today I think what we're seeing is that there has definitely been some -- I think from what we see in the market there's kind of two price points at the consumer level in North America, people have been having some success at this kind of the $20 and the $30, plus or minus.

I think those are likely to be where people try to bring the new higher performance products.

I think we'll probably see actually initially a little higher than that but it seems at least in that range you start to get people interested.

I think we're still talking about, though, really at this point I think we're talking about a nice niche business.

I think we've got a ways to go in terms of performance to get to all the applications and I think long term those costs have to come down further.

I'm not-- I don't think any of us know exactly what those points are going to be and I think what we're going to do is drive the technology to the point where we find out.

But I don't have a crystal ball.

I think the key is better performance at those price points will be where people will start and then we'll see where it goes from there.

Okay.

Thank you.

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

Your line is now open.

Thanks.

Hi, Chuck, you guys said that your CapEx would come down from $300 million to $250 million or $260 million last quarter.

Is it still in that $250 million, $260 million range?

It is.

It is.

Okay.

And then from the faster expected ramp of 150-millimeter wafers, what's driving that?

Is it the competitive dynamic?

Is it-- why the sudden acceleration?

Yes, it's-- Hans, we laid out the goal to get it qualified by the end of Q4 for a ramp up in Q1 a couple quarters ago.

What's really happened is the timing of the R&D expense.

So we're obviously doing process development.

We're doing process qualification and tool qualification all at the same time.

And so it's just as those things happen, the R&D team is focused on getting stuff done, not trying to manage exactly to the budget and frankly it cost us a little more last quarter than what we had budgeted for.

But I think it's still the right thing in terms of the long term.

Okay.

Thank you.

And your last question comes from the line of Bill Ong from Merriman Capital.

Your line is now open.

Good afternoon, gentlemen.

Qualitatively can you talk about how you first priced your four inch wafers over two inch so I can get a sense--?

Hello?

Bill, if you're still there, we can't hear you.

It looks like he has disconnected.

All right, thank you, Operator.

Bill we will try and get back to you separately.

All right, Operator.

And at this time there are no further questions.

Well what I want to do is thank you at this time and thank you for your time today.

We appreciate your interest and support and look forward to reporting our third quarter fiscal year 2011 results on April 19, 2011.

Good night.

Good night, thank you.

This concludes today's conference call.

You may now disconnect.