Wolfspeed Inc (WOLF) 2011 Q3 法說會逐字稿

Good afternoon.

My name is Tracy, and I will be your conference facilitator today.

At this time, I would like to welcome everyone to the Cree Incorporated third quarter 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, April 19, 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, Tracy, and good afternoon.

Welcome to Cree's third 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 third 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 and the Financial Information tab.

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

These may include comments concerning trends in revenue, gross margin and earnings.

Plans for new products and other forward-looking statements indicated by words like anticipate, expect, target and estimate.

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

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

Also, we would like to note that we will be limiting our comments regarding Cree's third 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 presentations and the recording of this call are copyrighted property of the Company, and no other recording, reproduction or transcription is permitted unless authorized by the Company in writing.

Consistent with our previous conference calls, we are requesting that only sell side analysts ask questions during the Q&A session.

Also, since we plan to complete the call in the allotted time of one hour, we 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 May 3, 2011.

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

Thank you, Raiford.

Fiscal Q3 results were in line with our revised lower targets for the quarter.

Revenue for Q3 was $219 million, which resulted in non-GAAP earnings per share of $0.27.

These results reflect both our continued success in LED lighting and the challenges of managing the LED chip and components business through a business cycle with short lead times and low order visibility.

The market dynamics for LED chips and components resulted in weak demand for LED chips, a slower than targeted rebound in LED component sales in Asia and a more aggressive pricing environment.

Despite these challenges, we remain very encouraged by our progress in LED lighting and we continue to invest in the LED products and technology that we believe will drive LED lighting adoption and demand for our LED component products.

Revenue declined 15% from Q2 to $219 million.

The decline was primarily driven by lower LED component and LED chip sales with components accounting for approximately two-thirds of the decline and chips the other third.

The LED lighting product line grew double digits again on strength of sales to Home Depot and our OEM lighting partners.

LED component revenue was lower than our target due to a slower recovery in end customer demand in Asia.

Distributor sales to end customers have improved post Chinese New Year, but not as quickly as we previously forecast.

It took longer to work through customer inventories than we originally targeted, and pricing was lower than we had forecast.

LED chip revenue was lower than our targets due to weak demand and a very aggressive pricing environment.

These trends were in line with the trends reported by other LED chip suppliers.

Power and RF revenue was also slightly lower due to a slowdown in power sales for solar inverter applications.

Net income was lower than our target due to lower revenue and gross margin, which was partially offset by lower than forecast operating expenses.

R&D expenses were lower than our targets due primarily to the timing of 150-millimeter qualification expenses.

Despite the lower spending, the qualification remains on schedule.

Non-GAAP gross margin was 42.4% in Q3 due to several factors.

Lower pricing in LED chips due to weak demand, lower pricing in LED components due to a product mix shift, a more aggressive pricing environment for the turns or spot part of the business, and a higher percentage of spot business overall and lower factory utilization.

Our Q3 factory plan was based on the original revenue targets, so we ended with higher LED inventories than we planned.

Cash and investments remained solid at $1.1 billion, and we remain in the strong position to continue to invest in our business and lead the adoption of LED lighting.

Our Q4 backlog is running slightly ahead of last quarter's order rate, but below normal levels.

LED lighting bookings are solid, while LED components and LED chips are still operating in a short lead time environment.

The LED component business has improved post Chinese New Year at both our direct customers and our distribution customers.

While the business is trending in the right direction, our visibility remains limited.

Our LED lighting product line delivered solid growth in Q3, and it's targeted to grow again in Q4.

I have been asked recently to explain why our LED lighting revenue has continued to grow while our LED components revenue has declined.

First, our LED lighting product line is a good leading indicator for the North American indoor market.

While this is also a growing percentage of our LED component business, the growth in indoor application has been offset by the decline in LED sales for outdoor lighting, bulb retrofit and portable applications.

We also believe the change from 14 plus week lead times last summer to four week lead times recently has been a factor in the LED components revenue trend.

This resulted in customers reducing their inventories over the last few quarters while also increasing the competitive pricing pressure in the market.

Based on our understanding of customer purchases and their sales trends, we believe that our market share has remained relatively stable in the applications and customers we are focused on.

Again, we look to our LED lighting business as a leading indicator for market acceptance and target applications.

Our components business relies on our external fixture and bulb customers to develop their own products, to expand the market which has generally lagged our internal systems results in the past.

I'll now turn the call over to John Kurtzweil to review our third quarter results in more detail, as well as our targets for our fourth 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 for 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 third quarter of fiscal 2011, revenue was $219.2 million compared to a revised target range of $215 million to $220 million.

This is a 15% decline sequentially and a 6% decline year-over-year.

GAAP net income was $18.9 million, a decline of 62% sequentially and a 58% decline year-over-year.

GAAP diluted earnings per share were $0.17.

On a non-GAAP basis, net income was $30.1 million, a decline of 51% sequentially and a 41% decline year-over-year.

Non-GAAP diluted earnings per share were $0.27.

Non-GAAP net income excludes $11.2 million of expense net of tax, or $0.10 per diluted share from the authorization -- or excuse me, from the amortization of acquired intangibles and stock-based compensation expense.

We ended the quarter with $1.1 billion in cash and investments, which decreased $38 million since the end of December.

Cash provided by operations was $41.2 million, depreciation and amortization was $28.1 million, CapEx for the quarter was $62.8 million, and free cash flow was a negative $21.7 million.

Q3 GAAP gross margin was 41.7%, while non-GAAP gross margin was 42.4% which excludes stock-based compensation of $1.4 million.

This was in line with our revised non-GAAP target of approximately 43%.

We estimate that there was a gross margin benefit of approximately 200 to 300 basis points from fixed cost absorption due to the inventory build in Q3.

Operating expense for Q3 was $71.7 million on a GAAP basis and $60.2 million on a non-GAAP basis.

Non-GAAP operating expenses exclude approximately $8.9 million of stock-based compensation expense and $2.7 million of charges for amortization of acquired intangibles.

Non-GAAP R&D expenditures increased $1.7 million sequentially, but were $1.3 million below our targeted amounts for the quarter.

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.

SG&A expenditures were on target and increased $4.1 million sequentially.

Net interest income and other for the quarter was $2.3 million.

The effective tax rate for the quarter was 14%, which was below our target of 21%.

The lower tax rate is primarily related to truing up of the annual rate based on a change in product mix and revised profit estimates for the balance of the fiscal year.

Days sales outstanding were 52 as compared to 47 at the end of December, as the quarter's revenue was back end loaded.

Inventory days on hand were 119 days as compared to 96 days at the end of December.

Inventory increased by $24.1 million to $169.6 million during the quarter, with $18 million of the increase in finished goods.

This increase was primarily due to running the factory to original higher revenue targets.

At this time, we target Q4 revenue to be in a range of $225 million to $245 million, which is being driven by a number of factors including growth in LED lighting product sales, growth in LED components driven by increased sales to both our direct and distribution channel, LED chip sales down slightly from Q3 and flat to slightly lower sales in power and RF due primarily to weakness in the military RF market.

GAAP and non-GAAP gross margins are targeted to be 40%, plus or minus.

This target factors in the continued price competitive environment and lower factory utilization to drive inventories down, partially offset by yield improvements.

Our GAAP gross margin targets include stock-based compensation expense of approximately $1.6 million while our non-GAAP targets do not.

We are targeting non-GAAP R&D expense to increase by approximately a $0.5 million in Q4, primarily to support the 150-millimeter wafer qualification.

We target non-GAAP SG&A to be flat to down slightly from Q3.

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

Our GAAP operating expense targets include non-cash stock-based compensation expense of $2.3 million in R&D plus $6.6 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 approximately 14% for the fourth fiscal quarter, which includes a one time benefit of $1.8 million that has the effect of reducing our targeted tax rate by approximately 5 percentage points.

GAAP net income for Q4 is targeted at $16 million to $23 million.

Based on an estimated 110.5 million diluted shares outstanding, our GAAP EPS target is $0.15 to $0.21 per diluted share.

Non-GAAP net income is targeted to be $28 million to $35 million, or $0.25 to $0.31 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.

Our targeted capital orders for the fiscal year have been adjusted down to a range of $200 million to $210 million.

We are able to do this because our previous investments have put us in a solid position to increase volume for the quarters ahead.

As part of these targets, we continue to invest in our strategic priority such as the 150-millimeter production line to support the longer term growth of the Company.

Thank you, and I will now turn the discussions 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.

Our LED lighting product line continued to grow in Q3 led by increased sales in North America for commercial applications and sales of EcoSmart downlights to Home Depot.

Our international business was also solid, led by sales to Zumtobel.

We recently signed a two year extension of our agreement with Zumtobel to continue to work together to bring LED lighting and Cree TrueWhite technology to the European market.

During the quarter, we launched the LBR-30 LED lamp aimed at replacing energy wasting incandescent lamps commonly used in tracks, commercial and residential recessed downlights.

The new lamp delivers warm white light with unrivaled color accuracy and efficiency which is optimized for applications such as restaurants, retail stores, groceries and museums.

We are looking forward to releasing a new series of products in Q4 that we believe will continue to raise the bar and drive 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.

We continue to build on the new product momentum from last quarter with a number of new market leading products.

We introduced our XLamp MT-G LED, which is the first LED to deliver the performance required for high output halogen retrofit applications such as 35-watt to 50-watt MR16 replacement bulbs.

We expanded on our new XLamp XM-L LED platform by introducing neutral and warm white color temperature versions that once again set new benchmarks for light output and efficacy.

We released our XLamp XM-L EasyWhite LED which delivers a lower cost solution for 25-watt replacement lamps by combining the benefits of our unique color mixing technology in a single, high output, small footprint package.

And we expanded our portfolio of lighting class LEDs for linear lighting with the release of our new XLamp ML-B product family.

We have continued to increase LED performance and develop innovative new packages, optimized for specific lighting applications which we believe will enable our customers to deliver lower LED system costs and be more successful competing with traditional lighting products in the market.

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

R&D spending increased in Q3 to support the 150-millimeter qualification.

But the spending increase was lower than we had previously targeted due to improved efficiencies in the qualification process.

R&D spending is targeted to increase a little further in Q4 as we make the final push to get the first 150-millimeter products qualified by the end of the quarter, with the initial production ramp scheduled for Q1 of next fiscal year.

This is an important project that is targeted to provide cost levers for both our LED chip and LED component product lines in fiscal 2012.

Our fourth priority is to further develop our silicon carbide power product line.

We finished Q3 with slightly lower -- with revenues slightly lower than Q2.

We met our goal to bring new capacity on line in the quarter, but growth in sales for server applications and our new silicon carbide MOSFET was offset by a slowdown in sales for solar applications.

Although we are currently working through solar inverter related demand adjustments, the design activity remains strong across a range of applications.

We continue to invest in new product development to expand our product line into more mainstream power switching applications.

As we look ahead to Q4, we target revenue to grow to a range of $225 million to $245 million.

These targets are driven by a number of factors which include growth in LED lighting product sales, growth in LED components driven by increased sales to both our direct and distribution customers, LED chip sales down slightly from Q3 and flat to slightly lower sales in power and RF due primarily to weakness in the military RF market.

Although we see our core product lines trending in the right direction, our visibility is low which has reduced the predictability of our business in the near term and resulted in a wider revenue range for our targets.

We target Q4 non-GAAP gross margins at 40% plus or minus, as we factor in lower utilization to reduce inventory levels and the competitive pricing environment.

Factory execution and flexibility will continue to be critical.

The short lead time environment also makes it more challenging to forecast product mix and pricing trends.

Utilization will vary across different product lines, but in general is targeted to be 10% to 15% lower than in Q3 which will result in lower margins in the near term.

We plan to take advantage of some of the available capacity in Q4 to invest in the key areas and accelerate progress on certain R&D goals.

This is targeted to result in higher R&D spending in Q4, but should increase new product momentum heading into Q1.

We plan to manage other operating expenses for the quarter at similar levels as Q3 as we work to better align expenses with the current revenue levels.

As a result, we target non-GAAP earnings in Q4 of $0.25 to $0.31 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 remain focused on building on our success to continue to drive LED lighting adoption, set new standards for light quality and system costs and enable our LED component customers.

We are in the early stages of adoption and our products are well positioned in both LED lighting and components.

We are focused on enabling new applications to drive revenue growth and accelerate cost reductions to improve margins.

We remain confident we're on the right track as we look forward to further disrupting the market and leading the LED lighting revolution in the years ahead.

We will now take analyst questions.

(Operator Instructions).

Your first question comes from the line of Chris Blansett with JPMorgan.

Your line is open.

Good afternoon, guys.

Two quick questions here.

One is you have a pretty wide range for revenue for the second calendar quarter.

Wonder if you can give some idea of what puts you to the high end or the low end as far as your outlook is.

And secondly, if you could give us some color on how much inventory you expect to burn off during the quarter and how that translates down to utilization rates?

Yes, Chris.

So in terms of the revenue range, if I look at what's driving the range, it's really growth in both the lighting product line and targeted growth in LED components.

That's really based on the trends that we've seen post- Chinese New Year.

Offsetting that to some extent and really leads to some of the risk on the lower end of the range is that we know that we're currently targeting chips to be -- have some additional softness.

We know that power and RF is also flat to down slightly, so that's kind of a down side.

And then really the variability comes from two things.

One, we don't have a great backlog at this point.

So although we are running slightly ahead of last quarter, it's still relatively low visibility for us, so I think that adds in some risk.

And then the second thing is is that with what's happened in Japan, we know that that's putting a little pressure on both the chip business and to a much lesser extent, on the component business, so I think we're factoring in a little bit of uncertainty there.

So, main growth drivers, lighting components with some of those other risk factors I just put in there.

As far as the second piece on inventory, I don't know if John gave you a specific target earlier, I know we are trying to reduce it.

The net result though is that, and this will vary across the factory, but roughly in different parts of the factory it will be 10% to 15% lower utilization.

Now, you have to be a little careful.

That's not the total.

That's really in different places because depending on where the demand is we may have higher utilization in one part of the chip factory and a lower piece in components or vice versa.

So, it's really more of a directionally correct number.

All right, thank you.

Sure.

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

Your line is open.

Thank you.

Regarding your gross margin guidance, John, I think you said there were 200 to 300 basis points of benefit from over-absorption in the quarter.

So, if you take that out of last quarter's results, and given that you have to burn off inventory, you're going to have clearly lower utilization rates and so forth.

How confident are you in the 40% gross margin, and isn't there some risk in that?

Steve, this is Chuck.

The target is 40% plus or minus.

The way we came up with that is really a bottoms up.

What we're assuming is obviously chips will be a lower percentage of the business and components will be a higher percentage.

And so part of what you're seeing in there is we do think it will continue to be a competitive pricing environment.

We do know that obviously we have the utilization factor, so that's on one side.

But I think the targets are based on the fact that components growth helps the mix overall, and so it becomes an offsetting factor.

It is our best estimate and as you noted, we don't have great visibility, but when we look at it from a bottoms up, that's our best estimate at this point and that's how we're planning the quarter.

And then Chuck, you commented that you think you held share in the applications and customers that you're targeting.

Can you elaborate a bit on that?

You also said you saw pricing pressure.

Was it double-digit sequentially decline?

Yes, so on the share, what we're seeing is clearly we're focused on what I'll call the -- really the lighting market.

This is everything from indoor to outdoor lighting.

Typically though, these are more the design oriented applications, more spec driven.

What we're going to get qualified design in where people are worried about efficiency, they're worried about lifetime, reliability, those things.

I think -- second part of your question was what?

The rate of price decline, was it double-digit sequentially in the quarter?

The rate of price decline really varied a little bit.

It was -- in the chip business it was a significant double digits.

That was a pretty tough business last quarter, very competitive environment.

On components it was in the very low double digits, but it was more than we had seen six months ago.

But that being said, part of that is price declines and part of that is a bit of mix right now.

You've seen that pricing pressure coming from the traditional competitors, or are you seeing back lighting vendors trying to move up into that low end of the general lighting business?

No, the markets that we're competing in, Steve, it's mostly with the traditional vendors, right?

Our focus is really on what I would call the true lighting applications, so we're going to see the usual suspects there typically bidding on those jobs.

There is some business, and I'm excluding chips when I say that, we do have some business in the lower end of the market, the more consumer lighting applications, and we do see some of the Asian competitors there.

But I would say that that hasn't -- while that's a competitive piece of the market, I would say that ratio hasn't changed dramatically from quarter to quarter.

That part of the business is also competitive, but it's really a different segment from where our primary focus is.

Thank you.

Sure.

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

Your line is open.

Good afternoon, gentlemen.

Couple of questions.

Hey, Dale.

First of all, when you --

Are you there?

Dale, we're still here.

Okay, sorry.

When you take a look out at your designs and what you're designing for, could you talk about what kind of luminosity people are looking for in your new designs?

And the second part of the question is when -- in your move to the 150-millimeter, how much of an improvement in gross margin do you think you're going to get out of that move?

Yes, so, Dale, I think on the luminosity, I think what you're trying to figure out is what brightness categories people are designing in.

Is that really what you're referring to there?

Yes.

I think this is maybe a bit of a misnomer.

The answer is all of them.

One of the things we've done is that we have a huge range of products, right?

So we don't have -- we have our XPE, we have our XPG product family, which is what light people like to talk about.

But we have our XM series, our XPC series, we have our MX series.

We have ML-B, ML-C, MT-G, I could go on and on.

The point is that our goal is to actually design in products for certain applications.

So, for example, if someone's doing a street light, we're going to typically be working on XPE or XPG.

But when we're in an indoor application, we're much more likely to design an MX6, MLEE or the ML-B product.

And when we're in a bulb we could be looking at, depending on the bulb, everything across that range.

But then when you get into a specialty lamp like an MR16, we could be looking at the MT-G.

And so the point is, what's the right product for the application.

That's actually how we try to deliver the lowest system cost for the customer, and so our focus is picking the right ones there.

In street lights, there's a push towards brighter LEDs generally, but that doesn't mean we still don't have new designs based on XPE.

In fact, we do.

I've seen those recently.

There's a range there.

In the indoor linear stuff, you're in more of the smaller wattage products.

I would say in bulbs it could be any flavor of those.

And same thing for portable lighting.

It's just really a wide range and it's really no one answer for any one specific product.

As far as 150-millimeter benefit, the goal is is that we should get a 30% plus cost reduction over time when we get the majority of production qualified.

The caveat there is that that's when we're getting the majority qualified.

In the short-term, the goal is let's get the products ramped up next quarter and really, that benefit is really a function not just of going to 150-millimeter but as you know, it's really about utilization.

So, we also need to drive the utilization rates up because bigger wafers and lower utilization don't drive significant benefit.

We need to do both of those things.

One final thing, what are you seeing the uptick in the components business for the current quarter?

When you say uptick, what's your -- you mean just generally, what's the trend?

Yes, generally, what's driving that increase?

We have actually seen -- geographically, it's pretty much across our business.

We're seeing -- it's direct and distribution.

All the geographies are looking relatively -- the indicators are all going in the right direction.

And I would say we see it in applications ranging from indoor to including outdoor.

We see some bulb business.

I'd say it's fairly broad based.

It's no one specific thing.

But I'd say it looks more to us like it's just generally speaking, that broadly speaking demand seems to be picking up relative to where we were at this point last quarter.

Great.

Thank you.

Sure.

Your next question comes from Yair Reiner with Oppenheimer & Company, your line is open .

Yes, thank you.

Assuming you get to the midpoint of your guidance, do you expect inventories to be worked down to what you consider a normal level?

Or if not, how long do you think you're going to be kind of working uphill to try to reduce your inventories and have that as a headwind to margins?

Yes, the question there is that -- the trick to answering your question is that it's going to depend a lot on how Q1 and Q2 shape up, right?

So, depending on what the demand outlook there is, is we'll adapt to what we think the appropriate level of inventory is.

One of the things to keep in mind is that although our inventory went up, based on what we can tell, and the way we figure this out is we don't know what our customers' inventory is, but we kind of watch what the expedites are, and we have seen more customer expedites, more short lead time requests.

Our sense is that customer inventories are lower than they have been for the last couple quarters.

That's an estimate, but that's how we get there.

Second is, we do know that in distribution, the absolute inventory dollars are down this quarter from this point last quarter.

I think from those two standpoints we have less, so I think to some extent that extra inventory is part of our -- is part of the benefit for our ability to respond to some of the short lead times.

The question is what do we need to do in Q1 is going to depend on what Q1 demand is.

It's a little hard to call.

If I had to guess, if the business continues on the current trend, I would imagine that we'll be able to increase utilization some amount in Q1, but it's -- frankly, we don't have enough visibility to put any firm plans in place at this point.

But if you're asking for direction, that would be my best guess at this point.

Okay.

And then I know it's tough question at this point in the cycle, but any thoughts right now about your long-term business model?

I don't see us changing the long-term model at this point.

Just like when we were in a really kind of the peak of the last trend here when it was higher, we didn't really want to raise it any further.

I think if you look at what drives our business, it's going to be if you drive LED lighting adoption, then the market gets a lot bigger.

And if we drive it with innovative products we can get paid for that.

I still think there's an opportunity on the gross margin standpoint to meet those targets, and I think as we scale up the business, the operating expenses make sense as well.

That being said, that's not what I worry about in the next few quarters.

What we're really worried about is, let's get that adoption going.

Let's go turn on those new applications.

And really, we believe that the basic fundamentals of the business will really come back into line longer-term, and so our focus is really on near to mid-term things that we can do to drive that.

Thank you.

Sure.

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

Your line is open.

Hey, guys.

Question for Chuck.

Chuck, do you think outside of the inventory build in the marketplace, do you think that maybe the market for LED components and other things, chips, et cetera, has slowed down some?

Have you noticed anything relative to the total demand or forecast?

Harsh, if I look at the lighting piece, which is what we -- there's really two pieces, right?

There's the broad LED market, then there's the piece we're focused on, which is the lighting piece.

The broad LED market is being affected by back lighting demand, and that's moving around.

I think that has some bleed over effects, just on total inventory capacity.

But I think we're more focused on what happens in terms of lighting.

And what I can tell you is that I think if I look at -- I think what you're asking is not just our sales, but on our customers' sales of their products.

I think overall, our customers' business is growing.

I don't think it grew as fast as they thought over the last six months, so I think that's what caused part of the inventory reduction.

I think the other thing is industry capacity grew faster than their business grew, so we got into the short lead time environment, so you effectively have more supply than demand.

But if I look at what I can tell from our customers, I think on average their LED product sales are going up.

I think the basics is there.

I don't think we're seeing massive adoption, but I do think we're seeing incremental progress.

But with that being said Harsh, we're at what, 4% to 5% of adoption.

We're so early in the conversion cycle.

We're talking about a really small percentage of what is a very large potential market opportunity.

Chuck, very helpful.

And then just looking at your commentary, looks like components finally looking better, lighting looking good.

Chips, small decline.

Would you say -- I know you said the backlog's constrained.

Is this the best kind of circumstances that you've seen in the a couple of quarters, would you say this is the start of growth for you guys or would you say it's still kind of limited visibility?

We definitely have limited visibility.

That's important to keep in mind.

But if I look at the backlog relative to where we were at this point last quarter, we're slightly ahead of that.

So, that's an encouraging sign.

The lighting business itself, Harsh, that actually has been doing very well.

We feel fairly confident about that business and its ability to keep growing based on what we can see.

If I look at components, we're more looking at the leading indicators.

We've seen post- Chinese New Year, we've seen distribution sales pick up.

We've seen direct business pick up, we've seen quoting activity increase.

We've seen more customer expedites.

These are leading indicators.

What they haven't translated into is a full backlog.

So, we still have to book more business.

There is a spot part of the market we're still facing which adds some variability, but I would say if you asked me about lighting and about components, I'd say generally speaking, it's definitely -- lighting is looking good and components is trending in the right direction with the caveat that we still don't have great visibility.

That could be the best I can probably say on that.

Fair enough, thanks, Chuck.

Your next question comes from Joshua Paradise with Morgan Stanley.

Your line is open.

Hey, guys, thanks for taking the question.

No problem.

Can you talk about the volume growth and the price decline assumptions that are baked into the June guidance?

Yes.

I can't break out the specifics, but we're targeting -- we're assuming that the pricing environment remains competitive in a way that is similar to last quarter.

Now, that's a broad statement.

Keep in mind that there's lots of products, there's lots of trends within those.

But we're generally factoring in a fairly competitive pricing environment for both LED components and LED chips.

That implies then that volume growth is obviously in components is higher than that because we're targeting overall revenue and components to grow nicely.

I think you can see that we're feeling like volume is moving pretty well.

In terms of chips, I think that we're probably not looking at -- we're actually probably looking at relatively flat volume with lower pricing, and that's why it leads to slightly lower revenue there.

Does that answer your question?

Yes.

It would be nice if you could put some numbers around that.

But if you can't --

Yes, I got that, we're not going to be able to do that for you today, though.

Okay.

And then maybe one separate question.

You talked about specific products that get customers to a low total system cost.

Can you put some numbers around where your customers are today with the specific high quality products on maybe a dollar per kilolumen basis for the system and where you think that goes in 2011 and 2012?

Here's the problem.

Every application is going to be different.

And so it's going to depend on every specific customer's product application and the spec they're trying to hit.

When we throw around those big numbers, I think we basically potentially set -- we can set wrong expectations.

An example I would given you is with our new XM product, this is a very high performance product.

It's perceived as the most expensive LED we make, and if you look at it on a unit basis, it is.

But if you actually operate this device where we designed it to be operated at very high currents, you can create a very cost effective system.

So, in one case you can look at a product there if the customer drives it the way they would drive traditionally in LED, it's relatively expensive.

At the same time, it's possible to generate somewhere in the order of magnitude of a 10,000 lumen light source at a roughly $100 US cost.

Now, there's probably a few pieces you have to add around that, but it gives you an idea of what's possible if you run it correctly.

But that's one application.

And for every customer that would design it that way, there's equal or more number of customers that will design it differently.

But we're pushing the limits down pretty much across the board, but it's really going to vary on different applications.

And I think the key thing that we're understanding is that as LED costs come down, they're becoming a lower percentage of the bill of materials.

And so the trick is not just what's the LED cost, but what leverage can I get on the rest of the system, and that's really what we're spending our time working with our customers on right now.

Great, thank you very much.

Sure.

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

Your line is open.

Hey, Chuck.

Hey, Andrew.

So first question, if your pre-announcement, I think you indicated that the June quarter revenue would be up 10% to 12%.

And I think based on the midpoint you're now guiding to up 7%.

So I'm wondering, is that shortfall a function of units, or is it pricing?

Andrew, actually -- so that -- the two key growth drivers to that are LED lighting components, and those are both still trending in the same direction.

The difference is that what we have tried to factor in is that we know we're in a low visibility environment and we also know that chips is probably -- we're a little more conservative in our outlook on that than we thought when we gave that initial outlook.

And the third piece of that is now as we watch what's going on in Japan, I think we do think there will be some weakness, definitely in chips in Japan, but maybe even a little bit on the component side.

So, I think that's really what's moving the center of the range down a little bit.

Obviously, there's still an opportunity to achieve those targets, but I think we're trying to factor in some of the other risks that maybe weren't as obvious three weeks ago.

Okay, and then can you give us a little more color on your expectations for yield improvements?

And then separately, cost reduction as you go from 4-inch to 6-inch?

On yield, Andrew, there's two things we're doing to drive cost reduction.

There's -- yield improvement is one of them, and we get that in a number of different ways.

But primarily it's from process improvements that lead to generally more die per wafer or more good XLamps into the bins.

We do lots of things across the process from substrate all the way through packaging to make that happen.

The second thing we do is actually as we design new products, we try to actually design out cost or find ways to optimize costs in them.

We're getting cost reductions really two ways.

We lump it into yield improvement, but there's really two flavors to that.

In terms of 150-millimeter, as I mentioned earlier, the basic target is a 30% plus on the same wafer if you go from 100-millimeter to 150-millimeter.

But that's when you have the factory at similar utilization and that's when you get the majority converted.

We actually saw something similar to that or even slightly better when we went from 3-inch to 4-inch, so that's how we come up with that.

But keep in mind, that's for that specific change alone.

We're obviously looking at lots of other things yielding other cost reductions that hopefully will give us some additional leverage as we move forward.

It's really a combination of things that we're targeting over the next year.

Okay.

And then for the March quarter that you just reported, can you say whether or not your LED component units increased sequentially compared to the December quarter?

The units sequentially, I don't think units increased sequentially, but I don't have that data in front of me, but I'm pretty sure that it didn't.

ASP decline -- there was price erosion, but it wasn't so significant that it offset the units.

And again, there's a little bit of a trick there, Andrew.

Because the reason I can't give you specific numbers, that's really a function of the different mix of products, and so -- and I don't have that sitting in front of me at this moment.

Okay.

And then the last question, it seems to me, I think you addressed this in your prepared remarks, you talked about why does LED lighting continue to grow while LED components continues to come under pressure?

It seems to me that there's a lot less ASP erosion in lamps and luminaries.

So, if that's the case, should you be driving the Company more towards that business instead of components?

I think -- Andrew, I think what you are seeing is the nature of the components business going through the cycle.

I think over any long period of time we want to drive price reductions in both sides of the business because today the fact is that LED lighting adoption is a pretty small number.

And so the way we're going to drive adoption is to make both the LEDs, but really the systems more cost competitive.

And we're pretty aggressive in driving our costs down in that product line.

I think the subtlety there is, is there a benefit in systems?

There's definitely leverage.

But I think it's different than you're thinking about.

The reason we like that product line is it really helps us move the market.

One of the things I said earlier is keep in mind, when we're out there coming out with new products, we're generally setting new efficiency standpoint benchmarks or we're setting new price performance standpoint benchmarks.

For example, when we came out with our downlight at Home Depot, we really changed the perception of what's possible in terms of lumens per dollar for an LED downlight.

We're going to keep pushing the limits on products like that, and I think it's really the ability to move the market that gives us the most leverage there.

That being said, lighting is a very broad market.

It's more than just indoor.

There's outdoor, there's lots of these other applications.

I think the components business gives us a huge benefit to be able to access global trends that drive the business in a much more significant way than we can do with just our own systems product line.

I think the two continue to work together very well and frankly, we want to invest in both of them.

Okay.

Thanks.

Sure.

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

Your line is open.

This is Shawn, actually, for Ahmar.

I wondered if you guys could just give us a little bit more of the timeline of the 150-millimeter ramp.

Chuck, I think you said that we'll start ramping in September.

You're on schedule for that.

You guys have talked about that in the September quarter.

When should we look for a full ramp and for 150-millimeter?

The challenge with giving you that number is the original target that we've had is, we would like to convert the majority of production from across the fiscal year.

From start of Q1, fiscal '12 to the end of fiscal '12, the goal would be to get a majority of chip production on 150-millimeter.

The only caveat to that is really going to be is utilization.

If the business -- if we can drive adoption and generate revenue growth, we should be able to achieve that target.

Only reason I put a caveat in there is there is the idea that we want to continue to manage utilization as well, so turning on new capacity faster than we need to just to get the 150 millimeter, the real benefit comes from the combination of utilization and larger wafers, and so we're just going to manage that.

But I would say today our goal for the year will be to get a majority of products converted to 150-millimeter.

But I think we're going to be smart about managing that depending on what happens in the market where we could go faster or slower, depending on other market factors.

And in terms of this quarter in 3Q, are you guys able to split out the percentage of revenues that components and chips comprise of total revenues?

We don't break that out.

I can tell you that since lighting grew and both of those declined, it did move a little bit more towards systems than chips and components.

But what I would tell you is that components is still obviously a significant piece.

It's really that chips is changing more than anything else right now.

It's declining as a percentage of the business more than anything else.

And I think with our targets for Q4 what you'll see is components and lighting both continuing to grow based on our targets at a solid rate.

I think it will be really be, chips will continue to decline as a percentage based on our current target.

Thanks.

And one final one.

Just in terms of the commentary on the call here, do we think in this current quarter and 4Q that we're going to be basically bottoming out from the pressure that you guys have seen in the LED market?

Look, what we can see is is that we have positive trends on components.

Now I say that with -- and I said it a few times, I just want to make sure people understand that we're setting that in a relatively low visibility short lead time environment.

While the backlog's better than it was at this point last quarter, from where we were a year ago, we have much less visibility.

So, there's some variability built into that.

But yes, we see the positive trends in components.

Obviously, what we want to do is continue to see that continue.

We see a very solid trend and a very positive one in the system side of the business, and we have continued some weakness on chips.

The net result is is that we're -- that's our goal.

We're planning the business towards that way.

But at the same time, I think we're being a little cautious whether it be, for example in our revenue range because when you don't have great visibility, I think we want to factor that into just some of the variability of running the business in the short-term.

Your next question comes from the line of Olga Levinson from Barclay's Capital.

Your line is open.

Hi, thanks for taking my question.

My first question is around the conversion to 150-millimeter.

Beyond the guidance that you provided for OpEx in the June quarter, can you talk about what impact to OpEx the conversion will have, assuming that you do see relatively reasonable revenue growth that would drive the full conversion by the end of the fiscal year?

What should happen is over the last couple of quarters, we've actually increased R&D to really fund the qualification and get through that part of the curve.

What I would guess at this point is that we have a small amount of additional R&D targeted this quarter to get the qualification finished and start that conversion.

Now, I would expect is the 150-millimeter portion of R&D will decline as a percentage going forward.

We are going to invest in some other areas, but we probably -- depending on revenue growth, and that's a big if, we could see some leverage there, incremental over the next couple of quarters.

But it's really going to be a function of revenue growth, because at the same time there's lots of great new product stuff that we're working on that we want to continue to push into the market.

I know it sounds like a broken record, but when we're this early in LED lighting adoption, we do not want to forget to keep driving those products that are going to really enable more broad adoption.

Got it.

And then in terms of your LED lighting and fixture products, as they get to a larger proportion of your business, is there a specific limit of what you want to cap that at and what impact that would have on the gross margins and the OpEx going forward?

From a cap standpoint, there's really not a cap.

The strategy is to focus on specific applications where we think the market isn't moving fast enough to LED lighting and we can drive adoption.

The example there is we've been real focused on downlights and commercial, directional lamps because we felt like that was underserved and we could drive adoption.

That being said, we did some cool R&D on A lamps, but we're not making an A lamp because we see lots of good activity from our customers, and that's not our goal, right?

If we can enable our customers, great.

We can drive adoption that way as well.

It's not really a cap, it's more of a where are the applications.

And as long as we see underserved applications that we think we can make an impact on and really drive the price performance to where we can compete with conventional technology, if the market's not doing it on it's own, we're going to try to push it there.

That's our focus on that standpoint.

From an OpEx and gross margin, that business, generally speaking requires -- there's sales and marketing expense that's probably a little higher than typical in that business and R&D expense that on average is less than typical when you compare it to a semiconductor business.

And obviously CapEx is less than a traditional semiconductor business, so I think -- and when it comes to gross margin, our gross margins today, the components business has the best gross margin and then chips and the lighting business are in a similar range.

And so we would hope -- our goal is for lighting to improve over time, but in the near term, it probably has a slightly dilutive effect on the overall gross margin.

But again, it's a relatively small portion of the business in the near term.

Got it.

Thank you.

Your next question comes from Daniel Amir with Lazard Capital Markets.

Your line is open.

Thanks a lot, thank you for taking my call.

Couple questions here.

First of all, how do you see what's going on currently in China impacting your business in terms of the big growth that we're seeing on the LED chip production side?

And if you are seeing that's impacting your business, how are you addressing that here going forward?

Because that does seem like a going trend here that we're going to see in the next couple of years.

There's clearly been lots of investment in China.

The number of reactors, it's been pretty well documented, lots of reactors going in, lots of government subsidies.

What we've seen on the impact of our businesses, while there's lots of capacity, we don't see any significant impact on the lighting related businesses that we're focused on today.

We do see it in the off spec or low end market, but we really don't -- for Cree, we haven't really sold in that market for years.

So, it's really something that affects, I think the other Asian players a little more in the near term.

I think the real key is that either there has been a gap in terms of the performance required to enable lighting and the performance of a lot of our Asian competitors.

And for us, the focus is if we keep driving innovation and maintain that gap, that's really the key to our success, and so that's what we're focused on.

I think while everyone works on this, the key is to maintain that.

And I think maybe one of the misconceptions is, you have to remember most of the lighting market is still traditional technology.

If we just use our estimate, which is somewhere 4% to 5%, that means that 95% of the applications we don't have products that are good enough either from a technology standpoint or a value proposition, which generally gets back to technology, to compete with the conventional technology.

I think this idea that just more capacity solves the problem, I think at least at this stage of adoption, that seems a little naive to me.

I think it's really about do we have the right technology to actually turn on systems that make these applications more successful against the conventional technology.

Your question is valid, and we have to watch it.

I think it will be capacity in the market, but I'm not so sure it's going to affect the lighting business in the near term as much as our ability to drive adoption.

As far as longer term goes, if there's enough capacity in the market and it can service some of the needs, I think, at Cree I think I mentioned in the past that we've tried to qualify external sources for some of the low end of our product line.

We have not been successful to date.

I think we'll continue to evaluate that.

Maybe there's an opportunity.

But as of right now, we haven't been able to get the perform -- the combination of performance, quality and reliability to make that happen, so I think that's more the longer term view.

Again, kind of two different factors there.

Now, on the chip -- thank you.

On the chip business, you've guided down here.

What needs to happen for the chip business to actually turn around?

What's -- what are we looking for?

What should we be expecting here for whether to see it turn around here in that business next quarter maybe?

Our target for next quarter, Q4, I don't know if you're talking about that or Q1 --

No, Q1, excuse me, in the September quarter.

We're really not looking for a big turnaround in that business.

What I would like to do is the business has obviously gotten smaller than it was six to nine months ago, and so what we would like to do is we want to continue to maintain an exposure to certain markets and applications.

It's a nice opportunistic piece of business that lets us service some applications we don't have an interest in serving as a component supplier and it does give us some leverage and really also keeps us in contact with these applications in terms of competitive trends.

But our outlook right now is if it could stay at a similar range as what we're targeting at Q4, plus or minus, it's declining as a percentage.

Keeps us some good access to the market, I think that would be fine.

I think in terms of the margins on that business, that's really a supply and demand thing.

When we see supply and demand work through the cycle here at some point, what you'll see is that when supply tightens up a little bit, then the margins will come back and -- or at least improve from where they've been.

But that's really the dynamic that's at play there, and I think we're in kind of a wait and see mode where that will turn around.

Okay, thanks a lot.

Your next question comes from the Jesse Pichel with Jefferies.

Your line is open.

Good evening.

Thank you for taking my questions.

My first question is can you give us some idea of what your cost down target would be by transitioning to the 150?

I remember back in '09 when you went to 4-inch it had a positive effect on your margins, but of course that was a much better demand environment.

Keep in mind that we're going to start 150 next quarter.

And I would expect though if we're successful driving adoption, that's a big if, but that's the goal, then I think the demand environment is something that we're trying to effect through the -- on the innovation side, both at the component and at the system level.

If you just look at it on an apples-to-apples basis, as I said earlier, we would expect 30% plus cost benefit from the conversion from 100-millimeter, 150-millimeter, and that's excluding the other things we're working on, yields, product design and other cost leverage.

I think there's -- we have some good cost reduction opportunities out there, 150 specifically, but really beyond that.

And I think it's a combination of those things that gives us a good opportunity going into next year.

That being said, we still have to focus on driving adoption to drive demand.

And my second question is, can you give us some additional color on the China market in particular, what you're seeing there, you have operations there, and what really needs to happen for that market to recover?

Is it some structural change, or is it just more Chinese projects?

What we've seen is is that the China market overall, and I would say it's not separate.

What we've seen is a general improvement in demand there.

Just like I'm seeing it across the rest of the business, in components we have seen demand start to improve, and that's both our direct and our distribution customers.

And I really think it's a part of getting through the cycle where our customers were really reducing inventories for longer than we originally targeted.

I would say that today we're seeing a positive trend.

In terms of is there one big thing, the way we're building the business right now is we're trying to drive applications, both indoor and outdoor, bulb, portable, we're really working all the applications.

I think that there are clearly things that can happen in China to drive overall demand.

It's a function of a combination of regulatory infrastructure spending.

But I'll be honest, I think those same trends exist outside of China.

And so the way we look at it is if there's some benefit that's beyond the normal business cycle, great.

We're going to try to manage the more broad based stuff and take advantage of it if we do get some specific government related or other project that kind of moves the needle.

That's helpful.

Thank you.

Sure.

Your next question comes from Bill Ong with Merriman Capital.

Your line is open.

Good afternoon, gentlemen.

Thank you for taking my question.

I would like to get your view on the strategic leadership in the LED market.

We saw historically past chip leaders such as Intel and Broadcom, these leaders commanded high gross margins (inaudible) tough environment because of technical superiority.

Clearly, an industry leader but with less control on pricing, facing much more numerous players.

My question is that in this current competitive environment, can an LED industry leader also be a profit leader, just making demand more inelastic based on features for the price and subsequently, better gross margins?

Obviously, we're trying to do that.

If you look at our product offering, one of the reasons that we decided that the one size fits all doesn't work is that we actually looked at what it took for us, our own internal systems group, we asked what is it that's making us successful there?

And one of the things we found out is one size LED does not fit all.

If you notice our product line over 12 months, we've gone from really XPE, XPC and XPG to a much broader application focused set of products.

And really, when you introduce those, there's quite a design cycle before we're going to see the benefit of that, and so I think we're working through that today.

And obviously we think that if you solve the customer's problem, there's more -- and you do it better in terms of their system cost, that's where the gross margin opportunity lies.

That being said, I think you have identified that LEDs is a bit different than some of those of other markets where you really had one or two players.

We do have lots of people investing in this business, so I think out does create a bit of a dampening effect.

That being said, our focus is there's so much innovation left, let's go do that.

And if we turn on the big applications, the margins tend to follow that.

And although over the last couple quarters I know that the feeling is is that wow, what's changed?

I think what's changed is the business is getting bigger.

We're going through a cycle, but we're still pretty early.

I don't know how at 4% to 5% adoption we can't say that.

I think if you look at Cree relative to a lot of our competitors, our margins are doing, on a relative basis, fairly well, and the key is let's keep driving that adoption.

That's insightful, thank you very much.

Sure.

Your next question comes from Jed Dorsheimer with Canaccord.

Your line is open.

Hey, thanks for squeezing me in here, Chuck.

Just two questions.

First, on the technology, I know you've been pretty agnostic in terms of silicon carbide versus sapphire, and we saw that you recently signed a cross license with Osram.

Just curious, the 150-millimeter transition, is that going to be on silicon carbide, or will it be grown on a sapphire based product?

Jed, we did development on both, and we're going to start with silicon carbide for now.

We've had better results both in terms of yield and overall brightness on that platform, and I think it's probably a function of the fact that although we do R&D on both, we clearly -- our experience base is higher there, so it makes more sense.

We also -- I think it gives us some advantages to tune some things because we control the substrate to frankly make that transition a little easier.

Great, and then secondly, on the transition to 150-millimeter, just looking at the capacity increase, it gets to about 30% just on an area basis.

And so with utilization coming down sort of 10% to 15%, and with a quarter of inventory on the books now, as you manage through this transition, do you expect gross margins to sort of be in this range unless pricing increases or at least flattens?

It would seem to me that while the longer term targets still remain, as you go through this transition it's going to be tough to get those to increase, even with the cost reduction.

I think the key is what's the volume opportunity on the other side?

When we start the conversion, it's a long process, right?

I think it took us probably six, seven quarters to go from 3-inch to 4-inch.

And so I think over that period of time, we're working pretty hard to try to drive adoption and volume growth on the other side of that.

I think it's going to be a function of how those two come together.

If the market doesn't grow quickly, I think you're sensing the right issue.

At the same time, we're going to try to drive adoption and I think that we can have an impact on the other side of that conversion.

The first quarter of conversion would be a relatively small percentage in any case, so it's really more a fact of when we're looking out nine months from now, how is overall demand and adoption going?

Because I think that's where the big tradeoff will be is how much benefit from the conversion do you get relative to utilization?

And I think at this point we still see lots of opportunities to drive adoption, and that's at least how we're going to approach the problem in the year ahead.

Great, thanks.

Look forward to seeing you at Lightfair.

Thanks, Jed.

This now concludes the Q&A portion of the call.

I turn the call back over to the presenters.

Thank you for your time today.

We appreciate your interest and support and look forward to reporting our fourth quarter and fiscal year 2011 results on August 9.

Good night.

Thank you.

This now concludes today's conference call.

You may now disconnect.