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Cree Inc. (NASDAQ:CREE)

F1Q09 (Qtr End 09/28/09) Earnings Call

October 21, 2008 5:00 pm ET

Executives

Raiford Garrabrant - Director of IR

Charles Swoboda - Chairman, President and CEO

John Kurtzweil - EVP, Finance and CFO

Analysts

Harsh Kumar - Morgan, Keegan & Company

Dale Farrel - Cantor Fitzgerald

Michael Suh - Oppenheimer

Daniel Amir - Lazard Capital

Michael Burton - Thinkpanmure

Hans Mosesmann - Raymond James

Carter Shoop - Deutsche Bank Securities

Bennett Notman - Davenport & Company

Operator

At this time I would like to welcome everyone to the Cree, incorporated, first quarter 2009 fiscal year 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 October 21st, 2008. Thank you.

I would now like to introduce Raiford Garrabrant, Director of Investor Relations of Cree Incorporated. Mr. Garrabrant, you may begin your conference.

Raiford Garrabrant

Good afternoon. Welcome to Cree's first quarter fiscal 2009 Earnings 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, Chairman and CEO, and John Kurtzweil, Cree’s CFO, will report on our results for the first quarter for fiscal year 2009. 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 which is posted in investor relations section of our website at www.cree.com under financial metrics, quarter ending September 28th, 2008.

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

Also, we'd like to note that we will be limiting our comments regarding Cree's first quarter 2009 to a discussion of the information included in our earnings release and the metrics posted on our website. We will not be able to answer any questions that would involve providing additional financial information about the quarter, beyond the comments made in the prepared remarks.

This call is being recorded on behalf of the company. The presentation and the recording of this call are copyrighted property of the company and no other recording, reproduction or transcription is permitted unless authorized by the company in writing. Consistent with our previous conference calls, we are requesting that only sell-side analysts ask questions during the Q-and-A session.

Also, since we plan to complete the call in the allotted time of one hour, we recognize that other investors may have additional questions and we welcome to you contact us after the call by e-mail or phone at 919-287-7895. We are also webcasting our conference call to allow more flexibility for our conference call attendees. A replay will be available on our website through November 4th, 2008.

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

Charles Swoboda

Thank you, Raiford. Fiscal 2009 started strong in the first quarter with record revenue of $140.4 million, and non-GAAP net income of $13.2 million or $0.15 per diluted share. Non-GAAP gross margin increased to 36% for the quarter. These results were on the high end of our previously announced target ranges.

The revenue growth was driven by LEDs, including another strong double-digit increase in XLamp sales, High Brightness LED components and LED chip revenues were in line with Q4 and LED lighting sales grew double digits. The growth in LEDs more than offset a 14% decline in Power, RF and contract revenue, due most toll lower demand for our silicon carbide Schottky Diode products.

The strong increase in gross margin was primarily the result of higher throughput in our LED chip factory and improved XLamp yields, which resulted in higher XLamp product margins.

Working capital was in line with our target levels as inventory days on hand declined to 78 days and DSO declined to 66 days. Cash flow from operations was a very healthy $42.1 million for the quarter and our balance sheet remains strong with $339 million in cash and investments and no debt.

As we start our second fiscal quarter, we continue to evaluate the impact of the recent turmoil in the global financial markets on our customers and our business. We’ve seen some signs of lower demand for our power products and IT related application, but current customer forecasts for LED product remain pretty solid. We anticipate, however, that the economic uncertainty and lack of consumer confidence will eventually have some impact on the markets we serve.

At this time, our targets for Q2 indicate that we should be able to deliver sequential growth, but we are becoming more cautious about fiscal Q3, which is historically a seasonally slower quarter for Cree. As a result, we are taking a more conservative approach to operating expenses and capital spending in the near term. However, we still plan to make new investments to support the targeted growth in LED components and lighting product sales as the LED lighting revolution continues to gain momentum.

I will now turn the call over to John Kurtzweil to review our first quarter financial results in more detail and our targets for the second quarter.

John Kurtzweil

Thank you Chuck. I will be providing commentary on our financial statements on both the GAAP and non-GAAP basis, which is consistent with how management internally measures Cree's results. However, non-GAAP results are not in accordance with GAAP and may not be comparable to non-GAAP information provided by other companies. Non-GAAP information should be considered a supplement to and not a substitute for financial statements prepared in accordance with GAAP. A reconciliation of the non-GAAP information for all quarters mentioned on this call is posted on our website as well as historical summary of other key metrics.

For the first quarter of fiscal 2009 revenue was $140.4 million, which is within our targeted range for the quarter of $138 million to 142 million, a 24% increase over Q1 of fiscal 2008 and a 3% sequential increase over Q4.

GAAP net income was $5.9 million or $0.07 per diluted share, and within our targeted range for the quarter of $0.06 to $0.08. On a non-GAAP basis, net income for the first quarter was $13.2 million or $0.15 per diluted share, which excludes $7.3 million of expense net of tax, or $0.08 per diluted share from the amortization of acquired intangibles and stock-based compensation expense.

Non-GAAP earnings were consistent with the company's previously announced target range of $0.13 to $0.15. This is a 50% increase of non-GAAP earnings per diluted share compared to the first quarter of fiscal 2008, which excluded similar items, as well as realized gain on investment and property tax expense adjustments.

Cash provided by operations was $42.1 million. Free cash flow was $30.3 million, and we ended the quarter with $339 million in cash and investments and continued to be debt free.

LED revenue increased 32% when compared to the same period last year and 6% sequentially to $123.3 million, while non LED products and contract revenues were down 12% sequentially to $17.1 million and down 15% from the same period last year. LED revenue was led by double-digit growth in both XLamp sales and LLS products.

LED chips and our High Brightness products were in-line with our target and in a similar range as Q4. As we had forecasted at the beginning of the quarter, we saw a decline in our non-LED product lines in Q1, primarily due to lower silicon carbide power device sales and lower government contract revenue.

Q1 GAAP gross margin was 35.2%, which was an increase of 460 basis points year-over-year and 150 basis points sequentially. Non-GAAP gross margin was 36.1%, which excludes stock-based compensation of $1.3 million or approximately 90 basis points of margin. Non-GAAP gross margin was at the high end of our targeted range, primarily due to volume benefits from higher throughput in our LED chip factory and improved XLamp yields, which resulted in higher XLamp margins.

Operating expense was $44.7 million on a GAAP basis and $36.5 million on a non-GAAP basis. Non-GAAP operating expenses exclude approximately $4.1 million of stock-based compensation expense and $4.1 million of charges for amortization of acquired intangibles. This is higher than our targeted range, primarily due to increased R&D spending on new LED chip development and LLS products.

Net interest income and other decreased year-over-year to $3 million. But was above our target primarily due to higher cash balances than we targeted. Given the recent uncertainty in the debt market, and the most recent 50-basis-point drop in the Fed fund rate, the average return on cash is expected to decline in the second quarter. The tax rate for the quarter was 22.8% which is slightly higher than our 22.5% targeted. This relates to closing out fiscal 2007 and earlier returns with the IRS.

The balance sheet strengthened during the quarter as we continued to make progress on working capital. Day sales outstanding declined 9% to 66 days from 73 days in the prior quarter, as accounts receivable decreased by $6.9 million to $103.4 million on a 4.5 million increase in revenue. We also decreased our inventory days on hand 3% to 78 days from 80 days last quarter as inventory declined by $0.9 million to $79.2 million.

Cash flow from operations was $42.1 million and capital expenditures were $11.9 million for a free cash flow of $30.3 million during the quarter. We used $2.7 million in cash to repurchase approximately 130,000 shares of the company's stock at an average price of $21.18 per share during the quarter.

With the growing economic uncertainty, it has become more challenging to forecast the business and has increased the chance that our actual results could differ from our target. We anticipate that the lack of consumer confidence will eventually have some impact on the market we serve.

At this time, our forecast for Q2 indicates that we should be able to deliver sequential growth and we target revenue to increase to a range of $142 million to $146 million driven primarily by double-digit growth in both XLamp, LEDs and LLS product. We target High Brightness component sales to be in a similar range and LED chips slightly lower than Q1. Power and RF are also targeted to be in similar range while material sales and contract revenue are targeted to be a little lower than the previous quarter.

Gross margin is targeted to be in a similar range as Q1 with GAAP gross margin of 35% to 36% which includes approximately 900,000, or 60 basis points of stock-based compensation expense. On a non-GAAP basis, we target gross margin to be in a range of 35.5% to 36.5%, when you exclude the stock-based compensation expense. We are targeting slight improvements in gross margin from current products to be offset by slightly higher costs on the ramp-up of several new product during the quarter.

GAAP operating expenses are targeted to be approximately $45 to $46 million and include approximately $4.3 million of noncash stock-based compensation expense and $4.1 million of charges for amortization of acquired intangibles. We target R&D and selling expense to be flat quarter-over-quarter with an increase in G&A expense primarily related to litigation expense as we start to gear up for IP related trials scheduled for calendar 2009.

We target that litigation expenses will increase again in the third fiscal quarter when the Texas Bridgelux case is scheduled for trial, and remain at that level to the fourth fiscal quarter, due to preparations for the Newmark case, which is anticipated to be scheduled for trial in the summer of calendar 2009.

Interest income and other is targeted to be approximately $2.7 million, based on lower returns from our investment portfolio and lower average cash balances than in the first fiscal quarter. We are targeting our effective tax rate to be 22.5% for the balance of the year.

Based on an estimated 89 million diluted shares outstanding our GAAP EPS target for the second fiscal quarter of 2009 is expected to be in the range of $0.07 to $0.08 per diluted share when amortization of acquired intangibles and stock-based compensation are included. We target non-GAAP earnings per diluted share in a range of $0.15 to $0.16 for the second quarter of fiscal 2009. Our non-GAAP EPS targets exclude amortization of acquired intangibles in the amount of $0.03 and non-cash stock-based compensation in the amount of $0.05 per share.

Receivables are targeted to increase in relation to our revenue growth, while days sales outstanding are targeted to be in the current range or slightly higher. Inventories are expected to also increase to support our growing XLamp and LLS product lines, while days are targeted to remain in a similar range to slightly higher. We are targeting capital expenditures in the quarter to be in the range of $15 million to $18 million primarily for additional capacity, new product introductions and the continuing transition of LED chip production to four-inch wafers.

Thank you for your time and attention. I will now turn the discussion back to Chuck.

Charles Swoboda

Thanks, John. As I stated last quarter, we are focused on four key areas in fiscal 2009. To continue to drive our transformation into a global leader of energy efficient LED components and lighting products.

Our first priority is to drive topline growth for Cree through higher sales of LED components. In Q1, LED components continue to increase as a percentage of our overall revenue, as XLamp sales once again grew double-digits sequentially and High Brightness LED sales were in line with the previous quarter.

We target LED components to lead the growth again in Q2, driven by another double-digit increase in XLamp LED sales, while our High Brightness components are targeted to remain in a similar range as Q1.

Our second priority is to build upon our market leadership in LED lighting by driving LED adoption through higher sales of our LED lighting products, continuing to develop new products that raise the bar for lighting class performance, and expanding Cree's brand awareness through our market development activities.

LED lighting product sales increased in Q1 but at the lower end of our target range. The sales in Q1 were limited by some delays in a ramp-up of several new products, as orders increased faster than shipments.

In hindsight, we determined that we need to increase our finished goods inventory levels in North America to better serve this growing customer base. Demand has continued to increase for our flagship LR-6 product and we’ve already seen strong initial orders for our soon to be released LR-24 product. We are working to resolve the manufacturing bottlenecks and target double-digit revenue growth for these products in Q2.

We recently announced an important new strategic agreement with Zumtobel, who is one of the world's leading lighting fixture companies, where they will sell Cree’s award winning LED Downlights in Europe through their extensive sales channels, under both the Zumtobel and Thorn brands. This agreement signals an important step for Cree and are targeted to accelerate the LED lighting revolution across Europe by providing Zumtobel's customers with energy efficient and long-lasting products that save energy, save money, and help protect the environment.

We also made great progress extending our leadership in lighting class LED components in the quarter, as we released both our new XP and MC series of XLamp LEDs to initial production. These products bring lighting class performance to new package form factors, which should enable our customers to address a wider range of lighting applications.

Initial production for both of these products is underway in Durham and we plan to transition them to high-volume production at our China factory in the second half of this fiscal year.

Our third priority is to increase new product margins and build operating leverage. As we have stated over the last couple of quarters improving our gross margin is the key to driving operating leverage. And this starts with our new product lines.

We made nice progress in Q1 as gross margin increased to 36%, due primarily to higher LED chip factory utilization and higher XLamp LED margins, as we were able to increase XLamp yields. We remain focused on a number of activities to help improve margins over the next year, including further yield improvements at the chip and package level, capacity additions in Asia, volume benefits due to increased factory loading and the transition of LED chip production to four-inch wafers.

Our fourth priority is to continue to grow our commercial power and RF product revenue and transition this product line from the current level of a slight quarterly loss to adding to the bottomline in fiscal 2010.

As we had forecast at the beginning of the quarter, this business declined 14% in Q1 primarily due to lower silicon carbide power device sales as two of our major power supply customers reduced orders during the quarter in response to anticipated slower demand in the IT sector.

On a positive note, we recently received our largest order ever for commercial RF devices, which is expected to provide a solid base of RF business over the next year and should help offset some of the fluctuations in demand on the power side of the business.

Our goal over the next year is to begin to realize more of the potential for our Schottky Diodes from a broader customer base and we are working to increase both our direct and distribution sales coverage to improve our customer reach.

Expanding our sales channel remains a high priority as demonstrated by the recent addition of Digi-Key and Farnell to our global components channel. Sales to distribution continue to increase as a percentage of our total sales in the quarter, and we estimate that our distributors' days of inventory were in line with our target for both LED components and LED chips.

Our market strategy of using our LED lighting product to lead the industry is working. Recently, some of the traditional lighting companies have reacted to our award winning LED Downlight products and decided to introduce their own LED based product.

While this creates competition for our LED lighting product line, that is part of the plan, because it also stimulates overall demand for LED lighting, which then fuels the growth in LED component sales.

Given the financial market issues and greater economic uncertainty, it has become more challenging to forecast the business, and increase the chance that our actual results could differ from our target. We target revenue in Q2 to increase to a range of $142 million to $146 million, driven primarily by double-digit growth in XLamp LEDs and growth in our lighting products.

We target High Brightness LED components sales to be in a similar range as Q1 and LED chips to be slightly lower. Power and RF are targeted to be in a similar range while material sales and contract revenue are targeted to be a little lower than the previous quarter.

We target non-GAAP earnings in Q2 of $0.15 to $0.16 per diluted share, as higher sales and similar gross margins are somewhat offset by higher G&A costs related to IP litigation and some near-term execution risk in lighting and RF. Please note that our non-GAAP targets exclude amortization of intangibles, stock-based compensation expense and related tax effects.

Our strategy to focus on LED lighting to drive revenue growth has worked well over the last seven quarters and we are targeting more of the same in the year ahead. We are not immune to the economic cycle but we are well positioned to take advantage of the growing trend for energy efficient lighting, and we remain focused on our mission to obsolete traditional light bulbs.

We will now take analyst questions.

Question-and-Answer Session

Operator

Your first question comes from Harsh Kumar.

Harsh Kumar - Morgan, Keegan & Company

Hey, guys, first of all congratulations. These are, I'd say, extremely good numbers in what I'd characterize as an extremely tough environment. Couple of questions, your product, inherently by nature, is sort of discretionary, and somewhat to the high end of the range. Given this economy, first of all, I'm somewhat surprised you haven't -- you mentioned that you are seeing strong LED demand still, particularly in XLamp. Can you help us put together all the parts and pieces maybe what's driving that and why may you haven't seen some of what the rest of the world is seeing?

Charles Swoboda

Harsh, you know, obviously it's -- obviously if you listen to enough earnings calls you realize that we're seeing something a little different than other people. What I can tell you is what our customers are telling us right now, our XLamp continues to look pretty good this quarter. Obviously we're targeting double-digit growth again.

The High Brightness business looks solid. I think, maybe we're a little different there because we have pretty good exposure in the China market itself, and although the export business looks like it might be under a little pressure in China, I think there's still domestic growth there, and so obviously we benefit from products that are sold in China that stay in China.

And then I think on the LED chip side, I think what you’re seeing is that over the last couple years we’ve really reduced our dependence on the consumer side of the business. And that's not to say that we don't have some exposure there. We do. But I think what you’re seeing is the fact that lighting is the biggest driver, has kind of helped us probably whether this, at least initially, better than others.

What happens beyond Q2 and Q3, it's hard for us to forecast. We don't have that visibility right now. But I think the lighting markets, we're still seeing demand for our more energy efficient products, and I think it's generally helping us across the business. I would also say the other thing is that the conversion of back lighting for notebooks to LEDs is probably also helping a little bit on the chip side. So, I think we have two factors that are probably helping us at least in the near-term. And we'll see how that goes as we get through this quarter and into next.

Harsh Kumar - Morgan, Keegan & Company

Okay, hey, that was very helpful, Chuck. A quick follow-up for you. XLamp, great job on the gross margins, by the way, increasing them very nicely.. What do you -- how much room -- could you give us an idea of your XLamp's margin now equal to or are they still below your corporate average? And how much room do think is that and how long it will take?

Charles Swoboda

Well, XLamp is a name that we started out talking about one product and it's actually a whole family of high-power products now. So, I think if you look at our XR-E and XR-C products, which are the ones we've had in the market for over a year we've got them to China, we've been working on the yields, those are actually driving the gross margin of the company now. Those are adding to it. Those have -- we made tremendous progress in the last couple quarters there. At the same time we are now launching the new [XP-E] and MC series. So we're going to have new XLamp also coming on line.

So I think you would have to kind of split that out. If you look at the ones that have been running awhile, I think those are now driving the company's gross margins, and but I think the new ones are going to give us plenty of opportunity to increase yields and hopefully work those up. And it really goes beyond that because when you look at the Cree overall gross margins, remember that High Brightness, we have opportunity there. I think we have plenty of opportunity in chips, as well as on the lighting product and power and RF.

So we have made good progress specifically in the XLamp area but I think we've got room to improve in a lot of other ones. That being said this quarter is going to be obviously a little challenging because we've got a whole bunch of new products coming on line. So that's why we're targeting a similar range as last quarter.

Harsh Kumar - Morgan, Keegan & Company

Again very helpful Chuck. Last question and I'll let somebody else get on. Could you characterize for us if you are seeing revenues already from back lighting for laptops yet? Or how much it was or any way to break that out?

Charles Swoboda

What I can tell you is that our chip business is getting some business for the notebook back lighting market. I would tell you it's not a big piece of business but we are winning some chip business in that segment.

Harsh Kumar - Morgan, Keegan & Company

Great. Thanks Charles, I will jump back in. Thank you.

Operator

Your next question comes from [Dale Farrel] of Cantor Fitzgerald. Your line is now open sir.

Dale Farrel - Cantor Fitzgerald

Yes. Good afternoon gentlemen. Let me add my congratulations. Spectacular performance in these challenging times. My first question has to do with your recent announcements about your new distributors that you’ve got out here, including Digi-Key and

Charles Swoboda

Farnell.

Dale Farrel - Cantor Fitzgerald

…Farnell. And maybe you could give us a little bit of an overview here on your distributor strategy and the overlap or non-overlap of these various distributors out here.

Charles Swoboda

Yes, so if you look at what we started with obviously Arrow was kind of the – they are the big dog, they are one of the two largest distributors in the world. And so they are kind of core to our global distribution strategy and they are able to manage account, both small to medium size all the way up to those global companies. We also have World Peace, which is also a very important player. I believe they're now the third largest distributor in the world and they are a huge -- for our Asia strategy they're an important piece.

So we kind of have the big guys covered. What we have been looking to do is, is that there is, because we are getting into new markets, especially from a lighting standpoint, there is just -- we estimate there's thousands of small companies out there designing with LEDs, trying to create new products.

And we really wanted an exposure to what I'll call the catalog or the on-line distribution channel. And at the end of the day, Digi-Key and Farnell, Digi-Key in North America and Farnell probably everywhere else, are the two premier catalog on-line sales distributors. It's really an area that neither World Peace or Arrow puts much emphasis on. So it’s really important for us to build that piece out. It's not a significant high-volume sales channel but does it get to us lots and lots of customers and so that's what we're trying to do there.

Dale Farrel - Cantor Fitzgerald

Okay. And are you going to use this sales channel for all your products including the variations on XLamp?

Charles Swoboda

Yeah, right now we plan to use those channels for all of our LED components and also probably for, over time, most of our power components. We see both of those product lines there. Our LEDs are in those and power is currently in some of those distributors.

Dale Farrel - Cantor Fitzgerald

Okay. And ore quick question here. As we continue through this worldwide financial crisis, as we call it that, could you maybe talk a little bit about the competitive dynamics and the advantages that maybe your balance sheet and your IP give you as we move through this?

Charles Swoboda

Well, let's see. We'll start at the balance sheet. It's certainly nice to have $339 million in cash, and I will just anticipate potentially the next question, very conservatively invested. So we don't need to raise capital. We can use that to drive our business, and at the same time I think Dale you kind of sort like to know, we run this place relatively, conservatively.

So, I think it gives us lots of options to look at different ways to approach the market. We’re going to be able to drive the business where we think we need to. I think its going to put pressure on people that are highly leveraged, and so I think from just a pure balance sheet standpoint we have got a lot of options. I think from an IP standpoint,

I think what we've seen is the -- if you look at just some of the -- our Taiwan competitors, they are reporting pretty big declines, both quarter to -- month-to-month and year-over-year at least in the most recent data. I think what you see is they're clearly having trouble either accessing certain mark, either from a performance or an IP standpoint, and it's probably, in some cases, one or the other, and in some cases both.

And so I think that's also helping us probably hold up a little better than others. Again, you know I think we're all kind of curious what happens in Q3, but at least at this point the early returns say that we're in a -- relative to everyone else, we're in a favorable position.

Dale Farrel - Cantor Fitzgerald

Great. Thanks.

Operator

Your next question comes from Yair Reiner from Oppenheimer. Your line is now open sir.

Michael Suh - Oppenheimer

This is Michael Suh for Yair Reiner. Can you hear me?

Charles Swoboda

Yeah we can hear you.

Michael Suh - Oppenheimer

Okay. Congratulations on the quarter. Its great.

Charles Swoboda

Thanks.

Michael Suh - Oppenheimer

Can you give us a sense of any kind of revenue contribution by product segment or any kind of proportion?

Charles Swoboda

Like in which applications are driving it?

Michael Suh - Oppenheimer

Yeah.

Charles Swoboda

…or more from a Cree product line standpoint?

Michael Suh - Oppenheimer

I guess, components or XLamp kind of things?

Charles Swoboda

Okay. Yeah, I can do it, so let me a quick answer. I'll answer both of them pretty quickly. If you look, the fastest growing segment that’s really what's driving the growth is LED components. As I said earlier, the High Brightness was fairly stable with last quarter. So most of that growth this quarter came from the XLamp side of that product line. As we commented, chips were pretty similar to the previous quarter, so that's pretty stable.

And we got a little bit of incremental increase from the lighting products. So, I would say LED components is the growth driver and then power and RF was actually down sequentially. So that's kind of from a product standpoint.

If you flip that around and ask the same question from a market standpoint, it's really what we would call lighting applications, and that's a fairly general term. It's everything from architectural, portable, indoor and outdoor, commercial, refrigeration, all that large group of lighting. That would be, if you combine our chips, and all of our component products you would actually see that, that is by far the largest segment working in now and then followed by the display business would be the second. So that’s kind of what's driving from the an applications standpoint.

Michael Suh - Oppenheimer

Great thanks, very helpful. Which parts of those end markets do you see, you have the greatest degree of visibility? Whether it's, like you said, China or specialty lighting or consumer?

Charles Swoboda

I'm not sure that there's any one end market we have better visibility in right now. If I look at where we are at this point. At this point last quarter, we'll have about the same visibility, and it's pretty much spread pretty evenly across our business, whether it be High Bright components its about the same, chips is about the same, XLamp about the same.

The one area that we probably have better visibility on is the LLS or lighting products. Those are probably we have the most visibility on. It's a relatively small part of business but we clearly have pretty good order flow there. That one is actually probably running ahead of the rate it was at this point last quarter. But generally speaking, about the same.

Michael Suh - Oppenheimer

Okay, great, thank you. I guess one more question. Do you have any 10% customers, or I guess the add-on question is, maybe you can talk about related party contributions?

Charles Swoboda

Yes. So we don't breakout 10% customers or related parties on a quarterly basis. I can give you some color, though. If you look at the related parties we disclosed in our K they were Light Engine and [ConWin], they are part of the high brightness LED business and we mention earlier the high brightness was pretty flat quarter-to-quarter.

So that business is pretty stable and I don't have the specifics on those, but I think those guys were pretty close. I think they were down a little bit from the previous quarter but not a significant change down a little bit. And then I think the only other area that would probably a big customer Sumitomo and that’s been the chip business and they’ve been pretty stable for the last four, five, six quarters. That -- there's not really a big change one way or the other in that business.

Michael Suh - Oppenheimer

Do you have any feedback on those guys on visibility or anything like that?

Charles Swoboda

You know what, right now what we're seeing in the LED business is that the visibility from our customers is, they are giving us the same visibility that we get last quarter, and when we ask them, they're seeing about same right now. I think that obviously there's lots of uncertainty. None of us -- we never have visibility into the quarter beyond, but I think right now, I think we're all cautiously optimistic at the same time. We're not sure how Q3 is going to pan out this point.

Michael Suh - Oppenheimer

Great. Thank you very much.

Charles Swoboda

Sure.

Operator

Your next question comes from Daniel Amir from Lazard Capital. Your line is now open, sir.

Daniel Amir - Lazard Capital

Thanks a lot and congratulations on the quarter. Couple of questions here. First of all, follow-up on the LLS. Can you bit, highlight kind of where the success is now, what's going on kind of beyond the US? It seems like that, you said your visibility I guess is improving there?

Charles Swoboda

Yes. So on the LLS or LLS business that is primarily today a US business. So from what we actually sell direct that's all in North America. We do have the benefit of now is with the Zumtobel relationship we now have business in Europe that will be starting up as well. We'll make our first shipments to those guys this quarter. So that's really new business for us. And what it's really doing its giving us exposure to a whole and other continent that we frankly weren't selling our product into.

In terms of the stuff that is driving the order flow; In North America what we are seeing is we're about a year –a little over a year into selling the LR6 and what we're seeing is that in the whole retrofit market area where people are doing conversions, we continue to see uptake. There's small to medium size customers. And I think what we see is that this idea that spending a little money for LED lighting and getting a payback on both the maintenance and energy savings at least for some segment of our customer base is working pretty well at this point. Again it's a relatively small business today but the basic business theory we've been trying to improve since we bought that business so far is holding in there pretty well.

Daniel Amir - Lazard Capital

Okay. And on the power RF business, it looks like that near-term still is a bit choppy. Do you expect it to stabilize in the March quarter with this new order that you guys have gotten that will impact kind of calendar year '09 or is it something that is going to see still a bit of lack of visibility, I guess, in the near-term?

Charles Swoboda

Yes, the way I would look at that is, I would tell you that -- so there's really the two segments, the power and the RF side. I think the power side is kind of seeing some of that general economic weakness, because I think it's -- I don't know if it's IT sector related specifically or not, but that's where we're seeing it there. The good news is that with the RF order it's kind of helping offset that. So we're targeting power RF business to be fairly similar in Q2 that was in] Q1. And at this point I don't have good enough visibility on what it looks like in Q3. I would imagine because we have a pretty good base customer in RF it will be pretty stable here going forward and then it will really question of what happens on the power demand side. And I just -- It's too early to call that, how that might look in the first half of the calendar year.

Daniel Amir - Lazard Capital

Okay. And then last question is, where do you stand on kind of the four-inch wafer side? What's kind of the update there in terms of what your plan is?

Charles Swoboda

Yeah, so we've been working to qualify additional products, made progress last quarter. But in terms of a percentage of our production we're mostly focused on the engineering in terms of getting the product and the processes qualified. We have not converted a large percentage of the production yet. That will happen over the next several quarters. But one quarter in we're on track and I would say that our target to have pretty much all the major product lines fully converted by end of fiscal year, we should still be on track to do that at this point.

Daniel Amir - Lazard Capital

Okay, great, thanks a lot.

Charles Swoboda

Sure.

Operator

Your next question comes from Mike Burton from Thinkpanmure. Your line is now open.

Michael Burton - Thinkpanmure

Hey thanks. Can you guys talk a little bit more about your progress with your two new distributors? Obviously, it takes time to get these channels up. Are these distributors now pretty much on line, are comfortable with the level of inventory there or is there still some more ramp ahead of us?

Charles Swoboda

And when you say that are you specifically talking the about Digi-key and Premier Farnell?

Michael Burton - Thinkpanmure

Yeah, primarily, though, if you have more to go on Arrow and World Peace would love an update there too.

Charles Swoboda

Yeah, no problem. Last year both of those guys, I’d say in both cases that they are going pretty well.

Michael Burton - Thinkpanmure

And just follow-up with that. So what is the comfortable range in terms of days and then if you could just talk a little bit more about maybe by geography, how is Asia versus Europe right now and the US?

Charles Swoboda

Yeah. So we don’t breakout the specific days, what I can tell you that changing gives some flavor there by geography. I would tell you that North America were doing pretty well, Arrow was really leading the charge there. I think in Asia, both Arrow and WPR are important players probably WPR is really driving the sales on that market and they are doing a pretty well there, but WPR is probably a little bit ahead and then in Europe I’d say that’s the place we have the most work to do. You know Arrow is trying to develop that force, but we’re probably a little bit behind in terms of both sales generation and I think we probably got the most work to do there at this point.

Michael Burton - Thinkpanmure

Okay. Are any of these distributors approaching 10% of revenue?

Charles Swoboda

I don’t believe so at this point I have not broken it up, but I am pretty sure because its they are primarily selling XLamps today, I don’t think we are at that point yet.

Michael Burton - Thinkpanmure

Okay. Can you also talk a little bit more about end market applications, automotive versus displaying [climate] for the last quarter and then the outlook heading into the Q4?

Charles Swoboda

Yeah, so lighting is definitely the biggest, second is displays. Lighting I don’t and then finding that the lighting is probably almost twice as big as displays, and combine the two of them are significantly over 50% of the business at this point. The next big three, and these are all going relatively small compared to those to who are going to be Auto, gaming and mobile, and I would say that between those three -- they fluctuate from quarter-to-quarter. All of them are less than 20% of the business so they kind of move around quarter-to-quarter and what we will see overtime is we will start to see I think the whole notebook back-lighting segments start to come back up, but again its really just getting started at this point. So it's relatively small.

Michael Burton - Thinkpanmure

I got it and last one is, so there’s a lot of discussion that some of the Asian competitors seeing a pretty low utilization rates right now. What have we seen so far in, as for as pricing? Have you started to see some real pressure there in components or do you expect to the pick up going forward?

Charles Swoboda

Well, so I think there is two pieces to that is, both the chip side and the component side. I’d say on chips there is definitely excess capacity in Taiwan right now and I was just there couple weeks ago and it's pretty clear that their business, because its more linked to mobile and some of the consumer segment, I think they felt, they've seen the impact more than we have at this point.

So I think, if you're in the low-to-medium end of the chip business it’s a tough business but I don’t know that its significantly different than some of the signs we saw starting a couple quarters ago. So I think it's tough but we are out there, competing for that and as you can kind of see from our overall numbers at this point the strategy becomes more on the higher-end, more on lighting applications that’s held it pretty well.

I think on component side it's a little bit different. We primarily compete in components in lighting and in the second biggest market for us is displays. We are not a big player in the mobile or consumer markets in terms of our light, our LED component-level products. So, there is definitely some competitive things going on in terms of the component level business, that’s and things like both mobile and in the notebook back lighting. But we don’t have a big exposure to that at this point. And our overall challenge there is we’ve got to keep developing chips that are bright and cost effective enough, so our customers can win that business. And I said early we had some initial success. But, we got work ahead of those and we’re hopeful we can continue to win there but I would imagine that will continue to be a competitive segment. But one we want to keep some exposure to is important for our business.

Operator

Your next question comes from Hans Mosesmann from Raymond James. Your line is now open, sir.

Hans Mosesmann - Raymond James

Thanks, Chuck, couple of questions on LLF can you give us a sense of the -- how large that business is? I know it's a small part of the business but how big is it and can you explain to give us more granularity on the bottlenecks on the production side of that product group?

Charles Swoboda

Yes, it’s in the few million dollar range at this point Hans and in terms of the bottlenecks; when the business originally was a -- primarily a one or two SKU-type product. I think when we completed the acquisition it was primarily the 110 volts and had an Edison base and a GU24 base. That’s really a fairly simple product line.

We right now have, I think, we’re up to over 30 SKUs just on the LR6, we have the LR4 we’re going ready to launch the LR24. And really what we are managing is, as SKU full operation goes up it’s a lot of engineering time and energy to just get those products qualified ready for production get the sub-con qualified.

And it’s really what I would call new product introduction blocking and tackling and so it’s we directed more resource to work at it and I think it’s a just a matter of time and energy and we will work through that but it is definitely the complexity of the product line has gone up and that's what we're working to manage.

Hans Mosesmann - Raymond James

Okay, Thank you very much.

Charles Swoboda

Sure. Thanks, Hans.

Operator

We have a follow-up question from Harsh Kumar from Morgan Keegan. Your line is now open, sir.

Harsh Kumar - Morgan, Keegan & Company

Hey, guys. Quick question. You mentioned a lot of capacity in Taiwan. Are you seeing them get start to get really aggressive, perhaps on some of the markets you that you share on the border with them and I've got one more?

Charles Swoboda

Yeah. I would say they are already very aggressive but they saw their capacity numbers start to move away -- its been more than a quarter now. So I think they are already very aggressive on the mid to low ends of the marketplace and I am not sure. I haven't seen a dramatic change in the last few months. I think what's different is that I think they're complaining a lot more about their excess capacity than they were a few months ago.

Harsh Kumar - Morgan, Keegan & Company

Okay. And then how much revenue do you think you left behind on the LR6, or the LLF business?

John Kurtzweil

I'm not sure. I think in terms of the orders we have, I'm not sure we left a lot behind I think we're more worried about is as we sell those more integrated products, the customer expectation is that those are shipped from stock-type units. And so I think one of the things we've realized is that we have to have more North American inventory. So that whether it be a rep or a distributor when they want a product they are expecting one or two day deliveries on some of those things.

And so that's more of a -- we probably lost some in North America there, just because we didn’t have stock but I don't know that I can estimate how much that is and we're at the pretty early stages of the market. So that's -- I don’t know that we created any significant issues I think more than anything we've got to go ahead and address that, so we can take advantage of the opportunity but I don’t think its been a big number so far.

Harsh Kumar - Morgan, Keegan & Company

Fair enough, guys. That's it for me. Thanks. Great quarter again, great guidance.

John Kurtzweil

Thanks, Harsh.

Operator

Your next question comes from Carter Shoop from Deutsche Bank. Your line is now open, sir.

Carter Shoop - Deutsche Bank Securities

Hi good afternoon.

Charles Swoboda

Hi, Carter.

Carter Shoop - Deutsche Bank Securities

I wanted to touch base and try to better understand, what investors should be thinking about in regards to normal seasonality for this business. It sounds like for fiscal 3Q you are getting a little bit cautious about the seasonal factors there. Maybe if you could walk us through about what kind of seasonality we'll expect in this business and not at the overall mix of business has changed quite a bit over the past couple of years.

Charles Swoboda

I'll give you some color, I am not sure it’ll be as good as you might want to. I think we're still trying to figure that out a little bit ourselves. So, I think we know that on the chip business. We know that the parts of that that are kind of consumer related. We know there's a slow quarter there. We’ve seen that for a few years. And we have the most experience there.

In our high brightness business which includes the High Brightness products in the COTCO business in China, we know that Q3 the seasonality is not as much a demand issue for display, as much it’s a short quarter because of the Chinese New Year, the domestic stuff fundamentally has lower demand. So we have got those two factors that are kind of normal seasonality. What we don't understand yet is XLamp has obviously grown a lot in the last year, and I don’t know if we know anything about how to project what kind of seasonality there may or may not be. So I think our caution comes from the fact that we have got these macro-economic indicators. We know that that’s typically a quarter where we don't grow very much in chips and or the high bright business, and I think we're just trying to manage that so I think you're hearing us give caution but we don't have enough visibility to quantity any more for you at this point.

Carter Shoop - Deutsche Bank Securities

Would it be out of the realm of possibility to see a down quarter sequentially, or is it not seasonal?

Charles Swoboda

It would be, is it feasible, I think in this environment anything is feasible. I'm not sure though that -- we don't have enough visibility to give you that kind of guidance at this point.

Carter Shoop - Deutsche Bank Securities

That’s helpful. In regards to your guidance here for the December quarter, I want to better understand how much prudence you have put into that guidance given the overall macro-environment. I doesn’t sound like you're seeing a material slowdown. at this point. But just curious on how prudent you are being, maybe accounting for some potential slowdowns later at this quarter.

Charles Swoboda

Yeah, so that’s obviously dependent on a lot of discussion here internally. What we’ve decided to do is we have a process that we’ve used now pretty successfully to ramp up the last seven, eight quarters. It's been relatively accurate. And we went with that to provide our target, which has a lot to do with what our customers are saying. We checked. We try to force them to make sure they're comfortable, and things like that.

What I would tell you is that , I think our process is similar to what we've done in the past, and that's what led to our target. And since our visibility is similar to where it's been the last couple quarters, that's where we came up those targets. What I would also tell you though is that and we’re trying making for you to understand is we think that the [data] might be able to hire right now. Right, in other words, there’s so much other activity, what we're concerned is there may be higher variability than in the past. Again, our best estimates are the targets we provided. With that being said, I think we don't know at this point, so we're using the process that's worked well and just trying to let people know that we think the variability could be higher.

Carter Shoop - Deutsche Bank Securities

That’s helpful. I think some companies out there today are looking at their traditional process of how they provide guidance and maybe giving 5% to 10% haircut, just because of the increased uncertainties out there.

Charles Swoboda

You know, I can tell you we honestly looked at what a lot of other companies did, and I think where we came down was because, at least at this point, the LED forecast from all the major LED businesses are really looking relatively solid. We didn't feel like it was appropriate -- we didn't want to arbitrarily guide down there just because that’s not the message we’re getting from the customers at this point.

Carter Shoop - Deutsche Bank Securities

That’s helpful. Two more quick ones here. On the notebook, backlit, LCDs here and more LEDs rather, how big of an opportunity this will create over the next year? Is this going to become a meaningful driver for the LED chip business, or is it going to be more of a nice benefits but not a huge driver?

Charles Swoboda

Yeah, I would call it as an important driver for the industry and an incremental benefit for Cree's from a chip standpoint. So our focus is really been lighting markets has been a huge focus for us, but we don’t we can't ignore notebook back lighting and obviously we want to be successful at least participate in that. So I think what you could see is more about chip business could end up in that applications instead of some other may be lower-to-mid end applications over the next year. At the same time, I don't think it's as big a growth driver for Cree specifically I’d say some of the lighting trends are. So we want to participate but it's not the number one driver of the business is the way I would look at it. And again it's at that time chip level, not at the component level.

Carter Shoop - Deutsche Bank Securities

Absolutely. Within the chip business, could this market represent roughly a quarter of the chip business within a year?

Charles Swoboda

I don't think our chip business will see that type of percentage there but I do think it could be coming one of those segments when I talk about things like mobile gaming and auto, it could be of that size.

Carter Shoop - Deutsche Bank Securities

Okay. Last question on the litigation, the commentary there about how some of the cases are important and helpful. Would you care to comment on the financial impact going into the first half of calendar '09 in regards to the impact of these two cases?

Charles Swoboda

Well, we might be, I don't know, I am not prepared to give any targets on that at this point, John. I think which, the way I would look at this, you are going se an incremental increase this quarter. That is really prepping for what is expected to be a first calendar quarter trial in Texas.

There is not necessarily firm trial dates in all the other cases, so I think what we're basically saying is you could see another incremental increase in Q3. It's hard for us to give you a number yet, but yes, trial stays on track and all the other ones, depending on how they line up, there could be a second bump up in our Q3, but again, until we see exactly where those trials line up, it's hard to give you a number on that.

Carter Shoop - Deutsche Bank Securities

Okay. Thank you very much.

Charles Swoboda

Sure.

Operator

Your next question comes from Bennett Notman from Davenport & Company. This is your last question, sir.

Bennett Notman - Davenport & Company

Thank you and my questions were asked and answered. Thank you.

Charles Swoboda

All right. Operator, are there any more questions?

Operator

There are no more questions in queue, sir, if you would like to go ahead with your closing comments.

Raiford Garrabrant

Thank you, operator, and thank you, everybody who was on the call today. We appreciate your interest and support and look forward to reporting our second quarter of fiscal year 2009 results on January 21st2009. Good night.

Charles Swoboda

Good night.

Operator

This concludes today's conference call. You may now disconnect.

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Source: Cree Inc. F1Q09 (Qtr End 09/28/09) Earnings Call Transcript

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