Cree Inc. F3Q09 (Qtr End 03/31/09) Earnings Call Transcript

Apr.21.09 | About: Cree, Inc. (CREE)

Cree Inc. (NASDAQ:CREE)

F3Q09 Earnings Call

April 21, 2009 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

Dale Farrell - Cantor Fitzgerald

Yair Reiner - Oppenheimer

Steve Molanavich – Merrill Lynch

Carter Shoop - Deutsche Bank Securities

Michael Burton - Thinkequity

Jiwon Lee - Sidoti & Company

Jed Dorsheimer - Canaccord Adams

Operator

My name is Jennifer and I will be your conference facilitator today. At this time I would like to welcome everyone to the Cree, Inc. third quarter 2009 fiscal year financial results conference call. (Operator instructions)

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

Raiford Garrabrant

Thank you, Jennifer, and good afternoon. Welcome to Cree's third quarter fiscal 2009 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 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 posted in the Investor Relations section of our website at www.cree.com under FY2009 financial metrics.

Today's presentations include forward-looking statements about our business outlook and we may make other forward-looking statements during the call. These may include comments concerning trends in revenues, gross margin and earnings, plans for new products and other forward-looking statements indicated by words like anticipate, expect, target, and estimate.

Such forward-looking statements are subject to numerous risks and uncertainties. Our press release today and the SEC filings noted in the release mention important factors that could cause actual results to differ materially.

Also, we'd like to note that we will be limiting our comments regarding Cree's third quarter of fiscal year 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 presentations and the recording of this call are copyrighted property of the company and no other recording, reproduction, or transcription is permitted unless authorized by the company in writing. Consistent with our previous conference calls, we are requesting that only sell-side analysts ask questions during the Q&A session.

Also, since we plan to complete the call in the allotted time of one hour, we recognize that other investors may have additional questions and we welcome 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 of the webcast will be available on our website through May 5, 2009.

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

Charles Swoboda

Thank you, Raiford.

Revenue in the third quarter was $131.1 million with non-GAAP net income of $11.8 million, or $0.13 per diluted share. These results are within our previously announced targets for the quarter. Overall, revenue declined 8% sequentially when one-time licensing revenues excluded from the previous quarter. LED lighting sales increased double digits in the quarter, but were offset by lower LED component and LED chip sales, due to a more conservative inventory approach at our customers and distributors, a longer Chinese New Year shutdown for a number of our customers, and lower sales for automotive, mobile and consumer applications.

Demand for LED based lighting applications remain solid and saw incremental growth for notebook and TV back lighting applications.

Power and RF came in higher than targeted, while material product sales were similar to Q2.

Non-GAAP gross margin was 36.9% in Q3, which is similar to Q2 when you exclude the benefit of license deals last quarter. This is on the high end of our target range for the quarter, due to a beneficial mix and higher yields in LED components and a lower bill of material cost in LED lighting that more than offset lower factory utilization and a more aggressive pricing environment for LED chips and components.

Work in capital was in line with our targets and we strengthened our debt-free balance sheet as cash and investments increased to $405 million.

Our fiscal Q4 backlog has improved from this point last quarter and is in line with historical booking rates for the fourth quarter. Although the global recession continues to impact near term demand in mobile automotive and some consumer applications, we believe this will be offset by forecasted growth in LED lighting and other applications.

We are planning to increase both R&D and capital spending in Q4 for several key LED product areas to support the targeted growth in our business.

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

John Kurtzweil

Thank you, Chuck.

I will be providing commentary on our financial statements on both a GAAP and non-GAAP basis, which is consistent with how management measures Cree's results internally. However, non-GAAP results are not in accordance with GAAP and may not be comparable to non-GAAP information provided by other companies.

Non-GAAP information should be considered a supplement to and not a substitute for financial statements prepared in accordance with GAAP. A reconciliation of the non-GAAP information for all quarters mentioned on the call is posted on our website as well as a historical summary of other key metrics.

For the third quarter of fiscal 2009, revenue was $131.1 million and within our targeted range for the quarter of $128 to $135 million. This represents a 5% increase over Q308.

GAAP net income of $4 million, or $0.05 per diluted share, and at the high end of our targeted range of $0.02 to $0.05 cents per diluted share.

On a non-GAAP basis, net income for the third quarter was $11.8 million, or $0.13 per diluted share. This is at the high end of our targeted range of $0.10 to $0.13 per diluted share and excludes $7.8 million of expense net of tax, or $0.08 per diluted share, from the amortization of acquired intangibles and stock-based compensation expense.

LED revenue increased 7% when compared to the same period last year and declined 11% sequentially to $112.4 million while non-LED product and contract revenues of $18.7 million were down 4% from the same period last year but were up 22% sequentially.

Our power and RF business increased approximately 70% sequentially due to orders for silicon carbide Schottky diode, while materials and government contract revenue were in line with expectations.

Q3 GAAP gross margin was 36.1% while non-GAAP gross margin was 36.9%, which excludes stock-based compensation of $1 million. These were at the high end of our targeted non-GAAP range of 35% to 37%.

Operating expenses were $44.4 million on a GAAP basis and $36.1 million on a non-GAAP basis, which was in line with our target.

Non-GAAP operating expenses exclude approximately $4.2 million of stock-based compensation expense and $4.1 million of charges for amortization of acquired intangibles.

Overall, R&D and SG&A expenses were lower than our target as we implemented expense controls across the company. We did take a higher than targeted fix asset impairment charge for a total of $2.3 million of which $1.2 million was related to an abandoned manufacturing project as we decided to pursue other lower cost options to support our long-term capacity needs.

Net interest income and other decreased year-over-year to $1.9 million, which was close to our targets.

Given the Fed Funds rate, the average return on our cash is forecasted to decline again in Q4 even with the higher average cash valve as we continue to emphasize cash preservation over yields.

The tax rate for the quarter was 16% which is lower than the 24% targeted. This benefit is primarily the results of recording the favorable impact of a tax holiday granted at one of our manufacturing locations outside the US during the quarter.

We expect our rate to be 23% for the fiscal fourth quarter.

Our debt-free balance sheet got stronger during the quarter due to lower work in capital requirements and a strong cash flow from operations. We ended March with $405 million in cash, short term and long term investments, and continue to be debt free.

Accounts receivable declined by $5.6 million to $103 million while day sales outstanding increased to 71 days from 66 days. increase in revenue.

Inventory declined by $1.3 million and days on hand increased to 83 from 78 days. Inventories are expected to increase slightly in Q4 as we are planning to increase inventories in LED components and LED lighting products to be in a position to take advantage of spot business opportunities.

Cash flow from operations was $49.9 million and capital expenditures were $9.3 million for free cash flow of $40.5 million during the quarter. We are targeting increased capital expenditures for the Q4 to be in the range of $10 to $15 million, primarily for capacity increases in China and the continuing transition of LED chip production to four-inch wafers.

Year-to-date, cash provided by operations was $134.6 million and capital expenditures were $40.6 million, resulting in free cash flow of $94 million. We continue to make capital investments to support new product introduction and capacity expansion.

The uncertain economic environment continues to make it challenging to forecast the business and increases the chance that our actual results could differ from our targets.

At this time, we target Q4 revenue to increase to be in a range of $137 to $143 million.

GAAP gross margin is targeted to be approximately $1 million or 80 basis points less than our non-GAAP target of 36% to 38%, as our GAAP targets include stock base compensation expense, and our non-GAAP do not.

Chuck will give additional insight into our targets in a few minutes.

GAAP and non-GAAP operating expenses are targeted to increase by approximately $1 million, plus or minus. Our non-GAAP targets do not include approximately $4.3 million of non-cash stock-based compensation and $4.1 million of charges for amortization of acquired intangibles.

We target R&D to increase approximately 10% as we ramp up spending on LED components and LED lighting.

SG&A expenses are targeted to increase by approximately 5% to support new product launches and higher sales in both LED components and LED lighting products, as well as higher yearend internal and external auditing costs.

Interest income and other is targeted to be flat to down slightly. We are targeting our effective tax rate to be 23% for the last quarter of the year.

Based on an estimated 89 million dilute shares outstanding, our GAAP EPS target for the fourth fiscal quarter of 2009 is expected to be $0.05 to $0.07 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 $0.13 to $0.15 for the fourth quarter of fiscal 2009. Our non-GAAP-basis 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.

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

Charles Swoboda

Thanks, John. We remain focused on four key areas to continue to drive our business and leadership in energy-efficient LED components and lighting products.

Our first priority is to grow LED components. As expected, LED components declined single digits sequentially in Q3, as solid demand for indoor and outdoor commercial lighting was offset by lower demand for architectural and portable lighting applications, as well as shorter sales quarter due to a longer than normal Chinese New Year shutdown.

Sales to our distributors declined in the quarter, while distributor sales to customers actually increased slightly from Q2. This is a positive trend for our business and an indicator of growing end customer demand for LED components.

Our LED component distributor days of inventory remain within our target range. For Q4, we target LED component revenue to rebound with double digit growth in both our XLamp and high bright LED component product lines, driven by indoor and outdoor commercial lighting and incremental sales for LED video screens.

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

LED lighting product sales increased double digits again in Q3 led by sales of the LR6 downlights and our new LR24 luminaire. We target double digit growth again in Q4, although the rate of growth in this product line has slowed down due to lower spending and new construction.

Our success in Q4 will be partially contingent on our ability to ramp up production in sales of several key new products. We recently received commercial and residential energy star qualification for our best in class LED downlight family, which includes our LR6, LR5, and LR4 products. This is an important step for Cree and the industry. As the energy star program sets important standards and helps customers recognize high quality lighting products that can deliver on the promise of energy efficient LEDs.

We continue to set new standards for lighting class LED performance with the recent announcement across our entire white LED spectrum as well as the new tighter bin structure for warm white LEDs that are more in line with traditional lighting expectations.

Our third priority is to increase new product margins and build operating leverage. Despite a challenging economic environment and lower volumes, non-GAAP gross margins remain flat 36.9% in Q3. This is due to a favorable LED component mix and higher yields combined with LED lighting cost reductions that offset lower factory utilization and a more aggressive pricing environment for LED chips and components.

For Q4, we target higher factory utilization that should help offset a less favorable LED component product mix and a more aggressive pricing environment as competitors try to shift their focus from mobile and automotive to new applications, such as LED lighting.

We continue to focus on several key activities to further reduce product cost, including further yield improvements at the LED chip and component level, introduction of lower cost LED product designs, 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. Q3 revenue increased more than expected due to some spot orders for silicon carbide Schottky diodes and continued strength in our RF product line.

We don’t expect the spot orders to recur in Q4 for the base business is starting to gain some momentum. Our focus over the next couple quarters is to continue to build the customer base for silicon carbide power products as we focus more on new products, which should improve the operating margins for this product line.

As we look ahead to Q4, the uncertain economic environment continues to make it more challenging to forecast the business and increases the chance that our actual results could differ from our targets. Despite this environment, we see positive trends in LED components and target overall Q4 revenue to increase to a range of $137 to $143 million based on the following factors. Growth in LED lighting product sales due to continued adoption, growth in LED component revenue for lighting applications, LED chips, materials, and contract revenue in a similar range as Q3, and power and RF revenue down approximately $2 million from the previous quarter.

We target Q4 non-GAAP gross margin in a range of 36% to 38% at higher factory utilization and increase foreign production is partially offset by more aggressive pricing environment. As a result, we target non-GAAP earnings in Q4 of $0.13 to $0.15 per diluted share. Please note that our non-GAAP targets exclude that our non-GAAP margins exclude amortization of intangibles, stock-based compensation expense, and related tax effects.

As we look ahead, we continue to be optimistic about the growth opportunities for LED lighting. We remain somewhat cautious due to the potential impact on our customers’ business from the recession and we are closely monitoring design activity and sell-through in an effort to track the progress of the market. LED lighting is in position to benefit from the federal government’s focus on energy efficient products as part of the economic stimulus package and we are seeing continued momentum in LED lighting adoption as evidenced by recent LED street light projects announced in both Los Angeles and Pittsburgh.

We are currently our LED lighting and LED component product lines to grow next year and we are planning to continue to invest in R&D, sales and marketing, and capacity to enable and support this growth.

We will now take analyst questions.

Question-and-Answer Session

Operator

Your first question comes from Harsh Kumar from Morgan Keegan.

Harsh Kumar - Morgan, Keegan & Company

Chuck, your cell phone business as it relates to your LED business. Could you talk about if you’re starting to see a bottom there and how much is it as a percent of revenue?

Charles Swoboda

If you look at the application mix for our LED business today, mobile is a pretty small percentage. I think lighting is by far the biggest. It’s probably half the business today and then when you add in video screens, you know, that’s probably three quarters of the business. So mobile is a relatively small percentage. We continue to have some success on the high end of the market, but I’m not sure that we have enough business to really give you the overall trends. I can you that where you have high end, high value products, we continue to have some new design win success, but it’s a relatively small percentage of the totals. I’m not sure I can give you an overall trend of what goes on in that market. Our business has become much more lighting centric.

Harsh Kumar - Morgan, Keegan & Company

Chuck, now that you sort of hit bottom and starting to grow again, can I throw the question out to you again about your target financial model? Can you remind us if anything has changed? Would this be some blip in the industry and the economy?

Charles Swoboda

Our long-term model as we’ve been talking about for probably the last year or so has been to get into the 40-plus percent gross margin range and then over time build to what we target is a 20% operating margin. With that being said, I think you can see the progress we’ve made in the last four quarters on the gross margin and some of that’s dropped through on the operating margin line.

I would tell you that where we sit today, the focus is really continuing to do things to drive down the cost and find areas where we can drive more value, which helps on the margin obviously. Then over time, we should see some of that leverage as we get more top line growth. The focus right now is how do we take advantage of this emerging LED lighting market? So you’re actually seeing in our targets that we’re actually making some pretty significant near term investments in both R&D and sales and marketing to really drive that growth and so I think the operating margin goal is a little further out than what we think we can achieve on the gross margin side.

Harsh Kumar - Morgan, Keegan & Company

Are your margins and your lighting products, general and overhead lighting, are they up to snuff with your corporate margin goals?

Charles Swoboda

Downlight products? Yes. Specifically for our LED lighting system level products, they’ve made improvement last quarter. We did get some cost improvements on that, but they are still trailing the corporate average. Still room for opportunity for improvement. Components is what’s really driving the majority of the revenue. So it’s really more of a driver to the overall number than anything else. Components is actually running above the corporate average.

Operator

Your next question comes from Dale Farrell of Cantor Fitzgerald. Your line is now open sir.

Dale Farrell - Cantor Fitzgerald

Could you talk a little about what’s going on in China relative to the specific domestic markets over there? How far along you are and the follow-up to that is how far along are you on the four-inch conversion?

Charles Swoboda

When you look at the China business, there’s really two parts. You have China domestic market and China export market. The China export market continues to still be weak, pretty connected to the overall global economy, but the good news is most of our business is actually China domestic consumption for projects there. They have a stimulus package in China and that’s clearly adding to the momentum for LED lighting. It remains a healthy market for LED consumption generally and LED lighting specifically. So we see that as a pretty good place.

When you switch over to the export side of that business, that’s still lagging, but we have less exposure to that at this time.

On the four-inch question, we continue to make progress. We’ve got additional products converted on the four-inch. We remain on track that we should exit the fourth quarter with more than 50% chips made on four-inch wafers. So more of the majority of them and then as we go through the next couple quarters, we should get that up to a very high percentage of the total.

So we got probably a little bit of benefit in Q3. We should start to see some more benefit in Q4 and then really that should roll out more so in the first half of fiscal 10 when it’s fully online.

Dale Farrell - Cantor Fitzgerald

Spot orders for silicon carbide Schottky diode, it seems like an odd time in the economic cycle to see a large spike in orders. Can you give us color on what that was?

Charles Swoboda

I agree it was an odd time. I think what you see there is if you go back to our December quarter, we actually had a relatively weak quarter in that business and that was a product line that’s pretty connected to the IT side of the business, which from our standpoint, that supply chain slowed down for us in December.

So what we believe primarily happened is there was a bit of a catch-up there as we got into Q3 of really kind of over-correcting and having the kind of refill the supply chain did on that side. That’s why we don’t think it’s going to recur again.

We are making some nice smaller progress on the base little business, but that was really a case of December was probably artificially low and then the March quarter was artificially high to catch back up and we should get back to a more normal rate.

Dale Farrell - Cantor Fitzgerald

Lighting products, could you give us an idea of the percentage of products there? How much of your revenues are coming from the LR4 and LR6 versus the LR24’s there?

Charles Swoboda

In that business, the LR6 is still by far the majority of that business. We did start to have some more meaningful revenue from the LR24 and then we’re still having small revenue from the LR4. So if you kind of look at that business today, LR6 leads it and that’s the same both domestically and internationally. The LR24 would be a distance second and the LR4 is coming along, but really slower. The LR4 is much more affected by new construction design. It’s really not a retro fit. It’s only is a new construction product. Both the LR6, obviously the 6 is down like 1 is a larger market to start with for it and it was designed as a retro fit. So we kind of got the dual benefit of that and the product has been out longer.

The LR24 obviously, it’s got all the buzz from the Pentagon project. I think there what we see is is that you do have the ability to fit into some more retro fit type applications with that product.

Dale Farrell - Cantor Fitzgerald

The US stimulus, there’s several potential different pockets of money there. Where do you think people are targeting the most?

Charles Swoboda

I can give you some anecdotal events, because frankly it’s just not possible as to create a specific answer to that. I think we see it in both. So I think the whole federal government side of it has clearly got some momentum for LED lighting.

So the combination of that program and the Pentagon project, I think we’re seeing LED lighting get bid more there. Where do those bids turn out and who wins them and when that turns into real money and orders. We’re not there yet. I think that will play out here over the next few quarters.

I think on the other side, the states we seen, you know, I think there was someone gave me an estimate and this is a rough estimate, but I want to say there was somewhere around approximately 30 different municipalities, cities that have basically came up with street lighting type projects as part of the original stimulus proposal. Now who’s going to end up with that money and how many of those get fully funded? I don’t know, but I think it’s still a sign of we’ve gone from LED lighting being a novelty where you can have one or two examples to where there’s quite a number of people starting to put it into real projects.

What those numbers are, Dale? Unfortunately I just don’t have a specific way to quantify it at this point.

Dale Farrell - Cantor Fitzgerald

One last question. In the overall environment out there, are your customers telling you that’s there’s actual demand or saying this is just inventory rebuilt? How would you characterize the general demand for LED chips and so on out there?

Charles Swoboda

LED chips, components, and the lighting products, all three of them, I would tell you that what we believe right now in terms of our direct customers, is it’s real demand. So I can that the backlog obviously has come back pretty well. We’re ahead of last quarter, actually in line historical Q4 rates.

What we believe is that’s real customer demand. As far as our distributors are concerned, we know that their Q3 POS was up and the indications we’re getting is that the inventory in our case never got way out of whack. So I think in this case what we’re projecting is this is demand base, not channel fill, but we’ll see, but I think that’s our best estimate at this time.

Operator

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

Yair Reiner - Oppenheimer

So as you mentioned, competition seems to be increasing. There’s a lot of chip and component companies that have now awakened up to the idea of LEDs being used in general lighting. Can you give us a sense of how that has been impacting your win rate?

Charles Swoboda

I would say on the win rate, I don’t see a significant change at this time. What you have to remember is wanting to be in the business and thinking it’s a good idea and having the products to meet the customer needs and that momentum is a radically different thing.

So I think it’s clearly in terms of win rate, having seen a significant impact at this time. I think what we are forecasting is that we would expect when you see a slowdown in things like mobile or automotive, that some of our traditional competitors may put more focus on the lighting segment just because they’re obviously suffering in some of those businesses that were more hit by the recession. So that’s what we’re trying to project.

At the end of the day, lighting is about having the right products to enable the application. So I think we’re trying to build it into our targets, but at this point, haven’t seen it change the win rate dynamics yet.

Yair Reiner - Oppenheimer

In terms of your customers, as you get more of the large lighting guys moving into this space, do you expect that percentage of sales you’re selling as chips rather the components is going to change or do you think you’re still going to have components continue to increase as a percentage of your revenues?

Charles Swoboda

Right now, all of our plans suggests that components will continue to increase as a percentage. The chip is as our strategy frankly is to service our critical customers, we have a series of long-term important customers that we’re continuing to work with and try to enable them for the markets they want to be successful in, but almost all the growth of our business is projected to come out of the LED components business and that’s just because we think we’ve done a pretty good job of getting ourselves connected to those customers and applications and that’s where our focus is.

Yair Reiner - Oppenheimer

I think the opportunity for notebook back lighting has developed much faster than anyone predicted. Now it looks like the TV opportunity is also going to ramp quite quickly. Can you talk about your exposure there?

Charles Swoboda

I do want to clarify. If you go back three years ago, people thought the notebook business was going to happen then. So I don’t think it actually happened faster than anyone thought. I think it’s finally happened. In other words, there was several false starts of the last couple years. I think now it has truly got some real momentum and we’re starting to see it have an impact at the chip business. Again, we only service that market today as an LED chip supplier.

In terms of TV, that has some momentum, but I would tell you that I think the people that are excited about TV, it’s probably where notebook was, back lighting was, one or two years ago. So I think there are some discrete wins that are going on. There are some exciting new products, but in my mind I feel like the TV is running probably about 12 months behind the adoption cycle of the notebook market, but I would actually say that it’s probably pretty much in line with what we were thinking and it’s probably almost took a little longer than what some people were estimating a few years ago.

Operator

Your next question comes from Steve Molanavich – Merrill Lynch.

Steve Molanavich – Merrill Lynch

Could you repeat what you said about the impairment this quarter and any sense of impairments in future quarters?

John Kurtzweil

What we said about the impairment this quarter is about half of it or $1.2 million was for manufacturing project that we abandoned. We found other ways that we’re going to get our capacity and the rest of it is our normal process of reviewing our assets. So that’s about what it is.

Steve Molanavich – Merrill Lynch

So going forward, it’s kind of hard to say right now how you might review those assets, but would you expect a little bit every quarter?

John Kurtzweil

If you look at historical rates, Steve, you can see it’s usually a small amount, but you can kind of go back and look. It’s usually similar between a few hundred thousand dollars, half a million dollar range. This quarter obviously was a little higher than normal, mostly because of that manufacturing project that we decided not to pursue.

Steve Molanavich – Merrill Lynch

How should we think about capital spending? It was a little light this quarter. You said it’s going back to $10 to $15 million dollars. Does that over time kind of grow with revenue?

Charles Swoboda

I think what you’ll see is as we see the LED lighting momentum gain some attraction here and the growth of the revenue come, you’ll see us start to increase that number back up. I think originally we had much higher targets for this year and we slowed them way down when we saw the slowdown coming in our business and you’ll see us now start to ramp that back up.

Most of that though, to keep in mind, will probably be, some of that will be at the chip level to support the transition to four-inch wafers as well as some capacity. There will also be a chunk of that in China for the component expansion. That will be the two biggest chunks.

I think at this point, if revenue continues to grow in the next year, you would see us probably continue to invest at this rate or potentially even higher. Accurate, John?

John Kurtzweil

I think it would a little higher than what we did this year.

Steve Molanavich – Merrill Lynch

Where do you think we are in the overall adoption curve here and where are payback periods, because I know you’re very focused on trying to get those down.

Charles Swoboda

So I think LED lighting still accounts for significantly less than one percent of the lighting market. So I think we’re at the very beginning still. Obviously we’ve made progress from where we were a year ago, but that being said, we’re at the beginning of the cycle.

In terms of payback, I think it varies over time. The indoor lighting applications, still somewhere depending on the product, depending on the application, you’re probably looking at something in as good as a year, maybe as long as three or four years. It just depends on the product.

It’s going to also depend on their maintenance cost and electricity rates and I think those factors vary wildly.

On the outdoor side, our customers are telling us they’re hearing numbers from their customers somewhere in the two to three year range. Sometimes a little longer, sometimes a little shorter, but those are kind of the numbers right now and I think those will probably come down over time, but it’s going to be a function of how fast the system manufacturers can take the improvements in LEDs in terms of brightness and cost reduction and get them into products. Hard to give you an estimate on that, what might happen here over the next year. Clearly we’re trying to increase the value propositions, so that should flow through.

Steve Molanavich – Merrill Lynch

In a recession, does the lifetime cost of ownership argument become more powerful or less?

Charles Swoboda

If we were talking about a large percentage of the market, definitely the recession doesn’t help you, right? Obviously construction spending goes down. You obviously are shrinking some of the potential pool of dollars available for that. We’re so early though, I think what we’re seeing now is the people, like I said, we’re less than one percent of the market. When we’re at the early stage, I think the people looking at LED lighting continue to look at it despite the recession. They have motives that are payback, but they also have an interest in doing something, you know, thinking longer term to start with. With that being said, if your payback is in the one to two year range, that project has got a much better chance right now than the three to four years.

Operator

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

Carter Shoop - Deutsche Bank Securities

I wanted to ask a couple questions on the linearity of the business, first on the chip business. Was that a very backend weighted quarter?

Charles Swoboda

I would actually tell you that both chips and components were more backend loaded. Part of that was with Chinese New Year, where it fell in the quarter, and the fact that in some cases it was a two-week Chinese New Year shutdown instead of a one-week Chinese New Year shutdown. Week three to week five, there was a big chunk of the world that wasn’t doing anything.

I think this quarter was backend loaded in both of those product lines and backend loaded to some extent because the customers just weren’t there in the beginning of the quarter.

Carter Shoop - Deutsche Bank Securities

Doesn’t sound like demand picked up quite the same extent as some of your Taiwanese peers based on the monthly results they seen there. That was a pretty dramatic acceleration there, February over January and March over February.

Charles Swoboda

I think the reason for that, Carter, is that if you look at our numbers in December, they also didn’t go down very much. So we really have a very different chip business than they do. If you look at our December numbers, they were down dramatically and we actually had a very healthy December quarter. I think we were down almost exactly in line with what we expected in the third quarter and kind of in line with our strategy, right? We’re focused more on more the high value applications. We’re going to be a little less probably affected by some of the more mainstream mobile segments. Mobile is not as big as market for us. Trends in terms of things like the video screen business or the notebook back lighting or the lighting segment.

Carter Shoop - Deutsche Bank Securities

In regards to the RF market, when you say it’s mostly IT, is that three fourths the business IT? Also, are you shipping to distributors directly to OEMs?

Charles Swoboda

Within Power RF, there’s really two segments, there’s the RF segment, which is much more military customer oriented. RF is military, the power side is IT oriented. So the largest applications are things like server power supplies. Most of those customers are direct, although we do have some distributors in that business as well, but I think our largest customers there are direct customers.

Carter Shoop - Deutsche Bank Securities

In regard to LED components, it sounds like you’re expecting growth there in fiscal 2010. Are you sensing growth in both high bright and power component businesses?

Charles Swoboda

Yes, we expect both businesses to grow in fiscal 10.

Carter Shoop - Deutsche Bank Securities

Lastly, when you think about the high brightness business, are the margins there still materially higher than the corporate average by a factor of 2X or have the two narrowed a little bit?

Charles Swoboda

I don’t know we’ve ever broke out that high bright was higher by 2X on the corporate average. I think components is better than corporate average and high power is actually better than the high brightness segment, but I don’t believe we’ve given out specific targets. I’m describing gross margins not operating margins.

Operator

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

Michael Burton - Thinkequity

You mentioned lighting is half of LEDs now. Within that bucket, what is components versus systems?

Charles Swoboda

Components is the vast majority, chips would be second, and systems is the third piece. Systems is still a relatively small percentage of the overall LED business. It is growing nicely. When we bought it a year ago was a very small business and while it’s growing and gaining momentum, it’s still a single digit percentages of our revenue.

Michael Burton - Thinkequity

Double digit growth for XLamp and high brightness, I was wondering if you could characterize that as a percentage of your LED sales as well.

Charles Swoboda

The XLamp and the high bright business what we call LED components is running at half of the overall LED business. I don’t have the specific breakout, but it’s well over half.

Michael Burton - Thinkequity

With the ramp in the video and the win there, do you have a new ten percent customer and what are the margins in that business?

Charles Swoboda

The video is part of the high brightness business. There’s really not a significant ramp. I think this quarter we are expecting some growth there and we expect China video screen business to actually pick up this quarter relative to the previous quarter. So it’s not as much a ramp as it is really just seeing that business slowed down a little bit last quarter, see that strength in that business again this quarter. We don’t break out the different margins between those businesses, but the video screen business is similar to the rest of high bright, which is part of components overall is better than average and within those two high power is a little better than high bright.

Operator

Your next question comes from Jiwon Lee - Sidoti & Company.

Jiwon Lee - Sidoti & Company

On ten percent customers, was there any ten percent customers for the quarter?

Charles Swoboda

We don’t break out ten percent customers except at the end of the year.

Jiwon Lee - Sidoti & Company

Some of your large customers, have you finalized annual commitment with them for the fiscal 2010?

Charles Swoboda

If there are any large customers that we think are material, we’ll announce those, but actually if you look at our business, it’s actually becoming more diversified with a large number of customers. You’ll actually see less sensitivity to individual customers going forward.

Jiwon Lee - Sidoti & Company

On the notebook side, how many design wins should we expect?

Charles Swoboda

I don’t know if I can give you a design win number. What I can tell you is that we saw that business grow last quarter, so again this is LED chips. So again, we’re selling the chips to a packaging customer of ours who then is actually getting the design win. So I can’t give you specific design win, but I can tell you we did see nice incremental growth in that segment last quarter. It’s still a relatively small percentage of the total, but it is a growing percentage of that business.

Harsh Kumar - Morgan, Keegan & Company

Thanks for taking my follow-up. Chuck, at some point in time you expect increase pricing, top pricing environment as you put it. Where exactly are you seeing that? Second, have you started to see some of the Taiwanese guys step up in what I would describe as high quality lighting?

Charles Swoboda

What I’m expecting is that our traditional competitors will put more focus on LED lighting. We have not really seen any significant end roads from the Taiwanese packaging competitors in the lighting market.

In terms of pricing, I think it’s more of a projection of what we expect to happen given the outlook of what’s happening in the industry.

Operator

Your next question comes from Jed Dorsheimer - Canaccord Adams.

Jed Dorsheimer - Canaccord Adams

Chuck, I was wondering as we look at you transform the company into more of a lighting company, it seemed very natural to combine the chip and the packaging through the acquisition and through that process, we saw the components business really accelerate in the chip business come down a bit. As we look at the next growth phase of the company, I’m curious do you think we’ll see the same type of repeat in terms of see components sort of plateau and start to drive more of the systems?

Charles Swoboda

That’s a very logical conclusion to draw, but it’s actually not what we’re trying to do. So it is what happened in chips and components, but we knew that going in and we frankly did things to allow that transition to happen. We really focused our chip business just on our more strategic customers and high value side of that. We let and encouraged that transition to happen and I think we found a decent balance for us there.

Cree as a components supplier is where we can drive the majority of our growth. That doesn’t mean we won’t keep investing in the systems side of the business and it will add incremental growth, but if I look out over our plans the next few years, the vast majority of our growth is targeted to come from components. Systems should grow, but it’s really the key for us will be to win in components and I think we can do some exciting things in components and I think you’ll see us probably have some pretty nice niche business there, but I don’t think you’ll see us trying to become mainstream all things in lighting, because I think that’s what it takes to be really successful in systems over time. At this time, that’s not our focus.

Jed Dorsheimer - Canaccord Adams

So if we’re judging Cree on milestones going forward, should we start to see your products end up in more of the traditional fixture companies that are going to be introducing products into the markets or do we see the tactic that Cree creates either its own distribution network or how should we look at some of the milestones that we can judge you on in the lighting business going forward.

Charles Swoboda

Two pieces to that. If you look at the systems business, which is really about enabling and getting the market moving, you should look to see are we able to come out with products that turn on new categories, that really get the market to react.

So if we can come out with an LR24, basically a two-by-two lay and trouffer, do the other companies move into that marketplace and do LED versions of those products, because I’ll tell you, a year ago, most of them said it wasn’t even on their roadmap. So the question is does the LR24 not only generate some incremental sales, but do the big guys get into that business and move down that road and does the next product we do spur bigger lighting companies? Not just in North America, but really around the world to take action.

If that happens, then that’s what we’re kind of trying to do on the systems side and then what that means in components is you should look to see if we’re designed into the traditional lighting companies, but I would go beyond that. I’d look to see how much traction are we getting in lighting broader than that. I think anytime you have new technology entering the market, we absolutely want to work with the traditional players and make them successful, but I also think it creates an opportunity for a lot of the more medium to smaller size players who are probably going to be a little quicker to market, a little more willing to try the technology.

And so, for us, absolutely winning with the big guys is important, but we also want to make companies like beta LEDs successful, because frankly they’re hoping to create a category that before them no one was really working too hard on…so I think you got to look for both sides of it and again, I don’t think we’ll win on every account, but we’re hoping to just win at least our fair share or better and that should drive the strategy.

Jed Dorsheimer - Canaccord Adams

Two housekeeping questions. CapEx for the capacity expansion skewed to backend, front, any color on that? As a follow-up, it looks like dollar strengthening versus the yen. In one, you have some exposure in the chip business in both of those regions. Any hedging strategies going forward?

John Kurtzweil

On the CapEx, I would tell you that right now the investment is about 50-50 in terms of chips versus components. So we’re investing into more component packaging capacity in Asia, but we’re also making some investments in our chip fab and that’s really a function of both if the volume comes back but also still making investments to support the 100 millimeter transition.

In terms of the other question on the hedging, we’re continuing to look at it, but it’s not something I have in place today.

Charles Swoboda

Clearly there was a fairly significant shift over the last four or five months in some of those exchange rates. We think we’ve kind of factored that into the business and we’re managing through in more of a traditional manner, but at this point, we don’t have a hedging strategy to kind of offset that one way or the other.

Operator

Your last question comes from Yair Reiner – Oppenheimer. Your line is now open.

Yair Reiner - Oppenheimer

My question has been answered. Thank you.

Operator

I’ll turn it over to Mr. Kurtzweil for closing remarks.

John Kurtzweil

Thank you for your time today. We appreciate your interest and support and look forward to reporting our fourth quarter along with total fiscal year 2009 results on August 11, 2009. Good night. Thank you.

Operator

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

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