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Executives

Raiford Garrabrant – Director of Investor Relations

Charles M. Swoboda – Chairman of the Board and Chief Executive Officer

John T. Kurtzweil – Executive Vice President, Finance and Chief Financial Officer

Analysts

Harsh Kumar – Morgan, Keegan & Company, Inc.

Andrew Huang – American Technology Research

Jonathan Dorsheimer – Canaccord Adams

Carter Shoop – Deutsche Bank Securities

Yair Reiner – Oppenheimer

Cree, Inc. (CREE) F4Q08 Earnings Call August 12, 2008 5:00 PM ET

Operator

Welcome to the Cree, Inc. fourth quarter 2008 fiscal year financial results conference call. (Operator Instructions) I would now like to introduce Raiford Garrabrant, Director of Investor Relations of Cree, Inc.

Raiford Garrabrant

Welcome to Cree’s fourth quarter fiscal 2008 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 fourth quarter of fiscal year 2008.

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 the investor relations section of our website at www.cree.com under financial metrics quarter ending June 29, 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 earning, 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’ll be limiting our comments regarding Cree’s fourth quarter of fiscal year 2008 to 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 call we are requesting that only sell-side analysts ask questions during the Q&A session. Also, since we plan to complete the call in the allotted time of one hour, we recognize that other investors may have additional questions and we welcome you to contact us after the call by email 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 August 26, 2008.

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

Charles M. Swoboda

We finished fiscal 2008 with record revenue of $493 million, a 25% increase from fiscal 2007 as we successfully executed our strategy to drive top line growth from our LED components product line. Non-GAAP net income from continuing operations increased 33% from fiscal 2007 to $47.3 million or $0.54 per diluted share. In Q4, revenue increased to a record $135.9 million with non-GAAP net income from continuing operations of $14.5 million or $0.16 per diluted share.

These results include a $0.03 per share benefit primarily due to a state franchise tax credit that reduced G&A for the quarter. On a comparable basis to our previously announced target range, which excludes this $0.03 per share benefit, non-GAAP earnings would have been in the middle of our target range at approximately $0.13 per diluted share. Gross margin was 34.2% for the quarter which was on the lower end of our target range. The gross margin was affected by three primary factors. Despite higher sales we have lower utilization in our LED chip and wafer factory as we chose to manage down inventory levels. We were successful in improving XLamp yields but the improvements came online later in the quarter than we had forecast and RF product and government contract costs were higher than targeted.

Overall, these results are within the normal operating range of our business and illustrate the significant margin progress we have made when compared with a year ago. We also made good progress in managing working capital as we reduced inventory days on hand and accounts receivable which contributed to strong cash flow from operation of $36.7 million for the quarter. Revenue growth in the quarter was led by higher LED sales which included another double digit increase in XLamp LED sales, stronger than expected growth in High Brightness LED components, LED chip sales in line with our target at a few percent lower than Q3 and LLF sales in our targeted range.

Overall, LED component revenue for the quarter was approximately 30% higher than LED chip revenue and illustrates the tremendous progress we have made in building our LED component product line while still maintaining a strong merchant LED chip business. Our non-LED business was flat sequentially as higher power device sales offset slightly lower RF and government contract revenue.

I’m also pleased to report that we made great progress on all five of the key objectives that we had outlined for fiscal 2008. We grew XLamp sales more than 140% from the previous year and continued to drive the LED lighting revolution through our acquisition of LED Lighting Fixture and the growth in our LED city and LED university market development initiatives. We successfully integrated COTCO which has become our High Brightness LED product line and achieved a first year revenue and profit objective.

We continue to expand our global sales coverage and drive growth with our distribution partners as component distribution sales more than doubled over the previous year. We expanded our manufacturing capabilities in Asia as we transitioned most of our XLamp LED production to China during the year, which reduced manufacturing costs and positioned these products for improved margins in fiscal 2009. And we grew Power and RF product sales 23% year-over-year.

As we look ahead to fiscal 2009 we are targeting to build on the momentum we created over the last year. The LED lighting revolution continues to gain traction and our XLamp LED components and LED lighting solution product lines are well positioned to benefit from the growing demand for energy efficient LED lighting.

I will now turn the call over to John Kurtzweil to review our fourth quarter financial results in more detail and our targets for Q1.

John T. Kurtzweil

I will be providing commentary on our financial statements on both a GAAP and non-GAAP basis which is consistent with how management internally measures Cree’s results. However, non-GAAP results are not in accordance of 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 of GAAP. A reconciliation of the non-GAAP information for all quarters mentioned in this call is posted on our website.

For fiscal year 2008, revenue was $493 million as compared to $394 million for the prior year. This is an increase of 25% year-over-year. GAAP earnings were $33.4 million and $0.38 per diluted share for fiscal 2008. All non-GAAP earnings increased 33% to $47.2 million and $0.54 per diluted share. Cash provided by operations was $102 million, free cash flow was $47 million and we exited fiscal 2008 with $371 million in cash and investments and continue to be debt free.

For the fourth quarter fiscal 2008, we reported revenue of $135.9 million which is above our targeted range for the quarter of $129 million to $133 million, a 9% sequential increase over Q3 and a 22% increase over Q4 of fiscal 2007. Q4 is the first quarter we have a meaningful comparison to our prior year quarter since the acquisition of COTCO and illustrates the solid progress we have made in growing revenue and earnings.

GAAP net income from continuing operations was $6.6 million or $0.07 per diluted share which is above our targeted range of $0.04 to $0.06. GAAP net income, including discontinued operations, was $8.4 million or $0.09 per diluted share and includes a one time gain related to the sale of several patents related to the discontinued Cree microwave operation. On a non-GAAP basis net income from continuing operations for the fourth quarter was $14.5 million or $0.16 per diluted share which excludes $7.9 million of net expense or $0.09 per diluted share from the amortization of acquired intangibles and stock based compensation expense.

Non-GAAP earnings included a $0.03 per share benefit primarily due to a state franchise tax credit that reduced the G&A for the quarter. Excluding this $0.03 per share benefit, non-GAAP earnings were consistent with the company’s previously announced target range of $0.12 to $0.14. Non-GAAP net income has grown 95% when compared to the fourth fiscal quarter of 2007. LED revenue increased 11% sequentially to $116.6 million and by 27% when compared to the same period last year. While non-LED product and contract revenues were flat sequentially at $19.2 million, LED revenue growth was led by double digit growth in XLamp product sales for lighting application and higher than targeted demand for our High Brightness product line which also increased double digits during the quarter based on the strength of the China video display market.

LLF revenue was within the target range of $2.5 million to $3 million and LED chip sales were in line with our target for a few percentage points lower than Q3. Q4 GAAP gross margin was 33.6% and non-GAAP gross margin was 34.2% which excludes stock based compensation of $0.7 million or about 50 basis points a margin. Non-GAAP gross margin was at the low end of our range of 34% to 36% due to several factors. Despite higher sales we have lower utilization in our LED chip and wafer factory as we chose to manage down inventory levels. We were successful in improving XLamp yields but the improvements came online later in the quarter than we had forecasted and our RF products and government contract costs were higher than targeted.

Operating expenses were $40.4 million on a GAAP basis and $31.7 million on a non-GAAP basis. Non-GAAP expenses exclude approximately $4 million of stock based compensation expense and $4.8 million of charges for amortization of acquired intangibles. This is lower than our targeted range as we recorded approximately $3 million or $0.03 per share benefit to SG&A expense primarily due to a state franchise tax credit. This is partially offset by increased selling expense of approximately $0.6 million and increased litigation expense of approximately $1 million during the quarter as we had targeted.

R&D expenses increased slightly to $15.8 million in Q4 and were in line with our targets. Net interest income decreased to $2.5 million from Q3 and was below our targets. We used $51 million to repurchase approximately 2 million shares of the company’s stock at an average price of $25.96 per share during the quarter. We have also taken a more conservative position with our investment portfolio over the past two quarters given the recent uncertainty in the debt markets and as such our average return has declined since Q3.

The tax rate for the quarter was 16.9% and for the year it was 22.5%. The integration of LED lighting fixtures, which we acquired in March, has progressed as expected. Revenue last quarter was in the target range and is forecasted to grow double digits in Q1. This business was approximately $0.02 diluted for the quarter and as the year progresses it is targeted to become less diluted each quarter with the target to be accretive by the fourth quarter of fiscal 2009.

The COTCO acquisition was accretive in 2008 and the earn out requirements for fiscal 2008 were met per the purchase agreement. As a result we will be paying the $60 million earn out in cash this quarter. During fiscal 2008 we had two 10% customers: Sumitomo and Seoul Semiconductor. Sumitomo revenue was relatively stable throughout this past year and ended at 13% of revenue. Seoul Semiconductor revenue increased 16% for the year and ended at 13% of total company revenue.

In fiscal 2008, we had two related party customers as a result of the COTCO acquisition: Light Engine Limited and Konwin Technology Limited. Light Engine Limited is a subsidiary of United Luminous Holdings which is owned by Paul Lo and is a former sister company of the COTCO LED business. Light Engine is primarily focused on value added modules and systems for lighting products. Sales to Light Engine were $35 million in fiscal 2008 or 7% of total company revenue. Konwin Technology Limited, which is primarily focused on LED modules for video displays is a related party due to Paul Lo’s family’s minority ownership in Gold Peak Industries, resulting in an indirect beneficial ownership of approximately 11% of Konwin. Sales to Konwin were $30 million in fiscal 2008 or 6% of total company revenue. These two customers grew in line with the overall growth in lighting and video display applications.

The balance sheet strengthened over the quarter as we made great progress on working capital. Days sales outstanding declined 9% to 73 days from 80 days the prior quarter as accounts receivable decreased by $1.2 million to $110.4 million on a $10.9 million increase in revenue. We also decreased our days on hand of inventory 13% to 80 days from 92 days last quarter, an inventory decline by $3.2 million to $80.2 million. As we become more vertically integrated, we are continuing to refine the appropriate amounts inventory within our internal global supply chain. Cash flow from operations was $36.7 million and capital expenditures were $18.2 million for a free cash flow of $18.5 million during the quarter.

For the first fiscal quarter, which ends on September 28, we are targeting revenue to increase to a range of $138 million to $142 million due to higher LED sales which are targeted to offset a 10% to 15% decline in non-LED products and contract revenue. XLamp and LLF product revenues are both targeted to grow double digits again. High Brightness LED components and LED chips are targeted to be in a similar range as Q4. Sales of our non-LED products are targeted to be down this quarter primarily due to lower sales for both our Power and RF product lines and lowered government contract revenue.

Power customers have pushed out orders to rebalance their inventory while some of our RF foundry jobs have been delayed. Despite these challenges we continue to win new designs and are optimistic about the potential for these product lines. While we expect there will continue to be some fluctuation in these product lines over the next year we target the growth in the LED business to more than offset this variability.

Gross margin is targeted to be in the range of 34% to 36% on a GAAP and non-GAAP basis with approximately $700,000 or 50 basis points of stock based compensation expense in the G&A target. We are targeting some improvement in gross margins as we get the full quarter benefit from new product yields that we made at the end of last quarter and slightly higher factory utilization to offset negative impact of lower Power and RF revenue. As we grow our business we will continue to introduce new products into the factory and with that there is an inherent variability in our cost structure. For example, this quarter we are introducing two new XLamp products and two new LLF products into production and we estimate that it will take time to work through the new product launch challenges and for the product yield to achieve targeted production levels.

GAAP operating expenses are targeted to be approximately $43 million and include approximately $4 million of non-cash stock based compensation and $4 million of charges for amortization of acquired intangibles. We target increase R&D slightly and continue to increase our investment in sales and marketing. Litigation expenses targeted to be flat with the previous quarter as the BridgeLux trial has been delayed until after the first of the calendar year at which time we forecast an increase in litigation expenses.

Interest income is targeted to be approximately $2.3 million based on lower cash balances and lower yields from our investment portfolio. We are targeting our effective tax rate to be 22.5%. Based on an estimated 89.5 million diluted shares outstanding our GAAP EPS target for the first fiscal quarter of 2009 is expected to be in a range of $0.06 to $0.08 per diluted share when amortization required 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 first fiscal quarter 2009 which includes approximately $0.01 loss related to the lower power, RF and contract revenues.

Our non-GAAP basis EPS targets exclude amortization of acquired intangibles in the amounts of $0.03 and non-cash stock-based compensation in the amount of $0.04. Receivables are targeted to increase in relation to our revenue growth while day sales outstanding should be in the current range plus or minus. Inventories are expected to also increase slightly yet days are targeted to remain in the current range plus or minus. We are targeting capital expenditures for the quarter to be in the range of $18 to $20 million primarily for capacity additions, new product introduction and the continuing transition of LED chip production to four inch wafers.

For fiscal 2009, we target our growth to come from our LED components and LLF products. We target the rest of our product lines to be in a similar range of fiscal 2008. We target progress in gross margins yet it is not expected to be linear throughout the year as we will be introducing new products which, based on experience, typically have lower margins to start and then improve as yields increase over time. Gross margin improvement is targeted to be the key driver to building operating leverage in fiscal 2009 as operating expenses are forecasted to grow as we invest in R&D, sales, marketing and the additional cost of intellectual property litigation expenses in the second half of the year.

Thank you and I will now turn the discussion back to Chuck.

Charles M. Swoboda

As we start fiscal 2009 we recognize that there’s a growing uncertainty around the world regarding the near term global economic environment especially in businesses that are affected by trends in consumer spending. While this is a challenge that all companies will need to manage in the year ahead, we continue to target growth opportunities for Cree in fiscal 2009 due to the increased adoption of LED lighting. We are focused on four key areas to continue to drive our transformation in to a global leader of energy efficient LED components and solutions.

Our first priority is to drive top line growth for Cree through higher sales of LED components. For the year we are targeting strong growth in LED sales as well as incremental gains in high brightness LEDs. To achieve this goal, we need to continue to expand our global sales team with the biggest investment in Europe to improve both our direct and distribution sales coverage. Our second priority is to build upon our market leadership in LED lighting by driving LED adoption through higher sales of our LED lighting solution 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. In terms of our LED lighting solution products, more than 100,000 LR6 downlights have been sold since the product was released a year ago, and this was for a lighting product category that didn’t exist prior to the LR6. This product has won numerous awards and established a new standard in LED downlights.

We plan to build upon the success of this first product in fiscal 2009 as we add the LR4 and LR24 products to our no compromise energy efficient LED lighting solutions product offering. Much of our success in establishing Cree as a leader in LED lighting has come from our new product innovation and we need to continue to build upon our performance leadership in fiscal 2009. We have recently announced two new lighting class additions to the XLamp product family that should enable us to address a wider range of lighting applications. The XP series of XLamp LED is targeted at applications needing lighting class performance similar to our XRE series products but with a smaller footprint. The MC series of XLamp LEDs is targeted at applications needing very high lumens in a single package such as MR16 bulb retrofits. We have started initial production for both these products in Durham and 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. While we made a lot of progress in growing the business over the last year, we recognize the need to improve our gross margins as a company and this starts with our new product line. These products made significant progress last year on gross margin but are still below the corporate average. We target to increase new product margins in fiscal 09 through a combination of cost reduction activities for the next year including yield improvements at the chip and package level, capacity additions in Asia, volume benefits due to increased factory loading and the completion of the transition of LED chip production to four inch wafers. Gross margin improvement is targeted to be the key driver to building operating leverage in fiscal 2009 as we plan to continue to invest in R&D, sales, marketing, infrastructure and the additional cost for IP litigation.

Our fourth priority is to continue to grow our commercial power RF product revenue and transition this product line from the current level of a slight quarterly loss to adding to the bottom line in fiscal 2010. Despite the tremendous potential of these products for high efficiency power switching, RF and microwave applications, this business is still in its early stages. Although we have had success in winning new designs in volume applications such as server power supplies, we still have a limited number of customers which can cause demand to fluctuate pretty significantly from quarter-to-quarter. Our goal over the next year is to begin to realize more of the potential from a broader customer base with new design wins for our Schotky Diodes and solar inverters and new business for our GaN RF products in a range of military and wireless applications. Additional sales should reduce our reliance on government contract revenue and provide the increased volume to reduce costs and improve margins on these products.

As we look ahead to the first quarter, we target revenues to increase to a range of $138 to $142 million drive primarily by double-digit growth in XLamp LEDs and our LLF products. We also target LED chip and high brightness component sales to be at a similar level as Q4. The growth in LED sales is targeted to more than offset an estimated 10% to 15% decline in power, RF and contract revenue for the quarter. We target non-GAAP earnings in Q1 of $0.13 to $0.15 per diluted share as we target slightly higher factory loading and the full benefit of our XLamp yield improvement to more than offset the negative impact of lower power and RF sales. Please note that our non-GAAP targets exclude amortization of intangibles, stock-based compensation expense and related tax effects.

Our strategy to drive revenue growth by focusing on LED lighting worked well in fiscal 2008 and we target to build on this success in fiscal 2009. We made an impressive transition over the last 18 months in converting Cree from an LED chip company driven by mobile phone market trends to a broad based LED company with chips, components and systems that are leading the LED lighting revolution. While we recognize that there is caution in the market about the global economic environment, we remain optimistic about the year ahead and believe we can continue to grow our business as the momentum continues to build for our new products and energy efficient LED lighting.

We will now take analysts’ questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Harsh Kumar – Morgan, Keegan & Company, Inc.

Harsh Kumar – Morgan, Keegan & Company, Inc.

Based on your commentary Chuck, you said you were going to draw down on inventory and that was basically what led to the margins. How long will you be doing that? In other words, is that something we should expect a reversal in? Then, I’ve got a couple of more questions.

Charles M. Swoboda

What happened last quarter was we were really rebalancing the overall inventory across the business. Now that we are vertically integrated from wafers to chips to components to systems and we’re global, we’ve been working through how to best balance that. I think from what we saw last quarter our target for this quarter is to have factory utilization at a fairly similar level, a little bit higher maybe than last quarter so that I don’t think there will be a change effect in the numbers. Our targets for inventory are slightly higher inventory in line with revenue growth which would keep our days in a similar range plus or minus.

Harsh Kumar – Morgan, Keegan & Company, Inc.

So this is the end of the rebalancing, it looks like you are back to sort or more normal levels it sounds like?

Charles M. Swoboda

Harsh yes, but keep in mind that we’re not going to see a significant increase in LED fab or wafer fab loading in the next quarter either so it’s not really a rebound, it’s more of a stabilization at this point and slight improvement as we go forward here.

Harsh Kumar – Morgan, Keegan & Company, Inc.

Then second point related to gross margins was XLamp transitioned to China, could you just Chuck maybe give us a general update, is that something that you’re done with or how far along are you? Just any color would be very helpful.

Charles M. Swoboda

The majority of all our XRE products are now produced in China. In fact, we have essentially zero production left here in Durham other than for special requests. We are now ramping up a pilot production of both our XP and our MC products here in Durham and we’ll be doing that over the next couple of quarters and once we get through that initial pilot product phase, we will then start to transfer those to China in the second half of the fiscal year. But, all-in-all, if I look back on the past year, the transition to China went really well. The challenge now is to keep driving yields up and really look for that improvement to help us on the gross margin front.

Harsh Kumar – Morgan, Keegan & Company, Inc.

John you mentioned that you’ll be paying COTCO the $60 million odd dollars, is that built in to your guidance because it was coming over at roughly a $0.02 impact to EPS, maybe I’m a little bit off. But, is that something that’s built in to your guidance?

John T. Kurtzweil

It’s built in to our guidance and I’ve taken that in to account in my calculation for the interest income.

Charles M. Swoboda

Of course, it only really affects interest. There is no share impact whatsoever.

Operator

Our next question comes from Andrew Huang – American Technology Research.

Andrew Huang – American Technology Research

It looks like there was some good news and some bad news so first on the good news, I’m pretty sure your LED revenue was well ahead what anyone else had modeled so I’m curious, within LED revenue which segments kind of surprised you the most?

Charles M. Swoboda

Well, if you look at the targets we had set out, I would tell you that we have predicted double digit growth in XLamp and that came in pretty much on plan, maybe slightly better, a little ahead of plan. LLF was right in the targeted range and it was really the high brightness business that gave us probably the most upside in the fourth quarter. We had targeted a little bit of incremental growth and instead we actually got double digit growth there.

Andrew Huang – American Technology Research

On the chip business was that kind of down a couple of points sequential as you had expected?

Charles M. Swoboda

Yes. It was in line with our targets, down a few percent from the previous quarter but right in line with kind of how we had modeled the quarter going in.

Andrew Huang – American Technology Research

On the high brightness, was that a result of the Olympics at all? Or, is that just totally independent of the Olympics?

Charles M. Swoboda

The high brightness business, the Olympic effect we got really pretty much ended in Q3. We had very little, if any, impact on our Q4 numbers from the Olympics. I will tell you though, it was strength in China and it’s really the video display business that is driving it. I would attribute it more to overall infrastructure investments in China that are driving the whole video screen market. So, it was not Olympic related so all the stuff you saw at the Olympics, most of those products we sold well before Q4, in fact most of those we sold well before Q3 and so what you’re really seeing now is just infrastructure build out in China and it was just a nice upside for us last quarter.

Andrew Huang – American Technology Research

So, it seems like if you’re kind of guiding that business flat for the September quarter, that basically means you expect that high level of activity to kind of remain the same, is that right?

Charles M. Swoboda

Yes. Based on the outlook we have today, it looks like it should in Q1 stay in a similar range as to where we finish Q4. So it’s nice to have the upside but it’s also nice having it coming back this quarter to a similar level.

Andrew Huang – American Technology Research

On the chip revenue, it seems like a lot of people were kind of under the impression that your chip business would be under a lot of pressure this quarter and it seems like it was just in line. Can you kind of address that?

Charles M. Swoboda

Well, I think we probably were first Andrew to kind of come out and say we saw a little weakness heading in to the quarter so when we provided our targets back in early April, we had said we thought it would be down a few points sequentially. We were probably sensing a little bit of softness then and it came in pretty much what we thought. I think part of the difference might be is our customer mix. We have changed the business a lot so if I look at some of the talk in the marketplace, especially among the Taiwanese guys, there’s a lot of talk about trends related to mobile and some of those other very consumer driven applications and even in our chip business today, we have a lot of exposure to things, still a significant business in automotive, in to the gaming, in to the video screen market and in the lighting segment. So, I think at this time it’s really the fact that we have a relatively broad base of applications and the fact that the new products continue to kind of help us keep that business going. That’s probably helped us have maybe a little bit more of a positive outlook than some of the competitors.

Andrew Huang – American Technology Research

Then on the bad news, you’re non-GAAP gross margin was clearly a disappointment, it’s been down two quarters in a row now. So, my question is you have two new XLamps that are ramping this quarter, you have two new LLF’ ramping so it seems like it might be tough for you to delivery even a slight bit of sequential improvement on the gross margin. Can you just talk about how you’re going to get there?

Charles M. Swoboda

Yes, Andrew if you look at what happened last quarter, we obviously had hoped that gross margin would come in a little higher than it did but, if you look at what is it off by – from the middle of our range, we were probably off by 80 basis points and if you look at it on a non-GAAP basis. When I look at that, it’s really a couple of phenomena, one is I don’t think most people thought we would be able to grow revenue $10 million and take inventory down so the fact that we reduced the utilization in the chip factory and the wafer factory, I consider that to be good prudent business, I don’t consider that to be a disappointment so we’re actually happy about the fact that we were able to do both at the same time. But, the realty is that’s going to have some impact on the gross margin.

The second thing is we were hoping to get the XLamp yield improvements. The improvements we saw at the end of the quarter the last couple of weeks and we’re still seeing as we head in to this quarter, we had really hoped to get those online earlier in the quarter so that would have also given us a little more leverage. The other thing we can’t – that there’s variability in the business, when the RF and contracts cost come in a little higher, that business has some variability to it. So net-net I feel like we understand what happened there and so the challenge for this quarter is what we’re targeting is slightly higher revenues so it should help factory loading a little bit from last quarter and we should get the full quarter impact of better XLamp deals. If you take those two things, realize that the power and RF business is going to be down sequentially so that’s going to offset that somewhat, that’s why we’re looking for a little bit of improvement this quarter in the gross margins. If we do that, I think that’s a real healthy sign for our business.

Operator

Our next question comes from Jonathan Dorsheimer – Canaccord Adams.

Jonathan Dorsheimer – Canaccord Adams

I appreciate you breaking out the related party and the light engine, I was wondering a little bit of surprise though and John maybe you can explain the $35 million it would appear that based on the contract outlined in the addendum that it should be closer to $50 million. So, where is the delta of the $15 million given the guaranteed sales?

Charles M. Swoboda

If you look at the way the contract was written, they have to make an attempt, I think if you look at, I think it was in our proxy last year, if you look, they have to use their best efforts to try and grow the business but there’s no requirement for them to buy product if there isn’t a need for it. So, what you are seeing is the flow of their business as they have demand for it. John, is there anything you want to add to that?

John T. Kurtzweil

No, that’s exactly right.

Jonathan Dorsheimer – Canaccord Adams

I’m just surprised. But, they still got the earn out?

Charles M. Swoboda

Yes, because you have to remember that the earn out wasn’t just on what they bought, it was on the overall performance of the business and actually the business did real well in terms of both our revenue and our profit targets for the year. So, it was overall a strong year for that product line.

Jonathan Dorsheimer – Canaccord Adams

A couple of housekeeping questions, looking at the goodwill write up of the $56 million, is that all LLF related or is there something else in there?

John T. Kurtzweil

What that is, is because at the end of the quarter what we did is we accrued the earn out payment to the goodwill. You see the earn out payment of $60 million in there plus other yearend adjustments, that’s why it’s only at $57 instead of $60.

Jonathan Dorsheimer – Canaccord Adams

So you’re classifying the earn out as goodwill?

John T. Kurtzweil

Yes. So, there will be no P&L impact on that and no amortization of it.

Jonathan Dorsheimer – Canaccord Adams

Then, the cap ex, the $18 million but your property plant and equipment actually came down $3 million and D&A also came down $1 million. Can you just help me better understand how those moving parts work?

John T. Kurtzweil

What we also had during the quarter is we had some write offs of assets that went directly to the P&L.

Charles M. Swoboda

But overall what you’ve got going on is remember we were making pretty heavy capital investments if you go back five years ago and so we have a chunk of roll off that’s actually at this point you’re seeing the roll off rate and the addition rate vary a little bit from quarter-to-quarter but it’s not changing total depreciation by a lot at this current time. So, we’re getting the benefit of some of the investments we made five years ago, they’re starting to roll off as well as we’re investing too but it happens to be if you just look at timing five years period, we’re investing at about or slightly lower rate recently than we were five years ago and that’s a lot because it’s not just a chip business because there’s not as much cap ex required for some of the component sides of the business.

Jonathan Dorsheimer – Canaccord Adams

Sumitomo, 13% for last year?

Charles M. Swoboda

Yes.

Jonathan Dorsheimer – Canaccord Adams

And that was down from 27% correct?

John T. Kurtzweil

24%.

Jonathan Dorsheimer – Canaccord Adams

The other related party Konwin that’s associated with Gold Peak, is that related in any way to Lighthouse? I’m not familiar with Konwin.

Charles M. Swoboda

Yes. They actually provide LED modules to Lighthouse and actually Gold Peak owns Lighthouse which owns Konwin is how it works.

Operator

Our next question comes from Carter Shoop – Deutsche Bank Securities.

Carter Shoop – Deutsche Bank Securities

It looks like the tax rate was about $0.01 benefit relative to expectations on a non-GAAP basis. Is that the case? And if so, what drove that downward?

John T. Kurtzweil

What that is, is basically due to true ups at the end of the year and for the year the total tax rate was 22.5% versus our targeted 24%. And going forward, as you’re building your model, use 22.5%.

Carter Shoop – Deutsche Bank Securities

In regards to the share count, over the past two quarters it looks like it was up about 3 million over the past two quarters while LLF was about 2 million and you bought back 2 million this quarter. Can you help me understand why that increased? Is it partially due to the timing of the buybacks in this last quarter?

John T. Kurtzweil

Part of it is the timing of buybacks, we have an employee stock purchase plan and some other option exercises over the last six months.

Carter Shoop – Deutsche Bank Securities

In regards to the $0.03 benefit, you mentioned it’s mostly from the franchise tax credit but you also mentioned there are some other drivers in there. Would you be willing to explain what the other drivers are? Then, what that benefit was on a pre and post tax basis?

John T. Kurtzweil

On that stuff it was $3 million in total for that and everything else. It’s a bunch of smaller things but what we wanted to do is just call out and give you guys directionally where we’re going so you can compare us to our forecast next quarter as well.

Charles M. Swoboda

And our target range.

John T. Kurtzweil

And within our target range, yes.

Carter Shoop – Deutsche Bank Securities

One more housekeeping question here, it looks like SG&A was about $1 million below expectations if you take that out of the equation, that franchise tax credit. Was that mostly due to lower than expected litigation or was there something else there that helped drive SG&A a little bit lower than expectations?

John T. Kurtzweil

We continue to try and manage our G&A expenses and litigation came in slightly lower but not appreciably. It was just overall management on the sales side.

Charles M. Swoboda

We’re adding expenses, we’re investing in a lot of different areas and I think what you see is that although we had targeted some incremental expenses at a higher rate we frankly didn’t add them as fast as we were going. We were talking about a fairly sizeable increase and it just didn’t all happen last quarter.

Carter Shoop – Deutsche Bank Securities

Linearity in the quarter was it kind of as you expected or was the first half a little bit stronger? Could you expand on that a little bit?

Charles M. Swoboda

Traditionally we start out a little slower and get stronger as the quarter goes. I would say that Q4 was pretty similar to Q3 and the way our Q1 is shaping up, it looks to be about the same so it’s kind of similar I would say. We’re always a little more on the back half of the quarter than the front half but I would say it’s not drastically out of whack and it’s pretty similar, it’s not a big change from quarter-to-quarter.

Carter Shoop – Deutsche Bank Securities

Did you mention the XLamp sales were up 140% year-over-year? I just want to make sure that’s the correct number.

Charles M. Swoboda

Yes, that’s correct.

Carter Shoop – Deutsche Bank Securities

So would that be all organic or is there some benefit from accounting from the LLF? Was there anything involved in that?

Charles M. Swoboda

No, actually if we would not have bought LLF, it would have been up higher because we don’t get to count those sales anymore.

Carter Shoop – Deutsche Bank Securities

Just thinking about 09 obviously keeping that kind of growth rate, it would be very difficult. Any way to add some color about how you guys are thinking about XLamp sales? The commentary on a sequential basis is always helpful but maybe for modeling purposes do you think that could be up 40% 60% on a year-over-year basis?

Charles M. Swoboda

The way I would think about it right now is we’ve been doing kind of this double digit and obviously as the numbers get bigger we would like – the goal would be to try to keep it at double digits. I’m sure it will be on the lower end of the double digit range than the higher ones but we don’t have good enough visibility to give you a full year number on there but at least for the near term, based on the sales funnel and what we’re seeing, we’re obviously targeting double digits again here in Q1. And, just to give you a perspective, a similar rate as last quarter. Then, as the numbers get bigger, my guess is that will come down a little bit but still looking for healthy growth throughout the year, that would be the target.

Carter Shoop – Deutsche Bank Securities

So maybe coming down a little bit on a sequential basis but it’s possible to see double digit sequential growth throughout the next three quarters?

Charles M. Swoboda

At least for the next couple. We’ll have to see about the second half, it’s a little hard to just lay it out. Here’s the trick for that one, we obviously don’t have visibility in to the second half of our fiscal year, we also have these two new products coming on line so those are kind of wild cards. Generally speaking, they take six to nine months to get traction but depending on what kind of traction we get there, it’s a little hard for us to give you real good granularity at this point.

Carter Shoop – Deutsche Bank Securities

Two more quick ones, on the build out in Europe both in regards to direct sales and distribution, will that be for both LLF and for XLamp? And, can you talk about when that would be an impact to the P&L?

Charles M. Swoboda

We’re starting that now. We started a little bit in Q4, you’ll see some of that already built in our targets for Q1 but it’s for LED components in total so it will actually even support LED chips. So, it will really be something that will support primarily XLamp and the high brightness component product line but we’ll actually be also putting in at least a little bit of infrastructure to support our chip business in Europe as well. That is not really to drive our Europe [inaudible] at this point.

Carter Shoop – Deutsche Bank Securities

Last question, in regards to LLF, do you still feel comfortable with the original target for the sales there going out a year? Do you feel that’s doable? Do you feel like there could be some upside there?

Charles M. Swoboda

On that one, we had said originally that we thought it would add about $30 million for the year and that was a combination of incremental sales from LLF product plus some incremental sales from the XLamp. What we can see right now is that the XLamp piece looks to be on target and the LLF piece as well. Keep in mind, LLF is coming from a pretty small base so we’re looking at having to deliver pretty healthy growth each of the next several quarters to do that. With that being said, we’re going from one product, the LR6 to you know by the end of this quarter we’ve launched the LR4 and we’re targeting to get the LR24 out as well. So, I think it’s all within the range, our targets haven’t changed for next year. There’s a lot of moving pieces but I would tell you that given the success we’ve had in the first year with the LR6, we’re pretty optimistic about being able to achieve those targets next year. As far as any upside, it’s too early to make a call on that one, ask me six months in to the year after we get these two new products released and we’ll have a better sense of that.

Operator

Our next question comes from Yair Reiner – Oppenheimer.

Yair Reiner – Oppenheimer

First of all, are you able to share with us your backlog number exiting the year?

Charles M. Swoboda

You know, we will put that in our 10K, I don’t think we have that available today but it will be in our 10K as soon as it comes out. I don’t have that handy at the moment.

Yair Reiner – Oppenheimer

On XLamp, can you talk a little bit about what’s driving demand in the end market and to what extent the growth is being driven by kind of broader macro trends and to what extent is it a share game playing out?

Charles M. Swoboda

What I would tell you right now is that on the XLamp front the end markets today, if you look at the revenue in Q4, the majority of the revenue is a combination of portable architectural lighting and vehicle lighting so we’ve kind of got those as a majority but the fastest growing segment is what we call indoor/outdoor commercial, the stuff most people call general lighting. That has been, for the last couple of quarters, that’s the section of the XLamp business that’s growing the fastest. As we go in to next year, if you looked t the deals and the opportunities we’re working on, it’s really more the general lamination. It doesn’t mean that we see a fall off in portable or architectural it just means that other segment is the one that seems to be growing the most.

I would tell you right now, general lighting is much more about macro trends so this indoor/outdoor that’s really not a share gain, that’s more macro. In terms of winning in the portable and the architectural, that’s been a little bit of a share gain over the last year. But, I would be surprised if the other companies in the high power LED business aren’t also seeing relatively reasonably good business at this point. I don’t know that they’re growing at the same rate but I would be surprised if they’re not seeing similar positive market dynamics.

John T. Kurtzweil

I have backlog number here, at the end of June it was $89.3 million and the prior year was $69.8.

Yair Reiner – Oppenheimer

Going back to your large customers for the year, are you able to give us the year ago numbers for Light Engine and Konwin since we don’t have those? We have them for Sumitomo and [SOL].

Charles M. Swoboda

Light Engine and Konwin where really only parties for one quarter of last year and it was $9.7 million for our fiscal Q4 of last year. But, we don’t have it for before that because we didn’t acquire them until late in March.

Yair Reiner – Oppenheimer

I guess I’m trying to get at how important they were in terms of growth drivers for the COTCO business during FY08?

Charles M. Swoboda

They were part of the growth for COTCO. The way that works is Light Engine is really more on the lighting side of the business, value added modules and products for kind of the lighting market and Konwin is a separate company really connected to the video display side of the business. We actually saw generally in our business in both XLamp and in our high brightness growth in both of those market segments and they kind of paralleled that growth. I would tell you they saw similar trends, in the markets they were strong. We also had growth on our other customers as well. I would say it tracked relatively with the other trends in the business.

Operator

Our next question comes from Harsh Kumar – Morgan, Keegan & Company, Inc.

Harsh Kumar – Morgan, Keegan & Company, Inc.

You mentioned LLF was $0.02 dilutive in the quarter. I’m curious if you could reiterate what your plans are for accretion for that company? Then, I have one more.

Charles M. Swoboda

Harsh, John mentioned earlier what we’re trying to do is we’re looking for it to become less dilutive each quarter and targeting to exit Q4, fiscal Q4 with it becoming slightly accretive. So, it should reduce each quarter its amount of dilution but it will take the next three quarters and targeting by Q4 the thing will become breakeven and even slightly accretive as we exit.

Harsh Kumar – Morgan, Keegan & Company, Inc.

Then I had a quick question, I was somewhat surprised John, I had not seen this before, earn outs sort of being characterized, is that fairly common? Have you come across that before John?

John T. Kurtzweil

Yes. When you go back and look at it, we had goodwill, we had acquired intangibles related to it and anything over the purchase price and the acquired intangibles goes to goodwill. So, this is incremental cost for the purchase which goes directly to goodwill.

Harsh Kumar – Morgan, Keegan & Company, Inc.

Then last, just sort of a housekeeping question, when you say high brightness, Chinese high brightness [inaudible], that’s basically billboards right?

Charles M. Swoboda

Video screens, right. So, it could be billboards, it could be replay boards, stadium screens, things like that but the video screen business is definitely being driven by the advertising business.

Harsh Kumar – Morgan, Keegan & Company, Inc.

Then should we be reading in to your current [inaudible] that you’re still seeing traction despite that fact that the Olympics are sort of done? Business is still hanging in there flat to sort of modestly up?

Charles M. Swoboda

I would actually claim it as pretty much flat quarter-to-quarter right now is what we’re seeing for this quarter. Obviously, when you’re in the video screen business you talk in big capital projects and in China they don’t plan these things super far in advance but that being said, the current targets say that we should be pretty flat quarter-to-quarter.

Operator

Our last question comes from the line of Andrew Huang – American Technology Research.

Andrew Huang – American Technology Research

Just one last question on XLamp, I think your plan for the June quarter of this year was to triple your XLamp capacity in China. I’m just curious if you can comment on your future plans for XLamp capacity position?

Charles M. Swoboda

Sure Andrew. We were able to get the tripling of capacity in place so that went well this last year. We started last quarter a facility expansion in China to prepare ourselves for this year’s capacity needs and right now the plan we’re going with for fiscal 09 is we’re planning to more than double our total XLamp capacity for fiscal 09. So, that will be for a combination of both our XRE products and our new XP and MC products. But, we’re targeting more than doubling packaging capacity for that segment of the business.

Andrew Huang – American Technology Research

Just on clarification on Sumitomo, I think you mentioned that it was 13% of sales which is down significantly from the prior year but, I just want to be sure that I understand. Sumitomo is one of your chip customers, correct?

Charles M. Swoboda

Yes. Sumitomo is a distributor in Japan that sells to most of the major Japanese chip customers of ours and although its down year-over-year, keep in mind that that trend is actually very consistent with how we finished last fiscal year. So, the Sumitomo revenue has been essentially in the same range plus or minus 5%, 10% quarter-to-quarter for the last four, five, maybe even six quarters at this point. What had happened was remember at the beginning of that previous fiscal year we were running chip business much heavier so then we reduced the chip business and they’ve been pretty consistent at the same level since we went through that. I would also tell you Andrew that we have renewed the Sumitomo agreement for fiscal 2009 and its at a similar level as where we finished last year’s. The business is pretty stable right now.

Andrew Huang – American Technology Research

That’s all basically consistent with your goal of keeping that chip business flat sequentially going forward?

Charles M. Swoboda

Yes, the idea is to keep the chip business in a similar scale level as it is today. We like that business, merchant chip sales is good for us, it lets us go after – we have customers that can get to markets that we can’t get to and it builds scale for us from an overall factory standpoint and at the same time we’re not afraid of designing a new product and letting some of the old business go away and that’s kind of the strategy.

Andrew Huang – American Technology Research

On LLF, I think you put out a press release on IHOP, I’m just curious are there any kind of new major customers wins or kind of nationwide chains that you’re talking to?

Charles M. Swoboda

What I can tell you Andrew is there is testing going on at many of the nationwide chains you might be familiar with to test the products. The IHOP tests, just so you know, was a test by one of their franchisees in Virginia and what we’re now working on is how do we take those tests and convert those in to more of a national level roll out? We are having continued success in getting tests but we don’t have anything – we’re not prepared to announce anything on a national roll out but we’re absolutely working on it and I would imagine if the tests were successful that’s part of the sales plan for fiscal 09. We need to turn some of those tests in to bigger roll outs and that’s our goal for the year and at this point we remain optimistic that we should be able to make that happen.

Raiford Garrabrant

Thank you for your time and we appreciate your interest and support and look forward to reporting our first quarter of fiscal year 2009 results on October 21, 2008.

Charles M. Swoboda

Thank you.

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