Wolfspeed Inc (WOLF) 2005 Q3 法說會逐字稿

Good afternoon.

At this time I would like to welcome everyone to the Cree, Incorporated third quarter 2005 fiscal year financial results conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks there will be a question-and-answer period. [OPERATOR INSTRUCTIONS] As a reminder, ladies and gentlemen, this conference is being recorded today, Thursday, April 14, 2005.

Thank you.

I would now like to introduce Cynthia Merrell, Chief Financial Officer of Cree, Incorporated.

Ms. Merrell, you may begin your conference.

Thank you and good afternoon.

Welcome to Cree's third quarter of fiscal 2005 earnings conference call.

Before we begin the call, I want to take the opportunity to introduce and welcome Raiford Garrabrant, who is Cree's new Director of Investor Relations.

Some of you may have already met Raiford, while others will be meeting him over the next several months.

Raiford is a CFA and, prior to joining Cree, was a buy-side portfolio manager for almost ten years; and we are pleased to have his level of talent and analysis as a part of our internal team.

With that, I would like to introduce Raiford Garrabrant.

Thank you, Cindy.

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 919-313-5300, and we will be pleased to assist you.

Today Chuck Swoboda, our President and CEO, and Cindy Merrell, our CFO, will report our results for the third quarter of fiscal year 2005.

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

These may include comments concerning trends in revenue, gross margin and earnings, plans for new products and other forward-looking statements indicated by words like anticipate, expect, target, and estimate.

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

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

Also we'd like to note that, as a result of SEC rules, we will be limiting our comments regarding Cree's third quarter of fiscal 2005 to a discussion of the information included in our earnings release and the materials posted on our website, which you can find at www.Cree.com by clicking on investor information, and then click on financial metrics.

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 or reproduction 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.

However, we recognize that other investors may have additional questions, and we welcome you to contact us after the call by e-mail or phone at 919-313-5300.

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 April 28, 2005.

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

Thank you, Raiford.

For our third quarter of fiscal 2005, we reported revenue of $96.7 million and net income of $20.7 million, or $0.27 per share, which is in line with our previously announced targets for the quarter.

Overall gross margin increased to 53% in Q3 due to strong growth in high brightness LED product sales that offset softness in our mid-brightness category and shifted the overall product mix to the higher end, which resulted in a 6% increase in overall LED ASPs.

Gross margin also benefited by approximately 2 percentage points in Q3 due to adjustments made to the Company's sales return provision.

We were successful in managing LED costs through a combination of process improvements, productivity gains and better execution on the three-inch conversion.

For the quarter, approximately one-third of LED chips were produced on three-inch wafers and we plan to increase this percentage over the next several quarters as we qualify additional products and obtain customer approval for the conversion.

We continued to focus on R&D across our product lines during the quarter with a heavy emphasis on brighter blue and green chips, as well as further expansion of our high power LED product family for lighting applications.

As we start the fourth quarter we need to build on our success from Q3 while continuing to manage the current and emerging challenges in our business.

Based on comments and feedback from a number of sources, overall market demand for high-brightness LEDs declined in the third quarter due to a variety of factors including the seasonal trend for mobile phones.

As we look ahead to the fourth quarter, we are optimistic that demand may increase although the overall growth in the high-brightness LED is expected to be lower in calendar 2005 than it was in 2004.

To achieve our revenue growth objectives in calendar 2005, we need to continue to develop new products that enable our customers to grow their business through both new design wins and increased market share in key applications such as mobile phone back lights.

This market is dominated today by one major supplier, and we anticipate that the competition for these designs will be fierce, which means our ability to provide higher performance LEDs at lower costs will be critical factors to our success.

In addition to developing new products, we need to continuously reduce costs through productivity gains and yield improvements across the factory.

We also need to continue to manage the challenges, risks, and complexities associated with our conversion to three-inch wafers.

We need to develop higher performance products and increase our sales, marketing, and applications resources to drive the design activity for high-power packaged LEDs and silicon carbide Schottky diodes.

Growing a business based on new and disruptive technologies is more often a marathon than a sprint and although we must manage near-term execution, we need to stay focused on the issues that are critical to driving our long-term success.

In the fourth quarter we are targeting Company revenue to increase to a range of 98 to $102 million.

LED revenue is targeted to be the primary driver of this increase with some incremental contribution from government contracts.

One of the key factors to meeting our targets will be our ability to increase yields of our highest performance chips to enable our customers to increase market share in key applications, such as mobile phone back lights.

We currently have approximately 75% of our target revenue booked or under contract for Q4, which is similar to last quarter.

We target sales growth across our LED product families in the quarter as overall mobile phone demand increases and drives demand for both the mid-brightness and high-brightness categories.

As a result blended LED chip ASPs are targeted to decline 5 to 7% in the fourth quarter primarily due to market-driven price reductions.

To put this in perspective, if our ASP in the fourth quarter is in this target range, it would result in an overall 20% ASP reduction for the last 12 months, which is in line with historical trends.

Based on our current forecast product mix pricing trends, and target cost reductions, overall Company gross margin is targeted to be approximately 50% in the fourth quarter.

Q4 operating expenses are forecast to increase with targeted revenue growth as we continue to invest in product R&D while expanding our sales and marketing efforts to drive XLamp and Schottky diode product sales.

Based on these assumptions, we are targeting Q4 earnings of $0.25 to $0.28 per share.

We remain optimistic about the opportunities to expand our business for LED chips, XLamp and silicon carbide power devices and, therefore, continue to invest in new capacity and factory expansion.

The new building on our Durham campus for crystal growth through epi processes is on track and should be ready by the end of the calendar year.

We are still developing the time line for when we will need to bring our new RTP wafer fab on line, but we are getting the facility infrastructure prepared in the interim.

We are qualifying the first products at our Asian subcontractor for our back-end die fab operations, which should be completed by the end of our Q4.

We target capital spending in a range of 135 to $145 million for this fiscal year and plan to continue to invest in new equipment as we bring on line our new facilities in fiscal 2006.

LED sales for Q3 increased 2% sequentially and were led by strong growth in high-brightness chip sales, which drove the overall mix towards the high-brightness category; which increased to 66% of LED sales.

High-brightness LED demand was driven by white mobile phone applications for LCD backlighting, white key pads, and flash; as well as strong seasonal increase in demand for Pachinko machines in Japan.

This increase helped offset the overall softness in demand for mobile phones and lower demand for our mid-brightness chip products for the blue keypad application.

We were successful in ramping up capacity for the high-brightness X products in Q3 to meet the increase in demand, although we still need to improve our yields to meet demand for the very top bins of our blue and green product range.

As we look ahead to the fourth quarter, we target overall mobile demand to grow for both our mid-brightness and high-brightness products, as well as incremental growth in automotive and lighting applications.

On the R&D front, we continue to focus on brighter blue chips as well as renewed focus on brighter green chips.

The mobile phone market is driving demand for even brighter white LEDs, which require brighter blue chips that are optimized for both the chip lead and side looker packages.

Although our major customers have indicated that they can serve the current market with our high-end MB, XT 21 and XT 24 products, they are pushing for more XT 27 and brighter chips to raise the white performance bar even further.

We are aggressively pursuing multiple R&D programs to meet these emerging requirements and target releasing additional blue chip products over the next several months.

The lighting and large-scale LCD back lighting market are pushing for both higher-power blue and green chips, for blue plus phosphor white applications, as well as RGB white applications.

We target releasing additional products to address these market requirements in the near-term and we see this as an area-- we see this area as an ongoing development opportunity and important differentiator for Cree in the market.

We made incremental progress growing sales for our high-power XLamp LED product line in the third quarter, as we increased our focus and investment on the sales and marketing front.

Although this business still represents a small percentage of overall LED sales we have won some new designs which should provide a solid foundation to drive growth as we head into the new fiscal year.

This week Cree is exhibiting at the annual LIGHTFAIR trade show for the lighting industry that is being held in New York City.

We are lighting our exhibit booth with a concept lighting fixtures using our XLamp LED products that deliver approximately 190,000 lumens of solid-state LED light at half the energy of traditional incandescent bulbs.

Although this is a technology concept at this stage, we believe our exhibit helps demonstrate to the lighting industry that LED lighting is not just a future idea but feasible with today's technology.

We need to continue to invest in new products and the sales infrastructure to win new designs, so based on what I saw at the trade show this week, I believe we are on the right track to build a formidable high-power LED components business.

In addition to our XLamp product line, we are pursuing new lighting component platforms that are being designed to address specific market requirements for applications like LCD TV and monitor back lights.

We are working on several prototype designs with potential customers and believe that we have a unique technical approach which can help accelerate the adoption of LEDs for this application by providing the required brightness and uniformity with superior power consumption, form factor, and cost.

Although we are still in the development stages we believe we can be an important player in this rapidly emerging market.

We continue to invest in IP to support our leadership in the LED market.

In the third quarter we announced that we have expanded our cross license with Nichia to include white LED technology.

We believe that this agreement not only reinforces the importance of each company's white IP, but paves the way for Cree to more aggressively pursue expanding the sales of our chip and packaged LED products for the white market.

The power device business continued to make progress in the third quarter.

We target continued incremental growth in our base Schottky diode business over the next several quarters driven by the current power supply applications.

We recently qualified our Sunnyvale fab to produce 600-volt Schottky products, and we are working to build our sales, marketing and applications team over the next several quarters to expand our design activities beyond the power supply into new applications.

I would like to point out that there is a nice article about hybrid vehicles in the recent issue of Forbes magazine that provides a third-party perspective on the potential impact of power semiconductors in this exciting important market.

Silicon microwave sales declined in the quarter due to delays in designs at several customers.

We have-- we have been pursuing a couple of strategic alternatives over the last several months for the silicon portion of our microwave business and we're in the latter stages of the process.

We are currently targeting a decision and announcement during our fiscal fourth quarter.

In the meantime, we continue to shift our development emphasis to wide-band microwave applications where we believe we can offer a much stronger value proposition by leveraging our expertise in silicon carbide and gallium nitride.

The interest in silicon carbide foundry services remains high for military applications in the near-term and we continue to work on commercial applications for the longer-term.

We have transitioned the device portion of our laser development effort to our Santa Barbara R&D center.

Over the last several years, our primary approach has been to extend the lifetime of our devices based on the previous success we have had on silicon carbide substrates; however, we are also now working on devices made on gallium nitride substrates that are being produced at Cree using the technology we acquired from ATMI.

We're also working more closely with one of our development partners to accelerate the learning on device design and testing, and hope to make some significant progress over the next few quarters.

In the third quarter we delivered revenue of $96.7 million and earnings of $20.7 million, or $0.27 per share.

We were able to grow our LED business and maintain strong margins despite an overall slowdown in LED demand for the mobile phone market by increasing sales of our high-brightness products and managing costs.

As we head into Q4, we see good opportunities for growth and we need to stay focused on the key execution issues, such as developing brighter products, reducing costs, improving yields, increasing our sales and marketing efforts for the new businesses and managing the three-inch conversion.

Our fundamentals are solid and the balance sheet remains strong with cash and investments of $229 million.

In Q3 we took the opportunity created by the decline in our stock price to utilize some of our cash to buy back 1.45 million shares of our stock.

We are targeting a good fourth quarter with revenue increasing to 98 to $102 million and earnings of $0.25 to $0.28 per share.

In closing I would like to point out that although Cree is often judged by the near-term success of our chip business, this is actually a very narrow view of what we are working on for the future.

We have an envious technology portfolio, not only for LEDs and lighting, but also for wide bandgap power and microwave applications, which puts us in a strong position to grow in several parallel markets.

We intend to highlight the potential of these markets over the next few quarters, and look forward to the next several years as we demonstrate the real impact of this technology.

I will now turn the call over to Cindy.

Thank you, Chuck.

For the third quarter of fiscal 2005 we reported revenue of $96,710,000, which was similar to our second quarter results and was in the upper range of the guidance we announced on the last conference call.

For the nine-month period ended March 27, 2005, revenue was a record at $290,181,000, which was slightly below our revenue reported for all of fiscal year 2004.

For the most recent three-month period we also reported net income of $20,683,000 which included approximately $25,000 of net adjustments for certain accounting changes and taxes that did not change our reported earnings per share.

These adjustments included benefits to cost of sales which increased our gross margin by approximately 2 percentage points resulting from a change in our accounting for sales returns.

The sales return provision benefit was mostly offset with non-operating tax adjustments that were associated with a decline in the value of the Company's marketable securities, offset partly by a gain on the sale of a portion of these securities and other items.

Overall EPS was $0.27 and $0.91 per share for the third quarter and nine months ended March 27, 2005, respectively.

For the third quarter of fiscal 2005, LED revenue grew 2% sequentially to $80,634,000, and made up 83% of our overall sales.

Unit shipments declined 4% over the December quarter, but were more than offset by a 6% sequential rise in the blended average LED sales price as our product mix moved towards our high-brightness devices.

As a result, revenue from sales of our high-brightness products increased from 52% to 66% of LED revenue, while revenue from sales of our mid-brightness devices declined from 42% to 31% of LED revenue.

Revenue from the sales of our standard brightness chips also declined from 6% to 3% of LED revenue during this time.

During the third quarter, our LED revenue was negatively impacted by a one-time accounting change for deferred revenue and sales return allowances.

While this change decreased our LED revenue by approximately $441,000, it mostly impacted our balance sheet and gross margin.

Based on a detailed analysis of our overall sales return patterns, we believe that our estimated returns are better reflected by increasing our accounts receivable allowance reserve by $8.5 million over the December 2004 balance; which lowers our net accounts receivable balance, rather than recording estimates for future sales returns as deferred revenue.

With this change we have also reduced deferred revenue, which is a short-term liability, by $8 million as compared to the December of 2004 balance.

We expect this change to be neutral to our LED revenue going forward.

During the third quarter, we have also reclassified how we record foreign currency provisions that are contractually provided by certain of our customers.

As a result, during the third quarter, we reported $111,000 as LED revenue rather than other non-operating income.

We have now reflected this reclassification in the comparative periods of our financial statements.

Material sales were 8% of revenue for the March quarter, declining 14% sequentially to $7,594,000.

Material sales includes revenue for wafer and gemstone products.

Our wafer volume decreased 23% while our average sales price for wafers grew 2% compared to the December quarter, due to changes in our product and customer mix.

Our gemstone materials revenue increased 13% quarter-over-quarter to $2,057,000.

For the March quarter, revenue at Cree Microwave Sunnyvale declined 37% sequentially to $957,000 due to product delays from our customers.

We expect that this negative trend may continue because of ongoing customer delays.

During this time our advanced device products, which include silicon carbide Schottky diode and microwave sales, remained stable at $2,002,000.

Contract revenue made up 6% of our overall sales in the third quarter of fiscal 2005 and declined 9% sequentially to $5,474,000 as some of our older contracts ended.

Gross margin for the third quarter increased to 53% of revenues compared to 50% reported in the December quarter.

This increase was a result of two accounting adjustments and improved profitability for our LED product as our blended average LED sales price increased by 6% sequentially, while our blended average costs decreased 5% over the second quarter as we shipped a greater mix of our high-brightness products.

For our fiscal third quarter, we were successful in ramping up production of our X-class product, which enhanced our overall yield.

During the March, 2005 quarter, cost of sales also benefited from two adjustments that were associated with the change in accounting for sales returns.

In accordance with Generally Accepted Accounting Principles, when estimating sales returns from customers, the Company must also estimate the value of product that will be returned to inventory in the future from sales returns as a reduction in cost of sales.

Therefore, as of March 27, 2005, we reduced cost of sales by $1,630,000.

In addition, we also reduced our reserve for warranty cost by $582,000 which was mostly offset by the reclassification of $404,000 for patent amortization to cost of sales from research & development expense.

Our financial statements for comparative quarters have now been adjusted to reflect the patent amortization reclassification.

As a result of these adjustments, combined with the revenue impact from the change in our sales returns, our overall gross margin benefited by approximately 2% in the third quarter.

For the three months ended March 27, 2005, Cree Microwave lost $2.9 million pretax, and we do not target changes in business trends for this unit at this time.

Contract margins also improved from 16% to 22% of revenue sequentially, due to the mix of contract work that was performed.

Operating expenses, which are comprised of research & development and SG&A costs, increased from 20% to 22% sequentially.

During the third quarter research & development expenses remained even at $11.5 million, while SG&A costs increased by 15% to $9 million.

During the second quarter of fiscal 2005, SG&A expenses were lower as we accrued $1.2 million reimbursement approved by our D&O insurance carrier for certain legal fees related to securities litigation.

In addition, in the March quarter, our Sarbanes-Oxley 404 implementation costs increased by $186,000 sequentially.

Net interest income increased from $1.1 million to $1.4 million in the March quarter as interest income in the December quarter was offset by an adjustment of $265,000 for interest expense resulting from a settlement that was made relating to state income taxes from a prior year.

During the third quarter of fiscal 2005, we sold 343,000 shares of our investment in Color Kinetics, which generated a $2.8 million gain that is included in non-operating income.

As of March 27, 2005, we held 1,859,442 shares of Color Kinetics common stock as a marketable security.

In the third quarter of fiscal 2005 we also sold our investment in Lighthouse Technologies at its carrying value.

As a result, we no longer have any privately held investments that have a net carrying value on our financial statements.

During the third quarter of fiscal 2005 our income tax expense included $3.2 million of adjustments that increased our overall expense.

Cree made a pre-IPO investment in Color Kinetics which went public in June, 2004 and as of December 26, 2004, Cree had a $22.5 million unrealized gain on the investment recorded as comprehensive income based on a closing market price of $15.98 per share.

Because Cree had a prior year like-kind capital loss that was carried forward for tax purposes, under Generally Accepted Accounting Principles, we were required to reverse a portion of the tax reserve associated with the capital losses that were recorded in the prior year in the December quarter.

As a result, Cree reduced its income tax expense by $7.9 million in the second quarter of fiscal 2005.

As of March 27, 2005, the market value of Color Kinetics stock had declined to $10.01 per share, therefore, we had to increase our tax expense by $4.1 million to adjust for the change in market value in the March, 2005 quarter.

Going forward, the Company will be required to continue to record the tax-effect of any increase or decrease to the value of its investment in Color Kinetics as a reduction or increase in our tax expense.

Also in the third quarter of fiscal 2005, we determined that our effective tax provision rate had dropped from 32.2% to approximately 31.1%.

Therefore, in the March quarter we recorded a year-to-date tax benefit of $716,000 associated with the change in estimate.

We also recorded approximately $200,000 in other tax benefits during the third quarter.

At this time we target that our tax provision will be approximately 31.1% for the fourth quarter and fiscal year of 2005.

In May, 2004 our Board of Directors authorized an additional 5.1 million shares to be repurchased under our stock repurchase program.

During the March quarter we repurchased 1,450,000 shares of our common stock for $35.3 million, or an average price of $24.32 per share.

As of March 27, 2005, we had 5.5 million shares remaining under the program that have been authorized for repurchase.

During the third quarter, our cash and short-term investments declined from 287 million to 229 million, sequentially, due to our $35.3 million stock repurchase combined with capital spending of $37.2 million.

Our cash flow from operations was $16.6 million and $109.3 million for our third quarter and nine-month periods ending March 27, 2005, respectively.

Our day sales outstanding was 38 days based on our trailing monthly revenue profile.

And our inventory days on hand increased from 47 to 57 days during the third quarter.

The majority of the $4.3 million sequential rise in inventory resulted from a $3.1 million increase in wafer and LED work in process and finished goods inventory.

Due to the softer seasonal demand in our third quarter, most of our third quarter shipments were made in the month of March, which required us to build certain products in advance of receiving specific orders.

We also built inventory to support the qualifications of our contract manufacturer in Asia and our continued transition to three-inch wafers.

Our inventory balance was also ahead of our targets as we exited the third quarter due to improved production yields during the month of March.

The remaining $1.2 million increase in inventory was for raw materials for our X-class product and higher inventories of our power devices as we transitioned their production to our Sunnyvale facility.

Capital expenditures for the third quarter were $37.3 million mainly to support the capacity increases over the long-term for our LED production for equipment in epi, wafer fab and die test areas of the factory.

In addition, we purchased an existing wafer fab facility in Research Triangle Park, North Carolina.

Year-to-date we have now spent $119.9 million in capital expenditures and we target capital expenditures to be 135 to $145 million for fiscal year 2005.

Yesterday the compensation committee of our Board of Directors approved a resolution accelerating certain of the outstanding stock options previously issued to employees that are out of the money as of the market close on Friday, April 15, 2005.

This acceleration plan includes resale restrictions for our executive officers and members of our senior management team.

Out of money options held by non-executive directors were not accelerated.

In light of the upcoming changes in the accounting treatment requiring companies to expense stock options, the compensation committee determined that it would be prudent to accelerate these options to avoid recognizing future compensation expense associated with the options under the new accounting rules.

The Company is still reviewing all forms of compensation for its employees for the upcoming fiscal year and we will discuss any further changes to our compensation policy on our fiscal fourth quarter conference call.

As we begin the fourth quarter of fiscal 2005, we target revenue to increase to a range of 98 to $102 million; as we anticipate that the handset market will improve during the quarter and create more demand for our LED chips.

We target gross margin to be approximately 50% of revenue, plus or minus a few points, as we continue to migrate three-inch wafers for LED products and target depreciation expense to again increase as we continue to bring on capital equipment in-- online for the longer term.

Operating expenses which include R&D and SG&A are targeted to be in the same range as a percentage of revenue as the third quarter, but maybe slightly higher due to greater administrative costs for Sarbanes-Oxley 404 implementation and higher sales and marketing expenses for our new business units.

Therefore, based on an estimated 77.8 million shares outstanding, earnings per share is targeted in a range of $0.25 to $0.28 for our fourth quarter.

We are very pleased with our third quarter results as we were successful to ramp up our higher-brightness products for our new markets to offset the slowdown that we saw in blue keypad back light demand.

With the March quarter behind us, we are focused on meeting the challenges to achieve our growth targets in the fourth quarter.

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

Thank you, Cindy.

We'll now take analyst questions.

[OPERATOR INSTRUCTIONS] Christopher Montano, Wells Fargo Securities.

I had a quick question on the demand side of things.

Chuck, could you give us some color on the lack of demand across the board in the various markets that you're serving, to whatever extent you can?

Well, I mean, for the last quarter it was really, I would say, the biggest driver would have been really mobile phone driven.

And so we saw overall softness in products that would normally go there, whether that be the blue keypad application, or anything mobile phone driven was probably the single biggest driver in terms of softness.

There was some-- some general weakness in other areas but that's the only major one that stuck out.

Okay, as a quick follow-up and then I'll quit, could you talk a little bit about progress in penetrating the display in the handset market?

Well we definitely started to get some additional traction last quarter.

At this point I would still say that our business for mobile phones is still much heavier towards the keypad side than it is the display, but we have started shipping some of our brighter MB and XT products which has helped us start to get some wins.

I think what we'll really see, though-- we'll see more of that hopefully in the fourth quarter, but there was some success last quarter and we would hope to continue that as we go into the next quarter.

Jed Dorsheimer, Adams, Harkness & Hill.

A couple questions.

Maybe, Cindy, you could help me, I think I need to put my accounting hat on this quarter.

If we could just run through maybe starting with the 8.4 million.

Did the structure at Sumitomo-- the Sumitomo contract or OSRAM contract actually change this quarter?

And if so, what were the -- what are the implications of those changes?

No, as we previously announced the Sumitomo and OSRAM contracts both were signed through June, 2005, so there's been no change in the contract as of the third quarter.

What has changed is we have now developed a history of sales returns, and under Generally Accepted Accounting Principles, when you have a history of sales returns you will do your best to estimate what those returns are and show them as a reduction of accounts receivable and discontinue showing deferred revenue; so that's what we did.

Thank you for the explanation.

The-- that 8.4 million, did that flow through as revenue this quarter or is that going to be in the guidance for the 98 to 102 million?

No.

As I said in my conference call script, we recorded an additional reserve to accounts receivable or that increased by $8.5 million, and deferred revenue has decreased by $8 million; so the net effect of that was actually a reduction in revenue in the third quarter of about $441,000.

We also mentioned that we do not expect any-- any impact to LED revenue going forward from this transaction.

And then on inventories, the rise, the-- with the finished goods and the wafer materials, or the 3.1; is that primarily for keypad-related business or for-- in the display?

Yes, Jed this is Chuck.

I would say that it's much broader than that.

It's more of a case of, with the quarter being fairly back-end loaded to March, we were put in a position to have to, frankly, build the forecast earlier on in the quarter and so it's really spread across our product lines.

I wouldn't put it in any one product area although, obviously, our higher volume product, on a percentage basis, I would estimate that it relatively reflects kind of our overall mix of our business.

And then, Chuck, maybe you could give us a little bit more color with respect to ASPs.

I mean, it looks like the ASP growth, you know, certainly benefited during the quarter is-- is a result of -- or let me ask.

What-- what would the ASP change have been during the quarter if you X out your XLamp product?

I think it would be just about exactly the same.

I don't think XLamp was a significant contributor in this quarter to the ASP.

So I think the trends would essentially be the same.

Well, what -- maybe ask it differently.

What percentage of sales was XLamp?

I know in the past you've said that it was sort of less than 1%, or given -- could you give us a range?

It's probably still in a similar range.

So less than 1%?

I don't know exactly but it would be pretty close to that.

And then, going forward, as we look at the, you know, the progress that you are making with respect to, you know, the mid-brightness and standard brightness and the high-brightness, is there -- have there been any changes with categories and what you consider mid-brightness, what you consider high brightness and, you know, is that going to change as some of the high-brightness products maybe are considered sort of mid-brightness out in the market?

Well, we haven't made a change internally for consistency sake.

And if we look at where most of our mid-brightness products get sold and our high-brightness, there's still a pretty big distinction.

Our high-brightness family is still generally geared towards the more high performance applications, whether it be a white keypad display back light or some of the outdoor signage-type applications.

And our mid-brightness is geared more towards the indoor-type products or the blue keypad-type applications.

So I think it's-- I don't think there's been a shift that would put us in a position where we would want to change that.

I think what you're seeing is just-- just a significant increase from a demand standpoint from an overall mix just, you know, a big shift towards the high-bright category last quarter.

Just a couple more.

The benefit from the gain on the securities, should we treat that as a one-time item or do you expect to continue selling securities in Color Kinetics and maybe some of your other stock going forward?

Well, it would really only be Color Kinetics and we don't have any specific plans going forward.

So I don't know that you could put that on an ongoing basis.

And then moving to, you know, some of the newer markets that are starting to adopt the technology, I think there's been -- well, I don't think, there's been a recent rumor about a design win at Samsung, and that you were actually designed into that product.

Can you give us any sort of commentary on the -- whether or not that's actually correct?

And the reason I ask is, some of the conversations that I've had with Samsung and at the same trade show you were at, suggests that Lumileds is actually the incumbent.

So I'm just curious if could you give any color around that?

What I can tell you is that we can't comment on any design wins at this point, and so I could tell you we are working with a number of manufacturers on some designs, but we do not have any designs that we can discuss or announce at this time.

And one last question.

You know, this is really the first-- I think we've talked about it before, but the first time in the history that I've been covering your stock that I-- I remember you specifically mentioning the Pachinko market.

And, you know, it seems as if that was a benefit this quarter.

I'm curious if you could give us a little color with respect to the products that are going into that market?

Are those typically high-brightness products?

And I guess that's about it.

Yes, I would say the Pachinko market is generally buying today products that would fall into our high-brightness category.

And they use them for a combination of things, both blue and green, and also some of them are used to actually make white.

So-- and it's an interesting segment of the business.

It tends to be a bit seasonal.

And so we had a nice-- it was a nice benefit to have that business start ramping up when you had the mobile phone market slowing down; so it worked out well.

What percentage of sales?

Or can you give us a range as far as what the size of that business is?

No, I can't break it out for you.

And, you know, you mentioned the seasonality.

So should we assume that business pretty much goes away in the June time frame?

Not necessarily, but I don't think you'll see the change you saw from Q2 to Q3 but, at this point in time-- it is an ongoing part of our business, it just kind of depends on what the trends are; but I would say, at least in the interim, it should be an ongoing part of the business.

So the driver of growth, I think you might have mentioned this in the script, is really predicated on handsets in the second quarter, or-- or a resumption of sales demand there?

I would say it's an overall rebound in mobile phone demand which should drive kind of the products across our business.

It's one of the reasons that we would expect it to be kind of balanced between mid-brightness and high-brightness next quarter, in terms of growth in both segments; and so that's kind of how we would look at it.

I also-- we also seeing-- we are also seeing some rebound in things like just the more traditional markets on the automotive side, and then lighting, these niche-type lighting applications continue to be something that, while small, can provide some growth opportunities for us.

Harsh Kumar, Morgan Keegan.

A couple of quick ones for you.

Chuck, you talked about improvements on-- in yields on the three-inch processes.

Can you just qualitatively give us some sense of how things are going there?

And also your comfort level with the process at this point in time and possibly a completion date?

Well, I can't give you a completion date because it's an ongoing process.

Obviously our goal, as I said earlier, is to continue to increase the percentage over the next several quarters.

I think probably the most important thing to note is that, you know, the three-inch is going well enough, in addition to all our other cost reduction activities, that it's supporting our current business strategy.

So, as you can see this quarter, in both our-- our ability to meet the revenue side but also on the cost side in terms of gross margin, that it has enabled us to do that.

And I think we're well positioned to do that going forward.

As any conversion, though, there's ongoing challenges and we've got to continue to manage them, but we're pretty happy with the progress we made last quarter and we're looking forward to more success in the quarter ahead.

The other thing to keep in mind, Harsh, is that there's really two factors.

There is our ability to ramp it up, which I think we've done well over the last quarter, we have to get new products converted, and then we still have to get customer approval in many cases for those new products.

So it's a combination of factors that's driving it.

Okay.

And Cindy, a question for you.

What should we be assuming is a normalized tax rate going forward?

Yes, I said it'd probably be 31.1% in our fourth quarter and we have not yet put together our forecast for fiscal year '06.

Just following up on one of the earlier questions, Chuck, you said XLamp didn't really ramp very much in the quarter but your high-end products did.

Can you tell us what was working specifically for you in that high-end product?

Is there a particular product that stood out or an end market or application that stood out for that mix?

I would say it was a combination of products from the high-end MB to the XT 21's and 24's probably were the drivers, but-- and the applications ranged from, you know, the white applications that I mentioned earlier to the Pachinko applications.

Chuck if you were to guess what your percentage-- your split is for mobile applications between keypads and white LED, or back lighting, what would you say that was relative to, let's say, a quarter ago?

If you want to break out keypad--- keypad versus display or white versus blue?

Keypads versus display, let's do that.

I would say that on a keypad side that -- the blue side of it was clearly affected by the slowdown.

And on the white side, while we continued to have success, it was probably offset and balanced by the slowdown and then we'd had some pickup, I would say, on the back light last quarter.

And probably a little pickup on the flash as well.

And last question, and I'll turn to the somebody else.

You talked about a strategic decision to close the microwave business.

If I'm reading that correctly you lost about $2.9 million.

When we model going forward is that going to come back pretty much immediately or can you give us some guidance on that?

I actually think you misheard what I said.

I said that we are-- have a number of alternatives we're looking at, we're getting close to making a decision; and we expect to make that decision in the fourth quarter, but I did not say what that decision would be.

Hans Mosesman, Moors & Cabot.

A couple questions.

Let me go back to the 8 million deferred revenues, just to get a sense-- what was the impact to gross margins or the average selling prices by taking this to zero in the March quarter and adjusting accordingly on the AR line?

Hans, we said the impact was a reduction in revenue of $441,000 of making this change.

Right, in terms of gross margins, what would that be?

Well, in terms of gross margin, we also had a pickup on the cost of sales line item as well of about 2 percentage points.

Okay, let me have a follow-up here on the Pachinko side.

I understand it that-- I guess, Chuck, you can't at this time split it out in terms of the percentage of LEDs?

Yes, I don't have a specific breakout for you.

It obviously grew a lot last quarter, but it's not something I have a specific breakout for you on.

What has it been historically?

It ranges depending on what the demand is on a quarter-to-quarter basis.

It's going to move up and down, it's not something we've typically broken out specifically; but since, you know, anticipating the question of what was growing, if mobile phones wasn't growing, the market was down, it was a pretty interesting pickup for us last quarter so we thought we'd mention it.

Okay.

And then, lastly, in terms of the inventory situation, it's going up in the high double-digits.

Are you changing your manufacturing strategy at all in terms of perhaps slowing down, or are you going to continue at the pace that you suggested at the beginning of the calendar year?

I think that right now we continue on the overall investment in the factory standpoint.

In terms of how hard we're running it, it's really a balance, you know, we tend to run our factory fairly highly utilized, or at least that's our goal.

And so we try to find that balance.

When the orders aren't linear, then you have to make some choices early on in the quarter.

And so we're trying to find that balance.

We'll keep evaluating it each quarter and see if we can't tune it in a little better going forward.

Thank you.

At this time, there are no further questions.

I will now turn the call over to Mr. Raiford Garrabrant for closing remarks.

We appreciate your interest and support and look forward to reporting our fourth quarter and fiscal year 2005 results on August 11, 2005.

Please note that this date is two weeks later than our normal year-end conference call, but we want to be able to complete all of our requirements under the Sarbanes-Oxley 404 law prior to releasing our financial information.

Thank you.

This concludes today's Cree, Incorporated third quarter 2005 fiscal year financial results conference call.

You may now disconnect.