Wolfspeed Inc (WOLF) 2006 Q3 法說會逐字稿

Good afternoon, my name is Angela, and I will be your conference facilitator today.

At this time I would like to welcome everyone to the Cree, Incorporated third quarter 2006 fiscal year financial results conference call. [OPERATOR INSTRUCTIONS] Thank you.

I would like to introduce Raiford Garrabrant Director of Investors Relations of Cree, Incorporated.

Mr. Garrabrant you may begin your conference.

Thank you Angela, and good afternoon.

Welcome to Cree's third quarter fiscal 2006 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 919-313-5300, and we'll be pleased to assist you.

Today, Chuck Swoboda, our Chairman and CEO and and Cyndi Merrell, our CFO, will report on our results for the third quarter of fiscal year 2006.

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

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

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

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

Also, we would like to note that as a result of SEC rules, we will be limiting our comments regarding through third quarter the fiscal year 2006 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 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 recordings of this call is 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 site] 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 May 4, 2006.

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

Thank you, Raiford.

For the third quarter, we delivered record revenue of $107.7 million with net income of $24 million or $0.31 per share.

Our results included a $0.05 per share benefit related to taxes.

If you include the tax benefit, earnings were within our target range.

LED revenue for the quarter was in line with Q2 as seasonal slowness in the LED chip business was offset by strong XLamp sales, which were capacity limited in third quarter.

Gross margin for the quarter was 48%.

Which was slightly lower than Q2 but in line with our target range.

As XLamp and other new product lines ramp up we target initially lower gross margins until the product volume increases to a level that provides efficiencies of scale.

Operating expenses were slightly lower than our target of 25% of revenue, primarily due to lower R&D expenses, as we redirected resources and capacity to meet the product mix for LED chips and overcome some vendor related manufacturing issues in silicon carbide wafer production that has since been resolved.

As we look to our targets for the business areas, we remain on track to grow the XLamp product line to 10% of our overall LED sales and have a TV or monitor commercially released using our Colorwave LED backlight technology by the end of this calendar year.

As we start the fourth quarter, we are focused on a number of challenges in both our existing businesses as well as our new efforts in LED lighting, LCD backlighting, and power semiconductors.

We are moving our advanced device wafer fab in the fourth quarter from our Durham campus to the RTP campus to provide additional capacity and room to grow.

In the short-term, this will add incremental expenses, and additional execution challenges, associated with bringing the new fab on line while limiting our capacity and revenue for both high powered products and contract research.

To win in the white LED market, we need to continue to develop higher performance chips as well as packaging technology to improve the performance of our customers' white LED products.

We are working with our customers in a race against our competitors to win new white designs by offering higher performance and lower costs, which means we must continue to increase LED chip yield and factory productivity to support the market pricing requirements.

We need to complete our XLamp subcontractor qualification this quarter to support the higher sales targets.

We also need to increase our XLamp product presence in the lighting market through increased advertising, trade shows, and channel development.

Although the combination of managing our current LED business, while investing in several emerging new businesses, has created new challenges for our team, we're making good progress and positioning the Company for growth in the year ahead.

Q4 will be a transition quarter for Cree, as we add incremental expenses to support the emerging businesses and our new RTP fab without the benefit of significant incremental revenue to offset these investments in the short-term.

For the quarter we're targeting revenue in a range of $106 million to $110 million.

The target range is based on increased LED sales and incremental growth in high power products, partially offsetting lower silicon carbide wafer sales and contract revenue.

Although we have additional demand for high power products and contract research, the advance device wafer fab move is expected to limit Q4 sales in these areas.

For LED's we are targeting strong growth from our chip customers outside of Japan and XLamp to more than offset lower LED chip sales in Japan.

Based on recent orders and customer expedite requests, we target that LED chip sales for certain high brightness and mid brightness products for mobile application will be capacity limited in the quarter.

We currently have a little more than 80% of our target revenue booked or under contract for Q4.

Our current revenue forecast projects a heavier mix of new products including XLamp LED's, high end XR chips and silicon carbide [shockee] products, which currently have lower margins than our Company average.

This mix shift, combined with incremental costs associated with the new RTP fab, overall LED pricing trends, and planned cost reductions is targeted to result in overall Company gross margin for Q4 in a range of 46 to 47%.

Q4 operating expenses are targeted to increase by approximately $2.4 million to 26% of revenue as we increase R&D to support the new product lines, increase SG&A to support our expanded sales and marketing activities, and we incur approximately $1.3 million in incremental operating costs associated with the move to RTP.

Based on these assumptions, we are targeting Q4 earnings of $0.22 to $0.24 per share.

We currently target that some of the incremental costs we are adding in Q4 to support the move to RTP will be offset by incrementally higher revenue from high powered products and contract research in Q1.

The LED business continue to makes progress in Q3 as the XLamp product line grew nicely, which helped offset a seasonally slower quarter for LED chips in mobile phones.

As we indicated last quarter, the business in Japan is running below our original plan due to a combination of lower than expected [pachinco] demand, slower progress in winning new white design, and the impact of a stronger dollar versus the yen.

The trend in Japan has been offset by strength from our customers in other regionals due to new mobile white design wins, growing power chip demand and increase mid brightness sales.

The strength of our LED chip business from customers outside of Japan has significantly increased, which is consistent with comments from other suppliers in our industry who are also forecasting increased demand.

Overall LED ASP trends decreased in line with our target range at 5% although there was more pricing pressure in the mobile white applications due to increased competition for market share between our customer, [Nachia], and TG.

Our LED R&D teams continue to make brightness improvements in the third quarter to our XR chip products which is currently being used by our customers for high performance white mobile LCD backlight applications.

Our R&D focus has now shifted to finishing the development of our first EZBright chip product and working through the qualification process with our customers.

The preliminary customer feedback on EZ has been positive and we're optimistic that this product will not only be easier for our customers to use but should provide a platform, which gives uses higher performance and better margin leverage for the high end white applications going forward.

We target the initial EZBright production ramp up starting in the second second half of Q4 with the first volume shipments starting in fiscal Q1.

In the high power LED segment our XLamp product continue to gain acceptance in the market as we raise the performance bar for high power white LED's.

During the third quarter, we introduced a new, brighter XLamp that delivers 57 lumens at 350 milliamps, which is 47 lumens per watt.

We also announced the new warm white XLamp product for emerging residential lighting applications requiring color temperatures in the 2900 to 4500 kelvin range.

We continue to work on additional improvements for the XLamp product family including bright brighter, more efficient versions in which we plan to utilize our new EZBright power chip.

In addition to our product resultment efforts, we continue to expand our sales, distribution, and application support around the world.

Over the next few quarters we plan to launch a new marketing campaign to help drive awareness for Cree, our XLamp products and LED lighting.

Although XLamp is still a relatively new product line for Cree, we're confident that as we build our sales and marketing capability, and raise the performance levels for power LED brightness and efficiency, we can start to enable our customers to win more lighting business with LED-based products.

The Colorwave development team continues to build and refine our LED backlight unit technology at the LED component and systems' level.

Like any new technology development, we're working through a variety of challenges related to both the design and manufacturer of the Colorwave product and how our product integrates into the customer's end product.

At this point, we remain on track to meet our target of having a commercial TV or monitor released by the end of this calendar year.

In the high power product area, we are focused on transferring wafer production to our new RTP wafer fab.

Although this transition is expected to limit our capacity during the fourth quarter for both high power products and government contract research, it is an important investment to support the longer term growth of these businesses.

Over the last quarter, we have seen increased design wins for our silicon carbide Schottky diode products and power supply applications, and we're going need additional capacity in our new fab to support the projected growth in fiscal 2007.

Based on our current forecast, this business could be capacity constrained for the next few quarters while we ramp up the RTP fab.

Although today this is still a relatively small product line compared to our LED business we're becoming more optimistic the Schottky diode product could become a more significant growth driver in 2007.

I'm pleased to announce that Mike [McDevit] will be taking over as CFO on an interim basis, effect May 5.

Mike has spent the last three and half years with Cree in the senior financial positions of Corporate Controller and, most recently, as Director of Financial Planning.

I'm confident that Mike's financial leadership and experience will enable us to make a smooth transition and stay focused on our near term objectives while we continue the search and take the necessary time to make sure we find the right person to help us grow the Company to the billion dollar sales lever and greater.

With our technology strength and the emerging market opportunities we remain confident that Cree is in a unique position to grow our business by transforming the value proposition for both lighting and power switching applications.

Our primary strategy has, and will continue to be, to invest internally to develop the technology and infrastructure to achieve these objectives; however, as we develop our longer term plans, we're starting to look beyond our walls for ideas that could be integrated to make our core strategy to make our technology stronger, enable on us to better meet a marketing need, or improve our access to customers who can drive our growth.

In the year ahead, we plan to evaluate some external investment opportunities to use some of our financial resources to either acquire complementary technology or increase the overall scale of our business.

I'll now turn the call over to Cyndi.

Thank you, Chuck.

For purposes of our discussion today, all financial metrics will be based on results from continuing operations as we discontinued our Cree microwave Sunny Vail business in the second quarter of fiscal 2006.

In the third quarter of fiscal 2006, we reported record revenue of $107.704 million, which is slightly greater than the midpoint of the guidance range in the last conference call.

Revenue increased 2% sequentially due to higher sale of our XLamp devices, silicon carbide materials and high powered product.

These increases in our business were offset by slightly lower LED chip sales.

For the nine month period ending March 26, 2006 revenue was also a record at $316.246 million.

For the most recent three month period we also reported net income after discontinued operations of $24 million or $0.31 per share.

These results included two tax adjustments totaling $3.745 million, or $0.05 per share that benefited our net income in the third quarter.

For the nine month period, net income after discontinuing operations was $63.430 million, or $0.81 per share.

During the third quarter, of fiscal 2006 LED sales were even with results from the December quarter at $86.450 million and made up [88%] of our total revenue.

XLamp sales grew substantially; however this increase was offset by the seasonality of our LED chip business.

LED unit shipments increased 6% over the December quarter while our blended average sales price per LED declined 5% sequentially.

Despite the increase in XLamp sales during the March quarter, our mix of high brightness products declined from 38% to 33% of our LED revenue.

While our mid brightness devices increased from 62% to 67% of LED revenue.

As a result of the March quarter seasonality in our business, our high bright in the chip revenue was lower due to reduced demand for white mobile applications.

The trend was offset by increased demand for our mid brightness chips used for entertainment and other applications.

Material sales, which include wafer and [gemstone] materials were 9% of revenue for the third quarter, increasing 10% sequentially to $10.020 million.

Wafer revenue grew 14% to $6.211 million due to a change in product mix.

Revenue from [gemstone] materials increased 4% sequentially to $3.809 million.

[Inaudible] high powered products, which include Schottky diode and wide band gap microwave sales increased 4% sequentially to $3.838 million, and made up 4% of our overall revenue for the third quarter.

Contract revenue increased by $387,000 sequentially to $7.326 million and made up 7% of total revenue for the March quarter.

During the third quarter, fiscal 2006, gross margin was within our guidance at 48% of revenue.

Our overall LED profitability declined sequentially as blended average sales prices decreased 5%, while our average LED cost remained even.

Our average sales price decline was primarily due to a product mix shift towards our lower priced [lithrightness] devices and competitive pricing pressure on our high brightness chips.

Our blended average cost was even with the December quarter as the benefit our mix shift in mid brightness products was offset by a ramp us of new high brightness chips and XLamp products, which had a higher average cost as a result of lower yields.

During the March quarter, approximately 83% of our chips and 65% of our wafers were made from our 3 inch platform, which also lowered our blended average cost.

During the third quarter of fiscal 2006 we continued to improve the gross margin of our XLamp products; although the gross margin on these products is still below our Company average, we target additional improvements over the next several quarters as we ramp up a higher volume of these products.

Contract margins declined sequentially from 28% to 26% of revenue due to the mix of contracts under which work was performed.

Research and development expense were 12% of revenue for the three months ended March 26, 2006 and declined $1.5 million, or 10% sequentially to $13.3 million as we ramped up newer high brightness LED products in production, and we redirected resources and capacity from R&D to meet our production needs.

SG&A expenses were 11% of revenue, increased by $992,000 to $11.8 million due to higher sales, marketing and administrative costs to support our newer businesses.

Net interest income increased from $3 million to $3.5 million sequentially due our greater cash balance and higher interest rates received [from our guffman].

During the third quarter of fiscal 2006, our income tax expense included two adjustments totaling $3.7 million, the first adjustment was a $2.339 million benefit related to our investment in Color Kinetics.

We'll be required to continue to report the tax [prospective] in the increased and decreased to the devalue of our investment in Color Kinetics as a reduction or increase to our tax expense each quarter.

The other adjustment was a $1.406 million benefit related to a prior year estimate that was true up as our tax return was filed during the March quarter.

Our actual tax provision for fiscal year 2006 is still estimated at 32%.

For the third quarter of fiscal, 2006, we recorded $294,000 of expenses, net of tax, as discontinued operations related to the Cree microwave Sunny Vail.

This net expense was primarily due to adjustments to our lease obligations for the facility and other minor on going maintenance costs.

During the March quarter, we did not repurchase any common shares outstanding that were previously authorized under a stock repurchase program, therefore our dilutes shares outstanding were [inaudible] million shares.

As of March 26, 2006 our balance sheet was solid.

Our cash, short-term and long-term investments grew from $338 million to $367 million sequentially as cash flow from operations was $35 million for the third quarter.

Our cash flow was primarily generated by higher sequential profits, which was partly offset by higher accounts receivable and inventory balances.

Our day sales outstanding based on trailing monthly revenue profiles increased from 37 days to 41 days sequentially, resulting in $11.3 million increase to our accounts receivable balance.

The rise in accounts receivable was mostly do to the timing of payments received from our customers.

We expect that our day sales outstanding will rise to approximately 45 to 50 days over the next several quarters, which is still below our industry average.

As a result of our higher sales, our inventory days on hand remained even sequentially at 46 days which reflected a $1.6 million increase in our inventory due to higher work in process balances to support our growing product lines.

Capital expenditures and free cash flow were $22 million and $12 million respectively for the third quarter of fiscal 2006.

We calculate free cash flow as cash flow from operations less capital expenditures.

At this time, we target capital expenditures for fiscal 2006 to be in the range of $80 million to $85 million, and we anticipate higher capital expenditures in fiscal 2007 as we continue to invest in capacity to support the LED chips, XLamp, Colorwave and high power product business.

For the fourth quarter of fiscal 2006, we target revenue in a range of $106 million to $110 million as we forecast the combined $2 million sequential decline in [sold] and carbide wafer and contract revenue to be more than offset by greater sales for XLamp and Schottky diode products as they continue to gain traction in the market.

We target gross margin in a range of 46 to 47% of revenue as the mix of our fourth quarter sales is heavier towards our newer products that generally have lower margins.

Research and development expenses are targeted in a range of 12 to 13% of revenue as we focus on developing our high power LED's and higher brightness LED chips.

SG&A expenses are targeted to be approximately 12% of revenue as we continue to invest in sales and marketing expenses for our lighting and power business units.

During the fourth quarter, we plan to move our high power business, including our related government contract work to the RTP facility that we acquired a year ago in order to expand capacity for our Schottky diode business.

As a result of this move, we anticipate that we will incur a one time charge of approximately $1 million to write off plant hook up costs at our main facility in Durham, and we target a $600,000 to $700,000 increase in cost of sales and operating expenses.

Therefore, we estimate our fourth quarter earnings to be reduced by approximately $0.01 to $0.2 per share related to the one time charge in additional operating expenses for the move to the RTP facility.

Based on an estimated 78.9 million shares outstanding, earnings per share targeted in a range of $0.22 to $0.24 for fourth quarter of fiscal 2006.

In the March quarter, we were very pleased to meet our revenue and earnings targets in a typically slow seasonal quarter for LED chips.

As we enter our fiscal fourth quarter, we must continue to make investments in our business in order to meet the growth objective for our XLamp and Schottky diode products.

These product lines, which are currently operating near capacity, are growing rapidly, and we target that they will help to drive higher revenue in fiscal 2007 and beyond.

On a personal note, I am pleased that Cree has appointed Mike [McDevit] as its interim Chief Financial Officer.

I've worked closely with Mike over the past three and one-half years and am confident that his transition will be seamless based on his experience with our Company combined with the strength of our finance team.

As you know, I'll be leaving my position with Cree on May 5th.

I want to thank all of my many associates in the Wall Street investment community and most importantly the employees and friends that I have worked with at Cree.

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

Thank you, Cyndi.

As you know this is Cyndi's last quarter as Cree's CFO, and I want to personally thank Cyndi for her many contributions to Cree's tremendous success over the last ten years.

With that we will now take analysts' questions.

[OPERATOR'S INSTRUCTIONS] Your first question comes from Harsh Kumar of Morgan Keegan.

Hi, guys, first of all, Cyndi, we're going miss you as you leave Cree and then I've got a couple of questions, starting off with a question for Chuck.

Chuck, can you give us an idea of how much revenue was left behind in this quarter and how much revenue you think you are leaving behind as a guesstimate or an estimate in the next quarter because of capacity constraints?

Boy, Harsh, I don't have an exact number for you.

I would tell you that in the last quarter, it was primarily--probably the biggest limitation in the last quarter was on both the XLamp and Schottky business.

I think for this quarter, I would expect that we're working pretty hard to get our subcontractor ramped up on XLamp.

So that should hopefully give us a little bit of breathing room.

But now I actually see that shifting to the chip business, especially some of the higher performance products both in the mid brightness and hight brightness category for the mobile phone segment.

So I don't have a good number for you, Harsh, it's a---the ramp up in demand has been something that's occurred really over the last six weeks, especially on the chip side, so I think right now it's a little too early to estimate.

We're working pretty hard to see what we can do to increase capacity.

You also---Chuck, you also said XLamp was up pretty nicely or pretty strongly; can you give us a sense of how much that was or any other indication such as backlog or anything you can help us gauge how much of a growth we had in that sector.

Yes.

You know, Harsh, we don't break it out.

What I can--all I can really say is I think we had a nice growth last quarter and we would expect a similar kind of growth this quarter.

So, we're kind in in that same level on a relative basis, we're looking for kind of the same on the incremental growth and hopefully, if the sales funnel holds true that we can continue to have that kind of success going forward.

Obviously, we're pretty optimistic, but every quarter we've got to keep bringing that sales in and turn it into real orders until some of those projects turn into actual ongoing demand, we're still---we're optimistic but cautiously at this point.

Got it.

And then one more question for you.

Somewhat surprised that you saw price pressure on the white LED mobile applications.

And also your mix there for high brightness came down.

Can you shed some light on what kind of competition you're seeing; is there something new or maybe give us a sense of what is going on?

Yes, well.

First, Harsh, keep in mind in the mobile application it's a seasonally down quarter and you've got several companies fighting for market share.

So, I think that the fact there was pricing pressure there is pretty much a normal market dynamic when you have that phenomenon going on.

I think obviously as that business comes back hopefully this quarter and going forward and we see strength in mobile, that obviously could change those dynamics.

So, I don't think, from the expectation of, was it a lot different than what we should have expected?

Probably not, given the market share dynamics.

At the same time it is a good---it is a tough competitive environment [and she] is trying to defend their share; we're obviously trying to enable our customers to win and got TG out there trying to get in on the business as well.

It remains a good opportunity for us.

At the same times it's very competitive.

Let me just ask you one more question along those lines, then I---I promise I'll move way.

Are you seeing---you mentioned [inaudible] [PD] in the white space.

Are you seeing the Taiwanese at all?

Definitely---if you're talking about the low end white market, the Taiwanese are are definitely there.

Really where we're seeing the major push, and as people talk about the demand that they're trying to meet, it's much more on the mid to higher end of the marketplace and that's really a place that I would say today primarily that---in most of the places we are competing that really a Cree and a [Chia TG ] kind of application.

Especially on the high end.

Got it, thanks, guys.

Sure.

Your next question comes from Jed Dorsheimer of Canaccord Adams.

Hi, Chuck and Cyndi---have a few questions for you.

Chuck, first, as you make this transition in the power products, I realize that it's relatively small percentage of sales, but I'm just curious in your gross margin guidance, are you anticipating any yield impact in that particular group as you do go through this transition?

Yes, I would tell you that in the gross margin guidance we've got a couple factors.

We obviously got the Schottky business, which while it's still small, it would not be a positive contributor or at least not a significant one to gross margin at this time, and that's kind of normal for that stage of it.

So, that's having an effect.

I think that XLamp--we're making progress--I feel good about it, but it's still not to the level of our corporate average and until we build more sale it's probably not likely to be.

And as well as on some of the XR--- the really high end stuff.

I think the combination of those three products is probably having the most effect on that gross margin guidance.

So, it's less of at rest of -- really not the rest of the business.

It's really those things---that mix that's affecting that at least in the near term.

Great, thanks, and maybe--you mentioned the XLamp and you commented on ramping your subcons--- what percentage rate now are you outsourcing off-shore for your back end assembly and then, maybe, could you give us a comment on the timing of this ramp as far as what you think that would be as a percentage off the XLamp or total LED sales?

For Q3 it's primarily all Durham production.

We're just finishing the qual.

If that qual goes as planned this quarter, and that's not some--we haven't finished it yet.

That should be done this quarter.

We should start to see some contribution with still Durham docu being the primary supplier with then in our Q1 is where we might get into what I call a more balanced mode.

And, ideally what we're trying to get to is, I'd like to see pretty much balance somewhere in the 50-50 or even greater range between Durham and the subcon.

But that's going to take us a couple of quarters.

Right now, primarily Durham oriented ramp.

Great, and then, as you get to sort of a more balance 50-50, what do you think that would do to the cost basis?

Clearly, that will help our costs, the subcon will definitely help that but as much as anything, Jed, we're still at the point where the business, until we get up to that kind of that critical level--- part of this is just getting enough volume to offset the fixed costs, just in terms of ramping up a new business.

That's as much as what we're fighting right now.

I think later in the year that subcon benefit will be more important.

Right now, it's just if we can just keep building scale that by itself is helping us.

Great.

Just a couple more questions, if I can.

Chuck, you commented on some weaker trends in Japan.

And sort of curious if you could -- do you think this is coming from [Nokia] forfeiting it's 404 patent?

And increased competition out of Taiwan, because as we look at Stanley electrics' recent results, they seem to be increasing their CapEx, and I think they're a major player, particularly in the [pachinco]market which you also commented had some slower trends.

Could you help reconcile what I'm saying is a little bit of a disconnect there?

Yes, let me---if I don't get these pieces together, just remind me of which way you wanted them.

Let me start at back end. [Pachinco]?

I think we did -- we saw [pachinco]' it wasn't as high as what was expected, so we saw the seasonal trend but not to the same level we saw a year ago.

That's -- I would put that aside.

I think that's less related to some of the other issues than -- what at least our customers believe is not as big a ramp this season.

All right?

So, I sort of put that to the side.

On the 404 issue, I'll be honest, from my perspective, the Taiwan suppliers have kind of not been too worried about that for over a year now---that specific one, so I don't know that -- I know that there was a a press announcement about it, but I don't see that having a significant effect.

What I attribute it more to is, is that if you look at our business, it's kind of gone through these cycles where our non Japan business is strong and then Japan is weaker and then Japan gets ahead, and it kind of cycles back and forth.

It's interesting.

We have customers doing real well in Japan and we have one that's are struggling;

I would say on average our non Japanese customers we're seeing success in a number of different places there and the issues in Japan are kind of mixed; we have customers doing well and some that just--- they're working through the challenges of getting into the white game and they're struggling that with it more than some of our other suppliers.

So, I can't point to any one thing.

I think that might be overreading -- at least from my perspective, I wouldn't read too much into that.

I think it's a combination of factors.

Does that make sense?

Yes, thank you for the additional color.

Last question, it's two part.

You mentioned the one watt [warm] in under 3,000 kelvin color temp, but you didn't give a lumens per watt for that particular product, and I haven't been able to--to actually bench mark test that, so I was curious what is the lumen per watt that you're getting in, specifically with the warm white and then, the second question I guess is we've had some recent commentary in the market regarding your use of sapphire and I think it's been somewhat misconceived.

I was wondering if you could provide a little bit of color as far as your strategy with silicon carbide.

Are you moving to sapphire, and just elaborate there.

Thanks.

Yes--no problem, so on the on warm white, Jed, I think that--and, of course, I don't have the specs in front of me and I'll get you some parts to take a look at real soon here.

But I would tell you that.

Boy.

I think it's--I want to say it's in the mid-30s.

It is mid to high 30s I think is where the warm white comes out in terms of lumens per watt.

So, there is a penalty and efficiency when you go from the cool white, which is the first announcement to the warm white, and I think that's the range we're in.

And, I'll have to confirm for you later, but it's definitely a little bit less.

On the sapphire thing, yes, I'm not sure where that rumor came from or what that's all about.

I can assure you we're still growing all of our LEDs on silicon carbide substrates, and the key behind that is, is that we think it gives us an advantage in terms of how we grow epi and what we can do to get really efficient epi layers.

Now it is true, and as you know that---in our EZBright chip we do some things in terms of how we then manufacture the chip later that it's not -- you can't tell what substrate we grew it on.

At this point and time we're still pretty committed to silicon carbide, although, you know what?

If things change in the future--I think I've said it a couple of times in the past -- we're here to win in LEDs and we'll keep an open mind but for today, boy, silicon carbide thing still gives us a number of advantages both in terms of epi efficiency and cost.

Thank you,.

Sure.

Your next question is from Mike Barton of [Ink Equity].

Hey, I was hoping you could talk a little bit about XLamp and your progress there.

Are we still on target for XLamp to be 10% of revenues, I think you previously talked about the end of this calendar year.

Just curious in light of some of the capacity constraints you're seeing.

Yes, Mike, I'm not worried about getting -- at this point we're on track and I'm not worried about getting to 10% by the end of the calendar year---I think the capacity constraints are frankly within our planning level and I think we'll be fine.

So, we've got obviously a couple of quarters left to go do that, and I think we're right now we're well on track to getting there.

That doesn't worry me.

Okay, and then continuing with XLamp, are you seeing some significant pricing declines in XLamp products as you've brought that product to market from some of your competitors?

I think from our standpoint I don't think our XLamp product pricing has changed a lot.

I think, probably from where we started it's moved, but not outside of what I would consider to be a normal range.

I feel that it's---my understanding is it has caused our competitors' pricing to change, but I think that's to bring more in line with where we already were, so I think it's more of a reaction to what we have done in the marketplace than us changing anything from our standpoint.

Okay.

And then over into -- you mentioned Colorwave maybe coming out of this calendar year, that sounds like a little bit earlier than you may have previously mentioned, is there any -- do you have a customer there that you're already looking at ramping at end of this year?

Yes, and so Colorwave, we've kind of had our target from the beginning of the year has been we'd like to get a commercial product either in a TV or monitor released by the end of this calendar year.

I would say, it hasn't really changed.

We're still on track with that---we have a couple of different programs but one of them is probably a little more---it's probably the higher prop program and a little more high focused right now and we'll see if we get there but right now we're on track and I can't really give you much more than that until we get a little closer.

Okay.

Thanks.

Sure.

Your next question comes from Hans Mosesmann of Moors & Cabot.

Okay.

Thank you.

Hello, guys.

A few questions on Sumitomo.

The relationship that you have with them, will that also include XLamp as a distributor in Japan?

Right now, Hans, it's primarily focused on chips and material and we're in negotiations as to whether or not we'll utilize them for the XLamp product.

We have not chosen a distributor, so more on come on that one.

Okay, great.

Still on Sumitomo.

You mentioned last quarter that Sumitomo was running around 10% below the yearly contract.

Is there an update that you can provide us with that progress?

Yes, no additional update, we'll see where this quarter comes in.

They're definitely still running below plan but I don't have any further specifics for you until we see where this quarter comes out.

Okay, but there will be an announcement because usually the Sumitomo announcement gets announced in April or May.

Yes, I mean obviously we're ---at some point we will probably be giving you further update on Sumitomo, wherever that's at, and obviously when we file our K we'll disclose them and what their exact sales were for the year.

Okay, and have you provided a long-term goal for XLamp gross margins?

You know our target, Hans, is to get it kind of up in to the Company average level.

I think that, obviously, we're not at that stage yet, but that's our goal and that's kind of what we're moving towards and we'll see how we do.

I think at this point there's no reason not to believe we can't do that.

At the same time, it's going to--- we're a --- it's still a relatively small part of our business.

So, I guess as we ramp it up further and see what the market dynamics are--we'll have more to know--- we'll see more later but nothing to believe it can't get there.

Okay, and then the last question.

With commentary from Nokia, Motorola, Texas Instrument and some other guys--- they're seeing fairly decent seasonal trends in handsets and perhaps a little better.

What is your outlook, at least in terms of the LEDs you sell into the mobile space?

What's your sense of unit growth into the June quarter?

Yes, I don't have a specific unit growth number, but I would say, Hans, that we're seeing from a number of different suppliers that both in the mid brightness and the high brightness products that there is a----there's definitely been a pretty significant increase in demand over the last four to six weeks for mobile related products, both categories, and so I don't have a exact number for you, but I would tell you that at least from our supply side of that, and also what we're hearing from others in the industry.

I would say it's not just us here.

I guess what we're seeing on the supply side is similar so what they're saying on their side at this point.

Does that kind of get to where you were going? [Overlapping speakers] I don't know have a number for you, but I would say the trend appears to be about the same concept.

And you're factoring that into your guidance?

I think our biggest challenge -- well for this quarter, the biggest challenge is going is because that was something we didn't anticipate.

We're likely to be capacity constrained on those products until we get later in the quarter as we ramp up in to next quarter.

Right now the challenge for us is going to be capacity constraint on both the mid brightness and high bright for those applications I'm not sure we're going get benefit of it in the short-term until we get the capacity ramped up and we'll see how far we can get it this quarter.

Okay, and just one clarification on the constraints or capacity issues: that's EZBright?

No, actually EZBright is something we're not targeting to be a---we're don't see EZBright as being a significant contributor really until Q1.

This is mostly a combination of our high brightness X products---both the XT and XR as well as some of our high performance---our mid bright products.

EZ--we're probably another quarter way from when that is going a significant contributor.

We'll have a little bit of sales this quarter, but it's really a quarter off.

Okay.

Thanks.

Sure.

[OPERATOR INSTRUCTIONS] Your next question comes from Pierre Maccagno of Needham and Company.

Hi Chuck and Cyndi.

Could you clarify a little more the capacity constraint?

Is that of the chip level or the packaging level?

Specifically, what Hans and I were just discussing was at the chip level.

So we are -- based on some recent orders and some expedites, we are definitely getting into a mode where we have capacity constraints on some mobile related chip products.

Okay.

And have you continued your transition to the 4 inch wafers or has that kind of slowed down a little bit?

That would add a lot of capacity, correct?

Actually the transition is still to 3 inch.

We're not quite finished mak [overlapping speakers]---making that transition but right now, Pierre, it's really not that simple.

It's not just bigger wafers, just in terms of, how can we adjust our factory to have the right capacity in the right places to make this particular mix of products.

I would say it's not as simple as that.

In fact, I think we'll see some additional conversion of 3 inch, but that's not going to be the lever to get the capacity up.

At least not this quarter.

So, do you have to buy more equipment?

Is that what you have to do?

It's a little bit of a --- it's combination of some equipment and getting equipment in the right places and really just getting the factory balanced a little differently than it was as we came into this quarter.

And at the packaging level, what about there?

You're constrained there or?

We going to need the subcontractor---if the---we need the subcontractor in Asia to get qualified so that we can meet our targets for this quarter.

I believe we're on track to make that happen, but that will be required to meet our goals for the quarter.

So on both levels your constrained, then?

And actually as well as even on all of the silicon carbide Schottky business if relatively small; it will probably be capacity constrained this quarter as well.

We've had--as a couple of new products have ramped up both on the XLamp, the Schottky and also some of the new chips with this mobile, with the boost in mobile demand, we're basically trying to react to that right now and it's something that's happened fairly recently and we'll see how far we can make it this quarter and the trend continues it should put us at a good position, obviously, going into Q1, but we'll see where we're at then.

Okay, and then if you could clarify more about the Japan weakness.

Is that because of competition, or is that because of the handset market?

Boy, I wish I could tell you exactly what, Pierre.

We have some customers in Japan that are winning in handsets for mobile, for flash, other applications.

We have some customers that are struggling, I think it's a combination of how well some of our customers were able to go compete with [XG or TG] or whoever it is they are competing for market share and I think some of our customers are further along there then other, so I think it's a combination.

A little bit of technical issues.

I think some of it is who has the best sales channel, I think some of it's can they put the whole thing together?

And let's face it. [Achia's] not giving up the business without trying to keep that market share.

So, I think it's a combination of factors.

Some of those customers are doing better and frankly, some of them are not, they're not only meeting our expectations, I don't think they're meeting their own and so we're going continue to work with them and try to make them successful.

Meanwhile, strength outside of Japan continues to be strong, I mean---

I mean it--we are definitely seeing a real pick up in a number of places around the world for the non Japan business, and it's ---a lot of it seems to mobile phone related, but actually even in some non mobile applications we're seeing just general strength outside of Japan.

Okay.

Thank you very much.

Sure.

You have a follow-up question from Jed Dorsheimer of Canaccord Adams.

Thanks, one follow-up.

Chuck, noticeably absent in one of your comments regarding the power LEDs was commentary on [Lumoledge] from a competitive perspective;

I'm just curious if that was specific, have you seen any changes?

They've now been absorbed by Phillips and if you could provide any color there, thanks.

Yes, Jed, I would tell you right now what we've seen so far is obviously they went through the little change their name [inaudible] and did a couple of more kind of cosmetic things but in terms of what they're doing, I think right now I haven't seen any significant change.

My impression is they are pretty focused on trying to figure out how to-- they're trying--- it's my impression they're trying to push up the performance side, and so I think obviously we continue to try to raise that bar and we're in one of those races for who can keep raising the performance.

I think at the end of the day these markets need more lumens per watt really going to turn on some of those applications, so that's why we're--- we obviously like our position there and we're going keep trying to extend it and I would expect they're going try to counter that with additional products.

We'll have to see where that shakes out.

Reality, is is not a lot of to change.

They're still doing their thing and we're still fighting for new designs.

We're having some success, but my impression is they're still having success in other places, especially where they have a broader product offering.

Whether it be special optics or things like that.

It's going take us a while to get a product line that has all of the those different features that they've been working on for the last few year.

And are you also seeing OSRAM in that marketplace or not as much?

Definitely OSRAM is having some success.

It's interesting.

Their product's a little different than what Cree and [Lumoledge] are doing.

We know they're in the market.

I'm confident they're probably have some success, but their product comes at the solution a little bit differently and so we don't tend to be, it's not generally a head to head competition in those applications at this point.

Thank you,.

Sure.

You have a follow-up question from Harsh Kumar of Morgan Keegan.

Hey, guys just a pretty simple question.

When do you think you might be able to ease your capacity problems?

Well, Harsh, optimistically, I hope never frankly. [Laughter] As a practical matter, I think we're reacting a little bit right now because a couple of things have gone from a demand standpoint, I would say we weren't real well positioned for this spik--or this increase we're seeing right now.

I think it's going take us most of the quarter to really get our factory aligned and I would hope we would be in a much better position in Q1 to respond to what the demands are out there, obviously.

We're always making some investments, but this one caught up us a little off guard.

Okay.

And then gross margin.

I think the problem is that I think you mentioned at some point in time in your commentary that you're opening the next time we'll get up to corporate margins, I'm thinking that XLamp is probably one of your high brightness products; do you feel pretty good you might be able to get it above corporate margins once you ease all your capacity issues?

Harsh, at this point you have to remember that one of our other primary objectives in addition to what the corporate margin is is how fast can we grow the business?

So, from our standpoint, we're trying to make sure we position our LED products from both a performance but also from a price standpoint we want to turn on some of these lighting applications that frankly we're just touching the surface.

I'm not sure how far we're going to push that I think we're going opportunistic and see where do we--where we do find that price elasticity to really turn on some of these new applications that we really haven't gotten started yet, and so I'm going to take a wait and see on that.

The goal right now is let's get it ramped up.

We're having some success in improving the margins and as we get closer to that time wink we're going to have to make choices---if we can grow the business enough and turn out some applications, we may trade one off for others, but we're not there.

That's not the type of decision we have to make yet.

Got it, and last housekeeping and then I'll move way again.

Basically just want to clarify if all almost most of your XLamp or all of your XLamp is used for lighting?

Yes, but lighting means a lot of different things, it could mean architectural lighting, it could mean personal lightning it can mean various things like that.

I guess outdoor lighting and architectural is what I'm talking.

Outdoor lighting---architectural, some traffic, some transportation, there's people doing some personal lighting things, so it's a variation of all of those types of "things."

Does that make sense?

Well.

Let me rephrase the question.

Maybe, in your opinion what aspect of lighting do you think is driving this kind of demand you're seeing right now?

I would say that it's a combination of all of those things I've mentioned.

We were having success in everything from pool and spa lighting, to the architectural stuff that Color Kinetics does to the stuff you've seen that we've talked about that guys like Space Cannon do to companies in the transportation.

We really have -- it is a much broader market.

There's no one magical application and so it's a lot of different things.

What it is not is yet, it's not the really general purpose illumination.

All of those are kind of around the fringes of that.

There's a lot of activity there and that's where we're focused.

You have a follow-up question from the line of Hans Mosesmann of Moors & Cabot.

Thanks, Chuck, a clarification.

Your high brightness LEDs--- I calculate were down 12 or 13% in the March quarter, and now you're saying there's high brightness capacity constraints, is it a particular portion of the high brightness?

I just don't understand if your inventories went up and the sales were down.

That you would be capacity constrained.

Yes, no, I understand, Hans.

I think, one of the things to keep in mind is that our quarters up until recently haven't been the most level quarters.

We're obviously managing our factory to react to the demand the best we can.

I think last quarter it was just a combination of the mix was where it was.

The capacity constraint we're having this quarter is both a combination of mid brightness and high brightness and they tend to be the product that's are mobile specific so some of our big, very high end white product for the LCD display backlighting application as well as some of our mid brightness for other parts of the mobile products.

I think the challenge for us is that if we knew about all of this demand coming into the quarter, and we could have planned for it, I think we could have reacted a lot better.

Unfortunately, it hasn't come off -- it hasn't been that well.

We didn't see it coming until this quarter frankly got started and so we're reacting to that.

I thinks as we exit the quarter, we'll be able to balance this out a whole lot better and be in a better position going into Q1.

So, totally understand the question.

I think it's more of an issue of ---- If I would have known now what we kn -- if I had the information we had today six weeks ago, we had been a lot better able to react because but it's really been kind a trend that's really picked up during that time and it's kind of been evolving.

There are no further questions at this time.

Are there any closing remarks?

Yes, thank you, Angela.

We appreciate your interest and support and look forward to reporting our fourth quarter fiscal year 2006 results on August 10, 2006.

Thank you.

Ladies and gentlemen this includes today's conference call.

You may now disconnect.