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Good day, ladies and gentlemen, and welcome to the Cree third-quarter financial update conference call.

(Operator Instructions)

As a reminder, this conference call may be recorded.

I would now like to turn the conference over to Raiford Garrabrant, Director of Investor Relations.

Please go ahead, sir.

Thank you, Abigail, and good afternoon.

Welcome to Cree's conference call to discuss today's preliminary financial results press release.

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 would like to note that we will be limiting our comments to a discussion of the information included in today's press release.

We will not be able to answer any questions that would involve providing additional financial information beyond the comments made in the prepared remarks.

Consistent with our previous conference calls, we are requesting that only sell-side analysts ask questions during the Q&A session.

Also, as we plan to complete the call in the allotted time of 30 minutes, we ask that analysts limit themselves to one question and one follow-up.

We recognize the other investors may have additional questions, and we welcome you to contact us after the call.

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

Thank you, Raiford.

As we announced earlier this afternoon, revenue for fiscal Q3 is estimated to be approximately $367 million, which is below our previously-announced target range, due to lower commercial lighting revenue.

LED and Power and RF revenue was in line with our targets for the quarter.

We estimate that the lower revenue will result in non-GAAP earnings of $0.13 per $0.15 per diluted share, which is below our target of $0.22 per $0.29 per share.

Non-GAAP gross margin is estimated to be below our target at 30.5%, plus or minus, primarily due to an inventory write-down on LED tubes, and lower lighting factory utilization, which is expected to be partially offset by lower operating expenses.

Please note that these are preliminary estimates.

We will update our financial results in more detail in our regularly scheduled earnings release on April 26.

For fiscal Q3, lighting revenue is estimated at $187 million, which is 20% or $48 million lower than we had targeted for the midpoint of Q3 revenue guidance, due primarily due to lower orders driven by three primary factors: customer service disruptions related to our ERP conversion, new product delays, and weaker market conditions than forecast.

First, some US commercial lighting project business was lost due to customer service disruptions, primarily related to our transition to Oracle in the quarter.

The ERP conversion, which is necessary to support the long-term growth of our lighting business, effected lead times, deliveries, and customer responsiveness.

We believe that this disruption is mostly behind us, as on-time delivery performance has improved significantly over the last month, although it will take time to rebuild customer momentum.

Second, delays in our commercialization schedule for several new product platforms resulted in project delays, or customers shifting to alternate products.

Our strategy is to lead with innovation, and redefine product categories, but these products also push the capabilities of the technology and related manufacturing processes.

During fiscal Q3, we turned the corner on these new platforms, and new product momentum is improving.

The IG parking product family was released in December, and demand exceeded our production capacity, which we are now working to expand.

We announced our SmartCast PoE platform in February, which is compatible with Cisco's digital ceiling and the initial customer installations are underway.

The first products in the RSW street light family were released in March to very positive reviews, and the balance of this product family is scheduled for release during Q4.

Our breakthrough LN4 suspended linear products are in beta testing at customer sites, and on track to be released later this quarter.

We recently announced a major expansion to our indoor product portfolio with our new Essentia by Cree brand.

The flat-panel products were released in March, and new track and down-light products are scheduled for release later this month.

Our existing Cree canopy, area, and street light product families are all scheduled to receive significant performance upgrades in Q4.

The combination of the new platforms and product line expansion should provide our agents and channel partners a significant opportunity to win market share over the next year.

The third factor was weaker market conditions in January and February, due to a slower retrofit market for lighting products in the US, as well as project delays in our international business, due to the stronger US dollar.

Based on our channel checks, a number of retrofit projects were put on hold or deferred in the quarter, although the base business rate improved in March.

This segment accounts for the biggest part of our commercial lighting business, and seemed to be more affected than the new construction lighting business.

We also saw weaker demand and project delays in Canada and Mexico due to pricing and financing challenges, as our products became more expensive in local currencies.

We don't control the economic factors, but we can and are improving customer responsiveness and new product momentum.

To further strengthen our team and support our aggressive growth goals for this business, David Elien will lead commercial lighting on an interim basis, as we conduct a search for a new leader of this business.

David is a lighting industry veteran, with a track record of success, both prior to and at Cree.

Norbert Hiller will move to focus on longer-term growth opportunities as the leader of corporate business development.

I believe we have addressed the root causes of our recent business challenges, but recognize it will take time to build momentum for new products, and for the projects that are being specified today to ship in future quarters.

Backlog is similar to what it was at this point last quarter, but we see encouraging signs in the business.

The base order rate in commercial lighting improved in March, and we are optimistic that this, combined with demand for new products, will begin to drive lighting growth in fiscal Q4.

However, it is premature to provide specific targets at this time, and we will provide guidance during our regularly scheduled earnings call on April 26.

We've demonstrated over the last seven years, as we built the fastest-growing lighting company, that our strategy of leading with innovation works.

We've pushed the technology to deliver products that redefine what is possible, and deliver new capabilities.

Sometimes the development takes longer than expected, but this is one of the risks of being in the innovation business.

The ERP transition was more challenging than expected, but that investment is mostly behind us, and should improve our ability to serve our customers in the long run.

We are accountable for these results, and we have taken action to improve.

Our mission remains clear.

The world deserves better light, and we have the game-changing LED technology to make it reality.

We will now take analyst questions.

(Operator Instructions)

Brian Lee, Goldman Sachs.

Thanks for taking my questions.

This is Hank on for Brian Lee.

You mentioned the retrofit market, but is there a particular lighting end market, whether it was outdoor retail, that you can provide any specifics, and attribute that weakness to?

Hank, what I would tell you is, I would say it was broadly retrofit.

There is definitely, I would say, anything that's more on the industrial side seemed more affected, but we did see a cross segment, and if there is any one area that was weaker than others, I would say it would be more on the industrial side versus the pure commercial side.

Okay.

Thanks.

As a follow-up, did you see any big shifts in competitive landscape, or was this Company-specific?

From what we can tell from the data, we really think that this is more Cree-centric.

The combination -- we were the only ones that converted our ERP system in the quarter and let's face it, the lighting industry, and pretty much most companies have a history of making -- working through that transition with various disruptions.

We had that, and the new product delays.

Honestly, I think this is more Cree-centric.

I think there were some overall headwinds, as we talked about the retrofit and some of the currency stuff.

I would say the majority of this were the two things that I think we control, that we've addressed, and I think that we can affect going forward.

Jed Dorsheimer, Canaccord.

Thank you for taking my questions, Chuck.

Most of the commentary has been around the lighting business, since that's where the shortfall was.

On the components side, industry dynamics seem to have worsened from an oversupply situation.

I'm curious if you have any commentary around that business, and I know that was an area that was actually strong for you this quarter, whether or not you could give an update on the overall business activity, or whether or not that is sustainable.

Thanks.

Jed, what I would tell you is that the LED business came in right on plan, as we had forecast.

I think we are in a little different situation, since we took the actions last summer to go through the restructuring and reposition it.

We are a very high-power centric and focused on certain applications that drive that, so I think our trends, while they are obviously affected by the overall market, probably are a little different.

I also think, Jed, we have benefited from a little bit, the fact that, remember, in the first six months of the fiscal year, we were going through an inventory correction in the channel, and so we did not -- that was pretty much completed at the end of our fiscal Q2.

I think we also have the benefit of not having that overhang as we went through this quarter, which is probably why, at least from our standpoint, it is a little more predictable.

Great.

Thank you.

Tom Sepenzis, Northland.

Thanks for taking my question.

I'm just wondering.

You mentioned that you took a writedown.

I believe that was in the lighting inventory.

Is that correct, or was that LED?

No, that is lighting.

Okay.

Great.

Also, could you provide any color around what specifically, which products, or what type of products you saw the delays in during the quarter, and if that has been resolved, and you expect those to start shipping here in the second quarter -- or in the June quarter?

Sure.

Tom, just to clarify.

The write-downs were only one piece of it, and it was really just related to LED tubes, so that's lighting-specific for the tube segment.

In terms of what we saw in product delays, so we actually started to turn the corner when they started to come out.

What we have been working through over the last several quarters is we have three major platforms that were under development.

We have released the IG parking series in December, so that is one we started to see some actually momentum for in the last quarter, but our RSW and our LN4, which are all critical new platforms that really enable us to bring new features and new value to the market, those are the ones we have been working on.

We have got the first RSW out in Q3.

The rest of that family is scheduled for this quarter.

And the LN4 is now in beta testing and should be released this quarter as well.

It's really -- it was those three were the main platforms.

In addition to that, we did announce that we will be releasing the Essentia by Cree brand, which we hadn't previously talked a lot about.

That should, we think, give us some additional new product momentum heading into Q4 and beyond.

Great.

Thank you very much.

Edwin Mok, Needham & Company.

Chuck, just a follow-up on that, with some of these new platforms coming out, does this customer still need some time -- I guess I'm trying to understand the cycle time of that, and if the customer has used or switched to other of your competitor product.

Is there a risk that maybe it would take some time before they qualified a product, and therefore the ramp-up of these new products will take some time, and they might impact beyond this quarter?

Edwin, I think that we are seeing that right now.

Honestly, I think we have started to release the products, as I said, we released in December, and started to release one in March.

Have more coming.

I think there is a lag.

I think the difference, though, is one of the reasons I am more optimistic about Q4, is that the process has already started, but there is definitely a lag.

We also saw in addition to the new products, we also saw that the base order rate started to improve in March.

I think we have two things working for us, is that the base order rate seems to be improving.

If you add new product momentum on top of that, I feel cautiously optimistic that we are moving in the right direction.

I think in either case, when you have customer service disruptions or new product delays, it does take time to rebuild that momentum.

Okay.

Great.

That's helpful.

Then on a year-over-year perspective, looks like because of this disruption, this year might end up being a down year on a FY16 versus FY15 on your lighting product part of the business.

Do you see that as a short-term phenomenon, or do you believe that you can still grow the lighting business as you get through the June quarter?

Edwin, I think if you look at what -- we are three quarters of the way through our FY16, I think if you look at where we're standing even with these results, we're still doing pretty good year-over-year on a nine-month basis.

I think that from a lighting business standpoint, it is trending in the right direction.

I feel overall, like the business is still on the right track overall.

I think the strategy works.

I think we've got to get past the Oracle disruptions.

And second, as the new products come to market, we have got to rebuild the sales momentum around them.

I think we have proven of the last seven years that when we execute that strategy, it works pretty well, and we just got to keep doing it.

Jeff Osborne, Cowen and Company.

Just a couple follow-ups.

One is, can you just mention how you are going to rebuild momentum with the brand, Chuck, and is there a way to quantify how many orders were canceled, and if any of those lingered into the June quarter?

I'm not as worried.

I think our brand goes way beyond one quarter's Oracle transition, and some new product delays.

I think it took us a long time to build it, and I feel like we are still in a great position there.

As far as -- and by the way, we are not the first company in lighting to go through an ERP transition.

We are probably the last.

I believe they've all pretty much proven, you go through it, you get your on-time delivery and your customer service back up, and these things will take care of themselves.

I think we're already heading in the right direction.

There is a lag, but I think we are directionally going the right way.

As far as how much is lost versus delayed, I think it is a combination of both.

If projects had to happen, and we didn't have the products or couldn't deliver, that is lost business.

We know for sure that in some cases, there are products that are delayed, specifically in the case of ones that are waiting for new products to come out.

I think it is a combination of both, but it is hard to give you exactly how much falls in each bucket.

Got it.

With the momentum building, normally I would think seasonally that the backlog would be building versus where you were entering the prior quarter.

Has that been the trend in the past?

As you expect the backlog to build through the June quarter, can you touch on where are the areas of growth and maybe weakness from the broader market?

It sounds like industrial was softer, and commercial and outdoor were fine, but I just want to make sure.

There was a couple different comments about the moving pieces on the chessboard here, so, I want to get a sense of, A, where backlog should be, assuming this ERP hadn't happened, I thought it would have grown, and B, where the orders are going to come from over the next couple of months.

I think that, so just to be clear, I think of all the sectors, industrial had the most weakness.

We saw an overall decline across the business.

I just want to be clear, both indoor and outdoor declined, and it wasn't just industrial, but that was the one that stood out the most.

Just to clarify that point.

As far as backlog, I would expect backlog to start to grow.

Keep in mind that with the order flow, now that we've got -- the factory is able to execute, but by not having the orders, we were able to deliver on some pretty quick lead times there at the end.

I think, starting out with lower backlog, while it is different than normally we would start the quarter, it's not unexpected, given the dynamic we are working through.

Really, the key indicators for me are, if order rate in March is better than January and February, that is a positive sign heading into this quarter, and this is typically -- generally a better quarter for lighting.

And two, as new products get released, and that has already started, we should start to see some initially incremental growth from that, and that should build over time.

Those are really the two factors that give me some confidence that we are going back in the right direction.

I do want to be clear, it will take time to rebuild the momentum.

Colin Rusch, Oppenheimer.

This is Kristen Owen in for Colin.

Just a quick one for me.

The $5 million in operating expenses that you stripped out, can you talk a little bit about that, and maybe how you feel going forward?

Are your operating expenses now properly sized for the growth that you see over the next 18 to 24 months?

Kristen, that OpEx reduction, that is pretty much a variable OpEx, that moves with that business.

As the business -- as the revenue came in lower, most of that's variable with it.

I would say that the current rate is about right.

As the business grows, some of that will naturally come back to variable pieces.

I don't expect a significant change on that one way or another, right now, other than the variable piece, that will move with the business.

I think that, given that we think we are on the right track to get the lighting growth going again, I think that core spending will be appropriate, given where we want to take the business here over the next few quarters.

Thank you.

Sven Eenmaa, Stifel.

I wanted to ask in terms of your pricing strategy now, that you are focused on winning back some of the business.

What is -- has your strategy on pricing changed, and what are your margin expectations for new products?

Our pricing strategy has not changed significantly.

That is oftentimes, like in any industry, people like to use that lever.

What we are really trying to do with new products is to increase the value, and I would still expect that new products will give us some margin growth opportunity, going forward.

Pricing is a pretty short-term fix, and it doesn't generally get you very far.

Obviously, I think our team is looking at those variables.

At the end of the day, Cree's winning strategy is a combination of innovative new products that deliver great value, and we have to make sure we can enable the customer service and the channel to be successful.

And I think if we get the pieces together -- I'm sure we have a little work to do to rebuild some of the margin momentum, but overall, I don't change my longer-term outlook on what is possible, in terms of both my growth expectations, and also the ability to improve margins in lighting and overall.

What is the typical lead time for your retrofit projects you are doing?

Retrofit projects vary dramatically.

There us literally business that comes in that you are not actually, it's not even a project.

Someone is working on it.

You don't get any lead time.

It typically flows in, oftentimes through distribution or an agent, and it just happens.

Then, there is specified retrofit projects.

There actually spec projects, and we compete in all of them.

There is a turns mentality that is pretty unpredictable, some of the bigger retrofit jobs.

It depends.

If you are talking about a building, you probably have a month or two notice.

If you are talking about a street light, if it is a new street light, you have a lot of visibility.

If it is an upgrade, you might have visibility on the project, but not necessarily the timing.

For example, there were some projects last quarter where we had won the business.

There was one in particular that was not in the US, that the project was there, the financing had been delayed, just based on a currency swing.

We have got to work through that, but that is not a lost project.

I can't change -- we don't change the FX.

If the currency moves against you, they have to redo the financing, in that case, the peso to dollar moved.

(Operator Instructions)

Srini Sundararajan, Summit Research.

Thank you for taking my question.

My questions are specific to the month of March, and looking forward to April.

My first question is, the factory utilization, is it back to normal loss making levels in March?

As a second part of the question, are the ERP problems behind you, and running without a hitch in the month of March, and looking forward to April?

Let me take those in reverse.

ERP, in March, I would say our online delivery improved, and it was running pretty close to December levels, so I feel pretty good about exiting March, that the on-time delivery is generally speaking behind us.

The other thing we like to measure is the efficiency of how easy it is to get an order and acknowledgment back out.

Both of those seem to be running pretty well.

There is still a learning curve we are going through, but I would expect the majority of those are behind us now in March, and as we enter April.

On the factory utilization, that is really a function of the size of the overall business.

It was better in March.

I think there is additional efficiencies as we grow the business going forward.

It will depend on how the demand comes in Q4, and going forward.

I would expect that if the business grows, we will get some incremental gain back on that one, but it's really a function of what overall revenue is in Q4, and not ready to give any specific targets on that.

Thank you so much.

I'm showing no further questions.

I would like to turn the call back to Mike McDevitt for closing remarks.

Thank you for your time today.

We appreciate your interest and support, and we will report our third-quarter results in more detail on April 26.

Ladies and gentlemen, thank you for participating in today's conference.

This does conclude the program.

You may all disconnect.

Everyone, have a great day.