Fabrinet (FN) 2010 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth-quarter 2010 Fabrinet earnings conference call. My name is Regina, and I will be your operator for today. (Operator Instructions). I would now like to turn the conference over to [Mr. Paul Kalevis], General Counsel. You may proceed, sir.

Thank you, Regina, and good afternoon, everyone. Thank you for joining us on today's conference call to discuss Fabrinet's financial and operating results for the fourth quarter and full year of fiscal 2010, which ended on June 25, 2010.

With us on the call today are Tom Mitchell, Chief Executive Officer and Chairman of the Board of Directors of Fabrinet, and Mark Schwartz, our Chief Financial Officer and Executive Vice President. This call is being webcast from the Investors section of our website located at investors.fabrinet.com. Please refer to our website for important information, including our earnings press release. A replay of this call will also be available on our website at investors.fabrinet.com.

Before we begin, I would like to remind you that this conference call may contain statements that constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are not guarantees because there are inherent difficulties in predicting future results, and actual results could differ materially from those expressed or implied in forward-looking statements.

Such forward-looking statements include our expectations regarding future revenue growth and profitabilities; our expectations regarding the growth of and our performance in the optical communications; industrial lasers and sensors, and other target end markets; the benefits that we expect our customers to realize in using our manufacturing services; our expectations regarding our manufacturing capabilities relative to our competitors; our expectations regarding future growth in the United States, Europe, Japan and elsewhere; and our forecasted operating and financial results for the first quarter of fiscal 2011. These statements are based on the information currently available to management, and we undertake no duty to update this information except as required by law.

Investors are cautioned that forward-looking statements are subject to risks and uncertainties. Important factors including but not limited to less customer demand for our products and services than forecasted; less growth in the optical communications, industrial lasers and sensors market than we forecast; difficulties expanding into new markets; increasing competition in the optical manufacturing services markets; our reliance on a limited number of customers and suppliers; and difficulties in accurately forecasting demand for our services could cause actual results to differ from those in the forward-looking statements. For a more detailed discussion of these risk factors and other factors you should consider in evaluating Fabrinet, please refer to our SEC filings, in particular the section captioned Risk Factors in our final prospectus filed on June 25, 2010. Our final prospectus is available at www.sec.gov and under the Investors section of our website located at investors.fabrinet.com.

We will begin today's call with Tom providing an overview of our business, fourth-quarter and fiscal year 2010 commentary about developments in our business, and an outlook into our growth strategy and business trends. Mark Schwartz will follow with details about our fourth-quarter and fiscal year-end 2010 financial performance, and as well as guidance for the first-quarter fiscal 2011.

I would now like to turn the call over to Fabrinet's CEO and Chairman, Tom Mitchell.

Thank you, Paul. Good afternoon, everyone, and welcome to our earnings conference call for our fourth-quarter and fiscal year 2010, which is also our first earnings call as a public company.

Let me start by saying that we are very pleased with our results for the fourth quarter and record revenues of $157 million, a 15% sequential improvement and a 91% increase from our year prior quarter. We also had a very strong fiscal year with 15% revenue growth and believe that Fabrinet is well positioned to accelerate full-year revenue growth in fiscal 2011, while continuing our long track record of profitability.

As this is our first earnings call, allow me to provide you with a brief overview of our Company, the markets we serve and the key drivers for the growth of our business. I will then provide some additional color on our performance and development in the fourth quarter and the factors that give us confidence as we look ahead in fiscal 2011.

Fabrinet is a leading provider of high precision manufacturing engineering services and custom optics to component, module and subsystem OEMs for their most complex products. We currently serve three growing markets -- optical communications, high-powered lasers and sensors. Not only do we expect to benefit from growth in the end markets that we serve, but, as we increase our penetration in existing customers and attract new customers, we believe we will be able to grow faster than these markets grow.

For the optical communications market, we build devices used in telecommunications, data networking and cable transmission networks such as (inaudible), optical amplifiers, wavelength selective switches. These devices are critical to the architecture of current and next-generation networks to securely and cost-effectively manage network traffic. Growth in the optical communications is forecasted by industrial analysts to be approximately 13% over the next three to five years, stemming from continued demand for bandwidth from new applications such as high-definition video on demand and cloud computing.

As the leading producer of these cutting-edge optical devices for our OEM customers, we believe Fabrinet is well positioned to benefit from these long-term growth trends. Some years ago our unique understanding of optical materials and processors positioned us to enter the market for high power industrial and commercial lasers, which we simply call industrial lasers. Our industrial laser customers, we manufacture fiber lasers, solid-state lasers and gas lasers, many of which are used in critical and high precision applications such as laser surgery and semiconductor wafer processing.

The sensor market is another natural extension of our optical and optical mechanical knowledge. Today we built optical-based sensors such as gas monitoring systems for use in hospital operating rooms. The market for complex sensor technology are growing in a variety of diverse applications, including medical devices, semiconductor capital equipment and automotive equipment.

We also manufacture custom optics material, which are the building blocks for many of the optical devices we manufacture for our customers. For example, we fabricate optical crystals, optical prisms, wavelengths and beam splitters at Casix, our subsidiary in China. We have the advanced capability to polish these optical components in a very high degree of smoothness and coat the optics with antireflective coating to create the optical properties specified by our customers.

As another example, we draw clear fused quartz tubing and rods at Vitrocom, our subsidiary company in New Jersey. These tubes and rods are used to create optical barrels, sleeves and substrates for optical component packaging. We sell custom optics directly to third-parties, and we also integrate much of our production into assemblies of optical communication devices for our OEM customers. We believe our specialized knowledge and understanding of optical materials and optical properties is a significant competitive advantage.

Fabrinet is highly differentiated as an engineering and manufacturing partner for our customers for whom we tend to manufacture their most complex leading-edge products. Our customer relationships are characterized by close collaboration, new product introductions and design services. As a result, we are generally our customers' sole-source manufacturer for the majority of the devices we build. Our customers today include four of the largest six optical communications components and module OEMs, as well as four of the top six industrial laser producers. Our diversified customer base includes well-known names such as Coherent, Finisar, Infinera, JDS Uniphase, Newport Corporation, EMCORE and Opnext.

Now let me walk you through our growth strategy, including some accomplishments from our fourth quarter that give us confidence in our ability to continue to deliver revenue and earnings growth.

First, we have continued to increase our market share with existing customers because of our track record. With these customers, we have a distinct advantage in our ability to win new projects. Additionally our deep expertise in optical manufacturing and optical supply chain supports the seamless transfer of technology and production from the early stages of development to any volume production. Secondly, we continue to attract new customers in multiple geographic regions, two of the significant new customer wins, an optical communications customer in Europe and in an industrial laser customer in the United States. We believe the United States, Europe and Japan each represent significant opportunities for future expansion of our customer base. Lastly, we are committed to expand our custom optics capability -- encoding, polishing and fabricating. A significant portion of our fiscal year 2011 capital equipment expenditure is earmarked for custom optics.

Looking ahead, our visibility remains strong. Indications from our customers are positive overall, and we believe that microlevel trends, including continued demand for more bandwidth and the increased number of applications utilizing industrial lasers, optics and MEMS-based sensors positions us well in the future. We believe we're in a strong position that will serve as an excellent foundation for both the growth of our business and the overall value creation for our shareholders.

I will now turn the call over to Mark Schwartz, our CFO, for a more detailed look at our financial results.

Thank you, Tom. I will now provide more detail on our fourth-quarter and fiscal year 2010 results, followed by financial guidance for the first quarter.

The fourth quarter was very exciting for Fabrinet as we prepared for our initial public offering, which, as you know, was successfully completed on June 25 and provided us with approximately $24 million in net proceeds. As Tom mentioned, we are pleased to announce on our first earnings call as a public company that we recorded record revenues of $157 million in the quarter ended June 25, 2010, which represents the highest revenue we have ever recorded in a quarter. This revenue performance represents growth of 91% year over year and 15% quarter over quarter.

On an end market basis, revenue from optical communications was $126 million or 80% of total revenues for the quarter, while lasers, sensors and other revenue was $31 million, the remaining 20%. Quarter over quarter this represents growth in optical communications of 15% and 14% for lasers and sensors. On a year-over-year basis, revenue from optical communications has grown 72% and revenue from lasers and sensors 242%. As you can see, we are experiencing healthy growth in each of our end markets.

Our SG&A costs were $4.2 million or approximately 2.7% of revenue in the fourth quarter of 2010 compared to $3.3 million or approximately 4% of revenues in the fourth quarter of 2009. The increase in our SG&A expenses was primarily related to increases in salary and benefits expenses, the addition of one senior sales staff and increases in sales and marketing activities. We expect SG&A to be approximately 3% of revenues for the foreseeable future.

Our effective tax rate was 11.7% for the fourth quarter and 7.8% for the full fiscal year 2010. We expect our effective tax rate to remain at our historical levels of approximately 8% to 9% for the foreseeable future. Our net income was $13.6 million for the quarter or $0.43 earnings per share on a fully diluted basis, calculated from a share base of 31.5 million fully diluted shares. This represents a quarter-over-quarter increase of approximately 1% from a net income of $13.5 million in our fiscal third quarter of 2010 and a year-over-year increase of 245% from net income of $3.9 million in the first fiscal fourth quarter of 2009. It also represents our 42nd consecutive quarter of profitability.

Moving on to the balance sheet, we ended the quarter with cash of $84.9 million and an additional $26.3 million in receivables from the IPO, which we have since collected. This was a slight decrease in cash and cash equivalents from the previous quarter, primarily due to two items. The deposit of approximately $2.2 million paid toward the purchase of land, upon which we intend to construct a new manufacturing facility known to us as Building 6 and an increase in our inventories.

Our inventory days increased to 68 days this quarter, up from 64 days in the previous quarter. This was a deliberate decision in close collaboration with our customers to secure inventory to meet the continuing growth commands of our customers. We expect inventory days to return to historical levels over the next several quarters.

The purchase of land and construction of Building 6 is consistent with our conviction in the long-term positive dynamics of the markets we serve. The land is adjacent to our Pinehurst factory campus in Thailand. We expect to conclude the land purchase by the end of August at a total cost of approximately $7 million and have plans to construct a factory of approximately 300,000 square feet at a cost of $30 million. We expect Building 6 to be available for customers in the first quarter of calendar 2012.

As for cash flow, we raised approximately $24 million in proceeds net of expenses from our IPO. These proceeds will be reflected in our first-quarter results of fiscal year 2011.

During the fourth quarter of fiscal 2010, net cash provided by operating activities increased by $1.5 million as we used much of the cash generated during the quarter to purchase materials in support of the growth of our revenues. We extended $6.5 million for capital equipment and facilities during the quarter, which included the $2.2 million deposited toward the purchase of the land for Building 6.

Now I would like to discuss guidance going forward. For the first quarter of fiscal 2011, we expect revenues to be between $160 million and $165 million, resulting in $0.38 to $0.40 earnings per share on a fully diluted basis calculated from a share base of 34.3 million fully diluted shares outstanding on a weighted average basis.

In closing, I would like to say we are pleased with the execution in the fourth quarter and fiscal year 2010, and we believe we are well positioned to continue to execute successfully in the quarters ahead. While we remain mindful of the macroeconomic climate, we believe that enterprise and carrier demand for bandwidth hungry services continues to expand and the sheer number of applications for industrial lasers and optics and MEMS-based sensors continues to grow. Being uniquely qualified to efficiently and effectively serve companies in these markets, we are optimistic about our prospects for future long-term growth.

At this point, I would like to turn the call over for questions. Operator?

(Operator Instructions). John Marchetti, Cowen & Co.

I hope you guys can hear me okay. I just have a quick question for you, Mark, on the margin side. You obviously had a very good revenue quarter here. Gross margins were a little bit lower than what I was anticipating. Can you talk a little bit about maybe the mix impact of the quarter having a very strong optical quarter here or whether or not that has to do with some of the component issues? Is it costing you more to get that inventory in the facilities so you can turn it around for your customers?

I think you have hit on two of the major points, John, in particular, the component shortages, which I will spend a little bit of time to talk about.

Relative to our mix during the quarter, that generally does not have much of an impact on our gross margin. As the products that we build for all of our customers across all of the major product lines and industries that we serve, generally the margin profiles are very similar.

You mentioned component shortages. That for sure is something that is impacting not only gross margin, as you mentioned, but our revenues for the quarter. We believe that were there not the component shortages that we are seeing and others are certainly seeing in the markets today, that our revenue perhaps could have been as much as 5% to 7% to 10% higher for the quarter with also a positive impact on our gross margin.

That being said, we continue to believe that our gross margin will be as we have always forecasted internally and as we model it, which is in the 12% to 12.5% range. And we have been doing this for quite a bit of time now, John, having 42 quarters under our belt. And given the close collaboration we have with our customers and given the visibility that we have and the fact that as we sit here today, we are eight weeks into our fiscal quarter, we have good confidence that we will continue to maintain that profile going forward.

Great. Thanks and maybe just as a follow-up to that. You obviously increased inventory pretty substantially relative to where you were last quarter. You mentioned the hit to revenue even from this shortage this quarter. How do you feel about that supply chain right now? Does it feel like it is getting any better out there with the inventory that you brought on? Do you feel like you have at least sort of made a dent in the hit that you would have taken to revenue, or is that still something that we should think about persisting over the next quarter or so?

We continue to see it. Tom, as he does every quarter, just spends the last two and a half weeks visiting with the senior executives at many of our customers as is his practice every quarter. And, by and large, what we are hearing is our customers will take everything from us that we can build. And we are working on creative strategies with our customers to determine ways that we can bring in materials sooner to support revenue that they are expecting.

So I don't see an end to it right now, John. But there are other people smarter than we are in terms of supply chain and component shortages that might be able to give a better indication. But we don't today see that changing.

Sherri Scribner, Deutsche Bank.

I was curious a little bit, were there any IPO expenses in the quarter?

In Q4?

Yes, in Q4.

(multiple speakers)

Or should we expect any going forward?

No. Everything has been run through the P&L at this point.

Okay. All right. And I assume maybe that nets out in the $24 million that you got in cash?

That is exactly right.

Okay. And then also I was a little surprised to see that we have the related party revenue in the fourth quarter. My understanding was that JDS sold all their shares during the IPO process, but you expect that to go away in September?

Yes, we do. Because of the timing of the IPO closed -- well, the sale of shares on the last day of the quarter, the transaction did not effectively close until the following quarter. So JDSU will roll off in future quarters.

Okay. And then the tax rate being higher, I mean that shaved a couple of pennies off your EPS number, which could have been a little bit higher than it was. Is there any particular reason why you saw a higher tax rate? I know you have guided to the 8% to 9% tax rate going forward.

Yes, it was expected internally. Tax multinationally and with foreign exchange, etc., is not something that is an exact science. However, for the year our tax rate was where we expected it to be at 7.8%. This year we are expecting it to be between 8% and 9% for sure, and that is historical levels, and we expect that to stay the same going forward.

Okay. And then I guess a quick housekeeping question on fiscal 2011 CapEx plans. What do you expect to spend this year?

So from a maintenance perspective, we expect to spend about $4 million. In terms of growth capital, we are focusing on growing the customized optics portion of our revenues. And so we expect to spend about $7 million in that area. We expect to spend another $8 million to $10 million in the rest of our business, and that would be exclusive of Building 6.

As I mentioned, the cost of Building 6 for us in total is $37 million, approximately $7 million for the land and $30 million for the construction as we have mapped it out. We will start construction in the winter, and it will be completed and available for customers January 2012. During this fiscal year, through the end of June of 2011, likely we will spend about $10 million additional in CapEx toward that Building 6, and the remainder of the Building 6 construction costs will be in fiscal 2012.

Okay. So if I add that up, I'm getting somewhere around $29 million?

That is right. Our forecast for this year is about $19 million without Building 6.

(Operator Instructions). Ajit Pai, Stifel Nicolaus.

A couple of quick questions. I think the first is just looking at the book-to-bill for a large number of your customers, both on the optical side, as well as on the laser side. The most recent quarter has actually seen a book-to-bill that has declined from the prior quarter. So, in the visibility in the pipeline that you get from your customers, what kind of commitments do you have to make -- financial commitments -- in terms of inventory, etc.? And what drives your pipeline? Are these firm commitments that are -- that your customers have non-cancelable and non-returnable?

We have -- as you know, we work very, very closely with our customers. And, as a result, our customers are very much in tune with their inventory position at Fabrinet and what their ultimate responsibility will be with materials at Fabrinet.

And so when the customer provides us their demand forecast, particularly for the ensuing quarter, they have -- we are getting their best efforts in terms of their demand and their visibility. Because the customers know that generally under our contracts that some portion of those materials they will be responsible for.

Having said that, given some of the component shortages that we are seeing and our customers and others in the industry are seeing, again, working in close collaboration with the customers, there are pockets of materials, particularly when we are talking about analog devices, for example, where we may work with the customer and determine to bring in a specific amount of additional materials that the customer knows they would be responsible for.

So the level of responsibility, if you would, for Fabrinet relative to materials is unchanged, but we are continuing to work with the customers as they define their forecasts, and we determine how we can help them bring materials in to secure that they meet their revenue.

So would it be fair to assume that when you look at the inventory number that you have on your balance sheet that not all of the inventory is a risk to Fabrinet? A portion of that is going to be a risk to the customers?

By and large, the inventory on our balance sheet is risk to the customer. If we executed our supply chain as our customer directs us to, then the material is all earmarked for specific customers.

Got it. The second question just looking at capacity utilization of your current manufacturing facilities, I think Building 6 you mentioned that the CapEx, the bulk of it is going to be in fiscal year 2011, but it's also going to spill over into fiscal year 2012. So I would assume that production within Building 6 will only begin at some point in fiscal year 2012. So fiscal year 2011, how much can you actually ramp during fiscal year 2011 in terms of production in existing facilities and at what point do you get tapped out?

So, we believe, as we have modeled it, that we are comfortable running $200 million worth of revenue through our existing facilities. And when we looked at modeling Building 6 and we looked at some of the growth demands and requirements of our customers, we went back and in a best case scenario did an analysis of where we could push that number to by gaining additional efficiencies in the facilities space and other areas and determined that we could decrease that $200 million run-rate per quarter by as much as 10% to 12% if need be. We believe that we have more than sufficient capacity that will time out as we move into the expectation of bringing Building 6 on board in January of 2012. As we see it today, it will not be an issue for us.

And the last question I think would be just looking at geographies, Building 6 itself is in Bangkok itself. Are you looking at any expansion in other geographies over the next 18 months?

Not as we sit here today. I would tell you at some point, and we have already talked about it, at some point we will need to expand our facilities in China. That will not be what we consider the assembly work we do in Thailand. That will be expansion of our customized optics capabilities. (multiple speakers) You are very welcome.

John Marchetti, Cowen & Co.

Mark, you mentioned that you could do $200 million for the existing facilities and can boost that by 10% to 12%. When you get Building 6 online, what do you think that takes -- what does that take you up to once you get Building 6 ready?

It will depend on the ultimate size of the building. We believe today it will likely be 300,000 to 320,000 square feet, a similar size to our -- what we call our Building 5. For sure that will give us capacity to reach revenue in excess of $1 billion to $1.1 billion.

Sherri Scribner, Deutsche Bank.

I was curious if you could give us your top customers and what percentage they were of your revenue in the quarter?

Sure. I think it would be easier if I look at it from a fiscal year 2010 basis. And so for fiscal 2010, we have Oclaro, and then JDS Uniphase, then Opnext, Finisar and EMCORE.

And do you have the percentage?

Yes. 17%, 16%, 14%, 12% and 10%. And those obviously -- all 10% customers will be highlighted in our 10-K that we file in a few weeks.

Ajit Pai.

Just looking at the guidance that you provided on the EPS side and just given the strong upside that you had this quarter and then guiding down sequentially on EPS, I'm going to the drivers, and I think the most significant driver is probably just your share count. But you have highlighted that the tax rate goes down going into the next quarter. Can you just walk us through how much of that impact is going to be lower gross margins, and how much of it is going to be higher expenses?

No, we are expecting expenses to be right around 3% for the quarter, 2.9% to 3% for the quarter. It is not a reduction in gross margin per se. On a quarter by quarter basis, there tends not to be -- at least as we have seen it as we have been growing the last several quarters -- there has not been any seasonality in our business. Not to say that there is not seasonality in the markets we serve. But because we have been on a growth ramp we have not seen it necessarily.

But something that we perhaps have not highlighted in the past is that in the June quarter is our annual merit increases for all of our indirect staff globally. That is our engineering staff and finance and IT and HR, etc. And so that typically has an impact on our first-quarter gross margin. But for sure we are continuing to believe that our gross margin model will be as we had suggested previously, and that is in the 12% to 12.5% range going forward.

Got it. Thanks.

You are very welcome. One other point I would like to add to that is on the tax rate. And tax, as well, fluctuates quarter to quarter as a result of not only the various countries that we are producing out of and their tax years and so forth, but also the impact from FIN 48 under US GAAP when we take additional reserves and release reserves related to uncertain tax positions around the planet. So it's not uncommon for our tax rate to vary from 7% or even less in some quarters to 11% or 12% in a following quarter. But if you blend that together, you will see consistently over the years our tax rate has remained in that 8% to 9% range.

Ladies and gentlemen, this concludes the question and answer portion of the call. I would like to turn the call back over to Paul Kalevis, General Counsel.

That concludes Fabrinet's fourth-quarter and fiscal year-end 2010 earnings call. Thank you, everyone, for your participation.

Ladies and gentlemen, thank you so much for your participation in this conference. This concludes the presentation, and you may now disconnect. Have a wonderful day.