Fabrinet (FN) 2014 Q1 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by and welcome to the Fabrinet's fiscal first quarter 2014 earnings conference call. At this time, all participants are in a listen-only mode. Later, we'll conduct a question and answer session and instructions will be given at that time.

(Operator Instructions)

As a reminder, today's conference is being recorded.

Now my pleasure to turn the floor over to Paul Kalivas, Chief Administrative Officer and General Counsel. Sir, you may begin.

Thank you, Operator, And good afternoon, everyone.

Thank you for joining us on today's conference call to discuss Fabrinet's financial and operating results for the first quarter of fiscal year 2014 which ended September 28, 2013. With us on the call today are Tom Mitchell, Chief Executive Officer and Chairman of the Board of Directors of Fabrinet; TS Ng, our Chief Financial Officer; and John Marchetti, our Chief Strategy Officer. This call is being webcast and a replay will be available on the investor section of our website located at investor.Fabrinet.com.

During this afternoon's discussion, we will be presenting both GAAP and non-GAAP numbers. Our GAAP results and the reconciliation of our GAAP to non-GAAP results are attached to our earnings press release, which is also posted on our website.

I would like to remind you that today's discussion may contain forward-looking statements about the future financial performance of the Company. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from management's current expectations. These statements reflect our opinions only as of the date of this presentation and we undertake no obligation to revise them in light of new information or future events, except as required by law.

For a description of the risk factors that may affect our results, please refer to our recent SEC filings, in particular the section captioned risk factors, in our Form 10-K filed on August 6, 2013, and our Form 10-Q filed on May 3, 2013.

We will begin the call with brief remarks by Tom, John, and TS followed by time for questions.

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

Thank you, Paul, and good afternoon, everyone.

Fiscal 2014 is off to a strong start, and I am particularly pleased that our first quarter results demonstrated another strong quarter of revenue, margin, and earnings per share growth. With our strong customer relationships and expanded pipeline of new business, I am confident that we will be able to build off our successful first quarter and deliver a strong year of profitable growth.

As always, I want o thank you our employees for their hard work and all of our customers for their continued trust and support of Fabrinet. I will now turn the call over to John Marchetti, Fabrinet's Chief Strategy Officer, for a further discussion of the markets we serve. John.

Thanks, Tom, and thanks, everyone, for joining us today.

As Tom mentioned, fiscal 1Q was a solid quarter for us with sequential increases in revenue, margin, and earnings per share, all of which came in ahead of our expectations. The primary driver for the up side in the September quarter was an improvement in our Optical Communications business which increased nearly 12% sequentially. This improvement was seen in both our telecom and datacom end markets and represents a marked improvement over the prior quarter.

There continues to be a greater focus and effort in some of the more advanced components and modules in our Optical business. We expect these trends to continue and combined with the recent improvement in demand gives us confidence that the underlying fundamentals of our optical business remain strong. We expect to benefit through our customers as spending on optical equipment accelerates.

The Laser market, while stable over the last two quarters, has yet to show signs of any meaningful re-acceleration. The weakness that we saw in the government and research markets early in the calendar year appears to be behind us, while the industrial market remains mixed. We expect that over the near term our Laser business may continue to experience some sluggishness as demand still seems somewhat muted, but over the longer term we believe that the Laser market represents a significant opportunity for growth and is still in the very early stages of outsourcing.

Demand and visibility in our automotive segment remains fairly solid and while we did see a modest sequential decline in our September quarter results, we believe the longer term trend in this business is encouraging and we are excited about the opportunities for growth in the coming quarters.

While results in our non-optical business have not been as strong as we would have liked recently, we remain confident that our Laser Sensor and other segment will be an important driver of our top-line growth for the next several years. And as Tom has mentioned on several occasions, we will continue to explore ways to accelerate our growth in these and potentially other new markets.

As we look out into the remainder of fiscal 2014, we're encouraged by the overall growth prospects for our business. We continue to work closely with our customers to ensure that we are lining our resources to meet their current and future production needs and believe that our business will accelerate along with our customers as demand trends improve. Our new customer acquisition efforts are a vital part of our overall growth strategy, and while these new wins always take time to generate meaningful revenue, we believe the pipelines for this new business remain strong.

With that, I would now like to turn the call over to TS, our Chief Financial Officer, for a report on our financial results. TS.

Thanks, John. Good afternoon, everyone.

I'm pleased to report that Fabrinet delivered fiscal Q1 results well above our guidance range as we saw solid demand across the customer set. I would like to start with an update on the insurance recovery status, then move on to reviews of the results for the first quarter, and end with our outlook for fiscal Q2.

As a reminder, we continue to expect our financial results to be impacted for multiple quarters due to the timings of approval and payments of insurance proceeds. Claims for all losses related to inventory, property, and business interruptions have been settled and collected, and we continue to work with our insurance syndicate on our equipment planning.

In the first quarter we received an interim payment toward the inventory claim in amounts of approximately $6.6 million. So far in this process, we have received total payments against our claims in the amounts of approximately $36.1 million, and we will continue to aggressively pursue the balance. We will disclose additional information on the timing and payments of our insurance claims as it becomes available.

Now, to review the results for the first quarters of fiscal 2014. Please note that all numbers are GAAP unless stated otherwise. Our total revenue for the first quarter was $171.6 million, an increase of 7% sequentially and an increase of 8% compared to the first quarter of fiscal 2013. On an end-market basis, revenue from Optical Communication was $124.6 million in the first quarter, or 73% of total revenue, while Lasers, Sensors, and other revenue was $47 million, the remaining 27%.

Our share-base compensation expenses for the quarter were $1.6 million, of which roughly $1.3 million was included in SG&A. Our [flat] related item for the quarter was income of $6.6 million which consisted of interim payments on our inventory claim offset by additional payments from settlements of all customer claims of $8.3 million. These amounts are included in our results as other income and are excluded from our non-GAAP results. We intend to book the gains on insurance proceeds [in initial] period as those amounts become reasonably certain.

Our effective tax rate for the quarter was 3.9%, including the effect of flat-related insurance recovery. Without this item, our normalized tax rate would have been 5.8%. We continue to expect our effective tax rate to remain in the 5% to 6% range through the remainder of the fiscal year. On a GAAP basis, including flat-related income and share-based compensation expenses, our net income for the first quarter was $19.2 million or $0.55 per diluted share, compared to net income of $60 million or $0.46 per diluted share in the first quarter of fiscal 2013.

In the near term, we expect that our GAAP results may continue to fluctuate due to the size and timings of our future insurance recoveries. On a non-GAAP basis, net income totalled $14.2 million for the quarter, or $0.40 per diluted share, an increase of 11% compared to non-GAAP net income of $12.8 million or $0.36 per diluted share in the same period [two] years ago.

Moving on to the balance sheet and cash flow statement. We ended the quarter with a cash balance of approximately $164 million. Cash increased by approximately $14 million sequentially as a result of proceeds from insurance claims and strong working capital management partially offset by additional flat related payments to customers.

I would now like to discuss guidance for fiscal 2Q. We expect revenues of between $170 million and $174 million. GAAP net income per share is expected to be in the range of $1.54 to $1.56 with expected non-GAAP net income per share in the range of $0.40 to $0.42 based on approximately 35 million fully diluted shares.

That concludes our prepared remarks. At this point, I would like to turn the call over for questions. Operator.

Thank you, sir.

(Operator Instructions)

And it looks like our first question in queue will come from the line of Patrick Newton with Stifel.

Congratulations on a solid quarter and thanks for taking my questions.

The first one for Tom or John -- given the sale of Oclaro's amplifier business to II-VI, and you had some comments out of II-VI last week on its earnings calls that it hopes to eventually integrate its amplifier portfolio. I was hoping you could update us on the size of the business, to make sure we understood that. If you could comment on your relationship with II-VI, and then perhaps discuss whether or not you're going to maintain this amplifier business long term?

In terms of where we stand with that today, we continue to work with II-VI. That business just closed; and so we're still working through a lot of the particulars there. I don't really have a great update in terms of exactly where that stands over the longer-term period. Certainly, over the near-term period, operationally things have not changed really much at all for us. We continue to work through Oclaro for that business, at least on an operational basis, and expect to, certainly over the next several months if not several quarters.

In terms of the size of the overall exposure of that amplifier business, we haven't gone through and broken down product sets for customers in the past, and I'm not going to do it here today. I understand what you're looking for there, and if and when the time comes that we need to really bracket that exposure because we are fearful that it will move away, we'll do that at that time. But until something like that occurs, we're not going to share the by-product customer revenue with anyone.

Okay. That's understandable.

And then, John -- on the Optical Communications -- very solid quarter there. I'd love a little bit of an update on the datacom versus telecom. I know you said both grew sequentially, but is it fair to assume that datacom growth is still outpacing telecom? And then if you could remind us of what that mix is?

Sure. So, the overall mix didn't change much for us, Patrick, this quarter. We're still about two-thirds, one-third with more exposure to the telco side versus the datacom side. You're right that the datacom growth still is outpacing the telco growth. But what was nice for us, and obviously you can tell by the set of results, is that telco results -- having that start to really start to grow again, was very helpful for us. Because of the greater exposure to that side of the optical business, that's going to have an overall bigger impact for us than on the datacom side.

Specifically on the telecom side, if you could, it is great to see that start to grow. But if you could help us understand linearity in the quarter. Did it accelerate as we exited the quarter? Or where did it perhaps catch you a little bit by surprise that allowed you to put up the top line that you did?

And then you also alluded to modules becoming a more important driver of growth. If you could help us understand -- is this all coherent technology? And if you have any capacity builds as a result of some of this growth?

Sure, let me try to parse that out a little bit.

In terms of what we saw -- the challenge for us, whenever we give guidance in August, is you're never sure how the customer set is going to come back in September. So, we had talked on our last call about seeing a little bit of strength coming into the quarter as we started fiscal 1Q; but it sort of paused in August, which is absolutely normal, and you're never really quite sure what you're going to step back into in September. We were very happy to see that older growth and the demand -- late, if you will -- continue to be very solid right through the month of September.

So linearity in that September quarter is always a little bit strange because the middle month tends to be the weakest, where generally we kind of build nicely through the quarter. But we were very happy with the way customers came back in terms of demand in that month of September.

In terms of modules, coherent is certainly the biggest driver. We are seeing growth beyond coherent; but the coherent portion is still the biggest piece of the module growth right now.

Great. Thank you for taking my questions. Good luck.

Our next question will come from the line of Sherri Scribner with Deutsche Bank.

I just want to get a little detail on your expectations for the December quarter. It looks like -- sorry, it looks like you're guiding relatively flat for the September quarter. I wanted to get some sense of where you think the mix will come from in terms of optical and laser. I would assume that you think the laser business is relatively flat, so that would imply optical was also flat. So I was hoping to get some detail on that?

Sure, Sherri.

We are being a little bit conservative there, to be fair, as is typical with the way we guide. I think you're right in that, for the laser and sensor market, hopefully we'll see a little bit of growth there; but where we are right now, it wouldn't shock me if we do see flat as we continue to go through the rest of this calendar year.

For the optical group -- again, with the guidance range we gave, there is a little bit of upside in there. And our hope is obviously that will continue to accelerate. We're being a little bit careful. Last year we saw some great strength in the month of October only to have it fall off in the second half of November. So we're being a little bit cautious, but I think in general we're expecting some growth out of that Optical Communications side.

Okay. That's helpful.

And then thinking about the guidance -- in terms of the EPS guidance, what is your expectation for interest expense? Would you expect it to be about flat, so would you expect margins to be relatively flat? Or do you think that margins are improving?

Sherri, this is TS.

I think the interest expense is very small. We only had about $26 million debt remaining on the balance sheet, so that's not a significant number. We'll be flat; I would say that.

And in terms of guidance on the gross margin, we normally don't guide the gross margin. But as you can see, the earnings per share is slightly in $0.40 to $0.42, and obviously John always says that our guidance be conservative, so.

Okay. I probably misspoke a little bit there. I meant the net interest expense when I was talking about that. Would you expect it to be flat? Because that will impact whether your gross margins are better. But it sounds like you expect the margins to be up a slight bit but not substantially?

Right, that's correct.

Okay. And then also just wanted to quickly clarify in terms of the disconnect between your GAAP guidance and your non-GAAP guidance. It looks like almost more than $1 in terms of the difference. Is that related to flood recoveries? Can you give us some detail on what you're expecting there?

And then also the accounts payable ticked up substantially this quarter. Just wanted to get a sense of why that ticked up. Thanks.

Okay. Good questions, Sherri.

So, on the GAAP to non-GAAP, essentially, there are two big ticket items. The first one, of course, is stock-based compensation, so we [exclude] that and $1.6 million book in the quarter, [see on occasion] cost of goods sold; and then $1.2 million, $1.3 million is in the SG&A. So, there's the first piece. And then the second piece of course is the flat income. We [exclude] debt from the non-GAAP. So, you remove the two items I just mentioned, it's pretty much [comes out to] the GAAP number.

Again, I'm sorry. I wasn't very clear. I meant for the guidance -- I think that for the guidance, the EPS difference between GAAP and non-GAAP, it looked like it was about $1 or more?

Okay. Okay. Yes.

So, I mentioned in my prepared remarks that we still have the equipment claim to be factored, so the equipment claim we forecast we estimate to collect sizable amount. So if we are successful collecting those amounts, those are all going to the GAAP EPS. That's why it's different between $1.54, (inaudible) we are guiding, so.

And do you have a dollar amount that you expect for that?

If you will -- approximately $40 million.

Okay. And the accounts payable difference -- why that was up.

Yes, account payable -- you can see our inventories also went up quite significantly. And essentially, because of we are gearing up for the[ramp. So anyway, most of the account payable came from the inventory buildup.

Okay. Great. Thank you.

Our next question in the phone queue will come from the line of Alex Henderson with Needham & Company.

I wanted to press a little bit on the industrial laser piece. It seems pretty clear listening to at least one of the customers that you handle, that they're looking at a pretty steep decline in that business. So is it a situation where you have multiple customers here, and a couple of customers are growing nicely and one of them is under a fair amount of pressure? Or can you talk about a little bit about the mix within that, because the guidance that they had given is not consistent with the guidance you're giving, or the commentary you've given on that?

And then second, can you talk a little bit about your expectation for the auto segment? Sequentially, I would assume that, that's improving given your recent wins.

Sure Alex.

I think on the laser market, we do have several sizable customers within that -- or sizable, I should say, for us in terms of what makes up that segment for us. There's a little bit of movement around in there; but, to be fair, that business, while it hasn't grown as much as we had hoped, has been fairly stable for us over the last several quarters. So, we're not expecting a big change on a go-forward basis. We do build multiple laser types for multiple customers, so there's always a little bit of a mix shift from quarter to quarter in terms of what we might be focusing on from one quarter to the next. But that business has been, certainly over the last two or three quarters, pretty stable; and we would expect it to be that way going forward.

On the sensor side, or on the auto side, we are expecting hopefully that to start to tick up a little bit more aggressively, even if it's not by, say, the December quarter, certainly as we get into calendar 2014. As you said, we've had some decent wins there. We continue to get some new programs coming in. So, we're pretty encouraged by the pipeline that we've got on that auto side.

Okay. Second question and this is sort of a bucketing question.

If I were to bucket your coherent, your OTN, your carrier rate Ethernet, and your datacom businesses on one side; and Sonet/SDH 10-gig, long haul -- the multi-service edge stuff in the other bucket -- can you give us a relative sizing of those two buckets? To what degree we're seeing some shifting between those two buckets? And is the acceleration a function of some of those higher growth business accelerating? Or are these other stuff becoming -- the stuff that's declining becoming less of a drag?

Sure, sure.

So, obviously if you take the datacom piece, right, that's about a third of the overall exposure. If you layer in some of those faster-growing technologies, if you will, or some of the newer technologies -- I think that's probably a better way to put it -- we're probably somewhere around 55%, maybe 60%. That total goes that way.

So, for that other 40%, I do think it's a little bit of both, Alex. I do think you've seen a moderation of some of the declines in some of the more legacy-type technologies. But we still get a fair bit of growth out of 10 gig. So, I think those two pieces of that, say, remainder are the biggest drivers that are happening on that more legacy side of the business.

If you'll look at the accelerating piece, the strong growth areas -- coherent, OTN, carrier grade Ethernet and datacom -- could you rank order them in terms of what's driving the business?

Well, datacom has been strong now for several quarters. We're starting, I think, to see more acceleration in coherent and some of the others; and that I think is reflective in the uptick that we've seen in our telco business, where that datacom business, quite frankly, has been growing nicely for two or three quarters now.

Thanks.

Thank you, sir. Our next phone question will come from Subu Subrahmanyan with The Juda Group.

First, John, maybe a bigger-picture question. We're now seeing a couple quarters of growth. I'm just wondering from your customers' perspective, are we starting to get a sense of a trajectory of improvement? Is it still one quarter at a time? What kind of dialogue and visibility are you getting from your customers?

The second is on gross margin. We saw some improvement this quarter with tick up in volumes, and I'm just wondering, with a combination of flattish volumes getting wind of next quarter, and some currency benefit, what directionally you expect on gross margin?

Sure, so to your first question, Subu, I think customers are still being very prudent about it. I don't think anybody is getting ahead of themselves in terms of trying to outpace what they're getting in from their customers. I think that we've seen our customers be very measured in their approach to this, but I do believe that in general they're feeling better about their businesses today than they were feeling a quarter or two ago. I think that's certainly the case on the optical side.

In terms of your question about gross margin -- directionally, if we can provide a little bit of revenue uplift from where we are, then we should see gross margin tick up as well. Those two should certainly trend in the right direction even if they're not growing necessarily on the same curve. We would expect that, as revenue continues to move up, gross margin should move up with it.

Sure. I guess my question, first question, was more to follow up on that -- from September to December last quarter, as you mentioned, we saw an uptick and then it faded. I'm just asking if sentiment-wise it feels broader, more directional? Or still feels on a quarter-to-quarter basis relatively (inaudible)?

Right, and I apologize for not picking up on that the first time around. No, I do think it feels broader. And part of it last year as well there was probably a little bit of that demand that we caught that was still somewhat flood-related, as either some of our customers were replenishing some inventory or some things along those lines. This quarter, obviously with none of those effects, really having any impact whatsoever, it does feel a little bit more broader-based than just say a one-quarter phenomenon.

Understood. Thank you.

Our next phone question will come from the line of Paul Coster with JPMorgan.

A few quick ones.

First one -- the $40 million of cash that you expect to come in from insurance claims, is it unencumbered? Or does that cash go back out the door to customers?

No, I think we had settled with all the customers now as we mentioned in the prepared remarks. So, Paul, we are done with the customer, so the money comes to our pocket.

Okay. Very good.

You seem to be getting close to pre-flood revenue levels again, when gross margins were 100 basis points or more higher than they are today. What's the impediment as we creep back towards that level, from the impediment preventing you from getting back, if there are any impediments to sort of 12%, 13% range gross margins?

So, Paul, pending the [high budge trend] against US dollar, assuming they can return back to the previous level, we still believe that 12% to 12.5%, once available get up to about $195 million to $200 million is achievable. So we look at the cost structures almost every quarter, and that cost structure [could be] 12% to 12.5% gross margin, 9% to 9.5% on operating margins still intact.

Very good. And then, lastly, to what extent are you able to identify seasonality in the Optical Communications business? Specifically, the extent to which there's a December year-end budget flush that you benefit from?

Paul, what I would say is that is always customer- and end market-dependent. Typically, the carriers will spend a little more as they go through each successive quarter of the calendar year, and they spend a little bit more in December. If you look at some of the CapEx guidance that was given during the most recent set of results from some of the carriers, I certainly don't think most are expecting a big uptick into calendar year end.

So, it varies year to year. Typically, December is a little bit stronger, and then you're back down a little bit in the March quarter as budgets get reset and they have to get allocated and released and all those things. But I don't think we're expecting any kind of a huge flush into calendar year end.

Thank you.

Thank you, sir.

(Operator Instructions)

Our next phone question will come from Troy Jensen with Piper Jaffray.

Congrats on the nice results today.

So, maybe for TS -- can you just help me out with other income? Below the operating line, to get to this $0.40 to $0.42 this quarter, what are you assuming the other income will be?

Yes. Normally the other income consists of interest income and also the big ticket item is [changed gain], okay. So, we have a whole bunch of [forward] contracts at the end of the quarter, and according to the [common standard] you mark to market. So those forward contracts have certain value, and you compare with quarter end exchange rate at that time you mark to the market.

So, in the Q1 fiscal first quarter, we book about close to $1 million gain on that. Now, moving forward on the guidance, we assume this is zero, because we can't tell how the [bots] are moving by end of the quarter. So, other than the income interest expense, we basically assume nothing there.

Zero other income; so we should be like 8.5%-plus operating margins to get to that $0.40-plus range. Okay. That's perfect. Maybe just a quick one for John.

Oclaro/II-VI -- I know you can't say a lot, I get that. But can you just maybe paint out some worst-case scenario? How long is it before they would potentially try to move the business? Then maybe a best-case scenario -- is there anything you can pick up from II-VI? Is this an opportunity at all for you guys?

Yes, I think, to be fair, I think both of those options are still very much on the table, right? It depends ultimately what they want to do; which is best for their business -- for the optical amplifier business in particular. We think we can make a fairly compelling case to them to keep that business with us, but ultimately that's going to be their decision to make. Over time, if they do decide that we're the best way to continue to produce that product going forward, then I think it does open up opportunities potentially for other programs with them as we continue to go through that relationship.

If they do decide to move it, depending on when they actually make the decision, my assumption is that it would be at least a couple quarters once they make the decision before it actually got moved out of the barn. So you use that as a little bit of a reference. I think for the most part I don't think we're likely to see an impact to the fiscal 2014 number either way. But if they really wanted to make that decision very quickly it could potentially hit the 4Q number -- but certainly not before that.

All right. Well, good luck going for it.

Thank you.

Thank you, sir.

(Operator Instructions)

Mark Sue with RBC Capital Markets.

Gentlemen, I just had a question in what you're seeing from a geographic end demand point of view, recognizing a lot of the products do end up in different areas. Perhaps you could give us a sense of just China LTE -- what the pull-in might be from a high level sense? And just the strength of the total trends, the sustainability of that with a lot of the big projects that are going on with data centers in North America.

Sure. Thanks, Mark.

It is a little bit difficult for us to really get geographic trends, because in a lot of cases we're shipping to either another contract manufacturer or we're shipping to a customer, maybe not to the carrier directly. We saw a little bit of an uptick again in telco in September -- is that China related specifically? It's hard for me to tell. We saw North America get stronger as we came through the summer months, so that is continuing to be, I think, a relative source of strength as well. There could have been a little bit of an uptick in the China market; but it wasn't so much, Mark, that we actually could say, well, when China released some of that CapEx we absolutely saw it flow through immediately.

I see. That's helpful. Thank you for the additional color and good luck, gentlemen.

Presenters, at this time I'm showing no additional questioners in the phone queue. I'd like to turn the program back over to Management for any additional or closing remarks.

Thanks very much, and thanks everybody for joining us today. We look forward to talking to you soon. Have a great day.

Thank you, presenters, and thank you, ladies and gentlemen. Again, this does conclude today's call. Thank you for your participation and have a wonderful day.