Fabrinet (FN) 2015 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Fabrinet's third-quarter 2015 financial results conference call.

(Operator Instructions)

As a reminder, this conference is being recorded. I would now like to hand the conference over to John Marchetti, Fabrinet's Chief Strategy Officer. Please go ahead, sir.

Thank you, operator. Good afternoon, everyone. Thank you for joining us on today's conference call to discuss Fabrinet's financial and operating results for the third-quarter FY15, which ended March 27, 2015.

With me on the call today are Tom Mitchell, Chief Executive Officer and Chairman of the Board of Directors of Fabrinet, and TS Ng, our Chief Financial Officer. This call is being webcast and a replay will be available on the Investor section of our website located at investor.fabrinet.com. Please refer to our website for important information including our earnings press release and our non-GAAP to GAAP reconciliation.

I would like to remind you that today's discussion will 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 expectation. These statements reflect our opinions only as the date of this presentation, and we under take no obligation to revise them in light of new information or future event 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-Q filed on February 3, 2015.

We will begin the call with brief remarks by Tom, myself and TS, followed by time for questions. I would now like to turn call over to Fabrinet's Chairman and CEO, Tom Mitchell.

Thank you, John. Good afternoon, everyone. I am pleased with our third-quarter results, with the revenues and earnings per share ahead of our expectations. Our initiatives to expand our new product introduction and advanced packaging capability are well underway, and we are on track to ship our first products from our new West Coast facility in the current quarter.

We are gaining traction with these programs, and they are adding strength to our new business pipeline. This pipeline is critical to the long-term success of the Company, and we will continue to add resources to expand and strengthen this pipeline.

I will now turn the call back to John for a discussion of the markets we serve. John?

Thanks, Tom. Our third-quarter results came in ahead of expectations, driven by growth in our optical communications business, particularly in our datacom segment, which grew 20% sequentially. With the demand environment seeming a bit more stable than it was in the second half of last calendar year and contributions from our new programs continuing to grow, we expect our fourth-quarter revenue to increase sequentially in our optical and non-optical segments.

Our optical communications business turned in another solid quarter, increasing 14% year over year and 2% sequentially. We were particularly pleased with the sequential increase, as we did not recognize any consignment revenue in the third quarter. On a normalized basis, excluding impact of the consignment revenues on our fiscal 2Q results, the optical communications business increased nearly 8% quarter over quarter. Our split between telecom and datacom in the quarter was approximately 69% telco and 31% datacom, with both segments up on a sequential and year-over-year basis when excluding the impact of consigned revenues on our 2Q results.

Similar to other quarters, growth in our optical communications business was driven by advanced optical components and modules, including the 100 gig, while the improvements in our datacom business were driven by 10- and 40-gig solutions. As we look into the June quarter, we are expecting both our telecom and datacom businesses to increase modestly on a sequential basis.

Our non-optical business performed a little below our expectations, up 11% year over year but down 2.5% sequentially, on quarter-over-quarter decrease in our laser partially offset by an increase in auto business. Excluding the impact of the consigned revenue on 2Q results, our non-optical business would have been roughly flat on a sequential basis. In the current quarter we expect the non-optical portion of our revenue to increase modestly on a quarter-over-quarter basis.

In terms of revenue from new accounts, it again represented more than 10% of revenue, and now for the third consecutive quarter, up from approximately 6% of revenue in the same quarter last year and increasing more than 40% sequentially. We are encouraged by the increased visibility that we are beginning to see, in terms of the sustainability and predictability of this revenue contribution. We are confident that the investments that we have made over the last couple quarters to increase our worldwide sales effort will help us to broaden and strengthen this pipeline to ensure that it remains a healthy contributor to growth in the coming quarters and years.

We're also pleased with the progress we made to date on our new US NPI operations Fabrinet West. During the March quarter we've purchased facility in Santa Clara, are now in the process of equipping and staffing the factory, and expect to deliver our first products for customers from the site during the current quarter. In fact, last week our first demo units came off new lines. We're excited about the long-term opportunity that we believe this new operation will provide for both existing and new customers and expect that as this NPI facility grows it will provide increased opportunities for the transfer of volume products to Thailand.

With that I would like to turn the call over to TS for review of our financial results.

Thanks, John. Good afternoon, everyone. As in the past, all numbers presented here is a GAAP unless stated otherwise. Total revenue for third quarter was $189.5 million, an increase of 13% compared to total revenues of $167.7 million in the third quarters of last fiscal year and up a little more than 0.5 percent compared to last quarter. Please note that revenue in a quarter did not include any meaningful consigned shipment revenue excluded from FY14. Compared to approximately $8.4 million in consigned revenue recognized last quarter.

On apples-to-apples basis, excluding the impact of the consignment revenue, sales in the third quarter had grown 5% sequentially, well above our normal seasonality. We expect to recognize the remaining $4.6 million of consignment shipment revenue in the current quarter. On an end-market basis, revenue from optical communications was $136.6 million, or 72% of total revenue for the quarter, while revenue from our non-optical businesses was $52.9 million, the remaining 28%.

GAAP gross margin for third quarter was 11.4%, an increase of 25 basis points sequentially. Excluding share-based compensation expenses, non-GAAP gross margin was 11.6% in fiscal three quarter up 26 basis points quarter over quarter. For fiscal 4Q we are focusing a moderate sequential increase in gross margin. Our total share-based compensation expenses for the quarter were $2.0 million, of which roughly $1.6 million was included in SG&A.

As we highlighted on our last call, the increase in SG&A in fiscal third quarter was primarily due to the expansions of our sales team and increased expenses associated with our new Fabrinet West operation. We expect that we will remain at this level through the near term.

Our taxes in the quarter were net expense of approximately $1.1 million and our effective tax rate was 9%, above expected range of 6% to 7%. On a normalized basis our effective tax rate would have been 7% if we exclude one-time expense associated with our new Fabrinet West operation booked this quarter. We anticipate that our effective tax rate will continue to be in the range of 6% to 7% moving forward until Building 6 is substantially occupied.

On a non-GAAP basis net income totaled $13 million for the quarter or $0.36 per diluted share. Non-GAAP net income declined by approximately $1.4 million compared to last quarter due to the higher SG&A expenses partially offset by the improving gross margin. On a GAAP basis, including share-based compensation expenses and other expenses related to the draw down of a portions of our credit line, net income in the quarter was $10.8 million or $0.30 per diluted share, compared to GAAP net incomes of $47.7 million or $1.33 per diluted share in the third quarters of FY14. Please note that our GAAP net income in third quarters of FY14 was positively impacted by $38.2 million or $1.07 per diluted share due to the final payments of flux insurance proceeds.

Moving on to the balance sheet and cash flow statement, the end of the quarter with a cash and investment balance of $254 million. The cash increased by approximately $1 million sequentially, primarily from our operations.

During the quarter we spent approximately $25.5 million to purchase our new facility in Santa Clara and begin initial equipment installations. In the current quarter we expect an additional $5.2 million in cash expenses as we finished the initial equipment purchases and begin operations. In total, we expect that cash expenses associated with getting our new Fabrinet West operation up and running will be approximately $40 million for this fiscal year, in line with the range that we disclosed last quarter.

I will now like to discuss guidance for next quarter. We expect revenues of between $195 million and $199 million, which includes the remaining $4.6 million of consigned revenue excluded from FY14. GAAP net income per share is expected to be in the range of $0.33 to $0.35, and non-GAAP net income per share of $0.37 to $0.39 based on approximately 36.2 million fully-diluted share outstanding.

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

(Operator Instructions)

Our first question comes from the line of Patrick Newton from Stifel.

Thank you. Good afternoon, Tom, TS, and John. Thank you for taking my questions. Any chance that the remaining $4.8 million in consignment revenue that you have guided to in the June quarter could slip out beyond the June quarter?

Patrick, this is TS. No, I don't think so because we have the customer, actually, already sign, so it's part of the subsequent event for last quarter.

Okay. That's helpful. Digging in the segments, could you give us the mix between lasers and automotive and sensors in your other business? If we think about the new customer contributions, I think, were up 40% sequentially, is there out-sized exposure to lasers, automotive and sensors or is it on the optical communication side that you are seeing the new customer additions?

Sure thing, Patrick. To your first question, it hasn't been a real big change in the make up of that non-optical category. About two-thirds of it winds up being in the laser category. The remaining one-third is primarily auto, but that's where there is some other stuff in there as well. No real change there from a historical pattern that we have seen in the non-optical business over the last several quarters.

In terms of the growth in the new customer stuff, a lot of it has been in the optical business, although there are some new programs that are coming in on the non-optical side as well. Those tend to take a little bit longer to grow. In terms of the optical side, we did see some pretty good contributions this quarter, and it was behind some of the growth that we saw in the datacom business in particular.

Okay. I was a little bit surprised you were able to guide up your June quarter on the laser sensors other than given that there is a pretty well documented inventory correction at your largest laser customer. Is automotive picking up the slack, are there other laser programs picking up the slack, or is this inventory correction more smoothed from a production standpoint at the Fabrinet level? Or given you that trail your customers typically, could the September quarter be where we see that inventory correction have an impact to your business?

I'm not going to comment on any specific customer here, Patrick. I will say that our laser business was down in the March quarter. I think that whatever might have happened from a correction standpoint, I think we did absorb the bulk of it. As we are looking into June, I think it's a combination of all the factors you went through. We are expecting some of the non-laser business to grow, but we do have growth on a sequential basis, at least at this point, factored into our expectations for June.

All right, then just one more is on Fabrinet West on track to generate revenue in the current quarter, can you quantify this? I think in reference to some Q&A last quarter, you talked about tens of millions of contribution to revenue in FY16 from Fabrinet West, is that still the right way to think about it?

Patrick, this is TS. I think we are still trying to install the equipment, so if there is any meaningful revenue it will be in the next fiscal year.

Pertaining to FY16?

Yes.

Is that $10 million right way to think about it?

That's certainly our expectation at this point, Patrick.

Great. Thank you. Good luck.

Thank you. Our next question comes from the line of Sherri Scribner from Deutsche Bank.

Hi. Thanks. Nice job on the gross margin this quarter. I wanted to get a sense of what's driving that upside to gross margin and the improving gross margin as we move into the fourth quarter, is that largely mix? Or is that some better utilization of Building 6?

Mostly is mainly volume, volume leverage. We can see the revenue count pick up right now, and obviously, Building 6 is getting filled up, so as I always said, once the Building 6 is filled up, then they will help the margin. Essentially, I will say volume.

Perfect. Then, I guess I am surprised you guys are seeing such good demand and you feel good about visibility. Some of the other supply-chain companies have commented that the telecom segment is a big weaker. So just trying to get a sense of what you're seeing and why that's probably different from some of the other contract manufacturers? Thanks.

Sure thing, Sherri, I think what we talked about even coming into the March quarter was having some new programs that were far enough along in their ramp process that we felt good from those contributions. I think we saw some of that here in the March quarter results that we just shared with you. Our expectation is that's going to continue a bit into June, so it's providing us with probably a little better visibility and a little bit more growth than maybe some of the more legacy type businesses that are out there today.

I guess just following up on that, many of the supply chain companies have said that they're seeing weakness in the near term but they see strength in the second half of the year. Are you also expecting that?

I think anybody -- if you look at the carrier spending numbers, I think that's probably the expectation that's out there. I won't say that we have certainly seen it in the order book at this point. That's still a little bit far out for us. I think in discussions with customers, that's certainly what they're hoping will occur, but I don't think we are far enough along into the year where we can say with certainty that we're going to see that translate into orders in the second half.

Okay. Great. Thanks so much.

Thanks, Sher.

Thank you. Our next question comes from the line of Subu Subrahmanyan from The Juda Group.

Thank you. I have two questions. First on just the seasonal pattern. If you take on the consignment revenue, the last two or three quarters have been relatively flat quarters and not as much seasonality. I am curious why you think that's the case? You haven't seen as much of a seasonal pattern, and how you expect that to play out through the course of the year? The other question is on datacom revenue growth, the strong growth 20% quarter over quarter. Could you talk about was it driven by new programs, specifically your 40, 100 any particular product areas that drove that?

Sure, Subu. To your first part about seasonality, I think part of what has happened for us here, certainly in the March quarter going back to December, our December quarter was a little bit weaker than typical seasonality. I think that was largely due to some of the carrier spending patterns that I know got a lot of talk and discussion over the last couple quarters. I think with December having been a little bit less strong than is typical, we saw a March that was probably a little bit better than was typical as a result of that. We didn't see the order cuts that we typically see at the start of the calendar year. I think you know that combined with some of the new program growth that we had in the quarter certainly pushed us above what is normal seasonality.

Looking forward from here, I think for us, and again, we don't have visibility, certainly, out through the end of the calendar year. When you look at what some carrier CapEx numbers have been saying on that side, it would look like it's at least setting up to be a more typical year in terms of having the carrier spending build as we go through it. The datacom side of the business seems a little bit stronger. That probably dove tails right into your second question.

We did get a nice little kicker in the March quarter from some new programs on the datacom side. We expect that to continue a little bit into June. So, I think we are seeing, at least for us in particular, some strength there that we maybe didn't have in some prior quarters as these new programs come on and provide some of that lift.

Are those with new customers or are they just with existing customers, new programs?

It is a little bit of both, to be fair, Subu.

Then I have a question on Fabrinet West. I know you talked about opportunity, again. The question was asked about tens of millions, is it more meaningful as you get into the second half of FY16? Can you give us some color on the sort of customers that have signed up for this? Any count between component vendors and system members, any color on that would be helpful?

Sure. It is, I think, going to be more weighted to the second half of the fiscal year. Obviously, we are still in the process, right now, of just even getting the first couple lines set up and qualified. Our expectation is that we'll be able to ship at least some minimal revenue from that operation here in fiscal 4Q. As we go through the remainder of the calendar year, we'll probably be adding some additional lines and some capacity into that space as well. So I would expect that the contribution from this business is certainly going to be more weighted to the second half of the fiscal year.

In terms of the customers that are either with us today or certainly having discussions with us today, I think it is a mix of some current customers who we have been doing business with for a while, who are looking at it as certainly a more convenient way do quick turn NPI. But it's also being used by us with a lot of the newer accounts that we're really reaching out to for the first time, both in optical and in non-optical, as a way to make sure that we're able to showcase our abilities and let them know that we can prove out their designs on a quick-turn NPI basis, but then also provide that gateway to low-cost manufacturing in Asia.

Thank you.

Thank you. Our next question comes from the line of Alex Henderson from Needham.

Hey, guys. A couple of questions. Let me start off with the Fabrinet West investment. We talked a lot about the impact on revenue opportunity there, but can you talk about when the costs associated with the investments you are making there start to feather into the numbers? I assume that since you haven't got the production up and running that once you actually go to production, there is a step up in depreciation costs and the like. Can you step us through some of the mechanics of that?

Alex, That's a good question. As you know, right now we are in a preproduction mode and most of the costs are captured below the line. We say we have about spend $1.8 million between Fabrinet West and some of the new sales force we hired. As we bring in revenue, a portion of that will go into cost of goods sold. As to how much going up, a lot depend on the revenue. AS we arrange to wind up the capacity, some of these will come from the idle capacity going to the cost of goods sold. That will be the process.

So, we should be feathering in $1.8 million in quarterly costs going forward once production starts?

No, gradually. Okay, so if we are at capacity, let's say the whole factory (technical difficulty) $1.8 million, beside the sales expenses, the $1.8 million including the sales expenses, all the 4,900 of Fabrinet West costs will go to the production of cost of goods sold. So, how much to up then, a lot depend on the revenue ramp.

Isn't there a depreciation slug that kicks in immediately on production, though?

Yes. So right now the depreciation will kick in also, and also you are going to hire the labor, so that is not included in part of the $1.8 million. As we ramp, we'll have variable costs and we have the position come online and then there will be in the cost of goods sold.

Right, and the OpEx costs that would incrementally, quarter to quarter, kick in as a result of that would be what?

We don't know. A lot depends on the revenue pattern.

Can you give us a bracket of what sequential cost is? We have no way to model it otherwise.

I will say, if we fully ramp, right now of the $1.8 million we occurred in addition to the normal run rate before we had the 4,900 people, about $1.8 million. Of the $108 million, about $1.2 million belonged to Fabrinet West, $500,00, $600,00 belonged to the sales expenses. The $1.2 million eventually will go up to the cost of goods sold.

So we should be anticipating $500,000 or $600,000 increase in quarterly SG&A expenses?

The sale force will remain in that, the sales expenses. That is correct, Alex.

That's already in that number today, Alex. What you saw in this quarter already has that number in the SG&A line, and that should stay fairly stable.

So then when does the depreciation kick in? That's still the lacking piece, the piece that seems to be missing. What is the size of the dollar of depreciation and when does that kick in?

So, depreciation is not significant amount right now, because the building is, as I say, $25.5 million and building go by either 27 or 30 year, around that timeframe, so I mean the depreciation on the building is not huge number. Equipment is about -- right now, we only have two lines and two lines will be $4 million to $5 million plus your lease on improvement. Again, there only depreciate over periods of time. Depreciation at this moment is not significant. If you ramp to the full-blown facilities we occupy, then, yes, then the depreciation is significant. Then, by then you have the revenue to offset that.

So the other piece to the equation is the timing of the new building for your broader production, not FN West but the core companies --

Yes.

Can you talk about whether there has been any change in the timeline of when you think you will need to ramp that next building?

We talked about certainly this calendar year. The space today is at about 75% capacity. That's the entire campus. Building 6 is at about 60%, if you look at the newest building. Our expectation is that probably some point this summer, we'll start driving the pylons and start to get to work on that, which would bring that building online at the start of, or certainly probably within that first quarter or there abouts of FY17, Alex.

As we move to FY17 and that building starts to come online, what is the expected increase in costs and the reduction in gross margin associated with that?

Okay. Alex, assuming there is no revenue, just all things equal, no revenue the depreciation impacts is about maybe 10 to 15 basis points on the gross margin, assuming there is no revenue to offset that.

Okay and if there is revenues, obviously, that would have a pretty low margin to start with because your capacity utilization is quite low, right?

And use is not the basically the whole building. Once the building started as a whole building, you don't depreciate building floor space by floor space.

It takes a while to offset that.

What I am trying to figure out is, I just want to make sure I understand mechanically what you are describing here is a situation where as the high-margin revenues or the revenues from Fabrinet West kick in and start improving your margin from that perspective and improving your revenue growth, you will also be factoring in this new production facility, which will then pressure the gross margins and those two will countervailing forces. Are they roughly equal in that point in time, in terms of the margin impact?

That would certainly be the goal, Alex. But a lot of that is going to also be based on the success of the Fabrinet West operation and our ability to grow that the way that we think we can.

Then, just going back to the optics market for one last question. It sounds like the optics market saw a nice acceleration in demand throughout the quarter, which is not seasonally normal, a little bit better than normal seasonal. Can you talk a little bit about linearity of orders in the quarter, and whether you saw some acceleration? And is that a function of the cloud market taking off? Or is that a function of the metro market starting to kick in? How do you see the demand drivers?

Sure. I mean, again I think for us what was a little bit unusual in this quarter relative to some other March quarters, if you will, was typically we get a lot of order cuts late in the December quarter, early in the March quarter as customers look to clean out inventory at the start of the calendar year. Because I think the December quarter was a little bit weaker than some customers had originally anticipated, we saw those order cuts a little bit earlier in the December quarter. So we didn't really start this quarter in a hole, so to speak. Everything smoothed out from December on in.

It was probably, if anything, a little bit more of a linear quarter than we typically see in our March quarters. That said, what we did see, I think, the datacom market be a little bit stronger and came back, I think, off of some of the weakness that was out there in the second half of last calendar year. I think that, obviously, has a lot do with what we are seeing on the data center market side.

On the telco side, I think we saw a couple of product-specific areas that were a little bit stronger. I think we saw another decent quarter in rodums. We have had a couple customer who have talked publicly about the fact that most of that is going to lab and field trials and is not necessarily indicative of a big up turn in that metro market yet, but we did see some continued improvement in that market as well. So some of it I think was metro, but I think the stronger side was certainly on the datacom market.

Can you get any read on China demand?

That's tougher for us, to be fair, Alex. We ship to other CMs in China, so it's hard for us to really know exactly what builds are going on there. Quite frankly, unless they're submarine, where it's almost a direct correlation.

Great. Thank you very much. I'll cede the floor.

Thank you.

(Operator Instructions)

Our next question comes from the line of Paul Coster from JPMorgan.

Thanks for taking my questions. First, I just want to make sure that I understand the consignment revenue presumably as in the June quarter, can you confirm that? Can you confirm that it is not materially different in terms of gross margins to the rest of the business?

Paul, first question on the $4.6 million, it was a subsequent event and I think it's a done deal, so we're going to book that. In terms of gross margin, no, it will be much lower gross margin because we don't get the production assumption. The production assumption was done a couple of quarters ago. Therefore, the gross margin impact will not be the same as new view. All right, so we still get some gross margin, but it is not as high or normal as a new deal.

I think we're getting the impression there is lots of puts and takes here to gross margins immediately and over the medium term. Can you perhaps give us some sense of where you think your longer term gross margins are headed and why?

Look at the last two or three year pattern in our -- and then, again, now we are approaching the $195 million to $200 million level, I think all along we guided 12% to 12.5% impact. We have a lo of challenge here and there. The cost always go up, pricing always come down, but again, to cost reduction, we able to maintain that. We always say that when we get up to $195 million, $200 million, above that, we should feel comfortable at 12% to 12.5%.

Okay. Then on the Fabrinet West, I am just curious as to Tom's opening remarks about the pipeline growing. Can you explain to us what the go-to-market strategy is here? Is it really going off through existing customers but with a time-to-market type business here in the US? Or is it new customers and just completely -- or new product categories? I am just trying to understand what the value proposition is that you are presenting to the customers here, and which customers you are going after?

Sure, Paul. I think there is two ways to look at it. The first way, as you mentioned, is with existing customers. Today, we do a fair bit of NPI for existing customers at our Pine Hurst facility in Thailand. We have always had requests, and have for a number of years, to have facility that was more local to those customers, and as you know we do a fair bit of business right off of Route 237 there in California. So part of this is in response to that, to capture more of the earlier-stage, quick-turn NPI business from existing customers who want to run new products much closer to home, so that they can co-locate with a lot of the engineers.

The other side of this is to use this as a facility that can start with NPI and prove to new customers, both in optical and in non-optical, what the capabilities are, to show them that we can do complex assembly work for them, and then offer them a gateway transition directly to low-cost manufacturing located in Thailand. It's a dual strategy, if you will, where with existing customers, it's meant to capture more of the early-stage business to make sure that we can continue to transition those products to Thailand. Then, it's also for new customers, where it's a showcase -- customers who may not know us as well, who may be reluctant to do a new product initially, immediately in Thailand, to allow them to be a little bit closer to home. We can show them the capabilities we have, and when ready to go to full production, it's a seamless transition from the West Coast facility to our Thai facility.

Okay, just one last quick follow-up question, then. How many customers are actually up and running on the production lines already? How many do you think there might be in a year from now?

To be fair, we're not fully established yet. Like I said, we're still doing demo units on those lines, so I am not at this point prepared to discuss customers that are or aren't in the factory. I think, again, as we've said all along and TS mentioned, we'll have two lines up and running with customer product coming off by the end of June. Our expectation is that if that pipeline continues to grow, we'll put in some additional lines here before the end of the calendar year, and then from there it's all success based. The facility has room for 10 lines, as well as other capabilities that we can build in around that. But for right now, we've got line of sight on having those four lines in, and then from there a lot of it is going to be success based.

I am just trying to figure out whether we are talking about a handful of customers who will be doing a lot of diverse work with you or whether it's going to be potentially thousands of customers that you've got in this facility a year from now?

The goal long term, Paul, is to have a handful of both of those types of customers, a number of quick-turn customers who may be in and out a couple times a year as well as some larger (technical difficulties) who give you fairly consistent volume.

Okay. Thank you.

Thank you. That concludes our question-and-answer session for today. I would like to turn the conference back over to Management for any closing comments.

Thank you, everybody, for joining us today. We look forward to talking to you in the future.

Thank you.

Thank you.

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, and you may now disconnect. Everyone, have a good day.