Fabrinet (FN) 2016 Q3 法說會逐字稿

Welcome to Fabrinet's third-quarter FY16 financial results conference call.

(Operator Instructions)

As a reminder, today's conference is being recorded. I would now like to turn the call over to your host, Garo Toomajanian, Investor Relations.

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 of FY16, which ended on March 25, 2016. With me on the call today are: Tom Mitchell, Chief Executive Officer and Chairman of the Board of Directors of Fabrinet and TS Ng, Fabrinet's 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 expectations.

These statements reflect our opinions only as of the date of this presentation. 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-Q filed on February 2, 2016. We will begin the call with remarks from Tom and TS, followed by time for questions. I would now like to turn the call over to Fabrinet's CEO and Chairman, Tom Mitchell. Tom?

Thank you, Garo. Good afternoon, everyone. We delivered strong performance in the third quarter, with revenue and earnings per share that were above guidance. During the third quarter, we benefited from positive trends in the optical industry, which resulted in higher than expected demand from both new programs and programs that have been in production for two or more years.

With demand increasing, we are optimistic that we will continue to benefit from strong market trends in the fourth quarter and into FY17. From a capacity perspective, we are excited that the first building of our new campus in Thailand will be completed by September. This new campus will allow us to continue to meet increasing customer demand and to grow at a healthy pace. Now, I'll turn the call over to TS for details on the quarter.

Thank you, Tom. Good afternoon, everyone. I would like to provide you with more details on our performance by end market and our financial results. Total third-quarter revenue was $250.9 million, an increase of 32% from a year ago and above the high end of our guidance range. As a reminder, we did not record any consignment revenue in the third quarter of FY15. Our strong performance this quarter was primarily the result of positive trends in the optical communications, which generated demand that was above expectations.

Our optical communications business represents 77% of our total revenue, increasing more than 4 percentage points, both from last year and last quarter. Optical revenue increased 41% from a year ago to $192.2 million, while non-optical revenue increased 11% to $58.7 million. While we expect increasing diversification in our business to drive and increase our mix of non-optical revenue in the long run, over the near-term, very strong optical industry dynamics will likely continue to favor growth from optical revenue.

Within optical, the revenue split was 56% from telcom market and 44% from datacom market, as year-over-year, telecom growth jumped to 29% in Q3 compared to 5% in Q2. At the same time, datacom momentum continues to be very strong, with datacom revenue growing 60% from the third quarter of FY15, in line with 64% growth in Q2. As you might expect, growth in our optical communications business continues to be driven by 100-gig solution and other advanced components and modules including QSFP28 transceivers and silicon photonics modules.

We continue to see a mix shift toward 100-gig programs, whose revenue increased more than 175% from a year ago, more than offset revenue declines of approximately 10% from both 10-gig and 40-gig programs from the prior year. In fact, in the third quarter 100-gig program revenue was more than double the revenue we generated from 10-gig and 40-gig programs and was a meaningful contributor to optical revenue growth in the quarter.

Turning to our non-optical communication business, at $58.7 million, revenue from lasers, sensors and other markets represented 23% of total revenue. We saw year-over-year growth in each of the lasers, sensors and other revenue categories. Lasers, which make up 47% of non-optical revenue increased 8% from a year ago. Though up 50% from a year ago, non-automotive sensor revenue declined from the second quarter as certain consumer related programs slowed as anticipated.

Automotive revenue makes up 35% of non-optical revenue and increased 12% from a year ago. New business represents manufacturing programs from new or existing customers that were not in production two years ago. Revenue from new business represented 25% of total revenue in the third quarter, up from 17% of revenue in Q3 of FY15 and consistent with the second quarter mix. As we look to the near future, we expect that revenue from new business will continue to increase in dollars.

However, given strong growth trends from projects and related enhancements to programs that were in production more than two years ago, the mix of revenue from new programs may not increase as quickly as it did earlier in the year. To be clear, this is more a reflection of acceleration in production of existing customer programs than a change in the performance of revenue from new programs, from which we expect to see some growth on a dollar basis.

Revenue from our Fabrinet West New Product Introduction facility continues to grow. In fact, we already in the process of installing a third production line at Fabrinet West during the fourth quarter, which will support further revenue growth into FY17. We are making excellent progress with the first building at our new campus in Chonburi Providence in Thailand, with approximately 500,000 square feet of manufacturing space.

Our first new building in Chonburi will increase our total manufacturing space in Thailand by approximately 50%. Our new campus has space for two additional buildings of the same size which will bring our total manufacturing space in Thailand to approximately 2.5 million square feet, compared to approximately 1 million today. As Tom mentioned, we now expect our first building in Chonburi to be completed by September, with first customer shipments expected to begin in the third quarter of FY17.

Now turning to the details of our P&L, a reconciliation of GAAP to non-GAAP measures is included in our press release. Non-GAAP gross margin in the third quarter was 12.6%, an increase of 100 basis points from a year ago and up 10 basis points from last quarter, primarily due to higher than anticipated revenue. For the fourth quarter, we expect non-GAAP gross margin to be consistent with the third quarter, which was slightly above our targeted range of 12% to 12.5%.

Non-GAAP operating income was $21.7 million, or an operating margin of 8.6%, excluding share-based compensation expenses of $2.0 million, executive separation cost of $0.8 million and income from a flood insurance payment of $0.9 million. Non-GAAP operating margin improved 120 basis points from a year ago, primarily due to higher gross profit this year, as both the third quarter of FY15 and FY16 include startup costs associated with our Fabrinet West facility in Santa Clara, California.

Other income and expenses in the third quarter included a $3.2 million foreign exchange gain, reflecting delivery of contracted Baht against an unrealized loss booked in the first quarter. Approximately $2.3 million of the remaining unrealized loss will be reversed as contracted Baht is delivered. GAAP taxes in the quarter were a net expense of $2.0 million and our normalized effective tax rate was 5.8%, which was slightly lower than our expected range of 6% to 7%, due to the reversal of income tax expenses related to our US operations.

We continue to anticipate that our effective tax rate will be in the range of 6% to 7% for FY16. Non-GAAP net income was $20.8 million in the third quarter, or $0.56 per diluted share compared to $0.36 in Q3 of FY15, and was above the higher end of our guidance. On a GAAP basis, which includes share-based compensation expenses, executive separation costs, flood-related income, amortization of debt issuance cost and the unrealized gain from mark-to-market foreign exchange adjustment, net income for the quarter was $20.8 million or $0.56 per diluted share compared to $10.8 million or $0.30 per diluted share in the third quarter of FY15.

Moving on to the balance sheet and cash flow statement. We ended the quarter with a cash and investment balance of approximately $273 million. This represented an increase of more than $6 million from the end of the second quarter, primarily due to operating cash inflows that were partially offset by CapEx and revolving loan repayments. We continue to expect CapEx in FY16 to be in the range of $60 million to $70 million, with approximately $30 million of that in maintenance CapEx and the remainder going towards the land purchase and construction of a new manufacturing facility in Thailand.

I would now like to discuss guidance for the fourth quarter. We expect the strong business momentum we generated in the third quarter to continue into the fourth quarter. We expect revenue in the fourth quarter to be between $260 million and $264 million, representing growth of 26% to 28% from a year ago. Excluding the impact of $4.6 million in consignment revenue in the fourth quarter of FY15, this guidance would represent growth of 29% to 31%.

We anticipate non-GAAP net income per share in the fourth quarter to be in the range of $0.59 to $0.61, and GAAP net income per share of $0.55 to $0.57, based on approximately 37.2 million fully diluted shares outstanding. For the full year FY16, then, we expect revenue to be between $960.4 million and $964.4 million, representing growth of approximately 24% to 25%, or growth of approximately 27%, excluding the impact of consignment revenue in FY15.

In summary, we delivered a strong performance in the third quarter and are anticipating an even stronger performance in the fourth quarter. We are benefiting from robust industry trends as well as from investments we have made that are enabling us to attract additional programs from both new and existing customers. With new facilities coming online, two to three quarters from now, we are optimistic that we can continue to meet our growing demand into 2017 and beyond. Operator, we would now like to open the call for questions.

(Operator Instructions)

Alex Henderson, Needham.

I guess it's good being you guys these days, eh?

Seems to be.

A couple of quick questions. One simple one for you, TS, what should we be thinking about the tax rate for FY17? Is it going to increase a little bit because of Fabrinet West?

Not necessarily. I will still maintain 6% to 7% as previously guided. So remember, Chonburi is going to come online. It's all tax-free over there.

So, 6% to 7%, non-GAAP?

Right.

Could you break out -- just, I think you kind of hit some of it, but it was a little confusing on the breakout on 10-gig, 40-gig and 100-gig. What was the growth rate? What percentage of revenues coming from those three buckets?

Okay. We said we shipped more 100-gig than 10 and 40 combined. In this case, we are doubling. So in other words, if you look at the total transceiver and modulator, and you go by speed, we had two-thirds of the shipment in 100 gig and then one-third of the shipment in 10 and 40-gig, so to speak. Is that helpful?

Okay. So it's one-third, two-thirds. Is 10-gig and 40-gig declining? Or what's the trajectory of those two?

In my prepared remarks, we said it is down about 10%. So if you compare sequentially, it's down 10%, but it's made up by the 100-gig.

Great, that's very helpful. On Fabrinet West, you're indicating a third line. Are we still thinking that by the time we get to the December quarter that you will be producing $5 million to $10 million of quarterly revenue trajectory on that? Is that kind of the ramp on that?

That's right in line, Alex.

Perfect. I'll cede the floor. Thank you.

Thank you, Alex.

Patrick Newton, Stifel.

Congratulations on a great quarter. Three questions on my end. One is just a dovetail off of Alex's question on the NPI facility, how much of a loss was the facility in the March quarter? What's embedded in the June quarter? Then, if we think about the break-even you talked about, $5 million to $10 million is the right range for December. So should we think about breaking more -- is that the $10 million threshold being either kind of the December/March time frame?

I think, Patrick, your date of December is really in line with what we plan and what we anticipate.

TS, the loss per share?

Yes, so we don't break out that but in the past we've said most of the startup cost is in operating expense. So in the past quarter of Q3, we still look at about $2 million to $2.5 million baked into the operating expense. Now, bear in mind that $2.5 million has about $0.5 million sales and marketing, which rightfully belongs below the line. So I am hopeful that when you get to the breakeven level that $2 million will be fully absorbed into the cost of goods sold.

Alright, that's helpful. Then I guess shifting to new customer question. Japanese optical suppliers, I think, typically have not outsourced product, yet it seems like silicon photonics have some of these suppliers revisiting that strategy. So I guess my question is, as you look at new customers and new programs, do you see Japanese optical vendors as representing one-off opportunities for Fabrinet? Or could these clients potentially become material customers of Fabrinet long-term?

This is Tom. As we look at it, we don't see any one-off. Most -- every one of our Japanese customers today, which we are certainly proud of, is a continued customer with the Company.

Maybe I asked that incorrectly. I think historically you've had just a few programs with these guys, where hypothetically based on optical communications market share, they could be the size of your leading customer, if they were to outsource at the same rate. So maybe to ask differently, do you think there will be an increasing percentage of outsourcing from Japanese customers on a go-forward basis?

I think -- that's absolutely correct. We are experiencing increased experience in the Japanese outsourcing. Our sales efforts and engineering effort in Japan are quite successful.

Great. Then just one more if I may. Two trends that we're monitoring closely is ZTE and Verizon, although not direct customers, you do have several customers that supply those two parties. We have a strike at Verizon. Then ZTE had some hiccups and we have a temporary reprieve from that, that hopefully turns permanent. I'm curious if you have seen any vacillations in your order flow due to either of those changes in the market over the last month or so?

Patrick, this is TS. I think during the timeframe of OFC we had this scare of ZTE. I believe it's completely behind us right now. Most everybody is resuming shipping to ZTE. So far from our vantage point, I don't see any impact after the big scare. But in terms of Verizon strike, so far again we have not seen any impact. In the future, I don't know. If there's an impact, I don't think it's going to slow down the metro upgrade, maybe it's just a message of delay a little bit in terms of timing. But so far, Fabrinet has not seen any impact on that.

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

Thank you, Patrick.

Troy Jensen, Piper.

A nice quarter, gentlemen. TS, how about to start with you, can you just tell us what you are assuming for other income in that $0.59 to $0.61 earnings on the quarter?

For this quarter, there is really very little, in fact, almost none. There is a mark-to-market gain -- we excluded it from the non-GAAP reporting. There's something about interest expense, how we offset interest income expense. We have a flood income. We, again, excluded this from the non-GAAP. So from a non-GAAP standpoint, other income expense, I would say, is insignificant.

Okay. So would that imply that your SG&A declined slightly on a sequential basis?

A little bit, not a lot. Again, we will continue to see that -- I won't call it SG&A, I said operating expense, will be continuing to decline. A lot depends on how fast Fabrinet West performs. But if that gets to breakeven then, yes, that $10 million will be significantly lower.

Okay. Yes, understood. TS, while I've got you, did you say and I'm sorry if I missed it, but the number of 10% customer yet on the call?

On the 10% customer, no, we haven't said anything yet because we normally report once a year. So next quarter, I will have a report who will be the new 10% customer for this year.

Okay. But can you give us, if there was like two or three? Or just going to wait until the filings?

We are ramping a few customers. Honestly, until the last finishing line, I really cannot tell who will be the winner.

All right, understood. How about just a last one here for Tom. It sounds like you accelerated the opening of the new building. Can you just let us know what was the previous launch date? How much has it changed now?

We always had the end of September, as the opening of that facility. That in fact is going to happen. As TS said, we fully expect that we will be shipping product out of there in the third quarter.

Understood, guys, Keep up the good work.

Thank you.

Paul Coster, JPMorgan Chase.

A couple of quick ones. The new business that you are bringing on board. How does it compare with the incumbent business in terms of gross margin and the tender of the contracts?

Paul, this is TS. Typically, new business as we've discussed before, will come in a little bit higher than gross margin because we have room to improve the yield and so on and with the improvement we share with the customer. So I think for competitors, like existing product, existing customers, new business generates a little bit higher than the gross margin.

What about the contracts? How does that compare to your incumbent existing customers?

Contract you mean?

Yes, are they shorter duration contracts initially?

A little bit of background on that. Our customer base is not based on a contract, it's based on a volume supply agreement. A volume supply agreement really is what the customer and ourselves agree on is how we're going to run the business between the two of us. It's really not project -- in fact it is not project defined, it includes a relationship. Beyond that, it's all a relationship.

Okay, good. Thank you, that helps. My other question was, as we look to longer term into the next fiscal year, should we make any assumptions around gross margins with respect to labor costs? How do you see those evolving over the course of the year? What percentage of the overall COGS do they make up? Is there any risk there?

Yes. So in terms of volume -- as you know, the gross margin pretty much depends on the volume ? it's volume driven. The higher the volume, obviously we get better absorption. Again, in terms of volume, we only have 13-week visibility. So beyond 13-weeks, it's pretty cloudy. Until I know the volume, I really cannot project gross margin. But we do know that we have pressures on labor costs, obviously you understand that. We continue to find offsets and the offsets to -- productivity and to material pricing and so on. Cost reduction is an ongoing thing in a factory. So I feel the 12% to 12.5% we guided to all along is achievable. We're comfortable with that level. Beyond that, it all depends on the volume.

Okay, thank you very much.

Thank you, Paul.

Thanks, Paul.

Dave Kang, B Riley.

Nice quarter, guys. First question is, can you just talk about the products that are enjoying strong demand? Is it across the board? You talked about 100-gig but any other products besides 100-gig?

I don't know that they enjoy it, but we are ramping QSFP28 also as I mentioned in the prepared remarks. So 100-gig is the main driver, obviously silicon photonics is also ramping nicely, all the advanced components to support 100-gig. So those are the products we see as pretty strong. A lot of these are in the telecom in the past quarter or so.

What about -- you didn't talk about ROADM. How is that demand picture?

We see strong demand there. Again, for the specifics probably if you ask our customer, you might get better insight. But yes, you are right, we see pretty strong demand there.

But you haven't seen any kind of a slow down because of the Verizon strike have you?

No. I don't know, Tom, did you see any impact there?

No. We can really tell you that we have seen absolutely no effect with that strike.

Got it. Then any revenue you left on the table last quarter as a result of any component bottleneck or maybe your customers being capacity constrained these days?

No, I think across the board, I think we were able to rise to the occasion and ship as requested throughout the whole quarter.

Got it. Then -- so you talked about silicon photonics. What is it -- in terms of revenue, it's about what? 15%, 20% of revenue? How many customers are you involved with in silicon photonics at this point?

Dave, we don't go into that much detail. The only thing I can tell you is that in silicon photonics today, I think I have mentioned this before, it's increasing as a percent of revenue. Today it's already surpassed 15%. That's all I can tell you.

Got it. Fair enough. Then my last question is, from your end, can you tell whether the strength is coming from the US or China or both? Or which is stronger I guess, that's what I would like to know?

Okay. You are going to see tomorrow when we file the Q, essentially, we shipped more to North America in the past quarter than any other region. So that's in the Q.

Got it. All right. That was it for me. Thank you.

Thank you, Dave.

Tim Savageaux, Northland Capital Management.

A question on the guidance also along the product lines and also my congratulations on continued tremendous results. As you look, I guess, TS, last quarter, you mentioned that telecom joined the party as it were in terms of seeing growth resume kind of along the lines you've seen in datacom for the last several quarters. That really seem to accelerate this quarter with some pretty strong sequential growth.

So I guess as you look at your results and also your outlook, if you could characterize the telecom growth last quarter and maybe what you expect going forward, maybe via new and existing programs, where you seem to be indicating that some of your existing stuff has really picked up a bit or on a product basis -- I know a previous question was on ROADM, obviously, when you talk -- there's a portion of your business that's not allocated by speed.

What are you sort of seeing there? Or if you can give us a little more detail on sort of what was driving telecom in the quarter? How you think that might proceed heading forward, assuming you continue to see optical grow as a percent of your overall revenue?

Okay. All right. Let me try my best to answer that. I think if you look at both segments, telecom and datacom, both are growing -- continuing to grow. Obviously, telecom is accelerating, the growth is accelerating like we expected. So again, in the case of telecom -- a lot of that comes from existing customer, the legacy product, because they support the telecom growth. So some of what you mentioned, the ROADM, amplifiers and so on.

Those are supporting, the TC -- telecom upgrade and you can see it, we're in the cycle right now. We are in the upgrade cycle right now. Now, we see pretty good momentum too, even though datacom has been growing tremendously in the last couple of quarters, we see the momentum continuing. So, like I said, telecom comes to the party and continues to accelerate. That's all I can tell you. And the new business, some of which are supporting both segments, too. So we achieved multiple growth from all segments. Is that helpful?

It is. If I could follow-up very quickly on that. Well, maybe starting at a higher level, if you think about both your -- within your overall revenue base, your optical communications versus industrial or non-communication split. You seemed to indicate in your commentary you expect growth to be -- continue to be biased toward optical com.

But I guess, would you expect any meaningful changes in that sort of split, that 77% number? Then within optical com, the telecom versus datacom, I would imagine we would expect to see perhaps both of those numbers maybe creep up a bit in terms of telecom percentage and overall optical percentage or no, you tell me?

Okay. So for the ops com versus non-ops com, I would expect that the ratio will probably continue. We saw a nice growth 77% this past quarter on optical communications, and non-optical at 33%. I believe the same pattern will probably be maintained in the next quarter. All right? Within ops com, I would expect telecom will inch up a little bit compared to datacom. So next quarter, I believe that telecom -- I would expect telecom to be a little bit higher than, in terms of percentage, higher than the past quarter.

Great. Thanks. Very helpful, so too was the granular commentary on the non-communication side as well. Congratulations once again.

Thank you, Tim.

Alex Henderson, Needham.

A number of your competitors -- a number of your customers, excuse me, have said they are experiencing supply constraints. At least one or two of them have indicated that they are being pressed to deliver expedited orders. Can you talk about whether that's impacting your business? Are you seeing people trying to expedite orders and talking through premium prices to pull demand in a faster way? Does that reflect down to you guys? Or is that something that's somewhat transparent to you guys?

Alex, the one thing that we've never experienced in the industry is the price movement because of a shortage of capacity. But in this case, pricing has never been a factor. What we are experiencing is the capacity constraints that exist are primarily capacity constraints on equipment that's furnished or owned by the customer.

So their capital layout only carries to a certain capacity. The capacity constraints are not the constraints of the facilities, bricks and mortar, or headcount or those types of issues. Considering, as you well know, we believe we're in the early part of this ramping cycle. A ramping cycle does have capacity constraints as it moves forward.

So there was a discussion on the NeoPhotonics call about another 30,000 units of orders coming in from China in the back half of the summer. You've also got a ramp up above the datacom 25-gig -- 10-gig to 25-gig cycle and also a ramp up of the metro core cycle. So do you think that the industry demand picture will outstrip your ability to add capacity and your customer's ability to add capacity through the year end? Or do you think that there's more of a chance for some sort of balance? Or, how do you see that playing out as we go through -- then if you look at that facility that you have coming on, how much floor space have you already got commitments for?

Well, we have the floor space of about 500,000 square feet. We certainly have made some commitments to that square footage, but I really can't go through and define -- divulge who it has been made to. Back to your other question on -- I think the industry, as we go through this ramping period, which obviously is very good for everybody, is arising to the occasion to meet the demand. There are isolated cases of capacity problems, which obviously are resolved in a short period of time.

Okay. Just one last question on the capacity. Did you say that you had a significant portion of that 500,000 square foot committed to? Is that what I heard you say? I'm just not sure what you said.

What our experience is, and we have experienced it over about the last 15, 16 years, is that it takes us for a new facility -- and that's the largest facility we put in -- the balance of the others were about 300,000 square feet -- it takes us about three years to complete the assignment of all the space. And obviously about halfway through that, we start another building. But it is certainly, we certainly have a lot of space to be allocated in the 500,000 square feet.

Okay. I'll cede the floor. Thanks.

Thank you. At this time, I would like to turn the call over to Tom Mitchell for any closing remarks. Sir?

Yes. We want to say thanks for joining the call. Have a good evening.

Thank you, sir. Thank you, ladies and gentlemen. That does conclude your program. You may disconnect your lines at this time. Have a great day.