Fabrinet (FN) Q4 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Fabrinet's Fourth Quarter 2013 Financial Results Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would like to turn the call over to your host, Paul Kalivas, Chief Administrative Officer. Please go ahead.

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 fourth quarter and fiscal year 2013, which ended June 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 Investors 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-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. I am pleased that we ended fiscal 2013 on a positive note, with our fourth quarter revenue and earnings per share above expectations. As we enter fiscal 2014, I am confident that our healthy pipeline of new business, strong customer relationships and intensely focus on quality and total customer satisfaction will deliver another year of profitable growth. As always, I want to thank 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 further discussion of the markets we serve.

Thanks, Tom, and thanks, everyone, for joining us today. Despite a relatively anemic demand environment, fiscal 2013 was a solid year for Fabrinet, with double-digit growth in both revenue and earnings per share. Our non-Optical Communications business performed well, with 5% year-over-year growth, while our Optical business continues to track slightly above industry growth on the back of new program wins. In terms of overall demand trends, fiscal 2013 was a somewhat challenging year. While there was some variability from quarter-to-quarter, orders for the most part were flattish. These demand trends were prevalent across several of our lines of business, and were not attributable to any one particular customer or end market vertical, suggesting to us that demand was adversely affected by sluggish spending trends in multiple markets. Near term, we expect these current demand challenges to continue. In Optical Communications, we experienced some modest increases relative to our expectations in the quarter, with results suggesting to us that demand continues to firm up. However, we do not see a material increase in orders across the entire customer set, and as a result, we will continue to maintain a conservative bias toward the second half of the calendar year. Similar to what we have seen over the last couple of quarters, there continues to be a great deal of focus and effort in some of the more advanced components and modules. We expect these trends to continue, and it is this activity that gives us confidence that the underlying fundamentals of our Optical business remain strong and expect to benefit through our customers, and spending on optical equipment accelerates. Our Laser, Sensor and Other business was up sequentially in the fourth quarter, and remains an important avenue of growth for us. As Tom has mentioned on several occasions, we will continue to explore ways to accelerate our diversification efforts in these and potentially other new markets. The Laser market, while stable, has yet to show signs of any meaningful reacceleration. The weakness that we saw in the government and research markets over the last couple of quarters appears to have found a floor, while the industrial market remains mixed. We expect that over the near term, our Laser business may continue to experience some sluggishness. However, we continue to believe that the overall laser market is in the early stages of outsourcing, and represents a significant opportunity for growth over the next several years. Demand and visibility in our Automotive segment remain solid, and we are encouraged that signs point to this continuing. We are winning new business in this segment, excited about the opportunities for growth in coming quarters. Overall, we remain confident that our Laser, Sensor and Other segment will be a critical driver of our top line growth for the next several years. As we enter fiscal 2014, we are encouraged by the overall growth prospects for our business. We continue to work closely with our customers to ensure that we are aligning 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 pipeline for this new business remains strong. With that, I would now like to turn the call over to TS, our CFO, to report on our financial results. TS?

Thanks, John. Good afternoon, everyone. I am pleased to report that Fabrinet delivered fiscal Q4 results above our guidance range. I would like to start with an update on the insurance recovery status, then move to a review of the results for the fourth quarter and fiscal 2013, and end with our outlook for fiscal Q1. As a reminder, we continue to expect our financial results to be impacted for multiple quarters due to the timings of approvals, and payments of insurance proceeds. Claims for all losses related to equipment, inventory, property and business interruption had been submitted, and we continue to work with our insurance syndicates to settle these claims. As of this date, all claims have been settled, with the exceptions of our equipment claims. In the fourth quarter, we received a final payment towards the business interruption claim, in the amount of approximately $8.4 million. For the fiscal year, we have received further payments against our claims in the amount of approximately $29.5 million, and we will continue to pursue aggressively the balance. Additionally, as of the end of the fiscal year, we have signed settlement agreements with all of our customers impacted by floods. A few of them, having been completely paid off by us. 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 fourth quarter and fiscal 2013. Please note that all numbers are GAAP unless stated otherwise. Our total revenue for the fourth quarter was $159.9 million, an increase of 3% sequentially, and an increase of 12% compared to the fourth quarter of fiscal 2012. Please remember that the fourth quarters of fiscal 2012 were few, impacted by our flat recovery efforts. On an end market basis, revenue from Optical Communications was $111.8 million in the fourth quarter or 72 -- 70% of total revenues. While Lasers, Sensors and Other revenue was $48.1 million, the remaining 30%. For the fiscal year, our total revenue was $641.5 million, an increase of 14% compared to fiscal 2012, primarily as the result of our flat recovery efforts. For the fiscal year, revenue from Optical Communication was $449.8 million, or 70% of our total revenue, while Laser, Sensor and Other revenue was $191.7 million, the remaining 30%. We are pleased with our ongoing divestations of our revenue, and we'll continue to explore additional ways to associate these assets. Our share-based compensation expenses for the quarter was $1.1 million, of which roughly $945,000 was included in SG&A. For fiscal 2013, our share-based compensation expenses were $5.1 million, of which approximately $4 million was included in SG&A. Our flood-related items for the quarter was incomes of $6.1 million, which consists of the final payments on our business interruption claim of $8.4 million, offset by additional expenses from settlements of all customer claims of $2.3 million. For fiscal 2013, our flood-related income was $27.2 million, which consisted of payment received from our claims of $29.5 million, offset with additional expenses from settlements of all customer claims of $2.3 million. These, compared to a flood-related loss of $97.3 million in fiscal 2012. These amounts are included in our results as other income, and are excluded from our non-GAAP results. We intend to book the gain on the insurance proceeds in a future period, as those amounts become reasonably certain. Our effective tax rate for the quarter was 1.5%, including the effects of flood-related insurance recovery, as well as the release of some positive tax provision. Without these items, our normalized tax rate would have been 5.3%. For the fiscal year, our effective tax rate was 4.9%, in line with our expected range of 5% to 6%. On a non-GAAP basis, net income totaled $12.4 million for the quarter or $0.35 per diluted share, an increase of 60% compared to non-GAAP net incomes of $10.7 million or $0.31 per diluted share in the same period a year ago. Non-GAAP income in fiscal 2013 was $50.5 million, or $1.44 per diluted share, an increase of 16% compared to non-GAAP net incomes of $43.4 million or $1.25 per diluted share in fiscal 2012. On a GAAP basis, including flood-related income, share-based compensation expenses and other nonrecurring expenses, our net income for the fourth quarter was $15.1 million or $0.43 per diluted share, compared to GAAP net income of $7.5 million or $0.22 per diluted share in the fourth quarters of fiscal 2012. GAAP net income for fiscal 2012 was $59 million or $1.98 per diluted share, compared to a GAAP net loss of $56.5 million or a loss of $1.64 per diluted share in fiscal 2012. In the near term, we expect that our GAAP results may continue to fluctuate due to the size and timing of future insurance recoveries. Moving onto the balance sheet and cash flow statement. We ended the quarter with a cash balance of approximately $150 million. Cash decreased by approximately $8 million sequentially, as a result of payment made in accordance with flood settlement arrangements between us and our customer. I will now like to discuss guidance for next quarter. As both Tom and John discussed, we have yet to see signs of sustained increase in orders from our customers. As a result, we are remaining conservative in our outlook for fiscal Q1. We expect revenue of between $158 million and $162 million. GAAP net income per share is expected to be in the range of $0.46 to $0.48, with expected non-GAAP net income per share in the range of $0.31 to $0.33, based on approximately 35 million fully diluted share. 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 Sherri Scribner with Deutsche Bank.

I wanted to get a sense of the linearity in the quarter. I know you've commented a couple of times during the prepared remarks that you aren't seeing signs of a sustained improvement in customer orders and you're cautious for the second half. But you did see some upside, was that primarily at the end of the quarter, or can you give us some sense of linearity?

Yes, sure, Sherri. This is John. Yes, I think linearity was pretty much in line with what we expected. We did see a little bit of an increase later in the quarter, but again, I don't think it's anything that was terribly surprising to us, in terms of linearity relative to prior quarters.

Okay, and then just thinking about some of your customers have been positive. Had a positive preannouncement. We've had some positive earnings results and guidance. But you guys are guiding relatively in line. Are you not hearing from customers that they are more positive? Or what's causing your conservatism?

I think really, Sherri, it just comes down to orders. I mean, think most of the comps side are from the bulk of the customers, certainly publicly talkies about a seasonal uptick in the second half of the year. I think we certainly are hopeful that, that's going to end -- that, that's going to occur. But I don't think we've seen enough from an order pattern to suggest once we're going to see anything really outside of that yet.

Okay. And I just want to ask a quick question on the SG&A, it was down this quarter. Pretty low, considering where it's been. How should we model SG&A going forward?

Sherri, this is TS. I think the SG&A moving forward is still like what I -- we said before, $6 million to $6.3 million a quarter, including the stock-based compensation. Now this time, we took a $1 million reduction from the prior quarter. It's because we have the reduction in force -- more reduction in force. And then as of the end of the cutoff, we are less deeper and based on that actuarial study, we booked a [indiscernible] 7 liability, and that's why that -- we took that to the SG&A per the accounting standards.

Okay. So you won't see SG&A go down because -- even though you had a reduction-in-force?

No. This is only a onetime thing, and we'll be back to $6 million to $6.5 million, including the stock-based compensation.

Our next question next comes from Alex Henderson with Needham. Alexander B. Henderson - Needham & Company, LLC, Research Division: I got part of my answer on that last question. The exchange rate, the -- hit you guys pretty hard last quarter, it looks like it's essentially fully reversed. Should we be anticipating getting back some of that gross margin pressure that we had -- built into our models as a result of that in the prior quarter? And then second, I guess the, and then the answer to the operating line would be that we'd get the -- sales and marketing will come back and that will be partially offset again, I assume.

Yes, Alex, this is TS. On the exchange, if you remember last couple of quarter, we say we have a hedging program in place. We also already begin to buy some put option. And so you will see the benefits on assuming the baht against U.S. dollar continue to depreciate. You would see that coming, maybe 1 or 2 quarter lag. And that's how the hedging program is. So I think for the current quarter, at Q1, you might not see significant impact, and assuming baht continue to depreciate, then, yes, you might see some impact benefit in the following quarter. Alexander B. Henderson - Needham & Company, LLC, Research Division: So sequentially, fairly flat into this September quarter on gross margin, and the sales and marketing pops back up?

That's correct, yes. Alexander B. Henderson - Needham & Company, LLC, Research Division: Okay, and then, can you talk a little bit about the portion of your business that's coming from a couple of key pockets and a portion that's exposed to the other side of it, i.e. when you're looking at your business, how much do you see is coherent silicon photonics, the data center, 10 gig, 40 gig, 100 gig? Conversely, can you talk about how much of your product line comes from SONET STH 300-pin 10 gig long haul. The legacy stuff in 1 bucket, the growth segments in the other, so that we can get a sense of the mix of that?

Sure. So Alex, if you look at our Optical Communications business, we're about 2/3, 1/3 telecom to DataCom. On that DataCom side, we are primarily leveraged to the 10 and 40 cycle that's going on there. So I think, certainly on the DataCom side, the bulk of that is primarily in the growth year aspects, if you will, of the Optical Communications realm. On the telco side, it's still a little bit more mixed than that. I would say -- and I don't have the percentages right here in front of me, but between 100 gig and coherent, and some things of that nature, it's probably 20% to 25% of that telco-specific business, and the rest is mixed through -- like you're talking about some 10 gig transport as well as some of the other technologies. We don't have a ton of Sonic still that we're doing. So there's not a lot of exposure there. But there certainly is, is a fair bit of it still at the 10 gig speed. Alexander B. Henderson - Needham & Company, LLC, Research Division: And then last question for me, Casix, any thoughts how well that did?

We've really never broken Casix out specifically. It's still below 10% of total revenue.

The next question comes from Patrick Newton with Stifel. Patrick M. Newton - Stifel, Nicolaus & Co., Inc., Research Division: I guess the first one for Tom, on your prepared remarks, you talked about healthy pipeline of new business, and I was wondering if you can comment on this new pipeline entering fiscal year '14 compared to prior fiscal years. And the comment about the healthy pipeline directed at the Automotive and Sensor, given some of the strengths that you've seen there, at the Laser side, given that's an area where you've really been investing in, or even on the Optics side. Just -- what about some detail there?

Well, I think it goes back a bit, almost about 2 years ago. We really begin to focus on business development much more than we had in the past. And most of the -- not most, but just about all of the new business that we're fortunate enough to be able to secure, takes us about anywhere between 1 year and 3 years to materialize into meaningful revenue. And we're now beginning to see the efforts that we put in, starting in about 2 years ago, we're beginning to see that, that, that those opportunities are in fact in our sales funnel, our marketing funnel, and are beginning to work their way through that channel and begin to be real revenue contributors, as we go out of this fiscal year, into next fiscal year. So we're very encouraged by that. And the -- the other thing that's really quite encouraging is that we -- our Tier 1 customer base is continuing to show us revenues -- that future revenues, and future projects we're working on, and the new product introductions we're working on, all of that is really the basis for my comments. But I think it really does show that as we go forward, in 2014 and beyond, that our revenues have a have a real strong base to work off of. Patrick M. Newton - Stifel, Nicolaus & Co., Inc., Research Division: And if we take that and look at the pure growth numbers, I think in fiscal year '13, the Optical side outgrew the Laser, Sensors and Other side, which is somewhat of an anomaly. So should we see that slip back to kind of your traditional growth, coming from Laser, Sensors and Others, and Optical Communications also contributing, but to a lesser extent?

Well, I think that's to be fair, a lot of that is going to have to do on the different segment demand trends as well. There certainly is, all else being equal, I would expect that to occur. But we could certainly have quarters or depending on well those quarters stack up a full-year, where Optical may ultimately still grow faster, just based on the overall demand trends. But all else being equal, yes, we would still expect that, that Other segment, consisting of the Lasers and the Auto and Sensor business would grow faster. Patrick M. Newton - Stifel, Nicolaus & Co., Inc., Research Division: Okay. And then I guess, just kind of dovetailing off of Alex's question, you talked about not seeing a material uptick in orders across your entire material or customer set on the optics side, is what I'm reading into. And the question about the mix between kind of the product areas that are hot and not, the -- clearly it seems like you're seeing some of the similar trends on the DataCom and the 100G Coherent and then it's -- you said the legger, or more legacy businesses that -- are where you're not seeing it yet? Are there any pockets of strength in that legacy portfolio?

I mean, it's, it -- there are some, and it varies, I think, a little bit by customer. I think again, you still have an environment where, especially on the telco side, you don't have all of the carriers really out deploying this next generation of technology yet. And so there are certainly -- certain carriers out there that are putting in purchases for some of the older equipment, so to speak. So I think we'll probably continue to see that for a while. We certainly saw it at -- during the 10 gig transition. I like to think that as we continue to move forward, you'll see more and more of that shift towards the growth in your product, so to speak. But you're today there's -- there are still, obviously, some carriers that are out there that are purchasing some of the slower speeds, and for us and our customers, we're going to support them no matter what it is they want to build. Patrick M. Newton - Stifel, Nicolaus & Co., Inc., Research Division: And then, I guess just last one on the insurance side. I'm not sure that I caught this completely, but did I hear correctly that you've signed an agreement with all customers impacted by flooding, and that you -- did I hear correctly, that you've made advance payments to your customers on the insurance proceeds and therefore, you would be collecting directly the future insurance proceeds? Or can you help me -- fill me in there, I didn't quite understand that comment.

Okay. Patrick, we say, as of cut off, we have settled with all of the customers. A few of the big customers has been already paid off. So as of cut off, if you look at the balance sheet, we still have $9.8 million in the liability to the customer, and for this quarter, we will pay off those majority of those $9.8 million, and that's with a customer. So I hope that answers your question. Then with the insurance, we are pretty much settled and collect the money, except the big one, the equipment claim, which we are working on. Patrick M. Newton - Stifel, Nicolaus & Co., Inc., Research Division: And so this means that since you paid off your customers in full, that any incremental cash flows coming from that equipment claim, on a go-forward basis are 100% applicable to Fabrinet as opposed to some going to your customers?

That's a good observation. Yes. Patrick M. Newton - Stifel, Nicolaus & Co., Inc., Research Division: Okay, and then assuming -- what would drive you to prepay your customers? I'm assuming that you're not giving them $0.100 on the dollar. What -- is that accurate?

No. Of course, no. I think it's been almost 2 years. I, obviously, with the insurance company, it’s a different story. They drag their feet, it's a tactic to delay payment. Most of the insurance companies do that. Now with a customer, which we have a relationship, we have to basically support them. No, I think we just go by the whatever agreement we can -- they claim, and so it's a good settlement.

Our next question comes from Paul Coster with JPMorgan. Paul Coster - JP Morgan Chase & Co, Research Division: Can you share with us any customer concentration numbers?

Well, I mean I -- those will be in the K that we file in a little bit. The only 2, 10% or greater customers in the quarter were the same that we've had for the last several quarters, which would be JDSU and Oclaro. Paul Coster - JP Morgan Chase & Co, Research Division: And then, and I think it was in Tom's remarks, he talked about new customer wins and pipeline. I may have misunderstood, is it -- do you have new customers that are material and can be shared with us now, or are these anticipated and should we ever expect a customer, really to -- any single customer to move the needle, a new customer, that is?

It takes a while for those customers to build up to be a significant revenue contributor there, Paul. I mean, as Tom mentioned, this is an effort that goes back, quite frankly, about close to 2 years now, where we really started to refocus the business development efforts, not just winning customers, but winning new Tier 1 customers. We're quoting several programs. We have a lot of new customer wins, some are small, some have the potential to be large, and some are, in aggregate, as we start to pile up some of those wins, will be large. Is somebody going to get to the point where they're 20-plus percent of revenue, they're certainly not going to happen quickly. But I think with some of the customers, given some of the programs that we're potentially working on, how quickly they ramp, and what they ultimately could mean, they could certainly be, at some point in the future, 10% or greater customers. But I don't think it's likely that any of those would be that material in fiscal 2014. Paul Coster - JP Morgan Chase & Co, Research Division: Can I get one more follow-up, if I may? Tom talked about a very long lead time on sort of establishing business with a customer. Is that because, early on in the cycle, you win just a tiny bit of business, and they kind of qualify you over a period of quarters, and then eventually it grows into something, or is it because, as part of your customer on-boarding process, you're really having to identify tiny customers, and start small, and just hope that you picking the winners?

Well, I think a further definition for my talk on the lead time that it takes to put in place the meaningful revenue from the new customer or the new project from an existing customer, they all -- both in the same category. But like most all of those projects are all NPI projects, new product introduction. So we basic -- we basically start working with our customer and right after they finish the beta units, and we start with -- and then we work -- because they completed the Alpha units, and they're going working on the beta units and then, and then we come in and assist them. It's not really work with them to develop a manufacturing process, and the design for manufacturing, and all of that -- all of that effort and work that goes into that takes -- sometimes can take a year, or it can -- for sure, it takes more than 9 months. And then, there was a product, and those products have to be introduced to their customers, and their customers have to qualify those products. And then once all of that is in place, and that piece of business for the sake of conversation, totally belongs to us, and we begin to enjoy the revenue, going forward.

Our your next question comes from the line of Subu Subrahmanyan of the Juda group.

Tom, can you talk about the upside for the quarter versus your guidance that was higher than kind of the normal upside you've had? And you got didn't comment about the -- some strengthening in orders at the end of the quarter. Can you talk about that trend and if that reversed, why you don't believe there's more of a trajectory here than some of the more optimistic commentary coming from your customers?

Sure, Subu. I mean, you're right. It did strengthened as we mentioned a little bit towards the end of the quarter, the upside, relative to our expectations did primarily come from the Optical Communication side of the business. So that's really what drove the upside, relative to guidance this quarter. We -- I don't think it's dropped off dramatically. We haven't seen a big drop-off in those orders there, that's why we're potentially guiding flat with where we are today. And I think that for us, given where we are in the quarter, we've got about 1/2 of it behind us now, as we've got about 6 or 7 weeks left in the quarter to go through. Could we see a little bit more upside if orders improve in September or over the last few weeks here of August? Potentially, yes. So I think that there is an opportunity for that, by the same token, there's not this huge bias, I think that every week we're seeing a nudge up of those orders yet. And so, are we being somewhat conservative? I think that we are. But I think again, we're -- with the upside that we saw towards the end of this quarter, and then guiding flat off of that, I think we are capturing some of that in the guidance that we gave.

Understood. And on the gross margin side, I know you'd mentioned that the hedging is offsetting some of the appreciation of the U.S. dollar versus the Thai baht. But is it fair to say that if, even if we don't see further appreciation of the U.S. dollar, if a couple of quarters or I don't know how long you hedge for but a couple of quarters down the line, just the reversing of that, versus the year ago should be able to get gross margin back to the mid-11s kind of level, or is there something else that needs to happen as well?

Yes. Subu, it's yes. I think your observation is correct.

So we don't need a further appreciation, and the hedging is for a couple of quarters, and maybe starting December quarter, it reverses whatever is the FX-specific effect on gross margin, is that the right way to think about it?

Yes, that's correct.

This ends our Q&A for today. I'll turn it back to John Marchetti for closing remarks.

Great. Thanks, everybody for joining us today, and we look forward to talking to you soon.

Ladies and gentlemen, thank you for participating in today's program. And this concludes the program. You may all disconnect.