Fabrinet (FN) Q4 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to Fabrinet’s Fourth Quarter and Fiscal 2015 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded. I’d like to introduce your host for today’s conference, Mr. John Marchetti, Chief Strategy Officer. Sir, you may begin.

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 fourth quarter and fiscal year 2015 which ended June 26, 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 Investors Section of our Web site located at investor.fabrinet.com. Please refer to our Web site for important information, including our earnings press release and our non-GAAP to GAAP reconciliation. I’d 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, 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 5, 2015. We will begin the call with brief remarks by Tom, myself, and TS, followed by time for questions. I’d now like to turn the call over to Fabrinet's Chairman and CEO, Tom Mitchell.

Thank you, John, and good afternoon everyone. We ended fiscal 2015 with record revenue and growth across all of our market segments. We saw gross margins expand and delivered a solid year of earnings per share growth. Importantly, we made significant progress in both new product introduction and advanced pay packaging capabilities. As we start fiscal year 2016, I’m confident that these programs will continue to gain momentum and drive new revenue opportunities to deliver another year of profitable growth. I’ll now turn the call back to John for a discussion of the markets we serve. John?

Thanks, Tom. Fourth quarter results were ahead of our expectations, and we achieved record revenue levels driven by a sequential increase in sales across all of our market segments. As we begin our new fiscal year, the overall demand outlook for our business is encouraging and combined with contributions from our new programs; we expect our first quarter revenue to increase sequentially in both our optical and non-optical segments. Our optical communications business turned in a very solid quarter, increasing 34% year-over-year and 8% sequentially. Our split between Telco and datacom in the quarter was approximately 61% telco to 39% datacom, and we were particularly pleased that both our telecom and datacom optical communications businesses outperformed expectations in the quarter with both segments up on a sequential and year-over-year basis. On a normalized basis excluding the impact of the consignment revenue on our results, the optical communications business increased approximately 17% year-over-year and nearly 6% quarter-over-quarter. For fiscal 2015, optical communications revenue were $553.2 million, increased 14.3% compared to fiscal ’14, driven by 20% plus growth in our datacom segment. The full-year split between telco and datacom was 63% and 37% respectively. On a normalized basis excluding the impact of the consignment revenue on our results, the optical communications business increased approximately 8.6% year-over-year. Similar to other quarters, growth in our optical communications business was driven by advanced optical components and modules, including 100 gig on improvements in our datacom business or driven by 40 and 100 gig solutions. In the September quarter, we’re expecting both our telco and datacom businesses to increase modestly on a sequential basis. Our non-optical segment rebounded nicely off a muted 3Q, growing 17.5% year-over-year and more than 11% sequentially, driven by quarter-over-quarter increases across our laser, automotive, sensors and other businesses. On a normalized basis excluding the impact of the consignment revenue on our results, the non-optical communications business increased approximately 8.2% year-over-year and 8.7% sequentially. In the current quarter, we expect the non-optical portion of our revenue to be flat to up modestly on a quarter-over-quarter basis. For the fiscal year, non-optical communications revenue of $220.3 million increased 13.7% compared to fiscal 2014, driven by solid growth across all sub segments. On a normalized basis excluding the impact of the consignment revenue on our results, the non-optical communications business increased approximately 10.1% year-over-year. In terms of revenue from new business, it represented nearly 20% of total revenue in the quarter, up from approximately 11% of revenue in the same quarter last year and increasing by more than 20% sequentially. The focus on new business growth was one of our key strategic initiatives in fiscal 2015 and we’re encouraged by the progress made this year. We are confident that the investments made to strengthen our advanced packaging a new product introduction capabilities, along with additions to our worldwide sales efforts will help us broaden and strengthen this pipeline to ensure that remain a healthy contributor to growth in fiscal 2016 and beyond. We continue to work closely with our customers to ensure that we’re aligning our resources to meet their current and future production needs. To that end, we’re planning to build a new manufacturing facility in Thailand to increase our capacity. This increased capacity is needed, as we expect our current throughput in Thailand to be nearly 85% occupied by the end of the calendar year. Fabrinet West, our new U.S NPI operation launched earlier this year continues to ramp. We expect to begin shipping product for revenue in the September quarter. Early customer feedback has been encouraging and we remain confident about the long-term opportunity we believe this new operation will provide for both existing and new customers and expect that this NPI facility growth, it will provide increased opportunities for the transfer of volume products to Thailand. As we enter fiscal ’16, we’re excited about the overall growth prospects for our business. We believe the investments we’re making to expand our capabilities are focused on world-class customer service and manufacturing quality and a growing pipeline of new engagements positions us well for a profitable growth in the coming fiscal year. With that, I’d now like to turn the call over to TS, for a review of our financial results.

Thanks, John. Good afternoon, everyone. For our call today, I’ll start with the review of our fourth quarter results and later discuss our full fiscal year 2015 performance. As in the past, all numbers presented here are GAAP unless stated otherwise. Total revenue for the fourth quarter was a record $206.5 million, an increase of 9% sequentially and 25% compared to total revenues of $160.1 million in the fourth quarter of last fiscal year. Please note that revenue in the quarter included approximately $4.6 million in consigned shipment revenue compared to no contribution last quarter and a negative impact of $16.5 million to revenue in the fourth quarter of fiscal 2014. On an apples-to-apples basis, including the impact of the consigned revenue, sales in the fourth quarter would have grown 6.6% sequentially and 14.3% year-over-year. At this time, all of the consigned shipment revenue removed from our fiscal 2014 results has been recognized and we do not expect any impact to our future results. On an end market basis, revenue from optical communications was $147.6 million or 72% of total revenue for the quarter, while revenue from our non-optical businesses was $58.8 million, the remaining 28%. GAAP gross margin for the fourth quarter was 11.9% an increase of 50 basis points sequentially as higher sales drove better cost absorption. Excluding share based compensation expenses, non-GAAP gross margin was 12.1% in fiscal fourth quarter, up 50 basis points quarter-over-quarter. For fiscal 1Q, 2016, we expect gross margin to be flat to up slightly on a sequential basis. Our total share based compensation expenses for the quarter were 2.2 million, of which roughly 1.9 million was included in SG&A. As we highlighted earlier in the year, the increase in SG&A in fiscal fourth quarter was primarily due to increased expansions associated with our new Fabrinet West operations and expansions of our sales team. We expect that we will remain at this expense levels through fiscal 2016. Our taxes in the quarter were a net expense of approximately $900,000 and our effective tax rate was 6.3% within our expected range of 6% to 7%.We anticipate that our effective tax rate will remain in the 6% to 7% range through fiscal 2016. On a non-GAAP basis, net income totaled $14.5 million for the quarter or $0.40 per diluted share. Non-GAAP net income increased by approximately $1.5 million compared to last quarter driven by increased sales, partially offset by the higher SG&A expenses. On a GAAP basis including share based compensation expenses net income in the quarter was $13 million or $0.36 per diluted share compared to GAAP net income of $12 million or $0.30 per diluted share in the third quarter. Turning to the result for the fiscal year. Revenue was a record $773.6 million, an increase of 14.1% compared to fiscal 2014. Please note that our fiscal 2015 revenue include approximately $16.5 million of consigned shipment revenue that was removed from our fiscal 2014 results. On an adjusted basis, revenue in fiscal 2015 would have grown 9% compared to fiscal 2014. On an end market basis, revenue from optical communication was $553.2 million or 72% of total revenue for the fiscal year, while revenue from non-optical businesses was $220.3 million, the remaining 28%. GAAP gross margin for the year was 11.3%, an increase of 30 basis point compared to fiscal 2014, while non-GAAP gross margin for fiscal 2015 was 11.5%, up from 11.1% last fiscal year as higher sales drove better cost absorption. For fiscal 2015, our stock -- our share based compensation expenses were 8 million, of which approximately 6.6 million was included in SG&A. Our effective tax rate for fiscal 2015 was 8.4% or roughly 4 million in total tax expenses. Normalized for several items that occurred during the year, our effective tax rate would have been within our stated 6% to 7% range. Non-GAAP net income in fiscal 2015 was $56.4 million or $1.57 per diluted share, an increase of 3% compared to non-GAAP net income of $54.6 million or $1.53 per diluted share in fiscal 2014. On a GAAP basis, net income for fiscal 2015 were $43.6 million or $1.21 per diluted share compared to GAAP net income of $91.7 or $2.58 per diluted share in fiscal 2014. GAAP net income in fiscal 2014 was positively impacted by $44 million or $1.24 per diluted share due to the collections of insurance proceeds. Moving on to the balance sheet and cash flow statement. We ended the quarter with a cash and investment balance of $256 million. CapEx for the year was approximately $54.1 million of which roughly $26 million was used to purchase our new facility in Santa Clara. In fiscal 2015, we expect CapEx to be in the range of $50 million to $55 million, which includes approximately $15 million for our new facility in Thailand. I’ll now like to discuss guidance for the next quarter. We expect revenues of between $206 million and $210 million. 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 $0.41 to $0.43, based on approximately $36.5 million fully diluted shares outstanding. That concludes our prepared remarks. At this point, I’d like to turn the call over for questions. Operator?

Thank you. [Operator Instructions] Our first question comes from Patrick Newton of Stifel. Your line is open.

Yes, good afternoon, Tom, TS, and John. Thank you for taking my questions. Just jumping right in the results and guidance, I thought were pretty strong, especially considering how challenged the business environment has been for your largest laser customers across the board. So I was hoping to get some understanding there, especially given that you’re guiding for a flat to up sequential business in that segment. So could you help us understand, is the automotive and sensors business helping there and helping offset some of this laser softness? Is this one of the areas where you’re seeing the new customer strength that you alluded to or this clearly that optical is -- seeing a strengthening in order book and offsetting some of the laser softness?

Yes, Patrick, this is John. I think in general, we’ve seen a relatively stable environment within that non-optical segment as well. I mean, if you look at the commentary that we gave, looking into the September quarter, there certainly are some ups and downs within that, not every category is expected to be up on a sequential basis, but I do think that in total when we look at the changes across those different sub segments within that non-optical business, there really are big swings in anyone category. So while some maybe down a little bit, we’re able to make up for that, I think it’s some other categories. But there is no real one big swing factor in either direction that we are then making up for with something else. So in general, all of those businesses within that non-optical segment remain pretty stable even if there is obviously some variability within that.

And is that just due to you being maybe a quarter or two ahead of your customer’s revenue numbers or is that because you’re tied more to newer projects? I mean, it’s -- you had some pretty exacerbated down ticks in the laser revenue of some of your customers and it just seems like you’re bucking the trend?

Well and I think again I can only go off of kind of the outlook that we see in front of us here. There is a potential always that there is a little bit of a time lag. We are a lagging indicator to the group. So there is certainly the potential that as we move further into our fiscal year. We may see that come back to buy this a little bit at a later date. But where we’re sitting right now, like I said, across the board there certainly is a little bit of variability, but there isn’t any I think one sub category within that non-optical segment that’s particularly worrisome here for us.

Okay, great. And then, I guess, just shifting the Fabrinet West, I think you quantified that there should be a little bit of revenue contribution in the September quarter. Could you help us understand bit approximate expectation there? And then as we think about the tens of millions in revenue that you diluted to in the past, any change to that kind of wide outlook and any thoughts on how that should layer into fiscal year ’16?

Sure. I mean, as you look at it, I think from a near-term perspective, we’re just shipping product for the first time in this September quarter. So the contribution from revenue from our Fabrinet West operation in the September quarter is still going to be pretty de minimis. I don’t think its certainly going to be anything that we’re likely to call out when we do this call again a quarter from now. As we look longer term into the opportunity that we believe that facility holds, I don’t think there is any change there about our expectation that that this is going to be a critical component of our longer term growth strategy, especially as it relates to transferring products from that NPI facility here in the U.S to volume production in Thailand. So looking out on a longer term basis, and again that longer term contribution is still probably more of a ’17 event that it really is a ’16 event, we will wait and see as we get a little further into this. But I still think the expectation there is for ultimately this operation to be measured in tens of millions of dollars on a quarterly basis.

On a quarterly basis, okay. And then, last one if I may, on the gross margin side for either John or TS is I guess given that the NPI facility, I would have imagine should have an accretive gross margin and given that you just posted a 12.1 in the quarter. Should we expect as we move through fiscal year ’16 that Fabrinet should be able to secure a 12% plus margin through the year until the opening of building seven?

Patrick, this is TS. I certainly hope so. As John stated that right now the revenue is still pretty much the contract manufacturing sides of the business. We have not really book any NPI revenue there. So as you can see most of the start-up costs is below the line. So I would certainly expect that as we start shipping the revenue for Fabrinet West that will have some contribution to the margin.

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

Thanks, Patrick.

Thank you. Our next question comes from Vad Yazvinski of Jordan Capital. Your line is open.

Good afternoon, gentlemen. I have a question a little different from the previous caller. Obviously we’re an investor versus an analyst and from my standpoint you guys have done a great job over the last several quarters and even last several years kind of going through the issues and whether with flooding, et cetera. But now it appears that the business is firing on all cylinders and you guys are doing a great job, but the capital structure still appears to be in the need of an optimization, you guys obviously have excess capital in the balance sheet and it would be interesting to me as a shareholder to figure out what your thoughts on the long-term solution to there excess capital you guys have on the balance sheet, whether it’s [technical difficulty] share buyback, special dividend or -- I know you guys are going to probably answer that, you needed to expand the facilities both in -- on the West coast and maybe an extra facility in the far east, but nevertheless, I mean, you still appears that you have excess capital anywhere you slice it and the interesting thing to us as shareholders has been that one your largest shareholders have continued to kind of throw shares into the market every time the price gets at a certain point and what are the thoughts about buying back the remainder of the shares they might have and reduce some share count et cetera.

Thank you, Vad. I mean, what I would say we’ve discussed this before on I think some prior calls. Our first use of cash or a priority for use of that cash remains growth. We think there are several opportunities that are in front of us right now, both in terms of expanding into new geographies as well as expanding the footprint that we have in Thailand currently as we continue to work up against some capacity constraints in that region. So that I think still remains our primary focus for the uses of cash. And I think beyond that as we continue to move through this fiscal year, we will continue to evaluate where we’re relative to our own internal plan and the opportunities that are presented against us. And then, I think at some point down the road you will make the determination if we feel that its the right time to do something more shareholder focused, but I think for right now our focus remains on using that cash for growth initiatives, while we continue to evaluate other options for.

Understood. And as I said, that’s sort of an expected answer obviously, but it would still appear to us as shareholders, and this is just one shareholder raising their voice and mentioning it, but even assuming no other expansion in Thailand or investing more money in there, call it Fabrinet West, you still would appear to have excess capital and to us, its just interesting that we’ve been quite for a little while and lot of people have been, but it appears you guys are doing great and at this point, which is hard to imagine the use of capital that would require all that excess capital you have in the balance sheet, but it would be organic obviously. Externally I understand if you were to pursue a small acquisition or something like this that would make sense, but internally it still appears that you have excess capital at least to us shareholders.

We appreciate that opinion and like I said, we continue to evaluate the options that are in front of us and when that time is right or when we make that determination along with the board, we will put information like that out into the marketplace.

I appreciate. Thanks for taking my question.

Sure.

Thank you. Our next question comes from Paul Castor of JPMorgan. Your line is open.

Hi, thanks. This is actually Paul Cheng on for Paul Castor. Thanks for taking my question. Can you talk about the currency dynamics and OpEx, particularly from moving the Thai baht and how we should think about year-over-year benefit, if any?

Yes, Paul, this is TS. As we mentioned in the last couple of conference call, eventually the dollar cost average we hedge our Thai baht more from a long-term basis. So the quarter-to-quarter or day-to-day spot currency change really does not affect us in that regard. So, yes, the Thai currency and RMB in China has been depreciating, But again as you can imagine, the next few months we already bought a currency about few months ago and obviously that currency depreciation will benefit us more in the long-term basis. But on a quarter-to-quarter, we don’t see any impact here.

Okay. Thanks for that. And then, when should we see the flow through for both CapEx and OpEx for the new Thailand facility, in which quarters?

That I mean -- that will be primarily in 2017, once we start -- we will start construction here in fiscal ’16, but that won’t really hit the P&L until we get into fiscal ’17.

Okay.

You might have some balance sheet entry this year, FY2016. Within cash and construction and [indiscernible], but you will not hit the P&L until 2017, as John mentioned.

Okay. And then, where do you think OpEx level on a percentage of sales shakes out in the interim and possibly longer term. Thanks.

Okay. So if you look at our financial trend line, I mean, before we initiated two big projects, which is expand the sales organization and also invest in the Fabrinet West six months ago. If you look at six months ago, our [OpEx] is about 6 million to 7 million in the range. And today we’ve ticked up to about close to 9 to 9.5. So the additional expenses, $0.5 million of which is related to the sales organizational expansion here and the other 2 million to 2.5 million related to the Fabrinet West. So at some point in time, when we have the -- when we booked our revenue, and some or most of this will go up through the [indiscernible] line. But hopefully the revenue is bigger than the expenses, reclassified to cost of goods sold to create a gross margin and hopefully that gross margin is big enough above the average. So we can expand the overall company growth margin. So that has been the plan and right now for your model purpose, you can actually use 9 million to 9.5 million in total moving forward. Obviously a portion of this will have to go into cost of goods sold, depend on the ramp of the Fabrinet West.

Thank you.

Thank you. [Operator Instructions] Our next question comes from Dave Kang of B. Riley. Your line is open.

Thank you. Good afternoon. First question is regarding your top customers have the percentages remained pretty much the same as before or any changes?

The 10-K is going out in two days time. So Dave, you will see the 10-K pretty much the same as the previous -- for FY2015 will be the same as the previous year.

So basically two 10% customers and if you, 10% customers is that about right?

Yes, I will say that yes.

Okay, sure. Good enough. And then regarding your SG&A, what is that $858,000 for investigation costs?

Okay. Those are GAAP number. In the case of EPS, non-GAAP EPS, we cut that out. So in the previous quarter we booked I cannot remember exactly, but 2 million for the investigation related to the revenue recognition, we reported last year, last year-end. So and then, when come to pay the bill, we get a discount back from the service provider. So that -- let’s go back to the same line.

Okay. All right. And then, regarding the datacom business, what is your rough mix between 10G, 40G and 100G?

I think Dave, as you’re looking at it from just on the datacom side?

Yes, just datacom.

Yes, I mean, if you’re looking at 100 gig and 40 gig, those are much larger today than the 10 gig portion that we have on the datacom side, specifically.

Okay.

So when you look at that on a combined basis, the 40 and 100 are certainly larger than the – up than the 10. We typically don’t break it down much further than that, just because we don’t want to be saying too much about the customer products that we’re building right now. But I would say those two combined on the 40 and 100 gig size are certainly larger than the 10 gig portion of that business.

And some of your customers talked about incremental pricing pressure that they’re experiencing in 10g and maybe even 40g, now -- how does that flow through to you guys?

I mean, there is no direct pricing impact on us, meaning its therefore to lower prices to compete in the marketplace that doesn’t pass through directly to us. That said, we’re under continual cost pressure by our customers to always deliver better pricing to that. So this is -- I wouldn’t say we’ve seen anything that’s terribly abnormal on our front. But as Tom likes to say frequently, if you are if you keep getting punched in the face and somebody starts punching the face a little harder, I don’t know how much you really recognize that. So cost pressure is something that we deal with every single quarter and I wouldn’t say its been anything abnormal relative to what we use to seeing.

Got it. Thank you.

Thank you. At this time, I don’t see any other questions in queue. I would like to turn it back to management for any closing remarks.

Great. Well, thank you everybody for joining us today and we look forward to talking to you about a quarter’s time from now. Thanks very much.

Thank you very much.

Thank you.