Good day, ladies and gentlemen and welcome to Fabrinet's Financial Results Conference Call for the First Quarter of Fiscal Year 2020. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions on how to participate will be given at that time. As a reminder today's call is being recorded. I would now like to turn the call over to your host Garo Toomajanian, Investor Relations. Sir, you may begin.

Thank you, operator, and good afternoon, everyone. Thank you for joining us on today's conference call to discuss Fabrinet's financial and operating results for the first quarter of fiscal year 2020, which ended September 27, 2019. With me on the call today are Seamus Grady, Chief Executive Officer; and TS Ng, Chief Financial Officer. This call is being webcast and a replay will be available on the Investors section of our website located at investor.fabrinet.com. Please refer to our website for important information, including our earnings press release and investor presentation, which include our GAAP to non-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 opinion only as of the date of this presentation, and we undertake no obligation to revise them in light of new information or future events except as required by law. For a description of the risk factors that may affect our results, please refer to our recent SEC filings in particular the section captioned risk factors in our Form 10-K filed on August 20, 2019. We will begin the call with remarks from Seamus and TS, followed by time for questions. I would now like to turn the call over to Fabrinet's CEO, Seamus Grady. Seamus?

Thank you, Garo, and good afternoon, everyone. We delivered a strong performance in the first quarter with revenue and earnings that were above our guidance. Demand trends appear to be stabilizing in most of the end markets we serve and we're optimistic that we are positioned to deliver strong results in the second quarter. Revenue in the first quarter was $399 million, a slight decrease from the record fourth quarter as expected, with a 6% increase from a year ago. Non-GAAP net income was $0.86 per share exceeding the high end of guidance as gross margins improved to 12% in the quarter. Looking at our business by end markets, optical communications revenue of $302 million was up about $2 million from the fourth quarter and represented 76% of total revenue. Within optical communications telecom revenue of $230 million increased 7% from the fourth quarter and represented 76% of optical revenue. This growth is particularly notable considering we had expected telecom revenue to be flat at best. Further, we expect this momentum to continue in Q2. Datacom revenue was $73 million in the quarter, an expected decrease from Q4 of 15%. Datacom represented 24% of optical communications revenue. We believe this decline is primarily the result of broader industry trends and not due to execution or competitive issues. In fact based on anticipated near-term demand, we believe datacom trends could be nearing the bottom and we expect datacom revenue to be roughly flat in Q2. By technology, silicon photonics based optical communications revenue decreased from the fourth quarter to $77 million and represented 25% of optical communications revenue. Revenue from QSFP28 and QSFP56 transceivers was $45 million down slightly from fourth quarter. By data rate, 100-gig programs continued to represent nearly half of optical communications' revenue at $147 million. And products…

Thank you, Seamus, and good afternoon everyone. I will provide you with more details on our performance by end market and our financial results for Q1, as well as our guidance for Q2 for fiscal year 2020. Total revenue in the first quarter of fiscal year 2020 was $399.3 million and above the upper end of our guidance range. Non-GAAP net income was $0.86 per share and was also above our guidance range even after a foreign exchange headwind of $1.9 million and the mark-to-market loss on interest rate swap contracts of $1.7 million. These losses accounted for approximately $0.09 per share. Now turning to the details of our P&L. A reconciliation of GAAP to non-GAAP measures is included in our earnings press release and investor presentation, which you can find on our website. We were pleased to see non-GAAP gross margin in the first quarter improve to 12%, a 20 basis point increase from the fourth quarter as efficiency more than offset the impact of merit increases. Non-GAAP operating expense was $11.6 million in the first quarter. As a result non-GAAP operating income was $36.2 million and non-GAAP operating margin was 9.1% flat with the fourth quarter. Taxes in the quarter were $2.2 million and our normalized effective tax rate was less than 5%. We expect our effective tax rate to be 5% to 6% for the full year. Non-GAAP net income was above our guidance range at $32.2 million in the first quarter, or $0.86 per diluted share as I indicated earlier. On a GAAP basis, which includes share-based compensation expenses and amortizations of debt issuing costs net income for the first quarter was $25.9 million, or $0.69 per diluted share also above the high end of our guidance. Turning to the balance sheet and cash flow statement.…

[Operator Instructions] Our first question comes from the line of John Marchetti of Stifel.

Thanks very much. I appreciate you taking my question. A quick one first off Seamus. I was curious if in this quarter there was any revenue associated with that transfer program coming in. And if there is some of that in the guidance for next quarter as well?

Hi, John. Yes. We had some revenue from the transfer program. As you may notice from our cash, we did burn cash in the quarter. And in large part that was due to inventory that we purchased in the early part of the quarter and then our shipments as you can appreciate with a big transfer like that, we did have some revenue but it was pretty much back-end loaded in the quarter. So we have some receivables that fell into this quarter. So yes, we did have some revenue in the quarter and we continue in our guidance for this quarter as well. And we think it will be probably largely ramped, I think by the end of this quarter. We're a little bit ahead of schedule. I know previously we mentioned we thought it will be out into Q3. We think it will be largely ramped by the end of this quarter.

So just to be clear, by the end of this quarter you expect that whatever you're shipping for that program will be actually coming out of your production and not just out of inventory that you purchased?

Yes. We didn't purchase. The only inventory we purchase was raw material. We didn't purchase any finished goods or semi-finished goods or anything like that. So everything that was in our revenue last quarter was product we produced that will stay in this quarter. There's a little bit more of it this quarter and we expected to be fully ramped up this quarter.

And then if I can switch gears. You had a pretty significant sequential increase in the 400 and above speed check there. I'm wondering if you can talk about, if that was with existing customers and is more demand-related if there is some new customer activity mixed in there. Just any color you can give us behind sort of that ramp, that's fairly steep in that 400 and above?

It's a combination John of both existing and new customers. I would say, the majority of that revenue came from existing customers. So as you can appreciate any volume from new customers will be small in nature, but the majority of the revenue increase on the 400 gig came from existing customers.

And then lastly if I can, just curious about your comments about the datacom business getting a little bit better. What sort of visibility do you have there? And I guess what's changed over the last quarter or so to make you feel a little bit better about that? Thanks very much.

No problem, John. I think we feel like both datacom business, we think has maybe bottomed out/flattened. It was down last quarter as we said there. As expected our datacom revenue was down. We think it's kind of bottoming out this quarter. We think last quarter was probably a low point and we think it's flattening. So we're not exuberant, I would say. We're not guiding any huge increases on datacom, but we do feel I think our telecom business we think is quite strong and will be up. But our datacom business we think is still a little bit flat I would say. And that's really based on the forecast in orders we have from our customers. We have about typically 13 weeks rolling visibility. So we have some pretty good visibility and that's -- so that's based on the visibility we get from our customers John. Thank you, John.

Got it. Thank you.

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

You talked a little bit about this program that you're moving over from Berlin. Obviously, you've given guidance here for the full year fiscal year and in 2020 that this could be 10% plus of your revenues. It doesn't sound like in the first half, it's anywhere near that. Can you talk a little bit about the cadence of when you think it can achieve or exceed that full year mark? But I would assume that at some point it has cross over and be more than 10% to get to that level for the full-year?

Yes, Alex. The 10% comment that we made previously was in relation to Infinera as a customer in total, which will be the combination of the previous if you like existing Infinera business that we already have plus the transfer business from Berlin. So the 10% comment was not related to the Berlin business alone, the Berlin businesses in addition to the existing Infinera business so that may explain the disconnect there. I'm not sure if that's helpful.

Well so I am assuming that it still isn't over 10% at this point in time or anywhere close to it. So the comment still stands. When do you think that that program gets to a point where it's driving the type of revenues that would put them at over 10% as a customer?

Well again -- again we just reported 10% customers at the end of the fiscal year. We think we'll be ramped on the transfer business by the end of this quarter. That should put us at that run rate we think for the full year.

Right. So a second question if I could. On the ROADMs versus ACO DCO, there seems to be a shift fairly significant shift at that between what I would call optical switching and transmission in several companies' commentary. Can you talk to what extent you have exposure to a flattening market and the switching market and to what extent you think the acceleration in transmission can offset that?

So Alex this is TS. Again, as you know most of these ROADMs we build for one customer. And if you listen to the earnings call they -- essentially they are saying for the short term it's pretty flat. And in the long run, they still believe that it's going to go up. So basically, whatever they say applies to us because we only have one customer on the ROADMs.

Right. But the question really was to what extent can you use transmission to offset that over the next couple to three quarters. Do you have enough visibility on transmission and do you sustain your share of the business when that shifts between those two segments?

I would say I think we do. I think the shift between let's say transport and transmission, we have a number of customers in that space that should help us offset. But we don't have visibility two, three quarters out. We really just have that kind of rolling 13-week visibility. But we hope to be able to capitalize on that as they -- as that shift begins to unfold over the next few quarters. We have a good number of customers in that space. So we hope to be able to capitalize on that.

One last question then I'll see the floor. You indicated in past quarters that you were experiencing some lack of availability on some passive components and other fairly low cost, but critical components that are part of your production sets. Has the supply constraints on those products ameliorated, so that's no longer a drag? Or are we still absorbing that?

Yes. I think that if you're like passive supply constraint that was plaguing the whole industry. If I go back maybe three quarters ago or something like that that seems to have abated ameliorate at this stage. It's pretty much behind us. We think there's always -- we start every quarter with some challenges that our supply chain team has to go and secure. But that's just kind of normal course of business. But at overall I think industry-wide passive constraint that was there nine months ago, a year ago that seems to have abated at this stage. There's always certain charges here and there but nothing of any significance.

Great. Thank you very much.

Thanks Alex.

Thank you. Our next question comes from Samik Chatterjee of JPMorgan. Your line is open.

Hi, this is Joe Cardoso on for Samik Chatterjee. So, for my first question I wanted to dig in on the gross margin. I think last quarter you guided for moderation from Q4 to 1Q. And so I was just curious if we can double-click there and just figure out what has changed or what the variance was in when you guys initially guided there and what changed from what you guys reported in the first quarter.

Hi, this is TS. For the first quarter as in my prepared remarks, we see the efficiency more than offset the merit increase. Typically July August September we start giving merit increase for the whole year. So, that resulted about 20 basis points better than the previous quarter June quarter. So, June quarter was 11.8% and then moving to 12%. And moving forward, Q2, we don't guide gross margin. But if you just look backward based on the guidance it showed improvement from 12%. So, we are very happy that we are back to the 12% to 12.5% range and we'll continue to maintain that.

Yes. Let me just maybe add a lot of the good result we have in gross margin Q1, it's really down to a very tight cost control and efficiency gains from our team. Our internal team, the operations team, our supply chain team really do an excellent job keeping our costs under tight control and realizing efficiency gains. So, it's mostly driven by like I say efficiency gains and cost containment.

And then -- thank you. And then for my second question, relative to your commentary around the industrial laser market, it kind of seems like you guys are suggesting a little bit more of headwind or continuation of the headwinds that have been impacting that market while one of your biggest customers in the last earnings call kind of suggested that that market was dropping off if not actually improving. So, can you kind of explain what you guys are seeing there? Are you guys expecting it to trough in December and then improvement after there? Or whatever visibility you can provide will be helpful.

Yes, I think that's probably a fair assessment. That industry is going through a tough time right now. The competition is fierce. Spending seems to be tightening up. So that whole industry is going through a pretty turbulent time. We have a number of customers. We have probably four customers in that space right now; one customer being our bigger one. And really our shape and size in that market is a function of what's going on with our customers, so we're not immune from what's happening with our customers. So, it's pretty flat I would say. The laser market is pretty flat. Longer term we do remain quite optimistic as I might have mentioned in my prepared remarks. We do remain quite optimistic about the laser market because we think that some of the price pressure that the big companies in that space that the Western world companies if you like are feeling. We believe they will turn to outsourcing as a way to offset that pressure and will outsource more and more because to a large extent a lot of the companies in that space, they insource quite heavily they don't outsource that much. So, we think we're very well-positioned with the capabilities and experience we have. We think we're pretty well-positioned to capitalize as that industry looks to outsourcing. But overall demand, I'd say short-term is kind of flat as some of our customers have indicated.

All right. Thanks guys. And congrats on the results.

Thank you.

Thank you.

Thank you. [Operator Instructions] The next question comes from the line of Tim Savageaux of Northland Capital Markets. Your line is open.

Hi, good afternoon and congrats on the results.

Thanks Tim.

First question is on the 10% customer side, do you have any 10% customers outside of your traditional customer large customer in the quarter?

Well, as we said, we only reported 10% customers at the end of the year. We think we're probably tracking -- we've mentioned Infinera will likely be a 10% customer. There's a chance there's another one or two who could become a 10% customer for the full year, but it's probably too early to start flagging that at this stage. But we certainly feel we'll have two by the end of the year, yeah.

Okay. Appreciate that. And looking at telecom growth in the quarter, especially on the context the things that silicon photonics line down pretty reasonably. I wonder if you can characterize that 7% sequential growth in telecom. And then also I guess I've mentioned that in the context of your commentary on 400 gig growing so strongly and mostly from existing customers. But can you characterize the sequential growth either in the results or outlook or both in the context of contribution from new programs your ramp with your new customer versus existing business or existing customers?

Yeah. A lot of the growth in telecom in the quarter, a lot of that did come from our new customers, big portion did come from our new customer. 400-gig growth is predominantly from an existing customer. And then the decline in silicon photonics, some of our silicon photonics business is telecom-related, but some of those actually is datacom related. So the overall, I suppose the two are a possible telecom growth and a decline in silicon photonics in the sense that the decline in silicon photonics is mostly for the datacom customers.

All right. Understood. And any -- realizing you don't guide by these specific segments, but I wonder if you have any kind of anecdotal commentary as you look forward to that telecom growth continuing. Do you have any similar thoughts around what you expect out of the silicon photonics as you head into next quarter and throughout the year? Do you expect that to return to growth at some point?

Silicon photonics, I think a lot of that I think on the telecom side, we think it's going to remain strong. And also on the datacom side with several of our customers one or two of our customers have experienced a little bit of softness in the data centers so that does affect us on the silicon photonics side. But overall we think -- and again we only guide a quarter at a time. But overall I think the sentiment out there that we hear is the telecom will be quite strong and datacom is a little bit flat and will continue to be flat we think.

Great. Thanks very much. I’ll pass it on.

Thank you, Tim.

Thank you. Our next question comes from Alex Henderson of Needham. Your line is open.

Thanks. I was hoping you could give us the geographic split?

In terms of shipments, no more changes. North America shy of 50%. And the rest are split between China, the rest of the world. Southeast Asia is also a big portion. We ship quite a bit to Southeast Asia country.

And can you tell me what you said about the growth going forward in telecom again? I'm not sure I got it right in my notes. What was your expectation for telecom growth sequentially into the fourth -- CY 4Q, FY 2Q?

Well, we haven't guided specific growth for telecom I guess the discussion was really more around overall sentiment. The sentiment we hear from our customers is that telecom will remain, we think quite strong. Datacom is flat but we haven't given any specific guidance for our telecom revenue forward. We think we will do in next quarter.

I see. And one more question if I could. Around the Israel operation when would you expect to be able to actually generate some revenues from that facility? Is that six, nine months out? Or how far out does that take?

I think we'll be -- we're targeting to be up and running and ready to rock and roll in the early part of next year, so the kind of January to March time frame, so we'll be ready to do business. But it takes a little bit of time then to when the business grows the business, but I think it should be contributing to a certain extent in the, I would say in the June quarter. We would expect to see some revenue emanating from there in the June quarter, maybe a little bit earlier but that's what we're thinking right now. So right now we're fitting out the building and we're fortunate that the building we got has a lot of the infrastructure, because it was a semiconductor manufacturing facility originally. It has a lot of the facilities infrastructure already in place. So that shortens the time line for us. And we're planning to install the full suite of equipment, SMT equipment, optical packaging equipment and very importantly for our customers full failure analysis capability there. So we'll replicate all these on a smaller scale, the same set of capabilities that we have in Bangkok actually.

Do you see that facility as being roughly comparable sized to Fabrinet West?

It's a smaller facility. In terms of square footage it smaller. The Fabrinet West facility it's a great location it's a great facility. The building itself is probably a little bit bigger than what we would actually need. So it's a smaller facility. I think terms of square footage it's about...

20,000.

Roughly 20,000 square feet. So it's an ideal size actually for what we need. And similar to Fabrinet West, it's not going to be a huge revenue generator in and of itself. The main purpose of Fabrinet Israel will be to win customers that we then transfer to Bangkok. So we'll try and replicate the success we've had in Fabrinet West in Israel.

I see. Can you give us any sense of what's going on in terms of your factory utilization in your facilities when you might need to start moving on the next facility? Can you give us an update on that?

Yes. So we continue to create additional space at our main campus in Pinehurst and win new business in Chonburi. It's hard to say Alex really because we've been very successful. We probably surprised ourselves how successful we've been at gaining efficiencies and freeing up space in Pinehurst. So we're growing our Pinehurst facility our Pinehurst revenue on the same footprint. We're adding our new business into Chonburi. It's really hard to say at this point when we'll be ready to -- I'll put it this way if everything we have in the pipeline lands we'll be hurrying up but not everything will land. So I think we're still very optimistic I would say, about the need for us to grow Chonburi. And like I say if everything we have in the pipeline lands, we'll have to get going quickly. But it's very hard to put a date on that. I'm not being evasive it's just it's quite hard to put a date on it because like I say a lot of the growth with our existing customers will be in Pinehurst whereas Chonburi will be really more for the newer customers.

All right. One last question if I could since it sounds like you don't have too many in the queue. The 400 gig commentary, can you talk a little bit about whether that's on the telco side whether that's 400 gig or 600 gig? I assume that's mostly 600-gig product within that mix for telco. Is that correct?

It's a mixture of 400.

In Datacom?

Yes, yes mostly 400 gig, yes.

In datacom that's 400 gig but what about on the telecom side?

On the telecom side yes, that will be 400 gig.

Majority 400 gig, yes. Excluding the 600 gig that 1.2 terabytes that's excluded from the number Seamus just quoted.

Thank you.

Thanks, Alex.

Thank you. Our next question is a follow-up from John Marchetti of Stifel. Your line is open.

Thanks very much. Seamus, if I can just follow-up a little bit on that Israel site. It seems a little bit of a departure from the last couple of quarters, where it seemed like you had actually been backing off a little bit on the expectation there. Curious, if something changed in the environment or you just found an opportunity that or even just decided itself that made sense to kind of move forward your -- that sort of changed at least what I perceived to be the trajectory of that business. And just secondarily, if you can comment at all about the mix expected in there. I'm curious if this is mostly non-optical type of revenue that you think you're going to go after in this market or if it's a similar to the Fabrinet West, where it'll be a little bit of a mix of everything.

Good question. I think on the timing on the trajectory, we've always been I would say quite bullish on the need for us to bring up our facility in Israel. The hold up really John was just frankly being able to find the right location. We think Israel is a great location we have three or four existing customers there, so we'll be looking to service their needs and also grow our business there. So the customers we have, we've spoken to them and they're very supportive of the idea. Our hold up if you like was just it's literally finding the right location. There's a lot of let's say, incentives, government incentives to build in locations that would not be ideal for us. We're -- if you look at what we've done in Fabrinet West, we were right in the middle of Silicon Valley. Location is very important and it's the same in Israel. So it was really about just finding the right location and we've done that we've managed to find the right location. As to the mix, I mean our existing customers, let me just think for a moment are all optical communications companies.

And mostly datacom.

Yes. And mostly datacom. Our existing Israeli customers are all optical communications companies mostly datacom. So, we would be looking to obviously continue to grow business with those companies and add other communications companies, but also other non-communications companies that are in our technology sweet spot if you like of precision complex products, it's just LIDAR and other applications. And we're not limiting ourselves to optical, but we are limiting ourselves to high-technology complex infrastructure type products that was transferred to Thailand.

Thanks, very much Seamus.

Thanks, John.

Thank you. We have a follow-up question from Tim Savageaux of Northland Capital Markets. Your line is open.

Thanks. Wanted to focus back on your commentary on the pipeline, and I wonder if you can give us an update as to what extent kind of customers OEMs moving supply chains out of China is contributing to that pipeline I guess. In past calls, you characterize that is a tailwind, but pretty far out. I wonder if now that another quarter has passed, if you can give us an update on kind of what type of opportunities you might be seeing from this kind of shifts in global supply chain. Thanks.

So that's -- I would say that's still a tailwind, but still quite slow to move. Some of the pipeline that I referenced earlier is both a function of that, but it's really more a function of just continuing to grow our business with our existing customers and also adding new customers. We have a few big, I would say big opportunities in the pipeline and some of the things that we're quite excited about are some of the opportunities really moving up the food chain for us, moving up into the full system build full network systems. With the business, we have transferred from Berlin that gives us experience now with that full network system. We have some other business in that same space. So, we think we're kind of uniquely positioned that goes in our industry and that we're approaching the full system build from the -- if you like from the bottom up. We are producing the most complex high-technology components within the network system, so we think it makes sense for us to move up the food chain and produce the modules in the full system that goes with that. So, that's in large part what we're targeting Tim. And like I say, we have some pretty exciting opportunities there that we're pursuing.

If I could just follow up on that quickly. In your -- I imagine that comment in terms of moving up to the full systems level remains focused on optical communications, optical transport or are there kind of other parts of the networking universe where you see as opportunities?

It's mostly as you said the optical infrastructure equipment that the networking equipment. We're not planning to become, if you like a general large system producer for like the storage equipment or anything like that. That's just not in our sweet spot. It really only makes sense for us when we're producing a large portion of the high-technology components and content that goes into those systems. So -- and it also make sense for us. Let's say, it doesn't make sense for us to produce large systems, but we're not producing any of the content if you know what I mean. So, we would not see ourselves as just as an assembler. We will see ourselves as a high-technology producer of the industry's most complex technology and components. Therefore it makes sense for us to produce the full system. Does that makes sense Tim?

Sure, it does. Thanks very much.

Thank you, Tim.

Thank you. At this time, I'd like turn the call back over to Seamus Grady for any closing remarks. Sir?

Thank you, operator. Thank you all for joining our call today. We're excited to deliver strong results and a positive outlook as we continue to position the company for continued growth and diversification over the longer term. And we look forward to speaking with you again soon. Thank you and goodbye.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.