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Fabrinet (NYSE:FN)

F2Q 2014 Results Earnings Call

February 03, 2014, 05:00 PM ET

Executives

Paul Kalivas - Chief Administrative Officer, Executive Vice President, General Counsel and Corporate Secretary

David T. (Tom) Mitchell - Founder, Chairman and Chief Executive Officer

Toh-Seng (NYSE:TS) Ng - Executive Vice President, Chief Financial Officer

John Marchetti - Executive Vice President, Chief Strategy Officer

Analysts

Patrick M. Newton - Stifel, Nicolaus & Co., Inc.

Sherri Scribner - Deutsche Bank AG

Natarajan 'Subu' Subrahmanyan - The Juda Group

Troy D. Jensen - Piper Jaffray & Co.

Operator

Good day, ladies and gentlemen and welcome to the Fabrinet Second Quarter 2014 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 be given at that time. (Operator Instructions). As a reminder this conference call is being recorded.

At this time I would like to hand the conference over to Mr. Paul Kalivas, Chief Administrative Officer and General Counsel. Sir, you may begin.

Paul Kalivas

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 second quarter of fiscal year 2014, which ended December 27, 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. 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 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 November 5, 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.

David T. (Tom) Mitchell

Thank you, Paul and good afternoon, everyone. I am pleased with the results delivered in the second quarter. And Fabrinet remains committed to providing world-class engineering and manufacturing services to our customers and are working closely with them to meet their current and future production needs. This close collaboration, combined with our focus on total customer satisfaction gives me confidence that 2014 will be another profitable year of growth, as well as, I want to thank our employees for their dedication and hard work and all of our customers for their continued trust and support for Fabrinet.

I will now turn the call over to John Marchetti, Fabrinet's, Chief Strategy Officer for a further discussion of the markets we serve.

John Marchetti

Thank, Tom and thanks everyone for joining us today. 2Q was another good quarter for us, with revenues, margins and non-GAAP EPS ahead of forecast. Revenue in the quarter was driven by sequential and year-over-year increases in both our optical and non-optical businesses, with particular strength in our telecom segment, which was up approximately 10% quarter-over-quarter continuing on the improvement that we saw last quarter.

In telecom there continues to be a greater focus and effort in some of the more advanced components and modules, especially along the 100 gig coherent technologies while datacom demand for 10 gig and 40 gig solutions continues to be very healthy. We expect this strength to continue and while the March quarter tends to be a softer quarter in terms of industry demand we remain confident the underlying fundamentals of our optical business are strong and we expect to benefit through our customers as spending on optical equipment accelerates through the calendar year.

The laser market showed some early signs of improvement with modest increases on both a sequential and year-over-year basis. We expect that over the near term our laser business will continue to experience some lumpiness and demand still seems somewhat variable by application and end market, but over the longer term we believe that the laser market represents a significant opportunity for growth as it is still in the early stages of outsourcing.

The demand and visibility in our automotive segment remains solid with roughly flat results in the December quarter. We believe the longer term trend in this business is encouraging for us and we are excited about the opportunities for growth in the coming quarters.

Our results in our non-optical businesses have been mixed over the last several quarters. We remain confident that our laser, sensor and other segment will be an important driver of our top line growth for the next several years. And as Tom has mentioned on several occasions we continue to explore ways to accelerate our growth in these and potentially other markets.

As we look out into the remainder of 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.

With that I would now like to turn the call over to TS, our CFO for a review of our financial results. TS?

Toh-Seng (TS) Ng

Thanks, John and good afternoon everyone. I would like to start with a brief update on the insurance recovery status, then move through a review of the results of the second quarter and end with our outlook for fiscal Q3.

In the December quarter we did not receive any proceeds from insurance. However we did settle a premium claim with our insurance syndicate and we received a final payment of $38.6 million on January 21st which will be reflected in fiscal Q3 results.

With the settlement of our insurance claim I am happy to report that we are now essentially finished with our insurance process as claim for all losses related to inventory, property and business interruption had previously been settled and collected. Today we have received total payments against our claims in an amount of approximately $74.7 million and we estimate that overall cost of the flood less the insurance proceeds and other government grants was approximately $24.7 million. We expect our financial results to be impacted for another quarter due to the timings of insurance proceeds.

Now to review the results for the second quarter of fiscal 2014. Please note that all numbers are GAAP unless stated otherwise.

Our total revenue for the second quarter of fiscal 2014 was $178.6 million, an increase of 4% sequentially and 7% compared to the second quarter of fiscal 2013. On an end market basis revenue from Optical Communication was $129.7 million or 73% of total revenue for the quarter while laser, sensors and other revenue was $48.8 million, the remaining 27%.

Our share-based compensation expenses for the quarter were $1.5 million of which roughly $1.2 million were included in the SG&A. Our taxes in the quarter were a net benefit of approximately $1.4 million due to the release of certain provisions in complying with accounting standards FIN 48 and an increase in the value of deferred tax assets in our Chinese subsidiary. Without these items our normalized tax rate would have been 5.5%, within our expected range of 5% to 6%.

On a non-GAAP basis net income totaled $16 million for the quarter or $0.45 per share calculated from a base of roughly 35.6 million fully diluted shares. Non-GAAP net income grew 13% sequentially compared to non-GAAP net income of $14.2 million of last quarter and increased 16% compared to non-GAAP net income of $13.8 million in the same period last year

On a GAAP basis, including share-based compensation expenses, our net income was $14.5 million or $0.41per diluted share compared to GAAP net incomes of $16.7 million or $0.48 per diluted share, in the second quarter of fiscal 2013. Please note that our fiscal 2013 results included approximately $4.8 million or $0.14 per share in flood insurance recoveries.

Moving on to the balance sheet and cash flow statement; we ended the quarter with a cash balance of $180 million. Cash increased by roughly $60 million sequentially as a result of our stronger than expected second quarter results and solid working capital controls.

I would now like to discuss guidance for the next quarter. We expect revenue of between $162 million and $166 million. We anticipate non-GAAP net incomes of $0.32 to $0.34 per share based on a fully diluted basis of 36 million shares. We anticipate GAAP net income of $1.31 to $1.33 which includes approximately $38.6 million in final insurance proceeds.

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

Question-and-Answer Session

Operator

(Operator Instructions). And our first question comes from Patrick Newton from Stifel. Your line is open. Please go ahead.

Patrick M. Newton - Stifel, Nicolaus & Co., Inc.

Yeah, good afternoon, Tom, TS and John. Thanks for taking my questions. I guess just jumping on to the guidance of about three points softer than definitely what we were looking for, I would assume using JDSU's laser results from last week that perhaps that, that business has been pressured a little bit perhaps sequentially in the March quarter. And then I was wondering within your optical business are we anticipating both telecom and datacom are going to decline Q-for-Q? And then within guidance are there any product lines or technologies that represent the bulk of the sequential downtick in the outlook?

John Marchetti

Sure, thanks, Patrick. I mean in terms of looking into next quarter I think we are looking at the sequential decline right now probably more coming from the optical side than from the non-optical side. And then when you look at it within optical, telco is down a little bit more although datacom, I think, has a chance to be flattish but at least right now it's not indicating any real additional strength as we are looking out into the March quarter.

Patrick M. Newton - Stifel, Nicolaus & Co., Inc.

Okay. That's helpful. And then I guess, Tom or John you had two customers make public comments over the last several weeks, one being Oclaro discussing outsourcing of its datacom business and the other being II-VI discussing a strategic agreement with an existing contract manufacturer for its optical manufacturing business. So I guess would you give us any color on the timing for when Oclaro's outsourcing might occur and discuss your competitive positioning in order to gain that business? And could you also discuss the duration of the strategic agreement with II-VI or provide any details around that agreement?

David T. (Tom) Mitchell

Yeah, this is Tom. I think John would probably be -- have -- put more on color on the II-VI and Oclaro because he studies it so much.

John Marchetti

Thanks, Tom. No, I can't say that -- relative to II-VI we are not going to share a lot of details here but we do have a signed contract with II-VI now. That's really all I can say about the matter but I can confirm but we do have the signed contract.

In relation to some of the stuff that Oclaro has talked about we are certainly in the evaluation stages with that now. I don't really know the time frame with which we should be expecting something there. I think we'll leave to Oclaro to comment on that. But it's certainly something that we are taking a good hard look at right now.

Patrick M. Newton - Stifel, Nicolaus & Co., Inc.

John, for that signed contract can you at least discuss whether the duration is measured in quarters or years?

John Marchetti

Patrick, I really can't comment on the contract specifics at this point.

Patrick M. Newton - Stifel, Nicolaus & Co., Inc.

Okay, And just last one from me. During your prepared remarks you mentioned the thing about the unrest in Thailand. It sounds like your employees are safe, your operations aren't impacted and things must be running on smoothly. But I was wondering if you could walk us through what contingency plans you have in place. And then perhaps Tom just given your history in the country how would you compare the current tension to a prior period, '08, '10 is there anything operationally that we should be concerned about?

David T. (Tom) Mitchell

I don't think that we should be concerned at all about it. I have been manufacturing in Thailand since '84 and there have been some periods there has been a concern but never, never from a business concern. We've never missed the shipment out of Thailand since that period of time, all of our incoming goods have always come in and the Thai government is [serving] and supportive of the economy all throughout all these years.

And again what we see today is business as usual and so do the rest of the companies that are manufacturing in Thailand.

John Marchetti

Yeah and just to add to that Patrick in terms of the contingencies, we are in daily contact with all of our suppliers, with all of the logistics companies that we use, with the government, with the airfield. And right now we certainly have plans in place were something to happen. It doesn’t, as Tom indicated, we're certainly not overly concerned about it. At the factory it's absolutely business as usual. So until something changes I think that's exactly how we're going to continue to treat it.

Patrick M. Newton - Stifel, Nicolaus & Co., Inc.

Great, thank you for taking my questions. Good luck.

Operator

Thank you. And our next question comes from Sherri Scribner from Deutsche Bank. Your line is open. Please go head.

Sherri Scribner - Deutsche Bank AG

Hi, thanks. I wanted to get a little detail on your thinking about operating expenses as we move forward considering the step down in revenue. Should we think about SG&A being relatively flat and also sort of thinking about utilization rates how you are utilizing building six at this point and how much of a drag is sort of the under-utilization in the March quarter impacting your results -- the guidance?

Toh-Seng Ng

Sherri this is TS. I'll take the first question let John answer the phase issue. As far as SG&A is concerned operating expense should be flat because I think even though we guided down, we believe this is a temporary situation and also in the long run we shouldn't go back to the same revenue levels of revenues. So I don't think SG&A will fluctuate just based on a short term volume change.

John you want to take the next one.

John Marchetti

Yeah, Sherri in terms of space right overall the campus is running probably around 75% plus or minus a percent or so in terms of space being utilized. Building six is probably just over 50% full at this point. From an equipment perspective the factory is probably running in the load of mid-60s in terms of equipment utilization. So we'll continue to fill that up but sort of it's still a little bit of a drag on the gross margin line but we're slowly but surely absorbing more and more of building six.

Sherri Scribner - Deutsche Bank AG

Okay. That's helpful and then thinking about the June quarter and the rest of this fiscal year and thinking about the guidance that you gave for March, typically you guys don't see a lot of seasonality but you are guiding March quarter down I think at the mid-point of about 8%. What type of seasonality would you typically expect in the June quarter and how much seasonality do you expect in the back half of the calendar year?

David T. (Tom) Mitchell

Yeah I mean it's hard for us to certainly see out that far, Sherri, I mean but if we use last year as a guide we had a fairly steep decline sequentially off our December quarter last year and then managed to grow pretty well every quarter sequentially from there, as we went through the calendar year. And we're certainly expecting that we'll be able to grow sequentially again from this March quarter low point if you will.

How much exactly what we're anticipating, it's hard for us to say at this point but I would say that we do expect to grow sequentially as we move through the calendar year.

Sherri Scribner - Deutsche Bank AG

Okay. And I just want to follow up on some of the comments you made about Oclaro, I know nothing has been resolved at this point and you are evaluating and they are evaluating, but if something were to happen would you need to cut some of your expenses would their need to be some layoffs what are you thinking? Thanks.

John Marchetti

I mean I don't think at this point we're really anticipating that we're going to have a huge issue with Oclaro here any time soon. Were we to lose any major customer like that then I think we'd absolutely have to take a look at realigning our resources to make sure that we're matching what we have against the revenue levels that we expect going forward. So were we to expect something like that to occur then I think it would be reasonable to expect us to take actions to reduce our overall cost.

Sherri Scribner - Deutsche Bank AG

Thank you very much.

Operator

Thank you. And our next question comes from Subu Subrahmanyan from Juda Group. Your line is open. Please go ahead.

Natarajan 'Subu' Subrahmanyan - The Juda Group

Thank you, two questions. John, it looks like optical comp's down about 10% quarter-over-quarter. Can you just remind us what's your mix between telecom and datacom is in optical comp?

John Marchetti

Sure. We have got about two-thirds, one-third split Subu. Although this quarter it was a little bit more weighted to telco. So we're down probably the higher end of that.

Natarajan 'Subu' Subrahmanyan - The Juda Group

So that would suggest down 10% would be telco down almost 15%, assuming datacom's 5%. I guess my question is that's more than seasonal downtick and at least one of your large customers actually suggested March is up for telco and optical. So I am just trying to understand kind of the difference on this thing?

John Marchetti

I mean for us Subu, it's a situation where we roll up the customer orders and that's kind of where we are at right now. It's not I think in any one vendor's camp if you will. It's spread out fairly evenly across the mix. So again I understand it's down a little bit more certainly than we would like but that's kind of where we are right now.

We don't believe that it's got anything to do really with market share moving away from us or anything along those lines. I think it's just a proxy of that -- that's the order roll up that we have at this point in time. And so that's the guidance that we are giving.

Natarajan 'Subu' Subrahmanyan - The Juda Group

And given the Oclaro divestitures, can you just remind us the pieces of Oclaro that they were doing internally on the datacom side, what there is coming up I guess contract I guess. How much of that did you have exposure for versus what of that was their share of the pie, that you did not have exposure for before?

John Marchetti

I am sorry Subu, I just want to make sure I understand the question, would you please repeat it again.

Natarajan 'Subu' Subrahmanyan - The Juda Group

Yeah. I just wanted -- so there was some commentary about their datacom business outsourcing, what options they may be considering. I am wondering was that in Shenzhen with them or was some of that with you? Do you feel like some of the business that you have at Oclaro is being in some form [rebid], I guess?

John Marchetti

So the business that I think was mentioned earlier today would be stuff that I am assuming would come out of Japan, out of some of the old historic op mix business but I don't think it was coming out of Shenzhen.

Natarajan 'Subu' Subrahmanyan - The Juda Group

Understood. And final question on II-VI. II-VI obviously has made some comments about their own plans for vertical integration and outsourcing. And your exposure to Oclaro, a significant portion of that business into II-VI, can you just talk about does that in II-VI at the run rate are they a 10% customer that comes from Oclaro and how you at least over the next few couple of quarters see that playing out?

John Marchetti

Yeah, I mean I think that piece of business that we got from -- or that we now have with II-VI that came from Oclaro, we certainly anticipate that as that matures and continues, with any luck it will continue to grow with us as it has over the last several years as we had it with Oclaro as the product manager or the product owner there, I should say.

In terms of whether or not II-VI is a 10% customer I have got to figure all that out as it translates into what point they take ownership and who's books it's actually still on. I mean I am not trying to be evasive here, it's just I am not exactly sure quite frankly yet, exactly how it's rolling up and where it's being reported.

Natarajan 'Subu' Subrahmanyan - The Juda Group

Okay. Thank you.

Operator

Thank you. And our next question comes from Troy Jensen from Piper. Your line is open. Please go ahead.

Troy D. Jensen - Piper Jaffray & Co.

Hey. I just had a follow-up for John. So John you highlighted a 100 gig telco and 10 gig and 40 gig for datacom, we've heard that from some of the other optical guys too in the last week. Can you just let us know which of the two you guys have most exposure to or which one is going to be more important for growth in the future?

John Marchetti

Sure, I mean most of the 10 and 40 gig on the datacom side that's where we've got a little less exposure that we do to the telco. So overtime I think as telco catches up, because certainly 10 and 40 is a little bit stronger, not just for us but I think for the industry in general right now. But I think as 100 gig starts to gain some additional momentum and acceleration that will be a bigger importance for us going forward than 40 or 10 in the datacom side.

Troy D. Jensen - Piper Jaffray & Co.

And then as you said -- I am thinking about your confidence regarding around telco in 2014, myself and other people in the industry thought that was going to happen in '13, so just like to know where you get your confidence?

David T. (Tom) Mitchell

I think Troy a part of this is -- I don't see any major obstacles out there. I think it has been really a situation where we're just needing to see I think multiple operators come in and start to deploy at the same time.

And I think that as we are getting further and further into this deployment cycle we are starting to get some additional signs of that occurring, whether it's increased participation from some of the Chinese carriers, some early signs, I think of hope coming out of Europe, I think another sort of year of the U.S. market being a little bit further into its overall builds, that we are just, I think we are now starting to get enough of a sense that we are going to get multiple carriers participating at the same time.

That's really where our, I think our confidence comes from more so than anything else.

Troy D. Jensen - Piper Jaffray & Co.

Right, understood. Good luck, gentlemen.

David T. (Tom) Mitchell

Thank you.

Operator

Thank you. I am showing no further questions at this time, sir.

David T. (Tom) Mitchell

Great, well thank you everybody for joining us today and we look forward to speaking again soon. Good afternoon.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes our program. You may all disconnect and have a wonderful day.

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