Fabrinet's (FN) CEO David Mitchell on Q2 2016 Results - Earnings Call Transcript

| About: Fabrinet (FN)

Fabrinet (NYSE:FN)

Q2 2016 Results Earnings Conference Call

February 01, 2016, 5 PM ET

Executives

Garo Toomajanian - Investor Relations

David Mitchell - Chairman & CEO

Toh-Seng Ng - Executive Vice President, CFO

Analysts

Troy Jensen - Piper Jaffray

Patrick Newton - Stifel Nicolaus

Alex Henderson - Needham & Company

David King - B. Riley & Company

Tim Savageaux - Northland Securities

Operator

Good day, ladies and gentlemen. Welcome to Fabrinet’s Second Quarter Fiscal Year 2016 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 on how to participate will be given at the time. As a reminder, today’s conference is being recorded.

I would now like to turn the call over to your host, Garo Toomajanian, Investor Relations. Please go ahead.

Garo Toomajanian

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 2016, which ended December 25, 2015. With me on the call today are Tom Mitchell, Chief Executive Officer and Chairman of the Board of Directors of Fabrinet; and T.S. Ng, Fabrinet’s Chief Financial Officer. This call is being webcast, and a replay will be available on the Investor section of our website located at investor.fabrinet.com.

Please refer to our website for important information, including our earnings press release and our non-GAAP to GAAP reconciliation. I would like to remind you that today’s discussion will contain forward-looking statements about the future financial performance of the company. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from management’s current expectations. These statements reflect our opinions only as of the date of this presentation, 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 3, 2015. We will begin the call with remarks by Tom and TS, followed by time for questions.

I would now like to turn the call over to Fabrinet’s CEO and Chairman, Tom Mitchell. Tom?

David Mitchell

Thank you, Garo, and good afternoon, everyone. We are pleased to report second quarter results that were above our guidance for both revenue and earnings per share. These results reflect the strong business momentum that we continue to see as well as the healthy state of the industries we serve.

One of the important drivers of our growth is new business. In the second quarter, new programs represented 25% of the total revenue, which is an increase from 12% a year ago. This combined with growth from existing programs and contributions from Fabrinet West produced results that were above our guided range. We believe this momentum will continue into the third quarter and we are increasingly optimistic about the fiscal year.

In early January, we announced the hiring of Dr. Hong Hou as Chief Technical Officer. With extensive technical and leadership experience in the semiconductor and communication industry, Hong will be a valuable asset in support of new product introduction programs.

While we have ample capacity to meet increasingly customer demand, we have begun construction of the first building in our new campus outside of Bangkok. We expect this new building to be complete in about a year and will help us meet our growing demand.

Now, I’ll turn the call over to TS for a discussion of the markets we serve and our financial results.

Toh-Seng Ng

Thanks Tom, and good afternoon, everyone. I would like to provide you with more details on our performance by end market and our financial results.

Total second quarter revenue was $223 million and was above the high end of our guidance range. Revenue increased 24% from a year ago, or 29% when you exclude the impact of $8.4 million in consignment revenue in the second quarter of fiscal 2015. Our optical communications business represented 72% of our total revenue, consistent with our recent performance. Optical revenues of $168.7 million increased 26% from a year ago, and 9% from the first quarter.

Within optical, the revenue split was 54% to telecom markets and 46% to datacom markets, which are consistent with the first quarter. Our datacom represented a 10 percentage point increase from a year ago, as datacom revenue grew 64% from a year ago, while telecom revenue grew 5% from a year ago.

As in the first quarter, growth in our optical communications business was driven by our advanced optical components and modules, including our 100-gig solutions and new programs. In fact, revenue from 100-gig programs nearly tripled from a year ago, while revenue from 10-gig programs grew 36%, both of which more than offset the decline we saw in revenue from 40-gig programs.

Turning to our non-optical communications business, revenue from lasers, sensors and other markets represented 28% of total revenue and increased 18% from a year ago, and 4% sequentially. During the second quarter, strong growth in revenue from sensors again drove most of this increase, although the lasers and other markets including automotive also contributed to growth.

New business represented manufacturing programs from new or existing customers that were not in production two years ago. Revenue from new business represented 25% of total revenue in the second quarter, up from 13% of revenue in the same quarter last year. Our focus on new business combined with increasing production from existing programs resulted in strong overall growth in the quarter.

We ended the quarter with approximately 90% of our capacity in our existing facility Thailand occupied. However, it is important to realize that with our [factory within our factory model] will continue to have capacity to add additional equipment lines within our existing building.

On the basis of equipment, we believe we are currently at approximately 75% capacity. Therefore, we believe we have significant room to continue to grow and meet customer demand even while our new facility outside Bangkok is being completed. We closed the land purchased for our new campus in December and construction is already underway. We expect to begin occupying the new building in the second quarter of fiscal 2017.

Now, turning to the details of our P&L. Unless otherwise stated, all numbers presented here are on a GAAP basis. Gross margin in the second quarter was 12.2%, an increase of 100 basis points from a year ago and 20 basis points from last quarter, primarily due to higher than anticipated revenue. Excluding share-based compensation expenses, non-GAAP gross margin was 12.5% in the second quarter, an increase of approximately 20 basis points from the first quarter and at the upper end of our target range. For the third quarter, we expect gross margin to be roughly flat compared to fiscal Q2.

Our total share-based compensation expenses for the quarter were $3.1 million, of which roughly $2.6 million was included in SG&A. Our start-up costs related to our new Fabrinet West which are reflected primarily in operating expenses continue to have a slight negative effect on our operating margin.

GAAP operating margin increased to 6.3% in the second quarter compared to 5.7% a year ago. Non-GAAP operating margin was 7.9%, down from 8.1% a year ago with increased costs associated with ramping up production at our Fabrinet West facility.

Other income and expenses in the second quarter included a $5.4 million foreign exchange gain. As we noted last quarter, we expected that the unrealized loss in Q1 will reverse as the contracted baht was delivered. The remaining unrealized loss of approximately $5.5 million booked in Q1 will be reversed in tandem with the contracted baht delivery.

Taxes in the quarter were a net expense of $1.3 million and our normalized effective tax rate was 6.8%, which was within our expected range of 6% to 7%. We continue to anticipate that our effective tax rate will be in the range of 6% to 7% for fiscal year 2016.

On a GAAP basis, which includes share-based compensation expenses and the unrealized gain on mark-to-market foreign exchange adjustments, net income for the second quarter was $19.8 million, or $0.54 per diluted share, compared to $8.7 million, or $0.24 per diluted share in the second quarter of 2015. On a non-GAAP basis, net income totaled $18.2 million for the quarter, or $0.50 per diluted share, above the high end of our guidance.

Moving on to the balance sheet and cash flow statement, we ended the quarter with a cash and investment balance of approximately $257 million. This represents an increase of almost $19 million from the end of the first quarter, primarily due to operating cash inflows. During the quarter, we also drew $18 million against our revolving credit facility to purchase the land for our new campus and initial payments for new building construction.

We continue to expect CapEx in fiscal 2016 to be in the range of $60 million to $70 million, with approximately $30 million of that in maintenance CapEx and the remainder going towards the land purchase and construction of new manufacturing facility in Thailand.

I would now like to turn to our guidance for the third quarter. We are encouraged by our increasing business momentum and expect this momentum to continue in the third quarter. We expect revenue to be between $240 million and $244 million, representing growth of between 27% and 29% from a year ago. Recall that there was no consignment revenue in the third quarter of fiscal 2015. We anticipate GAAP net income per share to be in the range of $0.47 to $0.49, and non-GAAP net income per share of $0.52 to $0.54, based on approximately 36.8 million fully diluted shares outstanding.

In summary, we are pleased with our performance in the second quarter and remain optimistic that our strategy will continue to drive profitable growth going forward.

Operator, we would now like to open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Troy Jensen from Piper.

Troy Jensen

Maybe a couple of questions from me. First of all, if you think about your March quarter guidance, can you give us any indications on what you think datacom and telco will be in that mix? Are you expecting both to grow roughly the same or one will be stronger than the other?

Toh-Seng Ng

So if you look at Q2 results, majority, we’re riding on the datacom and we are so happy that telecom finally come to the party. So that momentum will continue. And again, we will see growth in both sectors, obviously datacom is going to slow down a little bit, but we are very encouraged that telecom have a real good momentum right now. So I’ll say both sectors are growing with telecom probably growing a little bit faster than datacom now.

Troy Jensen

And TS just another one for you, what revenue level do you guys need now with the new cost structure to hit your 9% to 10% operating margin target?

Toh-Seng Ng

The 9% to 9.5% we previously guided mostly relate to the Fabrinet West operating expense. You can see now we are at 7.9% now. Again, if we talk about Fabrinet West, it will continue to ramp. Last quarter, we saw some very nice revenue uptick from Q1 and that revenue momentum will continue. So when you get up to the tens of millions we talk about in the past, I will be able to see 9% to 9.5%.

Troy Jensen

One last question from me and I’ll see the floor. Just to go over that capacity numbers that you quoted again, so if I understand it, 94% of the capacity is currently taken as you think about its footprint, but only about 75% of it is utilized?

Toh-Seng Ng

Yes, we see 90% to 92% is our space capacity. So remember, we assign space to each of our customer. Within the space, within the factory, customer [indiscernible] add more line, go on to another shift, okay. So the space is about 90% to 92%, but the equipment utilization today is only sitting at 75%. So that’s what we said in our prepared remarks.

Operator

Our next question comes from the line of Patrick Newton from Stifel Nicolaus.

Patrick Newton

I really want to dig in on the new product revenue, 25% of sales that’s really impressive. But if we back into new products versus existing products, it’s clear that that is what has been the driver of growth over the last several quarters and whereas legacy products is doing well but not near at the same level. So I guess the question is this, what kind of visibility do we have on the new product revenue? Should we continue to anticipate that as a percentage of revenue it should increase over the next few quarters or do we need to start seeing the kind of non-new product growth rates start to accelerate in order to keep up the cadence of growth that you’ve been exhibiting?

David Mitchell

We believe that the new products revenue will continue to grow in the company and grow as a percent of our revenue. And then the legacy products also are continuing to grow. So we are experiencing growth in the new products and growth in legacy products.

Patrick Newton

Tom, is that visibility measured in quarters or measured in years from a new product continuing to increase as a percent of your total revenue?

David Mitchell

It’s measured in quarters.

Toh-Seng Ng

Patrick, let me just add a little bit of color here. If you look at Q2, we did $60 million more than Q1. Q1 [indiscernible] right. So I would say roughly speaking, the $60 million is split between existing customers which we don’t call new business and the new business [comes straight half] right. Now, the new business is a function of new customer come to us and a lot depends on the rate of the ramp. Sometimes, some customer ramp faster than other, these are new customers. And obviously the existing customer continues writing on the metro upgrade, things like that. So it will be a mixture. In the future, the growth will come from both of those. Is that helpful?

Patrick Newton

That’s helpful. I guess, maybe, digging further into that comment, so on the existing customers and kind of trying to get them to the party, to this new product party, is there aggressive inflection that you see or any customer commentary to date that points this inflection should happen because I think there is a growing expectation among investors that we have some of the good demand dynamics across the 100-g telecom side in the metro and also 100-g on datacom. So any signs that’s starting to build into your customers’ forecast?

David Mitchell

I think the last time we talked, looking at our process, the NPI, or new product introduction, we track that on a weekly and quarterly basis and customer by customer to see what is in the pipeline, what was coming out of the pipeline and when we expect that to go into production. So we certainly have a comfortable feel for what new products are going to come on our lines.

Patrick Newton

And then just last one from me, you answered the prior question and said in the prepared remarks that you are very comfortable with your capacity to meet current demand. And I guess just given the solid guidance on top of the utilization data that you gave us, is there any type of revenue capability or revenue generating potential that you could allude to in this current footprint, just help us understand when capacity needs to roll on.

Toh-Seng Ng

Patrick, when you say current capacity, you’re talking about the first campus, the current campus. The current campus, we’ll continue to try to get more space and again we have more than a million square foot and obviously sometimes you can rearrange and get a little more manufacturing space. So that process continues. I will say until the new building come online, in the next two to three quarters, we can meet our guidance and our revenue projections.

David Mitchell

I fully support that.

Operator

And our next question comes from the line of Alex Henderson from Needham.

Alex Henderson

I just wanted to clarify was the capital expenditure number that you’re talking about calendar year 2016 or fiscal year 2016, the $16 million to $17 million number?

Toh-Seng Ng

$16 million to $17 million is the fiscal year.

Alex Henderson

Fiscal year. And so if were to look at calendar year because obviously we’re already through the half of the year, are you expecting it to accelerate in the back half or would it slow down in the back half as you’re getting near completion?

Toh-Seng Ng

Based on my wild guess, okay, FY17, I don’t think we’ll spend $17 million because a lot of big ticket items like land and the building is already spent in FY16. So unless something come out, we buy another land somewhere else, I don’t see we’re going to be more than $17 million.

Alex Henderson

And then the comment on Fabrinet West, I was a little surprised to hear that you had already pulled revenue in there. Clearly, a ramp in that business is an important variable to margins because you’re absorbing the cost. If I understand it, you guys are modeling that on a cost plus basis and the margin structure is quite different than the corporate average. Can you talk a little bit about that? And what do you think the timeline is for getting up to say $10 million type quarterly run rate on that? Can you do that over calendar 2016?

Toh-Seng Ng

Calendar 2016, remember we said this is more fiscal year 2017 event to get up to the $10 million some. So obviously we hope to end calendar 2016 with somewhere closer to the $10 million some. As of today, we have many customer in the pipeline. We started with two and then the following quarter we have like 10 and then now we’re engaging more than 20. Again, some of this customer may not pan out now, okay, the pan out lot depend on how fast they can ramp. So I will say that $10 million we alluded to in the past is still on track, but exactly which quarter is hard for us to say.

Alex Henderson

Is it right that we should we thinking about this as 20% kind of gross margin business on a cost plus basis as opposed to your traditional model?

Toh-Seng Ng

Alex, I think your question is really with the industry. Most of our competitors in the Santa Clara area, I was told that their margin is around that. I could be wrong, but most of the information I got is they are closer to that. So you’re right.

Alex Henderson

So it’s likely that that’s kind of the model you’re targeting here then?

Toh-Seng Ng

Yes, that’s correct, Alex.

Alex Henderson

In terms of new customers, you gave a new customer metric for the trailing quarter. As you look forward into the March quarter, it sounds like you probably got a couple of additional new customers kicking in there as well. Is that new customer percentage likely to continue to increase as a percent in the upcoming quarter?

Toh-Seng Ng

Alex, we normally file for a few new customers every quarter. Some of these are very small, some are big. Again, as I said earlier, some may not pan out or maybe take long time to ramp to meaningful revenue. So again, as a sheer numbers of customer we sign doesn’t mean in five quarters time or two quarters time, you’re going to see big revenue. A lot depend on the program we’re working with them and also the market condition.

Operator

Our next question comes from the line of Dave King from B. Riley & Company.

David King

First question is any changes to your top customers’ percentages of sales?

Toh-Seng Ng

Top customer or 10% customer?

David King

10% customers, any changes to those numbers?

Toh-Seng Ng

So as I say, we have one more quarter before we hit year-end. We only do that at year-end and 10-K filing. So at this moment, it’s hard to say because the year is not over yet, Dave.

David King

I know you sell through your optical component customers, but do they tell you where the demand is, the end demand is coming from whether it’s China or North America? Any color on that?

Toh-Seng Ng

No. They ship to the end customer some of them will tell us [indiscernible]. We mentioned that in the last couple of quarters already in a call here.

David King

And then some of your top customers have said that they’re struggling with their own capacity situation they are maybe on allocation. Any of that impacted your business, any estimates on how much revenue was left on the table last quarter, fiscal second quarter, if any?

David Mitchell

I think across the board we didn’t leave any revenue on the table. We really have the capacity and we have the equipment to support the orders that we have.

David King

Any particular products that really stood out last quarter and then expected to be better than the industry average this quarter as well?

David Mitchell

I don’t think we mention that way, Dave. Again, maybe [my customer] maybe able to tell, right. But in general, this metro upgrade, we see a lot of activity in the 100-gig transceiver or modulator. We talked about that. And also in [indiscernible] that’s what I can tell you.

David King

And then maybe we can just talk about silicon photonics, that has become certainly a meaningful component, can you disclose the percentage of revenue and can you talk about some of the new customers expected to ramp this year, this calendar year?

David Mitchell

I don’t think I can get into the customer, because my customer may not want us to mention their name here. But I can tell you that the proportions of the opscon revenue for 100-gig has been increasing. And I think I believe I said we’re north of 10% of our opscon revenue come from silicon photonics.

David King

And lastly just wanted to ask about the non-optical business, can you just talk about the commercial laser business because it sounds like some of your customers are reporting that because of the macro headwind they’re seeing some choppiness, how is the commercial laser business for you guys? And can you just lastly talk about what to expect in the auto sensor, I guess that was really the main catalyst for that segment?

David Mitchell

On the non-opcon side, we see steady. We did not see the kind of wave we saw in the datacom or telecom, okay. They’re pretty steady and we continue to grind along. Obviously, the growth rate is lower than telecom and datacom. Laser, as you probably know, I think most of our customers are pretty flat on the laser side. Now, we had good growth on the sensor side last quarter, but again those are consumer electronics and they might just disappear, so we don’t know, we go by quarter by quarter, unlike most of the telecom product we can plan a little bit longer. So consumer electronics is subject to fluctuations from quarter to quarter.

Operator

And our next question comes from the line of Tim Savageaux from Northland.

Tim Savageaux

I thought you were on your way there to telling us 100-gig as a percent of overall revenue; you’ve given us a couple of different indications here. I believe last quarter that it was greater than 10-gig and 40-gig combined. This quarter, indication of tripling year-over-year. I wonder if we might be able to get any additional color on that. I assume it’s more than half of your optical com revenue or maybe any indications on how 100-gig was growing on a sequential basis? And I have a follow-up there.

David Mitchell

So internally we mention 100-gig as a percentage of opscom’s revenue [indiscernible] the speed of the transceiver. In the past, we said 100-gig, we ship more 100-gig than 10-gig and 40-gig combined, okay. As a percent of opscom, we are approaching maybe half of it, but not quite half yet, okay. So obviously we continue to see growth, alright. Obviously as a percent of transceiver and transmitter and modulator where you can measure by the speed and obviously 100-gig is more than half right now. Is that helpful?

Tim Savageaux

Very helpful, thank you. And just to follow-up on the rodem comment, I think last quarter you’ve indicated that you were beginning to see some indications of strength. It sound like it was more of an order or a forecast type of activity. I wondered – I’m guessing here that may have translated into more tangible revenue this quarter, but if you can update your previous comments on rodems and maybe indicate whether you have seen that transition into more steady revenue flow versus early indications of strength?

David Mitchell

I think consistent with most of the analyst report talking about metro upgrade, we see very strong rodem shipment. Obviously, some of the order definitely spill over to next quarter, that’s why our guidance is up on this quarter. So yes, the only thing I can tell you is that if you were to ask my customer more about the rodem story, but we’re a content manufacturer, I see a lot of activity there.

Operator

And our next question is a follow-up from the line of Alex Henderson of Needham & Company.

Alex Henderson

I just wanted to see, is Hong there?

David Mitchell

No, he is not here.

Alex Henderson

I was going to say congratulations to him for joining the company, hadn’t talked to him in a while.

David Mitchell

We’re very pleased about it ourselves.

Operator

Thank you. That concludes our question-and-answer session for today. I would like to hand the conference to Tom Mitchell for any closing comments.

David Mitchell

I just want to thank you guys for your continued support and we will talk to you again next quarter.

Operator

Thank you. Ladies and gentlemen, thank you for participation in today’s conference. This does conclude the program and you may now disconnect. Everyone, have a good day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!