Garo Toomajanian - IR Tom Mitchell - CEO & Chairman TS Ng - CFO.

Patrick Newton - Stifel Troy Jensen - Piper Alex Henderson - Needham Paul Coster - JPMorgan Tim Savageaux - Northland Capital Dave Kang - B. Riley.

Good day, ladies and gentlemen, and welcome to the Fabrinet's Fourth Quarter and 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 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. You may proceed..

Thank you, Nicole, and good afternoon everyone. Thank you for joining us on today's conference call to discuss Fabrinet's financial and operating results for the fourth quarter and fiscal year 2016 which ended June 24, 2016.

With me on the call today are Tom Mitchell, Chief Executive Officer and Chairman of the Board of Directors of Fabrinet; and TS Ng, Fabrinet's 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, including 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 reflects our opinions only as of the date of this presentation and we undertake no obligation to revise them in light of new information or future events, except as required by law.

For a description of the Risk Factors that may affect our results, please refer to our recent SEC filings in particular, the section captioned Risk Factors in our Form 10-Q filed on May 3, 2016. We will begin the call with remarks from 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?.

Thank you, Garo, and good afternoon everyone. Our performance in the fourth quarter after a year of strong growth for Fabrinet, fourth quarter revenue again exceeded our expectations largely due to greater than expected demand from new customer programs. The positive trends in the industry gained momentum in the fourth quarter.

We saw increasing revenue from nearly every customer with a substantial part of our growth coming from our Silicon photonics program; we are clearly benefiting from prior investments in advanced packaging. We believe we are in a growth cycle for the optical market and we expect these positive trends to continue to drive our growth in fiscal 2017.

We are pleased with the construction progress of our first building at our second campus in Thailand which we expect to be completed next month. This gives us confidence that we will be able to continue meeting the increased demand for the industry. Now I'll turn the call over to TS for details on the quarter and full year..

Thank you, 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 revenue in the fourth quarter was $276.4 million, an increase of nearly 34% from a year's ago and above the high-end of our guidance range.

Excluding $4.6 million in consignment revenue in fourth quarter of fiscal year 2015, revenue grew 37%. Non-GAAP earnings were $0.60 per share within our guidance range and were negatively impacted by foreign exchange headwinds which reduced EPS by approximately $0.04.

Our strong performance this quarter was primarily driven by positive trends in optical communications and strong demand for both telecom and datacom components and modules. Revenue from new business or programs that we started manufacturing in the past two years represented 27% of total revenue in Q4 and continued sequential gains.

Optical communication represented 77% of our total revenue during the fourth quarter consistent with the third quarter. Optical revenue increased 44% from years ago to $212 million, while non-optical revenue increased almost 10% to $64.4 million.

Within optical, the revenue split was 58% from telecom applications and 42% from datacom applications for the fourth quarter, as year-over-year telecom growth reached 36% in Q4. At the same time, datacom momentum continues to be very strong with datacom revenue increasing 56% from Q4 of fiscal year 2015.

Growth in our optical communications business continues to be driven by 100-gig solution and other advanced components and modules, including QSFP28 transceiver and silicon photonic modules. In Q4, 53% of optical revenue and 76% of transceiver revenue was for 100-gig modules and components.

Another significant contribution to our growth has been silicon photonics. Revenue for silicon photonic assemblies more than doubled from years ago and represented 19% of total revenue in the quarter. Turning to our non-optical communications business.

At $64.4 million, revenue from lasers, sensors, and other markets represented 23% of total revenue during the fourth quarter consistent with third quarter. We saw year-over-year growth in each of the lasers, automotive and other revenue categories.

Laser, which make up 50% of non-optical revenue, grew 18% from years ago reaching double-digit for the first time in a year. Non-automotive sensor revenue was stable at 7% of non-optical revenues and automotive revenue make up 43% of non-optical revenue and increased 4% from years ago.

Our new product facilities Fabrinet West continues to see growing demand with revenue in fourth quarter that is quickly approaching our targets of approximately $10 million in the December quarter, we remain confident in reaching this milestone.

During the fourth quarter, we order and began to install a third manufacturing line which will be ready to go into production next month. We are making excellent progress with first building at our new campus in Chonburi Province in Thailand, the roof is already up as we remain on track to complete the building by the end of September.

As Tom mentioned, we continue to expect first customer shipment in fiscal year 2017 and rent after that. In the meantime, in order to meet the growing demand for space especially from existing customers, we have been successful in converting non-manufacturing space in Thailand within our existing facility at Pinehurst into new manufacturing space.

As such, while we are at about 95% capacity from a space perspective, we are comfortable that we can convert additional non-manufacturing space to manufacturing space necessary until our new building in Chonburi campus is ready for occupancy. This is especially important for customers who wish to keep their operations consolidated at one site.

From an increment perspective, our utilizations remain lower at about 80%. Now turning to the details of our P&L, a reconciliation on GAAP to non-GAAP measures is included in our press release.

Non-GAAP gross margin in the fourth quarter was 12.7%, an increase of 50 basis points from a years ago and up 10 basis points from last quarter, primarily due to our strong revenue performance and volume leverage on fixed overhead.

Please note that non-GAAP gross margin excludes the impact of approximately $1 million in costs resulting from a non-recurring warranty charge or approximately 35 basis points of non-GAAP gross margins. The warranty charge relates to shipments from over two years ago for a program that has since ended.

Our relations with the customer remain healthy and we continue to do significant business with them. For the first quarter, we expect non-GAAP gross margin to decrease slightly from Q4, primarily due to the impact of annual merit increments as well as by the effect of non-linear revenue during our 14-week quarter.

Non-GAAP operating income in the fourth quarter was $25.1 million, and operating margins of 9.1%. Non-GAAP operating income exclude share-based compensation expenses of $2.1 million and a $1 million warranty claim expense that I mentioned.

Non-GAAP operating margin improved 180 basis point from years ago primarily due to higher gross margin and leverage to operating expenses with growing revenue. Both the fourth quarter of fiscal 2015 and 2016 include start-up costs associated with our Fabrinet West facility in Santa Clara, California.

Non-GAAP net income for the quarter included the impact of $1.3 million realized foreign exchange loss due to the strengthening of Thai baht towards the end of the quarter. Approximately $1.7 million of the remaining unrealized loss will be reversed as contracted baht is delivered.

Taxes in the quarter were a net expense of $1.8 million and our normalized effective tax rate was 7.6%, which was above our expected range of 6% to 7%. Due to the strengthening of U.S. dollar against renminbi, our subsidiary in China booked an additional tax to cover tax liability on unrealized exchange gain on U.S. dollar denominated deposits.

For our fiscal year 2016, our normalized effective tax rate was 6.7% and was within our expected range of 6% to 7%. We continue to anticipate that our effective tax rate will remain in the 6% to 7% range for the first quarter of fiscal year 2017.

Non-GAAP net income was $22.4 million in the fourth quarter or $0.60 per diluted share compared to $14.5 million or $0.40 per diluted share in Q4 of fiscal 2015.

As I mentioned earlier, foreign currency fluctuation reduced non-GAAP EPS by $0.04, including the $0.01 impact of additional tax on unrealized foreign exchange gains at our Chinese subsidiary.

On a GAAP basis, which includes share-based compensation expenses and amortizations of debt issuing costs, net income for the fourth quarter was $19.7 million or $0.53 per diluted share compared to $13 million or $0.36 per diluted share in the fourth quarter of fiscal year 2015. Looking at our performance on a full year basis.

We generated revenues of $976.7 million for all of FY 2016, up 26% from fiscal year 2015. Excluding $16.3 million in consignment revenue booked in FY 2015, revenue grew 29% in fiscal year 2016.

Optical revenue increased 32% from a years ago to $727.5 million or 74% of total revenue, while non-optical revenue increased 12% to $249.3 million or 26% of total. Within optical, the revenue split was 56% from telecom applications and 44% from datacom applications.

Non-GAAP gross margin for the year was 12.5% and non-GAAP operating margin was 8.4%, both of which expanded from fiscal year 2015, primarily due to leverage of fixed overhead as revenue grew.

Non-GAAP net income for the year increased by 38% to $77.7 million or $2.11 per diluted share, even with the full years of ramp-up costs associated with Fabrinet West. Moving on to the balance sheet and cash flow statement. We ended the quarter with a cash and investment balance of approximately $284.5 million.

This represents an increase of nearly $12 million from the end of the third quarter, primarily due to positive operating cash flow and increased drawing from bank's loan, in anticipations of paying construction liability due in first quarter one. CapEx was $7.1 million in the fourth quarter and $40.4 million for the full year.

For fiscal year 2017, we expect CapEx to be in the range of $60 million to $70 million with approximately $30 million to $35 million of that in maintenance CapEx and the remainder going towards constructions of our manufacturing facility in Chonburi, Thailand. I would now like to discuss guidance for the first quarter.

We expect the strong business momentum we generated in the fourth quarter to continue into the first quarter. We expect revenue in the first quarter to be between $306 million and $310 million, representing growth of 41% to 43% from a years ago. This strong growth includes the impacts of an additional week of business in the first quarter.

If quarter one was a normal 13-week quarter, we believe our guidance will be reduced by approximately $22 million. Our mid-points are approximately $286 million representing more typical sequential growth.

We anticipate non-GAAP net income per share in the first quarter to be in the range of $0.70 to $0.72, and GAAP net income per share of $0.63 to $0.65, based on approximately 837.6 million fully diluted shares outstanding.

In summary, we delivered a strong performance in the fourth quarter, capping a strong fiscal year performance and are anticipating continued momentum in the first quarters of fiscal year 2017.

We are benefiting from robust industry trends as well as some investment we are making the business that are enabling us to attract additional program from both new and existing customers. With new facility coming on about two quarters from now, we are optimistic that we can continue to meet our growing demand into 2017 and beyond.

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

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

Yes, good afternoon Tom and TS.

I guess first as a clarification, I'm sorry if I missed this, but you mentioned the new Thai facility will be configured next month, but what month should we expect for shipment?.

Patrick, this is TS. Yes, previously we said we'll complete by September, which is on schedule. And then we said that December is a quarter where we configurate the equipment and the first shipment will be some time in the March quarter..

Okay.

And any guidance on towards the front-end of the quarter or the backend, especially just given the capacity constraints that seem to be coming up?.

Not at this moment. We're still trying to actually range internally. It looks like printed circuit board will be the first product we will ship from there..

Okay, great. And then you did talk about having enough capacity with very strong demand environment, especially given that you're transferring some non-manufacturing square footage to manufacturing square footage.

Can you remind us the level of revenue the current footprint can handle?.

Okay. So currently, in a current campus, we call Pinehurst campus; we have approximately 1 million square foot of which you can assume that may be half is for manufacturing. The other half are warehouse, support, labs, and so on. So with the footprint, currently we're doing about 1.1 million, also 1.2 million.

If you look at 300 million run rate multiplied four is about 1.2 million. And we are essentially at capacity right now, 95% capacity. The rest or the 5% space are pretty much earmarked for the existing customer. So it's just to get 1.2 million to 1.1 million is the current capacity we have in the current campus..

Okay. That's helpful. And then I guess shifting to the NPI facility, you talked about being on track to achieve that $10 million quarterly run rate in the December quarter.

Can you help us think about how we should think about the ramp beyond the December quarter that's kind of stepping up as we've seen? Or at some point, should we see kind of a step function upward?.

A lot depend on the customer. Previously, we mentioned that we engage more than 20 customer -- potential customer. And a lot depend on how fast we can qualify their product and ramp to the mass production level. Again, so at this moment, we only guide up to December quarter, we'll get up to $10 million level..

Okay.

And then just last one, just given the unique circumstances associated with this NPI facility, TS, can you may be walk us through how much of the current OpEx of $2.1 million in most recent quarters associated with the MPI facility? And kind of how that should trail through the P&L or I guess, move up into the COGS line over the next couple of quarters?.

Okay. So about one or two quarters ago, or maybe even three quarters ago, I essentially say we have $2.5 million operating expense or start-up cost buried in the operating expense. Again, I say of the $2.5 million, $0.5 million legitimate belongs to below the lines because these are sales and marketing and some of the SG&A.

So I was expecting that the $2 million, if I can hit my breakeven, the $2 million should go up there, go to cost of goods sold. And we are marching towards that goal at the December quarter; we're going to hit $10 million, plus or minus $1 million. Hopefully, that a majority of the $2 million can be recuperated into the cost of goods sold..

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

Thank you, Patrick..

Thank you. Our next question comes from the line of Troy Jensen of Piper. Your line is now open..

Hey congratulations on a great quarter and great year gentlemen..

Thank you..

Thanks, Troy..

Hey, so guys, I guess I'd be curious to know what percentage of the new capacity you're adding here is already claimed by customers..

Tom, you want to answer that?.

Well the new capacity -- the new capacity is today not claimed and is being taken from non-production areas such as warehousing and we have a lot of that in our facility. And we're converting warehousing to not sure [indiscernible] about warehousing..

Hey Tom this is choppy that I guess the new building that you're adding, if that turns on, how much -- what percentage of that square footage is already accounted for?.

About 10%..

Only 10%? Okay.

And then for TS, when this new facility does light up, do you expect to have any type of a gross margin in downtick just because you're not that kind of full capacity?.

Yes. Good question. When accounting principles say when a building is ready for use, yes, they start depreciation, doesn't matter whether you use it or not. Okay. So if it's ready for use, which is like may be December quarter, I have to start depreciation.

And the depreciation plus a minimum utility to keep the place open, is our fixed cost, I previously estimated about 15 to 20 basis points dilution to the gross margin..

Okay. Perfect..

So it's not a big number. It's a 15 to 20 basis points. And as we provision product, we will hopefully, we will have a positive gross margin to cover all the costs, both fixed and variable..

Yes understood and then last question for you, TS. Given the 10-K here, I was just wondering if you could tell us who your 10% customers were for the year.

And how big they were?.

Okay. So the 10-K going out next few days, as you probably know, in our -- we have one 10% customer, which is Momentum, we've been having them for the last couple of years. 20% of our revenue came from Momentum; it's more than 10% customer. And that's the only one. We have other customer using multiple contract manufacturer.

Our contracture obligation and accounts receivable risk is with the contract manufacturer, not with the customer itself. So we cannot report that as the 10% customer..

Okay, understood. Good luck next fiscal year..

Yes..

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

Thanks. I was wondering if you could just give us that silicon photonics number that you gave, again. I didn't quite understand or hear correctly what you said..

Yes, its 19, that sounds like 90, I wish its 90, but it isn't. 19% of our revenue came from silicon photonics, about $52 million for the quarter..

And how many customers does that represent?.

We don't disclose that. A few of them, as you probably can guess..

It's a handful, right? I mean, we're talking about five or so customers plus?.

Yes. It's not like a few hundred, so it's handful, correct. Yes..

And can you split the datacom or the transceiver business between 100-gig and 10-gig, 40-gig, what was the rate of growth in 100-gig? And what was the decline or growth in 10-gig, 40-gig?.

Okay. So if you just look at transceiver and modulator, okay, the one you can measure by speed, we say three quarters of our transceiver shipment is all in 100-gig right now, in fact more than three quarters in 100-gig, the rest are 10-gig and 40-gig combined..

Right. But I didn't ask what the percentage was; I asked what the percentage change in the business was. I got the percentage on the prior dialogue.

But what was the change in it?.

Okay. I can tell you that 100-gig sequentially increased by 23%..

23% Q-to-Q? And I guess, it's triple digits year-over-year, yes?.

Yes. In fact, the 100-gig we shipped in quarter four is slightly above the same as the whole year, last fiscal year 2015..

Right.

And the data at 10-gig, 40-gig?.

I don't think breakdown that one. But the change --.

Do you know the rate of change?.

For the real change, I think 10-gig, flat or up a little bit. 40-gig was down.

So is that helpful?.

40-gig down, yes, that is helpful. Thank you very much. Going back to the comments about the 10 to 20 basis point hit when the facility comes on. So I assume that's in the December quarter that that kicks in, and as soon as you start ramping that 10 percentage points of committed volume, I would think that that would rebound.

Would you expect to be able to get back to the current margins within three or four quarters?.

Hard to say. Depending on how fast we ran, it's a 300,000 square foot, no, 500,000 square foot manufacturing building. Manufacturing is about 276,000 square foot, so it's a huge area. Typically takes about three years to fill up the whole factory. So a lot depend on how fast we can rent a new customer or existing customer in the campus..

So how much of the capacity needs to be utilized to get to utilization rate back to a point where we can get back to the margins we're currently demonstrating? And did Fabrinet West also help that?.

Yes, absolutely, absolutely. Another function and how fast Fabrinet West we can rent them to get positive gross margin. So Alex, if you look at the Chonburi, it's not -- I mean, I say 15 to 20 basis points is not, is a full point. I mean, so if Fabrinet West is successful, I believe that we can cover that that quickly..

Okay, I see. I'll cede the floor, thank you..

Thank you, Alex..

Thank you. Our next question comes from the line of Paul Coster of JPMorgan. Your line is now open..

Yes thanks very much for taking the question. Well, first off, the silicon photonics business. Obviously, it's being very well. You referenced, Tom, the apparent investments you've made.

What are they? And how exactly is this benefiting your customers? Do you have something proprietary that you're bringing to the table with respect to the solutions?.

Well, we're a manufacturer and about seven years ago, we put a substantial investment into advanced packaging. And that's certainly paid off for us absolutely as silicon photonics has begun to be realized in the industry.

And I think that we continue to put investments to the silicon phonics -- sorry, silicon photonics, but we have great belief that a big part of our industry will be moving further into silicon photonics as we go forward..

Okay. Fabrinet West, you said you got 20 customers engaged. So it must give you some clue as to where the industry is heading.

What is the sort of basic component of Fabrinet West? Is it communications side of your business or is it laser and other? And is this obstacle, is it pointing it towards 400G?.

Today it is primarily datacom, telecom and media as a matter of fact. Media is becoming a very important part of that company, the NPI Company..

Okay.

Are we seeing 400G yet amongst any of your customers?.

Very few. Only in the beta stage..

Okay. All right, thanks. Finally, on auto. Obviously, there's a lot of happening in the auto industry at the moment, you mentioned it's growing but obviously less though than other areas.

Do you have any sense as to whether auto is gathering momentum?.

In our case, it is gathering momentum. It's been growing at about 9% a year. And we told, we focus a lot on LED applications for headlights and taillights and have been quite significant in supplying those engines to supply that headlights and taillights..

Okay. Thank you very much..

Thank you. Our next question comes from the line of Tim Savageaux of Northland Capital. Your line is now open..

Hi good afternoon and congratulations on another nice quarter. I wanted to ask a quick question. And that is, I haven't heard you comment much on your ROTEM business in terms of a source of strength, and yet you obviously saw continue to see very strong growth on the telecom side.

Should we consider that may be you've taken a pause here this quarter, seeing stronger growth on the transceiver front drive, I'm wondering if you have any comments there?.

Tim this is TS. I think you probably heard a lot about ROTEM from one of our customers in the earnings call. And again, we do most of the ROTEM for them. They're basically two big player out there. The other customer, we don't really do the ROTEM, we just do the printed circuit board.

So I mean whatever the story you heard from ROTEM will count because we are the largest CM for them. So it applies to us.

Does that make sense?.

It certainly does. And another kind of more broad based question. You mentioned only one 10% customer for the year, but it sounds like if you aggregate a few CMs, there might be others.

But in general, and also relative to Tom's comments about almost every customer being up in the quarter or I don't know if you could say the same about the outlook, but obviously, there's been some volatility among at least one of your major customers.

I'm wondering if you could describe sort of the puts and takes among your kind of top customer group and how you were able to kind of may be execute through some volatility if indeed you saw any..

So as a CM, normally we don't go into customer territory. We don't -- I mean, we let a customer speak for their own story. But what I can tell you here, Tim, is that we have our top 10 customer account for about 80% of revenue. So if you look at the customer concentration has been mitigated pretty much.

I don't have one or two customer account for, in the past, more than half of my revenue. So the top 10 account for 80% and they are all growing very nicely. So between 5% to 10% customer, I have couple of them, they are all ramping..

Okay. And one final question and a brief one. On the silicon photonics, you did specify 19. I'm thinking that that is relative to 15% last quarter. I don't know if you've just been giving a range recently of 15% perhaps if you can comment on that.

Is that should we think that coincidently with the ramp in new programs as well? I imagine those two are related..

Yes. Obviously, silicon photonic customer is a big part of the new business, right? So we say 19% of our silicon photonics revenue, revenue come from silicon photonics. Now we have 27 new business. So some of them are not silicon photonic, some of them are mostly coherent optic and so we call that as a new business.

So 27% of new business of which 19% of our revenue came from silicon photonic. And at silicon photonic, years ago, it's about 8%, so we more than doubled the percentage of the revenue. The new business years ago, it's about 15%. We are almost doubled the new business year-on-year basis.

Is that helpful?.

Yes, very much. Thank you. I will pass it on..

Thank you, Tim..

Thank you. And our next question comes from the line of Dave Kang of B. Riley. Your line is now open..

Thank you, good afternoon.

So you had one 10% customer for the year but what about during fiscal fourth quarter? Were there multiple 10% customers?.

Based on the same rule, no. It's only one because when we look at AR rates, account receivable rate, because that's where the contracture obligation is. And the way that the product view by any customer, we don't count that, we count based on the contractual rate, so there's only one in Q4..

Got it.

And then regarding some of your customers talking about supply constraints, were you impacted by that supplier constraint issues during the quarter? Any kind of bottleneck?.

Obviously, we also depend on other suppliers to supply the raw material. We cannot make up something from nothing. We need total rosa [ph] to make into the finished goods. So as you see, the same story apply to my customer, apply to us too.

We depend on a couple of critical suppliers to give us raw materials and they don't deliver or they cannot deliver then obviously impact our revenue too. And a lot of these suppliers are appointed by my customers too. It's not 100% appointed by us..

Got it. And then I think you told me, in the past, your model is sort of like company within a company.

So if one of your major customers is having some issues, can you just walkover, I mean walk through the process, how that the production line just may be shifted to somebody else?.

Tom, I don't think we can do that.

Tom, do you want to add some color on that?.

Yes for the most part, that wouldn't really happen, each customer in its own integrated factory. And basically, it's his scale to take care of the requirements that they have for that quarter. And basically that scale stays the same..

So if, let's say customer exits, having some difficulties with their demand, then that production line basically becomes underutilized?.

It could be -- it wouldn't become underutilized but we would reduce the amount of manpower that was put into that shift. And may be and redeploy it into other non-competing areas..

Right. That's what I was after. All right. Thank you..

Thank you. I'm showing no further questions at this time. I'd like to hand the call back over to Mr. Tom Mitchell for any closing remarks..

Well, I want to thank the investors for a great quarter. And you can see that in front of us, we have the facilities and we have the backlog and we have the industry that will really support our aspirations for fiscal year 2017. Thank you..

Ladies and gentlemen, thank you for participating in today's conference. That does conclude today's program. You may all disconnect. Have a great day, everyone..