Garo Toomajanian - Investor Relations David Mitchell - Founder and Executive Chairman Seamus Grady - Chief Executive Officer Toh-Seng Ng - Executive Vice President and Chief Financial Officer.

Patrick Newton - Stifel Troy Jensen - Piper Jaffray.

Good day, ladies and gentlemen. Welcome to Fabrinet’s Financial Results Conference Call for the Second Quarter of Fiscal Year 2018. 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..

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 2018 which ended December 29, 2017.

With me on the call today are Tom Mitchell, Founder and Executive Chairman; Seamus Grady, Chief Executive Officer 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 and investor presentation, which includes a 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 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 07, 2017. We will begin the call with remarks from Tom, Seamus, and TS followed by time for questions.

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

Tom?.

Thank you, Garo, and good afternoon, everyone. I am pleased with our second quarter results and believe our new programs and diversification will continue to contribute to the success in the future. I’d like now to turn the call over to Seamus for his remarks. .

Thank you, Tom, and good afternoon everyone. I’ve spent my first four months at Fabrinet meeting with customers and employees, and I am even more enthusiastic about the quality of our business and the strength of our customer relationships than when I spoke with you a few months ago.

Our experience and reputation as a technology-driven manufacturer positions us uniquely in the marketplace. Since our founding, we have had a strong presence in optical communications, and I am looking forward to the continued expansion of our business in this dynamic market.

At the same time, I believe we can increasingly leverage our expertise in precision manufacturing and advanced packaging to other markets that are adjacent to the optical communications market.

We already have a strong presence in the industrial laser, automotive, and sensor markets, and we remain committed to our longer-term target revenue mix of 50% of our business coming from optical communications and 50% from other markets, namely industrial, automotive, and medical.

While we continue to make steady progress with organic growth, we also believe that M&A may be an effective way to accelerate this mix shift.

To be clear, however, the process of identifying and evaluating possible business combinations could be lengthy as we look for candidates that have the right balance of new market opportunities, reliable business trends, competitive margins, and strong reputations.

We believe that this more diverse revenue mix will drive more balanced revenue and profitability growth over the longer-term. Looking at our fiscal second quarter in more detail, we are pleased to report revenue up $337 million and non-GAAP EPS of $0.72 per diluted share, both of which were above the high-end of our guidance ranges.

This performance reflects the combination of continued weakness in the optical communications markets, growth in our non-communications business, and a meaningful contribution from new business.

In fact, this new business represented 35% of our overall revenue in the second quarter and at $119 million was consistent with our first quarter performance.

While we don’t break out financials by facility, we continue to see Fabrinet West and Fabrinet UK contributing to our overall growth, at the same time, while still relatively small, we are excited by the ramping production at our new campus in Chonburi.

Looking ahead to the third quarter, while we expect our revenue to decline on a sequential basis, we expect the full impact of cost saving measures taken in Q2 and further efficiencies to produce non-GAAP EPS, which is roughly flat sequentially, despite an anticipated decrease in revenue.

In summary, I am pleased that we exceeded our revenue and profitability expectations for the second quarter, more importantly, I believe that Fabrinet remains uniquely positioned to generate profitable growth over the long term as we leverage our manufacturing expertise, both within the optical communications markets and in other markets where our know how can drive a compelling value proposition for our customers.

Now let me turn the call over to TS to discuss the details of our second quarter performance and our outlook.

TS?.

Thank you, Seamus. I will provide you with more details on our performance by end-market and our financial results in Q2 of fiscal year 2018 and our guidance for Q3. Total revenue in the quarter was $337.1 million, a decrease of 4% from a year ago, but above our guidance range.

Non-GAAP net income was $0.72 per share, compared with $0.91 per share in the same quarter a year ago. In the second quarter, we experienced a $1.3 million or $0.04 per share foreign exchange headwind, compared to $1.9 million or $0.05 tailwind in the quarter a year ago.

Despite this foreign exchange headwind, non-GAAP net income per share still exceeded the upper-end of our guidance range. As Seamus mentioned, non-optical communications revenue continued to grow, but did not quite offset decline in optical communications revenue.

Optical communications represented 72% of total revenue compared to 77% in the first quarter and non-optical increased to 28% of total revenue. Within optical, telecom was again 60% while Datacom was 40%.

Reflecting the overall decline in optical revenue, 100 Gig solutions were $133 million, compared to $157 million in the first quarter, while 400 Gig solutions was roughly flat at $16 million.

Revenue from QSFP28 transceivers was $42 million, compared with $48 million in the first quarter, as the numbers of customers continues to transition to low-cost CWDM4 variant. Silicon photonic revenue was $74 million, down slightly from $77 million in Q1. Turning to our non-optical communication performance.

We have a strong overall performance as anticipated with record revenues of $95.2 million. Revenue from industry laser was a record $43 million, up 15% from Q1 and 20% from a year ago. Automotive revenue was also a quarterly record at nearly $26 million, increased 20% from Q1 and 18% from a year ago.

Sensors revenue was stable at approximately $4 million. Other revenue was $23 million, up 20% from Q1, and 44% from a year ago with contribution from Fabrinet West and Fabrinet UK. New business is an important contributor to our overall revenue.

In Q2, new business revenue was $119 million, consistent with the first quarter and represented 35% of total revenue. Now, turning to the details of our P&L, a reconciliation on GAAP to non-GAAP measures is included in our earnings press release and investor presentation, which you can find on our website.

Non-GAAP gross margin in the second quarter was 11.6%, slightly lower than at Q1 and below our target range of 12% to 12.5%, primarily due to the decrease in revenue as well as the continued strengthening of the Thai baht from the first quarter.

We continue to expect cost-cutting measures taken earlier in the quarter and improved efficiencies to drive improved gross margin in the second half of the year.

Non-GAAP operating income in the second quarter was $30 million and operating margin was 8.9%, flat from Q1, due primarily to tight controls of non-GAAP operating expenses including savings on the reduction in workforce that we made earlier in the quarter.

Taxes in the quarter were a net expense of $1.6 million and our normalized effective tax rate was 6.3%, consistent with Q1, and in line with our expected range of 6% to 7%. We continue to anticipate an effective tax rate of 6% to 7% for fiscal year 2018.

Non-GAAP net income was $27.3 million in the second quarter or $0.72 per diluted share, compared to $0.75 in Q1 and $0.91 a year ago.

On a GAAP basis, which includes share-based compensation expenses, costs related to the reduction in force we announced last quarter, amortization of debt issuing cost, and cost related to the completion of our CEO search, net income for the second quarter was $19.3 million or $0.51 per diluted share, compared to $25.3 million or $0.55 per diluted share in the second quarter of fiscal year 2017.

As I mentioned earlier, we experienced a $1.3 million or $0.04 per share negative impact from a stronger Thai baht on our GAAP and non-GAAP bottom-line result for the second quarter. Moving on to the balance sheet and cash flow statement, at the end of the second quarter, cash and investments were $287.7 million.

This represents an increase of' approximately $21 million from the end of the first quarter, primarily from the operating cash flows of $40.2 million, offset by CapEx of $10.2 million, and share repurchases of $10 million. We expect CapEx in FY 2018 all of which is maintenance CapEx to be approximately $35 million.

During the second quarter, we were active in our share repurchase program and bought back approximately 315,000 shares at an average price of $31.36 per share. Our Board of Directors has doubled the size of our share repurchase program from $30 million to $60 million.

As a result, $50 million now remains in our authorization and we expect to remain active in the buyback in the third quarter. I would now like to discuss guidance for the third quarter. We expect revenue to decline in Q3.

From a profitability perspective, we expect to see more meaningful benefits from the cost reduction me made earlier in a year and other efficiency combined to produce non-GAAP EPS that’s roughly flat sequentially despite an expected dip in revenue.

Therefore, for the third quarter of fiscal 2018, we expect revenue of between $316 million and $324 million. We anticipate non-GAAP net income per share in the third quarter to be in the range of $0.70 to $0.73, and GAAP net income per share of $0.50 to $0.53 based on approximately $37.9 million fully diluted share outstanding.

In summary, we expect the full impact of cost saving measures to offset some of the top-line impact, highlighting the flexibility of our operating model. Importantly, we continue to be well-positioned to benefit from improved market trend and increase diversification as we look ahead. Operator, we would now like to open the call for questions. .

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

Yes, good afternoon, Seamus, Tom, and TS. Thank you for taking my questions.

I guess, jumping right in on the guidance, TS, you talked about cost-cutting initiatives, but I am curious if you have any directional guidance you can provide us on the gross margin, whether it’s going to be up, down, or flat and then as we look at your various segments sequentially, specifically focusing on optical, is there an area whether telecom or Datacom that sequentially should have a larger sequential down tick?.

Hey, Patrick, this is TS. So, if you look at the implied EPS, $0.70 to $0.73 it goes backwards. I think we project a slight improvement in the gross margin despite the lower revenue and again a lot of this has come from the cost savings from the reduction in force we took in November.

Now in terms of mix, we foresee most of the downturn from the optical communication area, and for the non-communication side of the equation, we believe it will be flat or slightly, sequentially slightly lower.

Is that helpful?.

That’s very helpful. And I guess, if we focus on the laser, sensors, and other revenue was very impressive, historically, you have a large customer in your fiber lasers that when they have their product refresh, you tend to get a quarter or two of an impact and then historically there hasn’t been much follow-through from there.

We are still hearing from our own checks that it might be different this time.

I am curious, what you are seeing on that laser business that might make you think that perhaps it’s a little bit more sustainable from a growth perspective this time around?.

Yes, again, Patrick, we have about six or seven customer producing laser products. So, again, sometime on up one down and suffice to say that overall we see again pretty strong in that area. So, again fiber laser is only for one or two customers, and the rest of the customers in general look – the trend looks really good. .

Great. And just one more if I may, I guess for either Seamus or for TS is, if we kind of dive into the QSFP28 trends, you have the LR4 to CWDM4 transition and we have some normal seasonality in the March quarter.

I am curious if we try to ignore the seasonality, do you believe that this transition from LR4 to CWDM4 is largely behind your customers?.

Not 100% behind yet. We are very happy with the results on the ramp of the CWDM4 and suffice to say that some of our customers are still shipping LL4 and PSM4, but they are ramping down. So, yes, I mean, the story for FY 2019, it would be all – probably all CWDM4..

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

Thank you. .

Thank you, Patrick. .

Thank you. And our next question comes from the line of Troy Jensen with Piper Jaffray. Your line is now open. .

Hey, gentlemen, first off, congrats on the great results here. .

Thank you, Troy..

Thank you..

So, Seamus, for you, I mean, you touched on M&A here.

So I’d just be curious to know if your thoughts are small tuck-in deals or are you looking to do anything larger, more transformative?.

So, we are pretty much open for both. As you’ve seen from our results, our balance sheet remains pretty strong. We have a pretty sizable nest egg of cash. So I think we are well positioned to really tuck at any opportunity that comes our way, either smaller or like you say tuck-in acquisitions or larger deals.

So we are really looking to add capability, not just add revenue, we want to add capability that’s complementary to what we do. We are a technology-focused contract manufacturer, and we want to keep it that way. So we are really looking to add business that diversifies, improves our mix for results, so complementary to the technology we have today.

So we are really open to both smaller deals and larger deals. .

So, you also talked about other markets getting into, are there any specific verticals? Are you talking about different like processes?.

So, again, similar processes to what we do today. We are not going to become a broad based EMS company. We are going to stay focused on our core technology and then develop into other markets which are complementary.

A good example would be some of the autonomous driving technology that’s very complementary to what we do in the optical space today, but also, some of the medical equipments that we are targeting. The medical, industrial, and automotive will be the three, I would say, market segments, but with a real focus on technology. .

Okay, understood.

And for TS, could you give me – I’ve seen I’ve missed the new products versus existing products?.

Okay, the new business we call it, in the $119 million, 35% of our top-line. .

35%, so existing 65%, okay. And a last question for me.

The new facility that you guys opened not so long ago, just be curious to know, how much capacity is currently consumed?.

So we have about 20% to 25% occupied right now and about 45% to 50% what we call spoken for. So it’s about, again, 45% to 50% spoken for..

Any thoughts on breaking ground on the next building or is it far enough out that you don’t need to worry about just yet?.

I wouldn’t worry about a tad for this quarter, certainly. Really what we take is, once we get up to 60%, 65% output in that facility, we’ll build the second facility. We generally break ground and add capacity proactively. We are not going to wait for a customer to come. We are going to add capacity proactively.

So, we’ll take it up to – I would say, 65% there or thereabout output we would add a new facility there and we have enough land and space there to add several facilities. We probably have enough – certainly in terms of land and capacity. We have enough to last as far as I would say another eight to ten years. .

All right, perfect. All right guys. Keep up the good work..

Thank you, Troy. .

Thank you..

Thank you. And I am showing no further questions. I’d like to return the call to Mr. Seamus Grady for any closing remarks..

Okay, thank you very much everyone. Thank you for joining us on our call today and we look forward to speaking with you again soon. Thank you. .

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Everyone, have a great day..