Good afternoon. Welcome to Fabrinet's Financial Results Conference Call for the First Quarter of Fiscal Year 2021. [Operator Instructions]. 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 first quarter of fiscal year 2021, which ended September 25, 2020. With me on the call today are Seamus Grady, Chief Executive Officer; and Csaba Sverha, Chief Financial Officer.

This call is being webcast, and a replay will be available on the Investors section of our website located at investor.fabrinet.com. Please refer to our website for important information, including our earnings press release and investor presentation, which include our GAAP to non-GAAP reconciliation.

I would like to remind you that today's discussion will contain forward-looking statements about the future financial performance of the company. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from management's current expectations.

These statements reflect our 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-K filed on August 18, 2020. We will begin the call with remarks from Seamus and Csaba, followed by time for questions.

I would now like to turn the call over to Fabrinet's CEO, Seamus Grady..

Thank you, Garo, and good afternoon, everyone. We had an excellent first quarter with results that surpassed our expectations and reinforces our longer-term optimism.

Revenue in the first quarter was a record $436.6 million and was above the high end of our guidance range, driven primarily by stronger-than-expected performance in telecom and automotive. With a constant focus on efficiency improvements, gross margins increased to 12%, within our target range.

In addition, we continue to effectively manage operating costs. As a result, we also outperformed on the bottom line, delivering non-GAAP net income of $1.05 per diluted share. Our business also produced healthy cash flows, even as we continue to make growth investments. Operating cash flow was $34.5 million, and free cash flow was $21.9 million.

Looking at some of the details of the quarter. Optical communications revenue was $344 million, up 9% from the fourth quarter. Telecom revenue of $261 million grew faster than anticipated at 14% from the fourth quarter.

This sequential increase of more than $30 million in telecom revenue far offset the expected decline in datacom revenue, which was down 4% from the fourth quarter at $83 million. As anticipated, inventory issues that we experienced at one telecom customer now appear to be behind us.

We also continue to make progress on the transfer of an optical transport system program at Cisco, which is on track to ramp in the quarters ahead. In fact, we ended the quarter on a very high note when we were awarded Cisco's EMS Partner of the Year at their annual Supplier Appreciation Event.

Silicon photonics-based optical communications products represented 25% of total revenue in the first quarter, a historic high, driven primarily by telecom growth. Revenue from QSFP28 and QSFP56 transceivers also continued to grow and was a record $59 million, up 8% from the fourth quarter.

As reflected in our strong telecom performance, we continue to see strong growth at faster data rates. Revenue from 100-gig programs was stable at $150 million, while revenue from 400-gig and above grew 62% sequentially to $70 million.

Looking at our nonoptical communications business, our performance was better than expected, with revenue increasing $3 million sequentially to $93 million. Industrial laser revenue declined as expected and was $34 million, a sequential decrease of 16%, reflecting broader demand trends.

This was more than offset by automotive revenue, which increased sequentially to $35 million, a record level. A sequential revenue increase of 28% in automotive was driven by the combination of growth from new automotive programs and by an unanticipated return to growth from traditional auto programs.

Sensor revenue was stable at $2 million in the first quarter, and other revenue increased $2 million to $21 million. Looking to the second quarter, we expect to see similar business trends to the first quarter. We anticipate that telecom will continue to grow at a healthy pace, driven by newer programs and faster data rates.

This should largely offset a decline that we anticipate in datacom revenue based on current demand signals. In nonoptical communications, we expect continued softness in industry lasers, but are optimistic that automotive revenue growth will continue and largely offset those declines.

It's also worth mentioning that this near-term softness in the industrial laser market does not affect our optimism that the industrial laser industry will look to increase outsourcing in the years ahead.

In fact, intense competitive pressure could even serve as a catalyst, and we remain very well positioned to benefit when this industry transition begins to take place. We continue to pursue a multifaceted growth strategy.

This strategy includes leveraging the growth of the industries we serve, combined with investing in facilities and technologies that enable us to further penetrate existing customers and win new customers, both in the markets we currently serve and in new markets.

Our first quarter results demonstrate that we are benefiting from the successful execution of this strategy.

While we have no control over broader market trends, we remain focused on what we can control, including investments in next-generation manufacturing technologies and in capacity expansion as well as capitalizing on our early success pursuing system-level business and exploring opportunities in new markets that our advanced processes can serve.

As we execute on our strategy, we believe we are very well positioned to deliver superior returns for all our stakeholders. In summary, we're off to a positive start in fiscal 2021. Our strategy is working as strength from newer programs offset the softness we see in certain markets.

We are optimistic that we can continue to leverage our strong reputation in the markets to further advance our position as the leading manufacturer of the most complex products. Now I'd like to turn the call over to Csaba for additional financial details and our guidance for the second quarter of fiscal 2021.

Csaba?.

Thank you, Seamus, and good afternoon, everyone. I will provide you with more details on our financial results for the first quarter and our guidance for the second quarter of fiscal year 2021. We were very pleased to deliver financial results that exceeded our guidance ranges for the first quarter.

Revenue of $436.6 million was more than $6 million above the high end of our guidance range and a new record. Non-GAAP net income was also a record at $39.3 million or $1.05 per share, $0.05 more than the high end of our guidance range, largely due to our revenue upside and gross margin improvement.

On a GAAP basis, net income was $33.1 million or $0.88 per diluted share. Now turning to the details of our P&L. Unless otherwise noted, profitability metrics I refer to will be on a non-GAAP basis. A reconciliation of GAAP to non-GAAP measures is included in our earnings press release and investor presentation, which you can find on our website.

Gross margin was 12%, up from 11.8% in the prior quarter. This improvement was primarily a result of the strong focus on manufacturing efficiencies and continued cost reduction efforts. Operating expense during the quarter was $12.5 million, or 2.9% of revenue. This produced operating income of $39.9 million or 9.1% of revenue.

Taxes in the first quarter were $1.7 million, and our normalized effective tax rate was 4.5%. Turning to the balance sheet and cash flow statement. At the end of the first quarter, cash, restricted cash and investments topped $0.5 billion for the first time at $503.8 million, an increase of $8.3 million from last quarter.

Operating cash flow was an inflow of $34.5 million. And with CapEx of $12.6 million, free cash flow was $21.9 million in the first quarter. We did not repurchase shares during the first quarter due to the smaller open window after our year-end blackout period. At the end of the quarter, we had $100 million remaining in our share repurchase program.

We expect to implement a 10b5-1 plan in the second quarter that will enable us to repurchase shares even during blackout periods. This program will complement opportunistic open market purchases that remain subject to blackout periods.

Our primary capital allocation priorities continue to be risk mitigation, investment in long-term growth and returning value to shareholders through share repurchases. With our strong balance sheet, we expect to be active in all these areas in fiscal 2021. I would now like to turn to our guidance for the second quarter of fiscal year 2021.

We believe the trends we experienced in the first quarter will continue in the second quarter. In optical communications, we expect strong telecom revenue, driven by healthy demand from higher data rate products, combined with our newer program ramps.

This should more than offset export restriction-driven headwinds at any end customers of our customers. We expect datacom softness to continue with revenue down sequentially based on current Q2 forecast. Still, we believe that telecom strength will offset this weakness for total optical communications revenue that is roughly flat with Q1.

In nonoptical communications, we believe the near-term weakness from the industrial laser market will continue in Q2. On the other hand, we anticipate growing demand from new technologies like LIDAR, as well as traditional automotive programs continuing to improve.

This automotive trend should offset most, but not all of the softness from the laser industry. Therefore, we anticipate total nonoptical communication revenue to be slightly down sequentially. We expect total revenue in the second quarter to be between $420 million to $440 million.

From a profitability perspective, we are optimistic that we can drive efficiencies and anticipate that net income will be roughly flat with our record first quarter results. We expect EPS to be in the range of $1 to $1.07 per diluted share.

In summary, we are pleased with our execution in the first quarter and our financial results that exceeded our guidance ranges. We are proud of the success of various growth initiatives and our financial performance, and we look forward to continuing to deliver profitable growth as we execute on our strategy.

Operator, we are now ready to open the call for questions..

[Operator Instructions]. And our first question comes from the line of John Marchetti with Stifel..

Seamus, I was wondering if you could talk a little bit about some of the trends in datacom. Obviously, seeing very good telecom strength here.

But just wanted to get your take on maybe where we are in sort of this downtrend on the datacom side? And maybe looking out maybe a little bit longer term, to see what your expectations are for that portion of the business turning around a little bit?.

Yes John, unlike maybe some of the prior slowdowns that we saw where a lot of the slowdown previously was driven by pricing, that pricing seems to have stabilized. So that's the good news. The current softness appears to be demand driven, primarily demand driven. We do remain optimistic as demand for data bandwidth and capacity will continue to grow.

So over the longer term, we remain optimistic. But the downturn we're seeing right now is, let's say, more volume driven than price driven. At the same time, our broad portfolio of customer programs in multiple end markets means that the growth in other areas can offset much of the datacom softness we see.

So we don't see it as a -- not necessarily a very significant issue, but it is more volume driven, I would say, than price driven..

Okay. Okay.

And then if we move over to the guidance on the telecom side, I'm just curious, with all the puts and takes that we've heard from some of your customers and even some of the systems-level customers in the industry, how much -- as you're looking at, I don't know if it's possible, but can you sort of parse maybe what you're seeing from new program demand coming on, your revenue that maybe you wouldn't have had a couple of quarters ago versus sort of what the underlying demand is? And we're just trying to, I think, really to look more out into next calendar year to get a sense for maybe how the telecom business continues to perform..

So we're, I would say, quite happy with the progress we're making on the telecom side and the growth we're seeing there. We have -- in the past, we had a metric for new business, which we have -- we used to call revenue from new business historically, which referenced new customers, really since the beginning of 2014, which is really too long ago.

So given that many of these programs are now entering their sixth year, we no longer talk about that metric.

We're looking at to see if there's other measures that might make more sense but the new business that we see, we continue to increase both the dollars and as a percentage of total revenue, and that's both new business from new customers and new programs from existing customers.

Most of the growth -- the majority of the growth would come from new business with existing customers. But the pipeline, I would say, is quite strong, quite robust.

And as we've talked about in some of our prior meetings, we're going after, again, both new customers, but also new programs from existing customers and also looking to expand up the way vertically into the systems space with some of the customers who -- for whom we're providing component-level services today, and we're looking to expand that.

And we've had some success in that regard. So we feel quite positive, I would say, about the pipeline and about the new business wins we've been seeing..

Got it. And then maybe lastly, Csaba, I may have missed it, but did you give any of the 10% customer commentary in the quarter? I was hopping between a couple of calls, so I apologize if I missed that..

John, this is Csaba. Well, we are only providing 10% customers at the end of the year. So we haven't provided that, and we continue to stick to our process and provide that at our year-end..

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

I was hoping we could talk a little bit about the systems companies coming in, if you could give us some sense of where you are on bringing up Cisco, what the time line might be? When do you think that gets to kind of run rate revenues, and to what extent you think you're now at run rate relative to Infinera and where you are on any additional systems companies?.

So thanks, Alex. So first of all, yes, we did announce the Cisco. When we announced the Cisco win, let's say, we said that we expected Cisco to be a 10% customer in FY '21. We think we're still on track for that. We remain quite optimistic about that and about the pace of the ramp.

We think we should be ramped primarily, I would say, largely ramped at the end of the calendar year, we should be largely at the run rate by the end of the calendar year.

Again, the, let's say, the 10% nature of the customer, we will talk at that at the end of the year, but we're quite happy that we feel we're on pace there and should be largely ramped towards the end of the year. Infinera, we did the Berlin transfer with Infinera, that's now behind us.

And of course, in prior quarters, Infinera had talked about an inventory correction, which now seems to be in the past, and we're back to the normal run rate. So I would say we're at the run rate right now with Infinera. And then there's other system-level companies we're certainly targeting, but it's too early to talk about at this stage.

We're very much targeting, not a huge number of customers, we don't need a huge number of customers. We just need a small number of significant wins like we have been able to accomplish so far with both Infinera and Cisco. So we're very firmly targeting 1 or 2 more of those..

So looking at the Cisco Situation, is it fair to say a little bit in the fourth quarter, but not a material number and then ramping gradually in the first quarter and then hitting your kind of run rate as you exit the fourth quarter of fiscal year, but not a full quarter's worth? So the first full quarter would be then the third quarter.

Is that the right process?.

Yes. I think that would be fair, yes..

Perfect. And then going back to the datacom side for a second, if I could.

It's a little surprising because the datacom has been reasonably strong from most of the numbers that have been printed and I know you don't tie to any and specific, but obviously, we saw some pretty good numbers out of rest of the day at the same time that you guys are printing. And there's been other positive commentary around datacom.

So is that a function, do you think of, maybe some share shift within your customer base to people may be in your customer base? Is it potentially associated with some of the 5G stuff taking a little longer to ramp? What do you think is the -- behind that softness as the driver?.

We think it's probably more program transition-related than share shift. We certainly haven't lost any customers or any programs.

Sometimes, there might be some share shift going on, let's say, between our customers to, like you say, programs that we're not necessarily producing, but it's more likely to be program shifts within our customers where they're transitioning from one program to another and maybe ramping down an order program and haven't fully ramped up a newer program.

So we....

If I recall it correctly, you had said that, that was going to be the case in the third quarter calendar, but that you thought it would rebound in the fourth quarter. Now you're saying that you expect it to continue to be weak.

Is that because of a delay in that ramp and therefore, we should anticipate a nonseasonal benefit as it ramps in the normally seasonally weak March quarter?.

Yes, hopefully. I mean, we're still optimistic about that. But that transition that we talked about previously is continuing there. We -- I think that's probably a fair way to look at it. It's -- the transition is lasting a little bit longer than we'd like and that our customer would like, but we still feel optimistic about it longer term..

So any sense of what's driving that transition this differential? Then I'll see the floor..

Alex, this is Csaba. So what we have seen in the last, I would say, 2 quarters that you mentioned, we also had a transition of one of our particular customer. We thought it was going to be done largely this quarter that transition shift. We started to see the higher data rates of transceivers picking up actually. So that could be one of the drivers.

While 100G still remains very strong, you started to see QSFP56 is coming up and double the transceivers starting to come in the pipeline. So this might be a knock-on effect of bringing up the new products and then somewhat tapering off the 100G and at the same time, bringing up the higher data rate products.

So that's the common denominator we are seeing across many customers rather than any particular share or shift..

[Operator Instructions]. Our next question comes from the line of Dave Kang with B. Riley..

This is Danny on for Dave.

Going off the question about Cisco and Infinera, I was wondering if you could provide any additional color around the demand and around any ramp from Infinera in addition to Cisco?.

I'm sorry, we can't provide any outlook on demand from specific customers. We just -- we don't want to be speaking for our customers on these calls. So I'm afraid I can't provide that information..

Okay. Got it. That's fair. And well, I guess, an additional question would be, are there any verticals that you're particularly excited about? You mentioned the autos and telecom earlier.

What's giving you the confidence in these 2 sectors? And how should we think about that going forward?.

Yes. I think there's a few areas. So there's -- you mentioned automotive. For us, traditional automotive came back quite strong actually in the quarter a little bit unexpectedly. But maybe for us, more exciting is the new automotive, especially LIDAR. We've had some good solid wins in that space.

And that area is growing for us, it's a really good fit for us. In addition, the industrial laser business, even though that whole sector is somewhat down, it's very much under-penetrated from an outsourcing perspective. So we feel very positive about that sector longer term.

Third would be the system business and vertically integrating, moving up the value chain for our customers. We've had some really good success there. And we'll be very selective as we pursue that business. We're not just chasing revenue. We're chasing high-quality revenue from high-quality customers.

And so far, we've been very successful, I would say, quite fortunate in that regard. And then the fourth area is that, if you like, the broader area of precision sensors generally focused on some of the markets we serve traditionally, but also medical and some other markets.

So we feel we have a really good, let's say, mix of segments and sectors that have enough in common for us to be very effective for us and do a very, very good job for our customers, but also that provide good diversification for us. So we're quite optimistic, I would say, about our longer-term growth prospects.

I think it's shown through -- if you look at our growth over the last quarters it's been quite robust in the face of several headwinds like COVID and Huawei and whatnot. So we remain quite optimistic..

And we have a follow-up question from the line of Alex Henderson with Needham..

Okay. So I wanted to talk a little bit about the industrial laser business. The primary -- one of your primary customers obviously reported this morning, and they had a very steep decline in the trailing period, but offered sequential flat numbers, saying that they believe that, that business has finally bottomed.

And I know that you've been picking up some share as well. So trying to understand how do I look at the industrial laser business, which normally is seasonally stronger in the first half of the year next year as well.

So is it -- is there something beyond the current -- the obvious customer that is also seeing some weakness to cause it a conservative guide sequentially into the upcoming quarter?.

No. I think it's more to do with -- that's industry generally. We're -- currently we don't produce all of the products, if you like, for all of the customers. So we're really at the whim of the demand in the marketplace for the customers' products for the products we do reduce. The strategy is more around deeper outsourcing penetration.

Those companies, we believe, who are not yet that heavily outsourced, will need to outsource more and more. That's where we really plan to capitalize. So there's kind of a short-term version of the answer, Alex, and the long-term version. The short term, we're at the whim of what happens in that marketplace.

But longer term, we feel very positive about the industrial laser, if you like, segment for us, generally, it's a really good fit for us. So far, any of the customers we have in that space, we've done a very, very good job for them, and we think we can continue to expand the outsourcing.

We can expand our relationships with those companies as they're increasing the outsource..

We have another follow-up question from the line of John Marchetti with Stifel..

Seamus, I know you don't have any little direct exposure to Huawei. But with some of the key customers, certainly indicating that, that revenue stream is continuing to weaken as we look out over the next several quarters.

How do you think about that market for you or that share that, that represents? Particularly, as we look out into next calendar year, how quickly maybe can some of that get reallocated? Particularly, with your production lines, does it require a tremendous amount of rework to go from Huawei, say, to a different systems-level vendor? And just trying to think of maybe how we think about that as a headwind as we're looking more into calendar '21?.

Thanks, John. Yes. A couple of parts to the answer. First of all, the impact towards last quarter, let's say, the quarter just ended, was, I would say, negligible. If you can appreciate, the sanctions and everything else came very late in the quarter.

Therefore, the quarter was pretty much set, and we were able to pull in and ship most of what was needed by -- I think, the 14th of September was the date there. So there was a very minimal impact in Q1. Our Q2 guidance incorporates a headwind of about $25 million to $30 million from customers impacted by the Huawei sanctions.

So that's incorporated into our Q2 guidance. And in other words, not for the sanctions, we'd be guiding $25 million to $30 million above our outlook today. So it's not insignificant impact, it's a sizable impact. But we've been able to overcome that headwind and still guide up.

As regards how quickly our customers can convert over and how quickly we can convert over production lines, the converting of production lines is -- I don't want to minimize the impact, but it's quite small. The pacing item, we believe, will be more to do with those other non-Huawei customers getting the qualifications done in a timely manner.

They have to qualify the products. And that can take time, some time. So we don't anticipate any great delays on our part and, in some cases, our customers have been adding capacity to produce these products. And I think our customers remain quite optimistic about the products they have, they've some really excellent products.

So there will be, I would say, a transition over the next couple of quarters as our customers transition over to non-Huawei customers. And we're ready to support them. We'll do whatever it takes to make sure they're successful there. But I don't think there's any hugely gating item or pacing item from our side.

It's more to do with the end customer just qualifying the products.

Does that make sense, John?.

Absolutely..

Operator, if you're still on the line..

And I'm sure we have another follow-up question from the line of Alex Henderson with Needham..

So two questions, both on kind of progress front.

One is what's going on with your Israel prototyping facility? And second one is, could you give us an update on where you are on the production expansion and plans?.

Sure. So first of all, in Israel, we have a lot of, I would say, very exciting activity going on in Israel right now.

With a high level of -- with the facility up and running, we have a high level of interest from customers and that's both existing Israeli-based customers of ours, but also a lot of interest from new customers, new to Fabrinet customers. We've won some business.

It's not huge in terms of revenue, but it's hugely important in terms of bringing on new business and new customers. Of course, Alex, as you know, driving revenue is not necessarily the focus of a new product introduction facility.

The focus of NPI is more on winning new programs and new customer relationships with quick turn and prototyping and other late-design stage services as the enabler, if you like, of growth. And in that context, yes, the goal then, of course, is still very much, ultimately, to drive volume manufacturing to Thailand.

I would say in that context, we're very happy with the progress there and really have a lot of activity and a lot of interest and have won some business there. The second part of your question to do with the....

Just before we get off of that, those new customers to Fabrinet altogether?.

Some are, yes. Some are new customers to Fabrinet, and they're in the, I would say, in the communication space, but also in other noncommunications areas, such as new automotive, medical, defense and aerospace and other segments that are, I would say, new and exciting for Fabrinet. So yes, plenty of opportunity there.

It really is a very, very busy hot bed of technology and activity..

Perfect.

And on the capacity expansion progress in Thailand?.

Yes. So obviously, we're very happy, I would say, and excited to have a solution for increasing capacity at our main campus in Pinehurst from the customers who want to expand there.

We've started the expansion in the fourth quarter, and it will take several quarters until it's completed because unlike, let's say, a new building, in a sense, is more straightforward because you just build the building.

Whereas with a move like this on an already busy campus, there's a lot of moving around that has to happen before it comes into full effect. But we're -- I would say, the project is underway. And at the same time, we continue to attract new customers to the Chonburi campus.

And we're seeing much increased production volumes there and evaluating what our next expansion steps might be..

And I'm showing no further questions. I will now turn the call back over to CEO, Seamus Grady, for any further remarks..

Thank you, operator. Thank you all for joining our call today. We're pleased to have exceeded our guidance and reported record revenue and net income in the first quarter.

Our strategy is working, and we look forward to sharing more success with you as we look ahead as well as meeting with some of you virtually at the Needham conference in November and the MKM conference in December. Thank you, and goodbye..

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