Good day, ladies and gentlemen and welcome to Fabrinet's Financial Results Conference Call for the First Quarter of Fiscal Year 2020. 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. Sir, you may begin.

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 2020, which ended September 27, 2019. With me on the call today are Seamus Grady, Chief Executive Officer; and TS Ng, 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 opinion 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 20, 2019. We will begin the call with remarks from Seamus and TS, followed by time for questions. I would now like to turn the call over to Fabrinet's CEO, Seamus Grady. Seamus?

Thank you, Garo, and good afternoon, everyone. We delivered a strong performance in the first quarter with revenue and earnings that were above our guidance. Demand trends appear to be stabilizing in most of the end markets we serve and we're optimistic that we are positioned to deliver strong results in the second quarter. Revenue in the first quarter was $399 million, a slight decrease from the record fourth quarter as expected, with a 6% increase from a year ago. Non-GAAP net income was $0.86 per share exceeding the high end of guidance as gross margins improved to 12% in the quarter. Looking at our business by end markets, optical communications revenue of $302 million was up about $2 million from the fourth quarter and represented 76% of total revenue. Within optical communications, telecom revenue of $230 million increased 7% from the fourth quarter and represented 76% of optical revenue. This growth is particularly notable considering we had expected telecom revenue to be flat at best. Further, we expect this momentum to continue in Q2. Datacom revenue was $73 million in the quarter, an expected decrease from Q4 of 15%. Datacom represented 24% of optical communications revenue. We believe this decline is primarily the result of broader industry trends and not due to execution or competitive issues. In fact, based on anticipated near-term demand, we believe datacom trends could be nearing the bottom and we expect datacom revenue to be roughly flat in Q2. By technology, silicon photonics based optical communications revenue decreased from the fourth quarter to $77 million and represented 25% of optical communications revenue. Revenue from QSFP28 and QSFP56 transceivers was $45 million, down slightly from the fourth quarter. By data rate, 100-gig programs continued to represent nearly half of optical communications revenue at $147 million. Products rated at speeds of 400 gig and above were up strongly from the fourth quarter to $38 million, or 13% of optical communications revenue. Looking at our non-optical communications business, revenue moderated sequentially as expected to $97 million from $105 million in Q4. As anticipated, revenue from industrial lasers declined from the fourth quarter and was $41 million compared to $53 million in Q4. These same demand trends seem to be persisting so we anticipated industrial laser revenue to be roughly flat in Q2. Longer term, we remain optimistic about our potential to further penetrate the industrial laser market as more manufacturers inevitably turn to outsourcing to better compete in this global market that is in fact larger than the optical communications market. Automotive and sensor revenue were both stable at $24 million and $3.5 million respectively. Finally, revenue generated from other non-optical applications grew 15% sequentially to $28 million mainly from Fabrinet West. Fabrinet West has been a great success for winning business for our offshore volume manufacturing sites. We have seen numerous programs migrate from early prototyping in Fabrinet West to volume production in Thailand. At the same time, Fabrinet West has been an enabler for us to win business in new markets and with new customers that might have otherwise gone to competitors. As such, we have been focused on establishing a similar model to Fabrinet West in Israel. We already have a number of customers there and we believe we have the opportunity to grow our business with these customers as well as attract new ones. We have signed a lease for a building in Ra'anana, which is a former semiconductor manufacturing facility. It is already equipped with most of the infrastructure we need for a new product introduction center. We are currently in the process of setting up SMT lines, advanced packaging and a failure analysis lab similar to what we have to support NPI in our Bangkok facilities. We have hired a General Manager for Fabrinet Israel, and we are targeting to be up and running early next year. In summary, we believe we are off to a good start to the fiscal year with revenue and earnings that meet our guidance ranges and return to gross margins that were within our target range. We're optimistic that our telecom strength will continue and the datacom trends appear to be bottoming. In addition, we're excited to have achieved important milestones toward establishing a second new product introduction facility at Fabrinet Israel. Combined with our continued leadership as a contract manufacturer for the most complex products, we are very excited about our future. Now let me turn the call over to TS to discuss the details of our first quarter performance and our outlook.

Thank you, Seamus, and good afternoon everyone. I will provide you with more details on our performance by end market and our financial results for Q1, as well as our guidance for Q2 for fiscal year 2020. Total revenue in the first quarter of fiscal year 2020 was $399.3 million and above the upper end of our guidance range. Non-GAAP net income was $0.86 per share and was also above our guidance range even after a foreign exchange headwind of $1.9 million and the mark-to-market loss on interest rate swap contracts of $1.7 million. These losses accounted for approximately $0.09 per share. Now turning to the details of our P&L. 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. We were pleased to see non-GAAP gross margin in the first quarter improve to 12%, a 20 basis point increase from the fourth quarter as efficiency more than offset the impact of merit increases. Non-GAAP operating expense was $11.6 million in the first quarter. As a result, non-GAAP operating income was $36.2 million and non-GAAP operating margin was 9.1%, flat with the fourth quarter. Taxes in the quarter were $2.2 million and our normalized effective tax rate was less than 5%. We expect our effective tax rate to be 5% to 6% for the full year. Non-GAAP net income was above our guidance range at $32.2 million in the first quarter, or $0.86 per diluted share as I indicated earlier. On a GAAP basis, which includes share-based compensation expenses and amortizations of debt issuing costs, net income for the first quarter was $25.9 million, or $0.69 per diluted share, also above the high end of our guidance. Turning to the balance sheet and cash flow statement. At the end of the first quarter, cash, restricted cash and investments were $436.4 million compared to $444.7 million at the end of the fourth quarter. Operating cash flow in the quarter was $2.6 million and with CapEx of $6.3 million, free cash flow was an outflow of $3.7 million in the first quarter. During the quarter, our working capital increased to a higher than normal level in support of major new program transfer. This will begin to self-correct in the second quarter as we start to consume the transfer inventory and collect receivables. We did not repurchase any shares during the first quarter. As such, $62.2 million remains in our share repurchase program and we will continue to evaluate market conditions to opportunistically repurchase shares when possible. I would now like to turn to our guidance for the second quarter of fiscal year 2020. As Seamus described, we expect a strong second quarter and anticipate that revenue will be between $408 million and $416 million. From a margin perspective, we are optimistic that we will see efficiency continue to drive incremental improvements in non-GAAP gross margin within our target range of 12% to 12.5%. From an EPS perspective, we anticipate non-GAAP net income per share in the second quarter to be in the range of $0.91 to $0.94 and GAAP net income per share of $0.74 to $0.77 based on approximately $37.7 million fully diluted shares outstanding. In conclusion, we are excited with our strong performance in the quarter. We remain very positive about our long-term prospects for continued leadership in the marketplace.

Our first question comes from John Marchetti of Stifel.

Thanks very much. I appreciate you taking my question. A quick one first off Seamus. I was curious if in this quarter there was any revenue associated with that transfer program coming in. And if there is some of that in the guidance for next quarter as well?

Hi, John. Yes. We had some revenue from the transfer program. As you may notice from our cash, we did burn cash in the quarter. And in large part that was due to inventory that we purchased in the early part of the quarter and then our shipments as you can appreciate with a big transfer like that, we did have some revenue but it was pretty much back-end loaded in the quarter. So we have some receivables that fell into this quarter. So yes, we did have some revenue in the quarter and we continue in our guidance for this quarter as well. And we think it will be probably largely ramped, I think by the end of this quarter. We're a little bit ahead of schedule. I know previously we mentioned we thought it will be out into Q3. We think it will be largely ramped by the end of this quarter.

So just to be clear, by the end of this quarter you expect that whatever you're shipping for that program will be actually coming out of your production and not just out of inventory that you purchased?

Yes. We didn't purchase. The only inventory we purchased was raw material. We didn't purchase any finished goods or semi-finished goods or anything like that. So everything that was in our revenue last quarter was product we produced that will stay in this quarter. There's a little bit more of it this quarter and we expect it to be fully ramped up this quarter.

And then if I can switch gears. You had a pretty significant sequential increase in the 400 and above speed check there. I'm wondering if you can talk about, if that was with existing customers and is more demand-related if there is some new customer activity mixed in there. Just any color you can give us behind sort of that ramp, that's fairly steep in that 400 and above?

It's a combination, John of both existing and new customers. I would say, the majority of that revenue came from existing customers. So as you can appreciate any volume from new customers will be small in nature, but the majority of the revenue increase on the 400 gig came from existing customers.

And then lastly if I can, just curious about your comments about the datacom business getting a little bit better. What sort of visibility do you have there? And I guess what's changed over the last quarter or so to make you feel a little bit better about that? Thanks very much.

No problem, John. We feel that our datacom business may have bottomed out or flattened. As we mentioned, it was down last quarter, and our datacom revenue was as expected. We believe it is stabilizing this quarter and that last quarter was likely the lowest point. While we're not overly optimistic or guiding for significant increases in datacom, we do believe our telecom business is strong and will see growth. Our datacom business, however, remains somewhat flat based on the forecasts and orders from our customers. We typically have about 13 weeks of rolling visibility, which provides us with solid insight based on customer feedback. Thank you, John.

Got it. Thank you.

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

You talked a little bit about this program that you're moving over from Berlin. Obviously, you've given guidance here for the full year fiscal year and in 2020 that this could be 10% plus of your revenues. It doesn't sound like in the first half, it's anywhere near that. Can you talk a little bit about the cadence of when you think it can achieve or exceed that full year mark? But I would assume that at some point it has to cross over and be more than 10% to get to that level for the full-year?

Yes, Alex. The 10% comment that we made previously was in relation to Infinera as a customer in total, which will be the combination of the previous if you like existing Infinera business that we already have plus the transfer business from Berlin. So the 10% comment was not related to the Berlin business alone, the Berlin business is in addition to the existing Infinera business so that may explain the disconnect there. I'm not sure if that's helpful.

Well so I am assuming that it still isn't over 10% at this point in time or anywhere close to it. So the comment still stands. When do you think that that program gets to a point where it's driving the type of revenues that would put them at over 10% as a customer?

We just reported that 10% of our customers were achieved by the end of the fiscal year. We anticipate that we will ramp up the transfer business by the end of this quarter, which should allow us to maintain that run rate for the full year.

Right. So a second question if I could. On the ROADMs versus ACO DCO, there seems to be a shift fairly significant shift at that between what I would call optical switching and transmission in several companies' commentary. Can you talk to what extent you have exposure to a flattening market and the switching market and to what extent you think the acceleration in transmission can offset that?

So Alex this is TS. Again, as you know most of these ROADMs we build for one customer. And if you listen to the earnings call, they are essentially saying for the short term it's pretty flat. And in the long run, they still believe that it's going to go up. So basically, whatever they say applies to us because we only have one customer on the ROADMs.

Right. But the question really was to what extent can you use transmission to offset that over the next couple to three quarters? Do you have enough visibility on transmission and do you sustain your share of the business when that shifts between those two segments?

I believe we do have an opportunity. The transition between transport and transmission involves several customers that should help us mitigate any impacts. However, we lack visibility for the next two or three quarters; we can only see a rolling 13-week outlook. We are optimistic about being able to take advantage of this shift as it develops over the upcoming quarters, especially since we have a substantial number of customers in that area.

One last question then I'll see the floor. You indicated in past quarters that you were experiencing some lack of availability on some passive components and other fairly low cost, but critical components that are part of your production sets. Has the supply constraints on those products ameliorated, so that's no longer a drag? Or are we still absorbing that?

Yes, I believe the passive supply constraints that were affecting the entire industry have largely improved over the past several months. We think that issue is mostly behind us now. While we do start each quarter facing some challenges that our supply chain team needs to address, that is just part of the usual business process. Overall, the industry-wide passive constraints that were present nine months to a year ago seem to have eased. There may still be minor issues from time to time, but nothing significant.

Great. Thank you very much.

Thanks, Alex.

Thank you. Our next question comes from Samik Chatterjee of JPMorgan. Your line is open.

Hi, this is Joe Cardoso on for Samik Chatterjee. So, for my first question I wanted to dig in on the gross margin. I think last quarter you guided for moderation from Q4 to 1Q. And so I was just curious if we can double-click there and just figure out what has changed or what the variance was in when you guys initially guided there and what changed from what you guys reported in the first quarter.

Hi, this is TS. For the first quarter as in my prepared remarks, we see the efficiency more than offset the merit increase. Typically July, August, September we start giving merit increases for the whole year. So, that resulted about 20 basis points better than the previous quarter. June quarter was 11.8% and then moving to 12%. And moving forward, Q2, we don't guide gross margin. But if you just look backward based on the guidance it showed improvement from 12%. So, we are very happy that we are back to the 12% to 12.5% range and we'll continue to maintain that.

Yes. Let me just maybe add a lot of the good result we have in gross margin in Q1, it's really down to a very tight cost control and efficiency gains from our team. Our internal team, the operations team, our supply chain team really do an excellent job keeping our costs under tight control and realizing efficiency gains. So, it's mostly driven by like I say efficiency gains and cost containment.

Thank you. For my second question about your comments on the industrial laser market, it seems like you're indicating there are ongoing headwinds affecting that market. However, one of your largest customers mentioned in the last earnings call that the market was either declining or possibly improving. Can you clarify what you're observing? Do you expect it to reach a low point in December followed by improvement? Any insights you can provide would be appreciated.

Yes, I think that's probably a fair assessment. That industry is going through a tough time right now. The competition is fierce. Spending seems to be tightening up. So that whole industry is going through a pretty turbulent time. We have a number of customers. We have probably four customers in that space right now; one customer being our biggest one. And really our shape and size in that market is a function of what's going on with our customers, so we're not immune from what's happening with our customers. So, it's pretty flat I would say. The laser market is pretty flat. Longer term we do remain quite optimistic as I might have mentioned in my prepared remarks. We do remain quite optimistic about the laser market because we think that some of the price pressure that the big companies in that space that the Western world companies if you like are feeling. We believe they will turn to outsourcing as a way to offset that pressure and will outsource more and more because to a large extent a lot of the companies in that space, they insource quite heavily they don't outsource that much. So, we think we're very well-positioned with the capabilities and experience we have. We think we're pretty well-positioned to capitalize as that industry looks to outsourcing. But overall demand, I'd say short-term is kind of flat as some of our customers have indicated.

All right. Thanks guys. And congrats on the results.

Thank you.

Thank you.

Thank you. The next question comes from Tim Savageaux of Northland Capital Markets. Your line is open.

Hi, good afternoon and congrats on the results.

Thanks Tim.

First question is on the 10% customer side, do you have any 10% customers outside of your traditional large customer in the quarter?

We reported that 10% of our customers were accounted for by the end of the year. We believe Infinera will likely be a 10% customer, and there may be one or two additional customers who could reach that level for the full year. However, it's probably too early to make definitive statements at this point. We are confident that we will have at least two 10% customers by the end of the year.

Okay. Appreciate that. And looking at telecom growth in the quarter, especially in the context the things that silicon photonics line down pretty reasonably. I wonder if you can characterize that 7% sequential growth in telecom. And then also I guess I've mentioned that in the context of your commentary on 400 gig growing so strongly and mostly from existing customers. But can you characterize the sequential growth either in the results or outlook or both in the context of contribution from new programs your ramp with your new customer versus existing business or existing customers?

Yeah. A lot of the growth in telecom in the quarter, a lot of that did come from our new customers, big portion did come from our new customer. 400-gig growth is predominantly from an existing customer. And then the decline in silicon photonics, some of our silicon photonics business is telecom-related, but some of those actually is datacom related. So the overall, I suppose the two are a possible telecom growth and a decline in silicon photonics in the sense that the decline in silicon photonics is mostly for the datacom customers.

Understood. While I realize you don't provide guidance for these specific segments, I’m curious if you have any anecdotal insights as you anticipate continued growth in telecom. What are your thoughts on the potential for silicon photonics as you move into the next quarter and throughout the year? Do you foresee it returning to growth at some point?

Silicon photonics seems to be strong on the telecom side. However, we have seen a bit of softness with one or two of our datacom customers in their data centers, which impacts our silicon photonics segment. Overall, while we guide one quarter at a time, the general sentiment we are hearing suggests that telecom will remain strong, while datacom is likely to stay flat.

Great. Thanks very much. I’ll pass it on.

Thank you, Tim.

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

Thanks. I was hoping you could give us the geographic split?

In terms of shipments, no more changes. North America shy of 50%. And the rest are split between China, the rest of the world. Southeast Asia is also a big portion. We ship quite a bit to Southeast Asia country.

Can you clarify what you mentioned about the expected growth in telecom moving forward? I'm not sure I noted it correctly. What are your projections for telecom growth as we move into the fourth quarter and the second quarter of the fiscal year?

Well, we haven't guided specific growth for telecom I guess the discussion was really more around overall sentiment. The sentiment we hear from our customers is that telecom will remain, we think quite strong. Datacom is flat but we haven't given any specific guidance for our telecom revenue forward. We think we will do in next quarter.

I see. And one more question if I could. Around the Israel operation when would you expect to be able to actually generate some revenues from that facility? Is that six, nine months out? Or how far out does that take?

We aim to be operational and ready to conduct business in the early part of next year, specifically between January and March. However, it will take some additional time for the business to grow. We anticipate that it will start contributing to revenue by the June quarter, possibly a bit earlier. Currently, we are outfitting the building, which is advantageous since it was previously a semiconductor manufacturing facility and already has much of the needed infrastructure. This will help us shorten our timeline. We plan to install a complete range of equipment, including SMT equipment and optical packaging equipment, as well as full failure analysis capabilities for our customers. We will duplicate, on a smaller scale, the same capabilities we have in Bangkok.

Do you see that facility as being roughly comparable sized to Fabrinet West?

It's a smaller facility. In terms of square footage it's smaller. The Fabrinet West facility it's a great location it's a great facility. The building itself is probably a little bit bigger than what we would actually need. So it's a smaller facility. I think in terms of square footage it's about...

20,000.

Roughly 20,000 square feet. So it's an ideal size actually for what we need. And similar to Fabrinet West, it's not going to be a huge revenue generator in and of itself. The main purpose of Fabrinet Israel will be to win customers that we then transfer to Bangkok. So we'll try and replicate the success we've had in Fabrinet West in Israel.

I see. Can you give us any sense of what's going on in terms of your factory utilization in your facilities when you might need to start moving on the next facility? Can you give us an update on that?

We are continuing to expand our main campus in Pinehurst and are successfully securing new business in Chonburi. It's difficult to estimate timing because we have been pleasantly surprised by our success in improving efficiencies and optimizing space in Pinehurst. We are increasing our revenue at the Pinehurst facility without needing additional space, while we are concurrently integrating new business in Chonburi. It's challenging to specify when we will be fully ready; if all our current opportunities materialize, we will need to act quickly, but not everything will come to fruition. Nonetheless, we remain optimistic about our growth in Chonburi. While we will need to ramp up operations if our pipeline performs as expected, establishing a timeline is tricky. Much of the growth will occur with our existing customers in Pinehurst, while Chonburi will focus more on attracting new clients.

All right. One last question if I could since it sounds like you don't have too many in the queue. The 400 gig commentary, can you talk a little bit about whether that's on the telco side whether that's 400 gig or 600 gig? I assume that's mostly 600-gig product within that mix for telco. Is that correct?

It's a mixture of 400.

In Datacom?

Yes, yes mostly 400 gig, yes.

In datacom that's 400 gig but what about on the telecom side?

On the telecom side yes, that will be 400 gig.

Majority 400 gig, yes. Excluding the 600 gig that 1.2 terabytes that's excluded from the number Seamus just quoted.

Thank you.

Thanks, Alex.

Thank you. Our next question is a follow-up from John Marchetti of Stifel. Your line is open.

Thank you very much. Seamus, I would like to follow up on the Israel site. It appears to be a shift from the previous quarters, where it seemed like there was a reduction in expectations. I'm curious if something has changed in the environment or if you've identified an opportunity that prompted a decision to advance, altering what I believed to be the trajectory of that business. Additionally, could you comment on the expected mix of revenue there? I'm interested to know if you are primarily targeting non-optical revenue in this market, or if it will resemble the Fabrinet West approach, which had a mix of various types.

Good question. I think regarding the timing and trajectory, we've always been quite optimistic about establishing our facility in Israel. The main issue has been finding the right location. We believe Israel is an excellent choice, as we currently have three or four existing customers there, and we aim to meet their needs while also expanding our business. Our customers have expressed strong support for our plans. The delay was primarily about locating an ideal site. There are several government incentives to build in less suitable areas for us. As demonstrated by our work in Fabrinet West, being situated in the right place is crucial, and it's the same case in Israel. We have now successfully located the right spot. As for the customer mix, all of our current customers are optical communications companies.

And mostly datacom.

Yes. And mostly datacom. Our existing Israeli customers are all optical communications companies mostly datacom. So, we would be looking to obviously continue to grow business with those companies and add other communications companies, but also other non-communications companies that are in our technology sweet spot if you like of precision complex products, it's just LIDAR and other applications. And we're not limiting ourselves to optical, but we are limiting ourselves to high-technology complex infrastructure type products that will be transferred to Thailand.

Thanks, very much Seamus.

Thanks, John.

Thank you. We have a follow-up question from Tim Savageaux of Northland Capital Markets. Your line is open.

Thanks. Wanted to focus back on your commentary on the pipeline, and I wonder if you can give us an update as to what extent kind of customers OEMs moving supply chains out of China is contributing to that pipeline I guess. In past calls, you characterized that is a tailwind, but pretty far out. I wonder if now that another quarter has passed, if you can give us an update on kind of what type of opportunities you might be seeing from this kind of shifts in global supply chain. Thanks.

I would say that's still a positive factor, but progress is still quite slow. Some of the pipeline I mentioned earlier is due to that, but it's primarily about continuing to grow our business with existing customers while also bringing in new ones. We have several significant opportunities in the pipeline, and we are particularly excited about moving into full network systems. The business we transferred from Berlin has given us experience in that area. We have other projects in that same space as well, so we believe we are uniquely positioned in our industry to approach full system builds from the ground up. We are creating the most complex high-technology components within the network system, which makes it logical for us to move up to producing the modules for the complete systems that correspond with that. This is largely what we are targeting, and we have some exciting opportunities there that we are actively pursuing.

If I could quickly follow up on that, I assume your comment about progressing to the full systems level is primarily focused on optical communications and optical transport, or are there other areas within the networking landscape that you view as opportunities?

We primarily focus on optical infrastructure equipment rather than becoming a major producer of general systems like storage equipment, as that isn't where our strengths lie. It makes sense for us to engage in this area when we are responsible for a significant portion of the high-tech components that go into those systems. We don't envision ourselves merely as assemblers; we see ourselves as creators of sophisticated technology and components. This perspective supports our ability to produce complete systems. Does that make sense, Tim?

Sure, it does. Thanks very much.

Thank you, Tim.

Thank you. At this time, I'd like turn the call back over to Seamus Grady for any closing remarks. Sir?

Thank you, operator. Thank you all for joining our call today. We're excited to deliver strong results and a positive outlook as we continue to position the company for continued growth and diversification over the longer term. And we look forward to speaking with you again soon. Thank you and goodbye.

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