Fabrinet (FN) Earnings Call Transcript & Summary

So we haven't actually quantified it. It's in our communications infrastructure category, but it's a very important and fairly rapidly growing segment for us. We've been producing products in that space for several years. We have a couple of major customers there. So it's significant. It's a significant and important category for us, and it's one that's growing fairly rapidly as well. And again, it's right in our kind of wheelhouse of capability. And of course, the nice thing about the low earth orbit products is they're in low earth orbit, so they eventually get pulled into the earth's atmosphere and disintegrate and have to be manufactured again. So it's a really good fit for us, and we have a couple of really good customers there that we're growing nicely with.

I'm just going to read the next question that directly comes from the audience. And I think these are not exactly the way that I would ask them, but I'm just going to ask it and get your answer. What does NPO mean for you? Are you just assembling the ELSFP? What are the different revenue streams for NPO? And can this increase the gross margins? Now I don't think about you having kind of mixed gross margin, right? I feel like you have a fixed gross margin, but I should let you...

No, I mean NPO would be much better gross margin than the traditional business because it's much higher value-add content. If you take the COGS, the typical COGS on the product we make, hence the product, but let's assume it's -- if the COGS is 100%, let's assume that 70%, 80% material, 20% value-add. For NPO, it's much higher value-add content and much lower material content because the material, in many cases, is a wafer, which would be consigned by the customer, and then we take the wafer, we singulate it, we do the packaging and the testing at the die level and at the device level. So it's a much higher value-add content, probably lower ASP but higher margin. So it's a very good business for us. It's difficult for us to talk with any kind of credibility of what we'd actually be doing because we'd be disclosing what's going on with individual customers. But NPO, we believe should be a very good revenue driver for us in years to come. And like I say, it's a good margin enhancer. Our relationship with Raytek, we think, will be an important development in that regard. Raytek, very good -- they're a very good company. They will be setting up an operation on one of our campuses in Thailand in the coming months. So that's a critical and important part of our ability to provide these essentially kind of precision packaging services to our customers in regard to NPO and also CPO. And ELSFP, of course, is -- it's a product category that's -- it's more kind of like -- it's like -- somewhat like a traditional transceiver. They're not that complicated. ELSFPs are not that difficult. But there's a lot more opportunity for us in NPO than just ELSFPs.

Such as?

The packaging of the devices that I talked about.

Yes. And then, I mean, is there anything -- could we have just substituted NPO and CPO there? And -- or is there anything to add on CPO?

Yes, somewhat. They're quite similar. I think NPO is probably a little bit more straightforward than CPO. But they're both -- we're pretty excited about both opportunities and our ability to kind of win and grow with the customers there.

Great. And now I mean the -- I mean, look, the stock is down today. I mean there might be other reasons in the market, interest rates and things like that, but it's -- I mean, I simply think that we're just getting over this fixation with NVIDIA, right? So the good news is that we won't have it anymore after this, right? We'll move past this. But I mean, the growth here is incredible. And I think in response to a question, you said it's not beyond the bounds of possibility that FY '27 could grow faster than FY '26. And I guess, what would you have to -- we're really early in '27. So what would we have to see to know whether it could be even faster? And is there a capacity issue with growing even faster than last year? Would we run up against capacity issues? And then I guess I'm asking too many questions at once, but now going to an audience question, exiting fiscal '27 with Building 10 and the capacity expansion, what's the potential revenue run rate exiting the fiscal year?

So maybe I'll separate capacity from the revenue run rate because we don't forecast the revenue run rate a year from now. We only forecast one quarter at a time. And our forecast for Q1 is whatever we said in our guidance. The answer I gave was actually in response to a question from Tim during the call around is it beyond the bounds of possibility that -- or something along those lines that our growth in FY '27 could be even higher than our growth in FY '26. Our growth in FY '26 year-on-year was, I think, 36%? Csaba, is that right? 36%?

Right.

And it is not beyond the bounds of possibility that we could grow at a faster pace in FY '27. That's not a forecast. That's not guidance. But certainly, from a demand point of view, the growth looks to be very strong. in order for the growth to happen, a few ingredients have to be in place. One is the demand has to be there. That's for sure, the demand is there. Secondly, we have to have the capacity, and we have the capacity and we will have the capacity, and I'll walk through in a moment the capacity additions that we're making. And then we have to execute. The products have to work, and we have to be able to get components and all that stuff as well. But usually, the biggest challenge is demand. If we have the demand -- our history has been, if we have the demand, we execute, and we can deliver on that. So the demand looks to be there. We just have to make sure we can get the components and we can execute. And the really important message, I think you're exactly right, we want to get away from this obsession with NVIDIA and the growth is staggering and the diversification is also excellent. And the financial performance of the company is excellent. Everything is excellent. And yet the industry seems obsessed with NVIDIA. We're not a proxy for NVIDIA. We never have been. We never claim to be. In fact, we always say we're not a proxy for NVIDIA. But I think the more we say we're not a proxy for NVIDIA, the more people think we are. And we're not. We are a contract manufacturer who serves multiple customers, one of whom is NVIDIA, they're a very important customer for us, but we have several other customers as well. In terms of capacity, right now, our run rate at the end of Q4 was $5.3 billion, if you take our Q4 revenue times 4, $5.3 billion. Our capacity right now is for about $5.8 billion, which is our run rate at the end of Q4 plus the additional capacity we added in Pinehurst by converting offices into manufacturing space. So our capacity right now is about $5.8 billion. Building 10, when that's fully available, that will give us capacity for about another, at the high end, call it, about $3.5 billion of capacity. Nava, the new factory in Nava Nakorn, adds capacity for about $250 million. And then our Santa Clara operation that we just acquired will add capacity for about another $250 million. So if you add all those together, $5.8 billion plus $3.5 billion plus $250 million and another $250 million, that gets you to $9.8 billion of capacity in calendar Q1, let's say, in the March quarter -- early in the March quarter, actually. So that's an 85% increase versus where we ended the year in terms of capacity. So we certainly have the capacity to continue to grow and scale. And then beyond that, Building 11, which -- we haven't announced Building 11 yet, but Building 11, were we to pull the trigger on Building 11 will take probably 18 months to build, and that will add capacity for another $2.1 billion of revenue approximately. And the same for Building 12. So if we were to move ahead with those capacity adds, they would take about 1.5 years, about 18 months each. So over the next kind of 3 years, on top of the $9.8 billion of capacity that we'll have at the end of this year, we would be able to add another $4.2 billion, which would take us to $14 billion -- approximately $14 billion of capacity over the next few years of capacity, not a revenue forecast. But that's the first step for us to make sure we have the capacity ahead of the demand. And it's not a case of there's no field of dreams. It's not like if you build it, they will come. They are already here. The customers are here. They want the capacity. They want us to ramp with them. we have the demand in front of us. So we just have to make sure we keep the capacity coming on ahead of the demand and make sure we ramp it appropriately. We're also looking for more -- even with all of that, we're still looking for more land in Bangkok, in Thailand and looking to expand beyond our current footprint.

So I mean, you said the customers are here, the demand is here. But how much of that is actually orders versus forecast? Is there any kind of prepayment? Is there any kind of -- I guess the real question is, as the CEO and as you sit here, I mean, you've already -- you're already executing on Building 10. And it's very unusual, right, for you to talk about 11 and 12. In old days, that would never happen, right? I mean that shows we're in a new environment that you're even discussing 11 and 12 right now. But then to actually make the decision, yes, we're going to do this because we know the customer demand and it's not going to just instantly go away for some reason. I mean, how do you -- what are you watching and making these decisions?

Well, it's actually a really straightforward kind of calculus for us because it's -- the downside risk is tiny and the upside opportunity is immense. If you take the economics of Building 10, for example, and you can then extrapolate that for Building 11 and Building 12. Building 10, and Csab, please stop me if I get these numbers wrong, Building 10, it's about a 2 million square foot factory. It is revenue capacity for, I think we said about $3.5 billion of revenue. So the upside opportunity is the profit -- the operating profit that we're able to generate when we ramp up in Building 10. So it's immense. The downside risk, even if Building 10 were to sit idle, which it won't because we're actually already starting to install equipment. We're starting to get going on level on floor one of Building 10 already, and we'll start to occupy floor 3 in October. But anyway, even if Building 10 were to have sat idle, the gross margin headwind is about 15 basis points. So the downside risk is negligible. And the upside opportunity, just to put it in context, just over 5 months' worth of operating profit at full run rate we pay for the whole factory. So from an investment point of view, it's a really excellent use of the company's cash, leave aside the fact that we have to have this capacity for our customers. So the downside risk is tiny and the upside opportunity is immense. The downside risk, if we don't put this capacity in place, customers will have to go somewhere else and we lose out of the opportunity. So it's a very straightforward decision for us. Yes, ordinarily, we don't talk about buildings until we're ready to pull the trigger, but I think these are very different times. The demand is so huge. We do feel it's important to make clear that we will keep the capacity coming on ahead of the demand. I think at some point, there was a concern that were we building Building 10 too late. Initially, was it too soon? And then the question was, was it too late? And I think we'll find it was probably just at the right time, maybe just ahead of the demand curve. We do the same with Building 11 and Building 12.

Yes. I mean, generally, like what's the -- what's the CapEx for this? I mean, either -- I mean, the buildings are different sizes. So CapEx per building, I don't know if that makes sense. But it just seems like the dollar return per CapEx dollar spent is -- I mean, the investment here is obviously way lower than if you were building indium phosphide lasers, right, and to build those kind of fabs. I mean you're building manufacturing space, right? That's what this is. So how do we think about the CapEx?

We build the building, and that's the -- for Building 10, it's about $132 million, $133 million. But then the fit out of the factories within the factory, that takes place in concert with the customer. And typically, if it's generic equipment or standard equipment, we pay for it. If it's product-specific or unique equipment, we ask the customer to pay for it. But it's generally a fairly capital-light business that we have. Maybe, Csaba, if you want to talk about the CapEx for Building 10 and then what Building 11 or 12 would look like as well?

So again, our CapEx, again, going to cover the entire spend of CapEx for the last year was about $250 million. So we anticipate that to continue in the next fiscal year. Obviously, we are putting the capacity in place ahead of the demand. So we anticipate that the elevated CapEx levels to continue in the 2027. As you know that we have just acquired the Santa Clara facility for $75 million, $76 million. We are also finishing up Building 10. And obviously, as the fit-outs and all those equipments are going in, we anticipate that the CapEx spend in the next fiscal year to continue to be in this $250 million range. Obviously, we also have to be mindful about the ROIC that we generate. By adding this CapEx and financing the growth through our own cash, we have been still able to generate a very reasonable ROIC. I think it's in cost to 40% mark. So we continue to believe that investing in our own growth is the best use of cash as long as it generates the high returns of capital. So we continue to expect and we are comfortable financing it from our own free cash flow actually.

Okay. Super helpful. Csaba, let me ask you just about the first quarter EPS guide, right? Strong revenue guide, good EPS guide, but you talked about the EPS doesn't grow as much sequentially as the revenue does. And you said usual first quarter expense seasonality. Could you flesh that out more what that means?

Yes. So typically, in our first quarter, we increased our staff salaries and those merit increases are captured in our first quarter results. That has been the case for the past several years. So those seasonality -- [ external ] seasonality will be adding probably about 20, 30 basis point headwinds in the quarter. So that's the biggest change from a sequential basis. We did have some onetime other income in the prior quarter. So sequentially, those will not be included in our guidance. But fundamentally, that's the biggest element there, which is a temporary headwind. We anticipate that to make up with efficiencies throughout the year. So this temporary 20, 30 basis points are baked in our first quarter guidance.

And the investments in the buildings don't really have anything to do with it?

The investments in buildings, obviously, as we are shipping revenue from there, it doesn't provide any headwinds in our numbers. If the building were to sit idle, that would probably result a small headwinds in gross margin. But since we will be shipping products right away, it's not going to give any headwinds from investments.

And just in terms of sort of free cash flow, I mean, you have a lot of cash on the balance sheet, but with CapEx is elevated like this, there's not a lot of excess cash being generated. Are you comfortable with the balance sheet? I mean, is there any need to raise money?

We are very comfortable with the balance sheet. We still have ample of cash, and we also still have a lot of our cash is invested. Nevertheless, we took a small $75 million loan -- term loan just recently in August, we signed up with Thai Bank obviously to finance our growth in Thailand. So we are mindful about expanding our credit lines as well to make sure that we have ample of credit to support the growth and the business. But again, we are very comfortable with the balance sheet. And as you look at the last year free cash flow generation, it was somewhat $4 million. So again, it goes back to our strategy of reinvesting in the growth and financing it from our own capital. So we remain very comfortable with the balance sheet.

Okay. Great. What about just thoughts on buybacks here?

We have a structured buyback program in place. It has 2 legs. We have a 10b5 plan, whereby we fund the plan with the surplus cash that we generate from operating cash flow. Obviously, throughout the last year, that number hasn't been significant. And also, we also have an opportunistic buyback program. So we have, I think, $169 million left in our authorization. So we are committed to return the surplus cash through buybacks and opportunistically as we see fit.

Yes. The discussion earlier that NPO CPO could actually be a gross margin tailwind is very interesting and not even something I considered because I just thought your gross margins and operating margins would always be in a super tight range because that's the price that you charge, right? And there's very little OpEx and it's kind of like we charge a markup and this is it. So over -- I mean, without giving guidance, so it's hard to do, but I mean, could we get higher margins in the future than we have now? And if so, like would it be a meaningful impact? Or would we still be close to where we are now?

I think if you look at kind of what drives the margin, if you -- as the material percentage goes up in a particular product for any given product, the gross margin percentage typically comes down, even if the gross profit dollars goes up. So if you have a $10,000 product versus a $1,000 product and they have the same amount of value add in them or transformation, then the $10,000 material content product will have obviously more profit dollars, but a lower profit percentage, if that makes sense. And the point about NPO and CPO is they're more in the packaging than in the traditional contract manufacturing realm. So that business just by its very nature because it is a lot less material content, a lot more value-add activity, the margin tends to be a lot higher, the margin percentage. But then the ASP is lower. So you kind of trade one for the other. I think that more can really help the margin. But it's like everything else, you have to have a mix of that work. You can't have all -- you don't haul steak in your diet, but you don't haul fiber either if you're following. It's a bit like that. You're going to have a mix of business, a mix of higher volume, maybe lower margin business, but then this business would be much higher margin, but lower ASP. But we think very sticky business because these things are difficult to make.

Okay. Great. And I'm going to ask one more question from the audience that's here. And then just a final question to you from me. But the audience question, which again, I'm just going to read, how can we think about the 3 other customers in datacom, so not NVIDIA. Are these 1.6T? How do you think about share? And how much visibility do you have to the ramps?

So the non-NVIDIA customers in datacom, let's say, hyperscale direct and then merchant, they are mostly initially 800-gig short-reach transceivers and then moving to 1.6T in the future. But the initial -- our initial foray will be with 800 gig.

Do you spend any time thinking about share? I mean you're not going to have like a majority share at any of these customers. I don't imagine, unless there are small merchants, but I should let you talk, not me talk.

We don't overly analyze share. I mean, obviously, we want to have a decent share for us to be able to provide good service for the customer and for us to be an important supplier for them, we want to have a decent share. But we don't always -- it's not always easy for us to calculate the share. We tend to end up guesstimating the share and they don't always tell us what share we have. But certainly, we focus more on can we -- can we grow the business with the customer to a significant level, whereby we're able to provide them good service. If you're only doing $5 million or $10 million a year, it's very hard to provide good service for the customer if your revenue is down at that level. Whereas when you're up in the multi-hundred million level, it's much easier to have the right resources, the right team and infrastructure in place. So we're more focused on growing each of these opportunities to become a significant revenue opportunity and significant piece of business for us rather than obsessing about share.

Yes. Great. And then my final question, I mean, you just reported last night. Obviously, not the best stock reaction today, but this is just one day. So my question to you is just what message do you want to leave investors with as we start on this fiscal '27 journey?

Well, I think we have a track record of excellent execution over many, many years. We've gone from several years of double-digit compound CAGR. And then in FY '25, we had, I think, 19% growth, FY '26, 36% growth. While executing, we believe, better than anyone in our industry -- in the contract manufacturing industry. We have a track record of excellent execution and a really deep customer relationships that are actually expanding. We're growing both the number of customer relationships and deepening the relationships with those customers. So we have really excellent growth in front of us and a really excellent customer base and really good diversification. That's the message really. We're -- we believe we're a very good company. We run the company very well. We're very focused on doing an excellent job for our customers and hopefully providing excellent returns for our shareholders, and we plan to continue to do that.

Well, great. I really enjoyed speaking with you today, gentlemen. Keep up the great work. I look forward to following it more. And again, thanks for being here. We all appreciate it.

Thank you, Mike. We appreciate it. Thank you. And thanks for everyone -- thanks to everyone for participating. Thank you. Bye-bye.