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Don’t be surprised if you walk into a Fabrinet manufacturing plant and recognize someone from JDS Uniphase. The Thailand-based EMS company has purchased no less than six plants from JDS, one of its biggest customers. It’s one big reason why, starting with its January 2000 acquisition of Seagate’s 230,000 sq. ft. plant in Bangkok, Fabrinet has more than tripled its global manufacturing capacity and leveraged its skills building disk drives into optical components and medical electronics.

In February, chief financial officer Mark Schwartz shared some of the lessons Fabrinet has learned over the past six years.

MS: JDSU has actively sought to restructure its operations over the past several years. As their manufacturing partner, we have assisted where our expertise in product transfer could accelerate the wind-down of manufacturing operations. In December 2004 we acquired two JDSU factories in Asia [in Singapore and Bintan, Indonesia]. In May 2005, we acquired plants in Fuzhou, China, and in Mountain Lakes and Ewing, New Jersey. We have since closed all the factories but CASIX in Fuzhou, China, and VitroCom in Mountain Lakes. And we announced [on Feb. 15] the acquisition of the manufacturing operations of its Ottawa plant and we will wind this location down too.

In Singapore and Indonesia, JDSU had great factories. We wanted to find a way to maintain at least the design teams. The cost of operating the two factories together was within 10 or 15% of our costs in Thailand. But the products were similar to the products we were building for JDSU in Thailand and it made more sense to drive to scale, and aggregate production in Thailand. The personnel in Singapore and Indonesia were very capable; they could have done the job too.

The CASIX acquisition in China was interesting on a lot of levels. It gave us our first footprint in China. CASIX fabricates base optical components, namely fabrication and coatings for waveplates, laser crystals, optical prisms, windows, lenses, mirrors and beamsplitters. We were their seventh largest customer before we acquired them. Our customers today tend to want to move up the food chain; for example, those at the component level trying to get into higher level modules and even some system builds. For us, it was an opportunity to get into a product area that didn’t compete against our customers.

Similarly, VitroCom is a producer of custom and standard borosilicate, clear fused quartz, and synthetic fused silica glass tubing and rods. Both acquisitions provide Fabrinet with control over critical sources of supply by vertically integrating our supply chain. From a management perspective, the GMs of both companies report directly into our CEO and both GMs have weekly calls with Fabrinet’s management team to review quarterly and annual objectives.

MS: In every case where we have done this, JDSU has communicated openly with its employees about the transition or the wind-down of operations. At every opportunity we have to communicate with the employees prior to closing, we try to demonstrate that we are mindful of the circumstances, sympathetic to the impact it has on each employee and their families, and, perhaps most importantly, that what we say is honest and the best information we have at that time. We believe it is important to earn the trust of each employee and make them comfortable with their decision to become an employee of Fabrinet. So, for example, we work hard to ensure that, where possible, all benefits and company policies remain the same, such as salaries, pay scales, pay periods, health and insurance benefits: we try to duplicate as best as we can what currently exists. When we tell employees these things – that salaries won’t change, that if you expect a pay raise you’ll still get it – and follow through, that’s how we start to build the right relationship. In most situations, I believe the employees really felt that we cared, which we did and do. We strive to take the stress out of the situation for each employee as best as we can.

So every week, no matter where the site was, we’d travel to the site and have an all-hands meeting. By the third or fourth meeting most people felt what we were telling them was true, and by that time they’d seen or heard from the payroll and benefits companies, which is critical for their families. We always try to keep continuity in management, even in China. The intent is not to revamp management but to use the best that exists. In Singapore we borrowed one of the senior JDSU managers to lead our team, because they recognized him and they knew him, rather than bringing in someone totally new, which could have been even more disruptive. In North America, we’ve brought in some outside folks that have either joined the team or have special areas of expertise. In Ottawa, complex manufacturing processes will be transferred to Asia and Europe. So on our team we have a dedicated transfer director with over 20 years experience in process transfers. Another member of our team has similar experience in the transfer of equipment and inventory.

We approach each acquisition on two different levels. There’s the technical level, the product and the transfer. And there’s the HR aspect, which is certainly more critical upfront. We have to be sure everyone is willing to be frank with us on potential technical concerns and cost drivers such as product yield or manufacturing cycle time, as well as any concerns we need to be aware of in the product transfer. So to get the comfort level from the employees is critical.

On the HR side, as factories wind-down, we often plan job fairs where we bring in companies from the local area that might be hiring, as well as provide career training and placement services.

MS: Since we acquired our first factory in China in May of 2005, I don’t know if we have enough experience in China to provide a comparison. Communication in both geographies is the key. We’re still learning some of the political and financial processes in China, like exporting and importing goods. We had always heard to beware that the rules change every day, but in our experience I don’t think that is actually true. The rules are not very different from what we see in Thailand and other places. You have to pay your taxes, keep accurate records, be a good citizen.

One difference between China and Thailand is the ease of obtaining visas in Thailand for travel to foreign countries. In many cases, we ask our engineers and operators to travel to our customer sites for training or support. Typically, our Thai folks are able to obtain visas in shorter time and with fewer difficulties.

MS: I would suggest much less emphasis has been put on automation. The demand, generally, for optical communications components and modules, has not again reached the levels of 1999 – 2000. Automation is volume driven. So companies performing their cost-benefit analysis relative to automating process steps, have in many cases opted not to invest in automation. We have not seen significant deployment of automation in legacy products, although the current generation of new products, showing signs of stronger demand, is taking advantage of automation where cost effective. Certainly we have witnessed improvements in fixturing, alignment, jigs, but overall, the assembly line today doesn’t look much different than it did five years ago.

MS: Tom Mitchell was one of the founders of Seagate and its president from the late 1970s through 1991. Fabrinet was his idea, spawned from a visit in 1999 to an optical assembly plant in Taiwan. As he tells it, the assembly lines reminded him of a disk drive manufacturing line from the 1980s. Tom saw an opportunity to take the lessons learned from the disk drive manufacturing world and apply them to optical communications components and modules.

In terms of looking for the right manufacturing environment, the assembly of optical components didn’t require an SMT factory. What we needed were the engineering and manufacturing skill sets from the disk drive industry that could be leveraged into optical components and modules: cleanroom disciplines, soldering and epoxy proficiency, mechanical assembly skills, process engineering. When Tom acquired our first factory in January 2000 from Seagate, along with approximately 1600 manufacturing engineers and operators, we had almost no optical engineering knowledge. But our customers were willing to train our employees because of the manufacturing technologies we brought to the table. Of course, in the past six-plus years we have acquired expertise in manipulating light and assembling optical devices.

You do hear a lot of comparisons between semiconductors and optics, though very few on our team are from [the former]. By and large our manufacturing skill sets came from assembling disk drives.

As an example, our workforce had proficiency in soldering, from building disk drive assemblies such as hydrodynamic motors. These motors required very precise soldering and alignment tolerances that exceeded, in many cases, the requirements for the assembly of optical devices. So when we brought companies such as JDSU to Thailand for the first time to understand our capabilities, they saw our proficiency in areas such as soldering. It made sense that the transition for our skilled operators from the manufacture of mechanical disk drive assemblies to optical products would be easier than training folks from a standing start. Our manufacturing processes really reduced the learning curve.

MS: IP protections are provided to every customer. Most of the protections are driven by our customer’s demands, starting shortly after we began operations, where Company A wasn’t so excited about having their products manufactured in the same building as Company B. So we were instructed that if we maintain proprietary protections A, B, C, etc. then they would be comfortable with having their product manufactured on the same manufacturing campus as their competitor. So in that respect, our earliest customers drafted our IP protection policy. It still varies from customer to customer. Documents may be protected differently, engineering or manufacturing areas may have fogged windows, keycard entry, dedicated employees, etc.

MS: I’m not in a position to comment on it. I know that our supply chain spends a lot of time trying to understand the technical requirements and the liabilities with our customers and supplier partners. Our contracts with customers generally relieve us from liability for excess materials, but that is a discussion we would rather not have with our customers. Getting everyone on the same page with respect to when those lead-free components cut in, for example, is more productive. You can’t have any surprises with your customers.

MS: We’re constantly reflecting on and reviewing the lessons learned. Particularly in a factory wind-down, you are organizing a company with a short lifespan, and establishing and maintaining your corporate books and records to reflect the nature of the organization. One critical area is tax. Determining the allocation of earnings for the goods and services created and delivered in each domicile, so all the revenue collection organizations involved properly understand your tax obligations and agree with your position. Another critical area is in financial reporting. Our accounts are maintained under U.S. GAAP and we review each transaction with our auditors. It can be a frustrating experience, as GAAP rules do not always allow a company to portray a transaction in a way that is most meaningful for shareholders and others to absorb. It is something we struggle with and something we’re learning to deal with each time. While the net profit and loss from any particular transaction is accurately represented, the road to get there has all sorts of twists and turns and footnotes and comments. I’m left to wonder, on occasion, if GAAP reporting accurately portrays the financial state of a company, particularly at the gross margin line. I’m sure this is a concern many CFOs share.

Business terms and conditions dictate accounting and tax treatment. But there are often alternative business terms that are preferable from an accounting and tax perspective, with little or no impact on the business objective. At the front end of a transaction, we try to structure the agreement documents to clearly tell the story of the transaction for all downstream parties to understand. “Telling the story,” often in the agreement’s preamble, assists in answering the inevitable slew of questions from accounting and tax folks and can get you, in a timely manner, to the proper accounting treatment of the transaction. While the tail should not wag the dog, you must consider the business objectives in parallel to the tax and accounting treatment. In international transactions, every jurisdiction has different laws in terms of notice obligations, severance obligations, etc. Having both a legal and finance background is helpful to me in anticipating issues and probable outcomes.