Fabrinet (FN) Q3 2022 Earnings Call Transcript

Fabrinet  (NYSE: FN) Q3 2022 earnings call dated May. 02, 2022

Corporate Participants:

Garo Toomajanian — Investor Relations

Seamus Grady — Chief Executive Officer

Csaba Sverha — Chief Financial Officer

Analysts:

Alex Henderson — Needham — Analyst

Unidentified Participant — — Analyst

Presentation:

Operator

Good afternoon. Welcome to Fabrinet’s Financial Results Conference Call for the third Quarter of Fiscal Year 2022. 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 provided 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.

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 third quarter of fiscal year 2022, which ended March 25, 2022. With me on the call today are Seamus Grady, Chief Executive Officer; and Csaba Sarah, 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.

During this call, we will present both GAAP and non-GAAP financial measures. Please refer to the Investors section of our website for important information, including our earnings press release and investor presentation, which include our GAAP to non-GAAP reconciliation.

In addition, today’s discussion will contain forward-looking statements about the future financial performance of the company. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from management’s current expectations. These statements reflect our opinions only as of the date of this presentation, and we undertake no obligation to revise them in light of new information or future events except as required by law.

For a description of the risk factors that may affect our results please refer to our recent SEC filings, in particular the section captioned Risk Factors in our Form 10-Q filed on February 1, 2022. 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, Seamus?

Seamus Grady — Chief Executive Officer

Thank you, Garo. Good afternoon everyone and thank you for joining us on today’s conference call. We delivered a solid third-quarter performance with strong execution from the team. Our supply chain headwinds continue to offset a very strong demand environment. Revenue in the quarter was $564.4 million dollars, which was within our guidance range and grew 18% from a year ago and was essentially flat sequentially. Operationally, we continue to perform at a very high level, which contributed to record non-GAAP operating margins of 10.5% in the quarter, resulting in non-GAAP net income of $1.50 per share.

Looking at the quarter in a little more detail demand across all our product categories remains robust with supply constraints remaining our biggest obstacle to higher growth. During this period of component shortages, our team has done a terrific job managing these constraints to better serve our customers. One way we do this is to help our customers source and qualify alternative parts and materials for products we manufacture for them. Sometimes, these substitutions are very straightforward and at other times more complex products can require re-qualification and validation not just by our customers, but by their end customers as well.

During the third quarter, certain customer programs were delayed by these component re-qualification efforts adding an estimated $15 million supply chain-related headwind to the $30 to $35 million supply chain impact we had previously estimated. The good news is that these alternative components have since been fully qualified and we have already resumed shipments of the associated products, meaning that the revenue has essentially shifted from the third quarter to the fourth.

Now let me provide some additional color on the third quarter. By end-markets, we had another strong quarter for optical communications. Telecom revenue grew both sequentially and year-over-year and datacom revenue grew from a year ago, but declined sequentially as this was the area most impacted by the component re-qualifications, I just discussed. Non-optical communications revenue grew both sequentially and year-over-year to the highest level in our history, driven primarily by strong automotive revenue, which was up more than 10% sequentially. While we have no direct business in Russia or Ukraine, our automotive business saw a small impact in the quarter from customers with other suppliers in the region.

Turning to capacity expansion construction of Building 9, our new 1 million square feet building at our Chonburi campus is nearly complete. This building increases our total footprint by approximately 50% to more than 3 million feet, which will provide us with ample capacity to meet demand from new and existing customers for some time. In fact, we’re excited that certain existing customers experiencing rapid growth are already in discussions with us to expand into the new building. More on this during our Q4 earnings call.

As we look at the fourth quarter more broadly, a strong momentum across all of our business is continuing. Our team continues to do an excellent job managing component supply issues but these supply chain constraints, have not shown any signs of improvement. And if anything are increasing. As Csaba will detail in a moment, our revenue guidance for the fourth quarter would have been $40 to $45 million higher, if not for these headwinds, which have grown substantially since the beginning of the year. That said, we expect it to continue to benefit from our enviable track record of execution that drives industry-leading margins.

In summary, I’m very proud of our team’s strong execution both in managing supply constraints as well as delivering industry-leading margins with the demand trends that remain very strong across the board. We are confident that we can deliver top and bottom-line growth in the 4th quarter including record profitability. Now I’d like to turn the call over to Csaba for additional financial details on our third quarter and our guidance for the fourth quarter of fiscal 2022. Csaba?

Csaba Sverha — Chief Financial Officer

Thank you, Seamus. And good afternoon everyone. Demand trends in the markets we serve continue to be very healthy. As reflected in our 18% growth from a year ago, while demand continues to increase, supply-related headwinds also grew in the third quarter, resulting in a slight sequential decrease in revenue to $564 million, which was within our guidance range. Another quarter of strong execution produced non-GAAP earnings per share of $1.50 which was consistent with the prior quarter. By end market, optical communications revenue was $440 million, down 2% from last quarter, but up 22% from a year ago. Within optical telecom revenue of $358.3 million increased 2% sequentially. Datacom revenue declined 17% to $81.7 million due primarily to the re-qualification delays that Seamus discussed.

By technology, silicon photonics revenue was $149 million, on 8% decreased sequentially reflecting the datacom revenue decline. At 26% of total revenue, our silicon photonics mix was the second-highest in our history. Revenue from products rated at speeds of 400 gig or more was up modestly from Q2 reaching a new record of $184 million. Revenue from 100 gig product dip 11% sequentially to $126 million. Non-optical communications revenue was up 7% sequentially to $124 million and represented 22% of total revenue. Within Nonoptical communications, automotive revenue was $53.3 million, up 13% from last quarter and the industrial laser revenue was $39 million, which grew 9% sequentially.

Other non-optical communications revenue moderated slightly to $32.1 million. As I discuss the details of our P and L, expense and profitability metrics provided are on a non-GAAP basis unless otherwise noted. A reconciliation of GAAP to non-GAAP measures is included in our earnings press release and investor presentation which you can find in the Investor Relations section of our website.

We executed very well in the quarter. Gross margin reached 12.7% and by further assisted by a slight foreign exchange tailwind. Operating expenses in the quarter, we have $12.6 million or 2.2% of revenue. This resulted in record operating income of $59.2 million or 10.5% of revenue. Effective tax rate was 5.4% in the third quarter and we continued to anticipate that our tax rate for the fiscal year will be approximately 3%. Non-GAAP net income was $56.2 million or $1.50 per diluted share, which is consistent with our record second quarter performed. On a GAAP basis, net income was $1.35 per diluted share.

Turning to the balance sheet and cash flow statement at the end of the third quarter, cash, restricted cash, and investments were $515.1 million, down $5.1 million from the end of the second quarter. Operating cash flow was strong $50.4 million with capex of $23.5 million, free cash flow was $26.9 million in the quarter. During the quarter, we increased our buyback activity and repurchased 239,000 shares at an average price of $102.4 million for a total cash outlay of $24.4 million. As a result, $52.3 million remain in our share repurchase authorization. Now I will turn to our guidance for the fouth quarter of fiscal year 2022.

As Seamus indicated demand for our services remains very strong across our business. We anticipate revenue in the range of $570 to $590 million in the fourth quarter. This guidance includes the impact of growing supply constraints which we estimate to be $40 million to $45 million in the fourth. We are optimistic that our strong execution will extend into the fourth quarter and we anticipate non-GAAP net income to be in the range of $1.52 to $1.59 per diluted share.

In summary, we are very well pleased with our strong execution and the positive demand trends we continue to see across our business. We are optimistic that despite increasing supply chain pressures, we will be able to deliver sequential growth in both revenue and profitability in the fourth quarter. Operator, we are now ready to open the call for questions.

Questions and Answers:

Operator

[Operator Instructions] Our first question comes from Alex Henderson with Needham.

Alex Henderson — Needham — Analyst

Thanks. So I wanted to go to the re-calibration on the datacom products and recalls often take quite a bit of time, was the total impact of that in the March quarter, or does that also cover into the April quarter, and so it’s holding back the June quarter somewhat as well, so that the full qualification processes will probably impacts positively somewhat sequentially June [Phonetic] quarter, but also positively impact the September quarter.

Seamus Grady — Chief Executive Officer

Yeah, Alex. This is Seamus. I think the impact was in the Q3. The full impact was in Q3. Unfortunately, the qualification took a little bit longer than we would have liked right at the end of the quarter. So we weren’t able to catch up, but it’s behind us now. So the full impact — the full impact was in Q3, and therefore the full benefit will be in Q4.

Alex Henderson — Needham — Analyst

Okay. There is no additional supply constraints that are created by those re-qualifications that actually helps mitigate some of the supply constraints? Is that right?

Seamus Grady — Chief Executive Officer

Yeah, that’s correct. There is no additional constraints due to that particular qualification. That’s not to say there won’t be others that will pop up from time to time and certainly other supply constraints, but that particular specific issue is done and behind us.

Alex Henderson — Needham — Analyst

Okay. So clearly the lockdowns in China, on top of everybody’s mind in terms of supply chains and pretty difficult for us to evaluate. So can you give us any kind of quality comments around the degree to which you might have things that are embedded in your products that are derived out of China, that might be impacted, like circuit boards and things of that sort? What portion of your supply chain is emanating out of China and is it exposed to either the two regions that are currently being talked about there has been a lockdown most aggressively.

Seamus Grady — Chief Executive Officer

I think our — I mean, the proportion of our supply chain would be similar to other contract manufacturers the lockdowns that certainly exacerbated the global supply chain issues, but the impact on us has not been very significant thus far in Q3. The biggest supply headwind continues to be from just standard — fairly standard parts as increase in demand puts more pressure on supply chains. Now that was further stretched by the timing of the re-qualification issue that we talked about earlier.

And again while [Phonetic] the re-qualifications are complete, we expect additional headwinds from increased demand will persist into Q4. And probably beyond that actually and an impact of — we’ve included an impact of $40 million to $45 million in our Q4 guidance due to due to supply chain headwinds, but we haven’t been hugely impacted by China. I think again towards the end of the quarter, we had to do a little bit of scrambling. I would say while the lockdown was going on in Shenzhen. It impacted more logistics than actual component supply. A lot of — lot of material comes through Shenzhen, but we were able to scramble and recover from that. But thus far we have not been significantly impacted by the lockdowns in China.

Alex Henderson — Needham — Analyst

That’s good to hear. One last question, I’ll cede the floor. Can you talk a bit about the system market, how much of you benefited what’s going on relative to the systems to ramp from the existing customers, and then when you think about your outlook and your degree to which you’re impacted by that $40 million to $45 million, how are you taking into account the 50% to 100%, of a full-year product in the backlog at those companies. I assume that that’s not reflected in your numbers in any way or in that $40 million to $45 million.

Seamus Grady — Chief Executive Officer

No, because I think what’s maybe more interesting is the backlog that they have. Yeah. It might be a full year’s backlog, but unless that translates into a huge increase for us, it’s not particularly relevant to us. We continue to pursue new system wins at existing customers and new customers. In situations where we’re already making a lot of the content that’s where it makes more sense for us and where we can be most effective and more successful, timing of the new wins, it’s very hard to predict as you know, Alex, and they usually driven by some sometimes some external catalysts are external factors. So we’re optimistic that there will be more system wins in the future. We can’t guess as to when that might be, but the demand remains strong. Overall, the demand remains strong. Very strong, I would say and the — the only thing limiting our revenue and our growth right now is component supply.

Alex Henderson — Needham — Analyst

So on the system side, it is apples to apples at this point, we’re not seeing any extraordinary growth as a result of new systems lines coming in as opposed to the customers that you have won, you have now fully up on what projects they had. Correct?

Seamus Grady — Chief Executive Officer

That’s correct, and there are the two big ones that we’ve talked about in the past are essentially grandfathered in at this point, and the growth that we’ve been seeing, nice growth. If you look at our year-on-year growth, it’s very nice growth, it’s without those systems in Q3, without additional growth with those systems in Q3.

Alex Henderson — Needham — Analyst

I see, thank you.

Seamus Grady — Chief Executive Officer

Thanks, Alex.

Operator

[Operator Instructions] Our next question comes from Samik Chatterjee with JP Morgan.

Unidentified Participant — — Analyst

Hi, this is Angela Jen [Phonetic] on for Samik Chatterjee. Thanks for taking my question. On the gross margin line, you’ve posted the highest gross margin that we’ve seen in years. We are wondering is there pricing [Indecipherable] on gross margins, how are you maintaining high gross margins despite all the current supply issues?

Csaba Sverha — Chief Financial Officer

Hi, Angela. This is Csaba. Yes, so we indeed benefited from ongoing cost reduction efforts mainly on our gross margin line. So there is no pricing or whatsoever. We typically pass on the supply-related headwinds on our customers without marking them up. So there is definitely no pricing-related tailwinds coming through the gross margin line. So we continue to improve our cost structure and improve the gross margin and in addition, in the last quarter, we saw a 20 basis point benefit from exchange rates. So most of our labor cost base is in Thailand and we saw a depreciation in the last six to nine months as we are executing our hedging strategy, we were able to drop an extra 20 basis point to the bottom line, in last quarter.

Unidentified Participant — — Analyst

Got it. So barring that you’d be about 12.5% and that’s what you posted in the last quarter. So I guess the new question becomes, is it sustainable this for 12.5% gross margin or even beyond that moving forward.

Csaba Sverha — Chief Financial Officer

Obviously, we are not guiding gross margins, but we are working hard to continue our cost reduction efforts and obviously, the exchange rate is rather unpredictable. So I would say the best way to think about it, we have been executing our strategy in terms of cost reduction and maintaining [Indecipherable] in our target gross margin range. So I think the best way to think about it is to really look forward on these cost reduction efforts and if we see any benefits from exchange rates we will be communicating and articulating that.

Unidentified Participant — — Analyst

Okay, got it. And then just quickly before I cede the floor in that $40 million to $45 million, in supply headwind is any part of that embedded sort of impact from Russia, Ukraine, or China or any of that macro and is it possible to sort of give us a window into how big that impact might be or become?

Csaba Sverha — Chief Financial Officer

Yeah, no not on the supply side. We don’t have any suppliers in either Ukraine or Russia. Some of our customers, particularly on the automotive side were impacted because they source a lot of cables and cable harnesses out of Ukraine in particular, but we haven’t been impacted directly, we don’t have suppliers in either Ukraine or Russia.

Unidentified Participant — — Analyst

Okay, got it. Thank you.

Csaba Sverha — Chief Financial Officer

Thank you.

Operator

I’m showing no further questions in queue at this time, I’d like to turn the call back to Seamus Grady for closing remarks.

Seamus Grady — Chief Executive Officer

Thank you for joining our call today. We’re optimistic that as we continue to navigate supply chain constraints impacting the industry, strong demand trends and excellent execution from our team will result and record top and bottom-line results in the fourth quarter. We look forward to speaking with you again. Goodbye.

Operator

[Operator Closing Remarks]