Fabrinet (NYSE:FN) Q3 2023 Earnings Call dated May. 08, 2023.
Corporate Participants:
Garo Toomajanian — Vice President of Investor Relations
Seamus Grady — Chief Executive Officer
Csaba Sverha — Chief Financial Officer
Analysts:
Samik Chatterjee — JPMorgan — Analyst
Alex Henderson — Needham & Company — Analyst
Troy Jensen — Lake Street Capital Markets LLC — Analyst
Presentation:
Operator
Good afternoon, and welcome to Fabrinet’s Financial Results Conference Call for the Third Quarter of Financial Year 2023. At this time, all participants are in a listen-only mode. Later we’ll 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 like to turn the call over to the host Garo Toomajanian, Vice-President of Investor Relations. Please go ahead.
Garo Toomajanian — Vice President of 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 2023, which ended March 31, 2023.
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. 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 reconciliations.
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 7, 2023. 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 our call today. We exceeded our guidance for both revenue and non-GAAP EPS in the third quarter. Total revenue in the quarter was $665.3 million, an increase of 18% from a year ago. During the second quarter, supply headwinds impacted revenue by $30 to $35 million as anticipated. We continue to see a gradual loosening of component supply and we expect further improvements in availability over the next few quarters.
Our strong revenue performance and solid execution produced non-GAAP EPS of $1.94 in the quarter, above our guidance range, and up $0.44 from a year ago. Looking at the quarter in more detail, revenue was essentially flat sequentially for both optical and non-optical communications and there is a little better than our expectations. Within optical communications, telecom revenue decreased sequentially as anticipated. This was primarily due to specific component constraints, we called out last quarter impacting silicon photonics programs and to a lesser degree from ongoing commodity semiconductors constraints.
Datacom revenue was similarly affected by supply constraints, but the supply impact was more than offset by growth from some next-generation non-silicon photonics programs. As a result, we had a record datacom performance producing strong quarterly and year-over-year growth. For non-optical communications, our business was up more than 30% from a year ago and was relatively stable with the second quarter as we maintain strong automotive revenue levels.
Looking to the fourth quarter and beyond, we are not immune from the near-term inventory corrections being experienced in the broader optical ecosystem. While we are not approximately for the industry. We expect the impact of inventory absorption in some product areas to be a headwind to our revenue in the fourth quarter. On the other hand, we continue to see gradual improvements in component availability. Longer-term, we believe end-market growth drivers remain intact, and we continue to be optimistic about our position in the markets and our ability to execute efficiently.
In summary, we delivered strong third quarter results with revenue and non-GAAP EPS has exceeded our guidance. We are seeing some demand variability as a result of inventory adjustments in the industry, as well as persistence but improving supply constraints. We remain confident in our ability to execute in this environment and deliver strong financial results.
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 2023. Csaba?
Csaba Sverha — Chief Financial Officer
Thank you, Seamus, and good afternoon, everyone. Our revenue and non-GAAP EPS exceeded our guidance ranges for the third quarter. Revenue was $665.3 million, which was up 18% from a year ago and down 0.5% from the second quarter. Demonstrating the leverage in our business model, profitability grew faster than revenue. The non-GAAP earnings per share of $1.94, up 29% from a year ago and also above our guidance range.
Looking at revenue in more detail. Optical communications revenue was $502.6 million, up 14% from a year ago and slightly down from Q2 as anticipated. Within optical telecom revenue was $380.2 million, which was up 6% from a year ago, but a decline of 3% from the second quarter. This decline was primarily due to increased supply constraints for certain semiconductors used in these products as we discussed last quarter. Datacom revenue was stronger than anticipated at $122.4 million. This record level revenue was up 50% from a year ago and 8% sequentially.
While supply headwind sustained our datacom potential, strong demand for higher data rate, non-silicon photonics products more than offset those headwinds. By technology, silicon photonics revenue was $108.7 million, a 12% sequential decrease due to the supply constraint that impacted telecom revenue. By speed, revenue from products rated 400 gig and faster was a record $221 million, up 17% from a year ago and 27% from Q2. It’s changed primarily from non-silicon photonics datacom products.
After our record Q2 revenue from 100 gig products was $112.3 million, down 10% from a year ago and 27% from Q2 as faster data rate products continue to see strong growth. We believe revenue from 100 gig products will continue to moderate. Non-optical communications revenue was $162.7 million, slightly above our record second quarter, representing 24% of total revenue. Our automotive revenue remains robust at $94.1 million, up 77% from a year ago and essentially flat with Q2. Industrial laser revenue was also relatively flat sequentially at $31 million. Other non-optical communications revenue increased from a year ago and from last quarter to $37.5 million.
As I discuss the details of our P&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 continue to execute very well and non-GAAP gross margin was 13.1%, up 26 basis points from Q2 and 40 basis points from a year ago. This result includes a benefit of approximately 20 basis points from FX tailwinds. Based on our hedging program, we expect these FX tailwinds to become mild headwinds in Q4.
Operating expenses in the quarter were $13.2 million or 2% of revenue. This produced a record strong operating income of $74.3 million, representing an operating margin of 11.2%. We continue to benefit from our strong balance sheet, it increasing interest rates, net interest income rose to $2.9 million or $0.08 per diluted share, more than offsetting FX losses.
With a more stable tieback in the recent quarters, our foreign exchange loss narrowed to $1.3 million in the quarter or $0.04 per share. This FX loss was primarily due to asset and liability revaluations at the end of the quarter. Effective GAAP tax rate was 6.5% in the quarter and they continue to anticipate an effective tax rate in the low-to-mid single-digits for the year. Non-GAAP net income was $71.8 million or $1.94 per diluted share. On a GAAP basis, net income was one dollar and $0.60 per diluted share. Note that our GAAP results include the restructuring expense of $5.9 million in conjunction with the closure of our UK facility, which we discussed last quarter.
Turning to the balance sheet and cash flow statements. At the end of the third quarter, cash, cash equivalents, restricted cash, and short-term investments were $538.7 million, up $11.1 million from the end of the second quarter. Operating cash flow was $37.1 million with capex of $19.8 million, free cash flow was $17.3 million. During the third quarter, we bought back approximately 35,000 shares at an average price of $116.72 for a total cash outlay of $4.5 million. As of the end of the third quarter, $90.8 million remained in our share repurchase authorization.
Now, I will turn to our guidance for the fourth quarter. As Seamus indicated, we are seeing the impact of inventory adjustments at our customers and their customers in the optical components market. As a result, we expect telecom revenue to be down sequentially in the fourth quarter but our datacom business is also experiencing the same inventory headwinds, we expect a continuous growth from certain higher data rate programs to more than offset this impact resulting in sequential growth in Q4. We expect our strong automotive revenue to be flat to up sequentially in Q4. We continue to see a gradual easing of supply-chain constraints and expect the revenue impact of these to decrease to approximately $15 million in Q4 or about half of what we saw in the third quarter. Considering all of these factors, we anticipate revenue in the range of $630 million to $650 million in the fourth quarter.
From a profitability perspective, we expect to extend our track record of strong execution in the fourth quarter. That said, as we indicated earlier, we expect the FX tailwind we have been experiencing to turn into mild headwinds in the fourth quarter. We anticipate non-GAAP net income to be in the range of $1.76 to $1.83 per diluted share.
In summary, we delivered a strong third quarter performance with revenue and non-GAAP EPS above our guidance. Our fourth quarter outlook is moderated by inventory adjustments in the optical communications ecosystem that we expect to be short-term in nature. We remain confident in our ability to execute well through this variability, and we continue to be optimistic about our market position and longer-term growth drivers.
Operator, we are now ready to open the call for questions.
Questions and Answers:
Operator
Thank you. [Operator Instructions]. Our first question comes from the line of Samik Chatterjee of JP Morgan. Your line is open.
Samik Chatterjee — JPMorgan — Analyst
Hi, thanks for taking my question. I jumped on a bit late in here, so I apologize if I might be asking something that you touched on your prepared remarks, early, but maybe just starting off with the set of your customers and the nature of the conversations you’re having with them related to the inventory digestion, but giving you any more color in terms of the duration of those inventory adjustments or any more color in terms of when they’re ordering a return to a more normalized pattern. Thank you and I have a quick follow.
Seamus Grady — Chief Executive Officer
Hi Samik. So as you know, we are really back to getting demand of 13 weeks at a time, which we’ve had before the component crisis, we had longer demand, we had a longer horizon on the demand during the components situation, but right now we’re really back to 13 weeks, rolling forecast from our customers. We don’t have great visibility beyond that, we do expect the inventory correction to be relatively short-lived. We think it’s maybe two quarters, something like that and then we should be back to more normal ordering patterns.
Samik Chatterjee — JPMorgan — Analyst
Okay. And maybe one for Csaba. The gross margins continue to be quite a grubber. Maybe if you can get a bit more color in terms of particularly sort of how you’re thinking about the puts and takes in relation to the near-term drivers including currency as well as the sort of the lower-volume leverage that you’ll have Thank you.
Csaba Sverha — Chief Financial Officer
Hi, Samik. Thanks for the question. So, we have been communicating that our gross margin has been aided by FX tailwinds in the past couple of quarters. In the recent quarter, we had about 20 basis point sequential tailwinds from that. As I also mentioned in our prepared remarks, we are anticipating this building to turn into a headwind in Q3. So overall with the Thai baht being now stabilized we no longer see these tailwinds continue in our results. However. We continue to improve our operating efficiencies. So any short-term demand correction or even longer-term potential decrease, we have already an agile business model and they small fixed-cost base. So we are confident that we will be able to maintain our strong operating performance as well. So again, the key message here is 20 basis-point tailwind in Q3 from exchange rate that’s really commoditized about approximately 30 basis points in our Q4 numbers.
Samik Chatterjee — JPMorgan — Analyst
Thank you. Thanks for taking my questions.
Csaba Sverha — Chief Financial Officer
Thanks, Samik.
Operator
Thank you. [Operator Instructions]. Our next question comes from the line of Alex Henderson of Needham and Company. Your line is open.
Alex Henderson — Needham & Company — Analyst
Great, thank you so much. Just to clarify. So when you’re talking about the 20 basis-point headwind going into a 30 basis-point — 20 basis-point tailwind going to a 30 basis-point headwind. Are we saying then that we should be looking at the 30 basis-point hit to operating margin sequentially from the March quarter to the June quarter, is that what I’m hearing?
Seamus Grady — Chief Executive Officer
That’s correct. Alex, yes.
Alex Henderson — Needham & Company — Analyst
Okay. Just wanted to make sure that we were in the metrics their. So, I know you don’t want to go beyond the June quarter, but have you had any conversations with your partners who probably talk to the OEMs, who are sitting on a fair amount of inventory on their books? What the slope is and the duration of this inventory correction that we’re currently experiencing in the June quarter and will it continue through the September and December quarters? So, how do you kind of play that scenario out over time without necessarily getting too through a forecast, which I know you won’t do?
Seamus Grady — Chief Executive Officer
Yeah, that’s correct, Alex. I mean, if we see, we have a certain amount of visibility, but further away from us, let’s say, the end customer is the worst, our visibility becomes so as you know we supply some to the complete network system companies, but a lot of what we produce, we produce for the component suppliers who in turn supply to the complete network system companies who supply to the operators. So to further where you go with a more — the more the less clear it becomes. However, based on the indications we’ve seen, we think it’s a relatively short-lived inventory correction, maybe two quarters, something like that. So this quarter and next quarter we think but it remains to be seen. We think it’s relatively short-lived.
Alex Henderson — Needham & Company — Analyst
Yeah, just one last question, I’ll cede the floor. The systems business, can you give us any clarity on how the systems business is progressing and kind of what the slope of the ramp there looks like? Obviously, that does not have the same component problem that some of these component companies have to deal with.
Seamus Grady — Chief Executive Officer
Yeah, so as you know, we have a number of system customers. The most recent one we added was with DZS. The DZS transfer is at this stage completed and we’re just going to be getting to ramp that business and we believe that there are still opportunities to win additional system business over time, I can’t afford to exist customers and new customers, and we’re certainly pursuing additional systems business, but there are a couple of things in order to keep in mind, as we have mentioned before. First of all, we’re very selective about the systems business. That makes sense for us. We need to make sure that we are either already making a large portion of the component content or we need to be confident that we will win a large portion of the content in those systems.
And then secondly, the system wins, in many cases, our ability to win that business is driven by external catalysts that we don’t really control. So we pursue it very closely and we’re quite optimistic, but several things have to line up for that to occur. That said, we are very well-positioned, we think to an additional system business over time and that kind of tech and provide significant cost-savings for the customers by eliminating our level of margin striking quite providing new revenue opportunities for us. We continue to be very positive and excited about it but as you know, Alex, there’s there’s not much to report until there until we have one landed. So we just work hard on those and keep pursuing those opportunities.
Alex Henderson — Needham & Company — Analyst
Yeah, no it wasn’t really the question, Seamus. The question is, can you give us some sense of whether there is growth in that business from an organic perspective or how should we be thinking about that business set, and I get it DZS feathering in the June quarter, but that’s really a September quarter. You got it, it’s going to take a little while for them to work down in inventory, correct?
Seamus Grady — Chief Executive Officer
Yeah, and I think if you look at hotspots, we mentioned in our prepared remarks. I think Csaba mentioned about our telecom business, which is actually a lot of that is not of the system wins — system we have sits in that space. So that is impacted by inventory correction is not just a component business, it’s also the network business that’s experiencing some inventory correction. So, our datacom business remains very strong. As we mentioned with the telecom business and the optical component business are the two areas most affected by the inventory corrections.
Alex Henderson — Needham & Company — Analyst
Okay. I’ll get back in queue. Thanks.
Seamus Grady — Chief Executive Officer
Thanks, Alex.
Operator
Thank you. One moment please. Our next question comes from the line of Troy Jensen of Lake Street Capital Markets. Your line is open.
Troy Jensen — Lake Street Capital Markets LLC — Analyst
Yeah, first off, congrats on the nice results, gentlemen.
Seamus Grady — Chief Executive Officer
Thank you, Troy. Great to talk to you.
Troy Jensen — Lake Street Capital Markets LLC — Analyst
Yeah, great to be back here, so. Hey, just a follow-up on datacom strength obviously the non-silicon photonics were up nicely, but was that specifically the new program wins, or is that just Pradesh strengthening category?
Seamus Grady — Chief Executive Officer
It’s a little bit of both, but it’s primarily new program wins. So we’re seeing a couple of things going on. First of all, we’re seeing the ramp of 400 gig inside the data center and it is now largely completed and as you can see we’re starting to see 100 gig begin to decline as 400 gig ramps but we’re also seeing ramp of higher data rate products, about 800 gig products — above 800 gig inside the datacenter and that’s largely driven by new, new demand and new applications inside the data center. So, we’re quite excited about it. So a little bit of both. So ramping 400 gig, but also we’re beginning to ramp new non-silicon photonics space products as well.
Troy Jensen — Lake Street Capital Markets LLC — Analyst
Got it. Guys, and I have got a couple of your GAAP obviously in my coverage guys but can you just remind me how long did it take to fill up Building 8 and what’s the progress now with Building 9?
Seamus Grady — Chief Executive Officer
Building 8, let me see it probably took us in total four-five years to fully fill Building 8, Building 8 is a 550,000 square-foot facility; Building 9 is a one million-square-foot facility. So, we’re off the ground and I let’s say, off to a good start in Building 9, but unlike before, we used to talk about statistics like occupied and spoken but we don’t provide that data any more. But certainly we are quite happy with the progress on Building 9 at this point.
Troy Jensen — Lake Street Capital Markets LLC — Analyst
All right, understood. Good luck guys and keep up the good work.
Seamus Grady — Chief Executive Officer
Thank you very much.
Csaba Sverha — Chief Financial Officer
Thanks, Troy.
Operator
Thank you. One moment, please. We do have a follow-up question from Samik Chatterjee of JPMorgan. Your line is open.
Samik Chatterjee — JPMorgan — Analyst
Hi, thank you for taking my follow-up. Thanks. Just a quick one there. Seamus, you mentioned the inventory digestion on the telecom side, just wondering like when you maybe even dial back, obviously a few quarters, we have gone through a period of supply issues, are you seeing any portions of the portfolio still being supply-constrained where there is still sort of the lead times that haven’t really come back to normal, and is that an additional sort of headwind that you tackling in some parts of the portfolio? Just wanted to check in on that and where the supply situation currently stands on most of the competency. In short, you are shortage of?
Seamus Grady — Chief Executive Officer
Yes, so we mentioned from our pension to $15 million a supply headwind in Q4. We’re — which. If you take the split between telecom and datacom the majority of that will be in our telecom business, but we are seeing that getting to taper off and I think we’re probably one or two quarters away from no longer calling us the supply headwinds. So it’s a 15 million headwind this quarter, it was a $30 million headwind last quarter and we really are back to a more normalized component supply situation like I say, to make, I think we’re probably one to two quarters away from no longer calling out the supply headwinds, hopefully.
Samik Chatterjee — JPMorgan — Analyst
Okay. And a quick follow-up on the 800 gig products that you are already ramping, is there any material variation in the gross margin that those come in at a rate of 400 gig, given that this is more obviously sort of at the leading edge of what’s being done it in the industry right now, how should we think about that?
Seamus Grady — Chief Executive Officer
No. Generally, newer products or maybe there’s a better margins in all products, obviously, but aside from that, the margin profile would be pretty, pretty standard for us, Samik.
Samik Chatterjee — JPMorgan — Analyst
Okay. Thank you. Thanks for taking the questions. Thank you.
Seamus Grady — Chief Executive Officer
Thank you, Samik.
Operator
Thank you. One moment please. Our next question comes from the line of Alexander Henderson of Needham and Company. Your line is open.
Alex Henderson — Needham & Company — Analyst
Great, thanks. I was hoping you could give us some content around the non-speed optical products. What’s going on in that segment and what your expectations are for the June quarter for that segment is, it’s not a big piece of the slowdown within that portion.
Seamus Grady — Chief Executive Officer
Yeah so, you’re correct, Alex. The non-speed-rated business is impacted by the inventory correction. As you know, we have more than one product in there and we have more than one customer in there, but that’s impacted by the inventory correction. As you noticed, Alex, we happen to actually broken out or quantify the impact of the inventory correction, but obviously, it is a headwind for us this quarter. And yes, you’re correct, a chunk of that is in the non-speed-rated portion of the business.
Alex Henderson — Needham & Company — Analyst
You guys normally give some indication of what that number was. I didn’t hear it in Csaba’s comments, can you give us what the non-speed revenues are?
Csaba Sverha — Chief Financial Officer
Yes, Hi, Alex. So the non-speed revenue was actually down sequentially in Q3 versus Q2 by about $10 million. So right now our non-speed rated business is sitting at about $145 million quarter run-rate.
Alex Henderson — Needham & Company — Analyst
And I would like to talk about the guide, can you give us any sense of what you expect that to do sequentially into the June quarter?
Csaba Sverha — Chief Financial Officer
We haven’t provided guidance for that and we are not intending to break down. This is we go into two product-specific details. So we are expecting it to be down obviously but not to give a number or two.
Alex Henderson — Needham & Company — Analyst
I got it, thanks.
Csaba Sverha — Chief Financial Officer
Thank you, Alex.
Seamus Grady — Chief Executive Officer
Thanks, Alex.
Operator
Thank you. I’m showing no further questions at this time, let’s turn the call back over to Seamus Grady for any closing remarks.
Seamus Grady — Chief Executive Officer
Thank you, operator. Thank you for joining our call today. We delivered strong third quarter results. As we look ahead, we are confident that we can execute well during periods of short-term market variability and we remain optimistic about the long-term growth trends in the markets we serve. We look forward to speaking with you again and seeing those of you who will be attending the JPMorgan Conference in Boston later this month Goodbye.
Samik Chatterjee — JPMorgan — Analyst
[Operator Closing Remarks].