Fabrinet (FN) Q4 2021 Earnings Call Transcript

Fabrinet (NYSE: FN) Q4 2021 earnings call dated Aug. 16, 2021.

Corporate Participants:

Garo Toomajanian — Investor Relations

Seamus Grady — Chief Executive Officer

Csaba Sverha — Chief Financial Officer

Analysts:

John Marchetti — Stifel — Analyst

Samik Chatterjee — JPMorgan — Analyst

Fahad Najam — MKM Partners — Analyst

Presentation:

Operator

Good afternoon. Welcome to Fabrinet’s Financial Results Conference Call for the Fourth Quarter of Fiscal Year 2021.

[Operator Instructions] 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 fourth quarter and fiscal year 2021, which ended June 25, 2021. 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 Investor section of 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 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 May 4, 2021.

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 Grady — Chief Executive Officer

Thank you, Garo. Good afternoon everyone, and thank you for joining us on today’s conference call. We had an excellent fourth quarter to finish a strong fiscal year with robust demand trends continuing across our business combined with excellent execution by our team, we delivered a number of records in the quarter.

Revenue was well above our guidance range and for the first time exceeded $0.5 billion at $509.6 million. In addition to record revenue, we also delivered record non-GAAP operating margins of 9.9%, resulting in an all-time high non-GAAP earnings per share of $1.31 in the fourth quarter. For the full fiscal year, we produced record revenue of $1.88 billion, representing industry-leading growth of 14% from the prior year. Non-GAAP net income was $4.67 per share. Total operating cash flow for the year was $118.7 million and free cash flow was $76.1 million.

Looking at some of the highlights of the fourth quarter. Optical communications revenue reached another new record, driven by strong telecom demand. Non-optical communications revenue also reached another record in Q4. Looking ahead, we remain encouraged by healthy demand trends across all lines of business as we continue to successfully navigate and manage component supplies.

We estimate that the supply constraints we are experiencing impacted our fourth quarter revenue by approximately $25 million to $30 million, and we expect to see a similar impact in Q1. Despite this headwind, we anticipate that revenue will continue to grow sequentially to a new record in Q1 as Csaba will outline in a moment.

We are also optimistic from a profitability standpoint. That said, in Q1, we anticipate a small non-recurring headwinds to net income. As you may have heard, Thailand, along with other countries in Southeast Asia has recently seen a rapidly growing number of COVID-19 cases. In response, lockdowns and other measures have been imposed, which primarily impact social gatherings.

Our manufacturing facilities are fully operational, but we have implemented additional safeguards beyond what we have been doing for the past 1.5 years in order to protect our staff. This includes increased testing and sending people home with pay, if they test positive for COVID-19. In addition, we have been granted permission by the Thai government to vaccinate our employees and have been carrying out this initiative for the past several weeks at our expense.

We are very pleased that at this time the vast majority of our employees have already received their second doses, such that by the end of this month, approximately 90% of our employees in Thailand will be considered fully vaccinated. We are proud to be able to carry out this effort that has both a very positive social impact, while also being good for our business, and we believe it will further enhance our very favorable reputation as an excellent employer in Thailand.

As we communicated earlier this year, we have broken ground on a new 1 million square foot building at our Chonburi campus. Construction is progressing and we expect the building to be complete in about one year. We also previously discussed our intention to add approximately 100,000 square feet of manufacturing space at our Pinehurst campus.

Just after the end of the fourth quarter, we completed the acquisition of 15 acres of land that had become available adjacent to our Pinehurst facility. This size will enable us to relocate some non-manufacturing activities from the current campus, which will allow us to increase our manufacturing footprint within our existing buildings. As a result, we are confident that we will continue to have ample capacity to satisfy the growing customer demand we are experiencing.

In summary, we had a very strong finish to a record year. We are optimistic about demand trends from all the markets we serve and we are well positioned to continue to deliver excellent results over the longer term.

Now, I’d like to turn the call over to Csaba for additional financial details and our guidance for the first quarter of fiscal 2022. Csaba?

Csaba Sverha — Chief Financial Officer

Thank you, Seamus, and good afternoon everyone. We had a strong finish to a record year with record revenue and non-GAAP earnings. Revenue of $509.6 million, up 6% from Q3 and 26% from a year ago, and was above our guidance range. We also executed very well, hit our highest gross margin in four years, and record operating margins to produce non-GAAP earnings of $1.31 per share, which also exceeded our guidance.

Looking at revenue in more detail. Optical communications was $387.8 million or 76% of total revenue, up 7% from Q3. Non-optical communications revenue was $121.7 million or 24% of total revenue, and increased 4% from Q3. Within optical communications, telecom revenue was $310.7 million, up 10% from last quarter. Datacom revenue was $77.1 million, down very modestly from Q3.

By technology, silicon photonics products made up 22% of total revenue or $110.2 million, up 5% from Q3. Revenue from products rated at speeds of 400 gig or higher was $133.3 million, up 27% from the prior quarter. This more than offset a 4% sequential decline of 100 gig products to $133.6 million in the fourth quarter. In Q1, we expect the optical communications growth trend to continue.

Looking at our non-optical communications business. Automotive revenue was $48.6 million, a slight decline from our record third quarter results. Industrial laser revenue more than offset this at $41.1 million, up 14% from the third quarter. Sensor revenue was $3.6 million and other non-optical communications revenue was up 14% to $28.2 million [Phonetic].

Now turning to the details of our P&L. Unless otherwise noted, profitability metrics are on a non-GAAP basis. 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. Gross margin of 12.3%, up 10 basis points from Q3 and was at the highest level in four years. Operating expenses in the quarter were $12 million or 2.4% of revenue, reflecting our operating leverage, resulting in operating income of $50.5 million or 9.9% of revenue, a record for the Company.

During the fourth quarter, we have recorded a tax benefit of $2.1 million. This is primarily due to the reversal of evaluation allowance related to certain subsidiaries as a result of better operating performance and effective control of operating expenses. We anticipate that our effective tax rate in fiscal year 2022 will be approximately 4%. Non-GAAP net income was a record at $49.4 million or $1.39 per diluted share. On a GAAP basis, net income was also a record at $42.4 million or $1.13 per diluted share.

For the full year, revenue was $1.88 billion, an increase of 14% from the prior year. Non-GAAP gross margin was 12.1% and operating margins were 9.5% of revenue. Non-GAAP EPS for the year was $4.67, up a strong 25% from fiscal year 2020.

We report 10% customers annually and in fiscal year 2021, we had three 10% customers. Cisco and Lumentum both represented 14% of revenue and the Infinera represented 12% of revenue for the year. Note that the Cisco revenue contribution includes a partial year impact from Cisco’s acquisition of Acacia. Excluding the impact of the acquisition, Acacia would also have been a 10% customer in fiscal year 2021. Our Top 10 customers represented 78% of revenue, compared to 79% in fiscal year 2020.

Turning to the balance sheet and cash flow statement. At the end of the fourth quarter, cash, restricted cash and investments were $548.1 million, an increase of $39.2 million from the end of the third quarter. Operating cash flow was $43.5 million with capex of $13.5 million; free cash flow was $30 million in the quarter.

In addition to expenses related to construction at our Chonburi campus, the recently purchased 15 acres of land, adjacent to our Pinehurst campus that will facilitate the manufacturing expansion we have in progress at that campus. Of the $13.2 million purchase price, 10% was paid during the fourth quarter and the remainder was paid in the first quarter of fiscal 2022.

We remain active in our share repurchase plan, and during the fourth quarter, we repurchased approximately 123,000 [Phonetic] shares at an average price of $85.88 for a total cash outlay of $10.5 million. Approximately $81.2 million remains in our buyback authorization.

Now, I would like to turn to our guidance for the first quarter of fiscal year 2022. We are entering the year from a position of strength and remain optimistic about the markets we serve, and our ability to execute. For the first quarter, we anticipate revenue in the range of $510-530 million, which will represent another record quarter for Fabrinet.

From a profitability perspective, we anticipate non-GAAP net income to be in the range of $1.29 to $1.36 per diluted share. I’d like to point out that this guidance includes the impact of our customary annual merit increases as well as approximately a $0.04 to $0.05 impact from the cost we are incurring in order to safeguard our employees through the vaccination program that Seamus described. We believe this employee safety costs are non-reoccurring, and that this program benefits our employees and their families, as well as the continued operational success of our business. If not for these non-recurring costs, our non-GAAP net income guidance for Q1 would have represented another quarterly record for the Company.

In summary, we are proud of our record fourth quarter and fiscal 2021 performances. We are excited about the prospects ahead and look forward to continued success for all our stakeholders.

Operator, we are now ready to open the call for questions.

Questions and Answers:

Operator

[Operator Instructions]. Our first question comes from the line of John Marchetti of Stifel. Your question please.

John Marchetti — Stifel — Analyst

Thanks very much. Seamus, I was wondering if you could just give us a little bit more color on that $25 million to $30 million headwind that you referenced both in terms of this quarter and the guide. Obviously having a very solid quarter here and the guidance certainly above where were most of us were expecting certainly indicates that you’re managing through this. Can you talk at all about maybe where you’re seeing some of those challenges. And you mentioned it lasting into September, do you — I guess asking for the crystal ball, do you think it goes much further than that?

Seamus Grady — Chief Executive Officer

Yeah. Hi, John. So the shortages that we saw in Q3 really continued into Q4, and I think that’s the case for everybody. And we expect that we’ll see them at least for another couple of quarters. We have been focused on being as proactive as possible to minimize the impact but in the end, in Q4, we believe revenue could have been about $25 million to $30 million higher or about 6% higher, if not for the shortages.

The impact would have been much greater if we weren’t doing a really good job, partnering with our customers and our suppliers to mitigate these supply constraints, including having longer visibility to demand requirements from our customers and then share that with our suppliers. We don’t have any special proprietary knowledge on about when the shortages may end. It could be a few more quarters we think, but we continue to anticipate and really manage through the shortages as best we can.

As regards, which part of the business was impacted the most? We have been — we’ve been really working, it’s really spread across all parts of the business. It’s — we’ve been working diligently just to secure component supplies for products across our entire portfolio, probably where we felt the most pain was in the automotive part of our business and the datacom markets. But, in fact, in the end, we were able to get all the components that we needed to make sure we got the customers, what they needed. We would have seen revenue growth from those parts of the business, instead of the decreases that we experienced.

So a mixed bag overall, it’s really spread across all parts of the business, John and we expect to continue for at least a few more quarters.

John Marchetti — Stifel — Analyst

Got it. That’s helpful, Seamus. And then maybe just into that telecom demand specifically, obviously a pretty big bounce here both sequentially and year-over-year. Sounds like you’re expecting that to continue here at the start of the new fiscal year. Any color you can share there, I mean, is this a situation where you think you’re obviously, you’re reading some of that demand on the table, but with visibility maybe increasing a little bit because people are putting orders in a little bit earlier. Do you get a sense of that strength is likely to continue as we look out maybe even a little bit further past September?

Seamus Grady — Chief Executive Officer

Yeah. I mean we obviously don’t guide beyond the quarter, we guide one quarter at a time, but I would say overall we’re quite upbeat of both the demand trends we’re seeing. It seems to be quite robust across all the markets we serve really, and the biggest challenge we have is the supply constraints. We’re not really constrained by demand right now, it’s a case of making sure we secure supply of the components, we need. But that demand strength that we’re seeing is pretty pervasive across most of the markets we serve.

John Marchetti — Stifel — Analyst

Got it. Maybe just one last one and I’ll jump back into the queue for Csaba. The $0.04 or $0.05 headwind that you talked about with some of the new COVID testing and some of the measures you’re putting in place there. I’m assuming that comes out of gross margin here in the September quarter, but then we should expect at least those cost to bounce back or be taken back out when we look at the December quarter.

Csaba Sverha — Chief Financial Officer

Hi, John. Yes, basically, most of that cost is going to come out from our gross margin. Most of that profit is going to be related to our gross margin. That includes cost of vaccination of people and also putting them on pay while they are isolated to protect them and also to prevent the wider spread in the factories. And obviously, again we are not guiding beyond one quarter at a time, and as you know, we also have our merit increases baked in our Q1 forecast, but we feel very, very optimistic about our efforts in making efficiency improvements to keep our gross margin in our guidance range between [Indecipherable].

John Marchetti — Stifel — Analyst

Thank you very much.

Operator

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

Samik Chatterjee — JPMorgan — Analyst

Hi, good afternoon and thanks for taking my question. I guess, clearly looks like telecom demand is quite strong. Wanted to see if you can offer what — how are you thinking about datacom here. It looks like even as telecom growth was quite solid, datacom was more flat year-over-year in revenues. Any kind of update or can you share, what are you thinking in terms of datacom more from a fiscal first quarter or even kind of from a full-year outlook that will be helpful, what happens in terms of growth outlook there. And then I have a follow-up, please.

Seamus Grady — Chief Executive Officer

Yeah, I think our strengthen in telecom in particular is — was very encouraging and it’s really a function of a lot of the large new business wins that we’ve had over the last year or 18 months. So, that’s a big driver of that growth. Another driver in our telecom space is driven by the data center business, even though it’s categorized — in our categorization, we categorize DCI, Data Center Interconnect as telecom, but a lot of the drivers behind that are actually datacom business.

So we feel quite good about the datacom business generally, and we’re seeing some strength then, and some increasing strength, I would say in, let’s say, 400ZR and we see that as a good driver of growth in the future, and again, that would be a mix of telecom and datacom. But overall I think we’re quite, I would say quite upbeat about both telecom and datacom, even though it, like I say, it appears that a lot of the strength is in telecom, but datacom is actually quite strong as well. If you understand my point that some of our datacom business is categorized as telecom because its DCI.

Samik Chatterjee — JPMorgan — Analyst

Got it. And then if I can just follow-up on the industrial laser segment, clearly a strong rebound here into the fourth quarter. What are you seeing in terms of the recovery there? Do we get to kind of what you’ve seen, I guess is more recent peak of almost like mid-40s per quarter or even higher pretty quickly with the recovery that you’re seeing? Any — kind of what you’re just hearing from customers would be helpful.

Seamus Grady — Chief Executive Officer

Yeah. I mean we’re pretty pleased, I would say, with the growth in the laser market, and we expect that business to be stable to growing a little bit in Q1. Longer term, as we always have been, we’re very optimistic about our position in the laser market and it is more of a — they feel like a slow build for us, we’re really reliant on a lot of those bigger laser companies outsourcing more. But overall we feel quite upbeat about the laser market. Guiding beyond Q1 we wouldn’t be ready to do that, but we do feel quite good about the laser markets.

Samik Chatterjee — JPMorgan — Analyst

Okay, got it. Thank you. Thanks for that color. Thank you.

Seamus Grady — Chief Executive Officer

No problem. Thank you, Samik.

Operator

Thank you. [Operator Instructions] Our next question comes from Fahad Najam of MKM Partners. Your line is open.

Fahad Najam — MKM Partners — Analyst

Thank you for taking my question. I wanted to…

Seamus Grady — Chief Executive Officer

No problem.

Fahad Najam — MKM Partners — Analyst

I may have missed, if you gave this earlier, but I joined the call late. Can you provide us any color on revenue from silicon photonics in this quarter?

Csaba Sverha — Chief Financial Officer

Hi Fahad, this is Csaba. So our silicon photonics revenue was around $110 million for the quarter. It was up about 5% sequentially and the highest level, so far. So, we see the silicon photonics growth to continue, and we are really optimistic and upbeat about that segment as well.

Fahad Najam — MKM Partners — Analyst

Got it. Thank you for that. So, if I may follow-up on that, what’s driving the strength in silicon photonics, so clearly datacom was flat. So, are you beginning to see some incremental opportunities from 400 gig ZR and anything you can describe in terms of the adoption of 400 gig ZR? Obviously, you’ve got a sizable customer that’s leading that product markets. So, any color you could present there would be appreciated.

Csaba Sverha — Chief Financial Officer

Yeah, so the silicon photonics revenue is actually driven by two factors. Obviously, we are winning new businesses from our existing customers in the silicon photonics part of our business. So, that’s continuing to gain market. We are also continuing to gain market share in that space. As you noted, 400ZR, we have a handful of customers in that space as well and we started to see that that we reached 400ZR revenue in our Q4 — fiscal Q4, even though it was not material, but based on the outlook, we are seeing, we are very optimistic about that area.

So, therefore silicon photonics is something that has been growing. If you look at our year-on-year numbers, it grew about 27% on a year-on-year basis and we continue to be very optimistic about that segment.

Fahad Najam — MKM Partners — Analyst

Appreciate the color there. So in terms of — just one last one from me on telecom just staying [Phonetic] there. Obviously you’re clearly seeing the benefit your customers have highlighted of strong demand for them and you’re impeded by component. Any sense on, like how — a lot of your customers have highlighted they think their component shortages are worsening at Q3, some may say that Q4 might be the worst, some say may be Q4 slightly better. So, can you give us some sense on how you are seeing the supply performance?

Seamus Grady — Chief Executive Officer

Yeah. Fahad, hi, this is Seamus. I think we’re hearing the same thing unfortunately where there’s no other — doesn’t seem to be any end in sight right now. At least I mean we said I think in our prepared remarks, we see it happening for another couple of quarters at least. But it’s probably more like another three or four quarters of a constrained component environment. Like — we suppose like our customers, we don’t have a crystal ball. We are getting better visibility, I think than we’ve ever gotten from our customers and we’re sharing that visibility with our supply base. But we don’t see it improving starting in the next couple of quarters, we don’t see it improving unfortunately. Other than…

Fahad Najam — MKM Partners — Analyst

And is it getting worse?

Seamus Grady — Chief Executive Officer

Hard to say. I think it’s certainly not improving. I think we’ve done a good job, I think positioning ourselves for success, making sure we factored in and take into account the constrained environment when we set our guidance, but also when we make our commitments to our customers. So, it’s a very challenging environment, but it’s like a lot of — it’s another new normal, I think it seems to be the phrase for the last year or so. And we just have to make sure we manage our way through it as best we can.

Fahad Najam — MKM Partners — Analyst

Thank you. Appreciate the answers.

Seamus Grady — Chief Executive Officer

No problem. Thank you, Fahad.

Operator

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

Seamus Grady — Chief Executive Officer

Thank you for joining our call today. We had a strong end to a record year with healthy market demand trends and a demonstrated ability to execute. We remain optimistic about our future. We look forward to speaking with you again soon. Goodbye.

Operator

[Operator Closing Remarks]