Fabrinet - Q4 2023

Transcript

Operator (participant)

Good afternoon. Welcome to Fabrinet Financial Results Conference Call for the fourth quarter and fiscal year 2023. At this time, all participants are on 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 conference over to your host, Garo Toomajanian, Vice President of Investor Relations.

Garo Toomajanian (VP 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 fourth quarter and the fiscal year 2023, which ended June 30, 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 investor 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. 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 May 9, 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 (CEO)

Thank you, Garo. Good afternoon, everyone, and thank you for joining us on our call today. Our fourth quarter financial performance exceeded our guidance for both revenue and earnings per share. Revenue of $655.9 million grew 12% from a year ago. We continued to generate double-digit operating margins, which helped produce non-GAAP earnings per share of $1.86 in the quarter. Our financial results for the year reflect our ability to grow and execute through supply headwinds that we experienced early in the year, and the inventory adjustments that we encountered in the second half of the year. Revenue of over $2.6 billion increased 17% year-over-year.

Non-GAAP operating margin expanded more than 50 basis points to 10.8% for the year, and we generated record non-GAAP earnings per share of $7.67, an increase of 25% from fiscal 2022, as we continue to demonstrate strong execution. Looking at the Q4 in more detail, revenue was essentially flat sequentially for Optical Communications. Within Optical Communications, telecom revenue saw a sizable decrease as a result of inventory digestion at our customers and their customers. The decline in telecom revenue was offset by record revenue growth in datacom on both a year-over-year and sequential basis. In fact, datacom revenue more than doubled from a year ago and grew more than 50% sequentially. This datacom growth was primarily driven by an 800G AI data center transceiver program for one of our customers.

In our non-optical communications business, revenue increased almost 25% from a year ago, but declined slightly sequentially. Looking to the Q1 and beyond, we expect the near-term inventory correction that our customers are experiencing to persist. However, we are confident that the very strong datacom performance we saw in the Q4 will continue to largely offset these inventory-related headwinds in our fiscal Q1. In fact, we are very optimistic about our overall market position, including the potential for continued growth in AI-related programs as we look ahead. In summary, our solid Q4 performance contributed to record results for the full fiscal year. We are excited about our strong industry position and are confident that we can continue to deliver excellent financial results in the coming year.

Now I'd like to turn the call over to Csaba for additional financial details on our fourth quarter and fiscal 2023, and our guidance for the first quarter of fiscal 2024. Csaba?

Csaba Sverha (CFO)

Thank you, Seamus, good afternoon, everyone. Revenue and EPS were above our guidance ranges in the fourth quarter. Revenue was $655.9 million, up 12% from a year ago and down 1% from the third quarter. This strong performance fell to the bottom line, resulting in non-GAAP earnings per share of $1.86. For the full year, revenue was $2.645 billion, an increase of 17% from the prior year. In fiscal 2023, we had four customers that each contributed 10% or more to revenue. Cisco contributed 16% of revenue, followed by Lumentum at 15%, NVIDIA at 13%, and Infinera at 12%. Our top 10 customers together made up 84% of revenue and included a diverse range of customers in telecom, datacom, automotive, and this industrial laser markets....

Looking at revenue in more detail, Optical Communications revenue was $502.1 million, up 8% from a year ago, essentially flat with Q3. Within optical, telecom revenue was $309.6 million, which was down 17% from a year ago and 19% from the third quarter. This decrease was primarily due to inventory adjustments in the industry. On the other hand, Datacom saw tremendous growth with the largest sequential and year-over-year revenue increase in our history. Datacom revenue in the fourth quarter was a record, $192.5 million. This represents growth of 107% from a year ago and an increase of 57% from the third quarter. The biggest contributor to our Datacom growth was an 800G program for AI applications.

By technology, silicon photonics revenue of $88.1 million declined 19% sequentially due to the inventory adjustments we discussed. By speed, revenue from product rated 400G and faster grew to a new record of $266.8 million, up 49% from a year ago and up 21% from Q3. Revenue from 100G programs was $96 million, down 32% from a year ago and 14% from Q3. As we anticipated, revenue from 100G products continued to decline due to inventory digestion and as 400G and faster products gain momentum. Revenue from non-speed rated products was $120 million, or 24% of optical communications revenue.

Non-Optical Communications revenue was $153.8 million, up 25% from a year ago, down 5% from our record third quarter and representing 23% of total revenue. Automotive revenue continues to be in the same range as the prior 2 quarters, reflecting improved component availability. Automotive revenue of $92.9 million was up 66% from a year ago, down 1% from Q3. Industrial laser revenue was $28 million, down 10% from Q3. Other Non-Optical Communications revenue was $32.9 million, up 10% from a year ago, down 12% from Q3. 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 Relations presentation, which you can find in the Investor Relations section of our website. Gross margin in the quarter was 12.8%. As anticipated, gross margin declined about 30 basis points from Q3 due to foreign exchange fluctuations and our currency hedging program. Operating expenses in the quarter were $14.9 million, or 2.3% of revenue, which was slightly higher than anticipated due to some one-time items and year-end adjustments. This produced operating income of $69 million, representing an operating margin of 10.5%. We benefited from an increase in interest income, which was $4 million, as well as a gain of $1.9 million from foreign currency asset and liability revaluations at the end of the quarter.

Effective GAAP tax rate was 9.4% in the fourth quarter, deflecting year-end adjustments. For the year, our effective GAAP tax rate was 4.7%, and we anticipate that our tax rate will remain in the mid-single digit in fiscal 2024. Non-GAAP net income was $68.4 million, or $1.86 per diluted share, and above our guidance range. On a GAAP basis, net income was $1.65 per diluted share. For the full fiscal year 2023, operating margins were 10.8%, an increase of 50 basis points from the prior year. Non-GAAP net income was a record $7.67 per diluted share, an increase of 25% from a year ago. As in fiscal 2022, EPS growth significantly outpaced revenue growth.

Turning to the balance sheet and cash flow statements. At the end of the fourth quarter, cash, cash equivalents, restricted cash, and short-term investments were $550.5 million, up $11.7 million from the end of the third quarter. Operating cash flow was a quarterly record of $71.1 million, with CapEx of $17.9 million, free cash flow was $53.2 million, also a quarterly record. For the full year, we generated record operating cash flow of $213.3 million and a record free cash flow of $152 million. We were active with our share repurchase program in the fourth quarter.

We took advantage of favorable market conditions to repurchase over 400,000 shares at an average price of $94.78, for a total cash outlay of $38.4 million. For the full year, we repurchased approximately 488,000 shares for a total cash outlay of $47.6 million, reflecting our commitment to return capital and drive value to shareholders. As a result, $52.4 million remained in our share repurchase authorization at the end of fiscal 2023. Since then, our board has authorized an additional $47.6 million for repurchases, resulting in $100 million currently available for repurchases. I will turn to our guidance for the first quarter. We expect inventory adjustments at our customers and their customers to continue into the first quarter.

These effects will be seen primarily in our telecom revenue. We believe that strength in new high data rate datacom programs for AI applications will largely offset the impact of these inventory adjustments. We expect automotive and industrial laser revenue to be relatively flat. We are therefore anticipating the total revenue in the first quarter will be moderately higher than the fourth quarter. We anticipate revenue to be between 650 and $670 million. From a profitability perspective, in the first quarter, we expect seasonal near-term pressure on gross margins due to our annual merit increases. As in prior years, we expect to continue executing well and to deliver improving efficiencies as we work our way through the year. With year-end adjustments to operating expenses behind us, we expect operating expenses to return to the 2% range.

Taking these factors into account, we anticipate non-GAAP net income to be in the range of $1.83-$1.90 per diluted share. In summary, we exceeded our fourth quarter guidance while successfully navigating through some unusual industry dynamics. While our business has been negatively impacted by inventory absorption, new programs have largely offset these headwinds, enabling us to deliver healthy results as we continue to focus on extending our track records of strong execution. Operator, we are now ready to open the call for questions.

Operator (participant)

Thank you. Ladies and gentlemen, to ask the question, please press star one one on your telephone. You will hear an automated message advising your hand is raised, and then wait to hear your name announced. To withdraw your question, please press star one one again. Please stand by while we compile the Q&A roster. Our first question comes from the line of Alex Henderson with Needham. Your line is open.

Alex Henderson (Senior Research Analyst)

Great, thank you so much. I, I, I know you've had a really great quarter here and, and a good solid guide in the September quarter. Looking at the news flow out of virtually every OEM customer out there, whether that be 20% some odd decline at F5, whether that be sharp declines at Juniper, whether that be a 37% decline in, in, in their service provider business at Cisco, whether it be ADTRAN or... I mean, literally across the board, there's been 12 companies, and across every single one of them, they've given some pretty weak guidance. I know that you guys lock in, you know, 90 days in advance because of the eight-12 week production window.

While the September quarter is, you know, a nice relief from that bad news, it seems like a lot of that bad news came in the June and July timeframe, and therefore might be less representative in the September quarter. I also know you don't like to give guidance for the quarter out, but clearly, this is an unusual situation, and the situation does require us to ask: Can you give us any sense of what's going on in that December timeframe based on what you've seen, you know, of late?

Csaba Sverha (CFO)

Hi, Alex. Yeah, a couple of things I, I would say. We, we believe the, let's say, the inventory digestion headwinds and the industry headwinds that really everyone is experiencing, that is factored into our, our September quarter guide. If you look at our overall business, you know, if you look at our, our Q4 results, you know, our telecom business is down, primarily driven by inventory digestion, and our datacom business is, is up nicely, primarily driven by a significant growth in AI transceiver, let's call it, AI transceiver business. You know, we, we don't feel like we're, we're missing something in the September guide. We think it's, it's representative. I'll put it this way, Alex, it's representative of the business that we have, and, and all we can do really is deal with what's in front of us.

We have 13 weeks rolling forecast from our customers. We guide 1 quarter at a time, as you rightly point out. But essentially what we're seeing going on, if you, if you were to distill it down into a kind of a short snapshot, our datacom business is, is up strongly. Our telecom business is down because of inventory digestion, but we think that will come back. You know, therefore when the-

Alex Henderson (Senior Research Analyst)

Could, could you talk a little bit about the capacity availability for the datacom piece? That's a pretty steep ramp on a year-over-year basis, going from essentially 0 to a very large number in AI. What does the slope look like in terms of your ability to continue that ramp in terms of capacity availability? Thanks.

Seamus Grady (CEO)

... Yeah, we, we have ample capacity, Alex. As you know, we, we recently opened the, the, 1 million square foot building 9 facility in Chonburi. We, we have ample capacity, and we have lots of room to expand and, and build more buildings, as needed. You know, the, the ramp is steep, but that's, that's what we do. That's one of the services we provide, is that kind of burst capacity when the customer has a very large, ramp, a very steep ramp. One of the services we provide is the ability to, to make sure we're not the pacing item. There's, there's lots of other, let's say, pacing items always, but we have to make sure we're not the pacing item. We're very focused on that, Alex, and we're very confident.

Tim Savageaux (Managing Director, Senior Research Analyst)

Totally understand, Seamus, but you must have some visibility in terms of testing equipment and other line capacity that the customer needs to install in order to get it in, which is the gating factor to ramping that datacom.

Seamus Grady (CEO)

That's correct. We, we, we do, but it wouldn't really be for us to, to speak to that, Alex.

Tim Savageaux (Managing Director, Senior Research Analyst)

Okay. Thank you. I appreciate the, the, the candid answers. Thanks.

Seamus Grady (CEO)

Thanks, Alex. Thank you.

Operator (participant)

Thank you. Please stand by for our next question. Our next question comes from the line of Samik Chatterjee with JP Morgan. Your line is open.

Joe Cardoso (Analyst)

Hi, this is Joe Cardoso on for Samik Chatterjee. My first question is just on the inventory digestion that you're seeing in the telecom industry. I guess, kind of just given your relationships with your customers and your experience in the industry, you know, is there any visibility at this point in time in terms of the longevity of this digestion cycle that we're going through? Like, you know, I think historically some of the folks have pointed to like a two-quarter digestion. You know, is that lining up to how you guys are thinking about it at this current time? You know, any color you can provide about around that, it would be helpful, and then I have a quick follow-up. Thank you.

Seamus Grady (CEO)

Inventory digestion is a, it's a difficult one to call, you know, and, and it's quite difficult for us to distinguish between, you know, the specific causes, let's say, of changes in order patterns or demand from our customers and, and from their customers. We, we have returned to getting 13 weeks committed orders from our customers, and we're, we're not really seeing the, the longer term visibility that we had during the supply, the supply chain crisis. Our customers are back to normal 13-week order patterns, but they don't necessarily tell us why the order size is what it is, if, if you follow me. And, and while everyone is talking about inventory digestion, it's not really possible for us to tell what is inventory digestion and what is a change in the demand, in the underlying demand.

secondly, you know, the timing of the inventory digestion is quite difficult for us to be precise about. We, you know, we hear the same, I suppose, the same industry observations that others have made, that it seems to be a two quarter, the timing of this seems to be about two quarters, and that as we get towards the end of the calendar year, we should start to see order patterns come back to normal in, you know, in the early part of calendar 2024. We, we, we just don't know, and I think we'll have to just wait and see like everybody else. That's, that's what we're hearing, but, you know, until we have the purchase orders, we're reluctant to kind of call it at this point.

Joe Cardoso (Analyst)

No, got it. I appreciate it, Seamus. I guess my follow-up is just around the 800G, and maybe I should just call it the AI opportunity for you guys in datacom. You know, obviously, you, you did... You're doing tremendously well with the current program that you won. I'm just curious, like, what is the opportunity for you guys to win an additional program beyond the current customer that you're in? You know, do you have any visibility around it? Is that opportunity materializing in any way? Just curious to hear your thoughts around expanding beyond just this current customer to perhaps a different supplier. Thank you.

Seamus Grady (CEO)

Yeah, we're not first of all, we're not going to break out, if you like, the AI program itself, because it's right now, as you rightly point out, it's coming from one customer, and we, we really let them, we let them speak to what's going on in that business. You know, what we can say is that that particular program is ramping very fast and has obviously become a meaningful contributor to our revenue and our growth rates and has really helped us to absorb the decline in the telecom business. The timing couldn't have been better, really. We also believe we're very much in the early days of this program and this opportunity. Very, very much in the early days.

We're, we're really just a couple of quarters into this, of what we believe, we, as we understand, it will be a very long, a very long cycle, and a very long trend. We're, we're looking forward to expanding, let's say, beyond, yeah, definitely beyond one customer, but also to multiple programs with, with the, you know, the customer base that we have currently. Nothing really to announce at this point, but it, it does seem to represent a very significant opportunity, and we're, we're very excited about it.

Joe Cardoso (Analyst)

Thanks, Seamus. Appreciate the responses and congrats on the results.

Seamus Grady (CEO)

Thank you.

Operator (participant)

Thank you. Please stand by for our next question. Our next question comes from the line of Tim Savageaux with Northland Capital Markets. Your line is open.

Tim Savageaux (Managing Director, Senior Research Analyst)

Hey, good afternoon, and congrats-

Seamus Grady (CEO)

Hey, Tim.

Tim Savageaux (Managing Director, Senior Research Analyst)

from me as well on the quarter.

Seamus Grady (CEO)

Thank you, Tim.

Tim Savageaux (Managing Director, Senior Research Analyst)

Did you... I don't know if I missed it, but in, in terms of the guide, which is, you know, kind of flattish overall, although, clearly better than might have been feared, do you expect the trends that you saw in the, in the fourth quarter to continue in terms of a significant decline in telecom and, and continued strong increase in datacom, or do you expect that to kind of, you know, maybe flatten out a little bit? I have a follow-up.

Shiva (Company Representative)

Yeah, hi, Tim, this is Shiva. Yes, we, we are expecting a pretty similar pattern in our Q1. I, I pointed out that we are anticipating telecom to be down sequentially in Q1, and we are anticipating datacom to be up. The trends haven't really changed, quarter-on-quarter. We also said that, auto and laser, we are anticipating to be flat. Telecom down, datacom up, and flat, auto and laser.

Tim Savageaux (Managing Director, Senior Research Analyst)

Okay, I guess I'd try to come back for a little more color on that. Just given the degree of volatility we saw in Q4, which is, you know, very significant increases in datacom, very significant declines in telecom. When you say expect a similar pattern, is that what you continue to expect? You know, big movements on both sides?

Shiva (Company Representative)

Yes.

Tim Savageaux (Managing Director, Senior Research Analyst)

Yes.

Shiva (Company Representative)

Yes, that is correct.

Tim Savageaux (Managing Director, Senior Research Analyst)

Okay, great. I want to follow up on the access or PON systems side. You announced a deal with Nokia recently. I imagine that's gonna take a, a while to, to ramp up, but between that and your preexisting relationship with DZS, I mean, at, at what point, I guess, in, in fiscal 2024, would you expect that to start to get material for you? Was it material at all in Q4?

Seamus Grady (CEO)

First of all, I think it wasn't hugely material in Q4, I would say. If you take the business with Nokia, it's important for sure, and we're very, very happy to be expanding the relationship with Nokia. You know, we don't believe it will be a material or, you know, a 10% customer or anything like that. It's an important piece of business. It's an important deal. It's important to Nokia. It's important to us to help them with their onshoring activities. In terms of the revenue impact, you know, I wouldn't want you to leave thinking that it's a hugely significant revenue driver. It's not.

Tim Savageaux (Managing Director, Senior Research Analyst)

Well, maybe a little bit more broadly, given they're in the same kind of neck of the woods or competitors. If you look at the access systems area in general...

Seamus Grady (CEO)

Mm-hmm.

Tim Savageaux (Managing Director, Senior Research Analyst)

you know, maybe refocus the question on that in terms of timing and degree of materiality in fiscal 2024, you know, including DZS.

Seamus Grady (CEO)

Yeah, it's difficult to say at this point, Tim. You know, we're, we're really focused on, you know, getting the products introduced. Obviously, DZS is, is, is now introduced and is in our, it's in our numbers, if you like. It's in our forecast. It's in our Q1 number. You know, Nokia, it's early days, but, you know, we think there's a, there's a lot of opportunity there, both in the access space, but in, in the onshoring, generally, opportunities for onshoring generally. Also, if you call it, if you like, friendshoring. You know, Thailand is a, is a friendly location to manufacture for, for our customers. We're very focused on that, but it's, it'd be very difficult to, to size it at this point, Tim.

Tim Savageaux (Managing Director, Senior Research Analyst)

Okay. Thanks very much.

Seamus Grady (CEO)

Thank you, Tim.

Shiva (Company Representative)

Thank you, Tim.

Operator (participant)

Thank you. Please stand by for our next question. Our next question comes from the line of Dave Kang with B. Riley. Your line is open.

Dave Kang (Research Analyst)

Yes, thank you. Good afternoon. My first question is, what was the supply chain impact in fiscal fourth quarter, and what, what is your expectation for this upcoming quarter?

Seamus Grady (CEO)

Dave, we had considered, if you look back at our last earnings call, we had forecasted or considered about $15 million of a revenue headwind from supply chain constraints in Q4. That's the way it panned out, really. You know, it was there or there about that level. The good news is that the supply environment continues to improve, and we're now at very manageable levels for supply headwinds. Just normal, you know, normal supply challenges that everyone faces. We really don't feel the need to call out that impact at this point. We're actually not calling out any specific number in our Q1 guidance. We won't unless something changes considerably in the future.

Dave Kang (Research Analyst)

Got it. My follow-up is, so last quarter, you talked about 3 tailwinds, 400G intra-data DCI, 800G intra-DCI, and 400ZR DCI. Have they changed since then? Which is the strongest of the three, for you now, and do you expect them to remain tailwinds for you, next calendar year?

Seamus Grady (CEO)

Yeah, I think-

Dave Kang (Research Analyst)

fiscal year.

Seamus Grady (CEO)

Yeah, fiscal year. I think they all remain tailwinds. I think, you know, I think the 800G AI data center transceiver program, if I had to, if I had to rank them in terms of, you know, the, the significance, that's probably the biggest opportunity, followed by 400ZR in terms of growth, and, and then 400G. I think that'd be the order in which I would, I would put them. I think we're, you know, we're, we're very, we're very excited. We're ideally positioned. We really think we're, we're ideally positioned. You know, the, the growth in datacom, again, largely driven by these three product areas, if you like, is, is more than offsetting the declines in telecom.

You know, in the future, as telecom comes back, you know, we think the, the growth in datacom is, is sustainable and is long term. We should benefit, we think, nicely when, when, when telecom comes back, after all the inventory has been digested.

Dave Kang (Research Analyst)

Just to be clear, you expect those rankings to be kind of, remain as is, in fiscal 24, or could they change?

Seamus Grady (CEO)

I think, I think maybe the 2 and 3 could change. You know, the let's say 400G growth could outpace 400ZR, but 400ZR is growing nicely. We have a number of customers in that area, as you know. You know, it's, it's growing nicely. I would say 800G, 800G is the biggest growth opportunity, and then followed by either, either 400 or 400G inside the data center. Both of those represent sizable opportunities as well.

Dave Kang (Research Analyst)

Got it. Thank you.

Seamus Grady (CEO)

Thank you, Dave.

Operator (participant)

Thank you. At this time, I would like to turn the call back to Seamus for closing remarks.

Seamus Grady (CEO)

Thank you for joining our call today. We executed well in a dynamic environment to produce fourth quarter results that exceeded our guidance ranges. We remain well positioned to continue our track record of strong execution, and we remain optimistic about the positive long-term trends in the markets we serve. We look forward to speaking with you again. Goodbye.

Operator (participant)

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.