Fabrinet Q4 2023 Earnings Call Transcript

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August 21, 2023

There are 9 speakers on the call.

Operator

Afternoon. Welcome to Cybernet Financial's Results Conference Call for the 4th Quarter and Fiscal Year 2023. 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.

Operator

I would now like to turn the conference over to your host, Giro Tomajanian, Vice President of Investor Relations.

Speaker 1

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 Q4 fiscal year 2023, which ended June 30, 2023. With me on the call today are Seamus Grady, Chief Executive Officer and Chavis Ferra, 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.

Speaker 1

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.

Speaker 1

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 Chava, followed by time for questions. I would now like to turn the call over to Fabrinet's CEO, Seamus Grady. James?

Speaker 2

Thank you, Garo. Good afternoon, everyone, and thank you for joining us on our call today. Our Q4 financial performance exceeded our guidance for both revenue and earnings per share. Revenue of $655,900,000 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.

Speaker 2

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 $2,600,000,000 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.

Speaker 2

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 800 gig 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.

Speaker 2

However, we are confident that the very strong datacom performance we saw in the 4th quarter will continue to largely offset these inventory related headwinds in our fiscal Q1. In fact, we're 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 Chaba for additional financial details on our Q4 fiscal 2023 and our guidance for the Q1 of fiscal 2024.

Speaker 2

Chaba?

Speaker 3

Thank you, Seamus, and good afternoon, everyone. Revenue and EPS were above our guidance ranges in the 4th quarter. Revenue was $655,900,000 up 12% from a year ago and down 1% from the 3rd quarter. The strong performance fell to the bottom line, resulting in non GAAP earnings per share of $1.86 For the full year, revenue was $2,645,000,000 an increase of 17% from the prior year. In fiscal 2023, we had 4 customers that each contributed 10% or more to revenue.

Speaker 3

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 industrial laser markets. Looking at revenue in more detail. Optical Communications revenue was $502,100,000 up 8% from a year ago and essentially flat with Q3. Within optical, telecom revenue was $309,600,000 which was down 17% from a year ago and 19% from the 3rd quarter.

Speaker 3

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 4th quarter was a record $192,500,000 This represents growth of 107% from a year ago and an increase of 57% from the 3rd quarter. The biggest contributor to our datacom growth was an 800 gig program for AI applications. By technology, silicon photonics revenue of $88,100,000 declined 19% sequentially due to the inventory adjustments we discussed.

Speaker 3

By speed, revenue from products rated 400 gig and faster grew to a new record of $266,800,000 up 49% from a year ago and up 21% from Q3. Revenue from 100 gig programs was 90 Revenue from non speed rated products was $120,000,000 or 24% of optical communications revenue. Nonoptical Communications revenue was $153,800,000 up 25% from a year ago, but down 5% from our record 3rd quarter and representing 23% of total revenue. Automotive revenue continues to be in the same range as the prior two quarters, reflecting improved component availability. Automotive revenue of $92,900,000 was up 66% from a year ago, but down 1% from Q3.

Speaker 3

Industrial laser revenue was $28,000,000 down 10% from Q3. Other non optical communications revenue was $32,900,000 up 10% from a year ago, but down 12% from Q3. 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. Gross margin in the quarter was 12.8%.

Speaker 3

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 $14,900,000 or 2.3 percent of revenue, which was slightly higher than anticipated due to some onetime items and year end adjustments. This produced operating income of $69,000,000 representing an operating margin of 10.5%. We benefited from an increase in interest income, which was $4,000,000 as well as a gain of $1,900,000 from foreign currency asset and liability revaluations at the end of the quarter. Effective GAAP tax rate was 9.4% in the 4th quarter, reflecting year end adjustments.

Speaker 3

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 $68,400,000 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.

Speaker 3

As in fiscal 2022, EPS growth significantly outpaced revenue growth. Turning to the balance sheet and cash flow statements. At the end of the 4th quarter, Cash, cash equivalents, restricted cash and short term investments were $550,500,000 up $11,700,000 from the end of the 3rd quarter. Operating cash flow was a quarterly record of $71,100,000 With CapEx of $17,900,000 free cash flow was $53,200,000 also a quarterly record. For the full year, we generated record operating cash flow of $213,300,000 and a record free cash flow of $152,000,000 We were active with our share repurchase program in the Q4.

Speaker 3

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 $38,400,000 For the full year, we repurchased approximately 488,000 shares for a total cash outlay of $47,600,000 reflecting our commitment to return capital and drive value to shareholders. As a result, dollars 52,400,000 remained in our share repurchase authorization at the end of fiscal 2023. Since then, our Board has authorized an additional $47,600,000 for repurchases, resulting in $100,000,000 currently available for repurchases. Now I will turn to our guidance for the Q1. We expect inventory adjustments at our customers and their customers to continue into the Q1.

Speaker 3

These effects will be seen primarily in our telecom revenue. We believe that strength in new high data rate datacom programs For AI applications, we largely offset the impact of these inventory adjustments. We expect Automotive and Industrial Laser revenue to be relatively flat. We are, therefore, anticipating that total revenue in the Q1 will be moderately higher than the 4th quarter. We anticipate revenue to be between $650,000,000 $670,000,000 From a profitability perspective, in the Q1, we expect seasonal near term pressure on gross margins due to our annual merit increases.

Speaker 3

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 to $1.90 per diluted share. In summary, we exceeded our 4th 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

Thank you. And then wait to hear your name announced. Our first question comes from the line of Alex Henderson with Needham. Your line is open.

Speaker 4

Great. Thank you so much. I know you've had a really great quarter here and a good solid guide in the September quarter. But Looking at the news flow out of virtually every OEM customer out there, Whether that be 20 some odd percent decline at F5, whether that be sharp declines at Juniper, whether that be A 37% decline in their service provider business at Cisco, Whether it be ADTRAN, I mean literally across the board there's been a dozen companies And across every single one of them, they've given some pretty weak guidance. And I know that you guys lock 90 days in advance because of the 8 to 12 week production window.

Speaker 4

So while the September quarter is A nice relief from that bad news. It seems like a lot of that bad news came in the June July timeframe And therefore might be less representative in the September quarter. I also know you don't like to give guidance For a quarter out, but clearly this is an unusual situation and this 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 of late?

Speaker 5

Hi, Alex. Yes, a couple of things I would say. We believe the Let's say the inventory digestion headwinds and the industry headwinds that really everyone is experiencing, that is factored into our September quarter Guide. If you look at our overall business, if you look at our Q4 results, our telecom business Is down primarily driven by inventory digestion and our datacom business is up nicely primarily driven by Significant growth in AI transceiver, let's call it, AI transceiver business. We don't feel like we're missing something in the September guide.

Speaker 5

We think it's representative I'll put it this way, Alex, it's representative of The business that we have 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 were to distill it down into a kind of a short Snapshot. Our Datacom business is up strongly.

Speaker 5

Our Telecom business is down because of inventory digestion, but we think that will come back. So therefore, when the

Speaker 4

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.

Speaker 5

Yes. So we have ample capacity, Alex. As you know, we recently opened the 1,000,000 square foot Building 9 facility in Chonburi. So we have ample capacity and we have lots of room to expand and build more buildings As needed. The ramp is steep, but that's what we do.

Speaker 5

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 make sure we're not the pacing item. There's lots of other, let's say, pacing items always, but we have to make sure we're not the pacing item. So we're very focused on that, Alex, I'm very confident.

Speaker 4

I 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?

Speaker 5

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

Speaker 4

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

Speaker 5

Thanks Alex. Thank you.

Operator

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

Speaker 6

Hi. This is Joe Cortosso on for Soumit 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, is there any visibility at this point in time in terms of the longevity of this Digestion cycle that we're going through, like I think historically some of the folks have pointed to like a 2 quarter digestion. Is that lining up to how you guys are thinking about it at this current time?

Speaker 6

Any color you can provide about around that, it would be helpful. And then I have a quick follow-up. Thank you.

Speaker 5

So inventory digestion is a difficult one to call and it's quite difficult for us to distinguish between The specific causes, let's say, of changes in order patterns or demand from our customers and from their customers. We have returned to getting 13 weeks Committed orders from our customers, and we're not really seeing the longer term visibility that we had during the supply chain crisis. So 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 you follow me. And while everyone is talking about inventory digestion, it's not really possible for us to tell What is inventory digestion? And what is the change in the demand in the underlying demand?

Speaker 5

And secondly, The timing of the inventory digestion is quite difficult for us to be precise about. We hear the same, I suppose, the same industry Observations that others have made that it seems to be a 2 quarter the timing of this seems to be about 2 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 the early part of calendar 2024. We just don't know. And I think we'll have to just wait and see like everybody else. But that's what we're hearing.

Speaker 5

But until we have the purchase orders, we're reluctant to kind of call it

Speaker 6

No, got it. I appreciate it, Seamus. I guess my follow-up is just around The 800 gig and maybe I should just call it the AI opportunity for you guys in Datacom. Obviously, 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, do you have any visibility around it?

Speaker 6

In any way, just curious to hear your thoughts around expanding beyond just this current customer to perhaps a different supplier. Thank you.

Speaker 5

Yes. So, 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. We'll really let them speak to what's going on in that business. 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.

Speaker 5

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

Speaker 6

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

Speaker 5

Thank you.

Operator

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.

Speaker 7

Hey, good afternoon and congrats from me as well on the quarter. Good afternoon, Tim.

Speaker 5

I don't know if I

Speaker 7

missed it, but in terms of the guide, which is kind of flattish overall, although Clearly better than might have been feared. Do you expect the trends that you saw in the 4th quarter to continue in terms of a significant decline in telecom and continued strong increase in datacom or do you That could kind of maybe flatten out a little bit. Then I have a follow-up.

Speaker 3

Yes. Hi, Tim. This is Chava. Yes, We are expecting a pretty similar pattern in our Q1. I pointed out that we are anticipating telecom to be down sequentially in Q1, And we are anticipating datacom to be up.

Speaker 3

So the trends haven't really changed quarter on quarter. And we also said that outrun laser, We are anticipating it to be flat. So telecom down, datacom up and flat, auto and laser.

Speaker 7

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

Speaker 3

Yes.

Speaker 7

Or

Speaker 3

Yes. Yes, that is correct.

Speaker 7

Okay, great. I want to follow-up on the access or PON systems You announced the deal with Nokia recently. I imagine that's going to take a while to ramp up. But between that and your pre existing relationship with DZS, I mean, at what point, I guess, in fiscal 2024 Would you expect that to start to get material for you? And was it material at all in Q4?

Speaker 5

So, first of all, I think it wasn't hugely material in Q4, I would say. And 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. But we don't believe it will be A material or a 10% customer or anything like that. It's an important piece of business. It's an important deal.

Speaker 5

It's important to know, okay, it's important to us to help them with their onshoring activities. But in terms of the revenue impact, I wouldn't want you to leave thinking it's a hugely significant Revenue driver, it's not.

Speaker 7

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, maybe refocus the question on that in terms of Timing and degree of materiality in fiscal 2024 including DZS?

Speaker 5

Yes, it's difficult to say at this point, Tim. We're really Don, getting the products introduced, obviously, DZS is now introduced and is in our numbers, if you like. It's in our forecast. It's in our Q1 number. Nokia, it's early days.

Speaker 5

But we think there's a lot of There both in the access space, but in the onshoring generally opportunities for onshoring generally. And also If you call it if you like friend shoring, Thailand is a friendly location to manufacture for our customers. So we're very focused on that, but it It will be very difficult to size it at this point, Tim.

Speaker 7

Okay. Thanks very much.

Speaker 3

Thank you, Tim. Thank you, Tim.

Operator

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.

Speaker 8

Yes. Thank you. Good afternoon. My first question is, what was the supply chain impact in fiscal Q4? And What is your expectation for this upcoming quarter?

Speaker 5

So Dave, we had considered, if you look back at our last earnings call, we had forecasted or considered about $15,000,000 of a revenue headwind From supply chain constraints in Q4. And that's the way it panned out really. It was there or thereabouts 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 supply challenges that everyone faces. And we really don't feel the need to call out that impact At this point, so we're actually not we're not calling out any specific number in our Q1 guidance, and we won't unless something changes considerably in the future.

Speaker 5

Got it. And my follow-up is,

Speaker 8

so last quarter, you talked about 3 tailwinds, 400 gig intra data DC, 800 gig intra DC and 400 ZR DCI. Have they changed since then? And which The strongest of the 3 for you now and do you expect them to remain tailwinds for you next calendar year? Or fiscal

Speaker 5

year? Yes, fiscal year. I think they all remain tailwinds. I think the 800 gig AI data center transceiver program, if I had to rank them in terms of the significance, That's probably the biggest opportunity followed by 400 DR in terms of growth and then 400 gig. I think that would be the order in which I would put them.

Speaker 5

But I think we're very excited. We're ideally positioned. We really think we're ideally positioned The growth in datacom, again, largely driven by these three product areas, if you like, is more than offsetting the declines in telecom. So in the future as telecom comes back, we think the growth in datacom is sustainable and is long term. So we should benefit, we think nicely when telecom comes back after all the inventory has been digested.

Speaker 8

And just to be clear, you expect those rankings to be kind of remain as is in fiscal 2024 or could they change?

Speaker 5

I think maybe the 23 could change. Let's say 400 gig Rod could outpace 400ZR, but 400ZR is growing nicely. We have a number of customers in that area, as you know. It's growing nicely. So I would say 800 gig is the biggest growth opportunity and then followed by either 400 CR or 400 gig inside the data center, both of those represent sizable opportunities as well.

Speaker 8

Got it. Thank you. Thank you, Dave.

Operator

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

Speaker 5

Thank you for joining our call today. We executed well in a dynamic environment to produce 4th 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. Bye bye.

Operator

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

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