Q2 2023 Fabrinet Earnings Call

Speaker 1: You.

Speaker 2: The conference will begin shortly. To raise and lower your hand during Q&A, you can dial star 11.

Speaker 3: music Good afternoon. Welcome to the financial results conference call for the second quarter of 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.

Speaker 4: As a reminder, today's call is being recorded. I would now like to turn the call over to your host, Gero Tomijenia, Vice President of investor relations. You may begin. Gero Tomijenia, Vice President of investor relations

Speaker 5: Thank you, operator, and good afternoon, everyone. Thank you for joining us on today's conference call to discuss Fabrinette's financial and operating results to the second quarter of fiscal year 2023, which ended December 30, 2022. With me on the call today, our shameless gradee Chief Executive Officer.

Speaker 6: and Chavas Fera, Chief Financial Officer. This call is being webcast and a replay will be available on the investor section of our website located at investor.fabernet.com.

Speaker 7: During this call, we will present both GAP and non- GAAP financial measures. We prefer to the Investor section of our website for important information, including our earnings, press release, and investor presentation, which include our GAP to non-GAP reconciliation.

Speaker 8: In addition, today's discussion will contain four looking statements about the future financial performance of the company.

Speaker 9: Forbidden statements are subject to risks and uncertainties that could cause actual results to differ, materially, from management's current expectations.

Speaker 10: The 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 feature 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.

Speaker 11: in our form 10Q filed on November 8, 2022. We will begin the call with remarks from Shamist and Chava followed by time for questions. I would now like to turn the call over to Fabianist, CEO , Shamist Ray. Shamist.

Speaker 12: Thank you, Garo. Good afternoon everyone and thank you for joining us on our call today. We had a strong second quarter with revenue above our guidance range at $668.7 million.

Speaker 13: This new quarterly record was an increase of 18% from a year ago and 2% from the first quarter.

Speaker 14: After adjusting for the 14 week period in Q1, revenue would have grown 5% sequentially.

Speaker 15: Supply constraints continue to act as a revenue headwind. While we continue to see pockets of relief in some areas, we have also seen increasing supply constraints in other areas.

Speaker 16: In aggregate, the revenue impact of supply constraints during the second quarter was approximately 20 million dollars, a little smaller than anticipated.

Speaker 17: That said, we continue to face supply issues with certain commodity components.

Speaker 18: While these supply constraints could worsen before they get better, we continue to anticipate a better supply environment later this calendar year.

Speaker 19: Our team executed very well in the second quarter, delivering non-GAAP operating margins of 10.9%, setting a new quarterly performance record.

Speaker 20: including the impact of an 11 cent foreign currency loss, non-GAAP EPS of $1.90 was in the upper end of our guidance.

Speaker 21: and would have been well above the range were it not for the foreign exchange impact. Looking at the quarter in more detail both optical and non optical communications saw quarterly and year over year revenue increases to new record levels.

Speaker 22: Within optical communications, telecom demand continues to be strong, but rather than you decrease slightly sequentially, primarily due to recent component charges.

Speaker 23: On the other hand, in DataComm we reached a new quarterly revenue record and also experienced our fastest sequential growth in 10 years.

Speaker 24: Turning to non-optic communications, we had another record quarter for automotive revenue. Supply improvements from the first quarter continued, driving strong growth in your automotive programs.

Speaker 25: This growth in automotive more than offset declines in industrial laser revenue in the quarter.

Speaker 26: Investing in our long-term growth remains a top priority for February .

Speaker 27: As you know, our recently opened Building 9 provides us with significant capacity to continue to scale our business over the next several years and we continue to ramp new programs for our customers in this state-of-the-art 1 million square foot facility.

Speaker 28: Looking ahead to the third quarter, we remain optimistic that the industries we serve can remain relatively resilient despite broader global economic trends. And this is reflected in healthy demand trends that we continue to see across our business.

Speaker 29: As I noted earlier, the supply environment is still challenging.

Speaker 30: Even though we continue to successfully mitigate the impact of supply shortages, we do expect greater revenue impact from supply headwinds in the Thoreau Quarher than in Q2. And this is reflected in the guidance that Chava will detail in a moment.

Speaker 31: Our business model remains very agile, flexible and resilient. Over the years, our ability to respond quickly to changing market dynamics has helped us to optimize our business in the face of changes in supply or demand.

Speaker 32: As such, we are confident that we can continue to operate very effectively in a dynamic global environment to the benefit of all our stakeholders.

In summary, we delivered strong second quarter results with revenue above guidance and record operating margins.

While the supply environment remains volatile, our demonstrated ability to execute reinforces our optimism that we remain well positioned to continue producing strong financial results as we look ahead.

Now I'd like to turn the call over to Chava for additional financial details on our second quarter and our guidance for the third quarter of fiscal 2023. Chava.

Thank you, Seamus, and good afternoon, everyone.

with delivered record revenue in the second quarter that was above our guidance.

Revenue was $668.7 million, which was up 18% from a year ago and up 2% from the first quarter, which you will recall was a 14-week quarter with an extra $20 million revenue contribution.

Adjusting for this extra week, sequential revenue growth would have been 5%.

After delivering record operating margin in Q1, we again reached a new high point with a non-gap operating margin of 10.9% in the second quarter.

Our foreign currency hedging program continues to dampen the impact of effects fluctuation on operating margins.

But our bottom line results were negatively impacted by foreign exchange evaluation loss of $3.9 million, or 11 cents per share in the second quarter.

As a result, non-GAAP earnings per share was $1.90 in the upper half of our guidance range.

Without this 11.4 and exchange rods, non-GET EPS would have been well above our guidance.

Looking at the revenue in more detail, optical communications revenue was $506.1 million, up both sequentially and from a year ago to a new record.

Within optical, telecom revenue was $392.9 million, which was up 11% from a year ago, but a decline of 3% from the first quarter, primarily due to increased supply constraints for certain commodity semiconductors used in this product.

Data Com Revenue on the other hand was very strong at 113.2 million dollars.

This record datacom revenue was up 15% from a year ago and 22% from Q1 due to combination of continued positive demand trends and better component availability for these products.

My technology silicon photonics revenue was $123.4 million. An 11% sequential decrease due to the same supply constraint that impacted telecom revenue.

The impacted telecom products are also primarily newer, faster speed-rated products and as a result, revenue from products rated at 400 Gb or more also declined 11% sequentially to $173.6 million.

I want to emphasize that we believe demand for this product remains robust and that this decline was primarily supply related.

Revenue from 100 gig products, on the other hand, was the highest we have seen in over two years at $153.4 million, up 10% both from a year ago and from Q1.

Non-optical communications revenue was also another record at 162.6 million dollars and represented 24% of total revenue.

As in Q1, growth in non-optical communications was driven primarily by automotive revenue.

which was a record $94.8 million, more than double from a year ago and up 9% from Q1.

In addition to a better supply environment for this product, we also benefit from continued demand strength for newer automotive products.

Industrial laser revenue was 30.9 million dollars, down 13% sequentially.

Other, non-optical communications revenue increased from a year ago and from last quarter to $36.8 million. As I discussed the details of our P&L, expense and profitability metrics provided are on a non-gap 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.

Our execution was very strong in the second quarter, as we reflected in our growth margins each tied our prior record of 13%.

Tail bins from foreign exchange hedges contributed approximately 20 basis points to this performance. And based on current FX levels, we anticipate that these tail bins could turn into mild head bins over the next few quarters.

Operating expenses in the quarter were 13.7 million dollars or 2.1% of revenue.

This produced record operating income of $73.1 million, or 10.9% of revenue. As I indicated in my introduction, a strong Thai baht and weaker U.S. dollar resulted in a foreign exchange loss of $3.9 million, or 11 cents per share.

primarily due to asset and liability devaluations at the end of the quarter. Thanks to our strong balance sheet, we continue to benefit from a higher interest rate environment.

with net interest income of $2 million or approximately 5 cents per diluted share, which partially offset FX losses.

Non-gap net income was $70 million or $1.90 per diluted share.

On a gas basis, net income was $1.71 per diluted share.

Effective tax rate was 1.7% in the second quarter and we continue to anticipate an effective tax rate in the low to mid-single digits for the year.

Turning to the balance sheet and cash flow statements.

At the end of the second quarter cash, cash-active oil and restricted cash and short term investments were 527.6 billion dollars.

up $27.7 million from the end of the first quarter.

Operating cash flow was $44.5 million. With capex of $13.4 million, pre-cash flow was $31.1 million.

We will continue to execute on our plan to return surplus cash to shareholders.

though buyback activity was low during the quarter.

Approximately $94.9 million remains in our share repurchase authorization.

On an operational note, earlier in the third quarter, we made a decision to exit our business in the UK.

Unlike our new product introduction facilities at Fabernet West and Fabernet Israel, our UK operation has not become a meaningful program to volume manufacturing in Thailand. Since the UK facility also operates at a relatively small scale, our operation has not become a meaningful program to volume manufacturing in Thailand.

serving mostly local customers, he estimates that the impact on non-GAAP financial results will be immaterial. We expect the rundown to be substantially completed by the end of the fiscal year.

during which we will help ensure a smooth transition for our customers. We expect to incur restructuring costs of approximately $3.5 million, which will be excluded from our non-GAAP results.

Now I will turn to our guidance for the third quarter.

We remain optimistic about the long-term dimensions across our business.

and our ability to manage supply constraints as effectively as possible.

At the same time, by general supply and alignment has improved, the availability of certain components worsened in Q2, impacting telecom railing.

From what we are currently seeing, we expect this constraints to be given tighter in Q3.

Therefore, our guidance assumes a supply chain headwind of 30 to 35 million dollars, which is about 10 to 15 million dollars greater than what we saw in Q2.

With these incremental supply constraints and typical QG seasonality in mind, the anticipates revenue in the range of $640 to $660 million.

The anticipates non-gap net income to be in the range of $1.86 to $1.93 per diluted share.

In summary, we had a strong second quarter performance with record revenue and margins.

While the supply environment is gradually improving, a small number of components continue to constrain our ability to meet customer demand.

Nevertheless, we remain confident in our ability to continue to execute well in Q3 and over the long term.

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

Thank you.

Ladies and gentlemen, to ask a question, please press star 11 on your telephone and wait for your name to be announced.

To withdraw your question, please press star 11 again. Please stand by while we compile the Q&A roster.

Our first question comes from the line of Samik Chatterjee with J.P. Morgan. Your line is open.

Hi, thanks for taking the question. I have a couple of maybe if we can start with the telecom and the supply constraints you're seeing there. I'm wondering if you can give us a bit more details about the kind of components you're seeing sort of the more worsening constraints on because it seems like it's a bit counter to what investor expectations are at this point for a more broad, broad road.

Yeah, hi, Soneq. Yeah, it's a.

It's an unusual situation. I mean, overall we're seeing the supply situation begin to improve in certain areas with certain suppliers who have been, let's say, problematic historically for the last several quarters. But we've also seen some new suppliers pop up.

And you know because the majority of our business is this telecom it's about you know 75% telecom 25% datacom

the shortches that we're seeing are in about the same proportion.

The devices, the specific devices are components that we see in short supply. They are to support very specific products used in certain telecom transceivers where demand continues to be healthy, but we still have a couple of outlier components. So I know it's a bit of a mixed message. Overall we see things improving and we especially see things improving as you said before in the second half of this year.

But last quarter we did have some, and this quarter again we continue to have some component charges that are specific to telecom.

For my follow-up, maybe if you can spend a bit more time on the data comes I'd understand you're still supply constraint there, but we've seen a lot more sort of pull back in the big customers and their graphics or sort of their overall spending plan. So when you think about sort of the current sort of pipeline there.

Are you seeing any softening of the pipeline outside of the supply constraints that you are still sort of navigating when you sort of look three to six months out? Are you seeing any softening of the demand pipeline?

So, I mean, as you know, Samik, we guide one quarter at a time, so we don't comment really on six months out in our guidance. We haven't seen any particular softening. We're still primarily supply constrained on the datecom side. Obviously, we grew very nicely in the quarter and our datecom business remains quite strong. So we're primarily...

supply constraint on the data come side and our business continues to grow nicely. You know, we had some good strong results for 100 gig products, a 400 gig remain strong again somewhat supply constraints, but the demand remains strong for, you know, across the product categories that we serve in the data come side of the business.

Okay, thank you. Thanks. Thank you. Thank you. Thank you. Please stand by for our next question. Our next question comes from the line of Alex Henderson with Needleman Company. Your line is open.

Great, thanks.

equally puzzled on the supply side because we had to expect it to improve not a road here. There's clearly a semiconductor company or two from the United States that are cited frequently as the source of

a lot of the consternation and the supply chain. Is it that typical source that is now improving and we're seeing a shift to a different geography, perhaps the COVID lockdowns or other issues shifting it?

to a different geography? Where's the nexus of this particular supply chain located? It's really twofold. Some of it is, again, we've called out a slightly higher supply headwind number in Q3. I think we've called it 30-35 million.

versus 20 million of about actual in Q2. Some of that is, it's a combination of really two areas. One is supply constraints that are COVID related, I would say in China. So some of the suppliers who had gone through some lockdowns and whatnot in China, we are seeing a slight

not huge but a slight headwind due to component-related supply constraints coming out of China at this quarter. And then secondly, we have a couple of some of the, and again I read, I want to get into naming specific suppliers, but some of the component manufacturers who historically, you know, certainly for the last several quarters, have been problematic.

you know, I've really improved and we are actually back to more normally times with many of the suppliers who historically were problematic. But unfortunately one or two new ones have popped up. And, you know, I think they go through the same cycle as the other ones. They'll increase capacity, they'll improve outposts. And, you know, they'll get things improved. But we are seeing that supply headwind is quarter. So, I understand Alex, it's a kind of a confusing message on the one hand we have.

We have certain commodities for things to have improved, things have stabilized, and we're back to more normal V times, but unfortunately we have, as I say, some of these new components suppliers who've cropped up as problematic, coupled with certain amounts of supply headwind coming out of China because of COVID. So if I'm looking at the guide for the upcoming quarter, could you give us any grain?

revenue growth by segment. Hi Alexei, we typically don't break this out in our guidance but as you can see we are calling out slight downward trends on quarter on quarter basis.

So they have been this primarily as applied related as we have discussed. So we will expect the telecon to be moderating slightly. And also data conviled have been very strong in a last quarter. It's going to probably moderate a slightly a quarter on quarter basis. But both segments are continued to be strong from demand perspective.

Nevertheless, the incremental headwinds are mostly concentrated around these two segments. Overall, demand side seems to be strong and robust, but our ability to fill that demand is really constrained around the material. So in both cases, I think we would expect a slight moderation or flat quarter on quarter in these two segments. The 30 to 35 million dollars, is that all in...

in the optical piece and is it evenly split between the two categories? Yes, it's primarily around optical communication. Our automotive and laser segments have been somewhat stable in the last two quarters. There has been significant improvement on the supply side in those segments. The 30 to 35 is mostly around optical communication and split around as a proportion of the range. Probably 75% is telecom, about 25%.

So, what are the needling or specifics on the Hadwin-1 component?

If I look at your sub 100 gig revenue, it's growing pretty nicely in the quarter.

So it would be 75% of the headwinds at $30 million headwinds.

of 400 gigs and above speed? That is correct, Farhad. In the last quarter, it was mostly in the higher data rates....

I don't know if it was my end, but I couldn't make out what you said, Tava. Can you please repeat again? I'm sorry. So, yes, the impact was in last quarter and this quarter mostly in our 400 gig and above product segments and the higher data rate segments. So both in Q2 and Q3, the expected headings are mostly going to be...

in that area, in that space. Again, these are very specific components impacting a handful of products in that range. Alright, my next question was, I know in the past you said that 400GB VR was in the highest, the biggest percent of your revenue.

One, does this component have an impact 400GR modules versus line cards or systems? And second is, can you also update us on the 400GR revenue?

One, does this component have an impact for having VR modules versus line cards or systems? And second is, can you also update us on there for having VR revenue? We are full, I assume. Yes, please.

So far, yeah, 400 ZR, we're quite happy with the progress we've made there. We think we're a leader in our industry in supporting 400 ZR. So we're very happy with, let's say, our penetration rate into 400 ZR and our ability to grow our business with our customers in 400 ZR.

Yeah, the shortages we talked about, you know, as Chavis said they break out approximately. So first of all, let's say the automotive and the laser business, I don't want to say the shortages are behind us because it's too early to declare victory, but certainly they've become much more predictable and the improvements we made, especially in automotive, in the prior quarters, seem to have continued you know in Q3. So the short stories we've called out in Q3.

are primarily related to optical communications. And that breaks out 75% telecom, approximately 25% datacom. 400 ZR, depending on the application, with a lot of our 400 ZR business, is categorized in our telecom number.

So, yeah, 400CR would be impacted, but, you know, again, we wouldn't be quite, we wouldn't be prepared to break out, you know, the split between 400CR and other types of products that we make. But again, for the DCI, this inter-interconnect products would be categorized in our telecom business, so they would be included in that 75% number.

But, you know, again, we wouldn't be quite, we wouldn't be prepared to break out, you know, the split between 400 and the R and other types of products that we make. But again, for the DCI, this inter-interconnect products would be categorized in our, in our telecom business. So they would be included in that 75% number. Got it. Got it.

If I could also ask you, you had previously mentioned that you had one prominent customer for 400 gigs VR. I think you most recently said it was two. How many customers are now ramping 400 gigs VR volume?

We have more than two. We have two who are, I would say, ramping nicely. We have another couple of customers who are still in the earlier stages, new product introduction stages.

But we have more than two customers, I would say, more than two less than five.

We feel we have a very good selection of customers there and we're very happy with the growth in that business.

Thank you.

Thank you. Please stand by for our next question. Our next question comes from the line of Tim Savageau with Mothland Capital Markets. Your line is open. Hi, good afternoon. And nice quarter. I have a question on your kind of non-speed rated portion of your business, which is at least the way I'm looking at the numbers, up pretty nicely, both sequentially and year over year.

something like 45% year over year. And I think historically we might associate that with kind of optical telecom, wrote them in amplifiers. But currently I think you've got something else to add to the mix in terms of the

the PON business. So that's a long way for me of looking for an update on the recent relationship with DZS. To what extent was that a major contributor to that growth and...

non-speed rated business or sub 100 gig, however you want to call it.

And what is your current assessment there in terms of getting up to?

kind of an initial full run rate and has your perception of the opportunity at DCS, you know, changed it all over the last little while.

Thanks. So Tim, I'll let Shabir go through the specifics in a moment, but overall in relation to DZS, we're very happy with the relationship, very happy with the pace at which the business is moving, and we're just looking forward to doing a very good job for DZS. They're a great company, and we're very happy to be participating in their supply chain.

Certainly in terms of transfer activity, we're nicely along and we've completed the bulk of the transfers, I would say, and we're really looking to start ramping to volume now. So we're probably a little bit ahead of, even though the total revenue, let's say last quarter, was not so huge from DZS.

but we're happy with the progress we're making on the transfers and really looking forward to ramping that over the next few quarters. As you rightly point out, the non-speed rated business is...

It's an eclectic mix of several types of products and maybe I'll let Shaba talk to the details of that.

Hi Tim, this is Cevat. On the non-speed rated business, we don't break it out, so it is a combination of lower than 100U products and non-speed data rate amplifier or other type of business. We also have some other categories there. What we have seen, particularly on year-on-year basis, I think it's mostly supply-related

I think the supply situation has significantly improved in that space. So again, the growth is indeed coming from the road on an amplifier space.

And the other category is that the low sub-hundred products remain stable. That's pretty much the color I can offer in this area.

Since you pointed to the year-on-year compare as being driven by rotom and amplifiers, does that imply that there's some other driver of the sequential compare?

I'll leave it there. Thanks.

I think it's the on the what we see is really the supply environment have been again I think it's overall the team has been over the last year this business have been probably harder hit in the early part of the last couple of quarters so the situation has been somewhat improving but

I would not want to speak on behalf of our customers how this business breaks out on a sequential basis reduces the supply constraints improving and the demand seems to be robust again both sequential and you are based

Okay, thanks. Thank you, Jim.

Okay, thanks. Thank you, Jen. Thank you. Please stand by for our next question.

We have a follow up from the line of the heart and jam. The line is open.

I wanted to clarify because a number of investors couldn't understand the response to my earlier question. So more explicitly, the telecom component shortages that you're seeing on the 400 gig, are they more on the VR side versus non-VR? Can you clarify? Yes, you're seeing that now as you can see that Walker Ginsburg is up 4-0-0.

I think what I said was we're not going to break that out any further than we have already. We're not going to specify.

whether it's VR or other products. It's approximately of the 30 to 35 million, we've called out approximately 75% of that is telecom products. And I was just pointing out that telecom includes obviously pure telecom products, but also our DCI, our data center interconnect products.

which would include 400 ZR. Got it. Thank you for the clarification. Thank you for having me.

Thank you.

I'm showing no further questions in the queue. I will now like to turn the call back over to Seamus for closing remarks. Thank you. Thank you for joining our call today. We delivered strong second quarter results. As we look ahead we remain confident that we can continue to perform well based on strong broad-based demand.

our demonstrated ability to execute through all kinds of market conditions. We look forward to speaking with you again soon and seeing those of you who will be attending the OSC conference in San Diego next month. Goodbye

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

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I'll see you in the next video.

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