Fabrinet (FN) Earnings Call Transcript & Summary

Good afternoon. Welcome to Fabrinet Financial Results Conference Call for the Fourth Quarter and Fiscal Year 2023. [Operator Instructions] 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.

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 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 Investors section of our website located at investor.fabrinet.com. During this call, we will present both GAAP and non-GAAP financial measures. Please refer to the Investors Section of our website for important information including our earnings press release and investor presentation, which include our GAAP to non-GAAP 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?

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 fourth quarter 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 800-gig AI data center transceiver program for one of our customers. In our nonoptical communications business, revenue increased almost 25% from a year ago, but declined slightly sequentially. Looking to the first quarter 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 fourth quarter will continue to largely offset these inventory-related headwinds in our fiscal first quarter. 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 fourth quarter 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?

Thank you, Seamus, and 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. 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 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 industrial lasers markets. Looking at revenue in more detail. Optical communications revenue was $502.1 million, up 8% from a year ago and 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 to 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 800-gig 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 products rated 400-gig and faster grew to a new record of $266.8 million, up 49% from a year ago and up 21% from Q3. Revenue from 100-gig programs was $96 million, down 32% from a year ago and 14% from Q3. As we anticipated, revenue from 100-gig products continued to decline due to inventory digestion and that 400-gig and faster products gained momentum. Revenue from non-speed related products was $120 million or 24% of optical communications revenue. Nonoptical communications revenue was $153.8 million, up 25% from a year ago, but 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 two quarters, reflecting improved component availability. Automotive revenue of $92.9 million was up 66% from a year ago, but down 1% from Q3. Industrial laser revenue was $28 million, down 10% from Q3. Other nonoptical communications revenue was $32.9 million, up 10% from a year ago, but down 12% from Q3. As I discussed the details of our P&L, expense and profitability metrics provided are on a non-GAAP basis unless otherwise noted. A reconciliation of GAAP to non-GAAP measures is included in our earnings press release and investor presentation, which you can find in the Investor Relations section of our website. 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 onetime 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. Now 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 million 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 to $1.90 per diluted share. In summary, we exceeded our fourth quarter guidance by 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 record of strong execution. Operator, we are now ready to open the call for questions.

[Operator Instructions] Our first question comes from the line of Alex Henderson with Needham.

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 in 90 days in advance because of the 8- to 12-week production window, 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 and July time frame, 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 the December time frame based on what you've seen of late?

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. So we don't feel like we're missing something in the September guide. 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 one 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. Our telecom business is down because of inventory digestion, but we think that will come back. So therefore, when the...

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 zero 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?

Yes. So we have ample capacity, Alex. As you know, we recently opened the 1 million 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, 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, and we're very confident.

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

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

Our next question comes from the line of Samik Chatterjee with JPMorgan.

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

So inventory digestion, it's 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. 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 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 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. But until we have the purchase orders, we're reluctant to kind of call it at this point.

Got it. I appreciate it, Seamus. I guess my follow-up is just around the 800-gig, and maybe you guys 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? 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?

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 -- really we'll 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. 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 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.

Our next question comes from the line of Tim Savageaux with Northland Capital Markets.

Congrats on the quarter. You -- I don't know if I 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 fourth quarter to continue in terms of a significant decline in telecom and continued strong increase in datacom, or do you expect that to kind of maybe flatten out a little bit? And I have a follow-up.

Tim, this is Csaba. 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. So the trends haven't really changed quarter-on-quarter. And we also said that auto and laser, we are anticipating to be flat. So telecom down, datacom up and flat auto and laser.

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. Would you say expect a similar pattern? Is that what you continue to expect? Big movements on both sides or...

Yes.

Yes?

Yes, that is correct.

Okay. Great. I want to follow up on the access on PON systems side. You announced a deal with Nokia recently. I imagine that's going to take a while to ramp up. But between that and your preexisting relationship with DZS, I mean, at what point, I guess, in fiscal '24 would you expect that to start to get material for you? And was it material at all in Q4?

So first of all, I think the -- 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 10% customer or anything like that. We -- 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. 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.

Well, maybe a little bit, but 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 '24, including DZS.

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

Our next question comes from the line of Dave Kang with B. Riley.

My first question is, what was the supply chain impact in fiscal fourth quarter? And what is your expectation for this upcoming quarter?

So Dave, we had considered if you look back at our last earnings call, we had forecasted or considered about $15 million of revenue headwind from supply chain constraints in Q4. And that's the way it panned out really. It was 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 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.

Got it. And my follow-up is, so last quarter, you talked about 3 tailwinds: 400-gig intra-data DC, 800-gig intra DC and 400ZR DCI. Have they changed since then? And which is the strongest of the 3 for you now? And do you expect them to remain tailwinds for you next calendar year or fiscal year?

Yes, fiscal year. Yes, 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 400ZR in terms of growth and then 400-gig, I think that would be the order in which I would bottom. 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 3 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.

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

I think maybe the 2 and 3 could change, let's say, 400-gig growth 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 400ZR or 400-gig inside the data center, both of those represent sizable opportunities as well.

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

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.

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