Good day, ladies and gentlemen, and welcome to Fabrinet's Financial Results Conference Call for the Third Quarter of Fiscal Year 2019. At this time. I would now like to turn your call over to your host, Garo Tumaginian, 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 third quarter of fiscal year 2019, which ended March 29, 2019. With me on the call today are Seamus Grady, chief executive officer, and TS Ng, 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.
Please refer to our website for important information, including our earnings press release and investor presentation, which include our GAAP to non GAAP reconciliation. I would like to remind you that today's discussion will contain forward looking statements about the future financial performance of the company. Forward looking statements are subject to risks and uncertainties that could cause actual results to differ materially from management's current expectations. These statements reflect our opinions only as of the date of this presentation, and we undertake no obligation to revise them in light of new information or future events except as required by law. For a description of the risk factors that may affect our results, please refer to our recent SEC filings In particular, the section captioned risk factors in our Form 10 Q filed on February 5, 2019.
We will begin the call with remarks from Seamus, NTS, followed by time for questions. I would now like to turn the call over to Fabrinet's CEO, Seamus Grady. General?
Thank you, Garo, and good afternoon, everyone. I am pleased that we exceeded our guidance for revenue and earnings per share in the 3rd quarter. Revenue in the 3rd quarter and non GAAP net income of $0.92 per share also exceeded the high end of guidance. These results also drove strong cash flows in the third quarter with operating cash flow of nearly $36,000,000 and free cash flow of $33,000,000. In addition to these strong headline results, we executed well in the quarter to produce non GAAP gross margins of 12.1% representing a return to our target range of 12 that we experienced in the first half of the fiscal year diminished significantly in the third quarter, supporting the return to our industry leading gross margins.
From an end market perspective, optical communications revenue of $298,000,000 or 75 percent of total revenue moderated 1% from the 2nd quarter. As anticipated, we saw continued sequential growth for telecom applications with revenue of $217,000,000, up 5% sequentially and representing 70 3 percent of optical communications revenue. Also as anticipated, datagon revenue decreased sequentially and was $81,000,000 or 27 percent of optical communications revenue. By technology, Silicon Photonics based optical communications revenue was 82000000 dollars or 27% of optical communications revenue, a slight improvement from Q2. Revenue from QSFP28 and QSFP56 transceivers was $44,000,000, a decrease from the 2nd quarter as growth in QSFP56 programs was more than offset by declines in QSFP28 programs.
As our customers transition to next generation designs. By data rates, 100 gig programs continue to represent about half of optical communications revenue or 146,000,000. Products rated at speeds of 400 gig and above grew 15% from the second quarter to $23,000,000 or 8% of optical communications revenue. Looking at non optical communications, revenue was $101,000,000, up 3% from Q2. Revenue from industrial lasers was $48,000,000 compared to $50,000,000 in the 2nd quarter.
Automotive revenue increased 6% to more than 24,000,000 with the majority of this growth coming from new automotive applications. Censor revenue was roughly flat at $4,000,000 in the third quarter. Finally, other non optical communications revenue increased 17% from the second to $24,000,000. Revenue from new business increased 4% from the second quarter to $152,000,000 and represented 38% of total revenue in the quarter. While we don't generally discuss specific transactions during the third quarter entered into an agreement with an existing customer that could have a meaningful impact on our results in the coming quarters and hence warrants further discussion.
We typically engage with our customers during the design phase and early in the manufacturing process to help them transition from new product introduction into volume manufacturing. During the third quarter, we signed an agreement with Infinera, an existing customer to assume manufacturing responsibilities for the products currently being manufactured at their Coriant division in Berlin. We already have staff in Berlin support this program and anticipate migrating the products currently being manufactured at this location to our facility in Thailand in the coming quarters. While we expect the revenue impact from this program to be small in fiscal 2019, we believe that it could lead to Infinera becoming a greater than 10% customer in fiscal 2020 and what we believe is a win win relationship. With this transaction as well as other new business wins we expect our first building in Chonburi to reach a level of 70% that is either occupied or spoken for in the coming months.
In summary, we're pleased to have exceeded our expectations for the third quarter with revenue above the high end of our guidance and to have delivered earnings per share that were also above the high end of expectations. We are pleased to see gross margins returned to our target range and are optimistic that our new program with Infinera will further support the momentum we see across our business. Now, let me turn the call over to TS, to discuss the details of our third quarter performance and our outlook. TS?
Thank you, Seamus and good afternoon everyone. I will provide you with more details on our performance by end market and our financial results for Q3 as well as our guidance for Q4 of fiscal year 2019. Total revenue in the third quarter of fiscal year 2019 was $399,000,000. Note that our adoptions of ASC 6060 fiscal year reduce our revenue by approximately $3,000,000 in the third quarter as compared to what our revenue would have been under ASC 605. Because we provide guidance under ASC 605.
This means that we will have exceeded the top end of our revenue guidance of $384,000,000 to $392,000,000 by $10,000,000 if we had reported under ASC 605. Non GAAP net income was $0.92 per share and was also above our guidance range even after an $0.08 per share foreign exchange headwind in the quarter. Aductions of ASC 606 further reduced our net income by approximately $0.01 per share. As compared to our guidance provided under ASC 605. Looking at the third quarter in more detail, Our quarter play out as anticipated with strong continued growth from telecom products, a sequential revenue decline from datacom products and non optical communication revenue that was slightly up from the second quarter.
Optical communications represent 75% of revenue with non optical communication represent 25 percent of revenue. Now turning to the details of our P and L, A reconciliation of GAAP to non GAAP measures is included in our earnings press release and investor presentation, which you can find on our website. Non GAAP gross margin in the 3rd quarter was 12.1%, an increase of 50 basis points from the second quarter and within our target range of 12% to 12.5% as component supply constraints have eased and as we continue to improve productivity. Non GAAP operating expense was 10,100,000 in the 3rd quarter. As a result, non GAAP operating income was a record of $38,000,000, an increase on the 2nd quarter despite slightly lower revenue.
Non GAAP operating margin was 9.5%, up from the 9.3% in the 2nd quarter. Taxes in the quarter were $1,500,000 and our normalized effective tax rate was 5.2%. We continue to anticipate an effective tax rate of 6% to 7% for the fiscal year. Non GAAP net income was above our guidance range at $34,300,000 in the third quarter or $0.92 per diluted share despite the foreign exchange headwind of $0.08 per share. On a GAAP basis, which include share based compensation expenses, and amortization of debt issuing costs, net income for the third quarter was $28,600,000 or $0.76 per diluted share also $0.01 above the high end of guidance.
Turning to the balance sheet and cash flow statement, at the end of the third quarter, Cash and investment were $408,900,000, an increase of $26,400,000 for the 2nd quarter. Operating cash flow in the quarter was 36,200,000 and with CapEx of 3,500,000 Free cash flow was $32,700,000 in the third quarter. During the quarter, we purchased 100,000 shares of our stock at an average price of 53.78 percent for a total cash outlook of 5,400,000 In addition, our board of directors has approved the repurchase of an additional 50,000,000 of cabinets ordinary share bringing the aggregate size of our repurchase program to 110,000,000 with 61,200,000 remaining. I would now like to turn to our guidance for the fourth quarter of fiscal year 2019. This guidance is based on ASC 605 and we will provide a reconciliation with our 4th quarter results.
Starting in fiscal 2020, our guidance will be under ASC 606. For the fourth quarter, we expect revenue to be consistent with the third quarter with a relatively flat performance from telecom, a modest improvement in datacom and a relatively flat non optical communication performance. As Seamus mentioned, we entered into an agreement with Infinera in the third quarter, whereby we will be assuming manufacturing responsibility of products currently being produced at Infinera Former Hollients Facility in Berlin. We expect this program to ramp over time and that we will ultimately transfer this manufacturing to our facility in Thailand while the near term revenue contribution is still fairly small. We believe that when fully ramped, this program could generate enough revenue to move Infinera from a less than 10% customer to a greater than 10% customer.
While this program will be accretive to non GAAP profitability, we expect gross margin headwinds to push us closer to the low end of our target range of 12 to 12.5% when fully ramped As with our customer specific program, we do not plan to breakout revenue from this relationship but may provide incremental color from time time that could be useful to investors. With that backdrop for the fourth quarter of fiscal year 2019, We anticipate revenue to be in the range of $396,000,000 to 404,000,000 representing growth of 15% to 17% from a year ago and grew approximately 15% for all of fiscal year 2019. From an earning perspective, we anticipate non GAAP net income per share in the fourth quarter to be in the range of $0.92 to $0.96 and GAAP net income per share of $0.78 to $0.82 based on approximately 37,600,000 fully diluted share outstanding. In summary, we delivered financial results that exceeded our guidance in the third quarter and we are well positioned for continued momentum across our business as a leading contract manufacturer for the industry's most complex optical and electronic components and devices. Thank
And our first question will come from the line of Alex Henderson with Needham. Your line is now open.
Thank you very much. So I guess I'm a little puzzled by the guidance on the revenue sequentially being flat in the June quarter. It's very much against the historical trends that suggest June quarter is sequentially always considerably up and seasonally much stronger quarter given what goes on in the 1st quarter, particularly in the telco, but even in the datacom side. I was hoping you might give us some sense of what it is that is causing that to be sequentially flatter. Is it capacity constraints?
Is it timing of new capacity adds, what's behind the mechanics there?
Hey, Alex. Thanks for the questions. This is TS. I think a mixture of all the things you mentioned, you know, 1st of all, the datacom is simply unsettled. You know, we, although we guided a little bit higher than a Q3.
But again, it's still out there. We are probably less than 20% of the the market share. A lot of our customer do not participate in broad range of datacom. So a lot of customers who are in a datacom, major player, are not doing business with us. So I really cannot tell align that with the industry.
So datacom, we believe you'll be a little bit uptick and telecom, as you mentioned, you know, a lot of capacity constraints and depending on how well we can execute those capacity together with the customer.
Yes, if I could just add, Alex, historically, you're right, historically, some years we have seen strong sequential growth in Q4. Over the years, it has been a little bit more modest. I guess, our forecasts are based on the committed orders we have from our customers. So it's really a reflection of what we're seeing from our customers. We are pleased I would say that after a challenging fiscal 2018, We have returned to year over year growth for every quarter in FY2019, and we're looking at about 15% growth for the year.
So just to the point though, I mean, it seems that this implies that there's some constraints that are a little artificial harder for to forecast. And I was hoping you might help with a little bit of that. To that extent that some of this is capacity constraint issue are you anticipating that after a quarter to quarter flatness, which is unusual in the June quarter that you might have more capacity coming on that would help you in the back half of calendar 'nineteen. And therefore, it's just a timing of when the growth kicks in, how should we be thinking about that beyond the current constraints?
I would say, obviously, we just guide 1 quarter at a time, but it's not a secret that we are installing capacity to support some of the capacity constraints we've had historically. And also with the new business coming our way, the new program we've from Infinera, we do see that having a positive impact in the back half of the year for sure.
So just to be clear, so the capacity constraints here are your capacity constraints or capacity constraints in particular products, what exactly were you referring to?
It's with specific products where the our customers make investments in, I would say, product specific unique equipment that can sometimes become the pacing item, usually a piece of test equipment. That's, you know, it's not a piece of of, let's say, standard equipment is more a piece of unique equipment. So typically our customers will make that investment ideally in an ideal world ahead of the ramp curve, but in some cases, the demand is outpacing the supply and it just takes a little bit of time. For capacity to catch up with the demand.
So this isn't a function of any move to Chombry or anything of that sort?
No, no, no, nothing at all to Chombry. It's to do with specific I would say product specific to be more precise test equipment and not at all a function of physical capacity.
Great. That's very helpful. Thanks very much.
Thanks, Alex.
Thank you. And our next question will come from the line of Troy Jensen with Piper Jaffray. Your line is now open.
Hey, gentlemen, congrats on the nice quarter and the new one.
Thanks, Roy.
Hey, guys. So, I guess, love to
get just a little bit more color on how big Infinera is. You said it could grow to greater than 10% customer, but to my knowledge, our current customer. So can you just kind of give us some form of reference? Are they close to 10% now? And this is a modest win, or are they well below and this is, you know, more material?
Well, there are less than 10% customer. Obviously, we're not going to put a number on that, Troy, freight. We really only report the 10% customers once a year and only when they become a 10% customer. So we'll report it looking back at some time in the future. But there are less than 10% customers there.
They're a very important customer for us. They've been a long standing customer for us and just an, you know, an excellent customer. It's been a great partnership between the two companies. The Berlin business or the Coriant business, I would call it, really what we're transferring, and we have a team on the ground right now in Berlin managing that transfer. We're transferring all of the business or all of the products that are currently being manufactured in Coriant in Berlin are being transferred to our operations in Thailand.
We're not just to be clear, we're not acquiring a facility in Germany or anything like that. We're just managing the the transfer of those activities to Thailand. And the products, it's a range of, I would say, line cards for transponders filters, optical amplifiers, interface cards, power management cards. And then as well as complete network systems for transport for both long haul and metro applications. And then in addition to that, there's also the repair center support and reverse and forward logistics that goes with that.
So it's a full suite of offerings or services that are currently being done out of the Berlin operation will be transferred to Bangkok. And it's an excellent fit with our core competencies and it really strengthens our already, I would say, our already excellent relationship with with Infinera. We do expect that they will become a greater than 10% customer with this transaction, but we're not putting a timeline on that. Okay. All right, understood.
And then how about just to dive further into the datacom business? It was down a lot sequentially, but now you're guiding it up. So you can just talk about the visibility you have for the datacom business and, you know, are you expecting to see growth in QSFP28 or different datacom products
So we're I guess it's a kind of a mixed message. And as you know, Troy, we don't break it out by individual customer, but what I would say is there's a number of factors going on. So there is some price, I would say price erosion where our customers are giving very significant price reductions to win market share. We're working with our customers to make sure when that happens that we're able to match that with cost reduction that we preserve our margin. So there's a combination of price reductions coupled with some product transitions where some of our customers, 1 or 2 of them are transitioning to new generation, new technology products.
And usually when that happens, there's a significant improvement in performance. So for example, a customer goes from a 100 gig product to a 400 gig product. The average selling price of the product goes up but the volume will drop in the short term. So we're seeing a little bit of that where there's a little bit of price erosion coupled with some product transitions. Overall, I mean, we're very optimistic about the datacom market.
I mean, datacenter rollouts around the world are just going at a phenomenal pace. So I would say over the long term, we still feel very positive about that market. And we think we have the right customers that we're supporting in that market space. But so it's a couple of things. It's not only one thing.
It's a couple of things and we are looking at a slight uptick then in Q4. With those same set of customers.
Thank you. And our next question will come from the line of John Marchetti with Stifel. Your line is now open.
Thanks very much. Just following up on on some of the guidance on the telecom side. You mentioned the capacity constraints there. Just curious, Seamus, in your conversations with customers and I'm certainly not asking for any one name in particular. But just curious if you're hearing about them seeing any sort of slowing growth, whether it's because of inventory build ups or some of the renewed risk that seems to be coming back in on China.
Just curious in your conversations with customers there, how that may be impacting some of the telecom demand or if they're sharing any of that color with you?
A little bit. I think what we're hearing. So again, you'll appreciate we're, a couple of steps removed from the end customers. Let's say you mentioned China. For example, the end customers in China.
But what we do hear from our customers is they tell us that they are not really seeing big inventory bills maybe like we've seen a couple of years ago. And then if there are inventory bills going on, and this I think was talked about on a couple of our customers' earnings calls the last few days, the last week or so. But if there is inventory bills going on, it's more in support of tenders that are going on where there's a fairly aggressive trial may be running at the moment. And then subject to the trial going well, there would be an installation in later in the year. Again, that's a little bit secondhand or maybe even thirdhand information.
So, you know, take it with a pinch of salt, I would say. But, I'll put it this way, we're not hearing, we're not hearing from our that this big inventory buildups going on. We're not hearing that. And the demand, you know, we touch wood. The demand does remain quite strong in the telecom space.
Got it. And then if I can just ask another question on the datacom side, you mentioned that transition from 28% to 56%. I'm curious in your mind sort of where the industry is in that transition and you mentioned obviously the uptick a little bit in datacom expected in the current quarter. Is that starting to be resolved or am I reading too much into to those 2 sort of comments together?
Yes, maybe reading a little bit too much. Bear in mind, we're especially with datacom, we're not not in any way a kind of a proxy for the industry. We don't have all the players and we don't make all the products for all the companies that we do support. Having said that on the transition to QSFP56, we're probably again, it depends on which customer we're talking about. We're probably in the middle of that transition, I would say, at the moment, in the early stages of it.
And the uptake we're seeing in the current quarter it's with a couple of customers. In other words, I suppose the softness we've seen, we don't see it as a long term trend. We see it more as a transition to newer products with higher ASPs with lower volumes to begin with, coupled with some price erosion from some of our customers.
Got it. And then yes, go ahead. Yes, sorry.
Yes, if you look at Q2, you are down 17,000,000 dollars, $18,000,000 on datacom. So the only way is to go up, you know, so we just guided a little bit maybe back to normal, normal car, normal frame, right, but this quarter was down it can be done.
Understood. Understood. And then one last question, if I could, TS, you mentioned, with Infinera coming on as it starts to become more than a 10% customer that pushes you down towards the lower end of the 12% to 12.5 gross margin guide. Does that have to do with them, you know, sort of now reaching certain volume break points and some things like that? Is the business that you're bringing over say structurally different than maybe what you see with some of your other customers?
Just trying to get a little color there on how we should think about once that business hits how gross margin maybe trends after that?
John, you're probably aware that in any product transfer, there's many moving parts and everything has to be light up, you know, the moon, the sun, you know, the river. So we said fully ramped. We'll get to them more than 10% customer. But, again, in the process, anything can just go sideways. Right?
So we are kind of cautious Obviously, you know, the margin also relates to some of the product. Most of the product we transfer, my understanding is is is a mass production. It's not a new product. If you listen to our earning call in the past, we always say that it is a brand new product. We have better opportunity for gross margin Right.
So these are the existing product. We are transferring the whole thing, into Thailand. So depending on how how small you go, that's why we cannot set a timing when you become a 10% customer. But yeah, obviously, we'll try to, you know, solve for the higher gross margin. But again, there's a lot of moving parts, as I say.
Thank you. Our next question will come from the line of Tim Savageaux with Northland Capital Your line is now open.
Hi, good afternoon.
Question on datacom. In the quarter. Did you see any impacts from the exit of your largest customer or at least the sale of that unit to a third party in China. And if not, do you what sort of impact you expect to see, from that transaction as well as kind of the broader exit of the datacom module business of that customer? Thanks.
So, Tim, just to make sure that we get a question right. You are referring to our top customer who want to diversify some of the datacom product. Correct? Mhmm. Yeah.
It's in progress. Again, so far this or next quarter, we do not see a major shift. You know, this will take some time to transition to maybe another another, customer, you know, and I understand that they are trying to sell their business to another customer And hopefully, you know, we continue to build those products. But so far in a Q4 guidance, we we did not factor significant drop in a particular customer, if that's helpful.
I think the question as well, Tim, was related to Q3. So no
Q3, no. Q4, maybe a slight, but it's not significant, yes.
And, okay, well, then to follow-up on the Q3 Datacom results, Can you characterize trends in your datacom business kind of relative to Silicon Photonics, or more traditional, datacom modules Is there any kind of divergence there or anything notable? I'm going to assume you did see an uptick in Silicon Photonics, a small one that that was driven by telecom growing?
That's fair observation, Tim. Yeah, most of the silicon photonic uptake it came from a a telecom. That's correct. Now in terms of datacom again, you know, we only have, like, our customer collectively, probably participate about 20 percent of the datacom, business. If you look at a major player, a lot of them, we don't have business with them.
So we can only look at the customer we have, the 13 week rolling forecast and try to do a guidance based on that.
Okay. And one last one for me, and I know you probably don't disclose this sort of thing, but in the past, you know, Infinera had some good times at bad times. Can you say whether they were ever a 10% customer for any particular quarter over the, I don't know, the last 5 years or so?
Again, as I say, we only report 10% customer 1 a year. In the last couple of years, they had never make it to the 10% customer for the total year standpoint. Go to quarter honestly, don't have the data in front of me, so it's hard for me to say.
Thanks Tim.
Thank you. And our next question will come from the line of Alex Henderson with Needham. Your line is now open.
Yeah. I just hope that we could try another way of slicing and dicing the, Infinera pumpkin. So is there if I exclude existing Infinera business and just look at the business that's being transported, is that roughly a 10% contribution excluding any business that you already had with them. Is that the magnitude of what's being transferred over?
Well, what we've said is the total will be we think we'll make an Infinera, the combination of Infinera plus Coriant a 10% customer. We're not really breaking it out at for Corianton. So
And so in terms of timeline, if you think about the the process flow here. I assume it it's a gradual fade in, as opposed to a hard, you know, flashover. Can you talk a little bit about the the mechanics of it, to help us think about how we should feather it in? Is it 10% of the benefit upfront and then 20% in the next quarter and 20% to quarter after that. Is that kind of slope, or is it 5% here, 8% there, and then, you know, 30% in a quarter.
Is there any window where we should be more aggressive or less aggressive to help us on the out year?
Sure. I think first of all, if I talk a little bit about the mechanics of the You're right. It is a gradual transfer. The question, of course, is how gradual and over how many quarters. So, these are, as you'd appreciate, these are complex products with existing customers who have to qualify a new production site.
We've actually started that process. We have over eighty people currently on-site in Berlin and that will grow to over 100 people over the coming weeks. We're transferring as we speak the revenue impact this quarter will be, I would say, minimal. And really, we'll start to see revenue impact next quarter. And beyond.
I think it's probably a 2 to 3 quarter timeline to get everything transferred and fully buttoned down and qualified and ramped up in Bangkok. So I would say over a 2 to 3 quarter time horizon.
One more question, if I could. So if when we were talking, last year, the bot had been, you know, setting up setting up for a pretty good benefit. And I think you'd talked about it potentially adding as much as a point to your gross margins if it had been at that level for a full year trailing. We've seen a lot of movement in it. It obviously isn't come back all the way to to where it was.
So I assume that you're still getting some benefit Is it reasonable to to think that there's, a little bit of a benefit from that to help offset some of the costs associated with the lower margins associated with this business move?
I, obviously, I like to think that way. But, if you follow Thai, political situation here, they just have the election about maybe a month ago, and they haven't announced a result yet. So, and they go to the crown, the crowning of the king, the new king, which is done last, right, last Monday, and they are supposed to announce the election result this way. So depending on who form the customer, the bot may go either way, depending on, you know, But right now, based on the prediction is that the pro military camp is probably going to take control, become a 5 minutes, run a government. In that case, the bot will continue to be stable and strengthened, which is a little bit I'm a little bit worried that because you know, because the country is doing well under the military region, so that tends to stable and, become stronger.
But I watch it very closely. Again, we stick to our, hedging policy, you know, 100%, 60% 25% for the next three quarters. Again, if there's an impact, there will be a delay factor, you will not impact right away because of the hedging program. And also based on the advice in the past, I like I'm trying to look at the document, all this as a cash flow hedge. So then we will take it to the balance sheet.
Okay. That that is the direction given to me. So I'm trying to, maybe beginning FY 2020. We try to get a good documentation and get all this thing into the other comprehensive income, which is in the balance sheet.
So would you then stop reporting negative currency or positive
currency translations
of the balance sheet, because they're functionally not really ongoing operational expenses?
Yeah. Well, if if it's not in the P and L, then I won't I won't highlight, you know, unless there's significant gain and loss. Right? If you look at this year, year to date, you know, I can't break even. Q 1, I have again, 3,000,000 q 2.
I have slight loss. And Q3, I have a lot. So year to date, you know, I'm okay. But then again, from a quarter to quarter, it fluctuates, you know, so that even be a a case to bring a holding to the balance sheet rather than impact every quarter, you know, only. So
I see. Okay. Thank you.
Thank you, Alex. Thanks, Alex.
Thank you. I'm showing no further questions in the queue. Now, it is my pleasure to hand the conference back over to Mr. Seamus Grady, Chief Executive Officer, for any closing comments or remarks.
Thank you, operator, and thank you for joining our call today, everyone. We're excited to deliver strong results and a positive outlook as we continue to position the company for sustainable growth and diversification over the longer term. We look forward to speaking with you again. Thank you and goodbye.
Ladies and gentlemen, thank you for your participation on today's conference. This does conclude our program and you may all disconnect. Everybody. Have a wonderful day.