Good day, ladies and gentlemen, and welcome to Fabrinet's Financial Results Conference Call for the Second Quarter of Fiscal 2019. At this time, As a reminder, today's call is being recorded. I would now like to turn your call over to your host, Garo Thomas Jameyen.
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 second quarter of fiscal year 2019. Which ended on December 28, 2018. 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.
Bevernet.com. Please refer to our website for important information, including our earnings press release and investor presentation, which include our GAAP to non GAAP reconciliations. 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.
In 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 November 6, 2018. We will begin the call with remarks from Seamus and Keyes, followed by time for questions. I would now like to turn the call over to Fabrinet's CEO, Seamus Green. Seamus?
Thank you, Garo, and good afternoon, everyone. We posted record revenue and non GAAP earnings per share in the second quarter. Revenue in the second quarter was above the high end of our guidance range at $403,000,000 and non GAAP net income also exceeded our guidance. At $0.97 per share. These results also drove strong cash flows in the second quarter with operating cash flow of nearly 35,000,000 and free cash flow of 30,000,000.
Upside was driven primarily by stronger than expected growth from the telecom market. Component supply constraints that we experienced in the first quarter eased somewhat in the second quarter. However, supply for MLCC and certain ASIC parts remain constrained. As such, we continue to see some headwinds to gross margins from our efforts to mitigate these supply constraints in order to meet customer demand and Both optical communications and non optical communications business grew sequentially as well as year over year. Oscar Communications revenue was $306,000,000 or 76 percent of total revenue and grew 9% from the first quarter.
Within optical, 100 gig transceivers continue to generate strong revenue with additional growth from non speed rated products such as amplifiers and ROADMs. Growth in optical communications was led by telecom products, which at 207,000,000 or 68% of optical revenue grew 16% from Q1 to an all time record. Datacom product were 32 percent of optical revenue at $99,000,000, a decrease of a few percentage points from Q1, primarily due to the transition of current products to the next generation designs. By technology, Silicon Photonics based optical communications revenue was 80,000,000 a slight decline from Q1, again primarily due to product design transitions. During the quarter, we started to see revenue from QSFP56 as 2 customers started migrating from QSFP28 to faster data rate QSFP56 transceivers.
Variance of the QSFP28 and now the QSFP56 transceivers, which can be both silicon photonics and non silicon photonics based continue to perform well, with revenue up 21 percent from Q1 at $55,000,000. By data rates, as I mentioned, 100 gig programs continue to dominate optical communications production at 52 percent of optical revenue or $158,000,000. Products rated at speeds of 400 gig and above represented more than 6% of optical communications revenue. With virtually all of this revenue from telecom applications. Looking at non optical communications, revenue was $98,000,000, up 1% from Q1 We continue to see momentum in the industrial laser market with revenue up 2% sequentially to 50,000,000.
Automotive revenue increased 4 percent to $23,000,000 with traditional automotive remaining stable and new automotive applications up a little. Censor revenue was flat at $4,000,000 in the second quarter and other non optical communications revenue was also stable sequentially at $21,000,000. Both new business and existing programs contributed to our top line growth in the second quarter, with new business up 7% sequentially to 147,000,000 or 36% of total revenue. We continue to generate strong interest from new and existing customers And while a little over 60% of our new building in Chonburi is spoken for or occupied, we have ample capacity to handle near term demand. TS will provide more color on our guidance, but we are optimistic that Q3 will represent a record 3rd quarter for us in terms of both revenue and profitable In summary, we're pleased with our record performance in the second quarter and remain enthusiastic about our longer term prospects as a trusted manufacturing partner for our customers' most demanding and complex products.
Now let me turn the call over to TS to discuss the details of our second 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 Q2 as well as our guidance for Q3 of fiscal year 2019. Total revenue in the second quarter of fiscal year 2019 was $403,100,000. Note that our adoptions of ASC 606 this fiscal year, contributed approximately $3,000,000 to our second quarter revenue. This means that we exceeded the high end of our revenue guidance of $380,000,000 to $388,000,000 under ASC 605 by $12,000,000.
Non GAAP net income was $0.97 per share and was also above our guidance range despite a $0.01 per share following a change headwind in the quarter. ASC 606 impact on net income was immaterial. Looking at the second quarter in more detail, our growth was driven primarily by the telecom market within optical communication. Optical communication represented 76 percent of revenue with non optical communication representing 24 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 2nd quarter was 11.6% An improvement from the first quarter was still a little below our target range as we continue to see supply constraints for certain components having a negative impact on overall gross margin. We continue to anticipate reaching our target range of 12 to 12.5% on a quarterly basis this fiscal year. Non GAAP Operating was $9,400,000 in the 2nd quarter, down from the 1st quarter, but up from a year ago. As a result, non GAAP operating income was $37,500,000, an increase from the 1st quarter and a year ago, and non GAAP operating margin was 9.3% compared to 8.5% in the first quarter.
Texas in the quarter was $700,000 and our normalized effective tax rate was 5.9%. We continue to anticipate an effective tax rate of 6% to 7% for the fiscal year. Non GAAP net income was a record $36,500,000 in the 2nd quarter or $0.97 per diluted share up from $0.92 in Q1 and $0.72 a year ago. On a GAAP basis, which include share based compensation expenses and amortization of debt issuing costs. Net income for the second quarter was $31,500,000, or $0.84 per diluted share, also a record performance.
Turning to the balance sheet and cash flow statement. At the end of the second quarter, cash and investment were $382,500,000, an increase of $30,100,000 from the first quarter. Operating cash flow in the quarter was $34,700,000 and with CapEx of $4,300,000 Free cash flow was $30,400,000 in the second quarter. We did not repurchase any share during the second quarter. Management will continue to evaluate the buyback program based on stock market conditions and our cash position each quarter as such as of the end of the quarter, $17,600,000 remain in our repurchase authorization.
I would now like to turn to our guidance for the third quarter of fiscal year 2019. While we are now reporting under ASC 606, this guidance is based on ASC 605. And we will provide a reconciliation with our 3rd quarter results. After reporting record revenue, and net income in the second quarter, we anticipate continuous year over year growth, but a small sequential decrease in total revenue in the third quarter, we continued sequential growth in telecom, offset by a small decline in datacom and a small seasonal decline from non optical communications. Despite this sequential decline in total revenue, we remain very optimistic and confident in our market position as reflected in anticipated year over year growth.
For the third quarters of fiscal 2019, we anticipate revenue to be in the range of 384 to $392,000,000. From an earning perspective, we anticipate non GAAP net income per share in the third quarter to be in the range of $0.86 to $0.90 and GAAP net income per share of 71 to $0.75 based on approximately $37,600,000 fully diluted shares outstanding. In summary, we are pleased with our record performance in second quarter. Our strong market position make us optimistic in our business momentum.
Thank
And our first question will come from the line of Alex Henderson with Needham And Company. Your line is now open.
Hey, thanks. A couple of quick questions just on the modeling data. The first one is, the tax line came in well below forecast. Looks like about a $0.04 positive to the numbers relative to what we had been modeling at 6.2. Should we be expecting since you're guiding to 6 to 7 for the year, that we make that up and that, in fact, for the full year on an annual basis, were in the 6 to 7, or are you saying that in the back half, you expect 6 to 7 on a quarterly basis?
Hey, Alex, this is Jess. Good afternoon. Yes, I think for the particular quarter, we report a little below $700,000 tax expense. Moving forward, in the second half, I would still go back to 6%, 67%.
So it's 67% on a quarterly basis, not on a full year basis then?
That's correct.
Good. Okay. That helps. And then the other one was, I was a little surprised that the decline of $400,000 or so in the sales and marketing line and what normally is a seasonally stronger quarter. Can you give us some rightsizing on that?
Should we be thinking that, that comes back up towards the 10, 10.5 range, or will it stay down here at the slower level?
No, we have a couple of adjustment in the last quarter at Q2, moving forward, I still look at around $11,000,000 a quarter.
$11,000,000 per quarter on the sales and marketing line?
Yes. That's correct, Alex.
That's non GAAP?
That's non GAAP, yes. Right.
Okay.
Then we plus the SEC, of course.
Right. Can you just tell me what it was you said that you that passives improved, but you said some chips were, still tight. What supplies are you still struggling with?
Alex, this is Shane. So primarily MLCCs and also certain ASIC devices. Overall, we did see an improvement. In the quarter, but we still have some tightness on a couple of categories here. MLCCs and ASICs being the 2 main ones.
So it sounds like you're expecting to get back to the 12 plus 12 or better range over the year, but given that you didn't say that about the the March quarter that we should be below that 12% hurdle in the March quarter?
I think we, I mean, we did improve from, I think we were at 11.2 the prior quarter than 11.6% in Q2. I think we continue to see some improvement and we said we think we can get back to the 12% range before the end of the year. Now whether we get back there in Q3 or in Q4, we still have that, component I would say slight headwind on the components there. But we think we can get back there certainly in this fiscal year, whether it's Q3 or Q4. Remains to be seen.
Okay. One last question, then I'll see the floor. I hate forecasting Forex, but Since December 31, there's been a spike in the exchange rate back to February levels. That ForEx move. I know you hedge it on operationally, but it does show up in the Forex exchange line.
What are we assuming for the March quarter in that line? Are we assuming $2,000,000 to $3,000,000 hit in that line? Or are you assuming 0 in that line?
So, Alex, for our guidance, we are showing 0. And the reason is that for this quarter, it's already fully hedged I have basically all the buzz I need for this quarter, March quarter. Now moving to June quarter, I have partially hedged And obviously, you're right. The but you do a U-turn right now is appreciating right now. And again, we had dollar cost average down to buy for June September quarter.
So if you're probably assuming the bus stay at this level, 31.3 this morning, in September quarter, You might see some headwinds on the gross margin again. But again, we don't know yet because if you stay at 31.3 today, tomorrow and get my backup to 33. So we are watching it very, very closely.
If I assume the exchange rate stays at the current level all the way through 2019, would that be a headwind against your gross margins in the June, September, December quarters?
Will be in the June, excuse me, in September, most in September December quarter, assuming it's there at 31.3.
We have to assume a flat currency, unless harder to file a cash currency than your numbers. I appreciate the content. Thank you.
Thank you. And our next question will come from the line of Troy Jensen with Piper Jaffray. Your line is now open.
Hey, so first, how about on the Silicon Photonics? You said it was down slightly there. I think you mentioned some product transitions anything else you can kind of provide on some details on what happened?
I think if you look at on the longer term, Silicon Connex as a technology segment is still doing very well. Last quarter, we see some design transition mostly from one customer. The rest of the customer in that group are all doing well. Okay. How about, I know
you don't like to talk about customers, but Cisco is acquiring Luxtera and Alexterra is one of your customers in this category. So could you maybe just help us size the opportunity there? Have you had any discussions with Cisco and their intents on wrapping ramping up a Silicon Photonics?
So yes, Cisco is a customer. There's nothing that we have noted yet. And as far as we know the deal, that acquisition hasn't closed yet. And all I would say is historically, we have benefited from those types of consolidations. But I think for us, it's too early to say yes, what the impact might be.
All right, perfect. And then, Seamus, I know you're saying end of last year kind of had multiple conversations with customers about China tariffs. And I know it'd be kind of a further out opportunity, but love to get an update there as any of these conversations get more serious.
Yes, so I think we continue to have conversations with and discussions with several customers, but they remain really discussions at this point. Like I said, we're still primarily at the discussion stage, nothing solids, nothing concrete to report there yet. It takes a long time as I can tell you, it kind of appreciates. Troy takes a long time from the initiative, discussion until it turns into Read business. It can be a 6 to 9 month process.
Best case and then you have the qualification timeline on top of that.
Totally understand, keep up the good work gentlemen.
Thank you, Trent.
Thank you.
And our next question will come from John Marchetti with Stifel. Your line is now open.
Thanks very much. Good afternoon. I just wanted to spend a minute if I could, Seamus, on the datacom business Obviously, it's kind of been bouncing around here a little bit weaker in the December quarter. You're talking about it being weak again in March. Just curious if you can sort of give us some color in terms of what you're seeing either from a demand or a pricing front, just trying to get a sense of maybe how that business or your expectations for that business as we kind of climb through 2019?
Yes. So I think you're right, John. The demands or datacom components strictly transceivers remains strong. The market has been experiencing some fairly intense price pressure And we've been doing our base, our product with our customers to work with the customers to reduce costs for these components, make our customers competitive in the marketplace. So I think the volume the demand remains strong, but there is some very significant pricing pressure coming from the end market.
While this can impact our revenue, like it did this past quarter, we typically share in the cost savings that we're able to generate with our customers. So we're able to preserve our margins. So so that it and again, we said the decline there in datacom, it's not isolated to one particular customer. It's across the board. But the demand is strong in terms of volume.
The price pressure is pretty intense. In addition, we don't expect the revenue there to go up in a straight line And we point out that we expect revenue from all the product lines to be flat to up on a year over year basis. Which does indicate continued positive trends.
And I guess following up on that, the move to QSS P56 and some of the things that you mentioned even in Silicon Photonics, would you expect those areas to be growth areas as you go through year? And then some of the other, obviously, the pricing and some of the drop off in 'twenty eight occurs. I'm just trying to think about this from a trends perspective.
Yes, I think that's fair. That's a fair assumption. The transition to QSFP56, it's 2 customers. And it's on products that are 4 100 gig and above So the volume growth that comes with that then, again, it won't be in a straight line, especially when the customer transitions, maybe from a QSFP28 100 gig product, for example, to a DOSFP56, 400 gig product. With that additional bandwidth that you have there, it takes a little bit of time for the volume to catch up.
But it's a high quality problem that we like to have because it means we're working on the most, the most current generation and next generation products. But like I said, with that does come, the fact that sometimes they don't grow in a straight line. We're happy to live with that.
Right, right. And then if I can just get in one last one, maybe on the telecom side. Obviously some continued strength in that business In discussions with your customers, is there any concern at all that with all the noise about what may or may not happen with Huawei and China and things like that, that there's a chance here that we actually have some overordering going on for customers serving that China market and that if things ultimately smooth out that there's a chance that we have a pullback on that demand front just because of some early sort of overordering and anticipation of an action that may or may not occur. Just curious in your conversations with customers, how they're viewing sort of that China market right now?
Yes, that's not something we've discussed with our customer John, honestly, it's, of course, there's always a chance that some of the customers and companies in the supply chain somewhere around the way our overordering If they are, they wouldn't necessarily tell us that if they were, and we really don't have any visibility into that, I'm afraid, John. And it's just not something that Thanks very much. Thanks, John.
Thank you. Our next question will come from the line of Alex Henderson with Needham And Company.
Your line is now open.
No, that's no surprise. So I wanted to ask a couple of questions relative to the merger between Oclaro and Lumentum, how do you think that that impacts you? Do you expect any change in production location that would favor you or any cutbacks in product line that might hurt you? And if those cutbacks occur, with other companies that are you're currently serving benefit? How does that all shake out relative to to your positioning?
I think it's, I think it's really very early to say it's too early to say, I think at this stage, you know, Again, we've been building products historically for both companies and now for Lumentum, they're our number one customer. And, historically have been in 2007. In our last fiscal year, we're at 17% customer now. There are 20 to roughly 23% customer. But it's really too early to say Alex what the impact might be in terms of any product shakeouts.
I guess from our perspective, we're reasonably optimistic in the sense that there's very little product overlap in what we make and what we have made historically for both companies.
And then, Alex, this year, we will learn more tomorrow from the Momentum Learning call, which I intend to value into.
Well, the good news is the call will happen before the morning call. So, before the morning open. Second question I wanted to talk a little bit about is, have you seen any change in the rate of adoption of the capacity at the the new plant. And I mean, 60% is pretty good, but it seems like that's starting to level out a little bit. Has there been some slowdown of footprint commitments?
No, I wouldn't say so. I think maybe the way to think about it, Alex, is, you know, the our existing customers, the majority of our existing customers are at the Pinehurst facility and they prefer to keep all the manufacturing at Pinehurst. And then from time and that facility is essentially full. Then from time to time, customers may free up additional space in Pinehurst as they move as a product to end of life and our line gets moved out and the new line moves in. So we're still able to grow.
In other words, obviously, we want to feel temporary as fast as we can. But there isn't necessarily a direct correlation between the pace at which we increased our occupancy in Chamboree and the pace at which we're able to grow the overall revenue of the company. We're above slightly above 60% right now in terms of occupied and spoken for. And I would say versus our own internal targets, we believe we're very much on track as regards, getting, getting full in Chambourine.
I understand that that's actually nicely ahead of where your original targets were. When do you think you might have to make a decision on actually starting the plant for the next build?
I think we've always kind of said once we get to 70% utilization, we're probably, maybe towards the end of the summer, I think we're probably looking at starting to make some decisions on what we want to do with our next building in charm rates, relatively straightforward for us. We own the land there. We have We have the details specifications for the building, so we know exactly what we've built. So we're able to move pretty quickly, but probably towards the end of the summer, I think, would be fair to say, what do you think?
Yes, that will be the timeframe. Yes.
Okay. And have you guys made any progress in finding, full time CFO to replace TS's retiring position?
Well, we have a very much a full time CFO, TS, and fully engaged We're continuing to look. We're not in any particular hurry. We continue to continue with the services. A lot of very good candidates. But we haven't found anybody at this stage that we're ready to talk about in terms of permanent replacement.
We'll continue to search.
Well, we'll be happy to keep TS as long as he wants to stay, but I guess that's not long in his agenda at this point. Just going back to the optical side for a second, you talk a little bit about, where you are relative to the production facilities, closures, at Sam Nina and moving some of those production to Thailand that your customer has been involved with. Is that now grandfathered into the numbers or is there still more to come from that?
So that's not a we don't have any direct involvement in that close down. So we're not really fully up to speed in what's going on there. Obviously, it's it's a conversation I'd say between our customer and Sanmina, we have benefited somewhat, but the exact status of that and what's finished in terms of transferring we don't have a good handle on.
Any thoughts on how
that plant
will the momentum plant that, is it going to be down the street from you? Is it going to be integrated into your facilities and how the back and forth between those two? Locations. I assume that those are going to be tightly wound.
Our facility and the mentioned facility?
Yes.
Yes, very much so. Yes, I mean, the some of the if you like some of the components and the products that we source today come from lamentum's facility. So that our 2 operations are very tightly coupled and work very closely together.
And one last question, if I could. The Israeli thought process progress lack of progress? Where are you on, on Israel?
So we continue to work on all three aspects of our efforts in Israel, the 3 aspects being further developing relationships with our existing customers there. Exploring relationships with new customers and then establishing our own facility either through Greenfields or acquisition. And we continue to make progress in all three But in terms of bringing up our own facility, it is quite slow going, I would say, because we're being very careful about making sure we have the right facility in the right location and the right size and capability. But we continue to see Israel as a great location to do business in a place where we're committed to bringing up an NPI facility, but nothing specific to announce at this time, Alex.
I just have one more question if I could. TS, could you give me a little granularity on what caused that decline in the sales G and A line, and why it bounces back so much. I mean, that's a pretty big delta between the three quarters.
I like to approach the year end. Typically, we adjust the bonus accrual for management. And so we kind of expect whether we're going to meet the target or not. So if you're not meeting the target, so we will go some of the accruals. So that's one thing.
And then we have certain, IT systems, which we get some credit on the vendor. So again, that affects the number. So, moving forward, I expect you go back to the normalized SG and A, which is about 11,000,000.
I'm sorry, did you say your bonus accrual did not hit company targets even though it beats consensus?
Yes. For example, we have the management has certain revenues and gross margin as a target. And then as we approach the year end now, We already have 2 quarters behind us. We will forecast whether we're going to meet the goal, whether we're going to have a payout. If we're not going to have a payout, we adjust accordingly.
Just at last year, management, there are any payout. So if you look at last year, first quarter, June quarter, we have a major write back on the accrual. And that's how we do the accounting. That's something
that you would have a disappointment relative to your bonus targets when you beat the high end of the guidance band. Is that because of expectations?
I'll tell you what, the our our board is pretty tough. I mean, guidance is one thing. It's going to go with another thing.
Okay. Well, that's interesting. Thank you very much for that context.
Thank you.
And our next question will come from the line of Dave King with B. Riley FBR. Your line is now open.
Thank you. Good afternoon. First, on the laser segment, what was the percentage of revenue and just how should we think about that segment going forward for the next couple of quarters with all the macro uncertainty and all that?
Okay. This is TS. I think the laser laser, we say about 13% of $15,000,000, right, $15,000,000 divided by $400,000,000, yes, it's about 13%.
And then going forward, Dave, that the same as I would say, laser, the industry laser market for us is a key target segment. We think it's a very large market in terms of the potential, and quite under serviced, I would say, in terms of the degree to which that market outsources today. So they we think it's kind of in the low to mid single digits in terms of how much of that market outsources today for is optical communications, about half of that's half of the manufacturing, let's say, in the optical communications market is out and up to communication is a $10,000,000,000 marketplace, roughly. Industrial lasers, about $15,000,000,000 marketplace And the degree to which it tells us, it's very small, 6% or 7%. So we see it as having very big potential for future growth.
Spoke about the
difference in terms of the technology. It's very complementary to the capabilities we have on the cost per communication side.
So you talked about like some customers or gaining market share or I guess some customers are coming to you guys. Is that still the dynamic here? I mean, and so we should be expecting a sort of sequential growth from December but to March to June. Is that how we should think about it or just can you provide more color on what how we should think about fiscal second half?
I think this, on a quarter to quarter basis, it's definitely some variation, right? In a longer term or medium term, we see that segment is growing simply because we are just into that is early innings. The market is so big. And obviously, you heard some of the weaknesses in certain pockets, but then on semiconductor related laser is big. Right now.
But again, our customer don't participate in every segment, okay, depending on what are the segment material processing it continues doing well. Micromachining is doing well. So a lot depends on this. Our customer is specific to society in which field All right. Suffice to say that most of our customers are growing, maybe FF1, see some decline in the demand.
So we are quite optimistic about that sector.
Got it. And I was wondering, I believe, your, the strength you're seeing in telco, I guess, ROADM is definitely one of the drivers wondering if you can kind of break the segment out, if possible?
Telecom, if you listen to some of my cuts, our customers earning call, they say they sold out. They sold out on the amplifier load them and they're adding capacity. So some of these are obviously, cascade down to our demand, our backlog from them. So, again, if you just listen to our customers who are specialized in telecom, Most of them are upbeat. So we have a 16% sequential growth and 43% year over year growth for that quarter.
So we continue to look out for the telecoms to provide the driver for the growth.
Got it. Okay. And then maybe, lastly, on II VI and Finisar, can you just remind us, 1st of all, are they both mid single digit type of customer and any overlap between those 2?
As of today, they both are single digit, yes. Single digit percent of our total revenue. And not much overlap.
Not much overlap.
Yes, because for Finisar, we always say that we only do the EBA that we looked at their module business. And then II VI bought the line from Oclaro many years ago, and that's the EDF and then a pump laser. So yes, so there are really no overlapping.
Got it. All right. Thank you very much.
Thank you, Dave.
Thank you. And I'm showing no further questions. So now it is my pleasure to hand the conference back over to Mr. Seamus Grady, Chief Executive Office for closing comments or remarks.
Thank you for joining our call today. We're excited to deliver strong results and a positive outlook as we continue to position the company for continued growth and diversification over the longer term, and we look forward to speaking with you again soon. Thank you and goodbye.
Ladies and gentlemen, thank you for your participation on today's conference. This does conclude
our program and we may
all disconnect. Everybody, have a wonderful day.