Ladies and gentlemen, welcome to Fabrinet's financial results conference call for the fourth quarter of fiscal year 2018. 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 given at that time. As a reminder, today's call is being recorded. I would now like to turn the call over to your host, Garo Toomajanian, Investor Relations.
Thank you, operator. 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 of fiscal year 2018, which ended June 29, 2018. With me on the call today are Tom Mitchell, Fabrinet's Founder and Chairman of the Board, Seamus Grady, Chief Executive Officer, and Toh-Seng 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 a 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. 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 8, 2018. We will begin the call with remarks from Tom, Seamus, and TS, followed by time for questions. I would now like to turn the call over to Fabrinet's chairman, Tom Mitchell. Tom?
Thank you, Garo. Good afternoon, everyone. I am pleased that we exceeded our revenue expectations for the fourth quarter, and I'm proud of the company's performance under Seamus' leadership as our CEO. As you may have seen from recent filings, I have stepped away from my operational role at Fabrinet as executive chairman. This marks the completion of the CEO transition we started several quarters ago. However, I plan to remain highly involved as chairman of the board at Fabrinet. I'd like now to turn the call over to Seamus for his remarks.
Thank you, Tom. Good afternoon, everyone. I'm pleased to share with you that our fourth quarter revenue came in above the top end of our guidance at $345 million, with non-GAAP net income of $0.81 per share, also above the high end of our guidance range. Operating cash flow was $48 million in the fourth quarter, and for all of FY 2018, we generated operating cash flow of $138 million and free cash flow of $104 million. We entered the quarter anticipating modest growth across most of the markets we serve, and I'm pleased to report that we experienced strong growth in our Non-Optical Communications revenue and modest, but still positive growth in our Optical Communications revenue. As TS will detail, we anticipate that this sequential growth will continue as we enter FY 2019.
With increasing demand, certain components came under supply constraints during the fourth quarter. We were able to successfully mitigate these shortage risks during the quarter, and we will continue to take appropriate steps to manage these supply challenges. Looking at our fourth quarter performance by end market, our performance was in line with expectations. Overall, Optical Communications revenue of $242 million was up marginally by $1 million from the third quarter. Within optical, telecom revenue of $156 million represented 2% sequential growth, more than offsetting a 1% sequential decline in datacom revenue. We are particularly pleased with the growth we saw from Non-Optical Communications programs. Both our industrial laser and automotive businesses saw all-time record quarterly revenue, with industrial laser revenue growing 36% from a year ago and 8% from Q3 to $47 million, and automotive revenue increasing 34% from a year ago and 20% from Q3 to $26 million.
Overall revenue from Non-Optical Communications programs was $103 million, up 30% from a year ago and up 13% from Q3. We expect there to be some quarter-to-quarter variation as we look ahead, we remain optimistic about our long-term prospects in the Non-Optical Communications space. Revenue from new customers and new programs from existing customers grew to $125 million in the fourth quarter, or 36% of total revenue, increasing over $9 million from the prior quarter. New business growth in the fourth quarter came from both optical programs as well as from Non-Optical Programs, such as industrial lasers and new automotive applications. Silicon photonics-based products saw their first sequential increase in a year, contributing $70 million to revenue in the fourth quarter, up 5% from Q3.
QSFP28 transceivers, which are both Silicon photonics and non-Silicon photonics based, also saw their first sequential growth in a year, with revenue of $45 million, up 20% from Q3, as increased volumes of lower price variants have now more than offset price decreases. By data rate, 100G programs continue to dominate Optical Communications production and represented 39% of total revenue in Q4, consistent with last quarter. 400G and 1.2 terabyte products are in the early stages of ramping, each representing 2%-3% of total revenue. Our new product introduction, our NPI services, are an important on-ramp for new business, with our investments at Fabrinet West and Fabrinet UK playing a critical role. Last quarter, we introduced strategic plans to establish our next NPI facility in Israel, and we look forward to sharing more on that as we progress beyond these early stages.
In addition to continued progress in industrial lasers and automotive, we also won a number of medical programs, which we expect will contribute over time as they ramp into volume production. We're expanding our advanced packaging capabilities at Fabrinet West to further strengthen our NPI manufacturing solutions for new and emerging technology-based products such as LIDAR, 3D sensing, and laser-based lighting products for the automotive industry. We're optimistic our core competencies and manufacturing solutions for products and systems requiring precision optical, mechanical, and electrical assemblies will continue to enable our expansion into these new markets. In summary, we are pleased to have exceeded our revenue and earnings expectations in the fourth quarter, and we continue to generate solid and predictable cash flow. We're enthusiastic about the first quarter and beyond, with stabilizing or improving trends across the markets we serve. We're excited about the many opportunities ahead.
Now let me turn the call over to TS to discuss the details of our fourth 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 Q4 and fiscal year 2018, as well as our guidance for Q1 of fiscal year 2019. Total revenue in the fourth quarter of fiscal year 2018 was $345.3 million, above the high end of our guidance range. Non-GAAP net income was $0.81 per share and was also above our guidance range. Net income in the fourth quarter benefited by $0.03 per share from a partial reversal of deferred tax asset valuation allowance, which was partially offset by a $0.02 unrealized loss from a mark-to-market foreign exchange adjustment. Excluding the positive $0.01 impact of this adjustment, non-GAAP net income was still above the high end of our guidance range.
For the full year, revenue was $1.372 billion and non-GAAP net income was $2.98 per share. Looking at the fourth quarter in more detail, as Seamus mentioned, we saw modest sequential growth from optical communication program in fourth quarter with a small sequential increase in telecom revenue, slightly offsetting a modest decline in datacom's revenue. Our strong 13% sequential growth in non-optical revenue to $103 million was a highlight in Q4, as it set a quarterly record driven primarily by growth in industry lasers and automotive revenue. For the fourth quarter, optical communication represented 70% of revenue in the quarter, and non-optical communication was 30% of revenue. Turning to the details of our P&L. A reconciliation on GAAP to non-GAAP measure is included in our earnings press release and investor presentation, which you can find on our website.
Non-GAAP gross margin in the fourth quarter was 11.8%, slightly below our target range of 12%-12.5%. We expect non-GAAP gross margin to return to within our target range during fiscal year 2019. Non-GAAP operating expense was $10.8 million in the fourth quarter, an increase from the third quarter, primarily due to a one-time reversal of management bonus accrual in Q3 as we discussed last quarter. Non-GAAP operating income in the fourth quarter was $29.7 million, a small decrease from Q3, though operating margin declined slightly to 8.6%. Taxes in the quarter were a net credit of $0.9 million, and our normalized effective tax rate was less than 5%, due primarily to strengthening of Thai baht, which created losses on US dollar-denominated liability that are tax deductible. For all of FY 2018, our effective tax rate was approximately 5%.
We anticipate that our effective tax rate will return to 6%-7% for fiscal year 2019. Non-GAAP net income was $30.7 million in the fourth quarter, or $0.81 per diluted share, compared to $0.71 in Q3 and $0.86 a year ago. On a GAAP basis, which includes share-based compensation expenses and amortizations of debt issuing cost, net income for the fourth quarter was $22.8 million, or $0.60 per diluted share, compared to $27.4 million or $0.72 per diluted share in the fourth quarter of fiscal year 2017. Turning to the balance sheet and cash flow statement.
At the end of the fourth quarter, cash and investment were $335.7 million. This represents an increase of $20.3 million from the end of the third quarter, primarily from the operating cash flow of $48.3 million, offset by a CapEx of $5.6 million, share repurchase of $20 million, and repayments of long-term bank loans of $1 million. Free cash flow, which is operating cash flow less CapEx, was $42.7 million in the fourth quarter. For all of fiscal year 2018, operating cash flow was $138.1 million. After subtracting CapEx of $33.8 million, free cash flow for the year was $104.3 million, representing a significant increase from fiscal year 2017 due to a meaningful decrease in CapEx and improvement in working capital. During the fourth quarter, we were active in our share repurchase program and brought back approximately 551,000 shares at an average price of $36.3 per share.
As of the end of the fourth quarter, $17.6 million remain in our repurchase authorization. I would now like to turn to our guidance for the first quarter of fiscal year 2019. With improving demand from optical communication customers and continuous momentum in our non-optical business, we're looking forward to another quarter of sequential revenue growth. Note that with the discussions of tariffs on product manufactured in China in the news, we currently do not expect a meaningful impact of our revenue, as Chinese components represent a de minimis portion of total values of our manufactured product. In addition, we'll be adopting ASC 606 as of the first quarter of fiscal year 2019 using the modified retrospective transition method. Our revenue guidance today is being provided on an ASC 605 basis, and we'll provide a reconciliation from ASC 606 to ASC 605 when we discuss our first quarter results.
With that in mind, we anticipate first quarter revenue to be in the range of $347 million-$355 million. From an earning perspective, we anticipate non-GAAP net income per share in the first quarter to be in range of $0.80-$0.83, and GAAP net income per share of $0.58-$0.61 based on approximately 37.9 million fully diluted share outstanding. Keep in mind that in Q1, we will bear the additional cost of annual merit increases, resulting in seasonal pressures on our gross margin. Before I conclude my remarks today, on a personal note, I would like to announce that at my request, the company has initiated a search for a new CFO as part of our leadership succession plan to assume my duty at an appropriate time.
After being with Fabrinet for an exciting 12 year and age catching up, I have decided it is time to search for and identify a qualified replacement who'll be ready to take on the new and ever-changing challenges in a fast-moving business. There's no timeline for this transition, as I'm not going anywhere, and I will continue to support Seamus and the management team in the day-to-day operations of the company. In addition, I'll be actively involved in and supporting the search and the eventual transition of my duty to the best fit CFO replacement for the company. In summary, we are pleased to have delivered fourth quarter financial results that exceeded our expectations.
We are encouraged to see improving demand dynamic among our optical communication customer and are optimistic that we will enter fiscal year 2019 with another quarters of sequential growth and believe we are well-positioned to strengthen our presence in both the opticals and non-optical communication market as we look ahead. Operator, we would now like to open the call for questions.
Thank you. Ladies and gentlemen, if you have a question at this time, please press star then one on your touch tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. To prevent any background noise, we ask that you please place your line on mute once your question has been stated. Our first question comes from the line of Troy Jensen of Piper Jaffray. Your line is open.
Hey, gentlemen. Congrats on a great result.
Thank you.
Thank you, Troy.
Shins, I guess, Seamus, you made a comment that silicon photonics grew sequentially and QSFP28 also grew sequentially. I'm curious to know, was that the same customer that drove that result?
It's across a number of customers, actually. It's across a number of customers.
Okay. All right, fair. How about, three months ago when you gave us guidance for this quarter, you talked about the ZTE sales ban impacting sales by $7 million. I'm just curious, when you look at the guidance for this upcoming quarter, is there a dollar amount that's still being impacted? Are you expecting kind of a full recovery?
Yeah, looking back at last quarter, we had mentioned last quarter that there was about a $7 million impact of ZTE factored into our guidance. We have no way to know really what the sales actually would've been without the sanctions, but we think about $7 million was the right ballpark, based on the conversations we had with our customers at that time. For this quarter, we don't expect to see the full impact of the sanctions being lifted in fiscal Q1. Remember, the sanctions were officially lifted in mid-July, and it takes a little bit of time for orders to restart. We would expect much less than $7 million of a benefit in Q1, let's say.
Okay. The recovery's probably post that, but understood. How about, Seamus, on the automotive sector, I think you said 22% sequential growth. Just confirm that, and then how many customers do you have in the automotive category that can move the needle like that?
We have a number of customers, and the growth in our automotive business, we have four customers approximately represent the majority of our automotive revenue. The growth that we're seeing is predominantly on what we refer to kind of internally as new automotive applications. It's across a number of customers, and it's in some of the newer technology in the lighting space and in the LIDAR space in particular.
Okay. All right, well, TS, I'm sorry to hear you're leaving, but I wish you the best, and then I don't want to keep up your work.
Okay. Bye.
Thank you, Troy.
Thank you.
Thank you. Our next question comes from Alex Henderson of Needham & Company. Your line is open.
Great. Thank you very much. I agree with that last statement, TS, we'll miss you when you leave.
Oh, thank you.
Congratulations on a great career. The first question I wanted to ask you is, when you're looking at the mix of business for the upcoming quarter, you said that optical would improve. Can you give us a little granularity between datacom and telecom? Within the datacom, what are you seeing in terms of pricing pressure? How should we be thinking about that? It looks like pricing in datacom's moderated somewhat.
Alex, in the guidance, last quarter, we were kind of expecting telecom to grow faster than datacom. As it turned out, telecom grew a little bit, offset by the datacom flat and down a little bit. In terms of datacom, we have six or seven customer. In fact, most of them are growing with the exceptions of one or two customer-specific program, maybe due to their product transitions and so on, and they are down. Overall, datacom, excluding the customer, it seems like everybody's growing. In terms of pricing, it's mostly felt by our customer because we are, again, we are not really involved with their pricing. We look at our cost and then put appropriate markups to cover our margin. Suffice to say that most of our customer had transitioned to the low-cost variance, within the QSFP28, for example.
That low-cost variant transition has meaningfully offset or counter the volume increase, okay? The transition to a low-cost volume has been mitigated, so to speak.
Okay, going back to the baht for a second, it's pretty clear that there's been a pretty significant move in that exchange rate. It takes a little while for that to matriculate through your numbers. I would assume, if we assume a flat exchange rate at the current levels, that it's a considerable positive going forward for the next couple of quarters. Can you quantify or give us some sense of the degree to which that's helpful?
Yes. The THB fluctuates quite a bit, okay. You're right, recently, it kind of depreciated to THB 33, THB 33.5 or so level. Again, remember, we hedge six months, okay. I hedge forward just to protect the downside. If there's any upside, assuming it sustains, assuming the THB stays at this level, I will see the benefit at least one and a half quarter out. Not in the immediate quarter, because in the immediate quarter, I bought all these THB about three to six months ago. Yeah, if THB continues to stay at this level, I will see some tailwind into the growth margin and into the P&L.
Would that be more of a CY4Q, FY 2Q, and CY 2H 2019 back half of FY 2019 benefit?
Yeah, I will say, it will be CY 2018. November, December, I might get some benefit. Right now, I still have some spending left unhedged, okay.
Okay.
Of course, March quarter, if I buy today, assuming I can lock in today, you will see the benefit. That's correct. Yeah.
The last question, then I'll cede the floor. You had made a comment, I think, on the gross margin non-GAAP improving somewhat as we go forward to normal levels. Can you remind us what you consider your normal levels? Within the context of the forward guidance, I know you don't want to give specifics on 606, but what do you think the dynamics are? Is it helpful or hurtful to your revenues, helpful to hurtful to your margins? Can you give us a little bit of taste of what you think might occur?
Okay. On the gross margin, we always mention ourself between 12% to 10.5%. We say that all the time in a conference call. If you look at our track record here, we were at 11.6% last quarter, FQ3, I mean. Then in FQ4, we are on track to 11.8%. We are not quite at the 12% yet, okay, but we believe that in FY 2019, within the fiscal year, we'll return to 12%, at least to 12%. That's internal management goal, to get to 12%. Again, FQ1, we see some headwind again because we give merit increase once a year, and we will see some seasonal pressure on the gross margin in FQ1, but we expect moving forward, we'll fully recover through the learning curve and the cost reduction efforts and so on.
In terms of 606, I just look at the July closing a little bit. There's really no major impact. If there's any impact, it will be in the tune of about maybe $3 million-$5 million revenue swing. In terms of margin, no, will be very small impact on that. We'll report that in September earnings call to show you how big is the gap. As of today, we don't expect any material impact to the revenue line and gross margin line.
Okay, great. Thank you very much.
Thank you, Alex.
Thanks, Alex.
Thank you. Our next question comes from Tim Savageaux of Northland Capital. Your question please.
Hi, good afternoon, I'll add my congratulations to TS.
Thank you, Tim.
Following up on that last response, to the extent, I don't know if you already hit this, but I think you just indicated you expect some seasonal pressure on gross margins in Q1 from Q4 levels. If that's the case, are you looking for a pretty sharp decline in OpEx sequentially from elevated levels in Q4? Is there any further tax benefit kind of informing the EPS guide for Q1?
Tim, good question. The seasonal impact has come from a merit increase we give to our folks in Thailand once a year, and actually all over the world once a year. The impact will be mitigated by other area, obviously, it's part of our business. We try to find offsets to the merit increase and may not necessarily recover within a quarter, okay? Typically, if you look at history, it will take at least about close to two quarters to recover that. New improvement, OpEx reduction, as what you said, and so on. We have spending control just to offset the merit increase. Yeah, we don't guide the growth margin, but you can see that some of the foreign exchange loss we experienced in the past hopefully will subsided a little bit because with the Baht now become cheaper.
Okay, thanks. Kind of moving on to the product side, I want to touch on Datacom again in fiscal Q4, just to see if we can understand the moving parts a bit better. You did report a sequential increase in silicon photonics and a pretty sharp sequential increase in QSFP28, yet you did see modest declines in the overall Datacom segment. I guess my first question, what would be offsetting the QSFP28 growth principally?
Tim, this is Seamus. I think we saw a nice increase in our Telecom business. Our Datacom business, as you said, was flat to down very slightly, down about 1%, and that's on an aggregate basis when we add up all the customers and all the products. I would say the reductions were isolated to one or two customers who are maybe going through combination of product transitions and a little bit of price pressure. We had some reductions on one or two customers. The majority of the customers, I would say probably 90% of the customers, we did see some nice growth on. While the number in aggregate is down a little bit, we wouldn't want to give the impression that Datacom is down. Datacom, we think, is actually quite strong, and the reductions were limited to one or two customers.
If that makes sense.
Okay, great. That follows right into my last question, which is, as you look forward, I think you might have said you expect sequential growth across the businesses, you obviously had a pretty sharp increase on the non-communication side in Q4. In terms of kind of relative performance across the business segments, it sounds like you might expect Datacom to resume sequential growth, though I'm not sure if you have any comments on that, in Datacom versus Telecom or within both of those silicon photonics, or whether you might expect non-communications to maybe flatten out for a bit as the communication stuff catches up in Q1.
Yeah, I think we were very happy with the growth, as you say, in the non-optical communications business in Q4. If you look at T.S.'s remarks, optical communications business is now 70% of our business, down from 72 historically, and it was actually a high of, I think, 78 at one point. We're making nice, steady progress there, growing our non-optical communications business, while at the same time growing our optical communications business. It's always a challenge when they're both growing. We want both things to happen. We want to grow all of the business, but we also want to reduce the percentage of the optical communications business. As we look out to Q1, I think it would be fair to say we're seeing solid growth in the communications business, the optical communications business, and it's across both Telecom and Datacom, and then continued growth in the non-optical.
The laser business remains very strong. Industrial laser business remains very strong. As does the automotive business, quite strong. It's really across the board, Tim. Thankfully, we're kind of benefiting from some nice growth across a number of sectors that we're participating in right now.
Tim, this is TS. If you listen to our customer earnings call recently, right? Most of them are pretty upbeat on the optical communication. We hope to ride on that optimism. One of the big customers talking about pretty robust in ROADM and so on, and also their fiber laser and their laser business. Another datacom guy is talking about really robust in the datacom. We hope our customer is right, and then we are riding on those trends.
Okay, thanks very much. I'll pass it along.
Thank you.
Thank you.
Thank you. Our next question comes from Alex Henderson of Needham. Your line is open.
That was unexpected. I just wanted to ask about the Lumentum plant that's being built next to your facility and the conversations you've had relative to that. There's been a lot of speculation on whether that's a good thing for you or a bad thing for you. I was hoping you might just give us some sense of what your read is relative to the relevance of that plant. I know that Lumentum has said that they're moving substantial portion of business out of China's Sanmina facilities into that plant and to Thailand. I was hoping you could give us a little bit of clarity around it.
I would say, Alex, I think we've kind of talked about this before. Lumentum used a number of contract manufacturers. We're by no means their only contract manufacturer. They use a number of them. Our understanding is that their plan is that they're consolidating manufacturing at some of their suppliers in China. For the most part, that business is moving to Thailand. We're not the sole beneficiary of that. Some of that business, we understand they're moving into their own facility. They're our number one customer, they're our biggest customer, they're a really excellent customer. Their business is just really strong at the moment, and we're really very fortunate to have them as a customer and to be able to participate with them. Our relationship with them remains strong. Our business with them is growing, I would say.
Yeah, they've established their own facility in Thailand, and it's actually near, quite close to our Pinehurst Campus. We do believe that this signals a closer rather than a more distant cooperation between the two companies. Overall, we see it as a positive in the sense that they're moving business to Thailand. Yes, they're moving business into their own facility, but for the most part, the business that's coming to Thailand is coming from Chinese suppliers. We see that as a positive.
Great. Thank you.
Thanks, Alex.
Thank you. We have a follow-up question from Tim Savageaux of Northland Capital. Your line is open.
Okay, maybe following on that response briefly, I realize this is information that's likely to be in your annual filings, you mentioned that Lumentum is your largest customer. I wonder, given that we're at the end of the year, if you might quantify that or tell us how many 10%-type customers you had for the year. Then maybe, if you were to look at Lumentum and Oclaro together, given the pending merger, how significant would they be as a combined customer?
Tim, this is TS. In two days' time, you'll see our K. Again, I can tell you that Lumentum is our number one customer last year. We only have one 10% customer, Lumentum at 17% of the revenue. When Oclaro merges, it will be 23%, 17 plus six.
Perfect. Thank you.
Yeah. Thank you.
Thank you, Tim.
Thank you. As there are no further questions in queue, I'd like to turn the call back over to Seamus Grady for any closing remarks, sir.
Thank you. Thanks, everyone for joining our call today and for your continued interest in Fabrinet. We're optimistic about the improving dynamic that we're seeing in the markets, and we look forward to speaking with you all again on our next earnings call in November. For those of you attending the Jefferies Investor Summit in Chicago next week and the Piper Jaffray Tech Select Conference in Southern California the week after, we look forward to seeing you. Thanks again and goodbye.
Thank you, ladies and gentlemen. This concludes today's conference. Thank you for your participation, and have a wonderful day.