Good day, ladies and gentlemen. Welcome to Fabrinet's Financial Results Conference Call for the Third 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.
To
call to discuss Fabrinet's financial and operating results for the third quarter of fiscal year 2018, which ended March 30, 2018. With me on the call today are Tom Mitchell, Founder and Executive Chairman, Seamus Grady, Chief Executive Officer and TS Ng, Fabrinet's 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 reconciliations. I would like to remind you that today's discussion will contain forward looking statements about the future financial performance 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 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 10Q filed on February 7, 2018. We will begin the call with remarks from Tom, Seamus, and TS followed by time for questions.
Would now like to turn the call over to Fabrinet's Executive Chairman, Tom Mitchell. Tom?
Thank you, Daryl, and good afternoon everyone. I am pleased we exceeded our revenue expectations for the third quarter. And today, we are well positioned to benefit from stabilizing demand, current customer growth, and new customer opportunities. I'd like now to turn the call over to Seamus. For his remarks.
Thank you, Tom, and good afternoon, everyone. We're pleased that our third quarter revenue came in above the top end of our guidance range with revenue of $332,000,000 and non GAAP net income of $0.71 per share, including the impact of a $0.06 foreign exchange headwind. This strong profitability is also reflected in cash flows with year to date operating cash flow increasing 49% to nearly 90,000,000 and year to date free cash flow of $61,500,000 compared to a little over $3,000,000 a year ago. We believe that business trends are stabilizing this is reflected in our expectations for increasing revenue in the fourth quarter, as TS will detail later. As in the second quarter, 72% of 3rd quarter revenue came from Optical Communications programs and 28% from non communications.
Within optical, telecom continues to dominate and the 64% of optical revenue, telecom revenue grew 6% on a sequential basis. We anticipate that We're also optimistic that our non optical communications business will resume sequential growth in the fourth quarter after a modest decline from record levels in the second quarter. These trends reflect not only market conditions of our customers and their customers, but our ability to attract new customers and new programs. Our strong position in the market is driven by our precision, manufacturing and advanced packaging. Over the years, we have reinforced this focus on optical communications while also leveraging it to enter adjacent markets such as optical sensing, commercial lasers, and medical.
New business, which again represented 35 percent of revenue in the 3rd quarter, continues to reflect this diversification. Fagrinet West, our new product introduction facility strategically located in Santa Clara, California has been instrumental in helping us get closer to customers and win new programs serving diverse end markets. While there's only one Silicon Valley, we believe there are a small number of global regions that share similar characteristics of a large concentration of technology companies. 1 of these locations is Israel, where we already have a number of customers. In March, we met early steps towards establishing a new NPI facility in Israel, where we can continue our proven model of providing local new product introduction services, helping our customers with design for manufacturability and then transferring those programs to Thailand for volume manufacturing.
While it's still very early days for us in this exciting region, we're confident that in Israel, we can replicate the NPI playbook that we have been successful with in Fabrinet West and Fabrinet U. K. Having already established a beachhead in Israel, including a new Executive Vice President to lead the charge We look forward to sharing our progress with you as we execute on our plans. In summary, we are pleased to have exceeded our revenue expectations in the third quarter, We're enthusiastic about the fourth quarter and beyond, with stabilizing our improving trends across the markets we serve, and we are excited about the many opportunities ahead. 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. Good afternoon, everyone. I will provide you with more details on our performance by end market and our financial results for Q3 of fiscal year 2018, as well as our guidance for Q4. Total revenue in the quarter was $332,200,000 above the high end of our guidance range. Non GAAP net income was $0.71 per share within our guidance range.
In the 3rd quarter, we experienced a $2,400,000 or $1,000,000 or $0.10 headwind in the third quarter of 2017. Excluding the impact of this headwind, non GAAP EPS would have been above our guidance range. Looking at the quarter in more detail, Revenue from Optical Communication Programs was $241,000,000 compared to 2 $7,000,000 a year ago and $242,000,000 in the second quarter. Non optical communications programs represented 72% of total revenue consistent with the 2nd quarter. Within optical, Telecom represented 64 percent of revenue, up four percentage points from the 2nd quarter.
In other words, in the 3rd quarter, telecom revenue increased by 6% from the 2nd quarter to 154,000,000. Data account revenue was $87,000,000 or 36 percent of optical communications. By speed, 100 gig solution continued to dominate with revenues of 129,000,000, down from $133,000,000 in the 2nd quarter. Revenue from 400 gig solution were $10,000,000 in the 3rd quarter, compared to $16,000,000 in the second quarter. Revenue from QSFP28 transceivers was $37,000,000 in the 3rd quarter compared to $42,000,000 in the 2nd quarter as a transition to lower cost CWDM4 variance continues with volume not yet high enough to offset lower prices.
Silicon Photonics revenue was $66,000,000 compared to $74,000,000 in the 2nd quarter. Turning to non optical communications. We again had a strong performer, but did not beat our record 2nd quarter performance. Non optical components and module represented 28% again in the 3rd quarter at 91,000,000. Revenue from the industry laser market was again a record at $43,000,000, up 23% from years ago.
Automotive revenue of $21,000,000 was below the records of nearly $26,000,000 in Q2, but up 6% from a year ago. Sensor revenue grew slightly to nearly $5,000,000 from $4,000,000 in the second quarter. Other revenues of $22,000,000 was down slightly from $23,000,000 in Q2. Finally, new business was $116,000,000 or 35 percent of revenue in the third quarter as it was in the second quarter. Now turning to the details of our P and L, a reconciliation on 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 11.6%, consistent with FQ2 and below our target range of 12, to 12.5%, primarily due to startup costs related to certain new customer programs as well as to the decrease in revenue and the continued lengthening of the tieback from the second quarter. We expect gross margin to improve in the 4th quarter but not enough to put us in the target range for all of FY 2018. Non GAAP operating income in the 3rd quarter was $30,100,000 and operating margin was 9.1%, up slightly from Q2 from cost savings from the reduction in workforce that we make in Q2 as well as approximately 1,000,000 dollars impact from the reverses of management bonus accrue against FY2018 objectives. Taxes in the quarter were a net expense of $1,500,000 and our normalized effective tax rate was 6.2% consistent with Q2 and in line with our expected range of 6% to 7%. We continue to anticipate an effective tax rate of 6% to 7% for fiscal year 2018.
Non GAAP net income was $28,400,000 in the third quarter or $0.71 per diluted share compared to 70 dollars in Q2 and 80¢ a year ago. On a GAAP basis, which include share based compensation expenses, and amortization of debt issuing costs. Net income for the third quarter was $21,100,000 or $0.55 per diluted share compared to $21,700,000 or $0.57 per diluted share in the third quarter of fiscal year 2017. As I mentioned earlier, we experienced a $2,400,000 or $0.06 per share negative impact from a stronger tieback on our GAAP and non GAAP bottom line results for the third quarter. Turning to the balance sheet and cash flow statements.
At the end of the third quarter, cash and investment were $315,400,000. This represents an increase of $27,800,000 from the end of the second quarter, primarily from operating cash flow of $52,700,000 which increased 31 percent from the 2nd quarter, offset by a CapEx of $6,900,000, share repurchases of $12,500,000 and repayments of long term loans from Bank of $3,400,000. Free cash flow, which is operating cash flow, less CapEx, was $45,800,000 in the third quarter, an increase of 53% from Q2. On a year to date basis, operating cash flow was $89,800,000. After subtracting CapEx of $28,300,000 Year to date free cash flow was $61,500,000, reflecting the meaningful decrease in CapEx that we have anticipated for FY 2018.
We expect CapEx in FY 2018, all which is maintaining CapEx to be approximately 35,000,000. During the third quarter, we were active in our share repurchase program and bought back approximately 422,000 shares at an average price of $29.58. As of the end of the third quarter, $37,600,000 remain in our repurchase authorization. I would now like to turn to our guidance for the fourth quarter of fiscal year 2018. Which incorporate approximately $7,000,000 negative impact from sanctions on ZTE.
As a reminder, we do not have any direct customer in China, but many of our customers do serve Chinese customers. With that background, we anticipate revenue to be in the range of $334,000,000 to 342,000,000 an increase from the third quarter as Shamer indicated. From an earning perspective, we anticipate non GAAP net income per share in the fourth quarter to be in the range of $0.73 to $0.77 and GAAP net income per share of 55 to $0.59 based on approximately $37,900,000 fully diluted share outstanding. In summary, we are pleased to have delivered and are enthusiastic about increasing revenue in the fourth quarter as customer demand across our diverse range of programs stabilize or improve. Our position in the market continued to strengthen as customer look to us to manufacture the most challenging designs.
Operator, we would now like to open the call
Our first question comes from the line of Alex Henderson with Needham And Company. Your line is now open.
Good afternoon. This is Dan Park on for Alex. Thanks for taking my questions. So just wondering regarding your comments on ZTE and Huawei. Have you seen any change in orders relative to ZTE and Huawei?
And how much of your silicon photonics businesses following off as a result of Q2?
So as we mentioned in our prepared remarks, the our estimate for Q4 is an impact of about $7,000,000 in our Q4 outlook. And that's included in the outlook we get for Q4. That number, we arrived at from discussions with our customers. So we feel pretty solid about that number.
Okay, great. And I guess my second question, have you seen a reacceleration in demand in the datacom space And to what extent is, is there a pressure on this business? Have you seen any evidence of demand the accelerate reacceleration in demand given some of the issues around the risk of workaround having been resolved. And volume changes at web 2.0 customers?
This is TS. I think the volume is already there in terms of quantity. The thin cloud, the whole, you know, the, the data is a pricing reduction. So, and we in our prepared remarks, we say that the lower prices is not enough to offset, you know, the, the volumes increase. So, if you're speaking to 2 parts, obviously volume continues to increase.
But again, you know, because of the price reduction, we can't really tell, you know. And our next
comes from the line of Troy Jensen with Piper Jaffray.
Hey guys, just a little color on the June guidance. Are you expecting both datacom and telco to grow or are they going to be stable in the laser business grow? Just any more insight would be helpful.
I think we at expect both segments to grow, moderately. And that's why you see how it reflected in our total guidance.
Okay. All right. Just to follow-up on the Silicon Photonics question, $66,000,000 this quarter. Can you just talk about customer concentration in there and is it still 3 big guys? Is it just any color you can give us just generically on silicon photonics would be great?
So essentially, we have a new entrant, about maybe 2 or 3 quarters ago, and they start ramping. So there's a new customer we acquire. And other than that, still the same customer profile, one of them has been ramping down if you listen to the earning call, they're talking about ramping down temporarily. And since their volume is coming back, if you look at from Q2 to Q3 to Q4, most of the customers are about the same. I said we added another new customer and they're ramping very nicely.
Okay.
All right.
Perfect. And how about that last question for me? Can you just talk, give us an update on the partnership with MACOM?
So there's nothing really to update on that. MACOM is a customer of ours. They're not a 10% customer. So we're not going to go into a huge amount of detail. But the remainder customer of ours is a number of programs we're working on with MACOM.
There's no real update since we last discussed it.
So I think previously there is believe that the June quarter, we could hit some threshold of revenues. Do you feel like you're still on track for that?
We're probably not in a position to really talk about that because it's more of our customers business for them to talk about. But we're still working with the customer and with the end customer on that program and it's progressing at a pace but we're not really in a position to give that level of guidance down to the program.
Thank you. Our next question comes from the line of Tim Savageaux with Northland Markets.
Hi,
good afternoon. A couple of questions. Hey, so to the extent you reported revenue above the high end of guide. I'd say as you look across your portfolio, where was kind of the upside surprise, if you will, from your perspective. Looks like telecom side's pretty been pretty strong.
I don't know if if you had unexpected strength there or anything else in particular to call out?
I would say if you look at the number in detail is a telecom sector and most of the screen is a non speed telecom gadgets that make the quarter. Those things like, pump laser, modem, amplifier and so on, that those we don't classify them by, you know, with a 100 gig or 400 gig and so on. So those are pretty strong segments. And that, you know, pretty much endorsed also verified by our customer in the earning call, if you listen to the earning call.
The other one I would just add to that is, our optical sensing business is up, was pretty strong last quarter as was a commercial laser business. That business is very strong. So it's across a number of sectors.
Understood and very helpful. And then to follow-up, in Silicon Photonics was down a bit in the quarter. And that's, I imagine, prior given that ZTE news was disclosed after the end of the quarter, I imagine the impact there, maybe it's not entirely in Silicon Photonics, but it'll be incremental in the June quarter. In terms of looking at the March quarter decline. How would you characterize the drivers of the silicon photonics decline in March?
So the March decline in Silicon Photonics, we have a mix of customers, in the Silicon Photonics space, but it is pretty concentrated, as we mentioned a moment ago. In a few with a few customers with one in particular, seeing weakness last quarter. And they talked about that in their call, but we do see that actually, recovering this quarter. So the ZTE effect is factored into our numbers. That's not to say that something else couldn't happen, but based on best information that we have right now, there's about a $7,000,000 impact.
Some of which is actually that, that, Silicon Photonics business.
Thank you. And our next question comes from the line of Dave King with B Riley. Your line is now open.
Thank you. Good afternoon. A couple of questions. First, regarding the $7,000,000 impact from ZTE, is that primarily one customer or Or can you just characterize that?
No, it's across a number of customers.
It's
more than one customer. It's across a number of customers. As you'd appreciate, we don't we don't ship anything directly to ZTE and we actually don't ship anything directly to China out of our product ships. That's works. But that $7,000,000 is across a number of customers who customers of ours who shift to ZTE.
Got it. And then on gross margin and SG and A, first of all, gross margin it was kind of flat. How should we think about 4th quarter and beyond? Can we get back to 12% or how should we think about that? And then also on SG And A, it was down about a little over $2,000,000, what drove that?
And is it kind of sustainable or is it going to pop back up to like over $10,000,000?
So, Dave, normally we don't guide a gross margin But if you take our guidance on the EPS and the revenue and work backwards, and given the knowledge of operating expenses are a little bit low in that Q3. I will say you will realize that the gross margins are improving in that Q4. We have implied a better gross margin going to June quarter. And again, on the CapEx operating expenses side, $8,500,000 are extremely low. We talk about reversals of some of the management bonus accrual.
I will expect to get back to about 10 to 10.5 level, the normal run rate level in the June quarter. So hopefully that's helpful.
Yes. And one more on CapEx. So $35,000,000 this year. How should we think about next fiscal year?
Next fiscal year, a lot depends on the revenue, okay. If we are going to ramp For example, like last year, 45% growth, obviously, we need a lot of CapEx. But, assuming normal growth, I would say it would still be around, you know, actually around 35 40,000,000. We won't commission the 2nd building until, you know, maybe at the end of 2018 or maybe the early 2019 calendar year, right, Jema?
Yes, I think if we get to the point where Chonburi is 70%, 80%, it's certainly 70 plus percent utilized will commission a second building. Obviously, that will then drive a much bigger CapEx in the year in which we do that. It's a problem we hope to have. But as of right now, I think that $35,000,000 to $40,000,000 is probably a good number for next year.
Yes, the
2nd building will probably spend in FY 2020 we've commissioned the construction in FY2019, but I think that the payment will be in 202020.
Got it. And one more question and this will be my final question is that on the silicon photonics, it was down slightly in third quarter. Is it going to be down or up or maybe flat in fourth quarter? What's baked into your guidance?
I think they have about 3 or 4 customers there, you know, a lot depends on their demand posture. One of them doing well, the other one see the temporary setback and, in the earning call, they're talking about coming back. So, hard to tell, but, you know, I think if both of them are doing well, obviously we'll see the number going up.
Thank you. And I'm showing no further questions at this time. So I'd like to return the call to Mr. Seamus Grady for any closing remarks.
Okay. Thank you, operator. And thanks for everyone for participating in today's call. We look forward to speaking with many of you at the upcoming investor events And we'll talk to everyone when we present our 4th quarter fiscal 2018 results in August. Thanks again, and have a great afternoon.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a great day.