Good afternoon. Welcome to Fabrinet's Financial Results Conference Call for the third quarter of financial year 2023. At this time, all participants are on listen only mode. Later, we'll conduct a question and answer session, and instructions on how to participate will be provided at that time. As a reminder, today's call is being recorded. I will now turn the conference to the host, Garo Toomajanian, Vice President of Investor Relations. Please go ahead.
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 2023, which ended March 31, 2023. With me on the call today are Seamus Grady, Chief Executive Officer, and Csaba Sverha, Chief Financial Officer. This call is being webcast, and a replay will be available on the investor section of our website located at investor.fabrinet.com. During this call, we will present both GAAP and non-GAAP financial measures. Please refer to the investor section of our website for important information, including our earnings press release and investor presentation, which include our GAAP to non-GAAP reconciliation. In addition, today's discussion will contain forward-looking statements about the future financial performance of the company.
Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from management's current expectations. These statements reflect our opinions only as of the date of this presentation. 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 7, 2023. We will begin the call with remarks from Seamus and Csaba, followed by time for questions. I would now like to turn the call over to Fabrinet's CEO, Seamus Grady. Seamus?
Thank you, Garo. Good afternoon, everyone, and thank you for joining us on our call today. We exceeded our guidance for both revenue and non-GAAP EPS in the third quarter. Total revenue in the quarter was $665.3 million, an increase of 18% from a year ago. During the second quarter, supply headwinds impacted revenue by $30 million-$35 million as anticipated. We continue to see a gradual loosening of component supply, and we expect further improvements in availability over the next few quarters. Our strong revenue performance and solid execution produced non-GAAP EPS of $1.94 in the quarter, above our guidance range and up $0.44 from a year ago. Looking at the quarter in more detail, revenue was essentially flat sequentially for both optical and non-optical communications and was a little better than our expectations.
Within optical communications, telecom revenue decreased sequentially as anticipated. This was primarily due to specific component constraints we called out last quarter impacting silicon photonics programs and to a lesser degree, from ongoing commodity semiconductor constraints. Datacom revenue was similarly affected by supply constraints, but the supply impact was more than offset by growth from some next-generation non-silicon photonics programs. As a result, we had a record datacom performance, producing strong quarterly and year-over-year growth. For non-optical communications, our business was up more than 30% from a year ago and was relatively stable with the second quarter as we maintained strong automotive revenue levels. Looking to the fourth quarter and beyond, we are not immune from the near-term inventory corrections being experienced in the broader optical ecosystem.
While we are not a proxy for the industry, we expect the impact of inventory absorption in some product areas to be a headwind to our revenue in the fourth quarter. We continue to see gradual improvements in component availability. Longer term, we believe end market growth drivers remain intact, and we continue to be optimistic about our position in the market and our ability to execute efficiently. In summary, we delivered strong third-quarter results with revenue and non-GAAP EPS that exceeded our guidance. We are seeing some demand variability as a result of inventory adjustments in the industry, as well as persistent but improving supply constraints. We remain confident in our ability to execute in this environment and deliver strong financial results. Now, I'd like to turn the call over to Csaba for additional financial details on our third quarter and our guidance for the fourth quarter of fiscal 2023. Csaba?
Thank you, Seamus. Good afternoon, everyone. Our revenue and non-GAAP EPS exceeded our guidance changes for the third quarter. Revenue was $665.3 million, which was up 18% from a year ago and down 0.5% from the second quarter. Demonstrating the leverage in our business model, profitability grew faster than revenue with non-GAAP earnings per share of $1.94, up 29% from a year ago and also above our guidance range. Looking at revenue in more detail. Optical communications revenue was $502.6 million, up 14% from a year ago and slightly down from Q2, as anticipated. Within optical, telecom revenue was $380.2 million, which was up 6% from a year ago, but a decline of 3% from the second quarter.
This decline was primarily due to increased supply constraints for certain semiconductors used in these products, as we discussed last quarter. Datacom revenue was stronger than anticipated at $122.4 million. This record level revenue was up 50% from a year ago and 8% sequentially. Supply headwinds restrained our datacom potential. Strong demand for higher data rate, non-silicon photonics products more than offset those headwinds. By technology, silicon photonics revenue was $108.7 million, a 12% sequential decrease due to the supply constraint that impacted telecom revenue. By speed, revenue from products rated 400G and faster was a record $221 million, up 17% from a year ago and 27% from Q2, with strength primarily from non-silicon photonics datacom products.
After a record Q2, revenue from 100G products was $112.3 million, down 10% from a year ago and 27% from Q2. Faster data rate products continue to see strong growth, we believe revenue from 100G products could continue to moderate. Non-optical communications revenue was $162.7 million, slightly above our record second quarter, representing 24% of total revenue. Automotive revenue remained robust at $94.1 million, up 77% from a year ago and essentially flat with Q2. Industrial laser revenue was also relatively flat sequentially at $31 million. Other non-optical communications revenue increased from a year ago and from last quarter to $37.5 million. I discussed the details of our P&L, expense and profitability metrics provided are on a non-GAAP basis, unless otherwise noted.
A reconciliation of GAAP to non-GAAP measures is included in our earnings press release and investor presentation, which you can find in the investor relations section of our website. We continue to execute very well and non-GAAP gross margin was 13.1%, up 10 basis points from Q2 and 40 basis points from a year ago. This result includes a benefit of approximately 20 basis points from FX tailwinds. Based on our hedging program, we expect these FX tailwinds to become mild headwinds in Q4. Operating expenses in the quarter were $13.2 million, or 2% of revenue. This produced record strong operating income of $74.3 million, representing an operating margin of 11.2%. We continue to benefit from our strong balance sheet.
With increasing interest rates, net interest income rose to $2.9 million or $0.08 per diluted share, more than offsetting FX losses. With a more stable Thai baht than in the recent quarters, our foreign exchange loss narrowed to $1.3 million in the quarter, or $0.04 per share. This FX loss was primarily due to asset and liability revaluations at the end of the quarter. Effective GAAP tax rate was 6.5% in the quarter. We continue to anticipate an effective tax rate in the low to mid-single digits for the year. Non-GAAP net income was $71.8 million or $1.94 per diluted share. On a GAAP basis, net income was $1.60 per diluted share.
Note that our GAAP results include a restructuring expense of $5.9 million in conjunction with the closure of our U.K. facility, which we discussed last quarter. Turning to the balance sheet and cash flow statements. At the end of the third quarter, cash equivalents, restricted cash and short-term investments were $538.7 million, up $11.1 million from the end of the second quarter. Operating cash flow was $37.1 million with CapEx of $19.8 million, free cash flow was $17.3 million. During the third quarter, we bought back approximately 35,000 shares at an average price of $116.72, with a total cash outlay of $4.1 million.
As of the end of the third quarter, $90.8 million remained in our share repurchase authorization. I will turn to our guidance for the fourth quarter. As Seamus indicated, we are seeing the impact of inventory adjustments at our customers and their customers in the optical components market. We expect telecom revenue to be down sequentially in the fourth quarter. Our datacom business is also experiencing the same inventory headwinds, we expect the continued growth from certain high data rate programs to more than offset this impact, resulting in sequential growth in Q4. We expect our strong automotive revenue to be flat to up sequentially in Q4.
We continue to see gradual easing of supply chain constraints and expect the revenue impact of this to decrease to approximately $15 million in Q4, or about half of what we saw in the third quarter. Considering all of these factors, we anticipate revenue in the range of $630 million-$650 million in the fourth quarter. From a profitability perspective, we expect to extend our track record of strong execution in the fourth quarter. That said, as we indicated earlier, we expect the FX tailwinds we have been experiencing will turn into mild headwinds in the fourth quarter.
We anticipate non-GAAP net income to be in the range of $1.76-$1.83 per diluted share. In summary, we delivered a strong third quarter performance with revenue and non-GAAP EPS above our guidance. Our fourth quarter outlook is moderated by inventory adjustments in the optical communication ecosystem that we expect to be short-term in nature. We remain confident in our ability to execute well through this variability, we continue to be optimistic about our market position and longer-term growth drivers. Operator, we are now ready to open the call for questions.
Thank you. Ladies and gentlemen, if you'd like to ask a question, please press star one one on your telephone. Again, to ask a question, please press star one one. One moment please for our first question. Our first question comes from the line of Samik Chatterjee of J.P. Morgan. Your line is open.
Hi, thanks for taking my question. I jumped on a bit late here, so I apologize. I might be asking something that you touched on your prepared remarks early, but maybe just starting off with the sort of your customers and the nature of the conversations you're having with them related to the inventory digestion. Are they giving you any more color in terms of the duration of those inventory adjustments or any more color in terms of when their ordering returns to a more normalized pattern? Thank you. I have a quick follow-up.
Hi, Samik. As you know, we're really back to getting demand of, you know, 13 weeks at a time, which we've had before the component crisis. We had longer demands, or we had a longer horizon on the demand during the component situation. Right now we're really back to 13 weeks rolling forecast from our customers. We don't have great visibility beyond that. We do expect the inventory correction to be relatively short-lived. We think it's, you know, maybe 2 quarters, something like that, and then we should be back to more normal ordering patterns.
Okay. Maybe one for Csaba here. The gross margins continue to be quite robust. Maybe if you can give us a bit more color in terms of particularly sort of how you're thinking about the puts and takes in relation to the near-term drivers, including currency, as well as the sort of the lower volume leverage that you'll have. Thank you.
Hi, Samik. Thanks for the question. We have been communicating that our gross margin have been aided by FX tailwinds in the past couple of quarters. In the recent quarter, we had about 20 basis point sequential tailwind from that. As I also mentioned in our prepared remarks, we are anticipating this tailwind to turn a mild headwind in Q3. Overall, with the Thai baht being now stabilized, we no longer see these tailwinds continue in our results.
However, we continue to improve our operating efficiency. Any short-term lived demand correction or even longer term potential decrease, we have a very agile business model and very small fixed cost base. We are confident that we will be able to maintain our strong operating performance as well. Again, the key message here is, 20 basis point tailwind in Q3 from exchange rate turning to mild headwind, about approximately 30 basis point in our Q4 numbers.
Thank you. Thanks for taking my question.
Thanks, Samik.
Thanks, Samik.
Thank you. Again, ladies and gentlemen, if you'd like to ask a question, please press star one one on your telephone. To ask a question, please press star one one. One moment, please. Our next question comes from the line of Alex Henderson of Needham & Company. Your line is open.
Great. Thank you so much. Just to clarify, when you're talking about the 20 basis point headwind going to a 30 basis point... Excuse me, 20 basis point tailwind going to a 30 basis point headwind, are we saying then that we should be looking at a 30 basis point hit to operating margins sequentially from the March quarter to the June quarter? Is that what I'm hearing?
That's correct, Alex. Yes.
Okay. Just wanted to make sure that we were in the right metrics there. I know you don't wanna go beyond the June quarter, but have you had any conversations with the, you know, your partners who probably talk to the OEMs who are sitting on a fair amount of inventory on their books of what the slope is and the duration of this inventory correction that we're currently experiencing in the June quarter? Will it continue through the September, December quarters? Or how do you know, kind of play that, you know, that scenario out over time and without necessarily getting to a forecast, which I know you won't do?
That's correct, Alex. I mean, we have a certain amount of visibility, you know, but the further away from us, let's say the end customer is, the worse our visibility becomes. We, as you know, we supply some to the complete network system companies, but a lot of what we produce, we produce for the component suppliers, who in turn supply to the complete network system companies who supply to the operators. The further away you go, the more, you know, the more the less clear it becomes. Based on the indications we've seen, we think it's a relatively short-lived inventory correction, maybe two quarters, something like that. This quarter and next quarter we think. You know, it remains to be seen, but we think it's relatively short-lived.
One last question. I'll cede the floor. The systems business, can you give us any clarity on how the systems business is progressing and kind of what the slope of the ramp there looks like? Obviously, that does not have the same component problem that some of these component companies have to deal with.
As you know, we have a number of system customers. The most recent one we added was DZS. The DZS transfer is at this stage completed, and we're just really beginning to ramp that business. We believe that there are still opportunities to win additional system business over time, again, at both existing customers and new customers. We're certainly pursuing additional systems business, but there are a couple of things, you know, to keep in mind as we've mentioned before. First of all, we're very selective about the systems business that makes sense for us. You know, we need to make sure that we're either already making a large portion of the component content, or we need to be confident that we will win a large portion of the content in those systems.
Then secondly, you know, the system wins, in many cases, our ability to win that business is driven by external catalysts that we don't really control. We pursue it very, you know, very closely, and we're quite optimistic, but, you know, several things have to line up for that to occur. You know, that said, we're very well positioned, we think, to win additional system business over time. You know, that can, that can provide significant cost savings for our, for the customers, by eliminating a level of margin stacking while providing new revenue opportunities for us. We continue to be very positive and excited about it.
As you know, Alex, there's not much to report until we have one landed, so we just work hard on it and keep pursuing those opportunities.
Yeah, that really wasn't the question, Seamus. The question is, can you give us some sense of whether there's growth in that business, you know, from an organic perspective or, you know, how should we be thinking about that business? I get it that the DZS is feathering in the June quarter, but that's really a September quarter full warp thing. It's gonna take a little while for them to work down their inventory, correct?
Yeah. I think if you look at what's we mentioned in our prepared remarks, I think Csaba mentioned about our telecom business, which is largely, you know, a lot of that is, a lot of the system wins, the system business that we have fits in that space. That is impacted by inventory correction. It's not just the component business, it's also the network system business that's experiencing some inventory correction. Datacom business remains very strong as we mentioned, but the telecom business and the optical component business are the two areas most affected by the inventory corrections.
I'll get back in queue. Thanks.
Thanks, Alex.
Thank you. One moment, please. Our next question comes from the line of Troy Jensen of Lake Street Capital Markets. Your line is open.
First off, congrats on the nice results, gentlemen.
Thank you, Troy. Great to talk to you.
Yeah, great to be back here. Hey, just to follow up, you know, datacom strength, obviously the non-silicon photonics, were up nicely, but was that specifically the new program wins or is that just broad-based strength in the category?
It's a little bit of both, but it's primarily new program wins. We're seeing a couple things going on. First of all, we're seeing the ramp of 400G inside the data center is now largely completed. As you can see, we're starting to see 100G begin to decline as 400G ramps. We're also seeing ramp of higher data rate products, 800G products above 800G inside the data center. That's largely driven by you know, new demand and new applications inside the data center that we're quite excited about. A little bit of both.
Thank you.
Ramping of 400G, but also, we're beginning to ramp new non-silicon photonics-based products as well.
Got it. All right, guys, I got a couple year gap, obviously in my coverage of you guys. Can you just remind me how long did it take to fill up building eight and what's the progress now with building nine?
Building eight, let me see. It probably took us, you know, in total, four or five years to fully fill building eight. Building eight is a 550,000 sq ft facility. Building nine is a 1 million sq ft facility. We're, you know, we're off the ground and I would say off to a good start in building nine. Unlike before, Troy, we used to talk about statistics like occupied and spoken for, we don't provide those, that data anymore. We're quite happy with the progress on building nine at this point.
All right. Understood. Good luck guys, and keep up the good work.
Thank you very much, Troy.
Thanks, Troy.
Thank you. One moment, please. We do have a follow question from Samik Chatterjee, J.P. Morgan. Your line is open.
Oh, hi. Thank you for taking my follow-up. Just a quick one there.
No problem.
I think, Seamus, you'd mentioned the inventory digestion on the telecom side. Just wondering like, when you maybe even dial back, obviously a few quarters, we have gone through a period of supply issues. Are you seeing any portions of the portfolio still being supply constrained where there is still sort of the lead times that haven't really come back to normal? Is that all an additional sort of headwind that you're tackling in some parts of the portfolio? Just wanted to check in on that and where the supply situation currently stands on most of the components you were shortage of.
We mentioned in Csaba's remarks, mentioned the $15 million supply headwind in Q4. You know, we're which if you take the split between telecom and datacom, the majority of that will be in our telecom business. We are seeing that beginning to taper off and I think we're probably one or two quarters away from, you know, no longer calling out the supply headwind. It's a $15 million headwind this quarter. It was a $30 million headwind last quarter. We really are back to a more normalized component supply situation. You know, like I say, Samik, I think we're probably one to two quarters away from no longer calling out the supply headwinds, hopefully.
Got it. A quick follow-up on the 800 gig products that you're already ramping.
Is there any material variation in the gross margin that those come in at, right, if we have 400 K, given that this is more obviously sort of at the leading edge of what's being done at the industry right now, how should we think about that?
No. You know, generally newer products are maybe a little bit better margins than older products, obviously. Aside from that, no, the margin profile would be pretty standard for us, Samik.
Okay. Thank you. Thanks for taking the question. Thank you.
Thank you, Samik.
Thank you. One moment please. Our next question comes from the line of Alex Henderson of Needham & Company. Your line is open.
Great, thanks. I was hoping you could give us some content around the non-speed optical products, you know, what's going on in that segment, you know, what your expectations are for the June quarter for that segment. Is that a big piece of the slowdown within that portion?
You're correct, Alex, the non-speed rated business, you know, is impacted by the inventory correction. You know, we have more than one product in there. We have more than one customer in there, but that's. Yeah, that's impacted by the inventory correction. You noticed, Alex, we haven't actually broken out or quantified the impact of the inventory correction, but obviously it is a headwind for us this quarter. Yes, you're correct. A chunk of that is in the non-speed rated portion of our business.
Well, you guys normally give some indication of what that number was. I didn't hear it in Csaba's comments. Can you give us what the non-speed revenues are?
Yes.
Hi, Alex. The non-speed revenue was actually down sequentially in Q3 versus Q2 by about $10 million. Right now our non-speed rated business is sitting at about $145 million quarter run rate.
And t alk about the guide. Can you give us any sense of what you expect that to do sequentially into the June quarter?
We haven't provided guidance for that, and, we are not intending to break down. This is, way goes into, to product specific details. This, we are expecting it to be down obviously, but not to put a number to.
I get it. Thanks.
Thank you, Alex.
Thanks, Alex.
Thank you. I'm showing no further questions at this time. Let's turn the call back over to Seamus Grady for any closing remarks.
Thank you, operator. Thank you for joining our call today. We delivered strong third quarter results. As we look ahead, we're confident that we can execute well during periods of short-term market variability, and we remain optimistic about the long-term growth trends in the markets we serve. We look forward to speaking with you again and seeing those of you who will be attending the J.P. Morgan conference in Boston later this month. Goodbye.
Thank you. Ladies and gentlemen, this does conclude today's conference. Thank you all for participating. You may now disconnect. Have a great day.