Fabrinet (FN) Q3 2021 Earnings Call Transcript

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Fabrinet (FN 0.75%)
Q3 2021 Earnings Call
May 3, 2021, 5:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good afternoon. Welcome to Fabrinet's Financial Results Conference Call for the Third Quarter of Fiscal Year 2021. [Operator Instructions] As a reminder, today's call is being recorded.

I'd now like to turn the call over to your host, Garo Toomajanian, Investor Relations. Thank you. Please go ahead.

Garo Toomajanian -- Investor Relations

Thank you, operator, and good afternoon, everyone. Thank you for joining us on today's conference call to discuss Fabrinet's financial and operating results for the third quarter of fiscal year 2021, which ended March 26, 2021.

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 Investors 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 our website for important information, including our earnings press release and investor presentation, which include our GAAP to non-GAAP reconciliation.

I would like to remind you that today's discussion will contain forward-looking statements about the future financial performance of the company. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from management's current expectations. These statements reflect our opinions only as of the date of this presentation, and we undertake no obligation to revise them in light of new information or future events, except as required by law. For a description of the risk factors that may affect our results, please refer to our recent SEC filings, in particular, the section captioned Risk Factors in our Form 10-Q filed on February 2, 2021.

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?

Seamus Grady -- Chief Executive Officer

Thank you, Garo, and good afternoon, everyone. We had a very strong quarter, representing our third quarter in a row of record revenue and earnings per share, both of which also exceeded our guidance. With sequential growth in all of the end markets that we track, total revenue was $479.3 million.

Non-GAAP operating margins of 9.5% were at the highest level in two years and helped produce record non-GAAP earnings of $1.21 per share. We generated these results while positioning ourselves for continued growth, and we are optimistic that we can deliver another record quarter in Q4.

Looking at some of the highlights of the quarter. Optical communications revenue reached a new record, driven primarily by record telecom revenue. Our Cisco optical transport system transfer program, which we have been discussing on recent calls, contributed to this strong performance. This program transfer was completed in the third quarter, reaching its full run rate about one quarter earlier than originally anticipated. Based on the success of this transfer, we believe that our unique value proposition in manufacturing complete network systems puts us in a strong position to win additional new business from our existing customers, as well as other systems manufacturers who are looking to leverage their supply chain by outsourcing more efficiently. Notably, these newer systems programs are having a positive impact on operating margins as we were able to generate this revenue with close to zero incremental operating expenses.

We also achieved record non-optical communications revenue in Q3. Revenue grew sequentially from all non-optical markets, with automotive reaching a new record revenue level and representing the largest non-optical category for the third quarter in a row. Newer automotive technologies were the biggest factors driving our strong automotive growth in the quarter.

In summary, we are pleased to have delivered record third quarter results that exceeded our guidance. We are optimistic about all the end markets that we serve and believe that with continued efficient execution, we'll be able to deliver an even stronger fourth quarter, resulting in our best year ever.

Now I'd like to turn the call over to Csaba for additional financial details and our guidance for the fourth quarter of fiscal 2021. Csaba?

Csaba Sverha -- Chief Financial Officer

Thank you, Seamus, and good afternoon, everyone. We are excited about our performance in the third quarter, which produced record revenue and non-GAAP earnings. Revenue of $479.3 million was above our guidance range, and non-GAAP earnings of $1.21 also exceeded our guidance.

Looking at revenue in more detail. Optical communications was $361.7 million or 75% of total revenue, up 4% from Q2. Non-optical communications revenue was $117.6 million or 25% of total revenue and increased 11% from Q2. Within optical communications, telecom revenue was $283.5 million, up 4% from last quarter. Datacom revenue was $78.3 million, up 5% sequentially. Silicon photonics remains an important revenue driver at 22% of total revenue or $105.4 million, up 4% from Q2.

Revenue from 100G products increased 8% sequentially to $138.6 million but remains below peak levels as growth from faster data rate products continues to accelerate. Revenue from 400G and faster was $105.1 million, up 1% from last quarter and more than tripled from a year ago. In Q4, we expect optical communications growth trend to continue.

Looking at our non-optical communications business. Automotive has grown to become the largest category for the third quarter in a row with record revenue of $52.5 million in the third quarter, up 12% sequentially, driven primarily by growth from new automotive programs. We remain optimistic about these new automotive programs as we look ahead. Industrial laser revenue was $36.1 million, up 7% from Q2. Sensor revenue was $4.1 million and other non-optical communications revenue was up 10% to $24.8 million.

We believe the combination of laser and automotive strength will generate sequential growth for non-optical communications again in the fourth quarter.

Now turning to the details of our P&L. Unless otherwise noted, profitability metrics are on a non-GAAP basis. A reconciliation of GAAP to non-GAAP measures is included in our earnings press release and investor presentation, which you can find in our website.

Gross margin was 12.2%, up from 12.1% in Q2 and in line with our target range of 12% to 12.5%. Operating expenses in the quarter were $12.7 million or 2.6% of revenue, reflecting our ability to grow revenue without meaningful increases in operating expenses. This produced record operating income of $45.6 million or 9.5% of revenue, the highest level in two years.

Taxes in the third quarter were $1.6 million and our normalized effective tax rate was 4%. We continue to anticipate an effective tax rate of about 4% for the year. Non-GAAP net income was a record at $45.4 million or $1.21 per diluted share. On a GAAP basis, net income was also a record at $27.5 million or $1 per diluted share.

Turning to the balance sheet and cash flow statement. At the end of the third quarter, cash, restricted cash and investments were $508.9 million. Operating cash flow was a strong $23.8 million. With capex of $6.4 million, free cash flow was $27.5 million in the third quarter.

During the quarter, we repurchased approximately 15,000 shares at an average price of $80.64 for a total cash outlay of $1.2 million.

I would now like to turn to our guidance for the fourth quarter of fiscal year 2021. We continue to be very optimistic about our business and anticipate another record quarter for revenue and profitability in Q4. We expect total revenue in the fourth quarter to be between $475 million and $495 million and EPS to be in the range of $1.18 to $1.25 per diluted share.

In summary, we had our best performance ever in Q3 and are well positioned to continue our track record of success as we look ahead.

Operator, we are now ready to open the call for questions.

Questions and Answers:

Operator

Thank you, sir. [Operator Instructions] I show our first question comes from the line of John Marchetti from Stifel. Please go ahead.

John Marchetti -- Stifel -- Analyst

Thanks very much. Seamus, I just wanted to clarify something on the Cisco business that you mentioned in your prepared remarks. Is -- are we at the full run rate now exiting the fiscal third quarter, or do you expect to be there in fiscal fourth quarter? I just want to make sure I have that correct and I heard you correctly when you were talking about that.

Seamus Grady -- Chief Executive Officer

Hi, John. Yes, I think we're at the full run rate exiting the quarter. We ramped about a quarter ahead of schedule. I think we -- I think it's safe to say we're at the full run rate at the end of the quarter. So I don't want to give the impression that there's going to be some meaningful uptick. And of course, we don't guide on a customer-by-customer basis, but we're at the run rate and have been for the better part of the quarter.

John Marchetti -- Stifel -- Analyst

Got it. And then I know it's incorporated within the guidance, but I was wondering if you could just spend a moment on maybe what you're seeing out there from a supply chain perspective? Obviously, a lot of different data points swirling around about where the supply chain stands. Just curious if you're seeing any material shortages that may be weighing on your outlook and if that's changing any of the demand profile or how you're thinking about maybe even as we get into the second half of this calendar year?

Seamus Grady -- Chief Executive Officer

Yes, for sure. It's -- we did see a certain amount of shortages in Q3, and we anticipate that they'll continue in Q4 and that's been factored into our outlook. We're not immune to these component charges like everybody else is. There always seems to be some component crisis either just behind us or just ahead of us. We had passives and capacitors before, now -- and it's semiconductor shortages right now.

We try to stay very close to our customers so that we're able to anticipate the demand. And then the more visibility we can give to our suppliers, the better positioned we are to support them. But yes, we have seen that component shortage situation that has impacted us in the past quarter, we think it's impacted the whole industry. But it's part of our job as a management team to make sure we stay close to our customers and our suppliers and proactively work on the issues so that we get the customers what they need and not use the components shortage as an excuse, if that makes sense. It's just -- it's part of the normal business. There's always some -- it seems like these days, there's always some crisis just ahead of us or just behind us. So we've just learned to live with that, I guess.

John Marchetti -- Stifel -- Analyst

And then if I can just ask one more, Seamus, just following up on that. From the shorter -- or from that supply chain tightness, is it a situation where customers have started to give you a little bit more visibility trying to get ahead of some of that, give you some sense of what they may need a few quarters out? Does it more limit your ability to maybe meet surprise upside in a quarter as opposed to meet planned demand? Just curious how we should think about it impacting the business over the next several quarters.

Seamus Grady -- Chief Executive Officer

Yes, I think you're right, John. We are getting more visibility as best as our customers can give us visibility, the normal visibility that they would give us, they're going far beyond that now in order to allow us to position the component inventory. Of course, that doesn't mean that we'll be forecasting our revenue beyond. We will continue with the one quarter at a time forecast. But our customers are giving us better visibility, I would say, so that we can give our suppliers better visibility and making sure we meet their needs and meet their upsides as well, because even in the component, the current component situation, we have had examples where customers have still come in with upside inside lead time in an already tightened situation. So better visibility around from our customers to us and then in turn from us to the supply base helps alleviate the problem but it doesn't make it go away.

John Marchetti -- Stifel -- Analyst

Great. Thanks, Seamus.

Seamus Grady -- Chief Executive Officer

Thanks, John.

Operator

Thank you. I show our next question comes from the line of Samik Chatterjee from JPMorgan. Please go ahead.

Samik Chatterjee -- JPMorgan -- Analyst

Hi. Good afternoon. Thanks for taking the question. I guess, Seamus, I wanted to start off with the optical segment. And if I heard you on the prepared remarks correctly, you mentioned that the 400G growth was about 1% sequentially lower than what you saw in 100G. So I just wanted to clarify that I heard it correctly and what's the driver there.

And also, generally, what we're seeing in the rest of the optical landscape, particularly aligned to telecom revenues, we're seeing more of an expectation of a back half of the calendar year kind of ramp, given demand coming from telco customers. So given that you just mentioned you have more visibility now into the back half of the calendar year, I just wanted to get your thoughts of what you're seeing. Are you expecting more of a sequential ramp as you go through the rest of the calendar year? Any insights to that would be helpful. And I have a follow-up as well.

Seamus Grady -- Chief Executive Officer

Yes. So I will -- hi, Samik. I will let Csaba give the detail on the 400G versus the 100G in a moment. But yes, the visibility we have from the customers is really more from the point of view of allowing us, as I mentioned earlier, allowing us to position component supply to support the demand that's there. We're not using it to forecast revenue out in the second half of the year or anything like that.

And then I'll let Csaba answer the question you had on the growth in 400G versus 100G.

Csaba Sverha -- Chief Financial Officer

Hi, Samik. This is Csaba. Yes. So in our 400G, we still had our record revenue. The sequential growth was indeed 1%. We shipped about $105 million in 400G, so that data rate is still ramping. Obviously, in 100G, we saw a little bit sequential increase. However, that's still lagging behind our highest revenue in the 100G category, which was about a year ago at $160 million.

So obviously, we don't really have a crystal ball how this decline of the 100G and ramp of the 400G is going to happen, but we remain optimistic that medium- to- long-term, 400G ramp is going to continue to accelerate more rapidly. So I would say it's a kind of dynamic situation and there is definitely a shift between 100G and 400G. Therefore, I wouldn't read in too much into one quarter sequential increase or decrease. So I think it's going to take a couple of quarters to taper off and see how the true picture on 100G and 400G is going to play out.

Samik Chatterjee -- JPMorgan -- Analyst

Got it. And then just going up, if I can quickly ask you guys on the -- just wanted to focus on the automotive segment as well. You had strong growth there. I think you mentioned new platforms that are launching are driving the growth. How much of that is the traditional use cases that you might have supported with, I think, some of your customers like Valeo versus some of the more LIDAR customers that you're supporting? And also, any -- when I think about the competitive differentiation in automotive LIDAR, just wanted to get your insight. Should I be thinking about the competitive differentiation in the manufacturing being very similar to the differentiation you already have in optical? Or given how the industry is evolving there, do you see the competitive differentiation being higher or lower in terms of the -- being a contract manufacturer for that industry?

Seamus Grady -- Chief Executive Officer

Yes. So I think -- so many questions there. So first of all, on the, let's say, the split between traditional automotive and what we call our newer automotive programs, the vast majority of the growth that we're seeing is on the newer automotive programs, so on the electric vehicle platforms and LIDAR and the like. The traditional business, it's good business, but it doesn't have the same level of growth. Let's say it's maybe a little bit more flat than these newer automotive programs. So the vast bulk of the growth we're seeing is on the new automotive programs.

In terms of the capability differentiation, yes, absolutely. We feel -- and it's -- I guess it's not just something we feel, it's something our customers tell us, is that our manufacturing capabilities are very well suited to their needs. They're very comfortable -- first of all, they're very complementary to what we're doing in the optical space in terms of how the products go together, the same level of difficulty, let's say, in putting these products together, some of the same processes in putting these products together.

So what we've learned over all these years in putting these optical products together is very complementary to the LIDAR products. And our customers tell us that, and they tell us that we're developing a reputation among the discerning LIDAR customers for being really good. We want to be in the same way that we feel we're the go-to supplier, if you like, in the optical space. We want to develop that same reputation in the LIDAR space, and we think we're developing that. So yes, so very much complementary set of capabilities, complementary to our optical capabilities.

Samik Chatterjee -- JPMorgan -- Analyst

Okay. Great. Thank you. Thanks for taking my questions.

Seamus Grady -- Chief Executive Officer

No problem. Thank you, Samik.

Csaba Sverha -- Chief Financial Officer

Thank you, Samik.

Operator

Thank you. I show our next question comes from the line of Alex Henderson from Needham. Please go ahead.

Alex Henderson -- Needham & Company -- Analyst

Thank you. First off, a great quarter and thanks for the good guide. I was looking at the industrial laser business, and I'm trying to understand the mechanics, implications of the change in ownership of one of the larger players. And to what extent do you think that has an impact on you one way or another? Do you think it's a positive, negative or neutral in terms of that change of ownership?

Seamus Grady -- Chief Executive Officer

So I guess it's early days, Alex. And Coherent is also a customer of Fabrinet, as is really -- well, I guess all of the companies that were involved in the situation there. But so far, it's early days. It's hard to tell at this stage. But historically, we have not lost business through industry consolidation, let's put it that way. And typically, we have tended to benefit from industry consolidation.

We did notice that -- the II-VI, in their public statements, they've announced some pretty significant synergies that they're needing to find. So we'd like to do what we can to help them find those synergies. Of course, we think we can help them find those synergies, so we'll be working with them when the time is right. It's too early at this stage. They haven't got approval for the deal yet. But certainly, we're -- I guess we're excited about it. We're looking forward to engaging when the time is right. But we don't -- and we never have had a preference as to which company would have been better for us to have acquired. We're happy to work with everybody.

Alex Henderson -- Needham & Company -- Analyst

Positive transaction for you that it probably brings more business to you as a result?

Seamus Grady -- Chief Executive Officer

Sorry, Alex. I missed the first part of your question there.

Alex Henderson -- Needham & Company -- Analyst

So it's a positive transaction in general for you. You think it will probably bring more business to you as a result?

Seamus Grady -- Chief Executive Officer

As I said, we -- at this stage, we don't know. It's really too early to say. But we're optimistic. We think we can help II-VI. We'd certainly be happy to do our part to help them realize the synergies they need to realize, but it's very early days yet to be trying to predict whether it's positive, negative or neutral for us.

Alex Henderson -- Needham & Company -- Analyst

[Technical Issues] again, most people thinking [Technical Issues] the magnitude of the impact in [Technical Issues]

Seamus Grady -- Chief Executive Officer

Alex, you're cutting in and out, Alex. We're having difficulty hearing you. Maybe if you could -- if you want to dial back in from a different line, we'll jump you back in at the end of the next question, if that's OK. We just can't hear you right now.

Alex Henderson -- Needham & Company -- Analyst

All right. Thanks.

Operator

Thank you. I show the next question in the queue comes from the line of Dave Kang from B. Riley. Please go ahead.

Seamus Grady -- Chief Executive Officer

Hi, Dave.

Danny Cheng -- B. Riley -- Analyst

Hey, guys. This is Danny on for Dave.

Seamus Grady -- Chief Executive Officer

Hi, Danny.

Danny Cheng -- B. Riley -- Analyst

Congrats on the quarter.

Seamus Grady -- Chief Executive Officer

Thank you.

Danny Cheng -- B. Riley -- Analyst

Yes. And yes, I was just wondering if you guys could provide any color on demand from certain regions, I'm thinking more from North America and China as NeoPhotonics noted that demand from there might be muted for the next quarter. I was wondering if you guys are seeing that impact as well and -- or how you guys are thinking about that?

Seamus Grady -- Chief Executive Officer

Yes. So we don't usually have great visibility into, let's say, the -- we know where we ship the products to. But ultimately, where they're destined for, we don't always have great visibility. Because as you can appreciate, we ship for our customers and then they ship on to their end customers; or, in some cases, we ship actually product to our competitors who maybe do something with it and then ship it on to our customers who ship it on to their customers. So we don't have a great feel for the end markets, if you like. We know where we ship the products to and we disclose that. But the end markets, we don't have great visibility into that, I'm afraid.

Danny Cheng -- B. Riley -- Analyst

Okay, got it. And I guess on the Cisco ramp, you mentioned, I guess, potential for expansion. I was just -- are you guys having any conversations that are particularly encouraging of late for the Cisco program or expansions with other customers?

Seamus Grady -- Chief Executive Officer

Yes. I think what we mentioned was Cisco is an example of, as was Infinera maybe before it, of the type of execution we're able to deliver for our customers, the fast transfers and obviously, the savings and the supply chain simplification that we're able to realize for our customers. And then I think we talked about the opportunity with maybe other customers in a similar vein. There are lots of other Cisco-like companies, if you like, out there that we feel we could do a similar job for. Of course, we're always in discussions with all of our customers, including Cisco, about expanding the relationship. And so far, the transfer of the optical transport business has done very, very well. We're very happy with that. We know Cisco's very happy with that. So we'll be looking to really capitalize on that and grow our business as best we can with Cisco but also with other customers.

Danny Cheng -- B. Riley -- Analyst

Got it. Thank you. Appreciate it.

Seamus Grady -- Chief Executive Officer

Thank you, Danny.

Operator

Thank you. [Operator Instructions] I show our next question comes from the line of Alex Henderson. Your line is open. Please go ahead. Alex Henderson of Needham, your line is open. Please proceed.

Alex Henderson -- Needham & Company -- Analyst

Great. I redialled in on different line. I hope you can hear me better at this time.

Seamus Grady -- Chief Executive Officer

That's much better. Thanks.

Alex Henderson -- Needham & Company -- Analyst

Yes, I hope I didn't miss it in the last question that happened while I was redialing in. But I was hoping you could go back to the supply chain and talk a little bit about the mechanics of the change in supply conditions. Obviously, you have a job of managing through it. But it seems pretty clear that almost everybody we've talked to has suggested that the supply chain pressures have built over the course of the first quarter and into the current quarter and are worse in the second quarter than they were in the first quarter. Could you describe whether you're seeing a larger impact that you're absorbing in 2Q, or are you absorbing a similar impact? And is it a function of the supply chain is now just simply constraining the upside to the numbers?

And then I would hope you explain to me how you get a potentially down EPS sequentially, given you have almost always had up sequential EPS from CY 1Q to CY 2Q. Why is the low end of the band below what you reported in 1Q? Is that a function of supply constraints or some other element within the mix that's exogenous to the typical pattern? Thanks.

Seamus Grady -- Chief Executive Officer

Thanks, Alex. So I'll let Csaba talk in a moment about the EPS outlook. But just on the supply constraints, yes, I think we're experiencing the same supply constraints that really everybody else is experiencing. And I would say it did get worse in calendar Q2 or Q3. I think we've become pretty good at two things; one is, managing through those type of situations, those type of supply constraints that seem to hit us from time to time, by working with our customers and working with our suppliers. And also, we're pretty adept, I think, at factoring it into our guidance so we don't break it out separately. We see it as our role really is to take it all into account, use our best judgment when we set the guidance to factor it in. That's what we did in Q3. That's what we did, if you go back year-and-half, two years ago when we had the MLCC shortages. And that's what we're doing for Q4. We've taken the shortage situation into account, the constraints into account when we set our guidance. But I think certainly, I think everyone would agree, were it not for these constraints, there is more demand there than can be supplied right now, were it not for these component constraints.

Csaba Sverha -- Chief Financial Officer

Okay. So Alex, let me clarify on the EPS. So the number -- the guide is $1.18 at the low end. We had -- actually, it's indeed lower than what we had posted for fiscal Q3. We had about $0.02 tailwind in Q2 from foreign exchange rates in our actual numbers, which we typically don't put in the guide. So that explains about $0.02 from the guide and also the lower band of the revenue guide is $475 million, and we finished at $480 million. So that's about $0.03 from sequential improvement.

Alex Henderson -- Needham & Company -- Analyst

But again, Csaba, normally, you are never down sequentially from the seasonally weakest first quarter calendar to the seasonally stronger second quarter. Is there something going on that -- is that a function of supply constraints?

Csaba Sverha -- Chief Financial Officer

The supply constraints are basically baked into our numbers. But again, the biggest part is the strong actual numbers in Q3, which was to do with the FX of about $0.02.

Alex Henderson -- Needham & Company -- Analyst

I'll cede the floor. Thank you.

Seamus Grady -- Chief Executive Officer

Thanks, Alex.

Operator

Thank you. That concludes our Q&A session. At this time, I would like to turn the call over to Mr. Seamus Grady, CEO, for closing remarks.

Seamus Grady -- Chief Executive Officer

Thank you, operator, and thanks, everyone, for joining our call today. We delivered a very strong third quarter with record revenue and EPS, and we expect to continue positive demand trends -- we expect continued positive demand trends to help us produce another record quarter in Q4, culminating in our best fiscal year ever. As we continue to execute on our strategy, we believe our business remains well positioned to continue delivering positive results over the longer term. We look forward to speaking with you again soon. Goodbye.

Operator

[Operator Closing Remarks]

Duration: 31 minutes

Call participants:

Garo Toomajanian -- Investor Relations

Seamus Grady -- Chief Executive Officer

Csaba Sverha -- Chief Financial Officer

John Marchetti -- Stifel -- Analyst

Samik Chatterjee -- JPMorgan -- Analyst

Alex Henderson -- Needham & Company -- Analyst

Danny Cheng -- B. Riley -- Analyst

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