Fabrinet (NYSE:FN) Q2 2024 Earnings Call Transcript

Fabrinet (NYSE:FN) Q2 2024 Earnings Call Transcript February 5, 2024

Fabrinet misses on earnings expectations. Reported EPS is $1.89 EPS, expectations were $2.04.

Fabrinet isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good afternoon. Welcome to the Fabrinet Financial Results Conference Call for the Second Quarter of Fiscal Year 2024. 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 provided 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, VP of Investor Relations. You may begin.

Garo Toomajanian: Thank you, operator, and good afternoon everyone. Thank you for joining us on today’s conference call to discuss Fabrinet’s financial and operating results for the second quarter of fiscal year 2024, which ended December 29, 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 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 the Investors section of our website for important information, including our earnings press release and investor presentation, which include our GAAP to non-GAAP reconciliation, as well as additional details of our revenue breakdown.

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, 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 November 07, 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?

Seamus Grady: Thank you, Garo. Good afternoon and thank you for joining our call today. We had a very strong second quarter, which again set new records for revenue and EPS, and also exceeded our guidance ranges. Rapid datacom growth continues to fuel our overall performance, driven by next-generation AI interconnect. Telecom revenue remains impacted by inventory absorption in the ecosystem, but we are encouraged that the magnitude of these declines is getting smaller. Total revenue was $712.7 million, an increase of 7% from a year ago, and 4% from the first quarter. Our strong execution helped to improve operating margins from the first quarter, and generate non-GAAP net income of $2.08 per share, a new quarterly record. Looking at the second quarter in more detail, optical communications revenue grew, both from a year ago and the first quarter.

Within optical communications, telecom revenue decreased sequentially as anticipated. However, within telecom, we saw increasing demand for extended reach, pluggable optics, which helped soften the sequential decline. We expect that this trend will continue in Q3. When combined with what appears to be a diminishing impact from inventory absorption, we believe telecom revenue could be up slightly in the third quarter. Datacom revenue growth was strong again in the second quarter, driven by AI optical interconnect products. For the first time in our history, datacom revenue exceeded telecom revenue, largely driven by AI programs. We expect to maintain this higher datacom revenue mix even as sequential datacom growth moderates and as telecom revenue trends improve.

Our non-optical communications business saw a small sequential revenue decline in the second quarter. This was primarily due to continued inventory absorption from certain automotive programs. We expect this inventory digestion in the automotive market to persist into the third quarter, but we currently anticipate a sequential improvement in the fourth quarter. Industrial laser revenue remained stable in the second quarter. Operationally, we performed very well in the second quarter, with operating margins improving to 10.7%, a 20 basis point improvement from the first quarter. Looking to the third quarter, we are optimistic that we can deliver another strong performance for revenue and profitability. Despite softer near-term automotive trends, we believe telecom is positioned to show sequential revenue improvement, led by growth in ZR.

In addition, we expect further growth in datacom revenue, which continues to be driven primarily by strength in AI programs. At the same time, we expect to extend our track record, a strong operational execution and profitability. In summary, we are excited to have delivered another record quarter for both revenue and earnings per share, and we are confident that we can deliver another strong performance in the third quarter. Now I’d like to turn the call over to Csaba for additional financial details on our second quarter of fiscal 2024 and our guidance for the third quarter. Csaba?

Csaba Sverha: Thank you, Seamus, and good afternoon, everyone. Second quarter revenue was above our guidance range at a record $712.7 million, up 7% from a year ago and up 4% from the first quarter. This strong top-line performance led to non-GAAP earnings per share of $2.08, which was also above our guidance range. This record EPS includes the impact of a foreign exchange evaluation loss, which reduced net income by $0.10 per share. Details regarding our revenue breakdown are included in the investor presentation on our website. So my comments today will focus mainly on the most noteworthy areas. Optical communications revenue was $567.9 million, or 80% of total revenue. Datacom revenue was $288.1 million, exceeding telecom revenue for the first time.

Datacom revenue increased 19% from the first quarter, driven primarily by 800-gig AI programs. Although the rate of sequential growth has begun to moderate, datacom revenue still increased by over 150% from a year ago. We expect new high data rate datacom programs to continue making significant contributions to our top-line as we look ahead. Telecom revenue was $279.8 million or just under half of total optical communications revenue. Telecom revenue declined 4% sequentially as we continue to see softness due to excess inventory in the channel. Similar to the first quarter, growing demand for 400 ZR programs helped to offset some of this impact. We are optimistic that in the third quarter we could see a small sequential increase in telecom revenue.

By data rate, products rated 400-gig and faster grew 118% from a year ago and 18% from the first quarter, and represented two-thirds of total optical communications revenue. Non-optical communications revenue decreased 5% sequentially to $144.8 million and comprised 20% of total revenue. This decline was driven primarily by inventory absorption of certain automotive products as we indicated last quarter. We anticipate automotive revenue will continue to decline in the third quarter, but expect to see a return to sequential growth in the fourth quarter. Industrial laser revenue was flat sequentially, and we expect that trend to continue in the third quarter. As I discussed the details of our P&L, expense and profitability metrics will be on a non-GAAP basis unless otherwise noted.

Gross margin in the second quarter was consistent with the first quarter at 12.6%. Operating expenses were $14 million, or 2% of revenue. This produced operating income of $76 million, representing an operating margin of 10.7%, an improvement of 20 basis points from the first quarter. With a strong balance sheet, we benefited from $7.7 million of interest income, which more than offset the $3.8 million FX loss from foreign currency assets and liability revaluations at the end of the second quarter. Effective GAAP tax rates was 5.2% in the second quarter, in line with the mid single digit level we anticipate for the fiscal year. Non-GAAP net income was a new quarterly record of $76.1 million, or $2.08 per diluted share. On a GAAP basis, net income was $1.89 per diluted share.

Looking at the balance sheet and cash flow statements, at the end of the second quarter, cash and short-term investments were $740.6 million, up $69.8 million from the end of the first quarter. The primary driver of this increase was healthy operating cash flow of $84.2 million. With CapEx of $9.8 million, free cash flow in the quarter was $74.4 million. We were active in our share buyback program during the quarter, repurchasing approximately 38,000 shares at an average price of $166.61 per share, for a total cash outlay of $6.4 million. In addition to investing in our growth, returning value to shareholders remains a key capital allocation priority. At the end of the second quarter, $93.6 million remained in our share repurchase authorization.

Now I will turn to our guidance for the third quarter. We remain optimistic about our business momentum and ability to execute well. In the third quarter, we expect further sequential revenue growth in datacom, which continues to be driven by demand for optical communications products for AI applications. In the telecom market, after several quarters of declines, we believe that we could see modest sequential revenue growth in the third quarter. We expect this increase to be driven by further stabilization of industry-wide inventory issues coupled with continued growth of data center interconnect products. We foresee another quarter of softness in our automotive business due to inventory absorption in the channel. And we expect that industrial laser revenue will be flat.

As a result, we anticipate total revenue will be in the range of $705 million to $725 million in the third quarter. We expect to continue to execute well and anticipate net income of $2.08 to $2.15 per share. In summary, we are excited to continue with our strong track record of exceeding guidance as well as achieving new records for both revenue and EPS. We are optimistic that we are well-positioned to deliver strong results again in the third quarter and extend our leadership position in the market. Operator, we are now ready to open the call for questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from the line of Karl Ackerman with BNP Paribas. Your line is open.

Karl Ackerman: Yes, thank you, gentlemen. I know you don’t typically guide beyond one quarter, but perhaps you could discuss the backlog visibility you have on 400-gig and above optics over the next few quarters as perhaps well as the breadth of high-speed optical programs ramping. I ask because while a peer of yours indicated a temporary pause in 400-gig and 800-gig deployments in March, backlog visibility appears very good for 800-gig, and multiple hyperscalers appear to be deploying 800-gig this year. So, if you could comment on that, the visibility you have, that would be very helpful.

Seamus Grady: Thanks Karl. Yeah. We have pretty good visibility, especially on the newer programs. Typically, in normal steady-state business, we would have rolling 13 weeks forecasts. But for these newer programs, we have visibility beyond that. As you rightly point out we just guide one quarter at a time, so I won’t get into too many specifics. But I will say we are optimistic about the breadth of the pipeline for 400-gig and above, 400-gig, 800-gig and higher and we have a number of programs and a number of customers in the pipeline that we are pretty excited about, but again nothing to get into too much detail about and we certainly don’t want to be announcing any products on behalf of our customers, but we are pretty optimistic about the pipeline that we have for those higher speed, higher data rate products.

Karl Ackerman: Great. Thank you for that. Perhaps if I may have a follow-up. Could you provide any update on the timing of building 10? And also if you could address your ability to service what appears to be very strong demand for high-speed optics in datacom, certainly the capacity that’s serving telecom were to tighten quickly as well. Thanks.

Seamus Grady: Yeah. Building 10, we opened building 9 a little over a year ago and we’re already ramping at a fast pace and building 9 — excuse me. Typically when we get to 70% utilization on our last building we then pull the trigger on the next building. We’re not at that point yet and nothing to announce certainly at this stage. It is getting closer. I think we are pleasantly surprised by the pace at which we’ve been adding capacity and ramping in building 9. Demand in particular for optical interconnect for AI applications is very strong and has been probably the biggest driver of our capacity additions in building 9. So again nothing to announce, but it is something that’s in, I would say if not the top of our mind, it’s close to the top of our mind and something we’re very mindful of and paying very close attention to and will be really making a decision on in the coming quarters.

I would say if I go back maybe a couple of years ago, a 1 million square foot facility like building 9 is to think that we’d be even contemplating a building 10 a little over a year after opening building 9 would have been hard to imagine but here we are. Capacity — the second part of your question, capacity additions in general, yeah, we’ve been we’ve been adding capacity at a fairly blistering pace and keeping up with supply really. We haven’t been — we have been able to keep up with all the demand thankfully. Any constraints we’ve seen along the way are typically component related, but we have been — we would have been able to ship more I would say over the last while were it not for a couple of component constraints along the way. With any of these new products especially when they’re ramping very quickly, component constraints can catch you out sometimes, but overall we’ve been very happy with the pace of growth and with the strength of the pipeline.

Karl Ackerman: Very helpful. Thank you.

Seamus Grady: Welcome.

Operator: Thank you. Please stand by for our next question. Our next question comes from the line of Alex Henderson with Needham. Your line is open.

Alex Henderson: Great. Thanks. First, just a clarification, can you depict whether you’re expecting any currency translations in the March quarter? I know the BOT has peaked around the very end of the December quarter and it’s come off some since then. So is that — are you assuming flat in that calculus?

Csaba Sverha: Hi, Alex. This is Csaba. Certainly, we had a revaluation impact in the December quarter, so we are off the peak, but as you know we are continuing to hedge our currency exposure. So, from operations perspective we anticipate a flat FX environment going into Q3. However, obviously, in the March quarter we do contemplate a certain exchange rate revaluation impact. Again, the BOT has reached the peak earlier, so we are contemplating some reval impact in the EPS, but not in the cost of goods sold environment if that makes sense.

Alex Henderson: Great. And the taxes, I assume, are going to be pretty consistent with the first half level and the second half. Is that a reasonable?

Csaba Sverha: Yes. That’s reasonable. We anticipate mid single digits.

Alex Henderson: So, I wanted to ask a couple of questions on operations. Can you give us any sense of what the non-speed products did particularly in the telco space, the ROADMs and OLS type products? And second, can you give us some sense of what’s going on with systems business which obviously has become an increasingly large piece of your business over time?

Seamus Grady: So, non-speed rated, Alex, in the quarter, maybe Csaba, if you can help me with the exact numbers, and then I’ll talk about what’s in non-speed raters.

Csaba Sverha: Yeah. So the non-speed rated business was flat, Alex, in Q2 versus Q1, it was $118 million revenue from non-speed rated, and I’ll pass back onto Seamus, but it does include more than ROADM, so I’ll let Seamus to clarify that.

Seamus Grady: That’s right, Csaba. It was 118, so up 1 million, slightly up from the prior quarter. And for us, non-speed rated includes ROADMs, it’s about a third of the non-speed rated business, also fiber arrays, another third, and then the balance is made up of other components, primarily optical amplifiers. So, there’s a good mix of products in there, it’s not just one particular category.

Alex Henderson: Right. And systems?

Seamus Grady: Systems, we don’t break that out separately. We remain optimistic about our — I would call it our pipeline of new business that we’re working on in that space. There, of course, are several opportunities to win additional systems business over time, both at our existing customers and new customers, and we have probably upwards of a dozen programs that are in our sites right now. The favorable economics are typically quite easy to demonstrate to the customer, the sales process for those can be very long, often requiring some external catalyst. So, we’re being patient, but we’re very focused on that.

Alex Henderson: Okay. One last thing, then I’ll see the floor. On the AI side, I assume that you’re still capacity constrained on production, as opposed to any demand issues, and that’s probably going to stay that way all year. Can you give us any sense of what the rate of commitment to new production capacity coming on looks like for that AI product line, and whether you expect to broaden your customer base in terms of other AI customers? Thanks.