Fabrinet
NYSE:FN
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Fabrinet
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Good day, ladies and gentlemen, and welcome to Fabrinet’s Fiscal Results Conference Call for the Fourth Quarter of Fiscal Year 2019. 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. And as a reminder, today’s call is being recorded.
I would now like to turn the call over to your host, Garo Toomajanian, Investor Relations.
Thank you, operator, and good afternoon, everyone. Thank you for joining us on today’s conference call to discuss Fabrinet’s financial and operating results for the fourth quarter and fiscal year 2019, which ended June 28, 2019.
With me on the call today are Seamus Grady, Chief Executive Officer; and TS Ng, Chief Financial Officer. This call is being webcast and a replay will be available on the Investors section of our website located at investor.fabrinet.com. Please refer to our website for important information, including our earnings press release and investor presentation, which include 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 SEC filings, in particular, the section captioned Risk Factors in our Form 10-Q filed on May 7, 2019.
We will begin the call with remarks from Seamus and TS, followed by time for questions.
I would now like to turn the call over to Fabrinet’s CEO, Seamus Grady. Seamus?
Thank you, Garo, and good afternoon, everyone. I’m pleased with our record performance for revenue and earnings in the fourth quarter, especially given some of the unusual business dynamics we experienced during the quarter.
Revenue in the fourth quarter was $405 million and non-GAAP net income was $1 per share, exceeding the high-end of guidance. These results also drove strong cash flows in the fourth quarter, with operating cash flow of nearly $42 million and free cash flow of over $36 million.
For the full fiscal year, revenue increased 15% to nearly $1.6 billion and non-GAAP net income increased 26% to $3.81 per share. Total operating cash flow for the year was a record $147 million, up $9 million from a year ago, and free cash flow was also a record at $129 million, up a healthy 23% from a year ago.
As I’m sure you know, the U.S. Department of Commerce export ban to Huawei that began in the middle of the quarter came as a surprise to the industry. We do manufacture products for some of our customers who ship to Huawei. While we estimate that this negatively impacted our fourth quarter revenue by approximately $9 million, we were able to offset that by better than anticipated performance from other businesses.
Looking at our business by end markets. Optical communications revenue was $300 million, up – or up about $2 million from the third quarter and represented 74% of total revenue. Within optical communications, telecom revenue was down $2 million from the third quarter to $215 million, or 72% of optical revenue, primarily due to the impact of the Huawei ban with other telecom products offsetting some of the Huawei-related pressure.
We had anticipated that datacom revenue would be up slightly from the third quarter. And, in fact, we saw a 5% sequential growth to $85 million, or 28% of optical communications revenue.
By technology, silicon photonics-based optical communications revenue grew 10% from the third quarter to nearly $90 million, the highest level in three years and represented 30% of optical communications revenue, the highest level in more than a year. Revenue from QSFP28 and QSFP56 transceivers was $46 million, up $2 million from the third quarter, primarily from increased revenue from QSFP56 programs.
By data rate, 100 gig programs continue to represent nearly half of optical communications revenue at $144 million. Products rated at speeds of 400 gig and above were roughly flat with the third quarter at $23 million, or 8% of optical communications revenue.
Looking at non-optical communications, revenue was a record $105 million, up 4% from Q3, with gains coming primarily from the industrial laser market. Revenue from industrial lasers was a record $53 million, or up 9% sequentially, though we don’t expect to sustain this level in Q1. Automotive and sensor revenue were both stable at $23 million and $4.5 million, respectively.
Finally, other non-optical communications revenue was also stable at $24 million. Revenue from new business increased 8% from the third quarter to $165 million and represented a record 41% of total revenue in the quarter.
Last quarter, we discussed an agreement with Infenera, where we would be assuming manufacturing responsibilities for the products being manufactured at their Coriant’s divisions in Berlin. We’ve made significant progress in transferring the production of these products from Berlin to our facilities in Thailand, and this process is now essentially complete.
While revenue from this program in the fourth quarter was immaterial, we expect it to begin to ramp in Q1 and contribute even more meaningfully beyond that. We continue to believe that Infenera could become a 10% customer by the end of fiscal 2020, up from single digits in fiscal 2019.
Speaking of which, we had one 10% customer in fiscal 2019 and that was again Lumentum, with combined Lumentum and Oclaro revenue representing 24% of our total revenue in fiscal 2019. Operationally, we remain focused on continued improvements in efficiency and expanding capacity, while enhancing the benefits our customers value most like our best-in-class on time delivery, quality and service.
To complement our ongoing cost reduction objectives, we recently introduced a new initiative that we call half, half 2x, [ph] with a goal of doing what we do today with half the people, half the space and twice the output. This half, half 2x effort has had a number of positive effects already.
To this initiative, we have improved operational efficiency and reduced cycle times for a number of processes through increased automation and optimization and the elimination of non-value-add activities. This initiative has enabled us to free up close to 120,000 square feet of manufacturing space at our Pinehurst facility in Bangkok. These efficiency gains have effectively increased the available manufacturing footprint at Pinehurst by more than 20%.
Half, half 2x is an ongoing process, whereby we expect to continue to reduce labor costs, improve cycle times and create more manufacturing space within existing facilities. As such, it means that our previous metric of how much of our Chonburi facility was either occupied or spoken for is no longer a meaningful gauge of our available capacity. It also means that we may be able to push the build-out of a second building at our Chonburi campus until fiscal 2021, instead of later in fiscal 2020.
As reflected in our guidance, our customers are working through the restart of certain shipments to Huawei. With this, we expect the timing of changes in supply chains to temporarily impact some of our optical communications business in the first quarter. Combined with the near-term slowdown in the industrial laser market, we anticipate a sequential decline in total revenue of approximately 4% in Q1 from our record performance in Q4. We believe that the impact of these supply chain resets will be temporary and we remain very optimistic over the longer-term.
Looking ahead to fiscal 2020, we expect to further capitalize on our leading position as the manufacturer of choice for our customers most complex products. We’re particularly pleased with our record financial performance for the fourth quarter, especially given the unanticipated dynamics impacting a small number of our customers.
Our revenue growth of 15% for the fiscal year reflects our ability to grow faster than the markets we serve. Our ongoing half, half 2x initiative is generating exciting results for us that enable us to better serve our customers while improving our efficiency. As a result, we believe we are very well-positioned to continue to deliver positive long-term trends as a leading contract manufacturer for the most complex products. We look forward to expanding our penetration within our target industries.
Now let me turn the call over the TS to discuss the details of our fourth quarter performance and our outlook. TS?
Thank you, Seamus, and good afternoon, everyone. I will provide you with more details on our performance by end market and our financial results for Q4, as well as our guidance for Q1 for fiscal year 2020.
Total Revenue in the fourth quarter of fiscal year 2019 was a record $405.1 million and at the upper-end of our guidance range after adjusting for $1.9 million contribution due to our adoption of ASC 606 this year. Going forward, we will be both guiding and reporting results under ASC 606.
Non-GAAP net income was $1 per share and was also above our guidance range even after a $0.01 contribution from our adoption of ASC 606, a foreign exchange tailwinds of $1.8 million contributed $0.05 to EPS upside.
For the full-year, revenue was $1.584 billion, an increase of 15% from fiscal year 2018, and non-GAAP net income was $3.81, an increase of 26% from the years ago. For the fourth quarter, optical communications represented 74% of our revenue, with non-optical communications representing 26% of our revenue.
Now turning to the details of our P&L. A reconciliation of 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 fourth quarter was 11.8%, a 30 basis point decrease from the third quarter, largely due to a shift in product mix, partly related to the ban on shipments to Huawei for a couple of our customers.
Non-GAAP operating expense was $11.3 million in the fourth quarter. As a result, non-GAAP operating income was $36.7 million and non-GAAP operating margin was 9.1%, compared to 9.5% in the third quarter, primarily due to lower gross margin. Taxes in the quarter were $1.2 million and our normalized effective tax rate was 4.4% below our anticipated effective tax rate of 6% to 7%.
Non-GAAP net income was above our guidance range at $37.6 million in the fourth quarter, or $1 per diluted share, as I indicated earlier. On a GAAP basis, which include share-based compensation expenses and amortization of debt issuing costs, net income for the fourth quarter was $33 million, or $0.88 per diluted share above the high-end of guidance.
Turning to the balance sheet and cash flow statement. At the end of the fourth quarter, cash and investments were $444.7 million, an increase of $35.8 million from the third quarter. Operating cash flow in the quarter was $41.9 million and with CapEx of $5.5 million, free cash flow was $36.4 million in the fourth quarter.
For the full-year, we generated operating cash flow of $147.4 million and free cash flows of $128.7 million, both of which are records. Due to the timing of open trading window, we do not opportunistically repurchase any share during the fourth quarter. As such, $62.2 million remains in our share repurchase program and we’ll continue to evaluate market condition to opportunistically repurchase share when possible.
I would now like to turn to our guidance for the first quarter of fiscal year 2020, which is now based on ASC 606. As Seamus described, we expect revenue to be between $386 million and $394 million. From a margin perspective, we expect non-GAAP gross margin to moderate slightly from the fourth quarter due to the impacts of annual merit increases, and we expect to see gross margin improve during a year towards our target range of 12% to 12.5%.
From an EPS perspective, we anticipate non-GAAP net income per share in the first quarter to be in the range of $0.80 to $0.84, and GAAP net income per share of $0.64 to $0.68, based on approximately $37.4 million fully diluted share outstanding.
In conclusion, we are excited with our record performance in the quarter. We remain very well-positioned to deliver profitable growth over the longer-term as leading manufacturers of the most complex high mix product.
Operator, we would now like to open the call for questions.
Thank you, sir. [Operator Instructions] And our first question will come from the line of Samik Chatterjee with JPMorgan. Your line is now open.
Hi, thanks for taking the question. If I could just start off on the guidance itself. You mentioned couple of drivers why you have a sequential decline in the revenue going from the fourth quarter to the first quarter. But if you can just kind of help us with the puts and takes between the fourth quarter and the first quarter, including how much are you expecting in terms of a headwind from the sanctions on Huawei, as well as kind of sounds more like you’re giving up some share as you do the supply chain reset? So can you just help us think about the quantifying those impacts?
Hi. This is Seamus. Thank you for the question. We have a couple of things. There’s a few things we outlined in our prepared remarks, so let me add a little bit of color. First of all, on the supply, we call, the supply chain reset, our customers have been finding resolution to the Huawei ban, and in some cases, they’ve been finding that by redirecting certain products to other of their customers, which means they’ve had to maybe repurpose existing products to suit other customers. So that has presented a few supply – I would call them supply chain challenges, albeit short-term and temporary in nature. So that’s the first point.
Secondly, as they – in terms of the overall demand, let’s say for Huawei, I should point out, Huawei is not a direct customer of ours. We don’t sell anything directly to Huawei. But it does seem just from the industry publications that we’ve read probably the same as you’ve read, that Huawei’s total demand seems to be slower due to slowness in China, but also due to maybe some of the stigma, we call it, hanging over Huawei and international markets like Europe.
So we do think that overall Huawei has done. We don’t have a good feel for what that might be percentage terms, again, as we don’t supply Huawei directly, but we do feel it is being a factor if you like in Q1.
And then thirdly, industrial lasers. Industrial lasers will continue to be down we think for another quarter or two. We believe that the worldwide market, especially for welding and cutting is down by about 10% quarter-on-quarter. We think that’s going to continue for a couple of quarters.
The final point I would make just in terms of maybe the guidance of some of our customers relative to our guidance, some of our customers are guiding up on 3D sensing significantly, which, of course, is a product that we don’t manufacture, we don’t participate in 3D sensing.
As regards, are we losing share? We don’t believe so. The short answer I suppose is, we don’t believe that we’ve lost any market share. We believe that’s where we continue to be the number one optoelectronic EMS company. As you can see from our results, we just posted record performance for revenue and profits. We once again generated significant cash and we continue to work with our customers on new opportunities and to quote new customers and new applications.
In FY 2019, we believe the EMS industry grew by about 7%. The optical industry grew by about 3%, and that includes 3D sensing, and we grew by about 15.5%. So we don’t believe that we’re losing any share.
Sure. Got it. If I can just follow-up quickly on the Infenera business that you mentioned, you’re largely done with the move of the footprint from Berlin to your Thailand facility. What about – was there any margin impact from that movement in this quarter itself? And how should I think about the impact on cash flow as you make that – do that transition was that entirely your fiscal 2019 impact, or is there some impact in fiscal 2020 as you do that transition?
So I’ll let TS maybe talk about the cash flow in a moment, just on the overall impact on revenue and margin. So in Q4, we had a small improvement in the revenue because of the Coriant and Infenera business, I think we called it an immaterial. So we had a small amount of revenue that we shipped in the quarter. It was probably a headwind in terms of margin for the quarter, as we did a start-up costs. We had a lot of activity going on that we haven’t fully covered those costs yet.
So in Q4, I would say, slightly positive for revenue and slightly negative to our margin. Then in Q1, we’re just beginning to ramp now in Q1. So, we’re obviously – we’re buying a lot of inventory. We’ve taken over a lot of inventory from the Germany facility, but we’re just beginning to ramp that this quarter and it will have, I would say, more of an impact this quarter. But by no means, we won’t be up to full volume for another one or possibly two quarters.
And then as regards to cash flow impact, I’ll let TS talk about that.
Yes. Good afternoon, Samik. On the cash flow side as with any new customer, when they give their forecast, we buy inventory, we put in resources, we pay our labor ahead of collection and we give them a nice payment term. In this case, Infenera is a trusted long-term partner and we extend the – actually the credit availability [ph]. So I will say, in the next two, three quarters, we will see a dip in our cash flow. And I expect by the end of the year, fiscal year, the cash flow will be pretty much due to rise or account, but even at a level. Is that helpful?
Yes, yes. Thank you. Thanks.
Thank you.
You bet.
Thank you. And our next question will come from the line of John Marchetti with Stifel. Your line is now open.
Thanks very much. TS, I appreciate kind of the color that you just gave there on the cash flows. Could you may be talk about just the gross margin in fiscal 4Q itself. It came in a little bit below what we were expecting? Obviously, you had a little bit of upside to revenue. Just curious if you can talk a little bit about that sequential decline in margin, specifically in that fourth quarter?
Okay. So we’re looking at a June quarter right from the March quarter. And as you probably know, Seamus just described, we have a scale of Huawei ban, okay. The Huawei ban you account as a surprise, a lot of efficiency, a lot of wait-and-see timeframe and at that point, as a manufacturing guy, it’s a wait-and-see lot of efficiency. So a lot of efficiency over there and also you heard about Coriant start-up. As with any new product we start-up, we put significant start-up costs, so those drag the margin a little bit. And we also have a one-month of merit increase.
We started to give all our employees merit increase, I think, June the 1st. So there’s a one-month impact there. Therefore, the margin dip from 12.1% in Q3 March quarter to 11.8% in the June quarter, and that’s – these two or three factors account for that margin erosion.
Okay, okay. And then, Seamus, you mentioned obviously in your prepared remarks, as the Infenera business starts to scale, but they could be a 10% customer. And I wanted to make sure that I heard you correctly. Do you think they can still be a 10% customer for the year, even with a little bit of the slower ramp to start in the first couple of quarters, or are you saying that, once fully ramped, they could essentially be a 10% customer? I just want to make sure I think about how to load that potential revenue in as I’m modeling out the fiscal year?
Yes. We think – while we certainly think there’ll be at that race at the end of the year. But we think there’s a good chance, there’ll be a 10% customer for the full-year, actually.
Okay, okay. Thank you. And then just lastly, on the laser color, Seamus. I mean, obviously, with that market slowing down a little bit, and so much, you’re still coming from your primary customer in that laser market, I’m just curious with that market now slowing a little bit, how have conversations changed, or what’s your outlook to bring on additional customers outside Lumentum through Amata, and how you’re thinking about that for maybe fiscal 2020 and beyond?
So we have a number of customers in the laser space. We have three or four of the kind of the big customers in that space. Lumentum is by no means our only customer. Again, from what we can see, the – let’s say, coating and precision welding market seem to be down about 10% quarter-on-quarter and most of our customers in that space have guided down. And a lot of them are talking about significant pressure from Chinese suppliers, who are moving into their space and really producing very low-cost products that our customers are finding it difficult to compete with.
So there’s kind of two parts of the answer, the short-term, long-term. Short-term, of course, it’s, of course, it’s not good in the sense that a 10% slowdown in a market we serve isn’t – is not a good thing. However, from our perspective, we think it might not be a bad thing in the longer-term, because we do feel it will act as a catalyst and encourage our customers to maybe move to outsource faster, because really for them to compete with very low-cost Chinese competitors, they’re really going to have to use outsourcing as a tool to allow them to compete.
So we do think, the competition our customers are facing from Chinese suppliers, albeit causing some short-term headwinds, we believe could act as a catalyst for outsourcing in the longer-term. Does that makes sense?
Thanks very much.
Thank you, John.
Thank you. And our next question will come from the line of Troy Jensen with Piper Jaffray. Your line is now open.
Yes. Congrats on the nice results, Seamus.
Thank you, Troy.
Thank you.
Hey, so, Seamus, for you. I guess, I’d like to talk a little bit about silicon photonics, and you had a record quarter here, but two of your top three customers weren’t in here. So just thoughts on that combination, and what it means to Fabrinet longer-term? And then, ultimately, can – silicon photonics still provide some of the same growth that you’ve had, historically with those two firms margin?
Well, first of all, it’s very early. We don’t really know what the impact would be as of yet. Again, historically, when our customers have come together, it’s tended to be good for us, historically, this one, it’s far too early to say. We still think that silicon photonics has a lot of legs left, and we do feel we’re certainly in the EMS space.
We’re the leading contract manufacturer, manufacturing silicon photonics-based products. And we do feel we’re the supplier of choice for those type of products. It’s very complex products, very difficult to manufacture with high reliability and high yield. We’ve been doing it for quite a while.
So we do feel we have an advantage over our competition. The long-term impact of, let’s say, Cisco and Acacia, I’m – we’re not sure yet at this stage, it’s very early to say. But we don’t – right now, we don’t see any negative. We think it’s a good combination, they’re a good match and we’re kind of excited to see where Cisco tends to – intends to take the product in the future.
So within silicon photonics, is it still three firms that make up the bulk of that business?
Yes. It would be yes.
Okay. And then how about…
But there’s also a number of, I would say, smaller players who have some really, I would say, really exciting technology, albeit that’s a quite small in terms of their overall size, quite small, but they do have some exciting technology.
Okay, all right. Perfect. And then last question, obviously the forum. Just thoughts on your QSFP28 versus QSFP56 going to see growth in both segments, or is it just the 56 going to drive the growth for the business going forward?
Based on the data in front of me, I think, yes, across broad-based. So I see both are growing. At Q4, we did $47 million higher than Q3. And moving forward, we see maybe a little bit of slowdown, because some of the consolidation going on with Oclaro [ph] and CIG and so on. So yes, but we’re still pretty optimistic about this form factor, QSFP28 as well as QSFP56.
All right. Thanks, guys. Good luck.
Thank you, Troy.
Thank you. And our next question will come from the line of Michelle Waller with Needham. Your line is now open.
Hi, thanks for taking the question. This is Michelle on for Alex.
Hi, Michelle.
So I have a quick one on SG&A. It looks like it increased about 12% quarter-over-quarter. And I was just wondering if that is due to the larger revenue for the quarter, or if there’s any other factors going on there that just came in a little – quite a bit higher than we were modeling?
Okay. Thanks for the question, Michelle. At Q4, about $1.2 million higher than the previous quarter, because we go to a restructuring and try to beef up our sales and marketing function, very important for the future. So we hire EVP sales and marketing, as previously announced, and now he’s trying to build his team. So moving forward, I will expect operating expense is about around the level of $11.3 million – $11.5 million per quarter moving forward.
Okay, that’s really helpful. Thanks. And one quick one. On the half over half 2x program you were talking about increasing the manufacturing efficiencies. So it seems like that’s going to push out the build out that you guys were going to potentially have in fiscal 2020 in the Chonburi facility, or I mean area?
Yes.
Just wondering if you can give some detail around that? I think you said was it 20% increase in efficiencies and what the utilization rate would be based off of that now? And yes, that’d be helpful any color there?
Sure. So our main campus in Pinehurst, most of our existing customers when they have new business that they want to bring our way, they really want to bring that business up in Pinehurst today. They don’t want to have their business split between Pinehurst and Chonburi. So Chonburi, we target more for new customers, new business they’re bringing in.
Therefore, in order for us to be able to grow with our existing customers, we need to be more efficient, we need to create space. And over the last year or so, we’ve created about 120,000 square feet of manufacturing space in Pinehurst. So that’s – it’s about a 20% increase in the manufacturing space that we have in Pinehurst, which is just a – it’s a really good result.
But it means we – we’re able to bring in new business, for example, like the Infenera business. The majority of the Infenera business, the product manufacturing will be in Pinehurst. Some of the repair and upgrades business that’s kind of a space hog, that will be in Chonburi, but the vast majority of that business will be in Pinehurst.
So, this is an initiative we’ve had going for sometime. We’ve never really talked about it publicly before. But it’s really part of the DNA of the company internally, about really doing more with less, the name we put on it is half half 2x, half to space, half to people, 2x the output. But it’s a way of really doing more with less, creating space, being more efficient, so that we can basically grow the company and bring in new business. And that does mean that we can – I mean 120,000 square feet, it’s a lot of space. It means we take – we will be able to push out the build-out of the next building in Chonburi to fiscal 2021.
Thanks. That’s very helpful. Thanks for clarifying. Thanks.
Thanks, Michelle.
Thank you. And our next question will come from the line of Tim Savageaux with Northland Capital. Your line is now open.
Hi, good afternoon. Let me go back on silicon photonics for a moment and then two high-level questions. First, silicon photonics, I wonder if you can characterize the growth in the June quarter as being driven more by telecom or datacom? And then do you expect silicon photonics to continue to grow into the September quarter?
Hey, good afternoon, Tim. This is TS. By looking at the data, June versus March quarter, silicon photonics grew about 10%, 82% to 90%. I will say, both segments, telecom and datacom, the silicon photonics are growing. I will say maybe the datacom gross slightly faster, but both segments are growing. Is that helpful?
Yes.
And then moving on to Q1, I think, Seamus already mentioned that we might see a temporary dip, okay, because some of the telecom products go to some rationalization. Again, I think the – both sector from June quarter to September quarter might be slightly down a little bit, so – from the June quarter level.
Got it. And that kind of feeds into my next question, which is, if you look at the overall sequential guide, I guess, down about $15 million mid-range, based on your your earlier comment, it seems like the bulk of that maybe two-thirds, I don’t know, is on the non-communication side, given the commentary about 10% sequential declines, I don’t know if that’s what you meant for the overall optical business? Or could you characterize your guidance in terms of non-optical versus optical? And then within optical, what you expect telecom versus datacom?
Normally, we don’t break down the guidance into the count quite detail. But I think, Seamus mentioned that the commercial laser right now, the whole industry is down.
Ye, 10%.
And yes, so we expect Q1 will be down from the June quarter, therefore, commercial laser, which is a non-optical communication side. And on the optical communication side, we see essentially – datacom will be down again. Telecom may be flat, yes. So currently, I think about the bulk of the guidance here. But we don’t mean, we go down into silicon level – silicon photonics level, or give us a bettering level. Thank you.
I appreciate the color. I really do. And if I could follow-up with one last one. Just to understand that supply chain reset narrative. I mean, I think, part of the strength of your footprint here is that you are located in Thailand, and then extensively, kind of not subject to a lot of what might play competitors who are more China-focused or China-based.
And in that context, I guess, I’m having a little problem understanding what you’re referring to with regard to the disruption coming from OEMs, I guess, extensively component guide shipping to the CNS of the world versus the Huawei’s of the world? How do I connect that back to Fabrinet?
So it’s really a function, Tim, of – if our customers, let’s say, stop shipping a certain product to Huawei, but they have another customer for that product, but it’s a slightly different very variant or slightly different flavor of the same product. So that have to do, I wouldn’t call it a redesign, it’s more of an engineering change that might require us to take away 10 components and add 10 other components.
So we’ll have to go out and source those components. So it’s really more, I think, one of the phrases are, one of our customers says, these are repurposing, where they repurpose existing products, some – and in some cases, those products may be already in production or about to start production.
So, like I say, we require, I wouldn’t call it a full fledge redesign, but more of an engineering change that once it goes through, it will create a component shortage that we have to go and fill. Does that makes sense?
It does. Thanks. I’ll pass it on.
Thank you, Tim.
Thank you. And our next question will come from the line of Fahad Najam with Cowen. Your line is now open.
Hey, guys, thank you for taking my question. Actually Tim kind of asked the questions I was going to ask, but I’ll ask them differently. In terms of your Q1 guidance, can you just help us understand in terms of the relative drivers? Is it the industrial business that’s a primary driver for the weakness, or is it the optical communication? And within optical, is it the datacom or the telecom? [inaudible] quantifying you just help us prioritize, which was the biggest driver for the long-term weakness?
And then related to the second question that Tim asked, if you look at the broad picture, U.S.-China trade relations deteriorating, one would expect you will be a net beneficiary of this trade war. And we want to think that you will probably benefit from this straight escalation. So it’s kind of puzzling that you’re highlighting the supply disruption to Huawei as a headwind. But is there a benefit are you seeing from the U.S.-China relations coming towards you?
Hi, Fahad. Yes, we are, but I think it’s may be slower to come than we would like. There’s a number of our customers are talking to us about switching their supply chain out of China and moving it to Thailand. Those conversations are still going on. It’s maybe slower to move than we would like. But I do think you’re right, it shows the tariff situation, we should be a beneficiary of that, because we manufacture everything, all of the products we manufacture, we manufacture in Thailand.
So yes, that should be a, again, a kind of a medium-term tailwind for us. You will appreciate unfortunately the two things, that’s a component shortages and reengineering supply chains, they don’t move at the same speed. When a component shortage happens, it affects us immediately.
When a customer decides to read to move their supply chain, let’s say, from China to Thailand, it can take, I would say, best case, six months, probably more like nine months, maybe even up to a year. And the pacing item is usually not at the speed at which we can move the product. The pacing item is usually the qualification cycle with their customers.
So, like I said, there are a number of conversations going on, but nothing of any in order to really talk about at this point. But your point is a very good one. Yes, certainly, the tariffs are a tailwind for us.
In relation to the Huawei situation, it’s really more of a temporary, I would call it, it’s a supply chain challenge. That’s – it’s a high-quality problem, because again, our customers are finding other customers for their products separate from Huawei, but it does present a short-term challenge in terms of just finding the right component mix to be able to get those products shipped and shipped out to our customers’ customers.
But it is very much, I would call it a temporary supply chain challenge. It’s not like the components, the supply chain challenges we had over the last couple of years that were kind of industry-wide and pervasive and went on for several quarters, that’s not what this is. This is purely a, I would say, a quarter, a temporary supply chain challenge that we feel is – will be very short lived.
Thank you. Regarding the Q1 guidance, if you could highlight, which is the primary driver, the industrial revenue business or the optical communications you want to combat?
I would say, it’s both. I mean, the industrial lasers, again, that business does seem to be a down about 10%, let’s say, number of our customers have indicated that. The optical communications, we do believe, again, even though many of our customers are back in business with Huawei, that – again, Huawei is a big customer of many of our customers. And even though they’re back in the business with Huawei a few things to remember.
Huawei remains on the Entity List, and those not all products have been turned back on. And then it does seem that even with Huawei being switched back on, Huawei’s demand is lower in China and in Europe as well. So we think maybe Huawei is not back on at the same level. So therefore, the – our guidance is – it’s both, I would say, up to communications and industrial lasers.
Appreciate it. Thank you very much.
No problem. Thank you, Fahad.
Thank you. And we do have a question coming from the live of Dave Kang with B. Riley FBR. Your line is now open.
Yes, thank you. Good afternoon. So, Seamus, I think you – I believe you said that Huawei impact was about $9 million for the quarter. So should we expect that to be like $18 million for the full quarter?
Yes, I don’t think so, because I think the $9 million – yes, the $9 million was recorded half of the quarter. So I guess that’s where you get the $18 million from…
Right.
Yes, I do think our customers have, let’s say, made up some of that. I’m not sure they’ve made up all of that, but they certainly made up some of that. So I don’t think it’s as straightforward as to start two times nine, it’s probably a bit less than that of an impact.
Got it. And then second question is, you have said multiple times that this Huawei situation to be temporary. But my understanding is that, your customers that have reported already, they talk about EAR versus non-EAR, so they were able to ship non-EAR products, the ones they couldn’t ship, obviously, EAR products. So that may not be a temporary situation. Just wanted to get your understanding on the situation?
Oh, yes, absolutely. I mean, there, obviously, Huawei is still on the Entity List and it’s up to our customers to get the necessary approvals to allow them to ship to Huawei. And that’s the approach we take a very careful approach. We don’t ship anything until we’re certain that our customer has the necessary approvals in place.
Overall though, I think with whether the products are on the – I guess, the point I was making, whether the products are on the list or not, overall, Huawei demand does seem to be down and they’ve talked themselves about being down. I think I read today $30 billion over the next two years because of the situation. And again, I think there’s a little bit of maybe stigma. Even outside of the U.S., some European countries are under pressure to not again, I’m not an expert on it. But from what I understand, I guess, same as you read, a lot of these countries are under certain amount of political pressure, maybe not to purchase from Huawei.
Got it. Thank you.
Thank you, Dave.
Thank you. And I’m showing no further questions in the queue. So now it is my pleasure to hand the conference back over to Seamus Grady for any closing comments or remarks.
Thank you. Thank you for joining our call today. We’re excited to have delivered strong Q4 results, which caps the best fiscal year in our history. We remain optimistic that our leadership as a trusted manufacturing partner positions us for continued success in fiscal 2020 and beyond. We look forward to speaking with you again soon. Thank you, and goodbye.
Ladies and gentlemen, thank you for your participation on today’s conference. This does conclude our program, and we may all disconnect. Everybody, have a wonderful day.