Fabrinet
SWB:FAN
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Earnings Call Analysis
Q1-2024 Analysis
Fabrinet
Fabrinet marked a robust start to the fiscal year with revenue reaching $685.5 million, up 5% compared to the previous quarter and onwards from the same period last year. After adjusting for an extra week in the year-ago quarter, revenue growth was an impressive 8% year-over-year. This top-line increase is attributed to strong datacom revenue growth driven by demand for next-generation optical interconnect in Artificial Intelligence (AI) applications, with an exceptional 160% year-over-year rise. These positive results led to a record quarterly non-GAAP net income of $2 per share, surpassing guidance expectations.
While telecom revenues showed a decline, this was more than made up for by a remarkable 26% sequential datacom revenue growth, showcasing strong performance in particular from 800-gig technology for AI applications. The belief is that datacom growth, particularly in AI, will continue to balance out any telecom sector weakness in the upcoming quarters. The expectation is sustained strength in datacom demand, contrasting the temporary telecom inventory issues.
Gross margins stood at 12.6%, slightly down from the previous quarter due to typical annual increases in employee compensation. Nevertheless, operating expenses decreased as a percentage of revenue, highlighting a more efficient cost structure as the business scales. Operating income proved steady at $71.7 million, mirroring an operating margin of 10.5%, in line with prior performance.
Fabrinet reported substantial cash and short-term investments totaling $670.8 million, a significant increase from the end of the previous quarter. This financial boost was largely through an impressive operating cash flow, which also facilitated a record high free cash flow of $133.6 million for the quarter. This strong liquidity position underscores the firm's ongoing financial health.
For the upcoming second quarter, Fabrinet estimates revenue to land between $680 and $700 million. While this suggests stable growth, earnings projections indicate a minor decrease with non-GAAP net income expected to fall within $1.98 to $2.05 per diluted share range.
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Good afternoon. Welcome to Fabrinet's Financial Results Conference Call for the First Quarter of Fiscal Year 2024. [Operator Instructions] 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. 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 first quarter of fiscal year 2024, which ended September 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 detail 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 opinion 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-K filed on August 22, 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 set new quarterly records for revenue and EPS in our first quarter, both of which were above our guidance ranges. Free cash flow also reached a new quarterly record. We achieved triple-digit year-over-year growth in datacom revenue driven by next-generation optical interconnect for AI applications. This datacom growth more than met up for continued but diminishing sequential declines in telecom revenue as inventory absorption runs its course.
Overall revenue was $685.5 million, representing an increase of 5% from the fourth quarter as well as from a year ago. Recall that the first quarter of fiscal 2023 was a 14-week quarter, adding approximately $20 million to revenue a year ago. Excluding this impact, revenue would have grown 8% year-over-year. Our strong revenue growth contributed to a record bottom line with non-GAAP net income of $2 per share.
Looking at the first quarter in more detail. Optical communications revenue increased from both a year ago and the fourth quarter. Within optical communications, telecom revenue decreased sequentially, though by a smaller amount than anticipated. Datacom growth more than offset the telecom [ to client ] gain with sequential growth of [ 26% ] from a very strong fourth quarter and year-over-year growth of over 160%. As in Q4, datacom growth was driven primarily by AI optical interconnect.
In our nonoptical communications business, revenue was relatively flat as anticipated. A small sequential decline in automotive revenue was largely offset by growth in industrial lasers and other nonoptical communications revenue.
Looking to the second quarter, we expect the industry-wide inventory adjustments in telecom to continue. We believe that datacom growth, particularly in AI, will more than offset these headwinds again in the second quarter. In short, we are optimistic that the telecom inventory-related issues are temporary, whereas the demand strength in datacom is sustainable.
In summary, our record top and bottom line results represented a strong start to the fiscal year, and we are confident that we remain well positioned to continue delivering solid results as we look ahead. Now I'd like to turn the call over to Csaba for additional financial details on our first quarter of fiscal 2024 and our guidance for the second quarter. Csaba?
Thank you, Seamus, and good afternoon, everyone. Revenue was above our guidance range at $685.5 million, up 5%, both sequentially and from a year ago. Keep in mind that the first quarter of the prior year benefited by approximately $20 million due to an additional week. Our strong revenue helped to produce record earnings. Non-GAAP net income was $2 per share, which was above our guidance range.
We have published additional details regarding our revenue breakdown in the investor presentation, which you can find on our website. So in looking more closely at revenue, I will focus my comments on the most notable changes.
Optical communications revenue of $533.3 million was a new quarterly record. Very strong sequential datacom growth of 26% more than made up for a smaller-than-anticipated decline in telecom revenue of 6%. Datacom growth is being driven primarily by 800-gig technology for AI applications. We believe there is still excess inventory in the supply chain. And in the second quarter, we expect datacom revenue to again more than offset telecom declines by a wide margin.
Looking at optical communications revenue by data rate. Growth in revenue from products rated 400-gig and faster was substantially greater than revenue declines from 100-gig products. Non-optical communications revenue was consistent with the fourth quarter at $152.2 million and represented 22% of total revenue. Automotive revenue declined 5% from the fourth quarter due to some inventory absorption. This was partially offset by a smaller sequential increase in industrial lasers and other nonoptical communications revenue.
As I discuss the details of our P&L, expense and profitability metrics will be on a non-GAAP basis, unless otherwise noted. Gross margin in the quarter was [ 12.6% ]. As anticipated, gross margin declined seasonally by about 20 basis points from Q4, primarily due to annual merit increases, which take effect in the first quarter. Operating expenses in the quarter were $14.9 million or 2.2% of revenue, an improvement of 10 basis points from the fourth quarter. We anticipate that operating expenses will continue to decline as a percentage of revenue as our business scales. Operating income was $71.7 million, representing an operating margin of 10.5%, consistent with the fourth quarter.
Our strong balance sheet again benefited our interest income, which was $5.9 million in the quarter. Our gains from foreign currency asset and liability valuations at the end of the quarter was relatively small at $0.4 million. Effective GAAP tax rate was 7.2% in the first quarter, which is above the mid-single-digit level we continue to expect for the fiscal year as a whole.
Non-GAAP net income was a new quarterly record of $72.8 million or $2 per diluted share. On a GAAP basis, net income was $1.78 per diluted share.
Turning to the balance sheet and cash flow statement. At the end of the first quarter, cash and short-term investments were $670.8 million, up $120.3 million from the end of the fourth quarter. This increase was driven primarily by strong operating cash flow of $145 million with CapEx of $11.4 million. Free cash flow was a quarterly record at $133.6 million. Our share repurchase program was not active in the first quarter. As a result, $100 million remained in our share purchase authorization at the end of the quarter.
Now I will turn to our guidance for the second quarter. As I mentioned, we expect inventory adjustment at our customers primarily in the telecom space to continue into the second quarter. We expect sequential revenue growth from high data rate data from AI programs to, again, more than offset these telecom headwinds. We anticipate automotive revenue to decline sequentially and expect industrial laser revenue to be relatively flat.
In total, we expect revenue to be between $680 million to $700 million. From a profitability perspective, we anticipate non-GAAP net income to be in the range of $1.98 to $2.05 per diluted share.
In summary, we are happy to have exceeded our first quarter guidance by producing record revenue, net income and free cash flow. We continue to balance consistent growth with improving profitability. We are optimistic that we can continue to execute well to deliver strong results as we look ahead. Operator, we are now ready to open the call for questions.
[Operator Instructions] Our first question is going to come from the line of Alex Henderson with Needham.
I've got a quick question for you on the news that came out of Jabil about the Jabil purchase of the silicon photonics business over at Intel. I know Intel silicon photonics has been historically a customer of yours. And I was wondering how you think that will impact you over time. particularly given the difficulty of moving an existing line.
Alex, yes, it looks like Intel wanted to exit that market for their own strategic reasons. The -- Intel has not been a 10% customer of ours. We have been one of 2 sources on the program that -- programs that we're involved with. We remain focused on being a manufacturer serving customers in the market rather than selling our own products. So for us, we understand Intel have sold the business in its entirety to Jabil, including development of new products, supply [ on ] products, et cetera. And that's just not a business that we're involved in. .
The immediate impact, it's really too early to say. The news only became official literally a few days ago, so we have to sit down with our customer and work out the transfer plan. And we're confident that in these situations, we provide a high level of service to our customers. And in general, we've become good at managing these transitions and usually find a way to come out on top.
Do you think that this represents an increase in Jabil trying to get into the optical market? Or do you -- what's your sight of the competitive implications of it?
Well, it's a different business, I guess, to the business [ Rodin ]. We manufacture other people's products. We have no interest in having our own products, so I would assume for Jabil, it's more of an -- I don't want to speak for Jabil, but it appears to be more of an OEM type offering that they'll be providing. And that's just not something that we're involved in. So I would see it as a different market to the market that we're involved, but we wish Jabil well.
I was hoping you could talk one more question, if I could, and then I'll cede the floor, about any potential pipeline activity or thoughts on how to get into the Ethernet side of the 800-gig AI opportunity.
Well, we just really follow our customers' lead, Alex, whichever protocol the customers deem to be the one that they want us to work and we're happy for us. We don't really mind whether the products are international or any other protocol, we don't really mind. So we work with our customers, and we're working with, I would say, a number of customers in this space to make sure we continue to provide the products that they need and the volumes that they need. But we really don't mind whether it's Ethernet or InfiniBand or anything else.
Well, yes, but your current 800-gig customer is almost exclusively InfiniBand and then [ Delink ]. And obviously, over time, the world will shift towards Ethernet. So the question is, do you have a hook into that stream?
We do indeed. We're working with, I would say, a number of opportunities that we're working on that will be both again InfiniBand but also Ethernet-based products.
Our next question will come from the line of Samik Chatterjee with JPM.
I guess to start off, maybe I can follow up on Alex's question here. How -- Seamus, as you move towards working with customers on the Ethernet side, what are you finding relative for the competitive landscape? Just from the outside in, from our perspective, it looks like more companies are in the manufacturing supply chain in relation to Ethernet. But can you share your thoughts about what you're seeing from a competitive aspect? And what's sort of the differentiation that you bring there into that ecosystem? And I have a follow-up.
I think, Samik, for newer products, whether it's 800 gig or higher speeds, we feel pretty confident that we're well positioned to support what the customers need. I think for older-generation products, it's the competitive landscape. It's much more competitive. But for new-generation products, for these kind of specific short reach, low power, low latency applications. there's really a handful of companies who are able to design these type of products, and we're well positioned to support them. So again, whether it's InfiniBand or Ethernet, we just follow our customers lead. Whatever they need from us, we're able to help them with. And again, our focus is always on producing the current-generation, products but also winning next-generation products. So we're very focused on that with our customers in this space.
Okay. Got it. If I can just ask as a follow-up on the guidance. Going from 4Q to 1Q, you had a sequential increase of about $30 million or so in revenue with datacom. Easily, the increase in revenues offsetting the telecom decline. As you look forward, I mean, you're carrying forward the same theme where datacom does offset telecom. But the magnitude of it seems to be much lower just given the $5 million sequential increase at the midpoint that you're guiding to. So maybe if you can help us with the puts and takes there. Is telecom declining more than sort of what we've seen from 4Q to 1Q? Or is it the datacom ramp is moderating, just given that you are maybe reaching more capacity with the customer that you're engaged with?
I would say, first of all, in Q1, our telecom declined probably less than we thought it would. It declined about 6%. We -- going into the quarter, I guess, we thought it might decline more than that, declined about 6%, which was primarily driven by stronger demand than anticipated for certain telecom programs, especially DCI. So again, driven by the data center and the growth going on in the data center but DCI products, which we categorize as telecom. That's the first thing.
And then as we go into Q2, yes, our -- we think our telecom business will decline further into Q2. As you know, we don't guide beyond 1 quarter at a time. But in a general sense, I think -- we think telecom will decline. Datacom will increase by more than that decline. And then as we look to the kind of future, again, based on the intelligence we have from our customers, we think the telecom decline is set to continue, probably until the middle of the calendar year, which would be the end of our fiscal year. So further declines this quarter and the next quarter, and then we think it will begin to bottom out in the -- we call it the June quarter. And then the rate of growth of datacom, I guess, it should slow down at some point. That rate of growth, it's been very strong for us. But it will inevitably begin to -- the growth will begin to slow at some point.
Our next question is going to come from the line of Mike Genovese with Rosenblatt Securities.
Can you give us any commentary at all on kind of performance breakout between 400G and 800G datacom or new programs versus existing older programs? Is there any color we can get there?
Well, in general, we break out 400 gig and above and which, of course, at this point, is a pretty large category. And at some point, we may want to revise how we do that. But for now, it's really everything in that 400 gig and above category, so 400 gig inside the data center, 400ZR, DCI, 800-gig AI, everything really in that 400 gig and above category. But the growth has been coming from primarily the higher-speed newer programs. Older programs and, let's call it, traditional datacom products have not been as strong, especially with the -- at the lower speeds, 100 gig and the like. The growth for us, certainly, we don't speak for the whole industry, but for us, the growth that we've seen has been primarily on the higher-speed newer programs, mainly focused around these newer AI applications, 800 gig being the biggest driver for us there.
Perfect. Maybe I'd follow up on that question by -- because I thought the color you gave about telecom and DCI driving less -- a decline in telecom but less than expected. I mean that was a great color. So maybe comparing how telecom came into how the older datacom programs, I mean was there any surprise on the upside there? Or did it behave -- or downside? Or did it behave as expected?
I think the traditional, we call it, traditional datacom, I think, behaved pretty much as expected. Newer datacom has been just very strong. But for us, it's expected, I think, at this point. And then like I said earlier, the strength in DCI was maybe a little bit of a surprise. We had expected telecom to be down. If you just took the guidance from our customers going into the quarter and you just straight line that, we should have been down double digits probably 12% to 15% in telecom. Instead, we were down about 6%, so down a lot less than we thought we would be, again, primarily driven by DCI. So even though it's in telecom, it's driven by the data center expansion that's going on everywhere.
Got it. Okay. Great. And then finally for me, just could you -- maybe Csaba or both of you talk about just the decision to not buy back stock in the quarter and kind of going forward, what you're thinking about buybacks.
Mike, this is Csaba. Last quarter, as I mentioned in our prepared remarks, we didn't buy anything back -- we have, obviously, an [ OMR ] opportunity in the open window. In addition, we have a 10b5 plan in place. The 10b5 plan is rule-based and subject to certain prices. Obviously, it didn't trigger last quarter. But obviously, we are still committed to return surplus cash to our shareholders. So obviously, we are revisiting the 10b5 plan from time to time and subject to the new pricing and the market conditions, we will make amendments, and we continue to be committed to return the surplus cash we generate to shareholders.
[Operator Instructions] Our next question is going to come from the line of Tim Savageaux with Northland Capital Markets.
A couple of questions. You'd previously described the AI connectivity opportunity, I think, at 800 gig or maybe just in general as in very early stages and a very large opportunity. I actually maybe missing a few varies there.
Yes. I think at one point, I maybe said very twice. I think I pulled off on very, very.
Well, I guess, as you -- as we've moved forward a few months here into the end of the year, would you add or subtract any varies at this point? Or can you give us your current assessment where Fabrinet is in terms of the ramp and how that opportunity is looking relative to what you were seeing previously?
I think we're still very optimistic about you can insert or remove as many varies as you like there Tim. We're still very optimistic about the market in general. I would say, the interconnect, the optical interconnect opportunity for artificial intelligence applications. And really, our position within that. We're building the products for the leader in the industry. It's their own design, their own product, and I know they have other choices. But for now at least, we believe they're quite committed to sourcing from us. .
We're still ramping. We continue to ramp both the existing programs, [ floral ], and there's additional business that we're looking at and getting qualified on. As you know, we're maniacally focused on executing the business that we've already won, but then on making sure we win the next-generation programs of new products. So we're working very, very hard on both of those, Tim. Both on executing, and I think we've done a very good job there. Maybe a very, very good job of executing. And we're also making sure we win the next-generation products and then execute very well on those. It's the best way to stay ahead of the competition is just work like crazy to delight the customer and make sure we do a great job and win the next-generation products. So that's really our focus. And we're -- we see a lot of kind of runway ahead of us, and we think it's a really good opportunity for us.
Great. Appreciate that. And just a follow-up. I know with ZR, I think you've gotten within shouting distance of 10% of revenue for you guys before the latest inventory correction. Given that you've called it out as kind of the source of unexpected growth in the quarter, maybe you can give us an update on kind of where that stands in terms of materiality of the overall business or telecom or however you want to talk about it. And I just got one more quick follow-up after that. .
Yes. I think ZR is very strong for us. We haven't broken it out yet in a separate category, but it is quite strong for us and continues to grow. It doesn't -- it doesn't necessarily grow in a straight line, so there'll be maybe still a little bit of stops and starts with 400ZR. But we're just very happy to be participating in it, and it was a source of really most of that offset between the -- what we would have expected last quarter, that kind of down 12% to 15%. The difference between that and where we ended up was primarily 400ZR for DCI applications. So we still think it's early days. We have a number of customers and a number of programs there, and we continue to ramp those and they're not all at the same stage. Some are ahead, some are just getting qualified. But we still think 400ZR has good runway left for us.
Well -- and this wasn't going to be my question, but now that you mention it. Should we look at this sort of ZR thing as kind of a blip that's coming in and coming back down? Are you seeing weakness elsewhere across telecom as you look forward into your December quarter guide and continued growth in ZR?
Yes. I think we have -- as I said earlier, we still see continued weeks in telecom generally. I think were not for 400ZR, there will be even more weakness. That's really in the traditional telecom, traditional telecom products. We see continued softness in the December quarter and really out to the mid -- probably out into the middle of next year when we think it will start to level out. .
Got it. And last question for me is given the growth that you've seen and the kind of metrics you've discussed in the past, where do we stand in terms of major additional capacity additions in the facility?
It seems -- in a way, it seems crazy that we're even talking about it. But it is something we have to [indiscernible] keep a close eye on as we ramp. It seems like the blink of an eye ago that we opened building in [ Charley ]. It's now completely full. and building that is off to a flying start. So we're keeping a close eye on that. I think in all probability, you could say, well, if we pull the trigger too early, what are the implications of that? They're very small implications really. So typically, what we've said in the past is once we get to 70% utilization in our last building, we'll build another building. whether we do that this time around or whether we pull the trigger a little bit earlier, remains to be seen. But I think we're -- I would say stay tuned over the next couple of quarters. It's not going to take us 5 years or anything like that to get to capacity and building [ 9 ]. We're off to a great start there. I was there last week and the [ facilitization ] that's going on in building 9 and the expansion is just amazing. It's really encouraging to see. And whether it was good luck or good planning on our part, I think our timing on building 9 line was, as it turns out, exactly right. A little bit of a look, I think, over H1. So we'll be keeping a close eye on that. And once we do make that decision, we communicate it on this call in due course. But again, the cost would be, subject to Csaba correcting me, I would say, if I put a range on the $50 million to $60 million for another 1 million square feet and about 1 year to 18 months time horizon. But yes, it's something we'll be keeping a close eye on.
We have a follow-up question from the line of Samik Chatterjee with JPM.
It's quick, I promise. Just Csaba, any color on -- I know you mentioned the gross margin moderated sequentially because of the merit increases. But as you embed that now into the cost structure, puts and takes about how to think about gross margin going forward. And then Seamus, either for you or Csaba, like the automotive revenue declining and you said it will decline modestly. Is that more of a temporary production-led headwind? Or is this a falloff of the legacy programs while growth is [ punting ] on the new programs. Any clarification on those 2 items?
Maybe I'll take the automotive question first, and then I'll let Csaba discuss the gross margin. Yes, we saw some, I would call it, inventory digestion going on in automotive this past quarter. We think it's primarily temporary, maybe another quarter or so of inventory digestion, but nothing to get too concerned about. We remain optimistic about our EV charging business overall. But like any business that's ramping, it's -- there's a little bit of inventory digestion going on. If you look at our overall revenue, we've always said we are around kind of the $90 million mark since we overcame the component charges a couple of quarters ago. So it's been pretty stable, actually, if you look at the last few quarters. In our Q3, we were -- we had $94 million of automotive revenue.
Last -- sorry, Q4 was $93 million, and then Q1 was $88 million, so not a huge amount of variation, kind of normal variability as our customers go through inventory digestion, I would say. But overall, we remain optimistic about that business.
Regarding gross margin, Samik, obviously, as you know, there are a lot of puts and takes in the gross margin. And this last fiscal quarter, we had a mild headwind as usually from merit increases and gross margin came in as we had anticipated at 12.6%. And obviously, we are working hard to make sure that we continue to execute well efficiently, provide cost reductions for our customers and also make sure that we manage the mix and mix of business to deliver industry-leading margins. I think we have done a good job there in the last couple of years.
But obviously, there are a couple of factors to be mindful that may result some seasonalities like the merit increases in the first quarter. It's also subject to foreign exchanges, which have been a tailwind in the past and then we managed to overcome the temporary headwinds there as well. So there are lots of puts and takes, but we are optimistic that we can maintain this middle 12.5% and round about gross margin above, working hard to make sure that we continue to deliver on the operating margins as we scale the business and accomplish our road map for growth
Our next question comes from the line of Dave Kang with B. Riley.
First question is regarding your 400-gig plus revenue of $322 million. What is the rough split between datacom versus telecom?
We typically don't break out and provide that breakdown. But obviously, as you appreciate, as what we have communicated in the past, datacom growth in that space have been obviously far more than the telecom growth. So you would think datacom is going to be much stronger in that area, but we haven't provided a breakdown on that.
Right. And then on the telecom portion of that 400 gig plus, I mean, is this growing? Or is it going through inventory [ cushion ]? Any color on that segment?
I think we touched on that as well that the traditional telecom business that's not DCI as we typically would include that in the telecom segment has been going through inventory digestion and has been there for a while, and we continue to see a headwind there. But our DCI and 400ZR particularly have been very strong over the last couple of quarters, and we continue to be optimistic on that space. So I think, again, the puts and takes there is traditional telecom still experiencing headwinds and the datacom, which is again driven by data center DCI, is going strong for us.
Got it. And just quickly on the number of 10% customers you had or near 10% customers, any new 10% or near 10% customers?
We are disclosing our 10% customers in our 10-K at the end of the year. So obviously, we have disclosed it in August. At that time, we obviously had 4 10% customers, but we are not disclosing this during the quarter. So you will have to wait for another couple of quarters to see if any changes there. .
And I'm showing no further questions. And I would like to hand the conference back over to Seamus Grady for any closing remarks.
Thank you. Thank you for joining our call today. We are very pleased with our first quarter performance including record revenue, net income and free cash flow. We're optimistic about the longer-term drivers of our business and our ability to continue to execute well to produce strong results. We look forward to speaking with you again and seeing those of you participating in the Needham Virtual Conference next week. Thank you, and goodbye.
This concludes today's conference call. Thank you for participating. You may now disconnect.