Good afternoon. Welcome to Fabrinet’s Financial Results Conference Call for the First Quarter of Fiscal Year 2023. 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..

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 and fiscal year 2023, which ended September 30, 2022. With me on the call today are Seamus Grady, Chief Executive Officer; and Csaba Sverha, Chief Financial Officer.

This call will be 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. 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-K filed on August 16, 2022. 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..

Thank you, Garo. Good afternoon, everyone, and thank you for joining us on our call today. We’re off to a strong start in fiscal 2023 with first quarter results that exceeded our guidance. Total revenue was $655.4 million with a better supply situation than anticipated, which contributed to our strong performance.

Revenue increased 21% from a year ago or 17% when we adjust for the contribution of approximately $20 million due to the 14-week quarter. In other words, revenue would’ve been $20 million lower if not for the additional week. Demand remains strong across the Board with sequential growth from nearly all the end markets that we serve.

Supply for some automotive components saw relief in the quarter resulting in a supply headwind to revenue that was only about half of the $25 million to $30 million we had anticipated. We also executed well to produce non-GAAP operating margins of 10.7%, consistent with our record fourth quarter and a full percentage point higher than the prior year.

Revenue upside and strong margins helped drive non-GAAP EPS of $1.97. Looking at the quarter in more detail, we delivered a record quarter for both optical communications and automotive revenue, even after considering the extra week in the quarter.

In the second quarter, we expect to start seeing optical communications revenue further supported by our new partnership with DZS, a global leader in access networking infrastructure, service assurance, and consumer experience software solutions.

Through our partnership, DZS will transition sourcing, procurement, fulfillment and manufacturing activities in its Seminole, Florida facility to Fabrinet. We believe this new systems win has the potential to be a significant contributor to our growth when fully ramped. Turning to non-optical communications, we had an especially strong quarter.

Automotive revenue was up more than $30 million or more than 50% sequentially as improved components availability allowed us to capture more revenue than anticipated in a quarter. Overall demand from our customers remains very strong, which makes us optimistic about our future.

While supply constraints remain a limiting factor on our growth, we continue to focus on managing supply conditions as effectively as possible. From a capacity perspective, we are very well-positioned to serve increasing demand.

Last week, we held an official ribbon cutting ceremony for Building 9 at our Chonburi Campus, adding approximately 1 million square feet of space. While we are maintaining our practice of letting our customers take the lead and announcing relationships, we are very pleased with the early demand and traction at Building 9.

Looking at the second quarter, we remain optimistic that strong demand trends will continue to drive growth both year-over-year and sequentially after factoring the additional week in the first quarter. We also remain confident that we can continue to realize incremental operating efficiencies as revenue grows faster than expenses.

In summary, we had a strong first quarter with results that exceeded our guidance. We are optimistic about continued demand in our markets and we’re well-positioned to extend our track record of success as we look ahead.

Now, I’d like to turn the call over to Csaba for additional financial details on our first quarter and our guidance for the second quarter of fiscal 2023.

Csaba?.

Thank you, Seamus, and good afternoon, everyone. We delivered strong first quarter results that were above our guidance ranges. Revenue in the quarter about $655.4 million, and represent a strong year-over-year and sequential growth even after backing out the approximately $20 million contribution from the additional week in the first quarter.

With excellent execution, we delivered our best ever non-GAAP growth and operating margin for the first quarter. The strong margins combined with foreign exchange tailwinds and higher interest income produced record non-GAAP earnings per share of $1.97, which was $0.18 above the high end of our guidance range.

Looking in the revenue in more detail, optical communications revenue was $497.6 million. Note that growth comparisons to prior periods should be adjusted by the additional week in Q1, but we believe that optical communications revenue would’ve been up both sequentially and from a year ago excluding the impact of the additional week.

Within optical, Telecom revenue was a record $404.9 million. Datacom revenue was $92.7 million. By technology, Silicon photonics revenue was $138.9 million, an increase of 3% from a year ago and decline of 8% sequentially.

The sequential decline is primarily due to approximately $15 million revenue that has shifted from Q3 due to alternative part rate qualification. Although, Datacom business tends to be more variable on a quarterly basis and continues to be impacted by supply chain headwinds, they anticipate that our Datacom revenue will increase sequentially in Q2.

Revenue from products rated at speeds of 400 gig or more was $195.2 million, up from a year ago, as well as sequentially. Revenue from 100 gig products remains stable and was $139.6 million, up modestly from a year ago, but down sequentially.

Non-optical communications revenue was very strong in the first quarter at a record $157.9 million and represented 24% of total revenue. Growth in non-optical communications was driven primarily from automotive revenue of $86.8 million, up 80% from a year ago and up 55% from last quarter.

During the quarter, we took advantage of availability of components that had been in short supply, enabling us to deliver meaningful growth. While the component supply environment remains challenging and maybe result in declining automotive revenue in Q2, we anticipate that strong demand will produce healthy year-over-year growth.

Industrial laser revenue was $35.4 million, down 5% sequentially, but remaining stable the longer term trends. Other non-optical communications revenue was $35.7 million. As I discussed, the details of our P&L, expense and profitability metrics provided are on a non-GAAP basis unless otherwise noted.

A reconciliation of GAAP to non-GAAP measures is included in our earning press release and investor presentation, which you can find in the Investor Relations sections of our website. We executed very well in the first quarter to produce particularly strong gross margins for the first quarter at 12.9% just below our fourth quarter performance.

We achieved these strong results despite the headwinds from annual merit increases, which were largely offset by increasing efficiencies and continued foreign exchange tailwinds. Operating expenses in the quarter were $14.7 million or 2.2% of revenue. This produced operating income of $70 million or 10.7% of revenue.

This performance represents our ninth quarter of generating record operating income. As a reminder, the vast majority of our revenue is in U.S. dollars as are the majority of material and component costs. However, a significant portion of our labor and operating costs are in Thai baht.

Through the cash flow hedging program, we have been following for many years, we are able to enhance our visibility as smooth out the impact of foreign exchange fluctuations over time. Nevertheless, from time to time, we could see larger impact as a result of currency evaluation of balance sheet items.

And in Q1, it’s resulted in $2.1 million or $0.06 per diluted share foreign exchange gain. The current interest rate environment combined with our strong balance sheet contributed approximately $1.2 million or approximately $0.03 per diluted share.

Non-GAAP net income was $72.4 million, or $1.97 per diluted share, which is another quarterly record and was above our guidance range. On a GAAP basis, net income was $1.76 per diluted share. Effective tax rate was 1.1% in the first quarter.

But for the year, we anticipate an effective tax rate in the low to mid-single-digit consistent with our history. Turning to the balance sheet and cash flow statements. At the end of the first quarter, cash, cash equivalents and restricted cash were $499.9 million, up $21.4 million from the end of the fourth quarter.

Operating cash flow was $60.6 million with CapEx of $10.3 million. Free cash flow was a quarterly record at $50.4 million. In fiscal year 2023, we will continue to execute on our plan to return surplus cash to shareholders.

During the first quarter, we repurchased approximately 47,000 shares for a total cash outlay of $4.9 million, approximately $95 million remains in our share repurchase authorization. Now, I will turn to our guidance for the second quarter.

We continue to be optimistic about demand across our business, as well as our ability to effectively manage supply constraints. By the component supply environments, so specific pockets of relief in the first quarter and we continue to expect improvements over time. These supply handlings continue to persist in many areas of our business.

As such, our Q2 guidance assumes the supply chain headwind of $25 million to $30 million. For the second quarter, we anticipate revenue in the range of $640 million to $660 million. It represents both year-over-year and sequential growth after backing out the contribution of approximately $20 million from the additional week in the first quarter.

We anticipate non-GAAP net income to be in the range of $1.86 to $1.93 cents per diluted share. In summary, our first quarter result provided a strong start to fiscal year 2023 with record revenue and earnings, which both exceeded our guidance.

With continued favorable business conditions, we are optimistic that our track record of success will extend into the second quarter. Operator, we are now ready to open the call for questions..

Thank you. [Operator Instructions] Our first question comes from the line of Alex Henderson of Needham. Please go ahead..

Thanks. Just a little clarity to start off with on the supply chain comment. So – and $30 million in the automotive was an impressive improvement, but I guess, to a large extent, most of the people following Fabrinet are more focused on the optical side.

Did your supply chain improve on the optical side? Because if I just take the $30 million out of the out of the revenues, so you were in line with our prior forecast?.

Yes. Hi, Alex. Yes, we called out the improvement on the automotive and just to remind our automotive businesses made up of – the improvement was in a new automotive business, which is made up of electric vehicles and also LiDAR. We hard to see some improvement, it’s too early to declare victory yet, but we have started to see some improvement.

And I think what’s particularly encouraging for us is, as in specific component shortages get cleared, we’re seeing that demand that we’ve been – we’ve had some pent up demand, let’s call it, for some time. Once those component shortages are clearing, we can see the revenue impact is almost immediate.

So this past quarter, the most of the biggest part of the impact is on automotive. Some on the optical side as well, but mostly on the automotive side. And as, like I say, as we clear those shortages that have been flagging us and everybody else for some time, it is converting to revenue very quickly..

So does that imply that the majority of the number that you threw out, I think it was $25 million to $30 million of supply constraints in the quarter has a shift in the mix to more optical supply constraints and maybe less auto supply constraints? I mean, how do we measure it? How do we think about that?.

Yes, for last quarter, I think that’d be a fair way to look at it. Most of the constraints were on the optical side..

I see, I see.

And just going back to the baseline businesses you gave a fair amount of granularity on the outlook, but I think could you talk about what you think the datacom and telecom, 400 gigs silicon photonics are going to do on a year-over-year basis since we have that extra year confusion? How do you expect those to behave year-over-year as opposed to quarter-to-quarter or adjusted for the quarter-to-quarter if there’s some way to do that?.

Hi, Alex. This is Csaba. Let me take that one. So I think you meant to say extra week we had in Q4 rather than extra year. So our silicon….

We misspoke..

All right. So our silicon photonics have been very strong both sequentially and on quarter-on-quarter – on year-on-year basis as well. So we continue to see 400 gig growing. The primary driver that we earlier spelled out was driven by 400 ZR which came off from a low base obviously this year. We continue to see very strong demand in that space.

So both silicon photonics and obviously the higher data rates remain very stable. Even though, on sequential basis you see a slight decline in silicon photonics revenue, but that has to do with a $15 million extra revenue that we had in Q4 from a prior quarter.

So overall, we are very optimistic about both silicon photonics and the higher data rate businesses that are coming down the track, both on telecom and datacom as well. And again, the year-on-year growth was primarily driven by the 400 ZR which remains very strong for us..

Yes. I was really talking about in the guide for the fourth quarter, whether you thought datacom and telecom would grow on a year-over-year basis, any calibration of that within the guide is what I was looking for..

So we anticipate that the higher data rates will continue to grow. So I – in the prepared remarks, I mentioned that our datacom business remains very strong, although some of the supply constraints were mostly in our datacom business. Again, those supply headwinds are still ahead of us, but we are very optimistic about the growth rate there.

So we do anticipate probably a slightly higher growth rate in datacom and for going into next quarter..

And on telecom..

Subject of supply constraints.

And telecom.

Any sense?.

I’m sorry..

And what about telecom?.

Telecom also continues to be strong. Again, that’s impacted by supply constraints, but we do anticipate that to continue to grow. Yes. Again, the demand is holding very strong in across the board. The caveat here is still that we are not out of the goods from supply perspective. We still have about $25 million, 30 million baked in our guidance.

So that’s mostly across the board, but subject to those supply constraint, we do anticipate both segment of our business to grow..

Okay. Thanks. I’ll leave the floor..

Thanks, Alex..

Thanks Alex..

Thank you. Our next question comes from the line of Samik Chatterjee of J.P. Morgan. Please go ahead..

Hi, thanks for taking my questions and congrats on the strong print here. I guess, I had a couple. So I’ll just sort of go through those.

One, I mean, if you can talk a bit more about the DZSI business win and I know you said that business starts to ramp up in the fiscal second quarter, but sort of how to think about the contribution from that business or that new win for the year.

How big do you see that opportunity being in the long run? Maybe if you can give some more color around that. The second one I did sort of adjust your fiscal first quarter revenue for the extra week, the $20 million that you said.

And I think still the sequential growth that you are implying at the midpoint of your guide going into 2Q is a bit softer than what we saw you sort of execute on last couple of years.

So I’m just wondering, like if you can talk to the sustainability of the non-optical revenue in the quarter is it that you had supply improvement and pulled through a lot of backlog, which is somewhat limiting, sort of the sequential improvement that we see – sort of sequential growth that we see into 2Q. Those are the questions.

Thank you for taking the questions..

Thanks, Samik and thank you for the comments. I’ll take the first question around DZS and then I’ll turn it over to Csaba for the question about the outlook.

Yes, did DZS business, as you know, we don’t size specific deals, but this is a meaningful program that transfers production from DCZ’s Seminole facility and Florida to our facilities in Thailand. It’s part of our strategy.

We continue to execute our strategy to add selective complete network system business, and we have a good track record of that now over the last couple of years. In this case, we’re transferring from high cost, high cost location to a low cost location, again, with the meaningful revenue upside.

We’re not going to size it, but it’s a meaningful revenue upside and really is a perfect fit with our strategy and capabilities and our track record of executing transfers very effectively and efficiently and allowing our customers to realize savings quickly.

DZS has other manufacturing capabilities, so this represents a portion of their production, but it is a meaningful deal that we’re proud to have won. We work hard to win this deal. The competition was strong, we believe and we’re very happy to have been awarded business and look forward to engaging with DZS to transfer production.

And again, it reflects the overall opportunity in the system space, which we’ve been very optimistic about.

And I think we’ve proven to be effective that if you go back to the Infinera, Coriant win a few years ago, then the Cisco business that we transferred, this will be the third, let’s call it, meaningful or significant complete network system win that we’ve had in the last few years..

So Samik, this is Csaba. Let me take the guidance section and the growth part of it. So as you mentioned, if you back out the extra $20 million from our Q1 revenue year-on-year, you would see about 17% growth in Q1 versus last year. And our guidance at the midpoint for Q2 calls for about 15% growth on year-on-year basis.

Again, as a reminder, in Q1 we saw a significant improvement in supply availability, so that explains a little bit higher growth rate than what you anticipate in the Q2 guidance. Nevertheless, again, if you go back to the supply headwind commentaries, I had we baked in about $25 million to $30 million supply headwind.

So overall, I think our growth rate is – and has been consistent with our longer term plans of about 15% growth rate. And I don’t see any major change in the trajectory of the demand environment. We are still operating in a supply constraint area.

So that’s one of the reasons why we are a bit cautious about the guide, which is still very strong 15% on a year-on-year basis..

Got it. Thank you. Thanks for taking my questions..

Thank you, Samik..

Thank you, Samik..

Thank you. [Operator Instructions] Our next question comes from the line of Fahad Najam of Loop Capital. Please go ahead..

Hey, thank you for taking my question. I’m still trying to get my head around the – your comment about improved supply chain. If my math is correct, the automotive revenue [indiscernible] probably more than the entirety of the supply chain headwinds that you’ve talked about.

So is it that the automotive supply improved and the optical communication supply chain worsened? Can you help us understand maybe clarify things a little bit more?.

No, I think the non-automotive or the optical performed pretty much in line with our expectations, but automotive did improve better than we had anticipated. And we were able to convert those, it’s a handful of components that have been in short supply for some time.

Once they became available, we were able to convert that that kind of pent-up demand into revenue quickly. But the – I think the revenue on the optical side of the business was pretty much in line with our expectations..

Appreciate that.

So given that there is a massive backlog in the automotive segment for you, how should we be thinking about growth in the automotive space? It seems like your commentary seems to suggest that optical communication supply remains challenging, but how is it looking out for automotive and how should we be thinking about automotive revenue throughout the rest of the year?.

I think it remains challenging for having across the entire business. We – I think we got a couple of breaks and let’s call it in the automotive business, but the supply situation remains challenging across the Board.

If anything the breakthrough we had in automotive last quarter, what it demonstrates, we think is, I know there’s been a lot of concern about is the demand real, is there double ordering going on? What we’ve been seeing is as the component availability clears that demand is converting into revenue immediately.

So the demand is there, the demand is real, we believe. But they – the supply constraints continues to be challenging across the Board. I wouldn’t see it as particularly better in automotive or better or worse an optical. It’s similar across the Board..

Got it. And then one last question for me and then I’ll hand it over to the floor.

In Building 9, how much of the square footage which is now looking for?.

Yes. We don’t report that metric, Fahad. We had an opening ceremony there last quarter. We’re very happy with, I’m sorry, last week, we had the opening ceremony in – I’m actually in Thailand right now. I was here for the opening ceremony. We we’re very happy with the progress there.

We’ve a number of customers, but we’re not going to be announcing or communicating metrics like occupied spoken for those type of metrics because they don’t really mean a whole lot. Other than to say, the vast bulk of the growth will be seeing over the next while we’ll be in the Building 9 location.

Our Pinehurst facility is more or less at capacity, building age is at capacity, so the growth over the next while will be in Building 9, but I would say we’re very happy with the progress there..

If I recall, I think last quarter you guys said you had two anchor customers for Building 9.

So anything else you think provide like customer account, just kind of measure how much better is it getting?.

Well, we have – yes, we have two anchor customers. We have other customers who were – we’re actively working with nothing to announce yet, but actively working with to get capacity set up there. And again a lot of the new business that we talked about like for example, the DZS win that will be ramping in Building 9.

So most of the growth, as I say, there’ll be exceptions here and there, but for the most part, the majority of the growth for the next while will be in Building 9.

I would say, if I – excuse me, if I compare it to – maybe if I can answer it this way, if I compare the – let’s say the rate of expansion, the rate of revenue growth that we envisage in Building 9, which again just remind us is a 1 million square foot facility.

If I compare it to where we were at the same period in Building 8, let’s say back in 2016, 2017, in Building 8, I think the rate at which we will grow Building 9, certainly right now it feels faster because when we opened Building 8, it was our first facility, our first factory in the new campus in Chonburi, there was a certain amount of maybe reluctance on a part of customers to be the first one to go there.

So there was a little bit of reluctance but now we’re five years down the line, that building is full. And from the customer’s point of view, they don’t really differentiate between Building 8 or Building 9, it’s all the Chonburi campus. It’s fully ramped. It’s going very, very well.

So I think our – the willingness of our customers to ramp in Building 9 is completely different to what we had five years ago in Building 8. So we feel very good about our ability to grow and add business to Building 9 quickly..

Appreciate the colors, Seamus. Okay. I’ll leave it there..

Thanks, Fahad. Thank you..

Thank you. Our next question comes from Alex Henderson of Needham & Company. Please go ahead..

Great. Thanks. So I just wanted to dig into the interest line and the FX line. So when you look at the guide that you gave for the December quarter, I’m assuming that the $2 million in FX falls out of it and that it’s effectively back towards zero.

And similarly if I look at the interest line, I’m thinking that with interest rates going up certainly here, but probably on a global basis, and I assume that you’ve got a fairly short-term orientation to your current massive cash balances.

So should we be expecting the interest income line to go up and will the FX zero out?.

Hi Alex. So yes, your math on the FX is probably right. We typically don’t guide the reevaluation below the line FX line. So we – as we realize the actual evaluation, we will – that your flow to the bottom line in the actual basis. But the interest rate – the elevated interest rates obviously are going to translate to a higher interest income for us.

So the trend had been going on in the last couple of quarters, so obviously you can see that picks up in our interest rate line. With our strong balance sheet and cash balances we do anticipate a strong contribution going forward. So again to simplify your question, FX out interest rate to continue to contribute..

So just going back to the interest rate line, it’s up about $1 million sequentially.

Is that predominantly a result of the change in interest rates or is there something else going on there? And should I be thinking of that rate of increase is what you’re likely to do over the next two or three quarters on a sequential basis, given rates are up at least in the U.S. 4%, which is a pretty big increase on your cash balances.

I would think that that would have a pronounced impact on interest income.

Can you just give us some sense of what the trajectory over time looks like there?.

So yes, indeed the incremental sequential increase in our interest income has to do with the increased interest rates. So again, we don’t like to speculate how is that going to work out in the future, but indeed, we have a very strong balance sheet and we do anticipate that to be a meaningful contribution as we look at it..

But you’re not really speculating if you just assume existing interest rates. So no further guidance whether that magnitude increase that we saw quarter-to-quarter is at least the assumption they used in the December quarter..

I’d like to stick to our core business when we give guidance out and leave the interest rates and the exchange rate as a side commentary. So I wouldn’t go to further details in terms of guiding interest rates..

Alex Henderson:.

I just got all the stuff I wanted or two, wow, I got what I wanted:.

Yes. I think Alex, it hasn’t resulted in really any change in the demand. Demand it’s just very strong and it really is a case of once we get the components, we can convert that, that pent-up demand into revenue and get it shipped. We’ve had strong backlog in really all of the markets we serve automotive in particular.

And in this case, once we were able to clear that components or a couple of components, we were able to very quickly convert to revenue and get it out the door. But no, it hasn’t resulted in additional demand. I think the demand is already very strong.

We’ll be happy if the demand remains and just converts over time as we’re able to get a breakthrough on these component charges..

And just to be clear, when you talk about your backlog, you’re not taking into account the – I don’t remember what the number was. Well, I guess we’ll get an update on tomorrow with Lumentum, but I think there was something like $75 million worth of backlog there.

And that’s not taking into account the 1.4 – excuse me, the $4.4 billion backlog at Ciena that none of that’s factored in, correct?.

Yes. We don’t actually talk about our backlog, Alex. We don’t size it. We don’t really talk about our backlog other than to say, it’s very strong and we have visibility for much further out than we would normally have because of the component supply situations. The backlog is very strong, but we don’t actually size it.

And then trying to foot, how much of momentum’s backlog is included in our backlog, how much of Ciena’s we don’t know. We just go by the demand that we get from our customers. We don’t try to round it with the numbers that they’re projecting to the Street in place..

Appreciate that and thanks..

Thanks, Alex..

Thanks, Alex..

Thank you. At this time, I’d like to turn the call back over to Seamus Grady for closing remarks.

Sir?.

Thank you for joining our call today. We’re off to a strong start in fiscal 2023 with first quarter results that exceeded our guidance ranges. We executed well to deliver strong margins despite seasonal headwinds, which increases our confidence that we can continue to deliver strong performance as we look ahead.

We look forward to speaking with you again and seeing those of you who will be attending the Needham Conference next week. Good-bye..

This concludes today’s conference call. Thank you for participating. You may now disconnect..