Good afternoon. Welcome to Fabrinet's Financial Results Conference Call for the Third Quarter of Fiscal Year 2024. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions on how to participate will be provided at that time. As a reminder, today's call is being recorded.

I would now like to turn the call over to your host, Garo Toomajanian, VP of Investor Relations. You may begin..

Thank you, operator. And good afternoon, everyone. Thank you for joining us on today's conference call to discuss Fabrinet's financial and operating results for the third quarter of fiscal year 2024, which ended March 29, 2024. With me on the call today are Seamus Grady, Chief Executive Officer, and Csaba Sverha, Chief Financial Officer.

This call is being webcast and a replay will be available on the Investors section of our website located at investor.fabrinet.com. During this call, we will present both GAAP and non-GAAP financial measures.

Please refer to the Investors section of our website for important information, including our earnings press release and investor presentation, which include our GAAP to non-GAAP reconciliation, as well as additional details of our revenue breakdown.

In addition, today's discussion will contain forward-looking statements about the future financial performance of the company. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from management's current expectations.

These statements reflect our opinions only as of the date of this presentation, and we undertake no obligation to revise them in light of new information or future events except as required by law.

For a description of the risk factors that may affect our results, please refer to our recent SEC filings, in particular, the section captioned Risk Factors in our Form 10-Q filed on February 6, 2024. 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 to those of you joining our call today. We are very pleased with our third quarter results that included revenue and EPS that were above the high end of our guidance ranges. Revenue was a record $731.5 million and non-GAAP net income was also a record result of $2.39 per share.

The quarter played out better than anticipated, with sequential revenue growth in optical communications from both datacom and telecom, accompanied by a small decline in non-optical communications, mainly from automotive revenue. Within optical communications, datacom revenue again outpaced telecom, with datacom revenue growing 150% from a year ago.

Datacom continues to benefit from demand for 800 gigs technology for AI applications, and we remain very optimistic about our position in that market. After several quarters of declines, telecom revenue saw sequential growth in Q3.

However, it's important to point out that this growth was driven primarily from data center interconnect products that more than offset continued sequential declines from traditional telecom. We expect to see continued choppiness in telecom revenue as our customers and their clients continue to work down elevated inventory levels.

Turning to non-optical communications, we saw a small sequential revenue decline. This was primarily due to near-term inventory digestion for certain automotive products in the quarter. Consistent with our comments last quarter, we are optimistic that automotive revenue will increase sequentially in the fourth quarter.

Industrial laser revenue remains stable in the third quarter. Looking to the fourth quarter, we are well positioned to end our fiscal year on a high note with another strong performance.

High data rate datacom products continue to be an important driver of our business momentum, and we are confident we can deliver another quarter of accelerating year-over-year revenue growth in Q4. With this momentum, fiscal 2024 will represent another year of record revenue for the company, with EPS again growing faster than revenue.

In summary, we delivered a record third quarter with revenue and EPS that were above our guidance ranges. We're looking forward to a very solid finish to an outstanding year for our company, and we're optimistic about what lies ahead as we further extend our leadership in the market.

Now I'll turn the call over to Csaba for more financial details on our third quarter and our guidance for the fourth quarter.

Csaba?.

Thank you, Seamus. And good afternoon, everyone. We had a strong third quarter. Revenue was above our guidance range at a record $731.5 million, up 10% from a year ago and up 3% from the second quarter. This drove non-GAAP earnings per share of $2.39, which was also a new quarterly record and above our guidance range.

Foreign exchange valuation gain of $0.09 per share contributed to our strong earnings per share, but non-GAAP EPS would still have been well above our guidance even without this tailwind. Details of our revenue breakdown are included in the investor presentation on our website, and I will focus my comments on the more notable metrics.

Optical communications revenue was $591.4 million, representing 81% of total revenue, an increase of 18% from a year ago and 4% sequentially. Datacom revenue was $305.5 million or 52% of optical communications revenue, an increase of 150% from a year ago and 6% from the prior quarter.

This growth came primarily from high data rate products for AI applications, which continue to see strong demand. Telecom revenue was $286 million or 48% of optical communications revenue.

Telecom revenue declined 25% from a year ago, but increased 2% from Q2 as data center interconnect growth more than offset continued decline from traditional telecom products. By data rate, products rated 400 gig and faster continued to dominate growth, increasing to $426.3 million in Q3, up 93% from a year ago and 13% from the second quarter.

Products rated at 100 gig continue to see revenue declines and were below 10% of optical communications revenue in the quarter. As anticipated, we saw a decline in non-optical communications revenue, which was $140.1 million, down 3% from Q2. This decline was primarily due to previously anticipated inventory absorption of certain automotive products.

Automotive revenue was $73.6 million, down 7% from Q2. We expect automotive revenue to increase sequentially in the fourth quarter as near-term inventory issues subside. Industrial laser revenue was flat sequentially. 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 third quarter was consistent with the second quarter at 12.6%. Operating expenses were $14.5 million or 2% of revenue. This produced operating income of $78 million, representing an operating margin of 10.7%, also consistent with the second quarter.

Our low fee cost structure helped us to maintain our industry-leading margins, which were in line with our long-term target ranges. Our healthy balance sheet coupled with elevated interest rates helped to provide $8.5 million of interest income.

As I mentioned earlier, net income benefited by $3.3 million, or $0.09 per share from foreign currency asset and liability revaluations at the end of the quarter. Effective GAAP tax rate was 2.9% in the third quarter. We continue to anticipate a mid-single digit rate for the fiscal year.

Non-GAAP net income reached $87.7 million or $2.39 per diluted share. On a GAAP basis, net income was $80 million or $2.21 per diluted share. Turning to our balance sheet and cash flow statements. At the end of the third quarter, cash and short-term investments were $794 million, up $53.4 million from the end of the second quarter.

The primary driver of this increase was strong operating cash flow of $100.9 million. With CapEx of $13.6 million, free cash flow in the quarter was $87.3 million. Our share buyback program was active during the quarter. We repurchased approximately 153,000 shares at an average price of $193.76 per share for a total cash outlay of $29.6 million.

At the end of the third quarter, $64.1 million remained in our share repurchase authorization. Now I will turn to our guidance for the fourth quarter. We expect datacom revenue to be slightly up sequentially in the fourth quarter.

This growth is being driven primarily by high data rate products for AI, which are more than offsetting the impact of the end of the legacy 100-gig program. For telecom revenue, we expect a sequential decline in the fourth quarter, as industry-wide inventory absorption continues to impact traditional telecom product demand.

We expect non-optical communications revenue to be up sequentially, driven primarily by an increase in automotive revenue. In total, we anticipate revenue to be in the range of $720 million to $740 million in the fourth quarter. We expect net income of $2.20 to $2.27 per share.

In summary, we had another record quarter with results that exceeded our guidance for both revenue and EPS. We are optimistic that we will see strong results again in the fourth quarter, closing out a year of record revenue and profitability. And we believe we are well positioned for continued success as we look ahead.

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

[Operator Instructions]. Our first question will come from Samik Chatterjee of J.P. Morgan..

I have a couple, but maybe if I can start with asking you about the telecom revenues and sort of the outlook you provided where you're expecting a sequential decline after the increase you had this quarter.

Any more color you can provide in terms of what you're seeing, why the DCI demand is not more sustainable and driving a more sustained sort of sequential recovery in that business. And any updated thoughts on how long the inventory digestion then sort of lasts that you've been calling out for a few quarters now? And I have a quick follow up..

The telecom softness that we've been seeing, we see it continuing for another few quarters. It's probably out into, it's hard to say with certainty, but it's certainly out into early part or even the middle of calendar 2025 before we see any real growth coming back and an increase in demand coming back in telecom.

That industry still seems to be going through this inventory digestion that we've been seeing. Our growth in telecom has been, as you rightly point out, on 400ZR. As you know, sometimes that type of business doesn't grow in a straight line. It's not always up and to the right in linear growth.

But certainly 400ZR, and I would say ZR generally, has been a strong point for us. Right now, we have five customer engagements on ZR, both 400ZR and also follow-on and next generation ZR products. So we're quite – I'd say quite optimistic over the medium to long term about DCI and ZR technology, in particular.

But, yeah, there will be a little bit of lumpiness as we go forward. But, yeah, telecom continues to be a soft spot in our business, but datacom continues to be very strong for us..

Maybe for my follow-up on the datacom side, you had about $7 million, $8 million of sequential revenue growth in datacom this quarter.

When you take out the 100 gig business that's rolling off, what does the underlying sequential growth there look like? Any thoughts on timing of when you start to see ramp of the 1.60 gig product in that derived revenue?.

If you look at our datacom business in the quarter, it grew 150% year-on-year and 6% quarter-on-quarter, which is still very strong growth considering, as you say, we did have that 100 gig product rolling off.

It's almost rolled off at this point, but that was rolling off in the quarter while the higher data rate products were continuing to go very strongly for us. The industry is transitioning away from those lower data products and less than – products that are rated at less than 100 gig accounted for less than 10% of our optical revenue.

800 gig demand remains very robust. And I guess, one of the reasons we remain very optimistic about the future and the strength in datacom is even with 800 gig remaining robust, once the next generation products, 1.6 comes along, we believe that will ramp and 800 gig will continue. So 1.6 won't replace 800 gig, this will complement 800 gig.

The exact timing of that, we're a little bit reluctant to talk about. We only guide one quarter at a time, and also our customer – we let our customers announce their product launches. But what I would say is, we're in a very strong position and we remain very optimistic about our position to continue to support the demand for these products.

The demand looks to be very robust, as you say, both for 800 gig and then, once 1.6 comes along, we think that will be very strong as well..

Our next question will come from Karl Ackerman of BNP Paribas..

I was hoping you could discuss the broadening or opportunity of broadening of customer design wins and engagements for both 800 gig as well as 1.6T later on this year. Because it seems based on your June quarter guide that this product transition that you've spoken about for 800 gig is certainly holding up better than what was expected 90 days ago.

So if you could just tie those two in, that would be very helpful..

Like you said, 800 gig remains robust. We don't see 800 gig tapering off anytime soon. And we are gearing up to support the next generation products, the 1.6 terabyte products.

Again, I'm reluctant to talk about the timing of that because we do only guide one quarter at a time, but we are very optimistic about that and we think we're very well positioned. There are a number of other engagements we have outside of our main customer there, but they're still in the relatively early stages, I would say.

And we're focused on making sure we continue to support our main customer in that space. And we're very, very happy, I would say, and excited about how we're positioned, both for 800 gig and also 1.6 and products beyond 1.6 as well. So we're working on a pipeline with the customer making sure we're geared up to support whatever they need from us..

Perhaps just to follow on that, I think there's a lot of confusion in the marketplace between when to use some of your products, AOC based products versus active copper cable products. And I think there was some confusion earlier this quarter.

Maybe just if you could highlight where you see your opportunities and whether you are seeing any cannibalization if at all for in-rack connectivity versus short-reach connectivity in the data center for 800 gig and 1.6T.

Again, it doesn't appear like there is an issue, but if you could just highlight where you see yourself broadening into or perhaps the opportunities that you see for 800 gig [indiscernible] beyond, that would be very helpful..

We certainly have not seen any cannibalization of the demand with copper. I think there's an application for copper. I think the NVIDIA CEO spoke about that recently, but it's a specific application where they use copper interconnects. It doesn't particularly cannibalize what we're doing for that customer.

So we just see 800 gig demand remaining quite robust. And the rate of growth, it seems like the rate of growth of optical interconnect in these AI data centers, it seems to grow more or less exponentially. As these data grow, the need for optical interconnect is, it's not going to go away. If anything, it's going to increase.

And each iteration that comes along, when 1.6 comes along, it doesn't seem like it's going to cannibalize 800 gig. 800 gig will continue at a pace, and if anything will also grow as 1.6 grows.

So it's a bit of an unusual – normally when there's a – let's say in the datacom world, when a new technology comes along, it tends to cannibalize the old technology. But certainly, as we go to higher speeds, 1.6 and beyond, it doesn't seem like the 800 gig is going anywhere, is going to decline. So we're quite excited about that..

Our next question will be coming from Tim Savageaux of Northland Capital Markets..

Congrats on the strong results. Maybe it's kind of related to the answer to the last question there.

I was going to ask, certainly coming out of OFC and over the last quarter, about your impressions of the size of this AI connectivity market and hope you might have some impressions just because of the kind of specificity of that comment about 1.6 sort of being additive to the mix and 800 gig continuing to grow.

I'd be interested in kind of – I guess, at what point you came to that conclusion on the one hand, and how does that speak to the overall size of the opportunity versus what you might have thought a quarter or two ago?.

I think, if you like, the view that we have that 1.6 will be additive and will not cannibalize 800 gig, that's really a function of looking at the architecture of the products that are in the pipeline, that are – it's in the public domain.

If you look at NVIDIA's website and you go to their GPUs, you go to their products, you look at the architecture of those products, 1.6 is additive to 800 gig. It doesn't appear to be cannibalizing it. When you look at the number of connections, it does not appear that 800 gig gets cannibalized when 1.6 terabit comes along.

So it's less of an opinion, I suppose, Tim, and more of a – it's just math. When we calculate out what's required, it seems like 1.6 will come along and 800 gig will continue. So that's really what's behind that. So no particular change in our perception the last 90 days.

I guess what we're all waiting to understand and waiting to see is the timing of the ramp of 1.6 and then, of course, the magnitude of that ramp, will it be as steep as 800 gig? I guess that remains to be seen..

And as you assess that here over the next couple of quarters, I imagine that might necessitate some capacity planning on your part, so I'll ask for my quarterly update on any plans for increased capacity or facilities expansion..

The perennial building 10 question. Yes, it's something we evaluate all the time. We have a little bit of space freeing up with the 100 gig program transferring out that frees up a little bit of space for us in our Pinehurst operation. But nevertheless, it's something we evaluate very regularly, at least every quarter.

And nothing to announce at this point, but what I will say is our Building 8 is basically full at this point. Building 9, the expansion of capacity into Building 9 is going very, very well. We're very happy with how that's been going.

It's really ahead of all of our expectations if I was to go back even a year or 18 months ago and try to predict where we are right now. I think we're very pleasantly surprised with where we are right now. And we just want to be ready for the next wave and the next phase of growth that might come in our direction.

Three things have to happen, Tim, for us to capitalize like we did in the last several quarters. The demand has to be there. We think that's pretty certain that the demand is there. We have to have the capacity. And then third, we have to execute. So we do very well when it comes to execution. We have a good reputation in that regard.

And capacity is really not a problem for us. We were able to capitalize on a very steep ramp and continue to ship significant volume to our main customer. But we'll be looking at capacity and looking at capacity additions closely over the next while.

I think the pace at which we're expanding in Building 9 is probably ahead of schedule and we're very optimistic about the future demand. We'll just make sure we're ready and that we have capacity because it's very low risk, Tim, for us to add additional capacity if we were to add another building.

It's about ballpark $55 million to $60 million of CapEx, which will add about a million square feet, there or thereabouts, and will give us capacity for an additional – depends on the products, but probably $1.2 plus billion of additional capacity. And the gross margin headwind for us to do that is about 10 basis points.

So it's a very tiny downside, if you like, in terms of the financial headwind, but the potential upside is huge. So it's very low risk for us to do that. But again, nothing to announce on this call, but certainly we would expect to be – we continue to evaluate it and I would say stay tuned for the next while..

Maybe just one more thing on that, can you remind us of kind of what the time frame is from kind of making the call there to breaking ground and then being able to ramp capacity?.

I think from when we kind of make the decision, I would say until we're up and running, it's probably 18 months, there or thereabouts, plus or minus. So we can do it pretty quickly. We have the recipe figured out at this point and really we will do more or less a repeat of what we've built before.

We might make some small changes, but for the most part it would be a very similar building to Building 10, albeit the mirror image of Building 10 if you know the geography of our Chonburi campus. We would build, like I say, a mirror image of Building 9. But about 18 months, there or thereabouts..

And I would now like to hand the call back to Seamus for closing remarks..

Thank you for joining our call today. We delivered another strong performance that exceeded our revenue and EPS guidance for the third quarter. We anticipate closing out another record year and believe we are well positioned to extend our success beyond fiscal 2024.

We look forward to speaking with you again and to seeing those of you participating in the J.P. Morgan and B. Riley conferences later this month. Goodbye..

And this concludes today's conference. Thank you for your participation. You may now disconnect..