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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good day, ladies and gentlemen. Welcome to Fabrinet's Financial Results Conference Call for the Fourth Quarter of Fiscal Year 2018. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instruction on how to participate will be given 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, 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 of fiscal year 2018, which ended June 29, 2018. With me on the call today are Tom Mitchell, Fabrinet's Founder and Chairman of the Board; 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 Web site located at investor.fabrinet.com. Please refer to our Web site for important information, including our earnings press release and investor presentation, which include a 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 recent SEC filings, in particular, the section captioned Risk Factors in our Form 10-Q filed on May 8, 2018.
We will begin the call with remarks from Tom, Seamus and TS, followed by time for questions. I would now like to turn the call over to Fabrinet's Chairman, Tom Mitchell. Tom?
Thank you, Garo, and good afternoon everyone. I am pleased that we exceeded our revenue expectations for the fourth quarter and I am proud of the Company's performance under Seamus's leadership as our CEO.
As you may have seen from recent filings, I have stepped away from my operational role at Fabrinet as Executive Chairman. This marks the completion of the CEO transition we started several quarters ago. However, I plan to remain highly involved as Chairman of the Board, at Fabrinet.
I’d like now to turn the call over to Seamus for his remarks.
Thank you, Tom and good afternoon everyone. I am pleased to share with you that our fourth quarter revenue came in above the top end of guidance at $345 million with non-GAAP net income up $0.81 per share, also above the high end of our guidance range. Operating cash flow was $48 million in the fourth quarter. And for all of fiscal year 2018, we generated operating cash flow of $138 million and free cash flow of $104 million.
We entered the quarter anticipating modest growth across most of the markets we serve. And I am pleased to report that we experienced strong growth in our non-optical communications revenue and modest to still positive growth in our optical communications revenue. Moreover, as TS will detail, we anticipate that this sequential growth will continue as we enter fiscal year 2019. With increasing demand certain components came under supply constraints during the fourth quarter. And we were able to successfully mitigate these shortage risks during the quarter and we will continue to take appropriate steps to manage these supply challenges.
Looking at our fourth quarter performance by end markets, our performance was in line with expectations. Overall, optical communications revenue of $242 million was up marginally by $1 million from the third quarter. Within optical, telecom revenue up $156 million represented 2% sequential growth, more than offsetting a 1% sequential decline in datacom revenue. We are particularly pleased with the growth we saw from non-optical communications programs. Both our industrial laser and automotive businesses, saw all time record quarterly revenue, with industrial laser revenue growing 36% from a year-ago and 8% from Q3 to $47 million and automotive revenue, increasing 34% from a year ago and 20% from Q3 to $26 million.
Overall, revenue from non-optical communications programs was $103 million, up 30% from a year ago and up 13% from Q3. While we expect there to be some quarter-to-quarter variation as we look ahead, we remain optimistic about our long-term prospects in the non-optical communication space. Revenue from new customers and new programs from existing customers grew to $125 million in the fourth quarter, a 36% of total revenue increasing over $9 million from the prior quarter.
New business growth in the fourth quarter came from both optical programs, as well as from non-optical programs such as industrial laser and new automotive applications. Silicon photonics based products saw their first sequential increase in a year, contributing $70 million to revenue in the fourth quarter, up 5% from Q3. QSFP28 transceivers, which are both silicon photonics and non-silicon photonic based, also saw their first sequential growth in a year with revenue of $45 million, up 20% from Q3, as increased volumes of lower price variants have now more than offset price decreases.
By data rate 100G programs continues to dominate after the communications production and represented 39% of total revenue in Q4 consistent with last quarter. 400G and 1.2 terabyte products are in the early stages of ramping, each representing 2% to 3% of total revenue. Our new product introduction or NPI services are an important on-ramp for new business with our investments at Fabrinet West and Fabrinet UK playing a critical role. Last quarter, we introduced strategic plans to establish our next NPI facility in Israel, and we look forward to sharing more on that as we progress beyond these early stages.
In addition to continued progress in industrial lasers and automotive, we also won a number of medical programs, which we expect will contribute overtime as they ramp into volume production. We’re expanding our advanced packaging capabilities at Fabrinet West to further strengthen our NPI manufacturing solutions for new and emerging technology based products, such as LIDAR, 3D Sensing and laser based lighting products for the automotive industry. We’re optimistic our core competencies and manufacturing solutions for products and systems requiring precision optical, mechanical and electrical assemblies will continue to enable our expansion into these new markets.
In summary, we are pleased to have exceeded our revenue and earnings expectations in the fourth quarter and we continue to generate solid and predictable cash flow. We’re enthusiastic about the first quarter and beyond with stabilizing or improving trends across the markets we serve, and we’re excited about the many opportunities ahead. Now, let me turn the call over to 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 and fiscal year 2018, as well as our guidance for Q1 of fiscal year 2019.
Total revenue in the fourth quarter of fiscal year 2018 was $345.3 million above the high-end of our guidance range. Non-GAAP net income was $0.81 per share and also above our guidance range. Net income in the fourth quarter benefited by $0.02 per share from partial reversals of the first time asset valuation allowances, which was partially offset by $0.02 annualized loss from the mark-to-market foreign exchange adjustments. Excluding the positive $0.01 impact of this adjustment, non-GAAP net income was still above the high-end of our guidance range. For the full year, revenue was $1.372 billion and non-GAAP net income was $2.98 per share.
Looking at a fourth quarter in more detail. As Seamus mentioned, we saw largest sequential growth from optical communication program in fourth quarter with a small sequential increase in telecom revenue, slightly offsetting a modest decline in datacom revenue. Our song 13% sequential growth in non-optical revenue to $103 million was a highlight in Q4, as we set a quarterly record driven primarily by growth in industrial laser and automotive revenue. For the fourth quarter, optical communication represented 70% of revenue in the quarter and non-optical communication was 30% of revenue.
Now turning to the details of our P&L. The reconciliation on GAAP to non-GAAP measure is included in our earnings press release and investor presentation, which you can find on our Web site. Non-GAAP gross margin in the fourth quarter was 11%, slightly below our target range of 12% to 12.5%. We expect non-GAAP gross margin to return to within our target range during fiscal year 2019. Non-GAAP operating expense was $10.8 million in the fourth quarter, an increase from the third quarter, primarily due to onetime reversals of mentioned bonus accrual in Q3 as we discussed last quarter.
Non-GAAP operating income in the fourth quarter was $29.7 million, a small decrease from Q3, though operating margin declined slightly to 8.6%. Taxes in the quarter were a net of $0.9 million and our normalized effective tax rate was less than 5% due primarily to strengthening of Thai baht, which created losses on U.S. dollars denominated liability that affected us for the quarter. For all of FY'18, our effective tax rate was approximately 5%. We anticipate that our effective tax rate will return to 6% to 7% fiscal year 2019.
Non-GAAP net income was $30.7 million in the fourth quarter or $0.81 per diluted share compared to $0.21 in Q3 and $0.86 a year ago. On a GAAP basis, which include share-based compensation expenses and amortization of debt issuing costs, net income for the fourth quarter was $22.8 million or $0.60 per diluted share compared to $27.4 million or $0.72 per diluted share in the fourth quarter of fiscal year 2017.
Turning to the balance sheet and cash flow statement. At the end of the fourth quarter, cash and investments were $335.7 million. This represents an increase of $20.3 million from the end of the third quarter, primarily from the operating cash flow of $48.3 million offset by a CapEx of $5.6 million, share repurchase of $20 million and repayments of long term bank loans of $1 million. Free cash flow, which is operating cash flow less CapEx was $42.7 million in the fourth quarter. For all of fiscal year 2018, operating cash flow was $138.1 million. After subtracting CapEx of $33.8 million, free cash flow for the year was $104.3 million, representing a significant increase from fiscal year 2017 due to a meaningful decrease in CapEx and improving working capital. During the fourth quarter, we were active in our share repurchase program and brought back approximately 551,000 shares at an average price of $36.3 per share. As of the end of the fourth quarter, $17.6 million remained in our repurchase authorization.
I would now like to turn to our guidance for the first quarter of fiscal year 2019. With improving demand from optical communication customers and continuous momentum in our non-optical business, we're looking forward to another quarter of sequential revenue growth. Now that with the discussion of tariff on product manufactured in China in the news, we currently do not expect a meaningful impact of our revenue as Chinese component represent the minimum portions of total values of our manufactured product. In addition, we will be adopting ASC-606 as of the first quarters of fiscal year 2019 using the modified retrospective transition method. Our revenue guidance today is being provided on ASC-605 basis and we'll provide reconciliations on ASC-606 to ASC-605 when we discuss our first quarter results.
With that in mind, we anticipate first quarter revenue to be in a range of $347 million to $355 million. From earning perspective, we anticipate non-GAAP net income per share in the first quarter to be in the range of $0.80 to $0.83 and GAAP net income per share of $0.58 to $0.61 based on approximately $37.9 million fully diluted shares outstanding. Keep in mind that in Q1 we will bear the additional costs of annual merit increases resulting in seasonal pressures on our gross margin.
Before I conclude my remarks today, on a personal note, I would like to announce that on my request, the Company has initiated a search for new CFO as part of our leadership succession plan to assume my duty at an appropriate time. After being with Fabrinet for an exciting 12-year and age catching up, I had decided it is time to search for and identify a qualified replacement to be ready to take on new and ever changing challenges in a fast moving business. There's no timeline for differentiation as I am not going anywhere and I will continue to support Seamus and the management team in the day-to-day operations of the Company. In addition, I'll be actively involved in and supporting the research, and the eventually transition of my duty to the best-fit CFO replacement for the Company.
In summary, we are pleased to have delivered fourth quarter financial results that exceeded our expectations. We are encouraged to see improving demand dynamic among our optical communications customer and are optimistic that we will enter fiscal year 2019 with another quarters of sequential growth, and believe we are well positioned to strengthen our presence in both the optical and non-optical communication market as we look ahead.
Operator, we would now like to open a call for question.
Thank you [Operator Instructions]. Our first question comes from the line of Troy Jensen of Piper Jaffray. Your line is open.
Seamus, you made a comment that silicon photonics grew sequentially and QSFP28 also grew sequentially. I'm curious was that the same customer that drove that result?
It's across the number of customers actually.
And then how about three months ago when you gave us guidance for this quarter you talked about the ZTE sales band and impacting sales by 7 million bucks. Just curious when you look at the guidance for this upcoming quarter is there a dollar amount that still being impacted or are you expecting a full recovery?
So looking back at last quarter we had guided -- we had mentioned last quarter that there was about $7 million impact on ZTE factored into our guidance. We have no way to know really what the sales actually would have been without the sanctions but we think about $7 million was the right ballpark based on the conversations we have with our customers at that time. Then for this quarter, we don’t expect to see the full impact of the sanctions being lifted in fiscal Q1, ramp of the sanctions were officially lifted in mid-July and it takes a little bit of time for orders to restart. So we would expect much less than $7 million of benefits in Q1, let’s say.
So then the recoveries probably post that -- understood. And how about -- Seamus, on the automotive sector, I think you said 22% sequential growth, so just to confirm that. And then how many customers do you have in the automotive category that can move the needle right there?
We have a number of customers and the growth in our automotive business -- we have about four customers approximately represent the majority of our automotive revenue. The growth that we’re seeing is predominantly on what we refer to internally as new automotive applications. And it’s across the number of customers and it’s in some of the newer technology in the lighting space and in the LIDAR space is secular.
And TS sorry to see you’re leaving, but I wish you the best and keep up the great work.
Thank you.
Thank you. Our next question comes from Alex Henderson of Needham. Your line is now open.
Thank you very much, and I agree with that last statement, TS, we’ll miss you when you leave. Congratulations on a great career. So the first question I wanted to ask is when you’re looking at the mix of business for the upcoming quarter, you said that optical would improve. Can you give us a little granularity between datacom and telecom? and within the datacom, what are you seeing in terms of pricing pressure, how should we’d be thinking about that? It looks like pricing in datacom has moderated somewhat.
Alex, in our guidance last quarter, we were expecting telecom to grow faster than the datacom. But as it turn out, telecom grew a little bit offset by the datacom flat and down little bit. So in terms of datacom, we have six or seven customer in fact most of them are growing with assessments of one or two customer specific program maybe due to the product transitions and so on and they are down. So our overall datacom excluding the customer since how everybody is doing.
So in terms of pricing it’s mostly felt by our customer, again we are not really involved with that pricing. We look at our costs and improve profit mark ups to cover our margin. But then suffice to say that most of our customers have transitioned to the low cost variance within the QSFP28, for example, and their low costs variance transition has meaningfully offset -- countered that volume increase. So the transition to a low cost volume has been mitigated so to speak.
And going back for a second, it’s pretty clear that there has been a pretty significant move in that exchange rate. It takes a little while for that to matriculate through your numbers. But I would assume, if we assume a flat exchange rate at the current levels that it’s considerable positive going forward for the next couple of quarters. Can you quantify or give us some sense of the degree to which that’s helpful?
Yes, the bar fluctuates quite a bit and you’re right, it depreciated 33, about 33.5 or so level. But again remember we had six months, I hedge forward just to protect the downside. So if there’s any upside assuming is sustained assuming the bar stays at this level, I’ll see the benefit in at least 1.5 quarter out. So not in the immediate quarter because in the immediate quarter, I bought all this about three to six months ago. So yes, if that continue to stay at this level, I will see some tailwind into the gross margin and into the P&L.
So would that be more of a CY4Q, FY2Q and CY2H ’19, back half of FY ’19 benefit?
Yes, I will say, will be CY 2018 -- this November-December, I might get some benefit. Right now, I still have some spending less on hedge and then of course March quarter if I buy today assuming I can lock-in today you will see the benefit, that’s correct.
And the last question and then I’ll see the floor, you had made a comment I think on the gross margin on GAAP improving somewhat as we go forward to normal level. Can you remind us what you consider your normal level? And within the context of the forward guidance, I know you don’t want to give specifics on 606. But what do you think the dynamics are? Is it helpful or hurtful to your revenues, helpful or hurtful to your margins? Can you give us a little bit of taste of what you think might occur?
On the gross margin, we always measure ourselves within 12% to 10.5% we say that all the time in a conference call. And if you look at our track record here, we were at 11.6% last quarter at Q3 I mean. And then at Q4, we are inch up to 11.8%. We are not quite at 12% yet but we believe that in FY 2019 within the fiscal year we’ll return to 12%. So that’s internal management goal to get to 12%. Then again at Q1 we will see some tailwind again because we get increase once a year and we will see some seasonal pressure on the gross margin at Q1. But we expect moving forward we’ll fully recover through the learning curve and the cost reduction efforts and so on.
In terms of 606, I just look at the July coding a little bit. There’s really no major impact, if there’s an impact it’ll be in the tune of about maybe $3 million to $5 million revenue stream. And in terms of margin it will be very, very small impact on that. But we reported in September earnings call to show you how big the gap is but as of today we don’t expect any material impact to the revenue line and gross margin line.
Thank you. Our next question comes from Tim Savageaux with Northland Markets. Your question please.
I’ll add my congratulations to TS. Following up on that last response, to the extent and I don’t know if you already hit this. But I think you just indicated you expect some seasonal pressure on gross margins in Q1 from Q4 level. If that’s the case, are you looking for pretty sharp decline in OpEx sequentially from elevated levels in Q4 and is there any further tax benefit informing the EPS guide for Q1.
The seasonal impact is coming from merit increase we give to our folks in Thailand once a year and actually all over the world once a year. The impact will be mitigated by other area obviously as part of our business we try to find -- offset the merit increase and it may not necessarily recover within the quarter. Typically if you look at history it will take at least about close to two quarters to recover that. New improvement of OpEx reduction effort is there and so on, so we have spending control just to offset the merit increase, so we don't guide gross margins. But you can see that some of the foreign exchange loss we experienced in the past hopefully will subside a little bit, because we see that baht now become cheaper.
And moving on to the product side, I want to touch on datacom again in fiscal Q4 just to see if we can understand the moving parts a bit better. You did report a sequential increase in silicon photonics and a pretty sharp sequential increase in QSFP28. You did see modest declines in the overall datacom segment. I guess my first question, what would be offsetting the QSFP28 growth principally?
I think we saw nice increase in our telecom business. Our datacom business, as we said, was flat to down, very slightly down about 1%. That's on an aggregate basis when we add up all the customers and all the products. What I will say is the reductions were isolated to one or two customers who are maybe going through combination of product transitions and a little bit of price pressure. So we have some reductions on one or two customers. But the majority of the customers, I would say probably 90% of the customers, we did see some nice growth on. So while the number in aggregate is down a little bit, we would not give the impression that datacom is down. Datacom we think is actually quite strong and the reductions were little bit to one or two customers.
And that follows right into my last question, which is as you look forward. I think you might have said, you expect sequential growth across the businesses. You obviously had a pretty sharp increase on the non-communication side. In Q4, in terms of relative performance across the business segments, it sounds like you might expect datacom to resume sequential growth. Though, I am not sure if you have any comments on that in datacom versus telecom or within both of those silicon photonics. Or whether you might expect non-communications to maybe flatten out for a bit as the communication stuff catches up in Q1?
I think we were very happy with the growth as you say in the non-optical communication business in Q4. If you look at TS's remarks, optical communications business is now 70% of our business, down from 72 historically. And it was actually a high of I think 78 at one point. So we're making nice steady progress there, growing our non-optical communications business while at the same time growing our optical communications business. So it's always a challenge when they’re both growing we want both things happen. We want to grow all of the business but we also want to reduce the percentage of the optical communications business. As we look out to Q1, I think it’d be fair to say we're seeing solid growth in the communications, the optical communications business and it's across both telecom and datacom and then continued growth in the non-optical. The laser businesses remains very strong, industrial laser business remains very strong as does the automotive business is quite strong. So it's really across the board, I’d say thankfully we're benefiting from some nice growth across the number of sectors that we're participating in right now.
If you listen to our customer earning call recently, most of them are pretty upbeat on the optical communications. So we hope to write on that optimism on that. One of the customers are talking about fully robust in ROADM and so on and also their fiber laser and laser business and another datacom guys talking about really robust in the datacom. So we hope our customer is right and then we are writing on those things.
Thank you. Our next question comes from Alex Henderson of Needham. Your line is open.
I just wanted to ask about the Lumentum plant that’s being built next to your facility and the conversations you've had relative to that. There has been a lot of speculation on whether that's a good thing for you or a bad thing for you. And I was hoping you might just give us some sense of what your read is relative to the relevance of that plant. I know that Lumentum has said that they're moving substantial portion of business out of China's Sanmina facilities into that plant and to Thailand. But I was hoping you could give us a little bit of clarity around it.
I would say, Alex, I think we’ve talked about this before. Lumentum use the number of contract manufacturers whereby no means their only contract manufacturer these are number of them. And our understanding is that their plan is that they're consolidating manufacturing at some of their suppliers in China. And for the most that is moving to Thailand where we're not the sole beneficiary of that -- some of that business we understand they’re moving into their own facility. But they're our number one customer, they’re our biggest customer, they’re really excellent customer. Their business is just really strong at the momentum and we're really very fortunate to have them as a customer to be able to participate with them.
Our relationship with them remains strong. Our business within them is growing, I would say. Yes, they’ve establish their own facility in Thailand and it's actually near or quite close to our Pinehurst campus. So we do believe that this signals a closer rather than a more distant cooperation between the two companies. So overall we see it as a positive in the sense that they're moving business to Thailand, yes they’re movie business into their own facility. But for the most part, the business that’s coming to Thailand is coming from Chinese suppliers. So we see that as a positive.
Thank you. We have a follow-up question from to Tim Savageaux of Northland Capital. Your line is open.
And maybe following on that response briefly and I realized this is information reflected in your annual filings. But you mentioned that Lumentum is your largest customer. I wonder given that we're at the end of the year if you might quantify that or tell us how many 10% type customers you had for the year? And then maybe if you were to look at Lumentum and Oclaro together given the pending merger. How significant would they be as a combined customer?
In two days time, you’ll see our K. But again, I can tell you that Lumentum is our number one customer last year. We only have one 10% customer, Lumentum at 17% of the revenue. When Oclaro mergers go through, it’ll be 23%, 17% plus 6%.
Thank you. As there are no further questions in queue, I’d like to turn the call back over to Seamus Grady for any closing remarks. Sir?
Thank you. Thanks everyone for joining our call today and for your continued interest in Fabrinet. We’re optimistic about the improving dynamic that we’re seeing in the markets and we look forward to speaking with you all again on our next earnings call in November. For those of you attending for Jefferies Investor Summit in Chicago next week and the Piper Jaffray Tech Select Conference in Southern California the week after, we look forward to seeing you. Thanks again, and good bye.
Thank you. Ladies and gentlemen, this concludes today’s conference. Thank you for your participation and have a wonderful day.