Fabrinet — Form 10-Q Summary
Business context and reporting period
Fabrinet provides precision optical, electro-mechanical and electronic manufacturing services, primarily for low-volume, high-mix products. This unaudited report covers the 13 weeks ended September 26, 2014, the first quarter of fiscal 2015; comparisons are with the 13 weeks ended September 27, 2013. Amounts below are in U.S. dollars.
Financial performance and liquidity
| Metric | Q1 FY2015 | Q1 FY2014 |
|---|---|---|
| Revenue | $189.3 million | $171.6 million |
| Gross profit / margin | $20.5 million / 10.8% | $18.6 million / 10.9% |
| Operating income / margin | $11.8 million / 6.2% | $18.5 million / 10.8% |
| Net income / margin | $11.0 million / 5.8% | $19.2 million / 11.2% |
| Diluted earnings per share | $0.31 | $0.55 |
| Operating cash flow | $15.8 million | $18.1 million |
| Capital expenditures | $1.5 million | $1.3 million |
Revenue grew 10.4%, driven by increased demand for optical and non-optical manufacturing services. Optical communications contributed $135.3 million (71.4% of revenue); lasers, sensors and other contributed $54.1 million. Cost of revenue rose 10.4% in line with sales, while gross margin slipped 0.1 percentage point. SG&A increased 30.5% to $8.7 million, including $1.6 million of Audit Committee investigation costs.
Net income declined year over year in part because the prior-year quarter included $6.6 million of flood-related insurance income, absent this quarter. Other factors included higher SG&A and a foreign-exchange loss of $0.1 million versus a $1.1 million gain in the prior-year quarter. The effective tax rate rose to 8.1% from 3.9%, primarily after a Chinese subsidiary’s 15% tax privilege expired and its rate increased to 25%.
Cash and cash equivalents were $244.7 million at September 26, 2014, versus $233.5 million at June 27, 2014. Current assets were $487.0 million and current liabilities $133.9 million. Total bank debt was $15.0 million, down from $16.5 million at fiscal year-end; the company also had an undrawn $200 million credit facility. The facility requires, among other things, at least $40 million of U.S.-based cash or qualifying securities. Fabrinet reported compliance with its debt and facility covenants. Operating cash flow was positive, though below the prior-year quarter; cash rose by $11.1 million during the quarter.
Material changes versus the prior comparable period
- Revenue increased 10.4%; North American and Asia-Pacific bill-to revenue rose, while European revenue fell. Customers outside North America represented 51.9% of revenue, down from 54.1%.
- Operating and net income declined despite higher sales, reflecting the absence of prior-year flood insurance income, increased investigation-related SG&A, and unfavorable foreign exchange.
- Customer concentration eased: two customers together represented 33% of revenue, compared with 50% in the prior-year quarter. The filing also reports four customers representing at least 10% of receivables at quarter-end.
- Inventory, net, increased to $128.7 million from $124.6 million at June 27; trade receivables increased to $107.9 million from $101.2 million.
Outlook, risks and unusual items
- Management expects available cash, operating cash flow and the credit facility to meet working-capital and capital-expenditure needs for at least 12 months, and believes current manufacturing capacity can meet anticipated production requirements over that period.
- Management expects the share of revenue from outside North America to decrease from Q1 FY2015 levels. It expects fiscal 2015 SG&A to rise in dollars but remain flat as a percentage of revenue versus fiscal 2014. It also expects incremental cost of revenue from diversification into industrial lasers, automotive, sensors and other markets, customized optics and glass, and geographic expansion; no amount was specified.
- On October 10, 2014, Fabrinet terminated approximately 100 employees and incurred about $1.0 million of severance and benefits costs, to be recorded in the next quarter.
- An Audit Committee investigation identified improper recognition of certain consignment revenue before goods were finished. The filing describes a material weakness in revenue-recognition internal controls; disclosure controls were deemed ineffective, and remediation was not complete. No executive officer involvement was found. Separately, certain FY2014 sales under volume supply agreements were recognized too early; the company said the errors were not material to previously issued statements. The filing says Q1 FY2014 comparative results were not adjusted; had they been, revenue, cost of revenue and net income would each have been $2.7 million, $2.4 million and $0.3 million higher, respectively.
- Key risks include customer and order concentration, short and nonbinding demand forecasts, sole-source supply exposure, inventory obsolescence, foreign exchange (especially the Thai baht), wage inflation, political and natural-disaster risks in Thailand, and dependence on tax incentives. A customer filed for bankruptcy in France in July 2014; Fabrinet said the expected impact was not significant. No material legal claims were pending or threatened.
Important facts for investors to verify
- Progress in remediating the revenue-recognition material weakness, including contract reviews, training and improved consignment controls.
- Whether demand growth and customer diversification can sustain revenue while protecting gross margins, particularly as SG&A and expansion costs rise.
- Customer concentration, order forecasts, receivables and inventory exposure, including the effects of the customer bankruptcy.
- Compliance with the $40 million U.S. cash requirement and other credit-facility covenants, and the intended use of facility borrowings for Thailand expansion or other corporate purposes.
- The impact of the China tax-rate increase, renewal prospects for the expired tax privilege, and the upcoming workforce-reduction charge.