Fabrinet 10-Q Summary
Business context and reporting period
Fabrinet provides advanced optical, electro-mechanical and electronic manufacturing services, primarily for complex, low-volume, high-mix products. This unaudited filing covers the 13-week quarter and 26-week first half of fiscal 2015, ended December 26, 2014. Comparatives are for the periods ended December 27, 2013. Dollar amounts below are in U.S. millions unless noted.
Financial performance and position
| Metric | Quarter ended Dec. 26, 2014 | Six months ended Dec. 26, 2014 |
|---|---|---|
| Revenue | $188.4; up 5.5% year over year | $377.7; up 7.9% |
| Gross profit / margin | $21.1 / 11.2%, versus $20.5 / 11.5% | $41.6 / 11.0%, versus $39.2 / 11.2% |
| Operating income / margin | $9.6 / 5.1%, versus $13.6 / 7.6% | $21.4 / 5.7%, versus $32.2 / 9.2% |
| Net income / diluted EPS | $8.7 / $0.24, versus $14.5 / $0.41 | $19.8 / $0.55, versus $33.7 / $0.95 |
| Operating cash flow | $30.6 for the six months, versus $36.8 |
Quarterly SG&A was $10.3 million, up from $6.9 million; first-half SG&A was $19.1 million, up from $13.6 million. Gross margin slipped as production costs rose. Profitability was further pressured by Audit Committee investigation costs included in SG&A: $2.5 million in the quarter and $4.1 million in the first half. First-half results also compare with a prior-year period that included $6.6 million of flood-related insurance income; that item was not recorded in the current period.
At December 26, cash and cash equivalents were $112.0 million and marketable securities were $141.3 million, totaling $253.3 million. Cash alone declined from $233.5 million at June 27, largely as the company invested in available-for-sale securities. First-half investing cash use was $147.4 million, including $143.7 million of security purchases and $5.4 million of capital expenditures. Total debt was $13.5 million, down from $16.5 million at fiscal year-end. The company had an undrawn $200 million credit facility and reported compliance with its covenants. Current assets were $490.4 million and current liabilities $136.6 million.
Material changes and unusual items
- Revenue grew in optical and non-optical manufacturing. Optical communications supplied 71.0% of quarterly revenue and 71.2% of first-half revenue. First-half revenue from lasers, sensors and other products increased to $108.6 million from $95.8 million.
- During the quarter, amended volume supply agreements supported recognition of $8.0 million of consignment revenue, with $0.8 million gross profit, once products were complete and ready for shipment and title and risk of loss had passed to customers.
- The company recorded approximately $1.2 million of severance and benefits costs for a workforce reduction affecting about 100 employees.
- Investments generated a $0.5 million unrealized loss in other comprehensive income; management said the declines were temporary and recorded no impairment.
- The filing describes prior-period revenue-recognition errors involving finished goods under certain customer agreements. The company concluded the errors were not material to previously issued statements and made no adjustments to the presented 2013 comparatives. It disclosed that, if adjusted, revenue and net income would have been lower by $6.4 million and $0.6 million, respectively, for the 2013 quarter, and by $3.6 million and $0.4 million for the 2013 six-month period.
Outlook, risks and contingencies
Management expects current cash, marketable securities, operating cash flow and available credit to cover working capital and capital expenditure needs for at least 12 months, and believes existing manufacturing capacity is sufficient for anticipated needs over that period. No specific revenue or earnings guidance is provided. Management expects fiscal 2015 SG&A to rise in absolute dollars but remain flat as a percentage of revenue versus fiscal 2014. It also anticipates higher employee costs in Thailand and China and incremental costs from diversification and geographic expansion. A Thailand facility remodel contract of approximately $3.7 million was entered into after quarter-end.
Revenue-recognition controls remain a significant concern: management concluded a material weakness existed in internal control over financial reporting, and disclosure controls were not effective as of quarter-end. Remediation—including contract reviews, technical accounting training and process controls—was underway but not complete. The Audit Committee investigation found process weaknesses and no executive officer involvement; the filing characterizes earlier control deficiencies as significant deficiencies, while the later assessment of the revenue-recognition control issue identifies a material weakness.
Key disclosed risks include dependence on a small number of customers (two customers together accounted for 30% of quarterly revenue and 31% of first-half revenue), short-term and changeable customer orders, supplier concentration and inventory obsolescence, foreign-exchange exposure to the Thai baht and RMB, and political or operational disruption in Thailand and China. Customer concentration, pricing pressure, wage increases, manufacturing yields, and potential interruption from natural disasters may affect results. The company reported no material legal claims pending or threatened. It had $5.9 million of purchase commitments and $4.0 million of future minimum operating lease payments at quarter-end. The $40 million minimum U.S.-located cash and securities covenant under the credit facility is also material to liquidity management.
Important facts for investors to verify
- Progress and effectiveness of remediation for the revenue-recognition material weakness, including controls over consignment goods and contract terms.
- Whether the amended consignment agreements and recognition of $8.0 million in quarterly revenue satisfy the stated recognition criteria, and how future consignment revenue develops.
- Drivers of falling operating and net margins, particularly investigation costs, production costs, workforce actions, and the absence of prior-year flood income.
- Customer concentration, order visibility, receivables and inventory exposure, and the financial condition of major customers and critical suppliers.
- Liquidity after the large shift from cash into marketable securities, compliance with the $40 million U.S. liquidity covenant, and planned capital spending and facility expansion.
- Tax exposure following expiration of the China tax privilege and the status of any renewal application.