Business context and reporting period
Fabrinet provides advanced optical, electro-mechanical and electronic manufacturing services, primarily for complex, low-volume, high-mix products. This Form 10-Q covers fiscal Q2 and the six months ended December 28, 2018; comparisons are with the periods ended December 29, 2017. Amounts below are in U.S. dollars.
Financial performance and position
| Metric | Three months ended Dec. 28, 2018 | Prior-year quarter | Six months ended Dec. 28, 2018 | Prior-year six months |
|---|---|---|---|---|
| Revenue | $403.1 million | $337.1 million | $780.3 million | $694.4 million |
| Gross profit / margin | $45.6 million / 11.3% | $37.2 million / 11.0% | $85.8 million / 11.0% | $77.5 million / 11.2% |
| Operating income / margin | $32.5 million / 8.1% | $22.2 million / 6.6% | $58.3 million / 7.5% | $46.9 million / 6.8% |
| Net income / margin | $31.5 million / 7.8% | $19.3 million / 5.7% | $59.4 million / 7.6% | $40.3 million / 5.8% |
| Diluted EPS | $0.84 | $0.51 | $1.59 | $1.06 |
- Quarterly revenue rose 19.6%; management attributed growth primarily to increased customer demand. Optical communications revenue grew 26.3% in the quarter, while lasers, sensors and other revenue grew 2.5%.
- Six-month operating cash flow was $69.3 million, versus $37.1 million. Investing activities provided $13.1 million, compared with $20.6 million used a year earlier; capital expenditures were $9.7 million versus $21.4 million. Financing activities used $13.6 million.
- Operating cash flow benefited from higher earnings and lower payments to suppliers, partly offset by increases in receivables, inventory and contract assets. Inventory was $277.9 million at December 28, up from $257.7 million at fiscal year-end.
- At December 28, cash and cash equivalents were $231.0 million and short-term investments were $151.5 million. Total borrowings were $66.6 million, including $3.3 million current and $63.4 million long-term; shareholders’ equity was $801.5 million. The company reported $382.5 million of cash, cash equivalents and short-term investments.
- Fabrinet had a $63.4 million term loan outstanding and $25 million of undrawn revolving commitments. It entered an interest-rate swap effectively fixing the term-loan rate at 2.86% through June 2023. The company said it was in compliance with credit-facility covenants.
Material changes versus the prior comparable period
- Quarterly revenue increased $66.0 million and six-month revenue increased $85.9 million. Six-month revenue growth was 12.4%.
- Quarterly gross margin improved 0.3 percentage points, while six-month gross margin declined 0.2 points. Operating margin improved in both comparative periods, with lower SG&A as a percentage of revenue contributing.
- Six-month net income increased $19.0 million. The comparison also benefited from a $5.9 million favorable year-over-year swing in net foreign-exchange results.
- The company adopted ASC 606 on June 30, 2018 using the modified retrospective method. For the current quarter, adoption increased reported revenue by $3.2 million and net income by $0.4 million compared with the figures the company presented as if ASC 606 had not been adopted; the corresponding six-month effects were $3.5 million and $0.4 million.
Outlook, management commentary and risks
- Management expects available cash, investments, operating cash flow and credit-facility funds to cover working-capital and capital-expenditure needs for at least 12 months, and said current manufacturing capacity should meet anticipated production needs for the next few quarters.
- Management expects fiscal 2019 SG&A to decline as a percentage of revenue from fiscal 2018. It also expects employee costs to rise in Thailand and China and incremental cost of revenue from planned expansion into new geographic markets. No specific forward revenue or earnings guidance is provided in the filing text.
- Optical communications represented 75.8% of quarterly revenue and 75.1% of six-month revenue. One customer accounted for 19% of quarterly revenue and 18% of six-month revenue, creating substantial customer-concentration exposure. Customer agreements generally lack minimum purchase requirements, and firm purchase orders typically do not extend beyond 13 weeks.
- Key risks include demand and pricing volatility in optical communications, supply constraints and sole-source suppliers, inventory obsolescence, Thai-baht exposure, wage inflation, and disruption to manufacturing concentrated in Thailand. The filing also identifies customer consolidation, tariffs and geopolitical or economic uncertainty as risks.
- Unusual or notable items include $0.8 million of interest-rate-swap mark-to-market loss in quarterly interest expense, workforce-reduction costs of $0.3 million in the quarter, and the reversal of share-based compensation associated with performance targets considered unlikely to be achieved.
- The company reported no material pending or threatened legal claims. Disclosed commitments include $1.5 million of bank guarantees, $6.5 million of future minimum operating-lease payments and a $4.6 million commitment to third parties related to land in Thailand. The text does not clarify the nature of that land-related commitment beyond the disclosure.
Important facts for investors to verify
- Whether the largest customer’s demand, pricing and payment behavior remain stable, and how customer concentration changes.
- Whether inventory and receivables growth converts into cash, given the working-capital outflows and rising contract assets.
- Whether gross margins hold up against Thai-baht appreciation, wage increases, material shortages and expansion costs.
- Whether the company maintains compliance with credit covenants and meets its $40 million U.S.-located cash and securities requirement.
- How ASC 606 affects period comparisons, and whether the disclosed land-related commitment and tax exposures change.