Item 2. Management’s Discussion and Analysis
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In addition to historical information, this Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements relate to our expectations, future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our or our industry’s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. Forward-looking statements include, but are not limited to, statements about:
•
our goals and strategies;
•
our and our customers’ estimates regarding future revenues, operating results, expenses, capital requirements and liquidity;
•
our belief that we will be able to maintain favorable pricing on our services;
•
our expectation that the portion of our revenues attributable to customers in regions outside of North America for the remainder of fiscal year 2020 will be in line with the portion of those revenues for the nine months ended March 27, 2020;
•
our expectation that we will incur incremental costs of revenue as a result of our planned expansion of our business into new geographic markets;
•
our expectation that our fiscal year 2020 selling, general and administrative (“SG&A”) expenses will increase as a percentage of revenue compared to fiscal year 2019 SG&A expenses;
•
our expectation that our employee costs will increase in Thailand and the People’s Republic of China (“PRC”);
•
our future capital expenditures and our needs for additional financing;
•
the expansion of our manufacturing capacity, including into new geographies;
•
the growth rates of our existing markets and potential new markets;
•
our ability, and the ability of our customers and suppliers, to respond successfully to technological or industry developments;
•
our expectations regarding the potential impact of the COVID-19
pandemic on our business, financial condition and results of operations;
•
our suppliers’ estimates regarding future costs;
•
our ability to increase our penetration of existing markets and to penetrate new markets;
•
our plans to diversify our sources of revenues;
•
our plans to execute acquisitions;
•
trends in the optical communications, industrial lasers, and sensors markets, including trends to outsource the production of components used in those markets;
•
our ability to attract and retain a qualified management team and other qualified personnel and advisors; and
•
competition in our existing and new markets.
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These forward-looking statements are subject to certain risks and uncertainties that could cause our actual results to differ materially from those reflected in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this Quarterly Report on Form 10-Q,
in particular, the risks discussed under the heading “Risk Factors” in Part II, Item 1A as well as those discussed in other documents we file with the Securities and Exchange Commission. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements. “We,” “us” or “our” collectively refer to Fabrinet and its subsidiaries.
Overview
We provide advanced optical packaging and precision optical, electro-mechanical and electronic manufacturing services to original equipment manufacturers (“OEMs”) of complex products such as optical communication components, modules and sub-systems,
industrial lasers, automotive components, medical devices and sensors. We offer a broad range of advanced optical and electro-mechanical capabilities across the entire manufacturing process, including process design and engineering, supply chain management, manufacturing, complex printed circuit board assembly, advanced packaging, integration, final assembly and testing. Although we focus primarily on low-volume
production of a wide variety of high complexity products, which we refer to as “low-volume,
high-mix,”
we also have the capability to accommodate high-volume production. Based on our experience with, and positive feedback we have received from our customers, we believe we are a global leader in providing these services to the optical communications, industrial lasers and automotive markets.
Our customer base includes companies in complex industries that require advanced precision manufacturing capabilities such as optical communications, industrial lasers, automotive and sensors. The products that we manufacture for our OEM customers include selective switching products; tunable transponders and transceivers; active optical cables; solid state, diode-pumped, gas and fiber lasers; and sensors. In many cases, we are the sole outsourced manufacturing partner used by our customers for the products that we produce for them.
We also design and fabricate application-specific crystals, lenses, prisms, mirrors, laser components, and substrates (collectively referred to as “customized optics”) and other custom and standard borosilicate, clear fused quartz, and synthetic fused silica glass products (collectively referred to as “customized glass”). We incorporate our customized optics and glass into many of the products we manufacture for our OEM customers, and we also sell customized optics and glass in the merchant market.
Recent Developments Related to COVID-19
In the quarter ended March 27, 2020, the effects of the global COVID-19
pandemic impacted us in several ways and created various challenges. It started with our Casix facility in Fuzhou, China, which manufactures custom optics components for us and other customers. In January 2020, while many factories (including our Casix facility) were closed for about eight days because of China’s Lunar New Year holiday, the Chinese government, as part of its efforts to mitigate the spread of COVID-19,
ordered that businesses in various parts of the country extend the holiday closures. The Chinese government ordered our Casix facility to not resume operations for almost two weeks. Because of the restrictions on travel in China in place during this period, many of our employees were unable to return from their holiday travel as planned. As a result, fewer than 90% of our employees were able to return to work at our Casix facility until early March. Our other manufacturing facilities also have been affected by various government restrictions put in place in their locations to slow the spread of COVID-19.
In Thailand, the government declared a national state of emergency effective March 26, 2020, to reduce the spread of COVID-19.
The government required the closure of various businesses, in particular retail establishments, and passed measures restricting movement and activities in Thailand. Our operations in Thailand have not been closed, and we have implemented a number of safety protocols that have allowed our operations in those facilities to continue. Our facilities in the United States, located in California and New Jersey, and in the United Kingdom have remained open, while adhering to the local government restrictions and orders implemented in March 2020, including shelter in place orders and social distancing guidelines, except that our facility in California was closed for about a week beginning in late March until it reopened in early April as a previously classified “essential” business.
The health and well-being of our employees is our top priority. Over the past several months, we have implemented significant precautionary measures throughout our worldwide operations to keep our employees and their families safe, such as mandatory temperature detection at building entrances, rigorous and regular facility and equipment disinfection, and mandatory personal protective equipment protocols, including (1) the wearing of face masks throughout our factories at all times, (2) distributing our employees across shifts to better maintain safe personal distances, (3) isolating incoming parts and materials for a week or more before unpacking, or baking them to kill potential viruses, (4) directing our non-factory
personnel to work from home, and (5) restricting all non-employee
visits to our campuses.
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During the quarter, we also experienced a shift in the demand for our services, with some customers canceling, decreasing or delaying their orders and other customers accelerating and increasing their orders. However, the most significant effect of COVID-19
on our operations this quarter was the disruption of our supply chain, in which we experienced significant fluctuations in the availability of parts and materials we need to manufacture products for our customers. We were able to mitigate some of these issues by quickly identifying and securing alternative sources; however, these mitigation efforts, combined with our employee safety initiatives, negatively affected our gross margins because they increased our costs and expenses.
Given the unprecedented global, human, and economic impact of COVID-19;
the extraordinary economic short-term uncertainty; and the evolving and differing national strategies for dealing with COVID-19,
it is extremely difficult and challenging to provide forward-looking disclosure. However, given the uncertainty and concern about the global economy and the health of various industries, we think it important to share some thoughts on how COVID-19
may impact our business in the future:
•
With work-from-home protocols in place around the world, global demand for internet bandwidth has grown and we believe it will continue to grow. Because the next-generation telecom and datacom products we manufacture for our customers are important to expand network capacity, we believe this will have a positive impact on our business in the long-term.
•
While we believe that the long-term growth outlook for the markets we serve has not been significantly impacted, in the short-term we are likely to continue to see regional downward demand adjustments for products we manufacture for our customers, especially if the COVID-19
outbreak intensifies or returns in various geographic areas as happened at the end of our third fiscal quarter. Moreover, we believe the markets for other products we manufacture, such as the industrial lasers and automotive markets, are likely to see reduced demand in a prolonged economic downturn.
•
We expect we will continue to experience disruptions in our supply chain and the availability of parts and materials will continue to fluctuate, especially if the COVID-19
outbreak intensifies or returns in various geographic areas. However, we believe we can mitigate these disruptions by continuing to identify and secure alternative sources.
•
A significant portion of our costs are variable and, because of this, we can adjust manufacturing costs relatively quickly to the changing demand of our customers. However, because the largest portion of our costs is for parts and materials, because of the supply chain issues noted above and, to a lesser extent, our commitment to the safety and health protocols we have implemented across our global operations, our gross margins will continue to be negatively affected for the foreseeable future, at least into the first half of fiscal 2021.
•
The safety and health of our employees is and will remain a key priority, and we will continue to follow robust safety protocols in all of our facilities.
•
Given our $457.8 million in cash, cash equivalents and short-term investments, and our total debt of approximately $54.8 million, as of March 27, 2020, we believe we are in a solid position from a capital and financial resources perspective.
Revenues
We believe our ability to expand our relationships with existing customers and attract new customers is due to a number of factors, including our broad range of complex engineering and manufacturing service offerings, flexible low-cost
manufacturing platform, process optimization capabilities, advanced supply chain management, excellent customer service, and experienced management team. Although we expect the prices we charge for our manufactured products to decrease over time (partly as a result of competitive market forces), we still believe we will be able to maintain favorable pricing for our services because of our ability to reduce cycle time, adjust our product mix by focusing on more complicated products, improve product quality and yields, and reduce material costs for the products we manufacture. We believe these capabilities have enabled us to help our OEM customers reduce their manufacturing costs while maintaining or improving the design, quality, reliability, and delivery times for their products.
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Revenues by Geography
We generate revenues from three geographic regions: North America, Asia-Pacific and Europe. Revenues are attributed to a particular geographic area based on the bill-to
location of our customers, notwithstanding that our customers may ultimately ship their products to end customers in a different geographic region. The majority of our revenues are derived from our manufacturing facilities in Asia-Pacific.
The percentage of our revenues generated from a bill-to
location outside of North America decreased from 51.0% in the three months ended March 29, 2019 to 49.7% in the three months ended March 27, 2020 and from 52.7% in the nine months ended March 29, 2019 to 49.0% in the nine months ended March 27, 2020, primarily because the increase in sales to our customers in North America was higher than the increase in sales to our customers outside of North America. Based on the short and medium-term indications and forecasts from our customers, we expect that the portion of our future revenues attributable to customers in regions outside North America for the remainder of fiscal year 2020 will be in line with the portion of total revenues attributable to such customers during the nine months ended March 27, 2020.
The following table presents percentages of total revenues by geographic region:
Three Months Ended
Nine Months Ended
March 27,
2020
March 29,
2019
March 27,
2020
March 29,
2019
North America
50.3
%
49.0
%
51.0
%
47.3
%
Asia-Pacific
34.4
37.9
32.5
39.9
Europe
15.3
13.1
16.5
12.8
100.0
%
100.0
%
100.0
%
100.0
%
Our Contracts
We enter into supply agreements with our customers which generally have an initial term of up to three years, subject to automatic renewals for subsequent one-year
terms unless expressly terminated. Although there are no minimum purchase requirements in our supply agreements, our customers provide us with rolling forecasts of their demand requirements. Our supply agreements generally include provisions for pricing and periodic review of pricing, consignment of our customer’s unique production equipment to us, and the sharing of benefits from cost-savings derived from our efforts. We are generally required to purchase materials, which may include long lead-time materials and materials that are subject to minimum order quantities and/or non-cancelable
or non-returnable
terms, to meet the stated demands of our customers. After procuring materials, we manufacture products for our customers based on purchase orders that contain terms regarding product quantities, delivery locations and delivery dates. Our customers generally are obligated to purchase finished goods that we have manufactured according to their demand requirements. Materials that are not consumed by our customers within a specified period of time, or are no longer required due to a product’s cancellation or end-of-life,
are typically designated as excess or obsolete inventory under our contracts. Once materials are designated as either excess or obsolete inventory, our customers are typically required to purchase such inventory from us even if they have chosen to cancel production of the related products. The excess or obsolete inventory is shipped to the customer and revenue is recognized upon shipment.
Cost of Revenues
The key components of our cost of revenues are material costs, employee costs, and infrastructure-related costs. Material costs generally represent the majority of our cost of revenues. Several of the materials we require to manufacture products for our customers are customized for their products and often sourced from a single supplier or in some cases, our own subsidiaries. Shortages from sole-source suppliers due to yield loss, quality concerns and capacity constraints, among other factors, may increase our expenses and negatively impact our gross profit margin or total revenues in a given quarter. Material costs include scrap material. Historically, scrap rate diminishes during a product’s life cycle due to process, fixturing and test improvement and optimization.
A second significant element of our cost of revenues is employee costs, including indirect employee costs related to design, configuration and optimization of manufacturing processes for our customers, quality testing, materials testing and other engineering services; and direct costs related to our manufacturing employees. Direct employee costs include employee salaries, insurance and benefits, merit-based bonuses, recruitment, training and retention. Historically, our employee costs have increased primarily due to increases in the number of employees necessary to support our growth and, to a lesser extent, costs to recruit, train and retain employees. Our cost of revenues is significantly impacted by salary levels in Thailand, the PRC and the United Kingdom, the fluctuation of the Thai baht, Chinese Renminbi (“RMB”) and
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Pound Sterling (“GBP”) against our functional currency, the U.S. dollar, and our ability to retain our employees. We expect our employee costs to increase as wages continue to increase in Thailand and the PRC. Wage increases may impact our ability to sustain our competitive advantage and may reduce our profit margin. We seek to mitigate these cost increases through improvements in employee productivity, employee retention and asset utilization.
Our infrastructure costs are comprised of depreciation, utilities, facilities management and overhead costs. Most of our facility leases are long-term agreements. Our depreciation costs include buildings and fixed assets, primarily at our Pinehurst and Chonburi campuses in Thailand, and capital equipment located at each of our manufacturing locations.
We expect to incur incremental costs of revenue as a result of our planned expansion into new geographic markets, though we are not able to determine the amount of these incremental expenses.
Selling, General and Administrative Expenses
Our SG&A expenses primarily consist of corporate employee costs for sales and marketing, general and administrative and other support personnel, including research and development expenses related to the design of customized optics and glass, travel expenses, legal and other professional fees, share-based compensation expense and other general expenses not related to cost of revenues. In fiscal year 2020, we expect our SG&A expenses will increase as a percentage of revenue compared with our fiscal year 2019 SG&A expenses.
The compensation committee of our board of directors approved a fiscal year 2020 executive incentive plan with quantitative objectives that are based solely on achieving certain revenue targets and non-GAAP
operating margin targets for our fiscal year ending June 26, 2020. Bonuses under the fiscal year 2020 executive incentive plan are payable after the end of fiscal year 2020. In fiscal year 2019, the compensation committee of our board of directors approved a fiscal year 2019 executive incentive plan with quantitative objectives based solely on achieving certain revenue targets and non-GAAP
gross margin targets for fiscal year 2019.
Additional Financial Disclosures
Foreign Exchange
As a result of our international operations, we are exposed to foreign exchange risk arising from various currency exposures primarily with respect to the Thai baht. Although a majority of our total revenues is denominated in U.S. dollars, a substantial portion of our payroll plus certain other operating expenses are incurred and paid in Thai baht. The exchange rate between the Thai baht and the U.S. dollar has fluctuated substantially in recent years and may continue to fluctuate substantially in the future. We report our financial results in U.S. dollars and our results of operations have been and could in the future be negatively impacted if the Thai baht appreciates against the U.S. dollar. Smaller portions of our expenses are incurred in a variety of other currencies, including RMB, GBP, Canadian dollars, Euros, and Japanese yen, the appreciation of which may also negatively impact our financial results.
In order to manage the risks arising from fluctuations in foreign currency exchange rates, we use derivative instruments. We may enter into foreign exchange currency forward or put option contracts to manage foreign currency exposures associated with certain assets and liabilities and other forecasted foreign currency transactions and may designate these instruments as hedging instruments. The forward and put option contracts generally have maturities of up to 12 months. All foreign currency exchange contracts are recognized in the unaudited condensed consolidated balance sheets at fair value. Gains or losses on our forward and put option contracts generally offset the assets, liabilities, and transactions economically hedged.
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We had foreign currency denominated assets and liabilities in Thai baht, RMB and GBP as follows:
As of March 27, 2020
As of June 28, 2019
(amount in thousands, except percentages)
Currency
$
%
Currency
$
%
Assets
Thai baht
885,394
$
27,277
44.2
664,860
$
21,628
60.0
RMB
189,575
26,918
43.6
53,393
7,767
21.5
GBP
6,171
7,541
12.2
5,270
6,682
18.5
Total
$
61,736
100.0
$
36,077
100.0
Liabilities
Thai baht
2,047,689
$
63,084
88.4
1,961,972
$
63,825
90.0
RMB
37,561
5,333
7.5
26,373
3,836
5.4
GBP
2,397
2,929
4.1
2,598
3,294
4.6
Total
$
71,346
100.0
$
70,955
100.0
The Thai baht assets represent cash and cash equivalents, trade accounts receivable, deposits and other current assets. The Thai baht liabilities represent trade accounts payable, accrued expenses, income tax payable and other payables. We manage our exposure to fluctuations in foreign exchange rates by the use of foreign currency contracts and offsetting assets and liabilities denominated in the same currency in accordance with management’s policy. As of March 27, 2020 there was $126.0 million of foreign currency forward contracts outstanding on the Thai baht payables. As of June 28, 2019, there was $72.0 million of foreign currency forward contracts outstanding on the Thai baht payables.
The RMB assets represent cash and cash equivalents, trade accounts receivable and other current assets. The RMB liabilities represent trade accounts payable, accrued expenses, income tax payable and other payables. As of March 27, 2020 and June 28, 2019, we did not have any derivative contracts denominated in RMB.
The GBP assets represent cash, trade accounts receivable, and other current assets. The GBP liabilities represent trade accounts payable and other payables. As of March 27, 2020 and June 28, 2019, we did not have any derivative contracts denominated in GBP.
Currency Regulation and Dividend Distribution
Foreign exchange regulation in the PRC is primarily governed by the following rules:
•
Foreign Currency Administration Rules, as amended on August 5, 2008, or the Exchange Rules;
•
Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996), or the Administration Rules; and
•
Notice on Perfecting Practices Concerning Foreign Exchange Settlement Regarding the Capital Contribution by Foreign-invested Enterprises, as promulgated by the State Administration of Foreign Exchange (“SAFE”), on August 29, 2008, or Circular 142.
Under the Exchange Rules, RMB is freely convertible into foreign currencies for current account items, including the distribution of dividends, interest payments, trade and service-related foreign exchange transactions. However, conversion of RMB for capital account items, such as direct investments, loans, security investments and repatriation of investments, is still subject to the approval of SAFE.
Under the Administration Rules, foreign-invested enterprises may only buy, sell, or remit foreign currencies at banks authorized to conduct foreign exchange business after providing valid commercial documents and relevant supporting documents and, in the case of capital account item transactions, obtaining approval from SAFE. Capital investments by foreign-invested enterprises outside of the PRC are also subject to limitations, which include approvals by the Ministry of Commerce, SAFE and the State Development and Reform Commission.
Circular 142 regulates the conversion by a foreign-invested company of foreign currency into RMB by restricting how the converted RMB may be used. Circular 142 requires that the registered capital of a foreign-invested enterprise settled in RMB converted from foreign currencies may only be used for purposes within the business scope approved by
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the applicable governmental authority and may not be used for equity investments within the PRC. In addition, SAFE strengthened its oversight of the flow and use of the registered capital of foreign-invested enterprises settled in RMB converted from foreign currencies. The use of such RMB capital may not be changed without SAFE’s approval and may not be used to repay RMB loans if the proceeds of such loans have not been used.
On January 5, 2007, SAFE promulgated the Detailed Rules for Implementing the Measures for the Administration on Individual Foreign Exchange, or the Implementation Rules. Under the Implementation Rules, PRC citizens who are granted share options by an overseas publicly-listed company are required, through a PRC agent or PRC subsidiary of such overseas publicly-listed company, to register with SAFE and complete certain other procedures.
In addition, the General Administration of Taxation has issued circulars concerning employee share options. Under these circulars, our employees working in the PRC who exercise share options will be subject to PRC individual income tax. Our PRC subsidiary has obligations to file documents related to employee share options with relevant tax authorities and withhold individual income taxes of those employees who exercise their share options.
Furthermore, our transfer of funds to our subsidiaries in Thailand and the PRC are each subject to approval by governmental authorities in case of an increase in registered capital, or subject to registration with governmental authorities in case of a shareholder loan. These limitations on the flow of funds between our subsidiaries and us could restrict our ability to act in response to changing market conditions.
Income Tax
Our effective tax rate is a function of the mix of tax rates in the various jurisdictions in which we do business. We are domiciled in the Cayman Islands. Under the current laws of the Cayman Islands, we are not subject to tax in the Cayman Islands on income or capital gains until March 6, 2039.
Throughout the period of our operations in Thailand, we have generally received income tax and other incentives from the Thailand Board of Investment. Preferential tax treatment from the Thai government in the form of a corporate tax exemption is currently available to us through June 2020 and June 2026 on income generated from projects to manufacture certain products at our Pinehurst campus and Chonburi campus, respectively. Such preferential tax treatment is contingent on various factors, including the export of our customers’ products out of Thailand and our agreement not to move our manufacturing facilities out of our current province in Thailand for at least 15 years from the date on which preferential tax treatment was granted (i.e., at least until June 2020 in the case of our Pinehurst campus and until June 2026 in the case of our Chonburi campus). Currently, the corporate income tax rate for our Thai subsidiary is 20%.
The Tax Cuts and Jobs Act (“Tax Reform Act”) was enacted on December 22, 2017 and provided for significant changes to U.S. tax law. Among other provisions, the Tax Reform Act reduced the U.S. corporate income tax rate to 21%, which is the current rate for our U.S. subsidiaries.
Critical Accounting Policies and Use of Estimates
We prepare our unaudited condensed consolidated financial statements in conformity with U.S. GAAP, which requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities on the date of the unaudited condensed consolidated financial statements and the reported amounts of revenues and expenses during the financial reporting period. We continually evaluate these estimates and assumptions based on the most recently available information, our own historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Because the use of estimates is an integral component of the financial reporting process, actual results could differ from those estimates. Some of our accounting policies require higher degrees of judgment than others in their application. We consider the policies discussed below to be critical to an understanding of our unaudited condensed consolidated financial statements, as their application places the most significant demands on our management’s judgment.
Our critical accounting policies are disclosed in our Annual Report on Form 10-K
for the fiscal year ended June 28, 2019. The adoption of new accounting policies and accounting standards are disclosed in Note 2 of Notes to Unaudited Condensed Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q.
There were no changes to our accounting policies other than the adoption of Leases (Topic 842) and Derivatives and Hedging (Topic 815).
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Results of Operations
The following table sets forth a summary of our unaudited condensed consolidated statements of operations and comprehensive income. Note that period-to-period
comparisons of operating results should not be relied upon as indicative of future performance.
Three Months Ended
Nine Months Ended
(amount in thousands)
March 27,
2020
March 29,
2019
March 27,
2020
March 29,
2019
Revenues
$
411,210
$
398,951
$
1,236,723
$
1,179,208
Cost of revenues
(366,874
)
(352,193
)
(1,097,242
)
(1,046,610
)
Gross profit
44,336
46,758
139,481
132,598
Selling, general and administrative expenses
(17,111
)
(14,132
)
(50,189
)
(41,296
)
Expenses related to reduction in workforce
—
(323
)
(16
)
(727
)
Operating income
27,225
32,303
89,276
90,575
Interest income
2,042
2,144
6,080
4,770
Interest expense
(238
)
(1,423
)
(2,812
)
(3,673
)
Foreign exchange loss, net
(8
)
(3,055
)
(2,949
)
(408
)
Other income, net
203
159
977
798
Income before income taxes
29,224
30,128
90,572
92,062
Income tax expense
(957
)
(1,493
)
(5,117
)
(4,064
)
Net income
28,267
28,635
85,455
87,998
Other comprehensive (loss) income, net of tax
(8,231
)
998
(7,997
)
1,178
Net comprehensive income
$
20,036
$
29,633
$
77,458
$
89,176
The following table sets forth a summary of our unaudited condensed consolidated statements of operations and comprehensive income as a percentage of total revenues for the periods indicated.
Three Months Ended
Nine Months Ended
March 27,
2020
March 29,
2019
March 27,
2020
March 29,
2019
Revenues
100.0
%
100.0
%
100.0
%
100.0
%
Cost of revenues
(89.2
)
(88.3
)
(88.7
)
(88.8
)
Gross profit
10.8
11.7
11.3
11.2
Selling, general and administrative expenses
(4.2
)
(3.5
)
(4.1
)
(3.5
)
Expenses related to reduction in workforce
—
(0.1
)
(0.0
)
(0.1
)
Operating income
6.6
8.1
7.2
7.6
Interest income
0.5
0.5
0.5
0.4
Interest expense
(0.0
)
(0.4
)
(0.2
)
(0.3
)
Foreign exchange loss, net
(0.0
)
(0.8
)
(0.2
)
(0.0
)
Other income, net
0.0
0.1
0.0
0.1
Income before income taxes
7.1
7.5
7.3
7.8
Income tax expense
(0.2
)
(0.4
)
(0.4
)
(0.3
)
Net income
6.9
7.1
6.9
7.5
Other comprehensive (loss) income, net of tax
(2.0
)
0.3
(0.6
)
0.1
Net comprehensive income
4.9
%
7.4
%
6.3
%
7.6
%
The following table sets forth our revenues by end market for the periods indicated.
Three Months Ended
Nine Months Ended
(amount in thousands)
March 27,
2020
March 29,
2019
March 27,
2020
March 29,
2019
Optical communications
$
308,566
$
298,139
$
933,013
$
884,454
Lasers, sensors and other
102,644
100,812
303,710
294,754
Total
$
411,210
$
398,951
$
1,236,723
$
1,179,208
We operate and internally manage a single operating segment. As such, discrete information with respect to separate product lines and segments is not accumulated.
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Comparison of Three and Nine Months Ended March 27, 2020 with Three and Nine Months Ended March 29, 2019
Total revenues
.
Our total revenues increased by $12.3 million, or 3.1%, to $411.2 million for the three months ended March 27, 2020, compared with $399.0 million for the three months ended March 29, 2019. This increase was primarily due to an increase in our customers’ demand for both optical and non-optical
communications manufacturing services during the three months ended March 27, 2020. Revenues from optical and non-optical
communications products increased by $10.4 million and $1.8 million, or 3.5% and 1.8%, respectively, for the three months ended March 27, 2020.
Our total revenues increased by $57.5 million, or 4.9%, to $1,236.7 million for the nine months ended March 27, 2020, compared with $1,179.2 million for the nine months ended March 29, 2019. This increase was primarily due to an increase in our customers’ demand for both optical and non-optical
communications manufacturing services during the nine months ended March 27, 2020. Revenues from optical and non-optical
communications products increased by $48.6 million and $9.0 million, or 5.5% and 3.0%, respectively, for the nine months ended March 29, 2019.
Cost of revenues
.
Our cost of revenues increased by $14.7 million, or 4.2%, to $366.9 million, or 89.2% of total revenues, for the three months ended March 27, 2020, compared with $352.2 million, or 88.3% of total revenues, for the three months ended March 29, 2019. This increase in cost of revenues was generally in line with the increase in sales volume, except for an increase in costs due to supply chain disruption resulting from COVID-19.
Our cost of revenues increased by $50.6 million, or 4.8%, to $1,097.2 million, or 88.7% of total revenues, for the nine months ended March 27, 2020, compared with $1,046.6 million, or 88.8% of total revenues, for the nine months ended March 29, 2019. This increase in cost of revenues on an absolute dollar basis was in line with the increase in sales volume.
Gross profit
.
Our gross profit decreased by $2.4 million, or 5.2%, to $44.3 million, or 10.8% of total revenues, for the three months ended March 27, 2020, compared with $46.8 million, or 11.7% of total revenues, for the three months ended March 29, 2019. The decrease was primarily due to a less favorable product mix and an increase in costs due to supply chain disruption resulting from COVID-19.
Our gross profit increased by $6.9 million, or 5.2%, to $139.5 million, or 11.3% of total revenues, for the nine months ended March 27, 2020, compared with $132.6 million, or 11.2% of total revenues, for the nine months ended March 29, 2019. The increase was primarily due to an increase in revenues and effective cost controls.
SG&A expenses
.
Our SG&A expenses increased by $3.0 million, or 21.1%, to $17.1 million, or 4.2% of total revenues, for the three months ended March 27, 2020, compared with $14.1 million, or 3.5% of total revenues, for the three months ended March 29, 2019. The increase was primarily due to (1) an increase in share-based compensation expenses of $1.4 million including $1.2 million from an increase in performance share-based awards granted in the period and $0.2 million from an increase in restricted share-based awards granted in the period; (2) an increase in new business start-up
costs in our subsidiary of $0.4 million; (3) an increase in severance liabilities expense of $0.4 million due to a change in labor protection law in Thailand in May 2019 that increased the required severance payment compensation for employees with 20 years of service from 300 days of wage to 400 days of wage; and (4) an increase in executive and management expenses of $0.2 million from bonuses and other benefits.
Our SG&A expenses increased by $8.9 million, or 21.5%, to $50.2 million, or 4.1% of total revenues, for the nine months ended March 27, 2020, compared with $41.3 million, or 3.5% of total revenues, for the nine months ended March 29, 2019. The increase was primarily due to (1) an increase in share-based compensation expenses of $4.5 million including $3.9 million from an increase in performance share-based awards granted in the period and $0.6 million from an increase in restricted share-based awards granted in the period; (2) an increase in executive and management expenses of $2.0 million from bonuses and other benefits; (3) an increase in severance liabilities expense of $1.0 million due to a change in labor protection law in Thailand in May 2019 that increased the required severance payment compensation for employees with 20 years of service from 300 days of wage to 400 days of wage; and (4) an increase in new business start-up
costs in our subsidiary of $0.9 million.
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Operating income.
Our operating income decreased by $5.1 million to $27.2 million, or 6.6% of total revenues, for the three months ended March 27, 2020, compared with $32.3 million, or 8.1% of total revenues, for the three months ended March 29, 2019. The decrease was primarily due to an increase in SG&A expenses.
Our operating income decreased by $1.3 million to $89.3 million, or 7.2% of total revenues, for the nine months ended March 27, 2020, compared with $90.6 million, or 7.7% of total revenues, for the nine months ended March 29, 2019. The decrease was primarily due to an increase in SG&A expenses.
Interest income
.
Our interest income decreased by $0.1 million, or 4.8%, to $2.0 million, or 0.5% of total revenues, for the three months ended March 27, 2020, compared with $2.1 million, or 0.5% of total revenues, for the three months ended March 29, 2019. The decrease was primarily due to a reduction in the weighted average interest rate compared to the same period in the previous year from 2.3% to 1.9%, consistent with global interest rate trends.
Our interest income increased by $1.3 million, or 27.5%, to $6.1 million, or 0.5% of total revenues, for the nine months ended March 27, 2020, compared with $4.8 million, or 0.4% of total revenues, for the nine months ended March 29, 2019. The increase was primarily due to an increase in the average balance of our outstanding cash.
Interest expense
.
Our interest expense decreased by $1.2 million to $0.2 million for the three months ended March 27, 2020, compared with $1.4 million for the three months ended March 29, 2019. The decrease was due to the implementation of cash flow hedge on interest rate swaps at September 27, 2019, which resulted in (1) the reduction of interest expense of $0.7 million from the recognition of an unrealized loss from mark-to-market
of interest rate swaps in other comprehensive income instead of in interest expense; and (2) the amortization of the fair value of interest rate swaps as of the hedge inception date of $0.4 million during the three months ended March 27, 2020 in relation to the application of hedge accounting which results in a decrease in interest expense.
Our interest expense decreased by $0.9 million to $2.8 million for the nine months ended March 27, 2020, compared with $3.7 million for the nine months ended March 29, 2019. The decrease was primarily due to an unrealized loss from mark-to-market
of interest rate swaps of $1.7 million for the three months ended September 27, 2019, before applying cash flow hedge, as compared to an unrealized loss of $1.6 million for the nine months ended March 29, 2019; offset by the amortization of the fair value of interest rate swaps as of the hedge inception date of $0.8 million during the nine months ended March 27, 2020 in relation to applying hedge accounting which results in a decrease in interest expense.
Foreign exchange loss, net.
We recorded foreign exchange loss, net of $8 thousand for the three months ended March 27, 2020, compared with a $3.1 million loss for the three months ended March 29, 2019. The decrease in foreign exchange loss was mainly due to unrealized gain from revaluation of outstanding Thai baht assets and liabilities of $3.3 million, offset by an unrealized loss from mark to market forward contracts of $2.1 million and other foreign exchange losses, net of $1.2 million for the three months ended March 27, 2020, as compared to an unrealized loss from mark to market forward contracts and revaluation of outstanding Thai baht assets and liabilities of $2.1 million, and a realized loss from payment and receipts of $0.6 million for the three months ended March 29, 2019.
We recorded foreign exchange loss, net of $2.9 million for the nine months ended March 27, 2020, compared with a $0.4 million loss for the nine months ended March 29, 2019. The increase in foreign exchange loss was due to a realized foreign exchange loss from receipts and payments of $1.6 million for the nine months ended March 27, 2020 as compared to a $0.9 million realized foreign exchange gain from receipts and payments for the nine months ended March 29, 2019.
Income before income taxes
.
We recorded income before income taxes of $29.2 million and $90.6 million for the three and nine months ended March 27, 2020, respectively, compared with $30.1 million and $92.1 million for the three and nine months ended March 29, 2019, respectively.
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Income tax expense.
Our provision for income tax reflects an effective tax rate of 2.4% and 5.2% for the three months ended March 27, 2020 and March 29, 2019, respectively. The decrease was primarily due to the fact that we had lower income subject to tax during the three months ended March 27, 2020 as compared to the same period in fiscal year 2019.
Our provision for income tax reflects an effective tax rate of 4.2% and 5.2% for the nine months ended March 27, 2020 and March 29, 2019, respectively. The decrease was primarily due to the fact that we had lower income subject to tax during the nine months ended March 27, 2020 as compared to the same period in fiscal year 2019.
Net income
.
We recorded net income of $28.3 million, or 6.9% of total revenues, for the three months ended March 27, 2020, compared with $28.6 million, or 7.1% of total revenues, for the three months ended March 29, 2019. The decrease was primarily due to (1) an increase in SG&A expenses of $3.0 million and (2) a decrease in gross profit of $2.4 million; partially offset by (1) a decrease in foreign exchange loss of $3.0 million, (2) a net change in interest income and expense of $1.1 million; (3) a decrease in income tax expense of $0.5 million, and (4) a decrease in expenses related to reduction in workforce of $0.3 million.
We recorded net income of $85.5 million, or 6.9% of total revenues, for the nine months ended March 27, 2020, compared with $88.0 million, or 7.5% of total revenues, for the nine months ended March 29, 2019. The decrease was primarily due to (1) a net increase in SG&A expenses of $8.9 million, (2) a net change in foreign exchange gain (loss) of $2.5 million, and (3) an increase in income tax expenses of $1.1 million primarily due to the valuation allowance for deferred tax assets; partially offset by (1) an increase in gross profit of $6.9 million due to increased revenues and effective cost control, (2) a net change in interest income and expense of $2.2 million, and (3) a decrease in expenses related to reduction in workforce of $0.7 million.
Other comprehensive (loss) income, net.
We recorded other comprehensive loss of $8.2 million, or 2.0% of total revenues, for the three months ended March 27, 2020, compared with other comprehensive income of $1.0 million, or 0.3% of total revenues, for the three months ended March 29, 2019.
We recorded other comprehensive loss of $8.0 million, or 0.6% of total revenues, for the nine months ended March 27, 2020, compared with other comprehensive income of $1.2 million, or 0.1% of total revenues, for the nine months ended March 29, 2019.
Liquidity and Capital Resources
Cash Flows and Working Capital
We primarily finance our operations through cash flow from operations. As of March 27, 2020 and March 29, 2019, we had cash, cash equivalents, and short-term investments of $457.8 million and $408.9 million, respectively, and outstanding debt of $54.8 million and $61.8 million, respectively.
Our cash and cash equivalents, which primarily consist of cash on hand, demand deposits, and liquid investments with original maturities of three months or less, are placed with banks and other financial institutions. The weighted-average interest rate on our cash and cash equivalents for each of the three and nine months ended March 27, 2020 was 1.9% and 2.0%, respectively, and for the three and nine months ended March 29, 2019 was 2.3% and 1.9%, respectively.
Our cash investments are made in accordance with an investment policy approved by the audit committee of our board of directors. In general, our investment policy requires that securities purchased be rated A1, P-1,
F1 or better. No security may have an effective maturity that exceeds three years. Our investments in fixed income securities are primarily classified as available-for-sale
and are recorded at fair value. The cost of securities sold is based on the specific identification method. Unrealized gains and losses on these securities are recorded as other comprehensive income (loss) and are reported as a separate component of shareholders’ equity.
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During the nine months ended March 27, 2020, (1) we paid off a term loan of $60.9 million under our previous Bank of America Facility Agreement, (2) our subsidiaries in Thailand drew down a new term loan of $60.9 million under a new Credit Facility Agreement with the Bank of Ayudhya Public Company Limited, and (3) we repaid $6.1 million of the new term loan under the new Credit Facility Agreement. As a result, as of March 27, 2020, we had a long-term borrowing of $54.8 million under our new Credit Facility Agreement. (See Note 14 for further details.) We anticipate that our internally generated working capital, along with our cash and cash equivalents will be adequate to repay these obligations. To better manage our cash on hand, we held short-term investments of $233.6 million as of March 27, 2020.
We believe that our current cash and cash equivalents, marketable securities, cash flow from operations, and funds available through our credit facility will be sufficient to meet our working capital and capital expenditure needs for at least the next 12 months. Our ability to sustain our working capital position is subject to a number of risks that we discuss in Part II, Item 1A of this Quarterly Report on Form 10-Q.
We also believe that our current manufacturing capacity is sufficient to meet our anticipated production requirements for at least the next few quarters.
The following table shows our cash flows for the periods indicated:
Nine Months Ended
(amount in thousands)
March 27,
2020
March 29,
2019
Net cash provided by operating activities
$
104,448
$
105,504
Net cash used in investing activities
$
(28,921
)
$
(79,045
)
Net cash used in financing activities
$
(32,000
)
$
(22,063
)
Net increase in cash, cash equivalents and restricted cash
$
43,527
$
4,396
Operating Activities
Net cash provided by operating activities decreased by $1.1 million, or 1.0%, to $104.4 million for the nine months ended March 27, 2020, compared with net cash provided by operating activities of $105.5 million for the nine months ended March 29, 2019. The change in net cash provided by operating activities was not significant compared to the same period of the previous year.
Investing Activities
Net cash used in investing activities decreased by $50.1 million, or 63.4%, to $28.9 million for the nine months ended March 27, 2020, compared with net cash used in investing activities of $79.0 million for the nine months ended March 29, 2019. This decrease was primarily due to net cash received from short-term investments of $88.2 million, offset by (1) funds provided to a customer of $24.3 million to support the customer’s transfer of certain manufacturing operations from Berlin, Germany to our facilities in Thailand, which the customer has agreed to repay by September 30, 2020, and (2) an increase in investments in property, plant and equipment and intangibles of $14.8 million.
Financing Activities
Net cash used in financing activities increased by $9.9 million, or 45.0%, to $32.0 million for the nine months ended March 27, 2020, compared with net cash used in financing activities of $22.1 million for the nine months ended March 29, 2019. This increase was primarily due to (1) an increase in ordinary shares repurchase of $15.3 million and (2) an increase of $3.7 million in net repayments of loans to banks. The increase was offset by (1) an increase in withholding tax related to net share settlement of restricted share units of $5.7 million and (2) the release of restricted cash in connection with a business acquisition of $3.5 million.
Off-Balance
Sheet Commitments and Arrangements
As of March 27, 2020, we had one outstanding standby letter of credit of 6.0 million Euros, which was related to our support of a customer’s transfer of certain manufacturing operations from Berlin, Germany to our facilities in Thailand. As of March 27, 2020, the standby letter of credit was backed by cash collateral of $7.4 million.
Recent Accounting Pronouncements
See Note 2 of Notes to Unaudited Condensed Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q
for recent accounting pronouncements that could have an effect on us.
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