Fabrinet 10-Q

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 future events or to 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 2021 will be in line with the portion of those revenues for the three months ended September 25, 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 2021 selling, general and administrative (“SG&A”) expenses will increase as a percentage of revenue compared to fiscal year 2020 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. 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 30 Table of Contents 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 The global COVID-19 pandemic has impacted us in several ways and created various challenges. At the onset of the pandemic, our PRC subsidiary, which manufactures custom optics components for us and other customers at its facility in Fuzhou, China, experienced a prolonged temporary closure following its customary eight-day Chinese Lunar New Year holiday in January 2020. In accordance with the Chinese government’s official efforts to mitigate the spread of COVID-19, our PRC subsidiary, along with other businesses in various parts of the country, delayed resumption of operations following the holiday closures for approximately two weeks. Furthermore, because of the restrictions in place on travel in China during this period, many of our employees were unable to return from their holiday travel as planned, resulting in fewer than 90% of our employees being able to return to work at our PRC subsidiary before early March. Our other global manufacturing facilities also have been affected by various government restrictions put in place to slow the spread of COVID-19. In Thailand, the government declared a national state of emergency effective March 26, 2020 and required the closure of various businesses, in particular retail establishments, and passed measures restricting movement and activities in Thailand. While our operations in Thailand have not been suspended, we have implemented a number of safety protocols to allow our operations in our facilities there to continue in accordance with government regulations. With the exception of our facility in Santa Clara, California, which closed for approximately one week beginning in late March before reopening in early April as a previously classified “essential business,” our facilities in the U.S., including in New Jersey, and in the U.K. 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. The health and well-being of our employees continues to be our top priority. Over the last few quarters, we have implemented significant precautionary measures throughout our worldwide operations to ensure our employees and their families remain 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 prior to unpacking, or applying extreme heat to them to kill potential viruses, (4) directing our non-factory personnel to work remotely, and (5) restricting all non-employee visits to our campuses. 31 Table of Contents During the three months ended September 25, 2020, we also continued to experience a shift in the demand for our services, with some customers canceling, decreasing or delaying orders and other customers accelerating and increasing orders. However, the most significant effect of the COVID-19 pandemic on our operations has been the disruption of our supply chain, including significant fluctuations in the availability of parts and materials necessary to manufacture products for our customers. While we were able to mitigate some of these issues by quickly identifying and securing alternative sources, these mitigation efforts, combined with our employee safety initiatives, negatively impacted our gross margins due to the associated costs and expenses. Given the unprecedented global, human, and economic impact of the COVID-19 pandemic, the extraordinary economic short-term uncertainty; and the evolving and differing national strategies for dealing with COVID-19, it is extremely challenging to provide a forward-looking disclosure. Despite the uncertainty and concern about the global economy and the health of various industries, we believe it is important to share our considerations as we continue to assess the impacts of COVID-19 as they relate to 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, especially if the COVID-19 outbreak intensifies or returns in various geographic areas as happened at the end of our third quarter in fiscal 2020. 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 respond to the changing demand of our customers. However, because parts and materials account for the largest portion of our costs, in combination with the supply chain issues noted above and, to a lesser extent, the expenses associated with 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, and 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 $496.4 million in cash, cash equivalents and short-term investments, and our total debt of approximately $48.6 million, as of September 25, 2020, we believe we are in a solid position from a capital and financial resources perspective. We expect that current cash and cash equivalent balances and short-term investments, and cash flows that are generated from operations will be sufficient to meet our domestic and international working capital needs and other capital and liquidity requirements for at least the next 12 months. 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. 32 Table of Contents 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 increased from 49.7% in the three months ended September 27, 2019 to 52.5% in the three months ended September 25, 2020, primarily because the increase in sales to our customers in North America was lower 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 2021 will be in line with the portion of revenues attributable to such customers during the three months ended September 25, 2020. The following table presents percentages of total revenues by geographic region: Three Months Ended September 25, 2020 September 27, 2019 North America 47.5 % 50.3 % Asia-Pacific 33.4 29.7 Europe 19.1 20.0 100.0 % 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 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. 33 Table of Contents 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 2021, we expect our SG&A expenses will increase as a percentage of revenue compared with our fiscal year 2020 SG&A expenses. The compensation committee of our board of directors approved a fiscal year 2021 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 25, 2021. Bonuses under the fiscal year 2021 executive incentive plan are payable after the end of fiscal year 2021. In fiscal year 2020, the compensation committee of our board of directors approved a fiscal year 2020 executive incentive plan with quantitative objectives based solely on achieving certain revenue targets and non-GAAP operating margin targets for fiscal year 2020. 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 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. 34 Table of Contents We had foreign currency denominated assets and liabilities in Thai baht, RMB and GBP as follows: As of September 25, 2020 As of June 26, 2020 (amount in thousands, except percentages) Currency $ % Currency $ % Assets Thai baht 484,800 $ 15,376 40.5 667,955 $ 21,617 41.8 RMB 99,204 14,563 38.4 158,060 22,402 43.3 GBP 6,278 8,011 21.1 6,220 7,726 14.9 Total $ 37,950 100.0 $ 51,745 100.0 Liabilities Thai baht 1,921,377 $ 60,938 89.3 2,102,392 $ 68,039 89.5 RMB 34,332 5,040 7.4 42,586 6,036 8.0 GBP 1,800 2,297 3.3 1,545 1,919 2.5 Total $ 68,275 100.0 $ 75,994 100.0 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 September 25, 2020, there was $130.0 million of foreign currency forward contracts outstanding on the Thai baht payables. As of June 26, 2020, there was $126.0 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 September 25, 2020 and June 26, 2020, 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 September 25, 2020 and June 26, 2020, we did not have any derivative contracts denominated in GBP. For the three months ended September 25, 2020 and September 27, 2019, we recorded losses of $1.5 million and $1.9 million, respectively, related to derivatives that are not designated as hedging instruments in the unaudited condensed consolidated statements of operations and comprehensive income. 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. 35 Table of Contents 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 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 on income generated from projects to manufacture certain products at our Chonburi campus is currently available to us through June 2026. Similar preferential tax treatment was available to us through June 2020 with respect to products manufactured at our Pinehurst campus. After June 2020, 50% of our income generated from products manufactured at our Pinehurst campus will be exempted from tax through June 2025. 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. 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 26, 2020. The adoption of new accounting policies and accounting standards are disclosed in Note 2 to the unaudited condensed consolidated financial statements. There were no changes to our accounting policies other than the adoption of ASC 326, “Financial Instruments—Credit Losses: Measurement of Credit Losses on Financial Instruments”. 36 Table of Contents 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. (amount in thousands) Three Months Ended September 25, 2020 September 27, 2019 Revenues $ 436,639 $ 399,296 Cost of revenues (386,159 ) (353,309 ) Gross profit 50,480 45,987 Selling, general and administrative expenses (16,863 ) (16,000 ) Operating income 33,617 29,987 Interest income 1,104 2,098 Interest expense (251 ) (2,393 ) Foreign exchange gain (loss), net 128 (1,953 ) Other income (expense), net 121 377 Income before income taxes 34,719 28,116 Income tax expense (1,668 ) (2,159 ) Net income 33,051 25,957 Other comprehensive income (loss), net of tax (2,757 ) (212 ) Net comprehensive income $ 30,294 $ 25,745 The following table sets forth a summary of our unaudited condensed consolidated statements of operations and comprehensive income as a percentage of revenues for the periods indicated. Three Months Ended September 25, 2020 September 27, 2019 Revenues 100.0 % 100.0 % Cost of revenues (88.4 ) (88.5 ) Gross profit 11.6 11.5 Selling, general and administrative expenses (3.9 ) (4.0 ) Operating income 7.7 7.5 Interest income 0.3 0.5 Interest expense (0.1 ) (0.6 ) Foreign exchange gain (loss), net 0.0 (0.5 ) Other income (expense), net 0.0 0.1 Income before income taxes 7.9 7.0 Income tax expense (0.4 ) (0.5 ) Net income 7.5 6.5 Other comprehensive income (loss), net of tax (0.6 ) (0.1 ) Net comprehensive income 6.9 % 6.4 % The following table sets forth our revenues by end market for the periods indicated. Three Months Ended (amount in thousands) September 25, 2020 September 27, 2019 Optical communications $ 343,917 $ 302,379 Lasers, sensors and other 92,722 96,917 Total $ 436,639 $ 399,296 We operate and internally manage a single operating segment. As such, discrete information with respect to separate product lines and segments is not accumulated. 37 Table of Contents Comparison of Three Months Ended September 25, 2020 with Three Months Ended September 27, 2019 Revenues. Our revenues increased by $37.3 million, or 9.4%, to $436.6 million for the three months ended September 25, 2020, compared with $399.3 million for the three months ended September 27, 2019. This increase was due to an increase in our key customers’ demand for optical communications manufacturing services during the three months ended September 25, 2020. Revenues from optical communications products increased by $41.5 million, or 13.7%, for the three months ended September 25, 2020. Cost of revenues. Our cost of revenues increased by $32.9 million, or 9.3%, to $386.2 million, or 88.4% of revenues, for the three months ended September 25, 2020, compared with $353.3 million, or 88.5% of revenues, for the three months ended September 27, 2019. The increase in cost of revenues on an absolute dollar basis was in line with the increase in revenue. Gross profit. Our gross profit increased by $4.5 million, or 9.8%, to $50.5 million, or 11.6% of revenues, for the three months ended September 25, 2020, compared with $46.0 million, or 11.5% of revenues, for the three months ended September 27, 2019. The increase was primarily due to a more favorable product mix. SG&A expenses. Our SG&A expenses increased by $0.9 million, or 5.4%, to $16.9 million, or 3.9% of revenues, for the three months ended September 25, 2020, compared with $16.0 million, or 4.0% of revenues, for the three months ended September 27, 2019. The increase was primarily due to an increase in start-up costs for our subsidiary in Israel of $0.8 million. Operating income. Our operating income increased by $3.6 million to $33.6 million, or 7.7% of revenues, for the three months ended September 25, 2020, compared with $30.0 million, or 7.5% of revenues, for the three months ended September 27, 2019. The increase was primarily due to an increase in revenues. Interest income. Our interest income decreased by $1.0 million, or 47.4%, to $1.1 million, or 0.3% of revenues, for the three months ended September 27, 2019, compared with $2.1 million, or 0.5% of revenues, for the three months ended September 27, 2019. The decrease was primarily due to a lower weighted average interest rate during the three months ended September 25, 2020 compared to same period in fiscal year 2020. Interest expense. Our interest expense decreased by $2.1 million to $0.3 million for the three months ended September 25, 2020, compared with $2.4 million for the three months ended September 27, 2019. The decrease was primarily due to lower unrealized loss from mark-to-market of interest rate swaps recognized to earnings as a result of applying cash flow hedge accounting during the three months ended September 25, 2020. Foreign exchange gain (loss), net. We recorded foreign exchange gain, net of $0.1 million for the three months ended September 25, 2020, compared with foreign exchange loss, net of $2.0 million for the three months ended September 27, 2019. The increase in foreign exchange gain was mainly due to an unrealized foreign exchange gain from revaluation of outstanding Thai baht assets and liabilities of $2.0 million for the three months ended September 25, 2020, as compared to an unrealized foreign exchange loss from revaluation of outstanding Thai baht assets and liabilities of $0.2 million for the three months ended September 27, 2019. Moreover, there was a reduction of foreign exchange gain (loss) volatility from the application of cash flow hedge which was implemented on December 28, 2019. Unrealized foreign exchange loss from marking-to-market of foreign exchange forward contracts after cash flow hedge application was $1.5 million for the three months ended September 25, 2020, as compared to unrealized foreign exchange loss from marking-to-market of foreign exchange forward contracts of $1.9 million for the three months ended September 27, 2019. 38 Table of Contents Income before income taxes. We recorded income before income taxes of $34.7 million for the three months ended September 25, 2020, compared with $28.1 million for the three months ended September 27, 2019. Income tax expense. Our provision for income tax reflects an effective tax rate of 4.5% and 5.6% for the three months ended September 25, 2020 and September 27, 2019, respectively. The decrease was primarily due to the fact that we had lower income subject to tax during the first quarter of fiscal year 2021 as compared to the same period in fiscal year 2020. Net income. We recorded net income of $33.1 million, or 7.6% of revenues, for the three months ended September 25, 2020, compared with $26.0 million, or 6.5% of revenues, for the three months ended September 27, 2019. Other comprehensive income (loss). We recorded other comprehensive loss of $2.8 million, or 0.6% of revenues, for the three months ended September 25, 2020, compared with other comprehensive loss of $0.2 million, or 0.1% of revenues, for the three months ended September 27, 2019. The increase in other comprehensive loss was mainly due to the implementation of cash flow hedge for foreign exchange forward contracts on December 28, 2019; therefore, unrealized foreign exchange loss of $3.2 million was recognized into other comprehensive income (loss), as compared to the three months ended September 27, 2019, other comprehensive loss comprised of unrealized foreign exchange loss of $0.4 million from foreign currency translation adjustment. Liquidity and Capital Resources Cash Flows and Working Capital We primarily finance our operations through cash flow from operations. As of September 25, 2020 and September 27, 2019, we had cash, cash equivalents, and short-term investments of $496.4 million and $406.8 million, respectively, and outstanding debt of $48.6 million and $60.9 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 the three months ended September 25, 2020 and September 27, 2019 was 0.9% and 2.0%, 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. During the three months ended September 25, 2020, we repaid $3.0 million of the term loan under the Credit Facility Agreement with the Bank of Ayudhya Public Company Limited. As a result, as of September 25, 2020, we had a long-term borrowing of $48.6 million under our credit facility agreement. (See Note 12 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 $307.2 million as of September 25, 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. 39 Table of Contents 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: Three Months Ended (amount in thousands) September 25, 2020 September 27, 2019 Net cash provided by operating activities $ 34,506 $ 2,647 Net cash (used in) provided by investing activities $ (58,434 ) $ 11,676 Net cash used in financing activities $ (13,067 ) $ (4,406 ) Net (decrease) increase in cash, cash equivalents and restricted cash $ (36,995 ) $ 9,917 Operating Activities Net cash provided by operating activities increased by $31.9 million, or 1,203.6%, to $34.5 million for the three months ended September 25, 2020, compared with net cash provided by operating activities of $2.6 million for the three months ended September 27, 2019. This increase was primarily due to (1) a decrease of $38.8 million in payments to trade accounts payable and (2) an increase in net income of $7.1 million offset by (1) a decrease in change of other current liabilities and non-current liabilities of $8.8 million, (2) a decrease in cash receipts related to the timing of collection of trade accounts receivable of $3.5 million, (3) an increase in unrealized gain on exchange rate and fair value of foreign currency forwards contracts and interest rate swaps of $4.0 million, (4) a decrease in change in inventories of $1.7 million and (5) an increase in change in other current assets and non-current assets of $3.6 million. Investing Activities Net cash used in investing activities increased by $70.1 million, or 600.5%, to $58.4 million for the three months ended September 25, 2020, compared with net cash provided by investing activities of $11.7 million for the three months ended September 27, 2019. This increase was primarily due to (1) an increase in purchases of short-term investments, net of proceeds from sales and maturities of $63.6 million and (2) an increase in the purchase of property, plant and equipment and intangibles of $6.5 million. Financing Activities Net cash used in financing activities increased by $8.7 million, or 196.6%, to $13.1 million for the three months ended September 25, 2020, compared with net cash used in financing activities of $4.4 million for the three months ended September 27, 2019. This increase was primarily due to (1) an increase in withholding tax related to net share settlement of restricted share units of $5.8 million and (2) an increase of $3.0 million in repayment of loans to a bank. Off-Balance Sheet Commitments and Arrangements As of September 25, 2020, we had one outstanding standby letter of credit of 6.0 million Euros related to our support of a customer’s transfer of certain manufacturing operations from Berlin, Germany to our facilities in Thailand. As of September 25, 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 for recent accounting pronouncements that could have an effect on us. 40 Table of Contents