Earnings Call Transcript
Fabrinet (FN)
Earnings Call Transcript - FN Q2 2021
Operator, Operator
Welcome to Fabrinet's Financial Results Conference Call for the Second Quarter of Fiscal Year 2021. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions on how to participate will be provided at that time. As a reminder, today's call is being recorded. I would now like to turn the call over to your host, Garo Toomajanian.
Garo Toomajanian, Host
Thank you, operator, and good afternoon everyone. Thank you for joining us on today's conference call to discuss Fabrinet's financial and operating results for the second quarter of fiscal year 2021, which ended December 25, 2020. With me on the call today are Seamus Grady, Chief Executive Officer and Csaba Sverha, Chief Financial Officer. This call is being webcast and a replay will be available on the Investors section of our website located at investor.fabrinet.com. Please refer to our website for important information, including our earnings press release and investor presentation, which include our GAAP to non-GAAP reconciliation. I would like to remind you that today's discussion will contain forward-looking statements about the future financial performance of the company. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from management's current expectations. These statements reflect our opinions only as of the date of this presentation and we undertake no obligation to revise them in light of new information or future events, except as required by law. For a description of the risk factors that may affect our results, please refer to our recent SEC filings, in particular the section captioned Risk Factors in our Form 10-Q filed on November 3, 2020. We will begin the call with remarks from Seamus and Csaba, followed by time for questions. I would now like to turn the call over to Fabrinet's CEO, Seamus Grady.
Seamus Grady, CEO
Thank you, Garo and good afternoon everyone. We had another record quarter with Q2 results that exceeded our guidance and support our longer-term optimism. In fact, based on our current outlook, we are positioned to deliver another record quarter in Q3 with strength across all key areas of our business. Revenue in the second quarter was a record $453.8 million, representing year-over-year as well as sequential growth. We remain focused on driving efficiencies, which helped generate margins that were at their highest levels in over a year. As a result, EPS also increased year-over-year and sequentially to a record $1.10. On today's call, I will focus my comments on the broader themes that drove our strong performance and support our outlook and Csaba will provide more details on our financial results and guidance. Our second quarter played out largely as anticipated combined with an unexpected positive surprise from automotive programs, which represented the most significant driver of upside in the quarter. In fact, automotive revenue grew more than 30% from the first quarter and more than doubled from a year ago. We continued to see a recovery from traditional automotive customers and even stronger growth from new automotive programs such as LIDAR, which are beginning to contribute to our growth in a more meaningful way. We are optimistic that this momentum in the automotive space will continue into the third quarter revenue. Revenue from industrial lasers was approximately flat and was slightly better than expected. We expect industrial laser revenue to improve in the third quarter and we remain optimistic about the longer-term potential for increased outsourcing from this market. In optical communications, we had anticipated that continued telecom strength would offset continuing softness from datacom products that are deployed inside the data center. In fact, we saw modest growth in optical communications revenue in the second quarter. Datacom revenue did moderate as we anticipated. However, this was more than offset by stronger telecom revenue. We are optimistic that datacom revenue will show an improvement in the third quarter and that both datacom and telecom revenue should increase sequentially. Part of our telecom growth was driven by our optical transport systems program at Cisco, which we have discussed on past calls. This transfer has been progressing very well and is ahead of plan. We had been anticipating that the transfer would be largely complete by the end of our fourth quarter and we now believe we are nearly a full quarter ahead of expectations. This faster ramp will also contribute to our anticipated growth in optical communications revenue in the third quarter. Due to the combination of the earlier Cisco ramp, growth from new automotive customers, and continuing optimism as we execute on our strategy, we are advancing our plans to expand our manufacturing footprint. We recently broke ground on a new 1 million square foot building at our campus in Chonburi, Thailand. This is twice the size of our originally contemplated expansion reflecting confidence in our ability to further scale our business over the longer-term. This expansion will roughly triple our footprint in Chonburi and will increase our global footprint by approximately 50% to 3 million square feet, providing us with considerable capacity to serve our anticipated growth. We expect construction to take approximately 1.5 years, which means we could start to see revenue from this facility in approximately two years. To summarize, we are very pleased that our second quarter represented record revenue and earnings with results that once again exceeded our guidance. Our continual focus on efficiency helped produce improvements in gross margin and operating margin in the quarter. As we continue to expand on our market leadership, we are optimistic that Q3 will be another record-breaking quarter for the company and we believe that growth from new products and programs will continue to demonstrate the success of our growth strategy as we look ahead. Now, I'd like to turn the call over to Csaba for additional financial details and our guidance for the third quarter of fiscal 2021.
Csaba Sverha, CFO
Thank you, Seamus and good afternoon everyone. We were excited to deliver a record performance that exceeded our guidance ranges. Revenue of $453.8 million was nearly $14 million above the high-end of our guidance range. This was our strongest revenue beat in two years and a new record. Optical communications was $347.8 million or 77% of total revenue, up 1% from Q1. Non-optical communications revenue was $106 million or 23% of total revenue and increased 14% from Q1. Within optical communications, telecom revenue was $273.2 million, up 5% from last quarter. Datacom revenue was $74.6 million, down 10% sequentially. While datacom revenue declined as expected, we were pleased to see growth in telecom more than offset this in Q2. We are also optimistic that datacom revenue will return to growth in the third quarter. Silicon photonics revenue was $101.8 million, down 6% from a very strong Q1, but up 24% from a year ago. Revenue from 100-gig products saw a decline as faster data rate products saw very significant growth. 100-gig revenue of $128.2 million was down 50% from Q1 while revenue from 400-gig and faster was $104.2 million, up 50% from last quarter and more than doubled from a year ago. Looking at our non-optical communications business, automotive has grown to become the largest category with record revenue of $47 million in the second quarter, up 34% sequentially and more than 100% from a year ago. As Seamus mentioned, new automotive programs which include LIDAR saw strong growth and we continue to be optimistic in this market. Industrial laser revenue was $33.7 million, down about 1 percentage point from Q1. Sensor revenue was stable at $2.8 million and other non-optical communications revenue was up 5% to $22.5 million. Now turning to the details of our P&L. Unless otherwise noted, profitability metrics are on a non-GAAP basis. A reconciliation of GAAP to non-GAAP measures is included in our earnings press release and investor presentation, which you can find on our website. Gross margin was 12.1%, up from 12% in the prior quarter. This improvement was the result of our ongoing focus on manufacturing efficiencies and cost reductions. Operating expenses in the quarter were $12.8 million or 2.8% of revenue. This produced record operating income of $41.9 million or 9.2% of revenue. Taxes in the second quarter were $1 million and our normalized effective tax rate was 3%. Due to tax incentives at our Chonburi facility, which represents a growing portion of our profit, we now expect our effective tax rate to be about 4% for the year. Non-GAAP net income was also a record at $41.5 million or $1.10 per share. On a GAAP basis, net income was $35.4 million or $0.94 per diluted share. Turning to the balance sheet and cash flow statement. At the end of the second quarter, cash, restricted cash and investments were $488.6 million. Operating cash flow was an inflow of $6.8 million, a decrease from the prior quarter primarily due to increased working capital in support of our strong revenue growth. With CapEx of $10.1 million, free cash flow was an outflow of $3.3 million in the second quarter. As Seamus mentioned, we have already broken ground on a new building at our Chonburi campus. We expect incremental CapEx of approximately $50 million over an estimated 1.5-year construction period. This investment is in alignment with our capital allocation strategy to invest in our longer-term growth. During the quarter, we repurchased approximately 102,000 shares at an average price of $69.64 for a total cash outlay of $7.1 million. These repurchases are also consistent with our capital allocation strategy. At the end of the quarter, we had 93 million remaining in our share repurchase program. I would now like to turn to our guidance for the third quarter of fiscal year 2021. We are optimistic that the positive trends we have been experiencing will continue in the third quarter and we expect revenue growth across all key categories. We expect optical communication to grow sequentially. Telecom growth is being driven by continued demand for higher data rate products combined with the earlier than expected ramping of our Cisco transfer program. We also believe that datacom trends are becoming more positive and we anticipate modest growth in this area. In non-optical communications, we also anticipate sequential growth. We expect trends we have seen with new automotive programs will continue in the third quarter. We also anticipate industrial laser revenue to increase sequentially as well. We expect total revenue in the third quarter to be between $455 million and $475 million and EPS to be in the range of $1.10 to $1.17 per diluted share. In summary, we are pleased to deliver a record second quarter result and are optimistic that the third quarter will produce another record performance. We are excited with the growth from new programs in multiple areas coupled with our ability to expand margins. We continue to aggressively pursue new opportunities that will further our position and drive growing revenue and profitability and enhance long-term shareholder value. Operator, we are now ready to open the call for questions.
Operator, Operator
Thank you. Our first question is from Alex Henderson with Needham. Please go ahead with your question.
Alex Henderson, Analyst
Thanks, guys. So a couple of questions. So just a little off subject. I wanted to make sure that you didn't have any issues as a result of any of your customers getting penetrated with the SolarWinds hack and experienced lateral or did you have any issues with SolarWinds?
Seamus Grady, CEO
Hi Alex, this is Seamus. No, we did not have any issues. We were quite fortunate not to be hit by the SolarWinds issue. We're not aware of any impact to our customers. So we've been quite fortunate. We do have obviously very, very tight controls, but I think there is an element of good fortune as well. So, thankfully, we haven't been impacted.
Alex Henderson, Analyst
I'm glad to hear that. Thanks for answering that one. The second question I wanted to ask was really could you just tell me what the tax rate comment was because I couldn't understand you when you gave the tax guide.
Csaba Sverha, CFO
Hi Alex, this is Csaba. So basically what we are commenting on our tax rate, we are anticipating more and more profit coming from our Chonburi campus where we have tax incentives. So that's obviously driving our tax rate down.
Alex Henderson, Analyst
Yes, I know, but you gave guidance, I just couldn't hear the number.
Csaba Sverha, CFO
Sorry about that. That's about 4%.
Alex Henderson, Analyst
About 4%, thanks. The second question I wanted to ask is obviously Acacia and Cisco merger looks like it's going to get done. Does that have any impact on you and given that closure, would it change your trajectory at all?
Seamus Grady, CEO
Yes, so far we feel good about that relationship. I think in the past we've said if the deal went through or if the deal didn't go through, we didn't really have strong views frankly one way or the other. So we're happy to see the deal go through. We think it's good for both companies and we're very happy with obviously with our relationship there again with both companies, now Cisco. So no major impact from our point of view.
Alex Henderson, Analyst
And how about the Lumentum acquisition that was announced. Any impact to you from that one way or the other?
Seamus Grady, CEO
We have maintained a strong relationship with Lumentum for many years, and they have been one of our largest customers for an extended period. Coherent is also one of our customers, though they account for less than 10% of our business, and our collaboration with them has been primarily in the industrial laser sector. It's still too early to make any definitive statements; we haven't had discussions with either company regarding the acquisition at this point, but we remain optimistic. Given our long history with both Lumentum and Coherent, we believe that any effects from their combination will not be detrimental to us. Historically, we have often benefited from such business mergers, but it's still in the early stages.
Alex Henderson, Analyst
From what I understand, Rofin's manufacturing presence within Coherent is very widespread, and Lumentum mentioned that 65% of their synergies are coming from consolidating operations in Thailand. I believe that this should be a significant advantage for you, as it appears that Coherent was not progressing as swiftly as Lumentum plans to do.
Seamus Grady, CEO
Well, we'd certainly like to take that, but I'd point out we're not the only manufacturer in Thailand. We're not Lumentum's only manufacturer and of course, Lumentum has their own facility in Thailand too. So I certainly wouldn't want to speak on Lumentum's behalf, but we'll be doing everything we can to try and win our share of that business.
Alex Henderson, Analyst
I see. And then finally, if I could just go back to the comments on Cisco happening faster, just a last question. So does that mean that we should anticipate that coming on faster and therefore having less growth impact as we move into the back half of the year and get against as those comps and as we move forward or do you think that the fast move is actually going to incent them to continue to move more production over to you?
Seamus Grady, CEO
No, I think your first assumption is correct. It's really pulled everything in by about a quarter, but you know, the business is what it is, it's a business that we've moved from our competitor in Chonburi. That's the transfer that's about a quarter ahead of schedule, but it just means that the growth has accelerated, but it's not necessarily going to result in more revenue if that makes sense.
Alex Henderson, Analyst
Great, thank you. I appreciate your answers.
Seamus Grady, CEO
No problem. Thanks, Alex.
Operator, Operator
Thank you. Our next question comes from John Marchetti with Stifel. Your question please.
John Marchetti, Analyst
Thanks very much. Seamus, the announcement of the breaking ground on the new building in Chonburi. It sounds like it really got pulled forward a little bit for you and I'm curious if that's just a function of the Cisco business being completed from the transfer process a little bit ahead of schedule or if it's some of this new LIDAR strength that you've alluded to. Just curious because it does seem like a fairly big departure from where we were even just a quarter ago?
Seamus Grady, CEO
It's been in the works and under consideration for some time. We never wait until the previous factory is full; we act on the next one in anticipation of growth. Much of the recent growth has come from new customers we've added in Chonburi. The Cisco transfer is significant, and a large portion of the business we moved from Infinera in Berlin went to Chonburi. Additionally, many of our new automotive programs, especially LIDAR and laser lighting, have been directed to Chonburi. We're getting quite busy there, so it's the right time to move forward with the next building. We usually don't announce when we're going to do this until it happens, so it may seem like a surprise this quarter. However, we hadn’t specified exactly when we would plan to build the next facility. This decision reflects our optimism about the growth trajectory we are on, and the new building will have a much larger footprint than the last one.
John Marchetti, Analyst
Got it. And then, if I just think about the 100-gig, 400-gig split. We've been talking a little bit in these last several quarters about sort of some of the challenges you've had on the datacom side because of that transition. It seemed like it hit pretty strongly this quarter. Do you think that inflection point is behind you and I'm just curious as we're looking out going forward, is the expectation now that, that 400-gig plus revenue continues to scale up, but I guess how much risk is there that the 100-gig continues to decline at that kind of rate that we recently just saw?
Seamus Grady, CEO
Yes, it's an interesting one. I think we talked about our datacom revenue, we're guiding up on that. We expect it to increase a bit in Q3. And that's, just to remind, we're talking inside the data center. So for us, datacom is inside the data center. Outside the data center are biz and interconnect we categorize in telecom. We have seen, I would say a fairly strong transition from 100-gig products to let's say 200-gig and 400-gig inside the data center. We have a few customers there who have transitioned to 200-gig or 400-gig products. It started I would say two quarters ago and it's really beginning to accelerate now and our anticipated sequential growth in datacom comes from those customers who are really transitioning. And also, we talked in the past about that trade-off between price and volume. We think that the demand trends and the pricing are now more, if you like, more in equilibrium than they were in the past. So, we see the datacom business going up now. So yes, we think that inflection point is kind of, we're kind of in it or it's maybe slightly behind us at this point. We should see those higher data rates data center products start to ramp now.
John Marchetti, Analyst
Got it. And then, one last question for you all. Given some of the strength that you've recently shown in auto and how you're discussing it going forward, we've certainly been hearing about some supply constraints, particularly within that market vertical. Just curious if that's something we need to be aware of or consider as we look at that business strength continuing through the year.
Seamus Grady, CEO
Yes, it seems to be a recurring issue in our industry where we face supply challenges approximately every 1.5 to two years. These significant supply constraints affect all of us, and it has become part of our standard operating procedure to identify and secure these critical parts. We collaborate closely with our customers and supply chain partners to ensure we receive our fair share of parts. Like others have noted, we've experienced longer lead times, primarily related to our automotive business. However, we have accounted for this in our guidance and will continue to do so. While it is indeed a concern, we don't want to overemphasize it. Our focus is on securing the parts and working together with customers and suppliers, and as mentioned, we have incorporated this into our guidance.
John Marchetti, Analyst
Great, thanks very much.
Seamus Grady, CEO
Thanks, John.
Operator, Operator
Thank you. Our next question comes from Samik Chatterjee with J.P. Morgan. Your question please.
Joe Cardoso, Analyst
Hi guys, this is Joe Cardoso on for Samik. So my first question is a follow-up on the automotive question that was just asked. I guess relative to our expectation, automotive continues to outperform expectations and it sounds like the primary drivers LIDAR and then to a lesser degree the traditional business. I guess if we compare it to like 90 days ago or 180 days ago, has this demand kind of caught you guys by surprise as well and like what's really driving this demand for LIDAR specifically. Is this going into production vehicles? Any color there would be helpful?
Seamus Grady, CEO
The growth in automotive for us has come from a few areas, primarily LIDAR, as you pointed out, along with traditional automotive. We rely on our customers' 13-week rolling forecast, but unfortunately, we don't have specific insights into the applications our customers are planning for the LIDAR modules we produce and ship. This question is probably better directed to them. However, we are very pleased to be part of that supply chain and believe we are well-positioned to capitalize on the anticipated explosive growth in the LIDAR sector. We consider ourselves the strongest contract manufacturer in this area, but regarding the specific applications, we can't provide certainty.
Joe Cardoso, Analyst
Got it. No, that's fair. And then my second question is more of a clarification or confirmation. I believe in the past, this is related to the Chonburi build out. In the past, you've disclosed that roughly one plant equates to 550,000 square feet or $500 million of total revenue opportunity. So is it correct to think the new building will account for roughly $1 billion of revenue?
Seamus Grady, CEO
Yes, I mean the ballpark math would be correct, yes, but it really does depend on the mix. If for a given 10,000 square feet, it depends and if you're producing a very densely populated very small, physically small transceiver versus a big system that has a lot of air in it, the revenue mix would be different, but they are the numbers we've used in the past, roughly 550,000 square feet is about $0.5 billion revenue capacity. So yes, that's the correct assumption at this point.
Joe Cardoso, Analyst
Got it. Appreciate the insight, guys. Congrats on the quarter.
Seamus Grady, CEO
Thank you, Joe. Appreciate it.
Operator, Operator
Thank you. Our next question is from Tim Savageaux with Northland Capital. Please go ahead.
Tim Savageaux, Analyst
Hi, good afternoon and congrats on the results.
Seamus Grady, CEO
Thank you, Tim.
Tim Savageaux, Analyst
All right, I wanted to follow-up on the kind of capacity addition question because of the way you put it upfront, realizing that you may not have kind of telegraphed the timing of breaking ground. You did mention it was twice what the original plan was. So I guess when was that original plan developed and how recently did it change and why did it change?
Seamus Grady, CEO
When I look at the original plan, we always expected that what we referred to as Building 8 in Chonburi would be replicated in Building 9, even without much detailed consideration. As we moved closer to the decision, we realized there was a trade-off between size and cost per square foot; generally, larger buildings have a lower cost per square foot. So we decided the timing was right to invest more in capacity. Like much of our operations, this facility will have a larger proportion of clean room space compared to other contract manufacturers, which takes time to prepare. This decision was reached through an iterative process rather than a sudden event. We have plenty of land available, so space was never an issue. The consideration was mainly about how large we wanted the building to be while accommodating parking for employees and future growth. I hope that clarifies your question, Tim.
Tim Savageaux, Analyst
Not quite, but let me try one more thing and then I'll move on to a couple of more detailed questions which is, you mentioned a number of factors kind of driving current capacity at Chonburi. Cisco is ramping faster, but it's not ramping larger in magnitude, I would imagine. I think that's kind of what you said. So I guess I'm still looking for outside of parking spaces, what sort of opportunities may have arisen in the last quarter or two, assuming if I'm correct that Cisco is just happening quicker, but in terms of its overall contribution is about in line with expectations. Are there anything that you can point to that might have given you a sense that you could make use of greater capacity?
Seamus Grady, CEO
Sure, well, of course, the Cisco opportunity that I mentioned, it's ramping in line with our expectations that we had when we won that business, but Cisco is a very large company and we'd be very, very determined to make sure we continue to expand that relationship. Maybe the specific program that we're transferring it is what it is in terms of the size and scale of that program, but we've certainly been working very hard to make sure we win additional business from Cisco. So that's one opportunity. Then the other is, there are a lot of other system opportunities that we're pursuing. We've had some considerable success we think with Infinera and with Cisco, but there are a lot of other companies out there that we'll also be pursuing. In addition, our automotive business is growing and LIDAR is becoming a bigger share of the automotive business and then also, we want to be able to make sure we have capacity for the inevitable move towards increased outsourcing in the industrial laser market because again, we think that, that industry is very under-penetrated in terms of outsourcing. So it's really to position ourselves to be able to fulfill the pipeline of the existing business and new business that we have in the works.
Tim Savageaux, Analyst
Got it. Crystal clear. And while we're on Cisco realizing, there's probably a limited amount you can say, I mean you have indicated that it's ramped quicker than expected. I assume not to the magnitude where you'd have any additional 10% customers in the second quarter, but would you expect that, that could possibly be the case in Q3 or sometime in the second half of the year in terms of adding new kind of logos to that 10% list?
Seamus Grady, CEO
I believe we will disclose the 10% customer information at the end of the year. I remain optimistic that Infinera will become a 10% customer, and we anticipate that Cisco will also reach that status, and I think we are still on track for that. Beyond that, I would prefer not to make any predictions.
Tim Savageaux, Analyst
Fair enough. And last question from me, you did see a decline in silicon photonics revenue in the quarter after a couple of quarters of very strong growth, at least sequentially, which seems to marry up to some degree with the decline in datacom. Should we assume that, that headwind came more from the datacom side versus your other silicon photonic applications and higher data rates in telecom?
Csaba Sverha, CFO
Hi, Tim, this is Csaba. Yes, that's pretty much a fair assumption. We do believe that the datacom has bottomed out. So silicon photonics had also been impacted with that downward trend in the datacom and we anticipate the growth is going to come back in Q3.
Tim Savageaux, Analyst
Great, thanks very much, and congrats again.
Seamus Grady, CEO
Thank you, Tim.
Operator, Operator
Thank you. Our next question comes from Dave Kang with B. Riley. Your question please.
Dave Kang, Analyst
Thank you. Good afternoon. My first question is regarding 100-gig and 400-gig. Just wanted some additional color. So I think you said 100-gig declined 15% sequentially whereas 400-gig plus increased 50% sequentially. Is that correct?
Seamus Grady, CEO
Yes, that's correct.
Dave Kang, Analyst
Now, are you lumping both datacom and telecom there and if you are, then can you just provide some color between datacom and telecom?
Csaba Sverha, CFO
Yes, we do have datacom and telecom combined in both categories. We usually not break out by data rate our datacom and telecom business. However, we did mention that in the datacom space, we are anticipating the 200-G and 400-G take a little bit bigger market share from the revenue. However that's at this point is not meaningful. So the growth on 400-G is primarily in our telecom segment. And as a reminder, our data center interconnect is also categorized in that category, which was a strong driver there.
Dave Kang, Analyst
Got it. You mentioned that datacom appears to have hit its lowest point. The last peak was about nine or ten quarters ago, specifically in the first fiscal quarter of '19, when it reached approximately $109 million. Can we expect to return to that level, or how should we approach the next cycle?
Csaba Sverha, CFO
Since that time, we have observed significant price erosion, which is a main reason for our revenue decline, despite strong volumes in the datacom space. Several factors contributing to that revenue were primarily driven by price erosion and lower average selling prices. Looking ahead, we prefer not to speculate beyond one quarter. At this moment, I won't comment on whether we will return to that rate, but the ramp-up of 200G and 400G is driving higher average selling prices. It is fair to say that pricing follows a cyclical trend, and it should continue as it has over the past 18 months.
Dave Kang, Analyst
Got it. Lastly, what is the rough mix between LIDAR and traditional?
Csaba Sverha, CFO
We usually don't break that out in terms of traditional and LIDAR, particularly not on LIDAR. So when we talk about newer automotive, it does include LIDAR and other newer automotive programs as well for example, laser lightings and e-vehicle related business as well. So we are not breaking it out from traditional, but the growth came in the past quarter both from strong traditional and stronger newer automotive products.
Dave Kang, Analyst
Got it. Thank you.
Seamus Grady, CEO
Thank you, Dave.
Csaba Sverha, CFO
You're welcome.
Operator, Operator
Thank you. And our next question comes from Alex Henderson with Needham. Your question please.
Alex Henderson, Analyst
Great, thank you. Couple of follow-up questions. When we look at the automotive segment, is it concentrated in a few names that are achieving the bulk of that revenue or is it distributed across multiple manufacturers?
Seamus Grady, CEO
Our traditional automotive business involves a few key players, with Valeo being our primary customer, although they do not account for 10% of our revenue. They're significant to us in this sector. As for our newer automotive business, we've previously mentioned Velodyne. They were initially brought to Fabrinet West by the customer and later moved to Bangkok. We only named them as a customer after securing Valeo's agreement, possibly last quarter or the one before that. We also have a few other newer automotive customers, including companies involved in laser lighting and electric vehicles, as well as additional LIDAR and ADAS firms. Many of these companies prefer we keep their identities private until they are ready to disclose that information. However, we have a robust pipeline for new business, primarily on the newer automotive side, especially with LIDAR companies. There are many LIDAR companies emerging, and while not all will succeed, we aim to collaborate with those we believe have the best potential. Therefore, we have a strong pipeline of LIDAR firms, but we are not in a position to disclose their names at this time.
Alex Henderson, Analyst
Right. So these are predominantly people who are then selling to the large auto companies as opposed to directly to the auto companies themselves?
Seamus Grady, CEO
That's correct.
Alex Henderson, Analyst
Okay. Second question I had, when you do kick this manufacturing plant into production, should we anticipate the same kind of 10 basis point to 20 basis point pressure to gross margins. It's a fairly modest hit for gross margins relative to the impact when you turn the plant on still. Is that the right way to think about it?
Csaba Sverha, CFO
So obviously, there will be more of depreciation expense of the facility. So as anything, as we run the facility, the absorption should more than offset, but initially the depreciation expense will obviously put the pressure on our gross margin. Nevertheless, as we have always been driving efficiencies to offset the headwinds in the past, we will continue to do so to make sure that we stay within our gross margin range.
Alex Henderson, Analyst
I recall last time you turned up the new facility, it was about a 10 basis point to 20 basis point hit. The question would be, is this twice that because it's twice the size or should it still be that kind of magnitude?
Csaba Sverha, CFO
Well, if you think about it, the depreciation expense of a $50 million investment, if you do the math, I haven't done the exact math at this stage, but that's what you should think about in terms of gross margin headwind.
Alex Henderson, Analyst
Okay. And then I noticed one of the OEMs in the networking space finally launched a co-packaged product. Are you starting to see more interest in co-packaging and to what extent is that creating a new growth vector for you?
Seamus Grady, CEO
We are and I think for us co-packaged optics is inevitable given the increase in speed and bandwidth from the networking silicon. You know it's probably a couple of years out before it becomes, let's say, mainstream, but we're very firmly working with our customers on that. And for us, co-packaged optics for us is more of an evolution from what we've been doing with regard to silicon photonics over the last several years. So we're seeing it being a driver for us in the coming years. Nothing imminent, but certainly it will become, you know, it's inevitable is the move to co-packaged optics.
Alex Henderson, Analyst
And then finally, can you talk about the baht, obviously, it strengthened over the course of last year, but it was fairly stable I think in the last quarter. Can you remind us how you are hedged and to what extent do you expect any variance from that hedging program?
Csaba Sverha, CFO
So basically, there are two aspects of the baht situation and overall exchange rate situation. If you look at our income statement, we have had about $500,000 loss in the last quarter with a small gain in the prior quarter. That represents approximately $0.02 headwinds, but when we look at the broader FX trends, primarily U.S. dollar has been weakening in the last couple of months. Obviously, there are two effects, baht is appreciating, U.S. dollar is strengthening which is representing a headwind for us. So the hedging program we have in place is a layer hedge. We are 100% hedged for the next quarter, 50% hedged for the following quarter, and about 25% hedged three quarters out. So, if you look at the market trends, we have a pretty predictable estimate for the current quarter, but as we go on in the future, the current market situation will be reflected in our future results. So in Q2, because of that, we didn't really have a significant impact from the baht because of the hedging program. However, as you look out to Q3, the baht have strengthened somewhat in the last three, four months and that impact is going to start putting the pressure on our Q3 gross margins, which is baked in our guidance at this point.
Alex Henderson, Analyst
Would have been improving further or otherwise. Go ahead.
Csaba Sverha, CFO
That is correct. Our margin expansion will occur as we need to offset that headwind and enhance efficiencies.
Alex Henderson, Analyst
All right. Okay, that's all I had. Thanks.
Seamus Grady, CEO
Thanks, Alex.
Csaba Sverha, CFO
Thank you.
Operator, Operator
Thank you, ladies and gentlemen. This concludes today's conference call. Thank you for your participation, and you may now disconnect.