Earnings Call Transcript - FN Q3 2020

Operator, Operator

Good day ladies and gentlemen. Welcome to Fabrinet's Financial Results Conference Call for the Third Quarter of Fiscal Year 2020. At this time, all participants are in a listen-only mode. Later, we will conduct the question-and-answer session and instructions for 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, Investor Relations.

Garo Toomajanian, Investor Relations

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 third quarter of fiscal year 2020, which ended March 27, 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 includes 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 February 4, 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?

Seamus Grady, CEO

Thank you Garo, and good afternoon everyone. Before I discuss the details of our results, I would like to tell you about how we are handling COVID-19. We are very fortunate that COVID-19 has not impacted our ability to keep our factories running globally. Needless to say, we greatly appreciate the extraordinary efforts of our employees and their families, our suppliers, and of course, our customers for their continued dedication and hard work during this challenging time. We've taken great measures to ensure the safety of our employees and their families and we are pleased to report that we are operating at 100% capacity and that our employees are well. Extreme flexibility, decisive response to the crisis, excellent leadership and teamwork, together with excellent partnerships with our customers and suppliers helped us make immediate changes to our build schedules and operating protocols to meet the volatile demand resulting from the crisis. We came to know about the COVID-19 issues from our factory in China in late January. The information received from our staff during the Chinese New Year was very disconcerting as the virus was reported to be similar to the SARS virus of 2003. We immediately implemented all of the measures taken in our China factory across all of our factories starting the first week of February. We continued to enhance the measures as recommended by the CDC, the World Health Organization, local and federal governments of the regions where we operate as well as based on our own research on the subject. The measures include monitoring body temperatures of all people entering the factories, cutting down on visitors, banning visitors from regions heavily hit by the virus, mandatory social distancing, frequent washing of hands, wearing face masks, stopping large group meetings, providing disinfectant in all areas of the factories and special training of staff on the symptoms and precautions to be taken in the factory and at home. We encouraged staff to work from home where possible and mandated that all vulnerable staff work from home. By mid-February, we started disinfecting all material coming in to ensure it was virus-free before it was issued to the manufacturing lines. Despite the challenges we faced, we demonstrated the flexibility inherent in our business model to produce financial results that were within our guidance range in our fiscal third quarter with revenue of $411 million and non-GAAP net income of $0.92 per share. This nimbleness also enabled us to generate significant free cash flow. Looking at some of the details of the quarter, our high-level business mix was relatively consistent with our recent history, with 75% of revenue from optical communications and 25% from non-optical communications. Optical communications revenue of $309 million was down 4% from the second quarter, but up 3.5% from a year ago. Within optical communications, telecom revenue was $224 million, down 10% from the second quarter, but up 3% from a year ago, reflecting some inventory adjustments associated with certain next-generation programs. Datacom revenue of $85 million rebounded nicely and was up 14% from the second quarter and up 5% from a year ago. By technology, silicon photonics-based optical communications revenue increased 5%, both from the second quarter and from a year ago to $86 million and represented 21% of total revenue. Revenue from QSFP28 and QSFP56 transceivers also continued to grow and was up 7% from the second quarter and 17% from a year ago at $51 million, or 12% of total revenue. By data rate, 100-gig programs grew 1% from the second quarter and 10% from a year ago to $161 million. Products rated at speeds of 400-gig and above declined 41% from the second quarter but grew 25% from a year ago to $29 million. Looking at our non-optical communications business, revenue of $103 million was essentially flat from the second quarter and up 2% from a year ago. Demand for industrial lasers was also flat sequentially with revenue of $46 million. During the third quarter we reclassified certain revenue from other non-optical revenue to automotive to better represent the end market being served. As such, automotive revenue was $31 million and other revenue was $22 million. Excluding the impact of this reclassification, revenue from automotive and other non-optical revenue would have been consistent with the second quarter. Sensor revenue was $3 million. As we look to and beyond the fourth quarter it's clear that there is extraordinary uncertainty ahead. In light of this, I wanted to share some thoughts on how the COVID-19 crisis could impact our business going forward. On the one hand, with work-from-home protocols in place around the world, demand for internet bandwidth has grown substantially. Clearly, the next-generation telecom and datacom products we manufacture for our customers, which make up about three-quarters of our revenue are critical to expanding network capacity. This will continue to be a positive driver for Fabrinet. On the other hand, we could continue to see regional downward demand adjustments if outbreaks return. In addition, markets for other products we manufacture, such as industrial lasers and automotive are likely to see reduced demand in a prolonged economic downturn. Our approach toward managing, shifting customer demand remains unchanged. Our employee wellbeing remains our top priority, and that means we will continue to follow intense safety protocols at all of our facilities. At the same time, the availability of parts and materials we need to manufacture are likely to face variability. And we will continue to work closely with our customers and suppliers to identify solutions to satisfy our customers' demand. These supply chain constraints are the primary factor that has pressured our gross margin in the third quarter and will likely continue to do so in the foreseeable future until the COVID-19 impact settles down. Because of this, we now expect our gross margin to be in the range of 11.5% to 12% or slightly below our target range of 12% to 12.5% for the full year. And we could see this pressure continue into early fiscal 2021. Fortunately, our business model remains extremely resilient and agile. More than 90% of our costs are variable with components and materials making up the greatest portion of our costs. Because of this, we are able to quickly adjust manufacturing costs to manage changing demand dynamics. As such, we believe we can maintain industry-leading gross margin levels despite the demands churn and material availability challenges. From an operating expense perspective, we continue to be a very lean organization and do not foresee meaningful expansion of operating expenses in the near future. From a balance sheet perspective, we remain very well capitalized with over $465 million in cash and investments and total debt of approximately $55 million. In addition, we continue to generate significant cash flow and anticipate maintaining that position in the upcoming quarters. In summary, we're in a very dynamic business environment and our within guidance performance in the third quarter is a strong reflection of our resiliency and agility. This ability to quickly respond to shifting markets has been a part of Fabrinet's core strategy since our inception and its value becomes most apparent when the environment gets challenging. As such, we believe we are uniquely positioned to continue to thrive during and post the COVID-19 crisis. Now I'd like to turn the call over to Csaba for additional financial details and our fourth quarter guidance.

Csaba Sverha, CFO

Thank you, Seamus and good afternoon, everyone. I will provide you with more details on our financial results for the third quarter and our guidance for the fourth quarter of fiscal year 2020. Total revenue in the third quarter of fiscal year 2020 was $411.2 million within our guidance range and slightly below our record second quarter performance as anticipated. Recall that in our last call, our revenue guidance incorporated an $8 million to $10 million impact from COVID-19. During the quarter, we have demonstrated our extreme flexibility to produce financial results that were within our guidance changes even though the actual impact on revenue from the pandemic was $12 million to $15 million or $4 million to $5 million more than we originally anticipated. Non-GAAP net income was $0.92 per share, which was at the lower end of our guidance range, even after the greater-than-expected effects on both revenue and expenses that Seamus discussed. Now turning to the details of our P&L. 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. Seamus described a number of extraordinary efforts we are going through during COVID-19 to remain operational while also keeping our employees safe. Combined with the revenue impact, gross margin was below our target range at 11.2% in the third quarter. Non-GAAP operating expense was $12.2 million in the third quarter flat with Q2. As a result, non-GAAP operating income was $33.7 million and non-GAAP operating margin was 8.2%. Taxes in the third quarter were $1 million and our normalized effective tax rate was 2.4%. With revenue streams coming from more advantageous tax jurisdiction, we now expect our effective tax rate to be below 5% for the full year. Non-GAAP net income was $34.8 million in the third quarter or $0.92 per diluted share, as I indicated earlier. On a GAAP basis, which includes share-based compensation expenses and amortization of debt issuance costs, net income for the third quarter was $28.3 million or $0.75 per diluted share, also within our guidance range. Turning to the balance sheet and cash flow statement. At the end of the third quarter, cash, restricted cash and investments were $465.2 million, up from $450.5 million at the end of the second quarter. Operating cash flow in the quarter was $51.8 million. And with CapEx of $12.1 million, free cash flow was $29.8 million in the third quarter. On a year-to-date basis, operating cash flow was $104.4 million and free cash flow was $77 million. From a capital allocation perspective, we remain committed to returning value to shareholders and have been focused on opportunistically repurchasing shares in the open market as permitted. During the quarter, we repurchased 355,000 shares at an average price of $58.27 for a total cash outlay of $20.7 million. At the end of the quarter, we have $41.5 million remaining in our share repurchase program. We will continue to evaluate market conditions to opportunistically repurchase additional shares when possible. I would now like to turn to our guidance for the fourth quarter of fiscal year 2020. We believe that long-term growth trends are intact for the markets we serve and that the current environment in many respects highlight the importance of products we manufacture. That said, we are not immune from the broader factors that are impacting some of our customers and this is reflected in our revenue guidance, which calls for a sequential decline of 6% at the midpoint. At the same time, the market uncertainty is greater than we have seen in some time. As such, we are expanding our guidance ranges to reflect this. For the fourth quarter, we anticipate revenue to be in the range of $370 million to $400 million including a $25 million to $35 million impact from COVID-19-related uncertainties. We are also reflecting in our guidance an approximately $15 million impact as a result of an inventory correction from one of our customers. As you'd anticipate from the factors that impacted our gross margin in the third quarter, many of which will extend into upcoming quarters, we expect gross margin to be in the range of 11.5% to 12%, slightly below our target range of 12% to 12.5% for the full year of fiscal 2020. From an earnings perspective, we anticipate non-GAAP net income per share in the fourth quarter to be in the range of $0.80 to $0.92, and GAAP net income per share of $0.64 to $0.76 based on approximately 27.6 million of fully diluted shares outstanding. In conclusion, we are pleased to see our resilient business model work successfully at a volatile time. While we see the potential for even greater uncertainty ahead, our flexibility and agility leaves us well-positioned to protect our business during this pandemic. We believe we can exit the crisis in an even stronger position and continue to be optimistic about our prospects to deliver shareholder value over the longer term.

Operator, Operator

Thank you. Our first question comes from John Marchetti with Stifel. Your line is now open.

John Marchetti, Analyst

Thanks very much. Seamus I was wondering if you could talk a little bit as we're looking out here to your fourth quarter guide about how you see some of the different segments playing out here. Telecom clearly seemed to slow here a bit. You saw some uptick in datacom in the March quarter and then you talked a little bit about the weakness in lasers that may be likely. Just curious if you can give us some qualitative comments on what you're seeing out there across those three markets and what's kind of embedded in that guide for 4Q.

Seamus Grady, CEO

Yes, thanks John. I would say datacom continues to be quite resilient and strong. The global demand for bandwidth is even more evident now. The Fabrinet team on this call is participating from various locations around the world, highlighting that the demand for datacom products remains robust. Overall, telecom demand is solid as well. Although we experienced an inventory correction this quarter, we believe that underlying demand remains quite resilient. In terms of industrial and automotive sectors, particularly automotive, demand for our automotive products is expected to remain soft for a while since car sales have declined. Industrial lasers also seem to be flat, influenced by the post-COVID economic environment. If the world economy picks up again, we have strong customers and valuable products for them. Overall, datacom appears strong, while telecom also has solid fundamentals despite the inventory correction with one of our customers. However, automotive will continue to be challenging for the next few quarters, and we expect industrial lasers to be slightly flat. On a positive note, optical communications products, which are performing well, account for 75% of our revenue, ensuring continued strength in this major segment.

John Marchetti, Analyst

And then Seamus if I can just follow-up on that inventory correction. You mentioned the $15 million hit to the fourth quarter guide. What was it in the actual third quarter? And did it relate to some issues with older inventory that wasn't able to be eaten up? Did it have anything to do with some of the new systems-level stuff that's been transferred over? Just curious if you can give us some additional color there. Thank you.

Seamus Grady, CEO

Yes, we're not going to provide the specific number for the inventory correction in Q3. There are several factors at play. We've accounted for the impact of COVID, which affected the availability of certain parts. We experienced some turnover due to a decrease in demand for specific products, which was offset by an increase in demand for others. The inventory correction you mentioned was included in our guidance earlier in the quarter, so we were aware of it. This situation is primarily due to a customer with excess finished goods inventory that they need to reduce. When they are working through their surplus, it means they don't need to order as much of our new products. Overall, we don't perceive this as indicative of a long-term trend. These fluctuations occur from time to time. Demand can surge significantly and then drop, requiring adjustments. It’s important to note that when inventory accumulates over several quarters, correcting it takes more than one quarter. Therefore, this is mainly an inventory correction with one specific customer, rather than a broader industry trend.

John Marchetti, Analyst

Thank you.

Seamus Grady, CEO

You're welcome, John.

Operator, Operator

Thank you. Our next question comes from Troy Jensen with Piper. Your line is now open.

Troy Jensen, Analyst

First off congrats on the nice results gentlemen.

Seamus Grady, CEO

Thank you, Troy.

Troy Jensen, Analyst

Seamus, maybe for you or Csaba. I guess, can you talk about customer concentration 10%? I guess, I would love to get an update on Infinera and how the Coriant business is stacked up and then maybe Cisco the new project you guys talked about and then the Acacia business?

Seamus Grady, CEO

There were a lot of questions there regarding customer concentration. As we indicated throughout the year, we expect to have more than one customer contributing 10% of our revenue, and we believe we are still on track to achieve that. The transition of the Infinera and Coriant businesses has gone very well, and we are successfully ramping those products, as well as others that are being transferred to us from different contract manufacturers. The transfer with Cisco is still in the planning stages, and we do not anticipate any significant revenue from that in Q3. We expect the transition to unfold over the next six to nine months, which will take a bit longer than the one we had with Berlin due to the urgency of that situation. Regarding Acacia, we continue to be a key supplier, and we are pleased with that relationship. However, for details on whether Acacia will be considered a 10% customer, you will need to wait for our Q4 call. Overall, we are happy with all our customers and feel optimistic about reporting a reduction in customer concentration and potentially more than one 10% customer in our upcoming Q4 results.

Troy Jensen, Analyst

Great. Okay. Perfect. And then Seamus, I dropped off for a bit. So I'm sorry, if this was addressed. But the 400G business, did you say it was down 41% sequentially? And could you just touch on that?

Seamus Grady, CEO

It was. I believe the comments regarding the 400G reduction and the inventory correction stem from similar causes. We don't notice any significant overall trend. Demand for newer programs can be quite unpredictable, with occasional spikes for next-generation products that might decline and then emerge again a few quarters later. So we don't see this as representative of any overall trend. Yes, there was a reduction of 41% in 400G.

Troy Jensen, Analyst

All right. Last one for me and I'll cede the floor. But you mentioned datacom being strong. Just curious, is it across all product segments in datacom or QSFP28, QSFP56 stronger than others?

Seamus Grady, CEO

Yes, it's across multiple product lines. I think the demand for bandwidth is going to drive a lot of demand. At the same time, we've heard that some of the major hyperscale companies have reported a decline in their ad revenue due to people working from home. This may soften demand, but so far, we’ve seen it hold up quite strongly. We're not the best at predicting macro trends; we mainly rely on customer forecasts. However, the overall sense is that demand remains strong. Our silicon photonics business increased by 5% from the second quarter and is up nearly 21% in revenue. Additionally, QSFP28 and QSFP56 grew by 7% from the second quarter and 17% from a year ago to about 12%. The 100-gig products continue to perform very well. Regarding 400-gig, when developing new next-generation products, demand looks very good over an extended period, although we do experience some intra-quarter fluctuations. Overall, we believe datacom remains quite strong.

Troy Jensen, Analyst

All right. Well, understood and good luck, gentlemen.

Seamus Grady, CEO

Thank you. Thank you, Troy.

Operator, Operator

Thank you. Our next question comes from Alex Henderson with Needham. Your line is now open.

Alex Henderson, Analyst

Thanks. So if you were able to get all the parts that you needed and you didn't have production issues, would the revenue guidance and the fact the most recent printed quarter have been higher? Or in other words, is the demand outstripping capacity and ability to procure?

Seamus Grady, CEO

Yes, overall, if you review our recently completed quarter, we reported $411 million, which factored in the customer inventory correction we discussed. We anticipated an impact of about $8 million to $10 million from COVID, which turned out to be slightly higher. The actual impact was between $12 million and $15 million. If you add this to the $411 million plus an additional $5 million from COVID, the total would be approximately $416 million. Within that figure, there was significant churn, meaning that certain SKUs were no longer necessary while others needed new parts. For the upcoming quarter, we have guided a revenue range of $370 million to $400 million. Calculating the midpoint gives us $385 million, and with a COVID impact of $25 million to $35 million, the midpoint of that is $30 million. Additionally, we've estimated the inventory correction to be around $15 million. Therefore, taking the midpoint of our guidance along with the midpoints for the COVID impact and inventory correction, we would be looking at about $430 million. Demand is strong, but it largely hinges on our capacity to acquire the necessary parts. We have great confidence in our team, customers, and suppliers to do what is needed to meet demand.

Alex Henderson, Analyst

Right. So I just wanted to make sure that that was all supply chain and not demand related. And I think you were pretty clear on that. The second question is the inventory correction, is that exclusively in the telco side of the business?

Seamus Grady, CEO

Yes.

Alex Henderson, Analyst

And once we clear that inventory out, should we assume then that the normalized rate of demand would be in fact that $25 million to $35 million higher, and therefore, looking out sequentially into the back half of the calendar year that kind of the baseline is what you report plus that inventory correction? I mean, to be blunt about it, virtually every other company that's printed so far whether it's MACOM, whether it's Inphi, whether it's Acacia this afternoon after the close, whether it's NeoPhotonics have seen much stronger numbers than you're guiding towards.

Seamus Grady, CEO

Yeah. I think that's a fair assessment Alex. You'd be in the ballpark with the assumptions you made there. It's an inventory correction again where our customer has built up maybe a little bit more inventory than they'd like. But it's the right thing for them to do. They should burn off what they have before they order new, which is just that we have this one quarter. And we do think it's a one quarter, we don't believe it's going to drag on. We do expect it to get back to normal levels in the September quarter and beyond.

Alex Henderson, Analyst

One more question if I could. Clearly the economic situation in Thailand has changed quite dramatically. I think you've gone from probably the strongest currency in that region to probably one of the weakest ones over the last three months. Can you talk a little bit about how you expect that to play out through your numbers? Shouldn't that be a pretty nice offset to some of the costs as we get into the back half of the year? It sounds like it probably will cause your margins to improve beyond the guide for this year. Is that the way to think about it?

Csaba Sverha, CFO

Yeah, hi, Alex this is Csaba. I'll take this question. So let me answer with the three aspects that we are seeing in the Thai baht devaluation. So, obviously, one of the things is the market-driven devaluation of Thai baht, which we have started to see starting from February. The other aspect of that is our hedging policy that, as we have communicated, we are usually entering in a quarter, with 100% hedged for the current quarter, 50% hedged for the next quarter, and 25% hedged in that situation for the following quarter. And also, the third factor is our hedge accounting that we have implemented this quarter. So all these three factors are – if you look at our Q3 numbers, we pretty much eliminated the exchange rate impact from Thailand this quarter by the sheer nature of hedging in place. So therefore in the March quarter, we haven't seen any significant impact from the currency devaluation. And also, as we are looking into our Q4, as we have had pretty much 50% hedged the situation by the time we started off this quarter, we will not see significant tailwinds from Thai baht this quarter. Obviously, we are buying forward the contracts every week. So we anticipate to see meaningful impacts from our fiscal Q1 2021.

Alex Henderson, Analyst

Right. And just one last question on the tax line, I was a little confused. You said – you gave the full year tax commentary being below 5%. But, are you also looking for the fourth quarter to be below 5%? I think it was obviously well below that in the March quarter.

Csaba Sverha, CFO

So, our March quarter has been about 2.4%. It has to do with our revenue from the different tax restrictions. So, we anticipate this to go up back in normal situation for Q4. But the overall tax rate for the year, we anticipate to still stay below 5%.

Alex Henderson, Analyst

So, it ought to be in the 5% to 6% range in the June quarter then?

Csaba Sverha, CFO

It's going to be below the 5% range, I would say.

Alex Henderson, Analyst

Okay. I got it. Thanks.

Csaba Sverha, CFO

Thanks, Alex.

Operator, Operator

Our next question comes from Samik Chatterjee with JPMorgan. Your line is now open.

Joe Cardoso, Analyst

Hi, guys. This is Joe Cardoso on for Samik Chatterjee. My first question, I was just curious to see what you guys – your expectation and/or visibility was relative to recoveries across the different markets that you play in?

Seamus Grady, CEO

Hi, Joe, I think as we talked about earlier, I think the markets remain pretty strong. The markets we serve are – remain pretty resilient. We think datacom is remaining resilient. We think telecom is resilient, albeit with one inventory correction that we've called out. Aside from that, we see it being pretty resilient. Industrial lasers we think is still pretty strong, but it's just probably a little bit flat based on the macro situation. And then automotive, who knows I suppose when that will recover. But it's a small part of our overall revenue. But I think automotive is going to continue to be impacted for a while until global economies open up again. So I would say the majority of the markets we serve, we feel very good about. We feel the demand is strong. We have – we're in the right – we're serving the right industries and we think we have just the best customers in those industries. So we're pretty – touch wood, we're feeling pretty confident, Joe.

Joe Cardoso, Analyst

Got it. And then just relative to the headwinds you're baking in for COVID and the inventory corrections you gave us the top line number. What are you guys expecting in terms of an EPS headwind there?

Seamus Grady, CEO

We've guided the EPS. I'll let Csaba – we've guided the EPS. We've quantified the revenue impact, let's say for COVID and inventory corrections. We're not going to break out let's say the EPS impact for COVID, or anything like that. It's a pretty dynamic – it would become a kind of a meaningless number, Joe to be honest with you, because we have a lot of challenges that, we just have to deal with in terms of changing demand the churn, we talked about, and also the component supply situation and the expenses we incur to continue to maintain – to keep all of our employees safe, which is our first priority. So there are several elements to it, if you like. There's mix. There's component supply constraints, we have to deal with. And then there's the expenses of keeping all our employees safe. But we haven't broken out, and we don't plan to break out, let's say the EPS impact of COVID. Csaba, anything you want to add to that?

Csaba Sverha, CFO

No. I think you summarized it very well, Seamus. So Joe, obviously, when we have put together our guidance, it's obviously incorporating the impact not only on the top line but on the EPS as well. So that's our guidance reflecting the revenue range, which obviously have a consequence on the EPS as well which is included in our guidance.

Joe Cardoso, Analyst

I understand, and I have one final question. Regarding share repurchases, you spent around $20 million this quarter. I'm curious if this was mainly influenced by the overall market conditions and a more opportunistic approach by the company, or if you view this as a potential strategy to enhance shareholder value in the future.

Seamus Grady, CEO

I would say it's both. As part of our capital allocation strategy, we were opportunistic this past quarter when we saw the share price and felt it was a good time to repurchase some shares. We're subject to open window constraints, but we believed it was a good moment to take action. We are committed to returning value to our shareholders, and share repurchase is a key element of that strategy. Whether we will continue this practice remains to be seen, as we do not preannounce our decisions but rather share updates after the fact. Currently, we have about $42 million remaining in our share repurchase authorization as we enter this quarter.

Csaba Sverha, CFO

Yeah. Yeah, we have $41.5 million.

Seamus Grady, CEO

Okay.

Joe Cardoso, Analyst

Thanks, guys.

Seamus Grady, CEO

Thanks, Joe.

Csaba Sverha, CFO

Thank you, Joe.

Operator, Operator

Thank you. Our next question comes from Tim Savageaux with Northland Capital Markets. Your line is now open.

Tim Savageaux, Analyst

Hi. Good afternoon.

Seamus Grady, CEO

Hi, Tim.

Tim Savageaux, Analyst

I have a couple of questions. Hi, Seamus. Regarding the inventory correction you mentioned being factored into your outlook for March, I have two inquiries. First, can I assume that this is reflected in the decline in revenue from 400-gig and above in the quarter to some extent? Second, concerning the outlook for June, is it that this might take longer than you initially expected, or is it that it will develop into a larger headwind throughout the quarter? How do you compare your current outlook on this to when you previously guided in the last quarter?

Seamus Grady, CEO

I believe you are correct, Tim, in identifying the 400-gig and above revenue as a key factor last quarter. For this quarter, I don't think the situation will extend beyond what we anticipate. It's quite uncommon for a customer to go through an inventory correction, and as you know, inventory accumulates over time. Correcting excess or surplus inventory requires some time. In this particular case, the customer is taking a couple of quarters to reduce their surplus inventory, which is actually beneficial for their overall health and strength. From our conversations with the customer, we understand it's a two-quarter issue. So, you can see the impact from last quarter, and for this quarter, we've estimated it will affect us by around $15 million. We expect to return to normal business levels with that customer by the September quarter, and we do not foresee this issue extending beyond the June quarter.

Tim Savageaux, Analyst

Understood. I want to revisit your thoughts on the pandemic's impact. You mentioned ongoing strength in demand for datacom. Should we interpret this as an expectation for an increase in datacom revenues? Or are you attributing the supply chain effects you mentioned across segments based on their previous performance? Additionally, I suspect there is some actual economic or virus-related decline in demand in sectors like automotive and potentially others, where you might typically see demand. Therefore, I'm trying to differentiate between the impacts driven by supply constraints and what you consider to be genuine demand issues in the $25 million to $35 million range.

Seamus Grady, CEO

I would say most of the COVID impact we've mentioned is related to supply rather than demand disruptions. The only significant demand disruption we've observed is in the automotive sector, which represents a small portion of our revenue. Beyond that, we haven't really experienced any major demand issues; it’s mostly linked to supply constraints. In some instances, these supply constraints arise from shifts in demand where we plan to produce specific products for a customer, only to pivot and build other products. Consequently, we face challenges in sourcing the necessary parts and components. However, the underlying demand remains quite strong. If I had to break it down, the bulk of the COVID impact we've noted this quarter is largely due to supply-related issues, which pose our biggest challenge. The two main concerns for me are whether we can procure all the parts needed to meet customer demands and how we ensure the safety of our employees. Those are the major challenges we anticipate for the foreseeable future until COVID is behind us. The impact of component shortages is unprecedented. Unlike past situations, such as MLCC or DRAM shortages, this is fundamentally different. It stems mainly from lockdowns in certain countries where suppliers must operate at reduced capacity or enforce social distancing, limiting their workforce. This means it takes time for suppliers to adjust, including adding shifts or working weekends to boost their output. Additionally, this issue spans across many commodities and is not confined to a single one. Yes, the challenges are significant this quarter, but that’s why we are here—to address these problems.

Tim Savageaux, Analyst

Got it. If I could squeeze in one last follow-up. I wonder if the overall logistical issues contribute to the challenges in onboarding Cisco and whether you still expect that they could represent above 10% of your customer base in fiscal 2021.

Seamus Grady, CEO

Generally, we don't discuss specific customers. Regarding the Cisco transfer, I hope it won't be a 10% impact because we are dealing with existing products that are already being manufactured by another supplier. The supply chain is already set up; this isn't a completely new product that requires establishing a new supply chain. It's a well-established family of products. We are quite optimistic about onboarding that business, though it will take about 6 to 9 months. The end of the calendar year appears to be a reasonable estimate for timing. We'll have to see whether Cisco will become a 10% customer. However, we are pleased with our efforts to diversify our customer base. Lumentum remains our top customer and will continue to be for a while. Other contenders include Infinera, Cisco, and Acacia, which is also a significant customer for us. We are satisfied with how we are broadening our customer mix.

Tim Savageaux, Analyst

Okay. Thank you.

Seamus Grady, CEO

Thank you, Tim.

Operator, Operator

Thank you. I'm not showing any further questions at this time. I would now like to turn the call back over to Seamus Grady for closing remarks.

Seamus Grady, CEO

Thank you, operator. Thank you all for joining our call today. We're pleased to have met our guidance in the third quarter during a very dynamic business environment. Our success is a direct reflection of our core strategy to operate a very agile and flexible business that lets us respond very quickly to shifting environments and we look forward to speaking with you again in the future. Until then, goodbye and stay safe. Thank you.

Operator, Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.