Alliance Fiber Optic Products Inc Q3 2008 Earnings Call Transcript

Alliance Fiber Optic Products Inc. (AFOP)

Q3 2008 Earnings Call

October 22, 2008; 04:30 pm ET

Executives

Peter Chang - President and Chief Executive Officer

David Hubbard - Vice President of Sales and Marketing

Analysts

Manoj Nadkarni - ChipInvestor Group

Stephen Votinghous - Private Investor

Jeff Paddock - Private Investor

Michael Burch - Kennedy Capital

Presentation

Operator

Good afternoon and welcome to the Alliance Fiber Optic Products Incorporated third quarter 2008 conference call. Thank you for joining us on today’s conference call to discuss AFOP’s third quarter 2008 financial results. This call is also being webcast by accessing on the Investor Relations page at www.afop.com and a replay will be available for one week by dialing 877-660-6853 and providing the account number 286 and the conference ID 299032.

Today’s call is being hosted by Peter Chang, President and Chief Executive Officer and David Hubbard, Vice President of Sales and Marketing.

 

Before I turn the call over to Mr. Chang, I’d like to make the following Safe Harbor statements. During the course of this conference call, Peter or David may discuss expectations and make projections or other forward-looking statements as to the company’s ability to improve financial results, focus on cost control and operational efficiency, develop products and technologies that customers desire, make prudent R&D investments, the features and benefits of the company’s products, market opportunities and the company’s future prospects.

We would like to caution participants that these statements and all other statements made by management on this call that are not historical facts involve a number of risks and uncertainties that could cause actual results to differ materially, including but not limited to general economic conditions and trends, the impact of competitive products and pricing, timely design acceptance by our customers, the level of order cancellations, the need for and magnitude of future inventory write-downs or impairment charges, timely introduction of new technologies, ability to develop new products and to ramp new products in the volume production, industry wide shift in supply and demand for optical components and modules, industry over capacity, failure of cost control initiatives, financial ability in foreign markets and other risks detailed in our SEC reports including AFOP’s most recent Form 10K for the quarter ended June 30, 2008.

 

These forward-looking statements speak only as of the date hereof. AFOP disclaims any intention or obligation to update or revise any forward-looking statements. Now, I would like to turn the call over to Mr. Peter Chang, President and CEO of AFOP.

Peter Chang

Thank you operator. Today I’m pleased to announce that our third quarter sales exceeded the guidance given in our previous conference call and the third quarter of 2008 set another record quarterly financial performance for AFOP. Our Q3 sales represent the sixth sequential revenue growth quarter. In addition to the significant revenue growth AFOP generated record quarterly profits, both operating profit and net profit.

In today’s conference call, I would first summarize our overall results and then David with review the quarter by product and region. Following that, I will go into more details on the financials and end it with our forward guidance.

In our overall financial results, revenues totaled $10.8 million in the third quarter which represents an 18% increase from the year ago quarter and 5% sequential growth over Q2 2008. We achieved operating profit and net profit of $1,046,000 and $1,345,000, respectively, improved significantly from the year ago quarter, with great appreciations to our valued customers.

I am also again very proud of AFOP employees who are consistently making progress and delivering such solid financial results at a competitively modest revenue levels we see in our peer groups.

Now, let me turn the call over to David to go over the progress we made in each product area in more details. David please.

David Hubbard

Thank you, Peter. This third quarter of 2008 came in consistent with our targets and strategies in several areas. With continued strength in most product lines we saw increases again in multi fiber assembly products for our data center applications. These products are clearly establishing a long term trend in redefining data center architecture and AFOP has its share of success with this more advanced interconnect technology.

Overall, connectivity products contributed well to the overall growth this quarter. We also saw continued growth in our filter lines in both telecom and CATV applications. Sales into Fiber-to-the-Home were on par with last quarter with some new projects emerging in Europe currently.

In the U.S., we believe Verizon FiOS will continue to deploy over the next several quarters and offer even some new product opportunities as well, as they continue their roll out in urban centers like New York City.

Let me review the products in a little more detail. The connectivity products, sales overall were up again over the two previous quarters. Much of the growth came from stronger than expected sales of our multi-fiber data center product line as mentioned and increases in total connector sales, as well. We continue to see strong demand in this segment from established premise and data center segment customers.

In addition, we were fortunate to be selected by Google for a sizeable global data center project. This involves some innovative cabling solutions from AFOP and while this program has mostly been executed we expect to participate with Google in the future as their special projects demand.

AFOP connectivity products for telecom systems and broadband markets remained in line with the previous quarter. We see continued movement towards 10G cable, fiber networks demands and overall we believe fiber is growing relative to copper as the medium for networking in the enterprise. Recent announcements in the industry regarding 100 gigabit Ethernet requirements and standards are encouraging and AFOP will be on the leading edge of facilitating this migration to higher performance levels in data networking applications.

 

For passive products, the lines were up to a new record level for Q3 and showed a year-over-year growth. CWM sales were a strong driver again as we continued shipments into several OEM’s in both telecom and broadband access markets. We anticipate continued growth of CWM revenue through 2008 and into 2009. FWDM sales grew as well as we saw increased demand from key telecom customers like Alcatel-Lucent for Fiber-to-Home applications. Verizon’s demand on FWDM remained steady as they continued to roll out the BIOS network.

 

As mentioned on our last call, we are also supported with our product development efforts advances in GPON technology to bring about WDM-PON and similar network advances towards 100 gigabit Ethernet. We see the next generation of networking providing demands for multiple AFOP product lines with the potential for increasing margins. As next generation platforms, based on WDM take hold, AFOP will be developing advances in our passive product line to take advantage of these opportunities.

Overall sales of our fiber-to-home specific products across connectivity and passive product lines grew relative to the year ago quarter. We see continued movement towards large scale deployments outside of Verizon in several areas of the world. In these international applications, there are new product configurations that are being requested and AFOP design experience is helping to secure future opportunities in this expanding field.

As mentioned last quarter, AFOP has developed an initial set of enclosure products for Verizon to serve NDU application for distributed architecture optical splitter. These products are currently under test and we expect to begin selling when we receive approval.

As Fiber-to-Home installations continue to rise globally, we believe AFOP is well positioned and regarded as an established solution provider in this market. We are now working on new product developments to expand and growth that position. We believe these investments in new products will generate upside growth potential over the next several years.

Now with respect to our customers during the third quarter Google, Cisco and LeBrun came in as our near 10% customers with Google joining the group for the first time this quarter. Our top ten list of major customers lead in their segments and we believe on AFOP ongoing growth potential as we increase share and develop new product solutions to meet their emerging requirements. As well, our top customers represent a broad-based coverage of communication market segment which strengthens our insight into broad industry trends and also mitigates the risk of too heavy a concentration in a single market segment during difficult economic periods.

From a geographic standpoint, Q3 sales in North America were up strongly with an increase in data center sales and sales for Google in particular. Asia was lower, while Europe saw growth coming from increases in CWM sales particularly. We believe that with our major customer’s strong position in their markets and the global demand for increased bandwidth services continuing to grow, we can be optimistic about achieving ongoing revenue streams in all geographies we serve.

Now, let me turn the call back to Peter to review our financial performance and forward guidance.

Peter Chang

In the third quarter 2008, once again we achieved great financial results; for the revenue for Q3 is another record at $10,829,000, an increase of 18% when compared to the year ago quarter and a 5% potential increase from the previous quarter. This is 20^th consecutive quarter with quarterly revenue growth on a year-over-year basis.

So far, for the first nine months of 2008, AFOP has produced 24% growth over the same period of last year. Gross margin come in at 31.6%, improved from the previous quarter. We have been achieving over 31% gross margin for the last seven quarters. With such a stable gross margin, we have achieved net profit of $1,345,000 in Q3 ‘08, a record quarterly profit in AFOP financial history. This represents over 12% in net profit margin in the quarter. This is the 10^th consecutive quarter where AFOP has delivered a profitable bottom line.

 

Earnings per-share is $0.03, same as the previous quarters. Included in the net profit calculation is $34,000 in stock based compensation expenses from the implementation of in part 123(R). In addition to the net profit, AFOP’s operating profit in Q3 also improved significantly from a year ago quarter. Operating profit of $1,046,000 is a significant improvement over operating profit of $630,000 for a year ago quarter. Above all, this is the first time we achieved a 10% operating profit margin on a non-GAAP basis since AFOP went public.

 

On the nine month basis, our operating profits have increased to $2.4 million and have produced 139% growth over the same period last year. Our operating expenses were for the third quarter of 2008, were lower than the previous quarter.

We continued incurring high R&D expenses because of the new product development and the customer-related activities which we believe would bring new business to AFOP in the future and represents AFOP’s commitment in continuously investing in new technology and the better product solution for our customers. In the coming quarter, we expect overall operating expenses to be in the similar range as the last few quarters.

 

Turning to the balance sheet; DSO - Days Sales Outstanding was 52 days for Q3 as compared to 57 days in Q2 ‘08. Inventory for Q3 was $6.4 million higher than Q2 levels. Inventory returns for Q3 decreased to $4.6 as compared to $4.7 in Q2 ‘08. Higher inventory is due to growing business and the new vendor management inventory also called VMI requirements by major customers. Looking ahead, we anticipate that our inventory levels will remain flat over the other higher in Q4 in support of the growing demands from our customers in the future quarters.

Regarding our total net cash balance, including long term investment on September 30, 2008, our cash level was increased by $1,757,000 and ended with $38.2 million. Included in this increase, there was an adjustment of $381,000 reduction on auction rate security related to long term investment in the end of Q3.

The total accumulated value reduction on our AIS long-term investment after the adoption of FAS 157 since January 4, 2008, is about $1.3 million and during the quarter with dividend also from UBS for payment of our AIS investment to its par value starting on June 30 2010, we keep working on AIS issue diligently to protect our legitimate right. In the meantime, we continue to encourage virtually all our auction rate security instruments.

 

As to the net cash balance in the end of next quarter, as always we continue investing in major areas of opportunities. We anticipate our net cash balance will increase assuming favorable AR/AP and anticipated inventory levels.

 

Now looking ahead, although the overall markets have been slowing with severe economic conditions recently and our business outlook will become conservative for the short term, we are optimistic about the demands from our customer base in the long term. With currently available information we are confident in delivering once again a record year for AFOP in both sales and the profit as fiscal year 2008 concludes.

We expect the gross margin will be in the similar range assuming our favorable product mix, stable pricing and the continuation of the efficient improvements in our Asia operation. In addition, we expect to generate additional net cash gains from our operating activities during the quarter.

Now I’d like to turn the call back to the operator for the Q-and-A session.

Question-and-Answer Session

Operator

 

(Operator Instructions) Our first question comes from Manoj Nadkarni - ChipInvestor Group.

Manoj Nadkarni - ChipInvestor Group

Can we talk more about different markets and product segments where you are seeing strength? You already talked about connectivity products in data center and the Google project that’s going on. Can you give some more color in that regard and also maybe talk a little more on what you see with FTTX in the US and overseas.

David Hubbard

Yes sure we’ll try to do that. If it’s a specific question may I can address it in a particular market; where do you like me to start?

 

Manoj Nadkarni - Chip Investor Group

In the connectivity products, where are you seeing strength product wise and geography wise?

David Hubbard

Connectivity has been strong in data centers, as I said which is in enterprise markets predominantly and we see that remaining is strong across many products. So we have the cable assemblies like I mentioned, multi fiber products, but also connector products that serve that market place.

 

Manoj Nadkarni - Chip Investor Group

You said the Google project was complete. Is it an ongoing thing or do you anticipate more projects like these?

David Hubbard

They had large scale project which took them over several months of deployment. Our understanding is that they should have additional demands for that configuration in the future, but they don’t have a pinpoint timing line at the moment.

 

Manoj Nadkarni - Chip Investor Group

And in the FTTX space, Verizon’s files, they have introduced it in New York City and also I think on the west coast at a few locations here. What are your expectations as far as growth in the United States?

David Hubbard

Well we just asked that question directly at Verizon because they just had some conferences and everybody from Verizon perspective is saying that they are continuing their plan to roll out roughly 3 million subscribers per year to complete their -- I think their trajectory was to get to 18 million subscribers, before they started doing any ratcheting down. So that is going to carry us for at least another couple of years.

 

Manoj Nadkarni - Chip Investor Group

 

Okay, and so 3 million subscriber rate, how does that translate to growth? Is it 20%, 30% growth annually or is it more than that?

David Hubbard

Well I think they hit that rate in 2008. I think that they’ll try to show they concluded 3 million, but it changes depending on where they do that 3 million. If they do it in cities, then it has some kind of configuration of products. If they it world, it’s probably more stable and more individual boxes to do it world. Right now they are doing urban, so there’s a lot of new products that are designed specifically for these multiple dwelling units.

 

Manoj Nadkarni - Chip Investor Group

 

If I may ask, are you one of the primary suppliers for the products you offer to them or do you have any --?

David Hubbard

We are currently considered what is the Tier-2 supplier. We supply products to customers that are selling into Verizon directly and we did receive a contract as a Tier-1 for this new enclosure product, but we haven’t begun shipping that yet.

Manoj Nadkarni - Chip Investor Group

Okay, and in terms of the FTTX, what do you expect or what are you seeing in Europe and Asia Pacific say Korea, Japan, China; are there any soft spots or are there any hard spots? Where do you see growth coming from?

David Hubbard

Japan has always been a strong market for Fiber-to-the-Home. Europe has a number of different initiatives and real programs going in and Asia. There’s a lot of countries in the world. There are hundreds of countries in the world. I’d say a fair number of them are looking at this fiber-to-the-home subject now or some are deploying already and some have large scale projects planned.

Manoj Nadkarni - Chip Investor Group

Do you expect, like the kind of penetration Fiber-to-the-Home has in Korea. Would you expect that kind of penetration in the other countries including the U.S. in the next three, four years?

David Hubbard

I think that each country has a different answer, so we can get into a long discussion and maybe some time that’s fine. For the purpose of this call, let me just say that Korea was very ambitious and had a very strong program, but when you talk fiber-to-the-home to the subscriber, you are talking to all the people, so it’s a huge increase in the amount of broadband products that go out to the market compared to telecom and other sectors.

Manoj Nadkarni - Chip Investor Group

I have a couple of questions for Peter. What was your cash flow from operations for the current quarter?

Peter Chang

I don’t have a specific number for that, sorry.

Manoj Nadkarni - Chip Investor Group

Roughly, can you make any comments; was it close to a million dollars or more than that?

Peter Chang

With our profit bottom line it should be more than $1 million, probably $1.5 million.

 

Operator

Your next question comes from [Steven Votinghouse - Private Investor].

 

Stephen Votinghous – Private Investor

I have three quick questions: The first one is, is there any plans of issuing any additional stock in the near term; second question is, with the stock price presently under $1 are you entertaining any reverse splits; and third is there anything on the program moving forward to get the word out to Wall Street on what a fine company you are? There seems to be very few analysts following the company. Thank you.

 

Peter Chang

Okay, so last question first all right. I think with this market unfortunately, Wall Street has the highest unemployment rate, we all know that. So probably not many analysts left okay; and your first two questions, certainly there are many ways to help (inaudible), so you can do a reverse split or you can do stock buyback, you can do all the dividend.

The key of the board and the management have been discussing all these possibilities, but most importantly is if we want to find out which options available the best, long term return on investments for the shareholders, because with the current cash and the market environment, maybe best to use the cash to do a good position to expand AFOP’s leading position.

 

Operator

 

Your next question comes from Jeff Paddock - Private Investor.

Jeff Paddock - Private Investor

 

I just wanted to also congratulate you on a great quarter and I appreciate you taking this call. I also had a couple of quick questions here and I’ll just kind of go one at a time and let you answer each one if you don’t mind.

First question, it kind of goes into the second caller. I’m actually completely shocked that your stock is trading where it is and I’m not really understanding why the lack of analyst coverage, but what concerns me is the lack of press releases.

You just talked about the deal with Google and that would have been nice to put out there on the line, because your stock, if you look at the numbers as you’re well aware, it’s really trading almost below cash value here. It is unbelievable with the type of growth you have had that your stock in your company is being completely ignored, so that’s my first question. So I just wanted to get some feedback there and then I’ll ask my second question.

 

Peter Chang

I think we are well aware of your concerned right. There are quite a few companies, probably in similar situation, that are probably the next enterprise value. So we are aware that most of times we see, if at the right timing, we will put out some good news release. Hopefully it helps in this tough market.

 

Jeff Paddock - Private Investor

 

The second question is with your stock below a dollar, obviously you’re going to have to take some action soon or else you are going to get a letter from the NASDAQ, so maybe..

 

Peter Chang

On that one, let me just tell you NASDAQ suspended the rule until next year due to the recent market situation.

 

Jeff Paddock - Private Investor

The other question is I noticed on your release that your diluted shares are down to $42 million and it looks like last year’s around $44,929. So can you explain that, why it looks like there’s a reduction in shares?

 

Peter Chang

No, I think just one is they call basic base, one is diluted based. So I think those two numbers are different.

Jeff Paddock - Private Investor

Do you feel that your stock price is being manipulated right now? I mean, seriously with everything that’s going on with the short sellers and with your complete lack of volume every day, it’s really easy for someone to get in there and short the stock and then cover the stock toward the end of the day where it just doesn’t appear that they are even doing it, but it almost seems like some body’s purposely trying to hold your stock down. I just wanted to get some comment on that, if you’ve taken a notice to this.

 

Peter Chang

It’s the way our management is running the company to grow the business and make more profit. So hopefully you can pas that question maybe to SEC or something. Hopefully they can help.

 

Jeff Paddock - Private Investor

Because, I mean I follow it and I’ve been an investor for awhile and I have been buying more and I really believe in what you guys are doing. You guys are doing a fantastic job but it just seems that with the lack of analyst coverage and the lack of press releases, I just think that’s hurting you guys in a way. As a shareholder, I feel it just doesn’t make any sense what is going on here with your stock price with everything you guys have done to work to improve things.

Peter Chang

Thank you for your continued support. Maybe that will present the best opportunity for you to accumulate more shares.

Operator

Our final question comes from Michael Burch - Kennedy Capital.

 

Michael Burch - Kennedy Capital

I wanted to ask you more on the business side; so you talked a little bit about the enterprise signing the connectivity and the first Google project. In terms of the cable side of the business, are you still seeing some steady business there. I mean you didn’t talk about it quite as much, so I just want to make sure we are not seeing anything weakening there. Maybe you can give us some more color about that side of the house.

 

Peter Chang

You mean our cable TV right? 

 

Michael Burch - Kennedy Capital

Correct. 

David Hubbard

Cable TV activity has been pretty stable. We are into some new projects. I think we mentioned a couple of quarters ago working on a new distribution technique to get a little more density for them to keep up with files and things and that seems to be going forward.

There hasn’t really been a slow down there. We would like to see this battle between the phone companies and the cable TV keyed up a little bit more and to do more to provide growth, but it hasn’t been slacking off.

Michael Burch - Kennedy Capital

So in terms of your opportunity there, obviously Comcast talks a lot about rolling out DOCSIS 3.0 which would not necessarily be something that would directly apply to you. Certainly from just the bits and pieces infrastructure, laying out a new network in sort of a new house development, which of course you’re not going to see quite that much of right now, I mean where do you see your best opportunity for that and do you think that’s something that could pick up more in 2009 as the MSOs start eating up your spending?

 

David Hubbard

Very basically, the movement on the part of the CATV companies for many years was to use multiple wave lengths to do their ring and the share hub which was a big boom for fiber optic companies. The transition now is to use the same multi-wavelength technology or similar technology to move out into distribution and get deeper into the neighborhoods with their fiber optics.

Every move by communication companies these days is to get more and more bandwidth with deeper to our subscribers so they can provide HDTV, 100 channels. If you look at viewers from AT&T, you get one HDTV channel in your home because they stuck with the copper pipe for the house. They are going to feel the pain about that.

We see just about every communication provider to the subscriber dealing with fiber optics, multi-wavelength fiber optics and that increases the total market definition for the kind of stuff we do.

Michael Burch - Kennedy Capital

 

And just to follow along with that I know you talked about it being fairly steady. So just to make sure I’m clear, you really haven’t seen any slow down from the actual cable operators in terms of purchasing and spending. That’s still going along without really too much hiccups given all the credit problems?

David Hubbard

We don’t sell directly to Comcast, we are on the second Tier right. So looking at our customer’s activities, one week a little down over here a little up over there; I don’t see any strong downturn yet, but we are just in the middle of the very difficult economic times and the amount of time it takes for what happened a few weeks ago to trickle down to Tier-II, maybe we haven’t seen it yet.

Michael Burch - Kennedy Capital

And I guess that kinds of leads me to the next question. What about Q4 and I know you guys talked about having a record year, you guys have done phenomenal for the first three quarters. So it leaves you a little bit of room between those three quarters and what you did last year. Can you give us a little bit more sense about actual Q4 and where you think things will be?

 

Peter Chang

Maybe what you wonder will be developed as a surprise later. So you do calculate those numbers and you find out what’s going on. Generally it’s going to be a little conservative since we lost more, but we are really confident and optimistic on a long term basis.

 

Michael Burch - Kennedy Capital

I’m not trying to put words in your mouth, but you’re implying that perhaps Q4 is maybe flat to down some then versus Q3?

 

Peter Chang

No, you say you didn’t want to trick me, now you’re trying to do that now.

 

Michael Burch - Kennedy Capital

I’m just trying to get some better sense about if the visibility’s changed for you. I’m completely with you on the long term picture.

 

Peter Chang

I think one year ago, Q4 we basically see the same thing, tying to give you the end year guidance and it really one of the big company so that’s why we usually have a turn. For Q1, Q2, Q3 and we then we give a more clear guidance, so we want to stay that way.

 

David Hubbard

On the sales side, the issue of visibility is one where events have just occurred which should have an impact on our overall markets and that’s why the market seems to be responding the way it is to current events. I anticipate shortening visibility cycles going forward, although right now we haven’t seen a huge impact, so we are just being a little bit conservative and not trying to call it too closely for you at this point in time.

Operator

 

Thank you. Ladies and gentlemen at this time I would like to turn the conference back to Mr. Peter Chang for closing remarks.

 

Peter Chang

As we look into the remainder of 2008, we believe we will deliver another record annual sales and annual profit. With solid progress made in the recent quarters, our goal remains to generate higher profitability through revenue growth and the gross margin improvement. We will continue staying on costs with our expense control, by carefully investing in technologies and solutions that will best serve our growing customer base and expand our market share.

So in the end, I thank you for your continuous support and interest in AFOP and we look forward to reporting to you again in January 2009 with hopefully with better results. Thank you.

 

Operator

Thank you. Ladies and gentlemen this concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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