Alliance Fiber Optic Products Inc. Q3 2009 Earnings Call Transcript

Alliance Fiber Optic Products Inc. (AFOP)

Q3 2009 Earnings Call

October 21, 2009 4:30 pm ET

Executives

Peter Chang – President and Chief Executive Officer

David Hubbard – Vice President of Sales and Marketing

Helen Chan – Marketing Communications Manager

Analysts

William Myers - Miller Asset Management

Manoj Nadkarni – ChipInvestor Group

[Charles Shirk] - Private Investor

Jeff Meyers - Cobia Capital

Presentation

Operator

Welcome to the Alliance Fiber Optic Products Second Quarter 2009 earnings conference call. (Operator Instructions) It is now my please to introduce your host, Helen Chan Marketing Communications Manager for Alliance Fiber Optics Products.

Helen Chan

Thank you for joining us on today's conference call to discuss AFOP's third quarter 2009 financial results. This call is also being Webcast by accessing on the investor relations page at 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 number 335122. 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 would like to make the following Safe Harbor statement. During the course of this conference call Peter or David may discuss expectations, may make projections or other forward-looking statements as to the company's ability to incur financial results. Focuses on cost control and operational efficiencies, develop product and technology 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 are not historical facts, involve a number of risks and uncertainties that could cause actually 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 into 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 as detailed in our SEC reports including AFOP's most recent Form 10-Q for the quarter ended June 30, 2009. These forward-looking statements speak only as of the date hereof. AFOP disclaims any intentional obligation to update or revise any forward-looking statements.

Now I would like to turn the call over to Mr. Chang, President and CEO of AFOP.

Peter Chang

Today as multiple companies continue to face difficult economic conditions AFOP's customer demand for the third quarter fell short of our expectations. With careful management we were able to adjust to this shortfall in demand and have still consistently produce scarce [2009] profitability. Our overall sales were off sequentially and clearly reduced relative to last year. However, we are confident that AFOP's market position remains strong and the source of revenue decline in Q3 is temporary in nature.

As we continue to invest in our longer term opportunities, we recently completed a major factory expansion extension to nearly double our available facility space. This improvement allowed us to further organize our lines for efficiency, improve the quality performance and to prepare the company for future business growth over the next year and beyond.

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

For our overall financial results Q3 revenues came in at $6.95 million, which is a 10% decrease overall Q2 2009 revenue of $7.7 million. This lower revenue level we achieved operating profit and net profit of [$115,000 and $217,000] respectively for the quarter. Growth margin were higher at about 33%, despite the revenue decline resulting primarily from cost improvement and product mix.

This gave us confidence we can increase profitability further as revenues increased with broad industry improvements with great appreciation for our valued customers and again very proud of all AFOP employees for managing well in these difficult conditions.

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

David Hubbard

The third quarter 2009, as Peter mentioned, did not measure up fully to our expectations overall at the top line. This was due mainly through a softening in demand for CWM products for our key European customers. We believe this shortfall resulted from a suspension of deployments at [Bush] Telecom a major end user and the overall program is expected to resume with renewed demands going into 2010.

Other segments of the business performed consistent with our expectations with the connectivity business in the single digits of growth for the quarter overall and sales into private and home and broadband markets overall were relatively flat. Let me review the product lines in more detail.

Connectivity product sales increased modestly sequentially, as I mentioned. Key customers saw their businesses pickup pace from the first half of 2009, but they have not seen yet a real recovery in network spending. As we have indicated, our customers are managing with lower than normal inventory levels so far in 2009. We believe this will help establish demand quickly as more market recovery emerges.

With the input from our customers we believe we have maintained our shares or improved them and while somehow [planned] activities tended to slow down the fall, this should have a minimal affect on AFOP and we're looking forward to increases in data center upgrades in the USA particularly.

Half those products were off from the previous quarter based on the CWM shortfall, as I said. CWM continues to be a strong product area and we continue to see broad-based interest in our line of compacts CWM modules. However, this quarter we could not rebound from the shortfall in demand from key customers.

We anticipate continued strength at CWM and [passive] line going into 2010, and we continue to invest to expand our offerings and capacities with our leading compact CWM product platform. This past quarter our [Nanomic] series of ultra compact four channel modules have been designed into customer CFP transceiver module applications for 40-gigabit and 100-gigabit Ethernet application. We believe this is a major industry product application for the coming years and our [Nanomic] technology is being well received at this stage of product development.

FWDM sales were stable with Verizon's related [FW] demands for [prior] continuing. There are ongoing requests for FWDMs from international markets. And as mentioned previously, we're currently working to pursue opportunities for next generation FWDM solution for those network requirements.

Again this one a one returns product application with significant potential demands in the coming years. AFOP continues to invest in bringing innovative products to market for these emerging areas of opportunity. Our new iC-VOA line variable attenuators is shipping now in production quantities to at least one key customer.

They have begun sampling an [XFP] pluggable version of this iC-VOA product. There is growing interest in the industry for a new generation of VOAs that are pluggable and accessible to customers after installation. This flexibility follows the trend of transceivers in this regard. Overall we believe our attenuator product line will be significantly enhanced with the addition of the iC-VOA over the coming years.

Overall sales of Fiber-To-The-Home specific products have brought connectivity and path to product line relatively flat for the quarter. We continue working with high-touch and manufacturing customers or dense fibric pigtail assemblies for existing and [NG Con] requirements. We continue to benefit from our investments in FOC third party qualifications of our connectivity products as new customers stress and request this qualification on new products they are targeting.

I would expect our customers during the third quarter [Fallade] was our only 10% customer. We consider AFOP market and customer diversity a significant strength in difficult industry periods as we've been experiencing. This diversity helps mitigate the risks of too heavy a concentration of sale in the simple market or customer.

We believe our exposure to the economic downturn was reduced by our broad product offering and market participation. In addition, we believe AFOP is well positioned with a large set of customers and products for economic recovery and our factory expansion investments are consistent with that participation.

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

Peter Chang

In the third quarter of 2009, we succeeded in improving our margins in spite of a revenue so poor and this resulted in ongoing profitable quarters. Revenue for Q3 2009 come in at $6.95 million, a sequential decrease of 10% from previous quarter and a decrease of 35.8% compared to the year ago quarter.

Despite the revenue shortfall which continuously include efficiency, cost reduction, and a favorable product mix, growth margins improved to a nine-year record level of 33% which improved the growth margin and well managed expense level we regenerated operating profit of $115,000 in Q3 compared with the $292,000 in Q2.

Our net profit in Q3 came in at $271,000 or $0.01 earnings per share which represent about 4% of net profit margin in the quarter. This is the 14th consecutive quarter AFOP has delivered a GAAP profitable bottom line. Included in the net profit [inaudible] is $29,000 in stock-based compensation expenses from the implementation of FAS 123(R).

Our operating expenses for the third quarter of 2009 increased compared with the previous quarter especially in P&A area. Higher P&A expenses in the quarter mainly come from one-time charges around $100,000 re-debted to an office land property tax adjustment in our four core projects.

In addition, as mentioned in the beginning, we conducted a China factory expansion project during the quarter. The target has been completed successfully in the early October so there will be some expenditure in the coming quarters. Even so, we expected overall operating expenses to be in the similar range as the last few quarters.

Turning to the balance sheet, DSO day sales outstanding were 52 days for Q3 as compared to 61 days in Q2 of 2009. Inventory [inaudible] were reduced quarter to $4.7 million from previous quarter. Our inventory level has been decreasing in the last four quarters continuously, [inaudible] for Q3 decreases as compared to 4.4 in Q2, mainly due to revenue drop.

Looking ahead, we anticipate our inventory levels will remain a threat or slightly higher in Q4 in support of a growing demand and the short return requirements from our customers in the future quarters. Our total net cash in the investment [errands] of September 30, 2009 increased by $1.91 million and were ended with $41.9 million. Such cash in the last two quarters result from good A/R corrections and inventory deductions.

In the meantime, we continue receiving some cash redemptions on our AIS investments. For the next quarter, with the payment of capital investment in recent China expansion project, we anticipate our net cash balance will decrease slightly.

Now regarding forward guidance, although the overall market has been reduced with the severe economy conditions and our business outlook has become conservative for the short-term, we are optimistic about the demand of our customer base in the longer term.

With current and better information, we anticipate that sales in Q4 2009 will remain growing sequentially. Operationally, we expect quarterly gross margin operating profit and net profit will continue at the current level in the coming quarter assuming stable revenue level of product mix, stable pricing, and a continuation of efficient improvement in our [Asia] operation.

And now, I'd like to turn the call back to the operator for Q&A session.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from William Myers - Miller Asset Management.

William Myers - Miller Asset Management

In addition to the weak demand, was there any pricing pressure on unit prices?

David Hubbard

Yes, I think as you can see from the margin improvement, we didn't see undue pressure on pricing. Really the shortfall came from, as I mentioned, a delay in this program over in Europe, but the pricing seemed to be consistent with our overall ASP picture.

William Myers - Miller Asset Management

I'd like to get, if possible, a little bit better picture of how your products relate to data centers. Are they primarily used to connect the equipment, the servers and storage within a data center, or are they primarily used to connect the data center to the outside world?

David Hubbard

I think the answer is some of both, but the largest demand for connectivity in the data center application is fiber management systems, which are really patch panels within the data center to connect various equipment so they can connect and disconnect and reconfigure the data center.

Operator

Your next question comes from Manoj Nadkarni - ChipInvestor Group.

Manoj Nadkarni - ChipInvestor Group

Can you please give details on the factory expansion in China and how that will affect your output and your cost structure?

Peter Chang

Yes, we did expansion mainly due to two factors. One is current utilization of our old facility, and the other is based on going forward demand. So now we're factoring in that timing and the good year, okay. So one side we can see we do need more space for future expansion and the other side is that we're going to have more space or better facility, we can also be more [vertical] integrated manufacturing, okay.

We can make parts in-house instead of outsource when the demand keeps growing in the future. So for the short-term, we don't see that much cost impact, even though we double the size. Until now, probably you will see a gross margin probably in a similar level.

Operator

Your next question comes from [Charles Shirk] - Private Investor.

[Charles Shirk] - Private Investor

I'm just curious about your stock buyback feelings at this point.

Peter Chang

Yes, I think looking at the cash management, our priority over time to grow the business through R&D and also possible [MA] activities, okay? So both for shareholder value and the buyback or cash dividend always been rate and discussed in the board meeting. So if we find that a buyback or a cash dividend turns out to be bad for the company's long-term liability and also to maintain the shareholder's value, then we will [inaudible].

Operator

Your next question comes from Jeff Meyers - Cobia Capital.

Jeff Meyers - Cobia Capital

Do you have any color at this point when you think the European project is start coming back?

David Hubbard

Yes, we have an indication that it should resume towards the end of this year into the first quarter. The exact timing of orders has not started yet, so it's still just a forecast but that's what we hear from the customer talking to their customer.

Jeff Meyers - Cobia Capital

Now, is any of that built into your assumption of growth in the fourth quarter or do you think you guys can grow without that coming back?

David Hubbard

We have factored in that timing as best we can to the fourth quarter projection.

Jeff Meyers - Cobia Capital

And in terms of tempting the customers, was [inaudible] greater than 20% or is there some between 10 and 20?

David Hubbard

[Inaudible].

Jeff Meyers - Cobia Capital

And just in terms of broad industry demand, where do you guys see now versus say six months ago?

David Hubbard

I think six months ago we were still reeling from the economic downturn that started at the end of the year last year. Going into the end of this year this year, there's general optimism that there's beginning to be a tailwind, and certainly in IT and telecom spending, I think we see some good words being turned around.

And SuperCom this week, we'll see what they say out there, and the SCTE the week after that to get a better read on what all the customers are saying. But generally, China's spending some increased dollars on IT and there's a stimulus package, so we feel pretty confident that 2010 is a better trend line.

Operator

At this time there are no further questions. I would like to turn the conference back over to Mr. Chang for any closing comments.

Peter Chang

[Inaudible] to generate more profit though revenue growth and the growth margin improvements while we continue staying on course with our expense counsel by carefully investing in the technology and the solutions that will best serve our growing customer base and expand our market share. Thank you for your continued support and interest in our company and we look forward to reporting to you again in January 2010.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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