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Alliance Fiber Optic Products Inc. (NASDAQ:AFOP)

Q1 2014 Earnings Conference Call

April 24, 2014 4:30 PM ET

Executives

Peter Chang – CEO

David Hubbard – EVP, Sales and Marketing

Analysts

Alex Henderson – Needham & Co.

Dave Kang – B. Riley

Graham Tanaka – Tanaka Capital Management

Operator

Good afternoon, and welcome to the Alliance Fiber Optic Products, Incorporated First Quarter 2014 Conference Call. Thank you for joining us on today’s conference call to discuss AFOP’s first quarter 2014 financial results. This call is also being webcast by accessing on the Investor Relations page at AFOP.com and a replay will be available on AFOP’s website 90 minutes after the live conference call.

Today’s call is being hosted by Peter Chang, President and Chief Executive Officer; and Dave Hubbard, Executive 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 into volume production, industry-wide shifts in supply and demand for optical components and modules, industry overcapacity, failure of cost control initiatives, financial stability in foreign markets and other risks detailed in our SEC reports including AFOP’s most recent Form 10-Q for the year-ended December 31, 2013.

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. Chang, President and CEO of AFOP.

Peter Chang

Thank you, operator. Thank you for joining us today. Last year ended on a high note and this year has started with even greater momentum. However we’re pleased to be able to reporting you earlier in the month that we exceed our previous growth guidance for last quarter. We received increases in demand after our last conference call and we were able to deliver this within the quarter. Some of it was the acceleration of the delivery which we had a previously scheduled in current quarter but delivered in the end of last quarter. All this helped us achieving much higher quarterly sales, despite synergy the Chinese New Year holiday any adverse weather conditions.

More importantly, AFOP operating and financial performances achieved new milestones in gross margins, operating margins, operating profit and profit. In addition, our balance sheet continued to grow stronger, this improvement and a greater performance in fact were on this strengths of our strategy and our executions over the long run and our customers in marketing formation and our commitment to improving shareholder value in AFOP. I want to thank all joined our growing list of valued customers and our exceptional teams for their accomplishments and our investors for their confidence in AFOP.

And now, let me turn the call to David to review the progress in each product area in more detail in the quarter. Following that, I will go into more details on the financials and forward guidance. David, please?

David Hubbard

Thank you, Peter. With tailwinds at the end of 2013 we entered Q1 2014 with overall optimism about the market and our prospects for 2014. As Q1 progress we saw increasing demand from our customers and really we formed well the support these opportunities even with the Chinese New Year’s holiday in our factory. This growth is particularly relative to a year ago also for Q1 which you go over 100% year-on-year quarterly revenue growth and sequential growth of 14% from our Q4 2013.

AFOP connectivity sales in Q1 were up sequentially and significantly increased year-over-year. Connectivity gains were derived principally from datacenter applications for 10G, 40G, and 100G Ethernet in particular. Overall Datacenter market CapEx growth continue. In addition, there is architectural shift to more connectivity intensive fiber which high speed finally for factory type network and new gate centers with reviewed – fees for service improvement efficiency and connectivity improvement and lower energy consumption.

AFOP continue targeting these trends and requirements successfully with our vertical connectivity technology and with both new components of – and value added products. These capabilities also leverage well with AFOP passive product line. As example we introduced recently at the AFOP conference in San Francisco a new Higher Density Push-Pull Density LC Connector –pack HD for high density. This new product helps customers set tables in higher density in both datacom and telecom structuring cable environment.

With the utilizer’s connector system with our CWDM, PWM paths to offer higher density access for multiplexing requirements in the same operation or datacenters across market segments. This is just one example of connectivity impact on products synergy enabled with AFOP core technology.

AFOP passive products were up sequentially and significantly increased from the year ago quarter. We saw pick-up with CWDM products in the telecom metro asset market and increased production shipments to a new major customer for CWDM in a cellular application.

In datacom, while we continue shipping volume production of the current generation NANOMUX CFP transceiver multiplexers to key customers. We have been working closely with existing and new customer on their smaller higher density second generation transceiver design which were – on the slide – conference well last month and will be brought to market by a range of transceiver suppliers in 2014 and beyond.

With me there are significant long-term volume opportunities for AFOP with this advanced free space optics passive platform and we continue to invest to gain additional design wins in this growing market.

AFOP is focused and enjoys significant business in both the datacom and telecom segments of the fiber optics industry with our strong connectivity and passive technology platform. We saw sequential and year-on-year growth in both telecom and datacom market sales. Datacom outpacing the growth of telecom but still from new businesses emerging both sectors as new generation network architectures and system solutions are forth coming industry wise.

Our ratio, sales in datacom and telecom was approximately 70, 30 they complained a couple of points in Q1 with the strong employee rate mentioned. AFOP sales to datacom application saw increase in demand as mentioned as well as some acceleration in orders from – which we are able to service.

During the quarter we increase sales to e-customer for our exact tap line of passive optical taps, the datacenter, and general enterprise applications. As we mentioned on the last call we see if there is an increasing trend from network optical tapping to ensure link performance optimization and to improved network security response time. With our exact tapped products we are we are well positioned to capitalize on these emerging applications.

Overall, AFOP sales to telecom customers were up this quarter due to improvements in CWDM products and to metro access network decline. We also ramp delivers of CWDM-2 new customer in cellular market has mentioned.

We are optimistic that both telecom and datacom offer ongoing growth opportunity for our connectivity and passive product list. More importantly, with environment degradation of these core technologies allow the AFOP to provide unique customer solutions or next generation network requirements as I described.

We had three 10% or near 10% customers in the first quarter. Geographically, sales were up sequentially in Europe and declined Asia. Sales were up significantly in all geographies on a year-over-year with some more strong growth rate both in the U.S. and Europe and slightly less growth rate in Asia.

Increasing bandwidth demand continue to drive the need for further network investment in both telecom and datacom communication markets. New mobile devices in more hand with spending mobile content is driving the for higher speed fiber optics in carrier central offices, cell towers and growing number of datacenters globally. Continue to invest and engage customers leveraging our complementary strength in both optical passives and fiber connectivity technology. We believe these trends in our technology synergies will offer many opportunity for AFOP product innovations and significantly business prospects in 2014 and beyond.

Now let me turn it back to Peter for the financials.

Peter Chang

Thank you Dave. Total revenue for Q1 came in over $24.8 million, an increase of 105% compared a year-ago quarter of $12.2 million and 14% higher than previous quarter. Thanks again to the effort of our exceptional teams meeting customer requirements during the quarter with continuous operational excellence, favorable product mix and the higher revenue level. Gross margin in Q1 improved to a record level of 40% compared with 39.3% in the previous quarter.

With better gross margin and a well-managed operating expense level we generated operating profit of $6.5 million in Q1, which is 266% higher than $1.8 million reported in the year-ago quarter and higher then than $1.2 million in the previous quarter. Our net profit come in about $5 million or $0.27 earnings per share compared with net profit of $1.9 million or $0.11 EPS in the previous quarter. The improvement in the net profit for Q1 was a one-time NOL revaluation charge of $700,000. Excluding this charge, revenue for Q1 come at $5.7 million or $0.21 per share and this is the 22nd consecutive quarter in a row AFOP has delivered a profitable quarter.

On the EBITDA the non-GAAP basis, net profit in Q1 was about $7.8 million or $0.33 earnings per share which bring a profit margin to a much higher level this compared to $2.5 million or $0.14 EPS in the year ago quarter and a profit of $6.6 million or $0.36 earnings per share in the previous quarter. To help the understanding we prepare reconciliation table to get a non-GAAP earnings in the press release.

Turning to our balance sheet our balance sheet became stronger with continuously improved quarterly financial performance with CapEx of $660,000 and the [C&O] payment our net cash, cash equivalents and the long-term investment increased by $4.7 million and ended at about $62 million which includes a $10.5 million five year bank CD currently headed under long-term investment.

Accounts receivable DSO was a healthy 46 days in Q1, better than 50 days for Q4. Inventory for Q1 decreased slightly from last quarter to $10.3 million. The inventory return for Q1 improved to 5.7, much better than 4.9 in Q4. We expect inventory level to be in the similar level or higher to serve the customers with better lead time and with the support of our continued growing demand.

Now regarding our guidance. I am glad to report that we expect revenue will be above $25 million which represents more than a 30% interest over the year ago quarterly sales. We expect gross margin and effective tax rate will remain in the similar level while non-GAAP EBITDA will improve. With such a strong opening to the year we are optimistic of delivering another record annual sales and annual operating profits in 2014 from our 2013 record levels. While data bandwidth demand continue increasing the next growing sector of the Fiber Optic industry is emerging and we are excited with the business prospects in this year and the coming years.

These expectations are based on the assumptions of a continuous economic recovery, continuously from our key customers, optical networking spending up at the current level, favorable product mix, stable pricing and a continuation of efficiency improvements in our operations.

And now I’d like to turn the call back to the operator for Q&A session. Operator, please go ahead.

Question-and-Answer Session

Operator

(Operator Instructions) I am showing a few questions our first is coming from Alex Henderson from Needham. One moment Alex while we open your line. Okay, Alex you are now open.

Alex Henderson – Needham & Co.

Great. Thank you. I’ve got a couple of questions just want to start off, just with the easy one the tax rate as I calculate it quite a bit higher than I was expecting you’re saying sequentially flat or you saying sequentially flat tax rate, sequentially flat tax dollars what did you mean by that just want to be clear. Could you give me the rate for the full year?

Peter Chang

The whole year we still expect under 20% and we want to be conservative.

Alex Henderson – Needham & Co.

Okay.

Peter Chang

And so I think that you look in there you have to be sure you think of that NOL related charge.

Alex Henderson – Needham & Co.

Okay. The second question can you talk about 10% customers in particular your one particularly large customer whether that increase as a percentage of sales in the quarter and if I exclude that particular large customer can you talk about what the rest of the company did in terms of growth?

David Hubbard

Yeah thanks, our large customer was up on a dollar basis, slightly down on a percentage basis. And the rest of the customer base made up aggressive gains. On a year-over-year basis that looks pretty good as well up flat 30%.

Alex Henderson – Needham & Co.

That’s very good. Thank you. And just one other question before I cede the floor, so have you had any additional traction in other web 2.0 infrastructure or service company players that may not have achieved that 10% threshold but are you showing some success in penetrating some of those other customers?

David Hubbard

Yeah let me comment that we reached a considerable number in web 2.0 through our existing OEM customers set and software [cabling]. And we also position ourselves for a direct customer relationship with that possible support beyond I don’t want to mention a specific names. But we are component supplier our products are used on a number of data centers through these various avenues.

So we feel that, we get a good sense of the expansion the datacenter market and participation in it via multiple peer structure.

Alex Henderson – Needham & Co.

All right. Can you just give me one other thing what’s the headcount and the actual number of 10% customers I think I missed those two data points?

David Hubbard

We have one 10% and three near 10%. Two new sorry.

Alex Henderson – Needham & Co.

All right and the headcount?

Peter Chang

Headcount is –- at the end of Q1 above the 1,700 people.

Alex Henderson – Needham & Co.

Thank you.

Operator

Thank you. So we’ll take our next question from Dave Kang from B. Riley. Dave, please go ahead.

Dave Kang – B. Riley

Yes, thank you good afternoon. I guess first question was back to the tax question. So you are saying this year it will be under 20% but next year should we still keep it around 20% is that correct or…?

Peter Chang

Next year if I will when you make more money you will probably pay more tax right. But we’re trying to manage effective tax rate as well as possible. So this year I would say below 20% for sure. I want to mention one thing Alex, ask you question about this quarter Q1 okay, effective tax rate if you take with NOL charge on the non-GAAP basis mainly effective tax rate will be much lower than, I think it would below 15% or so just when you calculate.

Dave Kang – B. Riley

Okay. And then can you give CapEx number for first quarter or can you repeat that number what is the budget for the rest of the year?

Peter Chang

I think last we had timing issue so we reported about $659,000 for Q1. So Q2 is definitely much higher, probably $2 million minimum.

Dave Kang – B. Riley

$2 million in the second quarter?

Peter Chang

Hopefully we need to spend more.

Dave Kang – B. Riley

Okay. Did you say $2 million in second quarter?

Peter Chang

Yeah.

Alex Henderson – Needham & Co.

Okay. And then on the second quarter guide I mean the second quarter is typically seasonally strong, granted first quarter was strong but are you essentially guiding flat, just wondering the dynamics behind what are your assumptions especially with your [inaudible] customers.

David Hubbard

Sure first of all as we mentioned we did have some acceleration of activity from Q2 back into Q1 which helped to the strong growth we saw in Q1. And Q1 was particularly robust compared to normal seasonal time.

Dave Kang – B. Riley

Sure.

David Hubbard

For the guidance the best way to characterize is that we’re just being looking conservative what being up to this revenue level talking to the customers we feel good about it but just a conservative posture.

Peter Chang

Yeah Dave you know that it’s better be conservative.

Dave Kang – B. Riley

Right. Can you give like a pure range sort of just saying over 25, I mean are we looking may be 25 to 27 or 25 to 26 any more granularity on that range?

Peter Chang

We [inaudible] higher number

David Hubbard

My definition there is no upper limit on the number I understand the question but we chose to state it that way.

Dave Kang – B. Riley

Okay. That’s fair enough. Then after been kind of flattish in second quarter I mean can we expect growth to resume in third quarter and into second half?

David Hubbard

Well we generally don’t put guidance out for the one quarter ahead if liable. In general you talk about markets sentiment, Q3 had a combination of generally good build season for access markets so that’s good. So we look forward to that period of time. We also can get into some obvious European time log to fix that. So it’s a generally good period but in terms of customers in general people are pretty bullish.

Dave Kang – B. Riley

Right. And then regarding China what’s the percentage sales to China? And can you just give us a more color on how the Chinese customers are doing?

David Hubbard

Yeah we don’t break out China as a geography and that kind of reporting overall is about 15% contributor to the total it’s been higher in the past and that’s I think so to manage all the market conditions.

Dave Kang – B. Riley

All right.

Peter Chang

And then when we do have a good application.

David Hubbard

Yeah we have good key customers and our NANOMUX products are selling to Japan now so that’s good. In general yeah.

Dave Kang – B. Riley

Right. Now but then I think let me say I think you said David that China or not you didn’t say China but I think you say Asia was down little bit was it function of China or was it more access business seasonality?

David Hubbard

Asia was down a little bit and I think it was China based.

Dave Kang – B. Riley

Right, was it because of the access? I mean are you guys involved in the access business that was impacted because of seasonality?

Peter Chang

No, I don’t think by percentages…

David Hubbard

I think it’s less to access a trouble answering a question that the stuff that sells into big customers over there which end up in different markets so I don’t want try to link it all.

Dave Kang – B. Riley

Got it. And lastly I mean can you just talk about capacity situation?

Peter Chang

Well mainly we will.

Dave Kang – B. Riley

So what are running at right now?

Peter Chang

We have been running at right now – I know we have some available capacity so that’s why we prove ourselves in the end of the last quarter which the ratio of the delivery were manageable so…

Dave Kang – B. Riley

So alright. And that was it thank you.

Peter Chang

Thank you.

Operator

Okay thank you. And our next question comes from Graham Tanaka from Tanaka Capital Management. Please go ahead sir.

Graham Tanaka – Tanaka Capital Management

Yes hi. Congratulations again nice quarter.

Peter Chang

Thank you.

Graham Tanaka – Tanaka Capital Management

Yeah just understanding the tax that you are expecting for the full year is going to be less than 20%, is that correct?

Peter Chang

Yes. That’s all we can say, we want to conservative and we want to use the models we don’t you to go low but again the overall consecutive rate and expecting cash rate might be greater than 20%.

Graham Tanaka – Tanaka Capital Management:

Okay. But as I think was it higher than that for the first quarter I believe right?

Peter Chang

No. But as I said you have to you use the cash we have a charge there on the front NOL related. So our really effective rate when actually would pay tax to a government are never being set up.

David Hubbard

Yes. So the effective rate is less than 20% is that because you are using up some AOL?

Peter Chang

Yeah. But we have about $5 million AOL yeah. And in mean time AOL are brought only in U.S.A and when we have operation Taiwan to China. So we have we make a profit there we have to pay their taxes.

Graham Tanaka – Tanaka Capital Management

So I assume that with the projected earnings growth that you will use up your you might use up the NOL this year does that mean the tax rate goes higher next year?

Peter Chang

Yes.

Graham Tanaka – Tanaka Capital Management

Okay.

Peter Chang

But the reason is that we do have operation in Asia. So that’s why we in factor the tax rate we don’t give out the 2015 that’s really far away.

Graham Tanaka – Tanaka Capital Management

Okay. And that would be helpful because I think a lot of analysts do it like to have two years of earnings out and then so that would be helpful to us if you give us a little bit of guidance later we’d appreciate it. The other is was there any foreign currency effect in the first quarter?

Peter Chang

Not much.

Graham Tanaka – Tanaka Capital Management

Okay. But prices how much were prices down on average how much?

David Hubbard

We went through our annual price adjustments nothing out of the ordinary.

Graham Tanaka – Tanaka Capital Management

Nothing out of the ordinary alright. And just curious if you might comment on what you think happen to market share in the main markets?

David Hubbard

Relative to our sales or?

Graham Tanaka – Tanaka Capital Management

What percent of the market did alliance have in the quarter versus you know?

David Hubbard

Yeah well I would say I don’t want to run through our number because we are recently small company. And it’s the much bigger players that it’s a percent that can back up the market so it’s difficult to do on call.

Graham Tanaka – Tanaka Capital Management

Okay. The number one customer I guess you report that in the 10-Q anyway right. So what percentage was that number one customer?

David Hubbard

It’s in the low 40’s.

Graham Tanaka – Tanaka Capital Management

Low 40% okay. And in dollars what did that customer grow year to year?

Peter Chang

Yeah year ago we had much better.

Graham Tanaka – Tanaka Capital Management

Much better than year ago but not.

Peter Chang

Yeah year ago yes.

Graham Tanaka – Tanaka Capital Management

So was that close to the 100% of the total?

David Hubbard

It was considerably more than a 100% growth year-on-year, this is the first quarter versus first quarter for the number of customers.

Graham Tanaka – Tanaka Capital Management

Right okay. And does that represent do you think a kind of above your spike or do you think that the growth can continue through the remaining quarters of year?

David Hubbard

I think we’ve characterized it in the past is in that is part of a long term activity with that customer how long is you can ask other items as well. But it’s definitely a long term activity.

Operator

Okay. Ladies and gentlemen this does conclude our Q&A session for today. I would now like to turn it back to your CEO, Mr. Chang for closing remarks.

Peter Chang

Okay. 2014 will [become more strong] [ph] than year ago quarter and our approach has been generating many good opportunities with our customers and our [products] [ph]. All this make us optimistic about continues growth in this year and the coming years. Our goal remains to generate a higher profitability through business expansion and [inaudible] [growth] [ph]. We will continue staying on top with our demonstrated operational excellence while investing carefully in the technology and the solution that will best serve our growing customer base and will expand our market share in the long term. [Inaudible] [ph] our commitment to continue to improving AFOP value for our important shareholders. Thank you for your continued support and interest in our company and we will be reporting to you again in July 2014.

Operator

Okay. Thank you ladies and gentlemen this thus conclude your conference for today. I did want to remind you that a replay will be available on AFOP’s website 90 minutes after the live conference call. Ladies and gentlemen this concludes your conference you may now disconnect.

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