Alliance Fiber Optic Products' (AFOP) CEO Peter Chang on Q4 2015 Results - Earnings Call Transcript

| About: Alliance Fiber (AFOP)

Alliance Fiber Optic Products, Inc. (NASDAQ:AFOP)

Q4 2015 Results Earnings Conference Call

February 18, 2016, 04:30 PM ET

Executives

Peter Chang - President & CEO

David Hubbard - EVP of Sales & Marketing

Analysts

Alex Henderson - Needham

Christopher Longiaru - Sidoti & Company

Dave Kang - B. Riley

Operator

Good afternoon and welcome to the Alliance Fiber Optic Products Inc. Fourth Quarter and Fiscal year 2015 Conference Call. Thank you for joining us on today’s conference call to discuss AFOP’s fourth quarter and fiscal year 2015 financial results.

This call is also being webcast by accessing 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 David 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 statement. During the course of this conference call, Peter or David may discuss expectations and make projections of 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 futures 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, abilities 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 report including AFOP’s most recent Form 10-Q for the quarter ended September 30, 2015. 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.

In the fourth quarter 2015 we did see some recovery of the business from our leading customers. However it was not enough to offset seasonal decline in other areas. Quite disappointed in the stringent decline in revenue in this quarter. We continue to make progress in key areas, which makes us optimistic with our prospects for 2016 and beyond.

Overall we had a good year in 2015 even with the Q4 decline and generally softer second half, we posted a near record year overall and we improved our position in that industry.

We're pleased and assured that we are a key and a strong supplier with our leading Web 2.0 customers with ongoing stable year and participation in the development of their next mutual platform. We’re setting another annual growth quarter -- annual growth record.

We still had a majority of our top 10 customers growing on annual basis. That growth mainly comes from new finished activities and new product design that offer exciting long term growth plus growth for AFOP.

The overall market for optical communication remains on a growth trajectory. Market sentiment as reported recently by our peers remains bullish.

We do not believe without any market share at our key customers instead new quarterly results and the business activity leave us encouraged that our new product penetration can make lasting contribution and the results in renewed growth for a company in this year and years ahead.

Again while there was a setback this quarter, we remain optimistic with AFOP's long-term opportunities.

In today’s call, David will review the progress in each product area in detail. Following that, I will go into more detail on financials and end up with our forward guidance. David please?

David Hubbard

Thank you, Peter. In Q4, we had a sequential shortfall resulting in an annual decline as well. We did have a sequential increase in sales from our number one customer, but still significant year-over-year and annual declines for now.

This sequential gain was not enough to fully offset unexpected declines on Metro CWM and some structured cabling customers otherwise where we were coming off of strong Q3 activity. As Peter said earlier, we have made progress over the year at developing other revenue streams and diversifying relative to this customer concentration.

Despite lower annual sales in 2015, we grew the business outside our number one customer over 2014. Products for applications inside industry leading transceivers grew over 50% in 2015 and represented 10% of sales for the year.

We see this area on a continuous growth trajectory in 2016 as more advanced transceivers for 100G reached the market. Telecom sales grew sequentially and year-on-year, while Metro CWM was off, access business involved with Telco customers was up and is expected to continue to contribute to 2016 growth as well.

Datacom captured the overall decline mainly due to seasonal declines with OEM customers and structured cabling. We see this area rebounding in 2016 with new 102 platforms dominating the datacenter build cycles as reported by our peers and market analysts recently.

AFOP connectivity sales in Q4 were off modestly mainly driven by shortfall in demand from OEM customers as mentioned and cellular customers. The decline in quarterly connectivity sales on a year-over-year basis was mostly attributable to the shortfall from our leading Web 2.0 customer.

AFOP has been delivering production volumes of optical subassemblies to support next generation transceivers based on a higher speed Silicon Photonics technology engine for our major OEM partners including Cisco. Overall levels were consistent with Q3 2015, but not high enough as originally forecasted.

We considered AFOP to be a leader with solutions utilizing our fiber rate technology for fabrication of these important embedded connectivity sub assemblies in next generation Silicon Photonics transceivers. We expect that volume demands for these solutions will contribute to ongoing growth in 2016 and beyond.

AFOP passive products Q4 increased year-over-year, but we down sequentially. Our passive free space passive optical subassemblies called POSA for transceiver application in Q4 were level with Q3, but increased on a year-over-year basis.

We're currently working with customers on CFP4 and QSFP solutions using AFOP leading NANOMUX POSA series in multiplexers. We believe there are significant long-term volume opportunities for AFOP with our advanced leading free space objects platform in 40, 100 and 400g medium reach and long reach transceivers for many growing applications including datacenters and DCI applications.

We continue investing to gain additional design wins in this growing market and to maintain AFOPs leading position. More importantly, during the quarter we completed factory and product qualifications for a key OEM customer of passive network monitoring component for a major U.S. carrier application. We believe that all these will add to passive product line growth in 2016 and later years.

We maintain our view along with many other that datacenter market CapEx will continue to grow in 2016 and beyond especially when new platforms of fiber optic infrastructure and components are employed to provide increased bandwidth, higher density and lower cost per gigabit at 100G. As we have stated in the past, this trend provides significant opportunities for both AFOP fiber connectivity solutions and passive product subassemblies.

Data centers will increasingly expand bandwidth through the move to multi-wavelength and multi-fiber optics in the next generation transceivers in which AFOP connectivity and passive optic lines, our transceiver solutions are already being utilized.

Overall market conditions were mixed for AFOP in Q4 with some places in telecom with good demand offsetting normal Q4 seasonal slowing in some sectors as expected.

We were encouraged our leading Web 2.0 customer requirements were down at some during the quarter and work has begun on our whole new cycle of datacenter platforms.

New AFOP targeted opportunities in both the datacom and telecom segments of the fiber optics industry are seeing ongoing traction with new design wins and qualifications adding a foundation for ongoing growth with our competitive and innovative connectivity and passive technology platforms.

Our ratio of sales in datacom and telecom came in about 50%-50% respectively in this quarter from 60%-40% last quarter, reflecting strength in telecom and some overall drop in datacom sales as mentioned.

We believe our ratio will return to traditional levels with increases in datacom sales across 2016 especially with the renewed demands from our leading Web 2.0 customer.

We had one 10% customer and three near 10% customers in the fourth quarter. The sequential increase in business from our Web 2.0 customer was from 14% of sales in Q3 '15 to 21% in Q4, but a significant drop from a year ago nearly 33% of sales at a much higher quarterly sales level as well.

So geographically sales were essentially level as a percentage of sales with Q3 in all our reporting regions. 2015 overall sales were down in the U.S. and increased in Asia.

The overall market continues to improve and advance AFOP has done well in 2015 to capture opportunities and execute efficiently, despite the shortfall in orders from our leading customer. Overall trends in datacom remain bullish. Our leading customer demand still exist. Telecom trends seem to be improving as well as reported by our peers this last month.

Our activity with many key customers gives us confidence that AFOP is well positioned to capitalize on the ongoing growth trajectory, which will offer ongoing growth opportunities for AFOP connectivity and passive product lines in 2016 and beyond.

Now let me turn the call back to Peter.

Peter Chang

Total revenue for the quarter come in at $15.4 million, a decline of 9% compared to the previous quarter and a 13% decrease with the year ago quarter. Revenue for 2015 was again over $18 million coming in at $81.2 million.

This compared to our $86 million record for 2014, we are not pleased with our forecasted decline as I mentioned, but we adjusted and managed this division resulting in limited financial impact from the lower operational level.

With great operational management, non-GAAP gross margin in Q4, 2015 coming at 41.2% a higher percentage, but this resulting gross margin and further well-managed operating expenses will generated non-GAAP operating profit of $4.1 million in Q4 2015, which results in 25.1% non-GAAP operating margin, demonstrate total business probability spend.

On an annual basis, 2015 non-GAAP gross margin was 41.3% again better than previous year. Non-GAAP operating profit was $22.1 million and non-GAAP operating margin was 27.3%.

Our Q4 non-GAAP net profit at about $800,000 over $0.05 earnings per share, lower net profit is partially caused by a foreign subsidiary annual tax adjustment of $2.1 million, which for our tax accounting discussion, we accrued conservatively for undisputed foreign profit in our subsidiary with the payment due in 2016 and 2017.

So if on an EBITDA non-GAAP basis, net profit in Q4 2015 was about $4.9 million or $0.29 per share which represent a profit margin at 29.7%.

For 2015, our non-GAAP net profit was $17 million or $0.90 earnings per share. On an EBITDA non-GAAP basis, net profit in 2015 was about $24.9 million or $1.41 earnings per share, which represent a profit margin at 30.6% level.

CapEx in the quarter is about $1.1 million. Our headcount was 1,576 people as of the end of Q4 at a similar level in Q4 that's where you expect the revenue growth to be new in 2016.

Turning to the balance sheet, our net cash, cash equivalent and the long time investment ended at $34.8 million. This is after the repurchase of over 2.5 million shares in our $35 million buyback program.

So outstanding shares are expected to be lower than 15.8 million shares for Q1. Account receivable DSO was 65 days in Q4. Inventory for Q4 increased to $10.9 million, while inventory turns declined to 3.5 from previous quarter.

We expect inventory levels to be at similar level in the current quarter to continue serving customers with better return and with the support of new growing demand after Chinese New Year in 2016.

Now regarding forward guidance, we feel that the growth in over 2016 will reverse the trend of 2015. With current activities we expect the sales in following quarters to be between $17 million and $19 million.

Gross margin expected to remain in a similar level or improved. With a higher level of sales net profit will increase with a few number of outstanding shares of the buyback program and without foreign subsidiary annual tax adjustment and per share where will recover from previous quarter significantly as well.

With this start and with the datacom investment from our customer peeking up through the year we are encouraged by the prospect to have a sequential quarterly growth with stronger second half of this year, which will result in another record year for AFOP in 2016.

Net expectations are based on several assumptions including continuous economic recovery, continues advantage from our key customer, optical networking spending up as the current level or higher, favorable product mix, stable pricing and with continuation of efficient improvement in our operations.

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

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question is from Alex Henderson of Needham. Your line is open sir.

Alex Henderson

So Peter, you gave me a hard time but anything blown off for risk of [simplicity] you guys, but where my enthusiasm is. Look it’s obvious that the 40% decline in CapEx that your largest customer had in the fourth quarter had a pronounced impact on the business and really no surprise there.

But it looks like that they've finished cleaning out that excess inventory and they've said that their spending intensions for next year are significantly greater, much more like 2014 in terms of spend.

Given that back drop, do you think it’s reasonable to expect that your top customer could then rebound up into the 30% plus percent of revenue vicinity? And then the second question is I’m a little surprised that the slowdown in the rest of the business the 8% growth outside of your number one customer seems a like low, you had been growing more like a 30% clip.

Can you build little more granular on what caused that slowdown because I was a little surprised by that piece of it?

David Hubbard

Yeah, so we had addressed that. First of all we tend to be kind of aligned with what you're saying there from what we hear at our key customer. So we think that actually they will rebound when they go into next generation platforms will be quite significant now that they have such a base of datacenter in existence.

They're not building one at a time now. They're updating many at a time. So that should be very healthy for us and we do expect that timing to come stronger across the year as Peter described, the trend overall for them. So that's good. With regards -- does that answer that for you?

Alex Henderson

Well, so we predicated on the 25 gig architecture rollouts for that upgrade to spending or in fact will we see that spending pull even before that upgrade cycle kicks in, in the back half?

David Hubbard

I think they're sum of both. There is infrastructure first of all goes in a little bit in advance as you know. So there is activity throughout the year, I don’t want to be too specific about it.

Alex Henderson

Okay. And then the second piece of it the 8% excluding your top customer seems a little light relative to prior trajectories?

David Hubbard

Yes we have several different things that kind of mix together. There are some lumpy programs. As we mentioned, we had a good strategic relationship going with Cisco with some transceiver optics that we're very excited about.

We think that, that has that kind of trajectory that one out of the two transceiver market has overall, but in addition, we had some starts on programs, which had strong quarters and then it take a while a little bit before they kick in, in 2016.

Like I mentioned the network monitoring type activity, we had a strong quarter one quarter and that's going to come back in 2016 and it would be more steady, so some of that affected Q4.

Alex Henderson

All right, the network monitoring, that's service provider monitoring right?

David Hubbard

Right, correct.

Alex Henderson

And just going back to that other 8% how much of that slowdown is a function of the low end pond segment of the market slowing?

David Hubbard

Well, I think we have a piece of that right. So I think that that's kind of been flat for us. It’s a drag when you compare it to the growth model, but it's been fairly steady and we had a lot of different participations in there. So I wouldn’t say it was really down. It was more steady I think.

Alex Henderson

Okay. I'll seize the floor. Thanks.

Operator

Our next question is from Christopher Longiaru of Sidoti & Company. Your line is open.

Christopher Longiaru

Hey guys thanks for taking my question. So your largest customer went up, datacom went down and your gross margins are higher. So can you explain how that ended up being the case and also what your expectations are and a little more granularity for how gross margins trend going forward?

Peter Chang

As I already told you before, gross margin is a mix of product ASP and also operational excellence. So really now one quarter is going to tell the whole story. So maybe Q4 and now we have a favorable product mix okay.

Even though the revenue level is lower. However, our team did excellent job to manage our operating expense line. I wish going forward we will have probably time to maintain the same level as we have accomplished throughout in 2015.

Christopher Longiaru

And just so I understand, so some of the datacom products are higher margin and some are lower and you alluded just the weakness being more datacom and obviously datacom was down as a percentage of revenue. So can you give us a little more granularity into which products were weaker and which products were strong and then also…

Peter Chang

I think that based on the revenue mix and the drop in last quarter it's fair to say datacom average wise have a higher, better gross margin than telecom.

Christopher Longiaru

Okay. But datacom was down and your gross margin was up right. So that’s what I’m trying to reconcile why was that the case because it can't be…

Peter Chang

I am monitoring overall right. However some telecom type of products have better margins. Okay. So really in the quarter it end up telecom product with good margin had a good sales. All right. So that's why we talk about the favorable product mix. Okay.

Christopher Longiaru

Okay. And then just in terms of outside of your largest customer, did you have any 10% customers in the quarter?

David Hubbard

No, we just had some between 5% and 10%.

Peter Chang

Three of them, yeah.

Christopher Longiaru

All right. That’s all I have. Thanks guys.

Operator

Thank you. Our next question is from Dave Kang of B. Riley. Your line is open.

Dave Kang

Thank you. Good afternoon. First of all couple of clarifications, first of all, did you say that top customer was 21% of sales? Did I hear that correctly?

David Hubbard

I will check that number for you.

Dave Kang

And then while you're at it, and then I think Peter you talked about the first quarter shares outstanding as what $16.8 million?

Peter Chang

No, I was -- estimated by about 2.5 million in share lower from…

Dave Kang

Oh, 2.5 million okay.

Peter Chang

Yeah we told you that 2.5 million shares right, okay because in our Q4 and 2015 EPS calculation perhaps your weighted average okay, so even in the end of December 31, 2015, our share in the market is much lower within our user calculation.

Dave Kang

Got it, got it. And then David you have that top customer at 21%.

David Hubbard

Yeah, yes it's 21%.

Dave Kang

Got it. So you went from 14% to 21% right.

David Hubbard

That’s correct, yeah.

Peter Chang

Not bear in mind, because they're eliminating….

Dave Kang

Understand and then regarding first quarter guide, so should we expect both it sounds like you're expecting datacom to outpace telecom based on the mix to be back to 60-40 is that right?

David Hubbard

Yeah, that’s the calculus.

Dave Kang

Okay. And then are we -- should we assume both top customer as well as other datacom customer, or is it mainly the top customer?

David Hubbard

Yeah, fairly broad based.

Dave Kang

Broad based. Got it and then I think somebody asked about this PON exposures, is it possible to break it out that PON or FTTH exposure? Is it fairly material or and is it more in the China or U.S.?

David Hubbard

No, it's going around the world. So it’s in different applications, but it's seasonally small total number.

Dave Kang

Okay. Okay. All right. I think that was it for me. Thank you.

David Hubbard

Thank you.

Operator

Thank you. We have a follow up from Alex Henderson of Needham. Your line is open sir.

Alex Henderson

Yeah so just want to make sure we pin this down accurately. The pending share count, not the average share count, but the pending share count as of the last day of December was roughly $15.7, million is that correct?

Peter Chang

I would say the better just say 2.5 million share lower.

Alex Henderson

Right, so $18.2 million of the average for the September quarter took 2.5 million out of it gets me 15.7 million. Is that the correct number pending share count?

Peter Chang

Yeah, that’s about right, yeah.

Alex Henderson

Okay. So are we still buying back stock in ’16? I assume we are, will that share count continue to come down?

Peter Chang

So, no I think yes, that was good, we put that on hold. We told you we have other event that's going on. So that's all I can say. So no more buyback right now.

Alex Henderson

Okay. So I should assume flat share count going forward from that level.

Peter Chang

Yeah…

Alex Henderson

And what about on the tax line that was a little bit of the normal tax rate? Should I be using three quarters of million to million dollars at quarter on that or?

Peter Chang

No, no let me explain to you a little bit on there. So you can understand. I was going forward effectively tax rate you can use 20% at rates before. What happened in that $2.1 million is mainly we shift our profit to our Asia subsidiary for lower tax rate right.

However, after few years a good profit there. Once you have accumulated the profit and over a million, they down the value have to pay the dividend okay. So, two choice, either you pay the dividend okay or you can pay 10% tax.

So what happened to us additional 10% okay, and that’s after we paid a regular tax okay. So however since we are a foreign investor, therefore we own our Asia subsidiary 100%.

So, as a foreign investor government will take 20% cost right away. So we choose to pay 10% additional tax for that our cumulative profit. So that’s the story. Okay.

If we continue making the money every year going forward and we continue to maintain to put our profit in our Asia subsidiary, this might happen at around a year. So unfortunately we're not big like Apple or Google. They now have operation in Ireland or some area. So in conclusion to your question is fair the 20% effective tax rate. Does that answer your question?

Alex Henderson

Yeah, I guess. Okay I get it. So I use the 20% tax rate going forward to better every two years I expect a bad quarter, attached to the fourth quarter.

Peter Chang

Yeah, that is very compensated yes. 20% will be the one we begin to accrue, going forward

Alex Henderson

All right, so you're accruing for that 10% in your assumptions at the 20% level?

Peter Chang

Yes, yes, yes.

Alex Henderson

Okay. That's fair.

Peter Chang

In the past okay maybe we've been using that some tax credit from Asia.

Alex Henderson

Right, I got it. Okay. Thanks.

Operator

Thank you. At this time, I would like to turn the call back to Mr. Chang for any closing comments.

Peter Chang

Okay. Thank you. So, despite the stringent and slight annual decline for 2015, we have a renewed emphasize on growth in the current quarter and preparing our company for strong growth in 2016.

Our goal remains to generate higher profitability through business expansion and revenue growth, but we will continue staying on course with our demonstrated operational excellence while investing carefully in the technology and the solutions that will best serve our growing customer base and will expand our market share in the long term.

All these efforts reflect where our commitment through continuously improving AFOP value for our important shareholders. Thank you for your continued support and interest in our company and we look forward to reporting to you again in next April.

Operator

Ladies and gentlemen, thank you for your participating in today’s conference. This concludes the program. You may now disconnect. Everyone have a great day.

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