AXT Inc (AXTI) 2002 Q2 法說會逐字稿

Good afternoon. My name is [Turo] and I will be your conference facilitator today. At this time I would like to welcome everyone to the AXTI corporate second quarter earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers remark there will be a question and answer period. If you would like to ask a question during this time then please press * then the 1 on your telephone keypad. If you would like to withdraw your question press the pound key. Thank you. I will now like to turn the call over to Dr. Morris S. Young, President and CEO. You may begin your conference sir.

Hello and welcome to AXT second quarter 2002 conference call. I would like to thank you to take the time to be with us this afternoon. I am Morris Young President and CEO of AXT. With me today is Donald L. Tatzin our Chief Financial Officer. Don will give you a detail financial [report] of the second quarter and following that I will comment on the quarter and current market conditions. Don will close our prepared comments with forward-looking financial guidance then we will open up the call for questions and answers. Don.

Thank you Morris. Before we begin I would like to remind you that during the course of this conference call we will make projections or other forward-looking statements regarding among other things, market conditions and trends, the future financial performance of the company, new products and the companies ability to bring them to market. We wish to caution you such statements are subject to risks and uncertainties that may cause actual results to differ materially. We refer you to the companies 10-K and 10-Q filings made in the Securities & Exchange Commission for additional discussions of risk factors that could cause actual results to differ materially from our current expectations. Now INAUDIBLE results of the quarter, revenue grew 14.4% during the second quarter of 2002 and 19.2 million compared with 16.8 million in the first quarter 2002 and 41.3 million in the second quarter of 2001. Revenue from our opto-electronic division did represent a 32.8% of total revenue for the second quarter of 2002 to 6.3 million compared to 5 million in first quarter of 2002 and compared to 3.2 million in the second quarter of 2001. Our high-brightness light emitting diodes revenue grew at 27.1% compared with first quarter and set another record with quarterly revenue. In the opto-electronic division, revenues for high-brightness blue, green, and cyan LEDs is 5.6 million. Our laser diode products are 679,000. Revenue from our substrate division did represent a 67.2% for total revenue for the second quarter of 2002 with 12.9 million compared with the 11.7 million in the first quarter of 2002 and 38.1 million in the second quarter of 2001. Total gallium arsenide substrate revenue was 9.8 million in the second quarter of 2002 compared with 7.6 million in the first quarter of 2002 and 26.8 million in the second quarter of 2001. Five and six-inch diameter gallium arsenide substrate revenue was 3.4 in the second quarter of 2002 compared with 1.3 million in the first quarter of 2002 and 8.5 million in the second quarter of 2001.

The increasing gallium arsenide revenue compared with the first quarter of large rate results additional demands from customer serving violets, red, and yellow, LEDs market. In the INAUDIBLE substrate revenue is $1.7 million in the second quarter of 2002 compared with $3 million in the first quarter of 2002 and $9.5 million in the second quarter of 2001. [InP] substrate revenue remains heavily dependent on fiber optic business. Raw material failed to $1.4 million. In the second quarter of 2002 North America revenue was 43.5%, Asia Pacific was 48.8%, and Europe it was 7.7% of total revenue. My comparison in the second quarter of 2001 North America revenue was 54.1%, Asia Pacific was 25.3% and Europe was 20.6% of total revenue. Buying customer for our high-brightness LED Agilent Technologies comprise 19.4% of our total revenue during the second quarter of 2002 and 17.4% in the first half of 2002. Gross margins was 15.3% of revenue for the second quarter of 2002 compared with 1.7% in the first quarter of 2002 and it was 39.3% in the second quarter of 2001. We expect our gross margin to recover to early 2001 level of our revenue increasing. Gross margin for our high-brightness LED product is 24% in the second quarter compared with 7% in the first quarter of 2002 as a result from increase size. Gross margin at the substrate division was 14% in the second quarter of 2002 compared with 1.8% in the first quarter of 2002 and 44.2% in the second quarter of 2001. The improvement in gross margins in Q1 results in a combination of volume increases, the affect of the asset impairment charge, and another cost reduction initiative. Selling, general, and administrative expenses were $4.7 million in the second quarter of 2002 compared with $5.2 million in the first quarter of 2002 and $5.4 million in the second quarter of 2001. Research and development cost were $1.1 million in the second quarter of 2002 compared with $1.4 million in the first quarter of 2002 and $3.4 million in the second quarter of 2001. Our expended revenue R&D of 5.7% in the second quarter compared with 8.1% in the first quarter of 2002 and was 5.9% in the second quarter of last year.

During the quarter, the companies had a 32.2 million as impairment charge with substrate business or laser diodes and signal operation and the diminishing in the value of our stock holding in Finisar Corporation. For our substrate business $14.1 million impairment charge recognized the fact that increasingly our production capacities is shipping the [shipment] and that the market continues to remain in strength. We will show a large way of customers to manage INAUDIBLE. As a result some of our production capacity in Fremont is expected to remain [hard]. 9.9 million impairment charge taken from the laser diode and signal system is expected to reflect our belief that recovery in the structure is likely to be slow and that our AXT as a software technology. We do not anticipate a near term substantial improvements in the business environment INAUDIBLE diodes. Interest expense for the second quarter of 2002 was 365,000 compared with 385,000 in the first quarter of 2002 and 515,000 in the second quarter of 2001. ProForma net loss for the second quarter of 2002 excluding the asset impairment charge discussed above and charge related to reduction of the value in our stock and market value of June 28, 2001 were 1.9 million and $0.09 per share compared with a loss of 3.6 million $0.16 share for the first quarter of 2002. Net gap loss in the second quarter of 2002 was 31.4 million $1.30 per share. In the second quarter a year ago company [crossed] a net income of $5.2 million or $0.23 per diluted share. Let us now turn to the balance sheet. Cash and cash equivalents in the majority of less than three months, short-term investments, other investments and high grade debt securities in majority less than two year were $60.4 million in June 30, 2002 compared with $56.3 million in March 31, 2002. The accounts receivable that are reserved were $14.4 million in June 30, 2002 compared with $14.4 million in prior quarter. The INAUDIBLE ON June 30, 2002 compared with 77 in March 31, 2002.

Net inventory decreased from 121,000 from 52.5 million in March 31, 2002, 52.3 million in June 30, 2002. Our total reduction of net inventory in our substrate division is 32,000 and $13.1 million and we expect further decline during the upcoming quarters as we sell inventory products to customers. Capital expenditure for [PPNE] during the quarter was $3.3 million. Depreciation was $2.5 million. Both of our capital expenditure is related to the expansion of our LED business and the completion of our substrate manufacturing facility in China. Net cash used by operating activity is $1.6 million in the quarter ended June 30, 2002 compared with cash generated from operating activities is $2.5 million in the quarter ended March 31, 2001. Net exchange in cash and cash equivalents majorities are less three months short-term investments other investments from high grade debt securities, securities less than three years with a negative $5.8 million for the quarter ended June 30, 2002 compared with negative $1.8 million quarter ended March 31, 2002. At June 30, 2002, we had 1517 employees in total less than less 1270 work in production compared with 1324 employees INAUDIBLE production in March 31, 2002. At June 30, 2002 574 employees work with the US were 943 with [us]. This concludes our review of our recent financial performance. Let me now turn the call back to Morris.

Thank you Don. This quarter we saw a acceleration of the recovery that began in Q1. We posed a double-digit sequential growth that exceeded expectations in both our LED and substrate businesses. With LED revenue increasing by 27% to set another record for AXT. Our substrate revenue grew by 9.9%. Gross margins in both businesses improved substantially by 17 point for LEDs and by 12 point for substrate. Also for the first time since we started our expansion into the LED business in 2000, we approach breakeven point at a pretax base. We are proud of the turnaround we have achieved since [depositing] at the end of last year.

We will see more growth opportunities in the coming quarter. We believe that our LEDs are used worldwide in a variety of applications including back lightnings, INAUDIBLE, traffic signals, and customer goods. We know that as the price of the high-brightness LEDs has declined major wireless handset manufactures are shifting a greater percentage of their production to handset with color display. When major handset manufacturer expected that phones with color display would drive approximately 50% of their handset sales next year. Each of these phones may use 10 or more high-brightness LEDs to supply the back light. Demand for our products outpace supply during second quarter. We benefitted by expanding our capacity and production volume. In fact our average cost for chip decreased by 17% during the quarter due to improved yields and high utilization of our production capacity. Most industry observers believe that the market for high-brightness LEDs will grow at attractive rates for the proceedable future creating opportunities for AXT. As LED technology improves and our cost declines, they are replacing existing sources of light and increasing number of [occupation]. This is happening quickly with true color display, traffic signals, back lighting, and real overtime spread to other applications. Successful LED competitors will have accommodation of low cost, high throughput, and yield leading technology. We believe our early decision to use high throughput low pressure [MOCVD] technology at low cost substrate enable us to create a cost and market position that opened new applications and market opportunities for our LED. During the recent months, we told you of our plans to increase our volumes and margins through our existing facilities in part by installing a new back hand equipment or processes which is beginning as shortly. We executed these plans successfully as demonstrated by the significant improvements in production volume and gross margins during the past six months.

We are now launching the next phase of our developments that will more than double of our current capacity and further reduce our cost. Following our success and establishing our substrate manufacturing facilities in China, we made a commitment to develop the LED production facility in China. By leveraging the infrastructure of our existing substrate operations, the LED division launched a [back hand] facilities in China during the past quarter. We obtained a full line of production facility in the United States including all of our [MOCVD] operation. We intend to aggressively expand the China operations so that it ultimately becomes our major back end process of locations. Over the time we expect to enjoy a significant unit cost reduction from our expansion. At the same time we expect to continue our advanced in technology so that our products remain competitive with industrial use. As I mentioned we are very pleased with our compound growth rate of 32% during the past two quarters. We believe that the market for high-brightness LED continues to grow rapidly. We have many opportunities to increase revenue in the near term. So we are guiding through a more modest growth rate for two reasons. First our capacity will expand to a lesser degree than they had in the prior quarters until our China facility expansion has completed in late Q3. Second our leading customer is guiding us to expect lower demand during Q3 as we will work with them to meet their products and expectations. Other customers has expressed interest increasing their purchases from us, but it is too early for us to access what they demand will be in the near term. We believe that we will resume a high growth rate beginning in the second half of the third quarter. Turning to the substrate business, as Don noticed we posed a 9.9% quarter over quarter growth in the second quarter reflecting a continuation of the recovery that we began to see in the first quarter. This revenue growth coupled with the price expense control allowed us to improve our gross margins in the quarter as well. 15 of our top 20 gallium arsenide customers purchased more substrate from us during the second quarter than they had during the first.

The increased demand has come from early from the wireless sector while we have noticed that some device manufacturers have announced witnessing the [TDMA] products. These products are devices manufactures LEDs substrate. [HPT] and [PM] devices are experiencing increasing demands and they are far more likely to be manufactured as VGF substrate. The gallium arsenide turnaround which started in the wireless sector expressed to substrate was red and yellow LEDs, VVD, INAUDIBLE and some electronic devices. The demand for six-inch diameter gallium arsenide substrate which had declined while our customers look from their inventory increased meaningfully in the last quarter as demand from our wireless customers surged. We believe that a combination of our VGF technology coupled with our early investment in capacity enables us to lead in the market for six-inch substrate in both availability and quality. We are pleased to see that more gallium arsenide users including [RFMD] and INAUDIBLE has announced plans to develop six-inch production line. Looking ahead we expect a continued strengthening of our gallium arsenide business. We believe that most of our wireless and LEDs customers at low inventory levels at the end of Q2. Furthermore, our production pace during this most recent quarter was not enough to support even the low ends of the range of handset volumes being forecasted for 2002. We therefore designs a positive indicators of a stronger second half. While there has been price pressure for gallium arsenide substrate, we believe that AXT is better prepared to succeed in a price competitive environment than our competitors. First, our channel manufacturing facility provides us with low cost based. Second while all substrate manufactures benefit from today's lower raw material cost particularly for gallium which has declined by almost two third during the past year. AXT obtained extra benefit from the raw materials joint ventures we announced last quarter. During the second quarter these businesses were profitable in supplying our own needs and insisting selling to extra gallium to our external customers at market price. AXT is the world leader in both gallium arsenide and [InP] substrate. The focus of the recovery in gallium arsenide devices are [HPT] and [PM] technologies shows there is no substitute for gallium arsenide with VGF strong substrate or for indium phosphide in fiber optics.

We expect to continue to lead our market to the next space of the market. We believe that VGF technology is increasingly becoming the standard for high performance gallium arsenide in the indium phosphide devices. AXT is the world leader in VGF technology. We have the right technology to build what the customer wants and we will be well positioned to grow at market becomes. In summary, we believe AXT is pleasing appearance of improving performance. Our LED business continued to grow and we are boosting our capacities and improving our product performance. Our core substrate business is rebounding. The competitive strength of our products, our market leading position, high quality large diameter substrates, and low cost raw material office are positioning us for sequential growth. We continued to take the step recline to reduce our cost structures where we are finding our production methods to improve yield, reduce costs, reducing our production, and administrative efforts in Fremont, and using inventory to support new substrate. The asset impairment charge Donald described got a book value of our production asset in our substrate and laser diode businesses in lined with business expectations. Moreover based on current estimate and assumptions we believe that our cash position will spend significant expansion of our LED businesses and our operations beyond 2003. We are well positioned with revenue and market share growth and we look forward to report to you on our profit. I will now turn the call back to Donald to give you our forward-looking guidelines. Donald.

Thank you Morris. As Morris said we see business condition improving both in the LEDs and substrate business specifically to anticipate our revenue in the third quarter will be up to 4-7% compared to the second quarter. Anticipate an increase in sales of LED products 3-7% of substrate revenue is expected to increase 5-8% compared to the first quarter. Gross margin in September quarter is expected to be 13-15%. The third quarter loss of share of $0.06-0.07. Capital expenditure is growing 2002 will be approximately $15 million significantly below the level INAUDIBLE 2001. We have sufficient cash funding capacity to meet our capital environment beyond 2003. This concludes our prepared comments. We are happy to answer your questions.

At this time I would like to remind everyone in order to ask question please press * then the 1 on your telephone keypad. Now we will pause for just a moment to compile with Q&A. Your first question comes from the line John Lau from Wit Soundview.

Hai. Given your recent comments on the 6-inch back conversion in the US and probably some in INAUDIBLE. I was wondering if you could give us some more color on the quality of the overall market is migrating or [it is just the one] as mentioned and how the expectations of the VGF is going on the six-inch migration and with the competition in the form of six-inch older LED process and finally I would like to ask could you give us some general comment on what the way for inventory in the channel.

Thank you John. The six-inch we believe has a extra advantage over the LED products mainly because most of the six-inch applications are InP and [HPT]. We are increasingly seeing our customers demand that six-inch line would need VGF only kind of substrate for their production on. So that will benefit us and we also have told you that not every gallium arsenide competitors are prepared for having a good yield on six-inch production. In fact, I think the number of competitors for six-inch line has reduced because most people just stop at four-inch development. I think the trend that went towards six-inch is going to continue because our customer wants to reduce their cost. They obviously get more benefits from the six-inch wafer than a four-inch wafer. The trial will continue and more recently we have INAUDIBLE they all announced in the near future they have been switch for INAUDIBLE. So we think the switch is one way and it is going to benefit AXT VGF type of substrate. John what is the next question. Do you want, I hope the inventory levels with our customers. While we believe although they are still some customers have inventories, but the number of customers which are ordering more from us are indicating that they have a very short inventory little less and they are ordering with very short tight demand in delivery time. We believe although they are still some inventory over end here, but most of the wireless customers have grouped out all the inventories.

Okay Morris, specifically for those customers that are ordering are they orders more into in lined with what they are ordering now or they are more in lined with demand or usage that would indicate you that the inventory level are pretty meaning.

We think the inventory is pretty less.

So going forward it looks like their consumption rate is in lined with their demand rate.

Yes.

All right. Thank you.

Your next question comes from the line of Christopher Versace from Friedman Billings Ramsey.

Hai it is Chris Versace. Just a couple of questions. You mentioned that your later production at the late hours you are seeing does are greater than the low end of the wireless expectations are out there. I am just wondering then they must have shifted around a little bit when you say the low end of wireless expectations what numbers are you coding.

Well we think between 300-400 in handset.

300-400. Okay and Donald I missed in your phosphide in your quarter. What was that again?

1.7 million.

1.7 million. Okay and what is the potential book at the end of the quarter.

It is less than INAUDIBLE.

Okay and the only one line that really becomes to my surprise was the R&D on a sequential basis was down couple of $100,000. We have seen a shift in the strategy here.

Some of that decline is mostly all of the decline is in the substrate R&D INAUDIBLE.

So is it fair to think that the second quarter was probably the high for the rest of the year.

Total dollar spent.

Yes.

It was actually low compared with what was spent.

No I am saying in the third quarter and the fourth quarter. It is probably flat to may be down slight in the back half of the year based on the Q2.

Pretty more flat.

Okay and then just one last thing you mentioned cost expand in the LED business is that how much of that capital expenditure number is going to be this year.

15 It is going to be the vast majority INAUDIBLE.

We have not spent any of that yet.

No we have not. The most of what we record is in the last couple of quarters as then LED related.

Okay and then just one last one gallium arsenide substrate pricing trends are we seeing further price erosion from the March quarter at a pricing kind of settling down now.

Well the price pressure is always there and I mean we always have customers who want flow of price with this environment people will do want to have price. As I indicated in this script I think we are better prepared in this very competitive pricing. And also gallium arsenide product is not a commodity used. Somebody had told me that during the gallium arsenide manufacturing conference somebody said there is a four-inch wafer offered INAUDIBLE well for those customer or device manufactures who are there to use those were you may have a INAUDIBLE you may have reliability problem. So it does need a very vigorous qualification process and its quality is really a very important to our customers. With the VGF also requirement which will benefit us to answer your question I do not think there is any very dramatic eroding affect. They do not decrease unlike last year we have been saying that INAUDIBLE increases slightly, but we did not see a major decreases.

So if we look at that sequential improvement that you had versus the first quarter for [cost] rate revenue can you give us a sense of how much was volume and how much was price?

Well it will increase INAUDIBLE in Q1.

So you are saying that they are more less flattish Q2 versus Q1.

I would categorize this slightly down. Also we do have other benefits such as we are going to China and we do have the benefit of lower raw material cost.

INAUDIBLE.

Yeah great thanks guys.

Your next question comes from Earl Lum from CIBC World Market.

Good afternoon gentlemen. Nice quarter. Couple of housekeeping questions first is that correct in understanding that your headcount now is 1570 tones.

INAUDIBLE yes.

Okay. And then with regards to the spread I missed the gallium arsenide revenue that you had put the quarter. Could you give that to me again?

Sure. Gallium arsenide was 9.8 million in the second quarter.

Okay. And then in the if you go over to your LED production certainly it seems like there is a lot of momentum there right now, but what were the split between high-brightness and laser diodes for the first quarter.

For the first quarter the high-brightness was 4.4 million and laser diodes was around 600,000.

Okay should we expect laser diode would be kind of flattish for the second half.

Flat for the first and the third quarter.

Okay and then you had mentioned I guess in terms of ship cost reduction quarter over quarter was that 17% that you had mentioned LED. Are you expecting that type of cost reduction as we continue sequentially going into the second half?

well I do not think we have mentioned. It will be so much in the third quarter and a reduction in the INAUDIBLE.

The combination of benefit of reduction in cost one is volume by utilization and as well as possibly with the move to China we will benefit as a lot more with the move to China we will probably go into a large gallium in the first quarter and we guided sort of moderate growth during the third quarter. So we do not expect INAUDIBLE.

Okay if you look at just over quarter over quarter [ASP] for the LEDs how would you characterize that in Q2 in going forward in the second half.

It was flat in Q1 and Q2 and going forward it really depends on what products mix with customer orders are because it is fairly why percentage INAUDIBLE.

Are you guys in the second quarter did you see a better mix towards green and the high-brightness green or could you characterize how the mix is going to shifted how it goes to look into the entry of the second half at that point in time or what is your visibility is looking like?

Well we do have a shift towards higher prices in the second quarter we did, but in the future if that trend is going to continue on our reliance I mean obviously the new the majority of these utilization I mean the demand is mostly lose, but we do have advantage in the green not from any competitors and suppliers at the same price having the same level of reliability as we can offer in the green and cyan HBLEDs.

Okay and then with Agilent being 19% in the second quarter are you expecting a sequential increase in revenues from your number one customer or in the third quarter or you are expecting that to down slightly given the guidance that you had mentioned and how is the visibility that you are getting from your number one customer as we move forward.

We do expect as we said in the sixth I think our major customers advising us they are going to pull down their demand because we are working with them to work out with the lists of product specification. So we expect the revenue to our first customers as the largest customer will increase in the third quarter.

And Morris when you say that you are working on a certification is this a new product transition space that you are entering in with the largest customers to work. They are ramping down one of your older products and trying to ramp a new one or what is the I guess the cause of the suppository in Q3.

While the cost of the suppository when we spend our products to our customers we always will agree upon that there is specification. We tested before we shift and during the last few weeks we found we have a sort of a product specification disparity between what we shift and our customer realize. So we are working out the [coloration] with our major customer and make sure that our product will we both agreed, but because sometimes this correlation may take longer time than we expect result that why I was taking it more cautious today.

Okay is this more related to like whatever the wavelength that you are testing to or the brightness level than is there.

This is a brightness level and the number of chips for higher up the range.

So is there any possibility that if the new specification comes and is tighter than the original specification that adverse is going to want to return some of the product that does not meet the original expectation.

We do not think so. We have not heard that. We do not think so.

Okay do you expect that they are going to continue to yield whatever that you have shifted them and once you set around what is the new specification are you have correlated then you saw ship in the new products. It is a sort of ramp again.

Right.

And then one final question. As we look forward what would be I guess was the asset impairment charges and all the other charges that you have taken for both the LEDs and the substrate what is kind of the breakeven levels for both of those divisions [out] moving forward.

Roughly for the LED and substrate division is around $15-16 million and then for opto-electronics it is $7-8 million.

Great thank you gentlemen.

Your next question comes from Pierre Maccagno from Needham &Co.

Hai Morris. The question for both the [ASP] and LEDs. How do you explain that they are flat? Is it that you are bringing up with brighter? How do you say that?

Well I think that in the script we have two reasons to guide cautiouslessly during the third quarter. We do believe the demand for high-brightness LEDs are continuing. It is a very high market out there. INAUDIBLE except to Asia and there is a lot of demand out there. But, as we said we have two reasons to be cautious. One is that we are expanding our capacity, but we may have an intermediate cause during the third quarter because some of the production line INAUDIBLE we do expect its come on line until the later part of the third quarter. The second issue was roughly as we said before our major customer that we need to work out is products specification we sent before what it can be more our records in promising a revenue growth.

ASD from same quarter.

We did not realize say noticeable decline in our prices were given products of any company and in addition the percentage of our products that was higher prices level therefore demand was slightly higher price higher due to INAUDIBLE.

Yeah there is not much of a pricing pressure let me put this way INAUDIBLE.

That is the good thing. What about the breakeven number that you gave. Is that based on revenue?

Revenue growth, it was estimated around $23.5 million overall breakeven revenue.

Is that from based on EPS.

This is EPS.

Okay some of the substrate can you give us break down and how much of it was wireless and how much of it was opto?

Let us say more over 50% was wireless and then much of rest of gallium arsenide for the red, yellow.

Can you clarify again the [ASP] will for the first yellow. Can you give us how much we designed over the quarter?

You know there is obviously we do not want to discuss price over the conference call because then every customers heard it they want the lower of the quoted price. We do work with our customers on different specifications. Some customers have very large volume and very consequent specifications then they probably would get a lower price growth. Some customers do have smaller volume and they have very difficult specification they have paid more. But as we said the price of competitive does right now we are not seeing the end of the price decline, but also we did say it is not declining dramatically. I think if I were to estimate total year over year would probably we are seeing between 15-20% price decrease in the most recent six months or a year. However, the other differentiation is some of the products such as four-inch gallium arsenide or wireless applications which is the legacy products everybody can make those products with price pressure of higher whereas in six-inch product and specification with higher and not every competitor can supply those VGF substrate to price with coding of this INAUDIBLE.

But historically your [ASP] is above 60% every year.

Historically it is long sense of 15%. Actually, we used to see between 8-10%. It has increased more recently. But also you have to remember that the gallium price also decreased substantially and also we enjoyed a price increase in fact during year 2000 and 2001. So this is also working fact the increase that we had before.

In the quarter what percentage of the business that was turned.

For the substrate INAUDIBLE, little over 50.

50%.

INAUDIBLE.

Good quarter. Thank you.

Your next question comes from Aalok Shah from Pacific Crest Securities.

Hai guys good quarter.

Hai Aalok thank you.

Couple of balance sheet question first. May be you guys can give over what is the cash for use again and what particular you will be using your cash flow. Also what you expect your cash flow to be like next quarter.

The cash was primarily there is 3.3 million for [PPND] and then we had a negative operating cash of 1.5 million, but other than that we had an increase in the prepaid expenses of about 2.3. And that is primarily related to capital expenditure for the LED business before we are making profit on your equipment and then some increases in prepaid expenses and substrate. Inventory continued to fall. Account receivables were basically flat.

Okay. Morris may be you can comment a little bit about the when we enter the quarter we did see these INAUDIBLE some historically low inventory levels. How much of this do you think is may be just replenishing that inventory and you did mention that you are trying to some more pattern that are improved just based on better order replenishment then, but some of this quarter based on inventory replenishment do yo think.

Aalok we do not think so. Most recently we obviously talked to our sales people very frequently. I think there is a consensus from our sales force has been activity for our gallium arsenide purchase actually it is lot more of best than what we sorted in the prior quarters. Because of our demand for our customers we think these are not in this environment, I do not think anybody will try to manufacture to put on the [Sheldon and put on inventory]. I think they are mostly they have this demand because they order at the liberty because the time is very short.

Don you mentioned your EPS breakeven points for revenues. What will be the cash breakeven points?

You want me on operating or earnings.

Just on operating business. Essentially, add in million and a half.

Roughly I may remember we have been carrying back positive operating cash flow from the last three quarter and revenues in Q4 and Q1 were less over this quarter.

Morris one last question. Our lead times improving free of them essentially would you say some along those line get or not yet.

For gallium arsenide it is no. I think it is about the same. Because we still have capacity.

Okay and one more for Donald. Could you break out the gross margins again for each sector?

All right sure. For substrate it was 14, and for INAUDIBLE it was 24, and then for overall opto-electronic include the laser diodes was 17.8.

Great again good quarter.

Your next question comes from [Dave King].

[DAVE KING]: Hai guys nice quarter. Regarding the LED customer. Could this be just a one quarter phenomenon I mean what gives you confident that they will come back in the later part of this half and could this does thus drive on much longer and can you just talk about other LED customers that are planning to step up in the second half. Thank you.

As I said ourselves we are not right now right now probably in South East Asia. What we see is the demand for the high-brightness LED is indeed very very high. I mean talking to many many customers and both one needs to work it out with the customers who first match the product with the delivery that was delivered to them and the match the product specification the demand. As your question how confident we are which has resulted an issue with our major customers. I think our confidence level is quite high. The reasons for the cautious guidance for a lower growth rate in the third quarter is taking that into account with only INAUDIBLE next week. We do expected to take a little bit time, but I think it is absolutely a specification matching issue we should be able to resolve it in the near future. But, if it is results, let us not also we emphasized, this particular customer are still taking product from us. They are, but just because we have the specification matching issue though they are scaling back for demand. But we think so much would result issue with them I think we can start setting up the production and the delivery to them again. And many other customers as I said I think we are for the first time starting to breaking through events automobile market and some appliances market you will be surprised to see that demand bringing at higher LED and we basically get qualified into a traffic light for our cyan LEDs to be used in United States. I think we do have strange in different pockets out of specification that we seem to market [that is rarely].

[DAVE KING]: Okay. Will pricing be different from our depending on the end market Indianapolis wireless based on the traffic or other markets on they will be more pricing pressure in other markets. Thank you. This is my last question.

Mainly the cyan and green, LED when the brightness level is high to our E grade and D grade they do come in at higher prices. The other price issue on LEDs and blue of course it is lower price. The other price issue about LED is pricing is lower as the volume. When the volume goes very high, the prices are low.

[DAVE KING]: Actually just a couple of more can you just talk about the linearity of order is that going to tell off towards the end of the quarter and how much production do you expect out of China in this quarter and in the fourth quarter. Thank you.

There was no significant difference from us.

Right. That seems to the last one was still the highest production for June, but during the third quarter we expect the first months to be the lowest and we believe that was a result issue with Agilent than we should pick up there is a order. And also we have auto customers demanding our products. As the production level from China is concerned, we said we are starting to set up the back end perpetually in China. The first starting machine is already installed. We are trying to qualify those products, but we expect meaningful productions from the China facility in both.

[DAVE KING]: Thank you nice quarter guys.

Your next question comes from [Steve Criger].

[STEVE CRIGER]: Hai good afternoon couple of questions. Don could you repeat the numbers of your expectations with sequential revenue growth.

Sure. We said overall it would be 4-7% and then LEDs would be 3-7% while our substrate would be 5-8%.

[STEVE CRIGER]: And then the other question I have is could you comment on the impact of Motorola development of gallium arsenide and silicon wafer. What affect that is likely to have on demand for gallium arsenide wafer.

This is Morris. I do not think there is going to be a meaningful impact through gallium arsenide substrate demand in the near future. I would characterize as to say we do have to worry about in the next two to three years. If we think it is mainly at this stage at least is a nearing INAUDIBLE. I mean gallium arsenide INAUDIBLE substrate has been worked on by many many people for all many years. Even if this product were to be very successful in development we still have to work out the reliability still have to qualify with its major customers and also has the demand ever increasing quality requirement such as more recently you see the market is shining the way from INAUDIBLE [HPT] and [PM]. The reason INAUDIBLE have the linearity, does have the power efficiency as [HPT] and [PM] will have. As a new substrate in using gallium arsenide and silicon for one it has very high defect levels. So it barely can meet best specification so for it to work out on all these details I think we can nothing is impossible, but I do not think there is a near timeframe.

[STEVE CRIGER]: Okay thank you.

Your next question comes from [Susan Shin].

[SUSAN SHIN]: Hai. INAUDIBLE. Good quarter guys. Transitioning in China when do you expect that transition.

What product?

[SUSAN SHIN]: Just as a whole.

For the substrate gallium arsenide transition for China we are towards the completion phase. Right now 70% of the production actually occurs in China for gallium arsenide substrate and we expect towards the first quarter of this year of 90% of the production will come from China for gallium arsenide substrate. For LEDs, however it is just at the beginning. We expect it to ramp in the next few quarters and meaningful production output was stopped to come out of China facility in the first quarter of this year.

[SUSAN SHIN]: Okay. What kind of margin improvement could we expect by the time this transition with gallium arsenide.

Well we believe we can reduce the cost of labor by substantially by operating China. We will also expect that the facility cost will be lower in China because you know that the capacity where we are seeking very aggressively increasingly our capacity though as exactly how what is the percentage of gain you can get. It is not estimated at this time. Because you know in the meantime also we expect in the future the price will continue to come down. [We do not know the reason] for the market event for high brand with LEDs because price is getting lower. We believe winning ticket is to have the right technologies to have the low cost bases as well as you will have the large capacity to meet market demand.

[SUSAN SHIN]: Could you give me a geographic breakout and may be if you just saw any specific area of strength.

Overall the second quarter revenue percentage in America customer is 43.5, Asia Pacific it is 40.8, and Europe it is 7.7.

[SUSAN SHIN]: Okay and going forward would you expect opto-electronics versus substrate to comprise I guess a well larger percentage of revenues or what kind of mix are we are going to see going forward.

Going forward we do expect LEDs all opto-electronics that has been tested although we do see a good balance fact on the substrate revenue because we think the potential for LED to expand rapidly. Perhaps it would take a slightly fast during the third quarter, but we do believe in the substrate first quarter first quarter or later part of the third quarter they showed INAUDIBLE wold be higher than substrate.

[SUSAN SHIN]: Okay last question on the March earnings call you said that you expect to sample six-inch faster rate this quarter. Did you do any of that and so [how that reference]?

We do have six-inch in the phosphide available. The last we checked with our sales force we have our people interesting in, but I guess with the telecom dialing it is basically because for them to produce the purchase orders. So we have not sold any significant change in phosphide substrate yet.

[SUSAN SHIN]: All right thank you very much.

Your next question comes from [Dan Tharp].

[DAN THARP]: Hai just a quick question on pricing. It sounds like demand for the high prices in LED is great, but pricing does not seem to follow through, how do that working in terms of the supply demand.

Are you saying that the demand for the high-brightness LED is very high and yet we are not increasing the price.

[DAN THARP]: Yes is that right.

Well you know in the marketplace you do not increase price to get the customers. I think we have been saying potentially you do enjoy some firming up in price and when customer give you a even larger order you do not give as much a price concession and you should be very thoughtful for that. The other is that the product mix as customer demand is high end and bring LEDs and they pay higher price in the second quarter. We do have that affect in the second quarter.

LEDs to some extent a displacement technology. These are the other forms of lighting and that has the market price ability comes down the market expansion we and others have raise INAUDIBLE.

[DAN THARP]: Yeah in terms of the volume being higher that is the result of shifting the product cycles towards more color LEDs and cell phones and other things like that. Is that accurate?

What we believe is the price and performance of the LED chip and including. There have many opportunities available. Cell phone is just one of them. One major cell phone nature they said that I think this year they expected the full color cell phones to be something like 10-15% of their products, next year they expected to be grow of 50% as translating to billing of the LEDs and the reason why we have seen a robust demand is because first of all INAUDIBLE at a lower voltage that this battery is operating at a portable pricing. Couple of years ago these high brand LED were selling for dollar piece they cannot afford it.

[DAN THARP]: So what was the price of the high brand facility you mentioned earlier in the call that you expect for the 10 LED for these color. What were the price point for each of those LED approximately it is $0.10, $0.15, $0.05, how do you think was that?

What you said was approximately right. It is more than $0.10. It is between $0.10-0.15.

[DAN THARP]: Okay great. Is there a lot of capacity coming on? I was INAUDIBLE saying that their expanding capacity is that are you finding that across the board as the demands were strong with everyone with increasing capacities of producing that.

Yeah we believe there is a capacity expansion yes. We are aggressively very aggressively pursuing capacity as an exception.

[DAN THARP]: Thank you.

I have a followup question from Earl Lum from CIBC World Market.

Yes Morris and Don just if we look at the substrate and the big jump that you guys had in five and six-inch in revenue in Q2 almost by 44% of your total substrate revenue. Are we expecting that is going to be the continued driver as substrate growth continues and the third quarter as again it be a kind of spread evenly between the other sizes and the five and six-inch.

I think the six-inch was a greater percentage of growth in Q2 and likely in Q3.

Okay so we do expect that six-inch will be above 50% of the total mix in Q3 and continued to trend upward or shortly kind of....

It is high what we are looking at what we at the same quarter last year it was now little over 35% that were now.

Okay and then you had a revenues of about 1.4 million in raw material could you comment define exactly what you were referring to.

We have talked in our last conference call that we have made a number of investments in joint ventures and try to signify gallium INAUDIBLE this will be sales of that on those products.

Okay are you expecting that to be flat or sequentially up in Q3.

I think that will be up.

That is just one product.

INAUDIBLE just to remain them and whatever the gallium all that kind of ramp into the other.

Yes going to ramp in raw material.

All right. Great thank you.

Your next question comes from Jason Sam from Roth Capital Partners, Inc.

Hai Don and Morris. Just a few quick questions. Now if INAUDIBLE sales do come in at about the 380 this year how would that affect sequential growth for the rest of the year for the substrate business?

Well Jason I think all can comment is we did a sort of a hand waving kind of a calculation. We believe it is going to come back, but on the other hand exactly what it is its kind of difficult was because they are many factors placed in queue to play. First of all last year or two years ago when assets was at 250 million copies of handset a year, but at that time there is a lot of four-inch demand and there is virtually no significant demand. We as compared to now the six-inch is actually at higher percentage and would play a very important role in INAUDIBLE. The other factors that two or three years ago the dominant technology by then was much back. [PM] and [HPT] was still only 30% of the world at the market, but right now, we believe that [HPT] and [PM] are predominant technology. So there are many other factors. We are seeing and we believe that the reason why our gallium arsenide substrate revenue was low was because a lot of our customers are working out the inventory. So even with not a substantial growth in the handset business total overall handset with volume we expect our gallium arsenide revenue to recover nicely.

So basically you are expecting to take chance away from your other major competitors.

INAUDIBLE.

Now if that is going to be product trend in terms of six-inch and the INAUDIBLE playing on a much bigger part in the future. In terms of the VGF development just looking at the [demand scale], they are vertical INAUDIBLE are they coming close to what you do?

What we believe in our marketplace was still leading price with margin, but this is a very few market demand. It has been quite a while for getting through the cents BP. We do believe we still have a comfortable margin leading over their ability to.

Don just a quick question on the LED business. First Don on the opto side, just for clarification did you say that the high-brighness LED revenue for the quarter was 4.4 million.

This was in Q1 for this quarter it was 5.6.

5.6 okay and the laser diode 600,000 for laser diode.

Yes.

Okay Morris you mentioned that there are not many people could match your high-brightness screen. Not to put you on the spass, versus the top three where do you think you stand?

I think the green and cyn just looking at our competitor specification. I think we are quite competitive come into our top competitor. Perhaps let me put this way I think we had a price issued on the blue and the green cyn. With the Japanese competitor obviously asking for a very high price for their green cyn chips I think we are very competitive end. So we are penetrating a lot of Chinese traffic. The traffic light made in China city comparision we are gaining a lot of market share from those application.

In true color display in China we believe we have a very strong for 2002. we have a lot of customers demanding our products because they not only need green, but also they need very reliable screen and brightness screen that it can be used outdoors, but because of our capacity contrain we really will fluctuated we cannot supply all the demand out there. And also we do have a very more customer. We do want to keep that customer happy first. So now that is why we need to expand capacity very quickly. So we can get to lot of these customers who want us.

Last question promise. Regarding the Agilent just to summarize the Asia that have the technical issue.

It is a technical issue yes.

Now specifically what is the customers specification change from the time they gave you the order to currently or did you guys just not feel all right.

It is more of the later, but INAUDIBLE when our customers. Actually our customer give a whole lot of different specification and according to different product what you call as product numbers they call for some change in INAUDIBLE and some change in INAUDIBLE some change in that is different possible that we supply into. We agreed upon INAUDIBLE we need to collaborate because where our customers into their prodcution line. They then have to put in their package and they measured again. These what we promise to deliver versus what they will be the measure is different that will have a problem. We need to INAUDIBLE and we need to work out the differences such that our customer will be back to very very happy. We do take it cautiously because they are saying because of the different in specification they are lowering the demand form our proudction in 2002.

So we believe if you can resovle it quickly then we can resume to the whole production rate, but if we do not then we are expected to delivery rate to be low that is why we guide the more moderate growth in the near future.

So when did you discover that when did they inform you about the issue?

Very recently.

Thank you.

You have a followup question from [Dave King].

[DAVE KING]: Yes. First do you still expect Agilent to be 10% cost in the September quarter and regarding sky works before merger Alpha was the regular customer and other was the more indirect customer. Can you just talk about impact on your business because of the merger. Thank you.

Dave expect Agilent to be still at 10% customer.

I think every worker is issued the forecast that they if we were all issues and demand increases and INAUDIBLE.

[DAVE KING]: Sky wart.

I think in the near term we do not see a whole lot of change. Half of still is a very major customer files. We do not believe they are going to switch substrate just because.

[DAVE KING]: Thank you.

You will have a follow-up question from Aalok Shah from Pacific Crest Securities.

Hai Agilent specification that you are INAUDIBLE other vendors.

What we believe Agilent has INAUDIBLE. We do not think we are so soft, but when high end we think we are major of that.

Are you implying that you might be a INAUDIBLE you do not need best applications.

No it is not a meeting specification, but one has to agree we mentioned every piece of chips when we ship out, but your measurement will be slightly different than your customers. Let say if they are usually it is 3% difference usually of course if it is 3% on that side you can probably take it. If there is 3% or 5% on the low side they have a higher rejection rate than they would be like to be. So we cannot automatically just upgrade our product toward a total different grade than we will lose our share to. So we just need to caloborate so that we spent our machine to test same level of the demand.

And then Don you said on the operating expense essentially is charge off. What is your expect operating cost 4.6.

I did no understand.

What do you expect our for the next quarter.

Cash flow or operating flow.

Just operating expenses.

May be little less this year we exclude the impairment charges go about 5.7 and 5.8 INAUDIBLE.

And then we are supposed to keep that INAUDIBLE. Thanks.

You have a followup question from Christopher Versace Friedman Billings Ramsey.

My question was already answered.

Your next followup question comes from Pierre Maccagno from Needham &Co.

I had a followup on the Agilent specification. The basic issue here is that you did the measyring that uses up with the INAUDIBLE.

It is mainly a measuring device. It is what they measure and what we measure. They are slightly different. They also play customer INAUDIBLE, but touched away that what we measure than what they. We are always into more firmly improved their yield and they will be happy.

INAUDIBLE.

Mostly a calibration.

Yeah it is not a manufacturing.

We do not think so although we are cautious because we do not know how long it is going to take us to because the customers are busy wanting to ship their products still sometimes it may take a while before we can, but our engineers are very active and working with them now to try to excldue.

For order like a range you want them INAUDIBLE. And the price between this and that range.

Yes obviously it is a previously we just give us cost numbers we are each correspondent for each specification. The wave line is the etc. therefore no INAUDIBLE.

This does not seem to be like a major recent, but some.

Well we do not, but we want to be cautious.

Okay thanks for your verification.

At this time gentlemen there are no further questions.

Thank you and for participation in our conference call. We look forward

Thank you for participating in today's AXT quarter earnings conference call. This call will be available for replay beginning at 7:30 PM Eastern time today through 11:59 PM on June 23, 2002. The conference ID number for the replay is 4620156. the number to dial is 1800-642-1687 or 706-645-9291. Thank you this concludes today's call. You may now disconnect.