AXT Inc (AXTI) 2003 Q4 法說會逐字稿

Good day, everyone, and welcome to the AXT fourth quarter earnings release conference call -- all sites have been placed into the conference in a listen only mode. There will be an opportunity for questions and answers later in the program. I'd like to turn the conference over to our speakers today, Dr. Morris Young, President and CEO. Go ahead please.

Hello and welcome to AXT's fourth-quarter and fiscal year 2003 conference call. I would like to thank you for taking the time to be with us this afternoon. I am Morris Young, President and CEO of AXT. With me today is Don Tatzin, our Chief Financial Officer. Don will give you a detailed financial view of the fourth-quarter and the full year. 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 including comments made in response to your questions we will make projections or forward-looking statements regarding among other things market conditions and trends, the future financial performance of the Company, new products and the Company's ability to bring them to market. We wish to caution you that such statements deal with future events and so are subject to risks and uncertainties and that actual events or results may differ materially.

In addition to the factors that may be discussed in this call we refer you to the Company's 8-K, 10-K and 10-Q filings made with the Securities and Exchange Commission, and available online by link from our website for additional information of risk factors that could cause actual results to differ materially from our current expectations. This conference call will be available on our website which is AXT.com.

Now onto the results for the quarter. Revenue for the fourth-quarter of 2003 was 9.1 million compared with 8.5 million in the third-quarter 2003. Total [indiscernible] [indiscernible] revenue was 7.5 million for the fourth quarter 2003 compared with 6.9 million in the third-quarter 2003. Five and 6 inch diameter [indiscernible] revenue was 1.6 million for the fourth-quarter of 2003 compared with 1.7 million in the third-quarter of 2003.

[indiscernible] phosphate subsidiary revenue was 512,000 from fourth-quarter 2003 compared to 496,000 in the third-quarter of 2003. In the fourth-quarter of 2003 North American revenue was 32 percent; Asia-Pacific was 57 percent; and Europe was 11 percent of total revenue. By comparison in the third-quarter of 2003 North America revenue was 36 percent; Asia-Pacific was 45 percent; and Europe was 19 percent of total revenue.

No customer comprised more than 10 percent of our revenue for the full year. One LED customer comprised 12.2 percent of our revenue for the fourth-quarter. Gross margin was 8.6 percent of revenue for the fourth quarter 2003 compared with 5.9 percent for the third-quarter of 2003. The improvement in gross margin compared with the third-quarter is due to a combination of cost reductions and revenue increase.

Selling, general, and administrative expenses were 2.5 million for the fourth-quarter of 2003 compared with 2.7 million for the third-quarter of 2003.

During the fourth-quarter of 2003 we collected some age receivables and subsequently reversed a provision for these amounts. Research and development cost were 289,000 for the fourth-quarter 2003 compared with 301,000 for the third-quarter 2003.

Operating loss was 2 million for the fourth-quarter of 2003 compared with a loss of 2.5 million for the third-quarter of 2003. Net interest and other expenses for the fourth-quarter of 2003 was 111,000, compared with 142,000 in the third-quarter of 2003. Fourth-quarter 2003 results include a write-down of 808,000 related to an impairment charge taken on an investment the Company holds in a U.S. private company.

Net loss was 2.1 million or 9 cents per share for the fourth quarter of 2003, compared with the net loss of 2.6 million or 11 cents for the third quarter of 2003.

For the full year ended December 31st, 2003, revenue was 34.7 million compared with revenue of 44.9 million in 2002.

Loss from operations for the year ended December 31, 2003 was 9.6 million compared with loss from operations of 39.7 million for 2002. Loss from our discontinued optoelectronics business conclusive of loss [indiscernible] 15.6 million for 2003 compared with the loss of 26.2 million during 2002 -- no tax. Net loss for the year ended December 31, 2003, was 26.7 million or $1.17 per share compared with a net loss of 81.2 million or $3.63 per share for 2002.

Let's now turn to the cash-flow statement and the balance sheet.

Net cash flow provided by operating activities was 310,000 for the quarter ended December 31, 2003, compared with net cash flow of 6.3 million for the quarter ended September 30, 2003. Operating cash flow during the third-quarter of 2003 included an income tax refund of 8.1 million.

Total cash flow is 2.9 million for the quarter ended December 31, compared with cash flow of 7.9 million for the quarter ended September 30. For the year, net cash flow provided by operating activities was 6.3 million. Cash and cash equivalents with maturities of less than three months, short-term investments and other investments and high-grade debt security with maturities of less than two years including restricted deposits were 44.6 million at December 31, 2003, compared with 44.6 million at September 30, 2003. Accounts receivable net of reserves is 6.3 million at December 31, 2003, compared with 5 million in the prior quarter. We saw an increase in accounts receivable of 1.3 million and day sells outstanding increased to 63 at December 31, 2003, compared with 53 at September 30, 2003, as a result of a higher percentage of sales to Asia-Pacific market -- where payment terms are generally longer.

Net inventory decreased 2 million from 26.1 million at December 30, 2003, to 24.1 million at December 31, 2003. Our total reduction of net inventory during 2003 was 13.5 million.

Capital expenditures in the quarter were 264,000 and depreciation was 1.2 million. Total capital expenditures for 2003 were 2.2 million compared with 14.2 million during 2002. During the quarter we paid 103,000 in long-term debt principle. At December 31, 2003, we had 972 employees in total, whom 818 worked in production compared with 886 employees in total of whom 728 worked in production on September 30, 2003.

At December 31, 2003, 119 employees worked in the U.S. and 853 are abroad. This concludes our review of our recent financial performance. Let me now turn the call back to Morris.

During 2003, we made significant improvements in our business. We increased our cash and short- and long-term investment by 25 percent while reducing our debt by 45 percent. We sold our struggling opto-electronic business; reduced cost by shifting more productions to China. They improved product quality. Customers responded to the improvements in [indiscernible] by increasing orders in the last quarter which resulted in our highest quarterly revenue since the fourth-quarter of 2002 and lowest operating loss since the third-quarter of 2001.

During 2003, we also benefited from the growth in our two largest end markets for gallium arsenide substrate (ph). Red yellow LEDs and wireless headsets. We estimate that these two markets generated approximately 90 percents of our fourth-quarter gallium arsenide revenue. Potential markets for gallium arsenide and indium phosphide (ph) including telecommunications saw limited improvements during 2003 and continue to present opportunities for future growth.

Price pressure continued throughout the year. However much of our sales of LED wafers are to customers in Taiwan and most of all, these sales are [indiscernible] denominated in Japanese yen. Therefore the strengthening of the yen against the dollar improved our competitive position and coupled with the ongoing quality improvements allowed us to gain market share among our LED customers.

Despite the price reduction, our gross margin increased by approximately 6 percent in the third-quarter of 2003 to approximately 8.6 percent in the fourth-quarter due largely to the shift of more production to China and the increase in revenue.

Products produced solely in China are now qualified by most of our customers. And we are working with our remaining customers to secure their qualification of China-produced products during early 2004.

We were also cash flow positive from operations in the fourth-quarter as a result of the increasing revenue, reduced costs, and continued use of inventory.

With all these things in place, AXT is coming back. Our strategy includes aggressive sales effort to increase market share within existing customers and to win back key customers that reduced their order volume with us.

We are augmenting our R&D efforts to close any remaining quality gas between AXT and our competitors. We are continuing to reduce costs, primarily by shifting our remaining U.S. base production to China.

Finally, we are continuing the cash conservation effort launched last year to ensure we remain financially strong and independent. In accordance with this strategy, we have shifted some of our staff responsibilities.

I have assumed direct responsibility for our Worldwide Sales and Marketing effort. We're strengthening management oversight of our China operations and our Beijing [indiscernible] factory and joint venture partner locations.

We're augmenting our R&D efforts by hiring engineers who are representing key portions of our training and section processes. Our technical support team continues to respond quickly to any customer concern. These actions are proving effective in the marketplace.

A quarter ago, we reported to you that we increased sales significantly with when a major LED customer. During the fourth-quarter, this trend continued as we increased sales to additional LED customers. Our top 10 fourth-quarter customers purchased an average of 75 percent more products from us during the fourth-quarter than they did during the third-quarter. Looking at the first quarter we see demand rising again from a broad range of customers.

We believe that this strategy, coupled with improving market conditions, will result in better performance during 2004.

Turning to market conditions, we expect our market will grow. We believe demand for headset units sales will grow by approximately 10 percent compared with 2003. In addition, we believe that a higher share of new head sets will be up to 2.5 at three G standards. The 2.5 and 3 G phones use more gallium arsenide (GaAs) per-unit than 2G phones because they have more power amplified for headsets. Our other large market LEDs is also expected to grow. More yellow LEDs are being used with blue LEDs to create white light and use of LEDs in automotive applications is increasing.

In addition the red, yellow LED market is switching to its greater use of gallium arsenide (GaAs) at expense of gallium phosphide. Therefore, we can grow faster that the red, yellow LED market since we benefit from both industry growth increasing penetration of gallium arsenide (GaAs).

We believe that this demand for gallium arsenide (GaAs) LEDs may increase by as much as 20 percent this year. As market demand for gallium arsenide (GaAs) substrate increases, industry suppliers are increasing their utilization rate. With current economic returns for the industry we believe that it makes little sense for a competitor to make significant capacity increases.

Therefore, as utilization rates rise, we believe that the rate of price reduction of the past two years will decline. As we still have substantial use capacity, we can accommodate new orders that could fill this capacity.

While we do not expect indium phosphide (InP) germanium (Ge) to be a large portion of our 2004 business we believe they are opportunities for revenue growth. Indium phosphide (InP) revenue has been flat at approximately $.5 million per quarter during the past year.

We are handling more increase and know that there is an increase for telecommunication firms installing additional infrastructure that could boost indium phosphide (InP) demand.

Regarding germanium (Ge)'s substrate we are in qualification with major satellites solar cell manufacturer and believe that we could see some revenue from this product during the second half of 2004.

Turning to our material products we also expect the improvement in 2004. We currently have investment totaling $1.1 million in gallium extraction and purification ventures. During 2003 these entities recorded revenue to third party of $2.7 million and they were near break even despite post demand and prices hovering near cyclical lows throughout the whole year.

We own 51 percent of the gallium extraction to our venture and 88 percent of the gallium purification venture with increasing demand for gallium arsenide (GaAs) substrate, we believe both demand and prices for gallium will increase during 2004.

In closing, 2003 was a year of recovery for AXT. We strengthened our balance sheet, reduced our cost structure, improved our product quality and refocused our attention on our substrate business. Looking into 2004, we're not satisfied to benefit only from the ventures taking in 2003 and from the market improving markets. We are aggressively reviewing our customer base and improving our competitiveness. [indiscernible] is to become the leading provider of compound semiconductor substrate. We believe that we have the foundation and means to achieve these goals. I'll turn the call back to Don to give you our forward looking guidance. Don.

We anticipate that revenue in the first quarter will be between 9.7 and 10.3 million. Gross margin is expected to be between 9 and 11 percent, sales general and administrative expense is expected to be approximately 2.7 million, research and development expense is expected to be approximately 300,000. Consolidated net loss, using our effective tax rate at zero percent, is expected to be between 1.8 and 2 million or between 8 and 9 cents per share assuming 23 million shares. Capital expenditures during 2004 will be approximately 5 million.

We have sufficient cash reserves and funding capacity to meet our anticipated capital requirements beyond 2004.

This concludes our prepared comments. We are now happy to answer your questions.

[Operator Instructions]. Pierre Maccagno, Needham and Company.

Couple of questions here. What is the breakdown between LED gallium arsenide substrates and handsets [indiscernible] handsets?

(MULTIPLE SPEAKERS)

Yeah, it's a little more between those two, 55, 45 in favor of the other [indiscernible] products.

Has that changed very much during the quarter or... ?

Went up a little bit from Q3 to Q4.

And for the LEDs size of these substrates is what? Three inches, is that mostly what it is?

No, actually there's a lot of 2 inch products. There are 3 inch customers as well and they go as big as 4 inch. Customers are 4 inch as well.

And -- (MULTIPLE SPEAKERS)

Mostly four and six.

can you tell a little bit about pricing pressure approximately how -- I mean how has that changed vs. couple of quarters ago? Is there much of a change there?

Well pricing pressure is still there but maybe I can comment in this way. I think our business is improving, we have a little bit more chance that we can negotiate a stronger position for AXT as a supplier because now the lead time for delivering products is increasing. It's increasing from approximately 2 to three weeks to four or five weeks now. And we think that utilization rate is -- of the industry -- is increasing so I believe that the pricing pressure is easing off as compared to two or three quarters ago.

What had it been more or less year-over-year would you say?

Well, last year was pretty bad. I think we estimated our price decrease by somewhere around 35 percent in last two years.

35 percent per year correct?

(MULTIPLE SPEAKERS)

[indiscernible] to know last two years. Combined at two years.

Okay, going forward, do you have any estimates?

Well, I think you have -- if the demand keeps strong then I think we have a chance to stabilize the pricing pressure for big price reduction. But and also I think that AXT does depend on size of the substrate. Certain segment of the market there are more pressure across their legacy products and they are more competitive in that particular segment and others' diameters -- there could be less of a capacity issue so that the price is firmer.

There is a difference in AXT per square inch between different sizes you're saying, no?

Right. Yes.

And the price of gallium -- has that been changing very much?

It is about flat.

Flat? Okay. Your capacity utilization -- what is it right now?

Well I think probably somewhere around 50 percent, 60 percent.

And finally and so at this point what is the percentage of your profit you make in the U.S. and going forward how fast are you planning to transfer that over to China?

We estimate we have about 10 percent effort [indiscernible] in U.S. We -- we'd like to bring all the production effort to China by the end of the first-quarter.

[Operator Instructions]. David Kang, Roth Capital.

Nice quarter, gentlemen. First of all, what was the legal expenses in the last quarter? And can you talk about the status of the litigation and also regarding your first-quarter guidance I was hoping to get a couple of numbers on legal expenses for this quarter as well as interest and other income please? Thank you.

The legal expenses -- about 250 to 300,000 for the fourth quarter. And we're hoping that will go down in first-quarter but time will tell. In terms of the net interest and other income we would expect that that would be between 50 and 125,000 in the first-quarter.

And can you talk about the status of it?

Status of what?

The litigation?

Well [indiscernible] continuing -- we're certainly hoping that we do get them settled by the [indiscernible] locations ongoing.

Okay and let's see, a couple more. How much [indiscernible] you have and as far as the quality gap between you and your competitors, can you give us a little bit more flavor for example -- what is it now vs. two, three quarters ago?

Well, Dave, I think AXT has always had a very strong product quality in terms of [indiscernible] property of the crystals. We always make the best quality product in terms of the crystal quality by VGF technology. We went into this quality issue in late 2002, actually, and that problem is essentially resolved.

We have absorbed quite a bit of R&D effort and as well as engineering effort and [indiscernible] procedures to eliminate that problem. And -- but like, we're in the manufacturing sector, so quality problems do pop up here and there and we believe that it's different today what we can do to assure our quality that will produce and what we did two or three quarters ago is that we believe we have better control of our quality and we install the laws of engineering and the quality procedures so that even if we were to encounter yet other problems our customers' site we can control the quality issue very quickly. But let me give you an example of some of the quality improvement we've made.

Some of our customers the LED customers, they are shifting a very large portion of their production requirements to AXT now.

Menosh Tukarne (ph) [indiscernible]

Congratulations on the (indiscernible) designs. Can you please explain the LED market again? Why do you think there will be nearly 20 percent growth?

We feel that the LED, as you know, the blue and green LED have been enjoying growth in excess of 50 percent in 2003 and 2002, I thought it was a tremendous growth too. In 2004 the projected growth is other 17 percent. So all this growth, actually, for every blue and green LED, somehow, you need a yellow or red to complement. For instance, if you are going to make a full-color display board, one just needs red along with the green and blue. And, also, as I explained if you want to make white light, one of the ways to make the white light is to mix the yellow light with the blue light to generate a white light. So we believe that market has a tremendous potential to grow and if you believe that blue and green LED has been growing for the last few years at a tremendous rate then LED markets for yellow and red which we supplied at gallium (indiscernible) substrate to our to our customers to generate those [indiscernible] grow accordingly. And the other segment we believe could be a very exciting growth opportunity for AXT is there is a segment of the LED market traditionally by the gallium phosphide substrate market.

In other words you can also make red LED using gallium phosphide. But because of the technology advancement of gallium arsenide-based LEDs, we believe our customers are telling us they are winning the war over the gallium phosphide-based LEDs. That market is almost a 50-50 split between gallium arsenide and gallium phosphide and that's why we believe there's a tremendous opportunity for gallium arsenide-based substrate LED market.

And growth for AXT in this segment, it will come from both expanded market as well as perhaps your winning the market share?

[indiscernible]

Okay and I have a question about the March quarter -- do you expect to be cash flow positive in the March quarter?

[indiscernible] operations we expect to be cash flow positive or approximately so and then overall our debt payment requirements are relatively low, so really depends on whether some of the capital projects we're getting implemented get completed this quarter or not.

Okay and can you also comment upon what kind of business you expect for the germanium (Ge) and indium phosphide (InP) in 2004?

You know indium phosphide (InP) I think it's bottoming out during the last two quarters. Although you know we do have more increase on indium phosphide but it's hard really to predict when the production order is going to come in. But let me comment on one thing on the indium phosphide (InP). Indium phosphide (InP) is a [indiscernible] material for [indiscernible]. There's no replacement, there's nothing to replace it, to compete with it so you just have to wait for telecommunications industry to come back and when they come back indium phosphide (InP) will come back. But will it come back to the peak of the market when AXT had $10 million a quarter -- I doubt it, not very likely, very fast, but it's a far high target to compare to $.5 million a quarter. As far as germanium is concerned we also hear that member of [indiscernible] launches is going to project growth on two for last year to 14 sometime this year so you know for every satellite there is roughly a demand, a requirement of about $700,000 [indiscernible] of germanium substrate. To make the satellite solar cells, and so you can take 14 but then you have competitors and you may not win those businesses but, nevertheless, there's a great potential for revenue to increase but if you always have a need for two satellites, obviously, you don't need a whole lot germanium substrate. So, again, germanium substrate for satellite solar cells there is very little competition. If one needs to launch a satellite you just need solar cells and germanium is a dominant technology to serve that industry.

[Operator Instructions] David Kang, Roth Capital.

Going back to indium phosphide, can you at least tell us what you see from as far as inventories that your customers are concerned and secondly, some of the wireless chip vendors more specifically [indiscernible] expect this current quarter to be weaker vs. fourth-quarter and, yet, you're inviting higher in terms of revenue guidance so does that mean the -- all the incremental growth will come from your LED business and not necessarily in wireless business? More clarity on that please, thank you.

Dave, let me answer the second question first. I -- know I think -- I do watch our customers whether they have you know more -- they're projecting high revenue or less, but as far as the first quarter is concerned we do see those LED and wireless to be strong particularly the 6 inch [indiscernible]. We do have a fairly (indiscernible) [TROUBLE HEAVY ACCENT] first quarter but you know whether there's one-to-one correspondence, it's hard for me to tell.

We do see that demand for both LED and 6 inch product for wireless to remain strong. What was the other question -- oh, indium phosphide.

I don't believe there's a whole lot of inventory in terms of substrates remaining at our customers' site. I think if there's any overhang it could very well be that our customer has made a lot of days [indiscernible] lasers and what not to make the device so they have a lot of inventory overhang in terms of unused components which they have not used up. But, again, you know it does depend upon whether the horizon -- the Verizon or Nortel -- are they going to build more telecom infrastructure and once they increase their budget, they will need indium phosphide material to make the components.

Okay and lastly can you talk about the linearity of the quarter? And some of the companies have indicated this. Have you seen any kind of a stretch out in terms of lead times? Thank you.

You mean the last quarter or this quarter, Dave?

Well actually both.

I think, our order increasing fourth-quarter. The fourth-quarter I think the beginning of the fourth-quarter the -- we've seen increasing order to the end of the quarter.

As far as the first quarter is concerned, you know, we always say that there are certain in our present environment we still need [indiscernible]. But the revenue recognized as well as the booking in our book is better than last quarter. That's why we guided our revenue to increase.

But do we still need some [indiscernible] in the first quarter? But the lead time is, actually, we are advising our customer to give us longer lead time. That is our capacity is starting to stretch and we need a little bit more lead time to make [indiscernible] our customers.

Chang Qiu, FORUN Technologies.

Sorry, I joined the conference late and maybe many of the questions already asked. Just in case, for the [indiscernible] revenue how many of that is already booked? How much you need for the returns of business for that to happen? [Inaudible question - highly accented language]

Chang, I think the advantage of the book business for this quarter, the ratio is better than last quarter. It has been improving. In fact, fourth-quarter was better than third-quarter and first quarter is better than the fourth-quarter.

Okay so you see sequential [indiscernible] in that quarter?

Yes.

How about [indiscernible] -- if you compared to January February, compare that to November/December time frame -- what do you see?

Well I don't have a very strong feeling of that because you know, none of our businesses for instance LED customers they can't come in and (indiscernible) business and depends on when you negotiate a contract, then it's very difficult to say month by month, but quarter by quarter we do have a business booking for this quarter is quite strong.

Maybe I'll ask another way. If there is no Chinese New Year in Taiwan do you think the first quarter will be even stronger or --?

In fact our customer in Taiwan is telling us that their production is continuing through the Chinese New Year.

Okay, okay. That's great. Thanks.

At this time, we have no further questions in the queue. We'd like to turn the program back to management for additional comments.

Thank you for participating in our conference call. We look forward to speaking with you again so -- [indiscernible].