AXT Inc (AXTI) 2004 Q1 法說會逐字稿

Good day and welcome to the AXT first quarter earnings release. At this time is my pleasure to turn the program over to interim CEO, Mr. Don Tatzin. Please go ahead.

Hello, and welcome to AXT's first quarter 2004 conference call. I would like to thank you for taking the time to be with us this afternoon. I am Don Tatzin, interim Chief Executive Officer. With me today is Wilson Cheung, AXT's newly appointed Chief Financial Officer. We're very pleased to welcome Wilson to AXT.

We will begin by giving you a detailed financial view of the first quarter as well as forward-looking financial guidance. Following that I will provide other comments on our recent investigation, the quarter and current market conditions. Then we will open up the call for questions and answers.

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 other forward-looking statements regarding among other things the impact of the disclosure of the results of the investigation that is described in today's press release and SEC filings, market conditions and trends and the future financial performance of the Company. We wish to caution you that such statements deal with future events and so are subject to risks and uncertainties, and that actually events or results may differ materially.

In addition to the factors that may 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 a link from our website for additional information on risk factors that could cause actual results to differ materially from our current expectations. This conference call will be available on our website at axt.com.

Now turning to our financial results, revenue for the first quarter of 2004 was 9.8 million compared with 9.1 million in the fourth quarter of 2003. Not included in revenue are shipments about which we are uncertain regarding their acceptance. Total gallium arsenide substrate revenue was 8 million for the first quarter of 2004 compared with 7.5 million in the fourth quarter of 2003.

Five and six-inch diameter gallium arsenide substrate revenue was 1.5 million for the first quarter of 2004 compared with 1.5 million in the fourth quarter of 2003. The increase in gallium arsenide revenue compared with the fourth quarter was the largely the result of additional demand from customers serving the LED market.

Indium phosphide substrate revenue was 516,000 for the first quarter of 2004 compared with 512,000 in the fourth quarter of 2003. Indium phosphide substrate revenue remains heavily dependent on the fiber optics business. Sales of raw materials were 1.2 million in the first quarter of 2004 compared with 1.1 million in the fourth quarter of 2003.

In the first quarter of 2004 North American revenue was 23 percent, Asia-Pacific was 64 percent and Europe was 14 percent of total revenue. By comparison in the first quarter of 2003 North American revenue was 46 percent, Asia-Pacific was 47 percent and Europe was 17 percent of total revenue. One LED-focused customer generated more than 13 percent of our revenue during the first quarter.

Gross margin was 5.5 percent of revenue for the first quarter of 2004 compared with 8.6 percent for the fourth quarter 2003. Gross margin was lower because we incurred production costs for products manufactured and shipped for which we did not recognize revenue due to uncertainty regarding their acceptance.

Selling, general and administrative expenses were 2.8 million for the first quarter of 2004 compared with 2.5 million for the fourth quarter of 2003. These costs include an accrual of 300,000 for auditing and Sarbanes-Oxley expenses for 2004. Research and development costs were 341,000 for the first quarter of 2004 compared with 289,000 for the fourth quarter of 2003. We're augmenting our R&D efforts to help improve yields and product quality.

Interest expense for the first quarter of 2004 was 109,000 compared with 96,000 in the fourth quarter of 2003. Interest and other income was 167,000 for the first quarter of 2004 compared with interest income and other expense of 15,000 for the fourth quarter of 2003. The change is due primarily to foreign exchange gains of our yen-denominated accounts receivable. Net loss for the quarter of 2004 was 2.6 million compared with a net loss of 2.1 million for the fourth quarter of 2003.

Let's now turn to the cash flow statement and balance sheet. Operating cash flow consumed by operating activities was 1.5 million for the quarter ended March 31, 2004 compared with operating cash flow of 310,000 for the quarter ended December 31, 2003. Total change during the quarter in cash, restricted cash and long-term investments, excluding the value of shares we hold in Finisar Corporation, was 2.5 million. The reduction includes the effect of the early repayment of a loan with a principal balance of 781,000 made to reduce our ongoing interest costs.

Cash and cash equivalents with maturities of less than three month short-term investments and other investments in high-grade debt securities with maturities of less than two years, including restricted deposits, were 42.1 million at March 31, 2004 compared with 44.6 million at December 31, 2003.

Accounts receivable, net of reserves, were 6.9 million at March 31, 2004 compared with 6.3 million in the quarter -- prior quarter. Days sales outstanding were 68 days at March 31, 2004 compared with 63 days at December 31, 2003. The increase in average days outstanding is largely due to the increasing share of revenue shipped to customers in Asia who are typically granted longer payment terms.

Net inventories decreased 1.2 million from 24.1 million at December 31, 2003 to 22.9 million at March 31, 2004. The Company continues to use inventory to reduce its cash requirements. Accounts payable and accrued liabilities decreased by 21,000 from Q4 of 2003 to Q1 of 2004 due to timing of payments in the ordinary course of business.

Capital expenditures in the quarter were 280,000 and depreciation was 1.2 million. During the quarter we paid 793,000 of long-term debt principal including 781,000 paid to retire one debt instrument early. At the end of March 31, 2004 we had 1,042 employees in total, up from 869 work in (ph) production compared with 972 employees in total, up from 818 work in production at December 31, 2003. At the end of March 31, 2004, 123 employees worked in the U.S. and 919 abroad.

Turning to our outlook for the second quarter, in April our total revenue was 3.7 million. We're now taking our final bookings for the second quarter and project that our revenue for the second quarter will be 9.1 to 9.8 million. Consolidated gross margin is expected to be between 8 percent and 10 percent. Margin may vary from this range depending on what further adjustments are required to the Company's reserves.

Consolidated sales, general and administrative expense is expected to be approximately 3 million. We're budgeting approximately 1.3 million during the next three quarters for a combination of Sarbanes-Oxley and auditing expenses and are including an estimate of the cost of the independent investigation. Research and development expense is expected to be approximately 350,000.

Consolidated net loss, utilizing our effective tax rate of 0 percent, is expected to be between 2.4 and 2.6 million, or between 10 cents and 11 cents per diluted share. Capital expenditures during 2004 will be approximately 3 million. We project that capital expenditures in Q2 will approximate 500,000. We have sufficient cash reserves and funding capacity to meet our anticipated capital requirements beyond 2004.

This concludes our review of our financial performance. Let me now turn the call back to Don.

I would like to begin by sharing with you information regarding our recent investigation and the corrective measures we have taken. On April 27, we announced that we are delaying our previously scheduled release of our first quarter results due to the investigation of certain product testing policies and practices. That investigation is now largely complete and we released our first quarter's results earlier this afternoon.

As part of the Company's implementation of our current business conduct and ethnics, we learned of certain failures to comply with requirements for product testing and the provision of testing data and information relating to customer requirements. The audit committee and the Company's Board of Directors began an investigation into our product testing practices and procedures with the assistance of outside counsel.

The investigation confirmed that certain requirements for product testing and the provision of testing data and information relating to product -- to customer requirements were not being complied with. We have now implemented measures to ensure greater operational controls and compliance with customer requirements.

First, management and the audit committee have concluded that additional management personnel are required to manage operations, quality control and product testing, and we intend to hire such personnel. Second, we're implementing additional training programs for employees involved in product production, testing and quality assurance.

Finally, certain executive management changes have been made. Morris Young will now assume responsibility for our churn operations. I will serve as interim CEO, and we have launched a search for a new CEO. We're pleased to promote Wilson Cheung to Chief Financial Officer. We believe that these measures will address the issues raised above, and provide a necessary operational oversight to ensure we comply with requirements for product testing and the provision of testing data and other customer information.

We're now meeting with our customers to discuss the results of the investigation as it affects them, and to describe the actions we have already taken to ensure the situation does not arise again. To date, we have contacted customers who generated approximately 70 percent of our first quarter substrate revenue. For these customers only a portion of our shipments to them came under the review of the investigation.

We have been pleased with the responses that we received from customers and their willingness to resolve these issues with us. With the investigation complete and a number of measures now in place to ensure greater operational control over our manufacturing and quality assurance processes, we're ready to close this difficult chapter and move forward with our business goals.

Now turning to the quarter, while the first quarter results are overshadowed by the investigation, I do want to highlight a few key points. First, we posted our second consecutive quarter of increasing revenue. Revenue has increased by almost 15 percent during the past two quarters. We believe that we're benefiting from increased demand, particularly in the end-use market for red and yellow light emitting diodes. Second, while our gross margin declined during the first quarter, it was affected by our decision to not include as revenue certain products about which we were uncertain regarding their acceptance.

With our new product testing procedures in place we do not anticipate a repeat of this event, and therefore believe that gross margin will be higher in the second quarter. Finally, additional customers approved our China production facilities, which will enable us to reduce costs further in upcoming quarters.

Turning to our (indiscernible) products, sales to third parties rose by $100,000 during the first quarter, offset by continued price pressure. As a result, our materials-related joint ventures operated at approximately break even levels. However, our gallium extraction and purification joint ventures are enabling us to purchase the quality of gallium we use in our products at less than we would otherwise pay to third parties. We believe that these joint ventures will be a strong asset to us as the market strengthens.

In conclusion, with the investigation complete and with a number of measures now in place to ensure greater operational control over our manufacturing and quality assurance processes, we're ready to close this difficult chapter and move forward with our business goals. We believe that our technology, capacity and low-cost manufacturing capability position us for continued growth. And we are deeply committed to restoring the confidence of both our customers and our investors.

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

(OPERATOR INSTRUCTIONS). Earl Lum with CIBC World Markets.

A couple of quick questions. With regards to your press release the audit committee said that there could be additional changes in some of the management and non-management functions. Does that mean that there is more changes that we could expect, or have those changes have already been implemented, and outside of hiring some executives for overseeing the quality you are pretty much through there?

We certainly made the most significant changes. I've now been on this job for about an hour and a half.

Congratulations there.

So I've got to meet some more people who I do know that well yet. But clearly the significant changes are made.

Okay. And at this point are there any pending lawsuits or any legal actions that your customers have stated that they might take because of the findings of the audit community, or is that not the case?

There's nothing pending. We're working with everybody, and many of them have, once we notified them, waved the issues at hand.

Okay. And then you said there was some orders there were canceled. Were they significant in material or are we talking a fairly small amount, because of the audit review and everything?

The orders that have been cancelled so far amount to a few hundred thousand dollars.

Okay. And then just one final question and I will let the next person take it. If you looked right now at your guidance for Q2, is that guidance being impacted because of what was going on with the audit committee relative to what you really see happening in the end markets? And can you kind of walk us through, because certainly it looks like the end markets are pretty strong here, guiding flat to slightly down. Is that primarily because of the impact from the audit community, Don?

Yes, this factors in the effect of those customers have canceled orders where we don't think at this point we will be able to get replacement orders and ship that product before the end of this quarter.

(OPERATOR INSTRUCTIONS). David Cohn (ph) with RBC Dain Rauscher.

Two quick questions for you. First of all, did you guys give a backlog number at the end of the quarter?

No, we traditionally haven't given backlog. Right now with the quarter almost complete in terms of being able to take orders, just about everything that we're going to sell this quarter is already on the books.

Okay. And my second question, Mr. Cheung, were you the former CFO of Network Peripherals?

No, that is incorrect.

That is a different Wilson Cheung. Good answer, Mr. Cheung. Thank you very much.

Dush Laman (ph) with Delta Partners.

Don, I had some questions -- I guess you mentioned that there are some revenue which haven't been included in the results, and you're waiting for acceptance. How much are those revenues?

It is several hundred thousand.

700?

No, several hundred thousand dollars.

Got you. And how much cash burn do you expect for this quarter?

Excuse me?

How much cash burn do you (multiple speakers)?

Well, operations our cash burn is about 1.5 million. And then given capital expenditures and debt repayments, you will recall that Wilson mentioned that we paid off about $780,000 of debt early to reduce our interest costs. Our total cash burn for the quarter was about 2.5 million.

And how much do you expect to burn this quarter? The quarter you are into?

I believe much closer to 1.5 to 2 million.

Got you. And then what is the relationship between sales increase and gross margins? I would assume that your cost of goods sold would be more or less flattish and any increase in sales should ideally be controverting to the bottom line and the net?

Well, it would -- remember in this quarter, because we chose not to recognize certain revenue, we did include in our cost of goods sold the cost of producing that product. And so that had the effect of reducing gross margin for this quarter. As I said, we would expect gross margin to increase in the second quarter.

But going forward I was more concerned about -- going forward this 9.2 million should ideally be more or less stay the same, or would it go up with the sales?

Well, we would expect that it would go up with sales. Certainly you saw an increase from the third quarter of 2003 to the fourth quarter of 2003 when our revenue went from 8.5 million to 9.1 million.

Got you. Got you. And just finally on this investigation and orders being canceled, after the new testing things take place and how does the peer cost structure stand vis-a-vis to other competitors? How does the pricing for you work out to be compared to the other guys?

Well, we still are the only competitor who has production facilities in China. And as we have said for the past couple of years, we believe that our costs are lower than those of our competitors, and that they remain lower than those of our competitors, and if anything as we do more of our production in China our cost advantage grows. And we would expect that our prices that we receive for comparable product will be roughly the same as those that our competitors get.

Got you. Just finally, lead times how much would those? And when do you expect cash break even and EPS break even?

Well, lead times right now are typically running about four to six weeks. Some are as short as two weeks. We don't think we will be cash or EPS break even for this coming quarter, and we will make a forecast for Q3 in July.

Chris Versace with FBR.

Just one quick question for you really on terms of pricing. And by the way, Don, congratulations in getting the big hot seat I believe.

Well, thank you. Yes, I'm feeling warm today.

But I just wanted to -- if you could kind of break it out not so much between gallium arsenide and indium phosphide, but really where you see the pricing and the trends of, I guess, the core end markets, which would be wireless and LED?

Yes, they're both under a lot of pressure and have been. I think one of the things that we're seeing is that more of the industry capacity is being used up. So that the rate of price decrease has probably gone down a bit in the last couple of quarters. So -- and we think that we continue to pull our costs down at least that same rate. So as I answered in response to the previous question, as we get our revenue up then I would expect the gross margins to start to climb again.

Okay. And then just strategically you guys have put a lot behind you, but looking forward there is a lot of other compound semiconductor products being offered, whether it is silicon carbide or gallium nitride, a lot of talks about those different types of materials for RF and other applications. Is there any thought now, again with everything behind you just about, to venture out into some other areas other than gas and indium phosphide?

There may be, but as we have said, our first goal is to make sure that our existing gallium arsenide, indium phosphide business returns to profitability. And as we get closer to that then we will start putting some efforts into looking for other opportunities, but we're not there yet.

Okay. And then just one last one. If I remember correctly, you guys had done some internal sapphire when you're doing your own LED business. And I forget, did you get rid of about or are you selling that on a merchant basis now?

We basically sold that portion of our business about a quarter ago.

For the sapphire aspect of it?

Right.

(OPERATOR INSTRUCTIONS). Manog Netcarny (ph) with AXT.

Can you please give again the revenue distribution by products and end markets for the March quarter?

I will ask Wilson to handle that one.

The gallium arsenide revenue was 8 million in the first quarter and compared to 7.5 million in the previous quarter. And the indium phosphide revenue was 1.5 million, which was flat compared to last quarter.

500,000 indium phosphide.

I'm sorry, 500,000, which was flat -- 516 versus 512.

Okay, and the rest of all the raw materials?

Right. Raw materials was 1.2 this quarter versus 1.1 last quarter.

Okay. Don, will you need to restate any previous sales or earnings as a result of the audit committee investigation?

We do not believe so.

Okay. And can you give us any details on the settlement you reached with Cree in March?

Well, we have indicated that we resolved the claims against each other, and they are fully settled, and it was an otherwise confidential agreement.

Jason Sam with Seidler.

Don, a quick question on the customer segment (indiscernible) like we are heading to the investigation. Do you expect to give any rebates or anything like that with the customers that are affected?

It really is -- it is going to vary with the customer. There are a couple of cases where we have some lower pricing in certain circumstances that we will now give that. But really we're working with each customer to make sure we resolve any issues that are outstanding and move forward.

Okay. So how is that going to affect any kind of numbers in Q2? Do you expect to have all these issues resolved by the end of Q2?

I would certainly hope so. And I believe that the guidance we gave -- the guidance we gave incorporates the affect that we think any further resolution is going to have.

Okay. And do you expect to have any kind of charges or anything like that?

Well, nothing other than what we have already anticipated either in our Q1 results or the Q2 guidance.

Okay. And now you mentioned that lead times in the four to six weeks area. What is your capacity utilization rate right now?

Well, probably about the same as it was last year, probably about 60 percent or so.

And pricing pressure you have mentioned had moderated, right?

Yes.

So from a demand standpoint Q1, Q2 I was hoping to see a little bit of a stronger Q2 number despite the fact that you do have a couple of hundred thousand worth of sales that you were not able to, I'm sure, add on there. But are you -- is demand that is expected or is demand -- you know, what is your visibility on the demand side?

Demand (indiscernible) for Q2 at this stage is pretty good. The bookings for the third quarter obviously are relatively low, as they typically would be at this point in time. But we are in conversation with a number of customers now who, while they haven't placed orders, we are in discussions with them about their Q3 order levels.

Okay. And the major customers that you have spoken with, you don't foresee that there is going to be any interruption in orders, right?

For the vast majority, no.

Okay, and one last question. You mentioned that you guys are doing a search for a CEO right now. So what does that means as far as you're concerned?

Well, I think you have to recognize that the reason that my title is an interim one is that the Board really needs the opportunity to appoint the person who is most likely to make AXT successful for its customers, shareholders and employees. And it hasn't had a chance to meet with or review other qualified candidates. So it is going to be doing that over the next period of time. But in the meantime I'm here. I am CEO. We've got a number of things we have to implement. I'm going to start implementing those. I do not intend to be a caretaker.

Okay. So as far as you're concerned your plan is long-term, and then you don't have (multiple speakers)?

Yes, I'm acting like I'm going to be here and this is going to -- AXT will be my legacy.

Earl Lum.

Earl Lum. Yes, Don, at this point if you look at your customer base was the either committee findings primarily focused on the electronic portion of your business and not the opto, or can you give us a little bit more guidance as to -- are was it across the board?

It was a bit of both, it crossed both.

Earl Lum. Okay. And at this point is the substantial portion of your customer base happy with the changes, or have they been notified of all of the management changes that are currently being undertaken over at AXT, and do they feel that is enough of a change to win back their support of you as a supplier?

Well, again, we told them when we have met with them that we already started some things. The information about the senior management changes only became public within the last two hours. So we will be going back and contacting them about those now. But so far the customers we have met with have been satisfied with the procedures that we had put in place, and in some cases we're providing them with a bit more information. But it is our intent to satisfy all the customers.

Earl Lum. Okay. And then at this point does it look like when we get to July we'll have a better idea as to what the longer-term financial model is going to look like, or will Wilson be able to provide us with kind of a better idea, not only just where the break even levels are going to, but what the long-term goal is for the Company as you move forward?

Yes, I think we will.

Okay, gentlemen, at this time we have no further questions. But I would like to offer our audience the instructions one last time. (OPERATOR INSTRUCTIONS). It appears that we have no further questions, gentlemen. I will turn it back over to you.

Great, well thank you again for participating in our conference call say. We look forward to speaking with you again soon.

That concludes today's presentation. We thank you for your participation. You may now disconnect your line.