AXT Inc (AXTI) 2004 Q2 法說會逐字稿

Good day, everyone. And welcome to the AXT earnings release conference. At this time, all sites have been placed into the program in a listen-only mode. There will be an opportunity later for questions in the program.

I would now like to turn the program over to CEO, Don Tatzin.

Hello and welcome to AXT second quarter 2004 conference call. I would like to thank you for taking the time to be with us this afternoon. I'm Don Tatzin, interim CEO of AXT. With me today is Wilson Cheung, our Chief Financial Officer. Wilson will give you a detailed financial view of the second quarter and, following that, I will comment on the quarter and current market conditions. Wilson will close our prepared comments with financial guidance ,and we will open up the call for questions and answers. Wilson?

Thank you, Don. 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 future financial performance of the company, the status of our intellectual property litigation, the impact of the investigation into our product testing practices and procedures, including customer response to the disclosure of the results of the investigation, as well as market conditions and trends. 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 periodic reports filed with the Securities and Exchange Commission and available online by 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, as to the results of the quarter. Revenue during the second quarter of 2004 was 9.5 million compared with 9.8 million in the first quarter of 2004. Total gallium arsenide substrate revenue was 7.5 million for the second quarter of 2004 compared with 8 million in the first quarter of 2004. Indium phosphide substrate revenue was 533,000 for the second quarter of 2004 compared with 516,000 in the first quarter of 2004. Raw material sales grew 1.5 million for the second quarter of 2004 million compared with 1.2 million in the first quarter of 2004.

In the second quarter of 2004, North America revenue was 22.9 %, Asia Pacific was 53.1% and Europe was 24% of total revenue. No customer comprised 10% or more of our total revenue during the second quarter of 2004 or during the first half of 2004.

Gross margin was 8.7% of revenue for the second quarter of 2004 compared with 5 .5 % for the first quarter of 2004. The increase in gross margin was due to a 745,000 sales return allowance recorded in Q1 as a result of our prior product testing practices.

Selling, general and administrative expenses were 3.2 million for the second quarter of 2004 compared with 2.8 million for the first quarter of 2004. The increase from the previous quarter was due to additional accrual of legal fees totaling 350,000. Research and development costs were 350,000 for the second quarter 2004 compared with 341,000 for the first quarter of 2004. As a percentage of revenue, R&D was 3 .7% in the second quarter compared with 3 .5% in the first quarter of 2004.

During the second quarter, we incurred a restructuring charge of 1.1 million as a result of announcing the near-term closure of our manufacturing operations in the U.S.. The 1.1 million comprised costs related to the reduction in force and leave costs associated with facilities that are no longer required to support production. We announced earlier that our restructuring charge would approximate 1 .3 million. The remaining 150,000 would be expensed when we completely move out of the facility.

Interest expense for the second quarter of 2004 was 58,000 compared with 109,000 in the first quarter of 2004. Other expense was 113,000 in the second quarter of 2004 compared with other income of 167,000 in the first quarter of 2004. Loss from operations for the second quarter of 2004 was 3 .8 million compared with a loss of 2 .6 million for the first quarter of 2004.

During the second quarter, we incurred a gain on discontinued operations of 222,000 to reflect a reduction in our estimated liabilities in closing down the opto-electronics business.

Net loss in the second quarter of 2004 was 3.8 million or 17 cents per diluted share compared with a net loss of 2.6 million or 11 cents per diluted share in the first quarter of 2004. Excluding the 1.1 million restructuring charge, our net loss in the second quarter of 2004 would have been 2.8 million or 12 cents per diluted share.

Let's now turn to the cash flow statement and the balance sheet. Operating cash inflow generated by operating activity was 1.3 million for the quarter ended June 30, 2004, compared with operating cash outflow of 1.5 million for the quarter ended March 31, 2004. A major cause of the positive operating cash flow was the reduction in accounts receivable by about 1.9 million. The total reduction in cash and equivalents including short-term investments was 687,000 for the quarter end of June 30, 2004, compared with the decrease of 3.7 million for the quarter ended March 31, 2004. The primary driver of the reduction in cash and equivalents in the past two quarters was the continuing paydown of our long-term debt.

Our debt-to-equity ratios improved slightly to .13 in the second quarter of 2004 from .15 in the first quarter of 2004. On the balance sheet, our combined cash and equivalents, including short-term investments were 43.3 million on June 30th, 2004, compared with 44.6 million at March 31, 2004. Of this amount, 8.6 million is held as restricted deposits and 2.3 million is the value of shares that we hold at Finisar Corporation at June 30, 2004.

Accounts receivable net of reserves was 4.4 million at June 30th, 2004, compared with 6.9 million in the prior quarter. Given better than expected AR collections, our days sales outstanding was 42 days at June 30th, 2004 compared with 64 days at March 31, 2004.

Net inventory decreased 1.1 million from 22.9 million at March 31, 2004, to 21.8 million at June 30, 2004. We continue to expect further declines in net inventory during the upcoming quarters as we sell inventory products to customers. Capital expenditure during the quarter was 421,000 and depreciation was 1.2 million. At June 30, 2004, we had 1,015 employees of whom 866 worked in production. 115 employees worked in the U.S. and 900 worked abroad, mostly in China.

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

Thank you, Wilson. While the second quarter was challenging as a result of the investigation regarding product testing policies and practices, we are already seeing positive developments resulting from it. We believe that by the fourth quarter, we can be in better financial and operating positions than we have been for some time.

Since becoming CEO, I have spent quite a bit of time with our manufacturing, technology and marketing staff. We have many hard working and dedicated people who are making substantial contributions to improve AXT daily, and I'm appreciative of their efforts.

Our customers are working with us to resolve the outstanding issues. Many customers were appreciative of the effort we made to contact them and provide information about our testing policies and practices. A number quickly placed new orders. We continue to work with other customers who are requalifying our products. These customers consistently indicate that they desire to place new orders with us as soon as their reviews are complete. We expect most of this work, which includes business to our China facilities by some customers, will be finished during the third quarter.

We have corrected the issues regarding our product testing. As part of our internal audit for the second quarter , we reviewed a statistically valid selection of shipments and found that all shipments after April 2004 met customer performance specifications. We will expect no less in future quarters and are adjusting our testing processes to ensure that we meet or exceed customer expectations.

We are adding experienced staff in key areas, including applications engineering, quality, and process engineering. We are automating the collection of portions of our product test data and are developing a companywide system related to product performance information. We are also testing and implementing new wafer processing procedures and equipment to boost product quality. These efforts will be ongoing, but I believe that we will enjoy substantial improvements during the next six months.

With regards to our move to China, we began to build our manufacturing operation in China in 1999 with the initial goal of adding capacity quickly and at a low cost in order to meet the demand for our products. When the market declined in 2001, and we were faced with a significant reduction in demand, China offered an opportunity to reduce manufacturing costs at a time when prices and gross margins were declining rapidly.

Since mid-2001, we have continued to shift an increasing share of our production to China to improve our cost structure related to operations and administration. This move will be completed during the third quarter and will allow us to focus all of our management and technical attention on one facility. Key engineering and management staff who used to divide their time between our U.S. and China facility will now concentrate their efforts in China. This should enable us to improve our processes resulting in greater yield and a more efficient operations. In addition, we will strengthen our China staff, including our engineering and R&D staff in the coming months.

During the next few quarters, we will incur costs to prepare our U.S. facility for either sale or lease and expect to have this work completed by the end of the first quarter, 2005..

I want to update you regarding intellectual property litigation in Japan. Both parties have completed submitting arguments and evidence. We will retain all our options, which include appealing any court decisions and launching an effort to have our competitor's patent invalidated in Japan.

In meeting with investors, I'm often asked to outline our strategy. I want to take a few moments to describe the core competencies that have and will guide AXT. Our first competency is our VGF technology, which is the basis for AXT's creation and is used in all of our substrate product. As the first company to commercialize VGF, we believe we retain the lead in using the technology to grow to high quality crystals with low dislocation densities.

Our second competency is our ability to create joint ventures in China with local partners. Our strength is in developing small joint ventures which are overlooked by bigger investors and which produce products used by our substrate business and others. We have five such ventures producing gallium, arsenic, boron oxide, and PbN, In each we have made a relatively small investment which provides us with either control or substantial influence in the business.

The largest of these interests today is Beijing Jiya Semiconductor Material company that produces raw gallium. During the second quarter, its sales to third parties was 394,000 and its net income, including net income from sales from our substrate division, was 149,000. We will continue to look for additional joint venture opportunities that fit our model.

Our final core competency is our ability to transfer manufacturing technology and operations from the U.S. to China. We have done this with our substrate business and enjoyed cost reductions as a result. As we look to the future, we have the potential to make new investments in technology-rich companies that need a China manufacturing base to improve their competitive position.

While our core competencies form the basis for our long-term strategy, in the near term our focus is on making our substrate business successful. We have faced the issues confronting us squarely and have made a commitment to ourselves and our customers to make the necessary improvements. Our customers have graciously extended us an opportunity to demonstrate that we will act consistently with our intentions. And for that, we are thankful.

While we expect that there will be some revenue loss during the third quarter as some customers are conducting their reviews, we are optimistic about the future. We are on a path to correct our previous mistakes, have substantially reduced our costs by making the decision to close U.S. productions, we are making AXT a stronger organization that is looking to the future. I look forward to reporting to you regarding our progress.

Wilson will now provide guidance for the third quarter. Wilson?

Thank you, Don. With our manufacturing transition to China due to be completed in the third quarter, we anticipate this cost-cutting measure will reap its full benefit by 2005. For Q3 2004 we expect revenue to be between 8.2 and 8.9 million and gross margin to be between 7 and 11%.

Sales, general and administrative expenses are expected to be approximately 2.5 million, R&D approximately 350,000, and restructuring charge approximately 150,000.

We project that our loss from operations will be between 2.1 to 2.5 million. Net loss from continuing operations is expected to be between 2 .3 and 2 .7 million or between 10 cents and 12 cents per diluted share. We project that capital expenditures in Q3 will approximate 500,000. We have sufficient cash reserves and funding capacity to meet our anticipated capital requirements for the next 12 months.

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

This is the teleconference operator standing by. We will be conducting a question-and-answer session at this time. If you are a member of our listening and would like to ask a question, please signal us by pressing the star 1 on your push button phone. We'll take questions in the order they are received. If you would like to remove yourself from the queue you may do so by pressing the pound key. Once again, to ask a question, please press star 1 at this time. We'll pause a moment before taking our first question .

We'll take the first question from Chris Versace at VR (phonetic). Go ahead, please,

Hey guys, this is actually Brandon in for Chris.

Hi, Brandon, how are you?

Hi. Good. Thanks. Just wondering. Where are you seeing some areas of wafer strength? And, then, can you just talk about the share loss or if there is share loss in gallium arsenide, wafers and, if so, where it is or where you're seeing that?

Brandon, I spent last week in Taiwan and what we're seeing there is pretty rapid growth in the LED business. And I also believe that AXT is doing very well in that segment of the business. And, so, when you ask about what's our area of strength, I would say, right now, that's the most outstanding one. I think that there is -- it's probably that, over the last quarter, we did lose some market share, I think with our forecast for Q3, we are anticipating losing a little more market share. However, because all of these customers are working to requalify us, I think we can regain much of that share either in the fourth quarter or by early 2005.

And then, do you know what percentage of your wafers are going into the wireless LAN end market?

The wireless LAN or . . . .

The wireless LAN at all or . . . .

Well, if you're talking about -- if you're talking about wireless handsets, then that's probably 30 to 35%. If you are jut talking about wireless LANs, that's going to be much smaller.

Much smaller? Okay. And then, have you calculated a new break-even levels for the business.

I'll let Wilson talk about that one.

Well, if you just use today's Q2 expense profile, we have done some calculations and we do believe that its going take a 14 million revenue with about 15 to 20% gross margin quarter to break even. But this doesn't take into account any anticipated cost savings for moving our entire manufacturing operations to China. So, of course, once those cost savings start to kick in, it will take less to break even.

And then, just one more. Can you just discuss briefly how much of the sequential decline was volume versus pricing in the quarter?

Most of the sequential decline in this quarter was volume related. Prices were relatively stable.

Okay. So you're seeing stable pricing in all geographic regions or are there certain ones?

They all vary a little bit. But I actually don't think there was much price decline in any particular region. If anything, a change in average prices will be much more due to a change in mix in product mix than a change in a particular product price.

So are you saying -- would you expect a typical price decline annually or are you saying that that might better than it has been in the past?

This is clearly better than what we have seen -- maybe going back over the last couple of years. If you recall that over a two or three year-period, we have been talking about price decline in excess of 40% over that period.

Okay, great. Thanks a lot.

Thank you.

Once again, to ask your question, please press star 1 on your push button phone. We'll take our next question from Darce Laman, Delta Partners. Go ahead, please

Yeah, Don. I have some questions regarding cash flow. What do you expect the depreciation for next quarter?

Next quarter, it will be flat, I would say around 1.2 million.

And just overall for cash flow expectations for next quarter? I mean, I would assume you -- it will be a positive cash flow?

We do expect operating cash flow would be flat or positive. So it should be around the same as Q2.

Got you. And Don, if you can help us, just utilization rate and the yields and pricing that you mentioned. It is more or less flat?

Pricing looks fairly flat. Utilization, and given the revenue is roughly the same, really didn't change very much. You know, yields were also about the same compared with Q1.

How much were those in Q1?

What, the yields?

Yes.

We have so many processes that it's misleading to talk about yield in any particular area because you have to combine it, and we actually don't disclose overall yield data.

And the utilization rate?

Utilization rates, you know, we are still probably running around 50 to 60%. So we have substantial capacity to grow without incurring additional capital expenditures.

Got you. And I remember Wilson mentioned about a break-even level. Is that a cash -- oh, you're cash flow (inaudible) -- sorry.

That's just a GAAP break-even point.

Got you. Just finally. Overall, Don, when do you see all these problems concerning that dusting (phonetic) issue is going to go away and what are you hearing from the customers and how big of an issue it is for them right now?

As I said, I think that those customers who are in the process of requalifying us, we think they can all be complete by the end of this third quarter, and then they'll start placing orders either late this quarter or early next quarter. Now, it may take them a little while to get back up to the old levels, but I would expect that, by late 2004, early 2005, we'll be back where we were. In addition, what I found while I was in Taiwan, was that the business there is doing well. We've got a number of customers who anticipate will start increasing their orders with us in the next six months.

Got you. Just finally from where you stand, how do you see Q4 coming up? From revenuewise, do you see some growth coming on in Q4?.

Well, I would think so just because we expect to be -- start getting orders from people who ordered in Q1 and then stopped when we requalified. We have not put out a specific forecast for Q4. We'll do that in about three months.

Great, thank you.

We'll go next to Jan Ku, Foreign Technology. Go ahead, please.

Good afternoon, Don and Wilson.

Hi. How are you?

I just wonder for the third quarter, you are guiding lower revenue. Is that mostly due to warranty decrease (phonetic), too?

It is and it's mostly due to what we talked about, which is customers who are requalifying, aren't ordering until that requalification is complete, and we anticipate that will be sort of either mid-way or towards the end of the third quarter.

Okay. And also, are you realizing any of the cost-savings by moving to China or where or when should that show up?

We'll start to see some saving this quarter, but as we mentioned, for the next couple of quarters, we're also going to be essentially refitting our existing facilities in the U.S. to either lease them or sell them. So those costs will offset some of the cost-savings for the next couple of quarters. I really think that we are looking at the full benefit of -- having finally decided to shut down production sometime in the first half of 2005.

Okay. Okay. Yeah, okay. Thank you.

Thank you.

Thank you.

We'll take a question from Manog Netcamy, Analysts Investment. Go ahead, please.

Yes. This is Chippy Lester (phonetic). Good afternoon.

Hi. How are you?

Good afternoon. What was the revenue distribution between wireless and LED in your substrate revenue?

Well, it's an estimate, because, you know, we don't know exactly what customers always do. But I would estimate that wireless was probably about 30% and LED about 60% and the rest would be miscellaneous products, some lasers, for example.

Okay. And you are guiding for lower revenue in the third quarter, again, between these two major end markets, wireless and LED, do you expect shortfalls in both areas or is it more so in the wireless?

More so in the wireless.

Okay. And in the second quarter, what portion of your revenues came from products that were made in China?

You mean where we manufacture our products in China?

Yeah.

During the second quarter, I would say every product had some of the manufacturing process occur in China. And probably about 20 to 30% had a portion of the manufacturing process occur in the United States.

And that will change to 100% by the first quarter of next year?

Yes.

Okay. And let's see. One other question about gross margins. What are your near-term or long-term plans to improve gross margins?

Clearly, the elimination of manufacturing in the U.S. is a big component of that. We continue to work with our suppliers to get them to reduce their costs to us. We continue to work on yield improvements and process improvements. All those former comments are part of it. In addition, additional revenue at this stage boosts our gross margin because a number of our manufacturing costs are relatively fixed.

Okay. Thank you.

Thank you.

Once again, to ask your question, please press star 1 at this time . We'll take a follow-up question from Jan Ku, Foreign Technology. Go ahead.

Okay.

Yeah. Maybe I missed this point in the earlier part of your presentation. For the product quality problem, when do you think that will be over?

Well, let me break it into two parts. We believe, based on the shipments that we've tested that every -- that what we are shipping now meets customer specifications. In terms of customers who need to requalify our China production, the current schedule calls for that to be completed by the end of the third quarter.

I see. Which means that you may qualify your China production -- which means they are comfortable with your quality?

Yes. I assume that or they wouldn't qualify it otherwise.

All right. Okay. Thank you.

Very good. Thank you.

Gentlemen, we have no further questions in the queue at this time.

Okay. Well, thank you for participating in our conference call. We look forward to speaking with you again soon.

This concludes today's telesession. We appreciate your participation. You may disconnect at this time. Thanks and have a great day.