AXT Inc (AXTI) 2004 Q4 法說會逐字稿

Good afternoon and welcome to the AXT fourth quarter and fiscal year 2004 earnings conference call. At this time, all participants have been placed on a listen-only mode and the floor will be open for questions following the presentation. It is now my pleasure to turn the floor over to your host, Mr. Don Tatzin, Interim Chief Executive Officer. Sir, you may begin.

Hello and welcome to AXT's fourth 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 CEO of AXT. With me today is Wilson Cheung, our Chief Financial Officer. Wilson will give you a detailed view of the fourth quarter and fiscal 2004 year-end and follow - - will give you a detailed financial view of the fourth quarter and fiscal 2004 year-end 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 provide projections or make other forward-looking statements regarding, among other things, the future financial performance of the Company, possible improvement in our competitive position, future substrate and materials prices, new opportunities for our China joint ventures, improvements in our production processes, product quality and yields, future customer orders, as well as market conditions and trends. We wish to caution you that such statements deal with future events, are based upon management's current expectations and are subject to risks and uncertainties that could cause actual events or results to 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, on to our fourth quarter financial results. Revenue during the fourth quarter of 2004 was 7.6 million compared with 8.5 million in the third quarter of 2004. Total gallium arsenide substrate revenue was 4.7 million for the fourth quarter of 2004 compared with 7 million in the third quarter of 2004. Indium phosphide substrate revenue was 325,000 for the fourth quarter of 2004 compared with 214,000 in the third quarter of 2004. Raw material sales were 2.6 million for the fourth quarter of 2004 compared with 1.2 million in the third quarter of 2004. The change in revenue mix will be addressed by Don later. In the fourth quarter of 2004, North America revenue was 17.7 percent, Asia-Pacific was 63.8 percent and Europe was 18.5 percent of total revenue. One customer comprised 12.8 percent of our total revenue for the fourth quarter of 2004.

Gross margin was 8.2 percent for the fourth quarter of 2004 compared with negative 26.2 percent for the third quarter of 2004. The 8.2 percent gross margin included year-end adjustments primarily related to a reduction in regular sales returns reserve and inventory valuation adjustments, which accounted for approximately 5 percent of the quarterly gross margin. Selling, general and administrative expenses were 3.1 million for the fourth quarter of 2004 compared with 2.5 million for the third quarter of 2004. The increase in SG&A compared with the prior quarter reflects higher legal and professional fees and a charge of bad debt expense of 300,000. Research and development costs were 391,000 for the fourth quarter of 2004 compared with 397,000 for the third quarter of 2004. Other income was 212,000 in the fourth quarter of 2004 compared with other income of 380,000 in the third quarter of 2004. Interest expense for the fourth quarter of 2004 was 63,000 compared with 60,000 in the third quarter of 2004. Loss from continuing operations for the fourth quarter of 2004 was 2.7 million compared with a loss of 5.2 million for the third quarter of 2004.

During the fourth quarter, we incurred a gain on discontinued operations of 444,000 as a result of a 250,000 mark to market adjustment on our Monterrey property, which is currently in escrow for sale at 1.4 million, and the release of approximately 200,000 of the escrow established upon the sale of the discontinued Opto-Electronics business. Net loss in the fourth quarter of 2004 was 2.3 million or $0.10 per diluted share compared with a net loss of 5 million, or $0.21 per diluted share in the third quarter of 2004. Let's now turn to the cash flow statement and the balance sheet. Operating cash outflow generated by operating activities was 918,000 for the quarter ended December 31, 2004, compared with operating cash outflow of 439,000 for the quarter ended September 30, 2004. The 918,000 operating cash outflow included a net balance sheet reclassification of 720,000 from fixed assets to other assets. The total reduction in cash and equivalents including short-term investments was 711,000 for the quarter ended December 31, 2004, compared with a decrease of 1.8 million for the quarter ended September 30, 2004. The primary driver of the reduction in cash and equivalents was our paydown of accounts payable, accrued liabilities and long-term debt. Our debt to equity ratio shows a modest improvement at 0.12 in the fourth quarter of 2004 from 0.14 in the third quarter of 2004.

On the balance sheet, our combined cash and equivalents, including short-term investments, were 40.4 million at December 31, 2004, compared with 41.3 million at September 30, 2004. Of this amount, 8.2 million is held as restricted deposits and 2.7 million is the value of shares we hold in Finisar Corporation at December 31, 2004. Accounts receivable, net of reserves, was 4 million at December 31, 2004, compared with 5.2 million in the prior quarter. Our days sales outstanding was 49 days for the December 31, 2004 quarter compared with 56 days for the September 30, 2004 quarter. Net inventory decreased 1.5 million from 18 million at September 30, 2004, to 16.5 million at December 31, 2004. We expect that net inventory will increase modestly in the first quarter as we have decided to manufacture some ingots in anticipation of orders because we are concerned that power shortages in China that are likely to occur later in the year could reduce our production capacity.

Capital expenditure during the quarter was 500,000 and depreciation was 1.2 million. At December 31, 2004 we had 1,010 employees, of whom 854 worked in production. 65 employees worked in the U.S. and 945 worked abroad, almost exclusively in China.

Now let's turn to our results for fiscal 2004. Revenue for fiscal 2004 was 35.5 million compared with 34.7 million for fiscal 2003. Total gallium substrate revenue was 27.3 million for fiscal 2004 compared with 28.4 million for fiscal 2003. Indium phosphide substrate revenue was 1.6 million for fiscal 2004 compared with 2.1 million for fiscal 2003. Raw materials sales were 6.5 million for fiscal 2004 compared with 4.1 million for fiscal 2003.

North America revenue was 21.2 percent, Asia-Pacific was 59.5 percent and Europe was 19.3 percent of total revenue. No one customer comprised more than 10 percent of our fiscal 2004 revenue. Gross margin for the year was negative 0.7 percent compared with 6.4 percent for fiscal 2003. Loss from continuing operations was 14.5 million compared with a loss of 11.1 million for fiscal 2003. Net loss was 13.6 million, or $0.59 per diluted share, compared with a net loss of 26.7 million, or $1.17 per diluted share for fiscal 2003. Operating cash flow generated by operating activities was 1.5 million, which included a 720,000 net balance sheet reclassification from fixed assets to other assets compared with operating cash inflow of 6.3 million for fiscal 2003, which primarily was due to cash receipts on disposal of our electronic - - Opto-Electronics business and the tax refund. This concludes our review of our fourth quarter and 2004 financial performance. Let me now turn the call back to Don.

Thank you, Wilson. During the fourth quarter, we made significant quality improvements in our 4-inch diameter gallium arsenide substrates. Samples sent to several customers that were processed using our new cleaning equipment appear to be largely haze free, similar to our 2- and 3-inch diameter substrates. Early in the first quarter we received orders for 4-inch diameter substrates from some customers who had not placed orders with us for several months and we believe this indicates a turnaround is at hand if we can maintain high quality. That improvement is welcome as it comes on the heels of a disappointing quarter. During the fourth quarter, substrate revenue declined by approximately one-third, primarily because of a seasonal fluctuation in demand from our LED customers. We were able to offset much of that decline with increased revenue from sales of raw materials, primarily gallium. However, some of the sales of raw materials in the quarter carried a lower than typical gross margin which, when coupled with lower substrate revenue, caused our gross margin to be slightly lower than anticipated.

We expect the first quarter of 2005 will be characterized by a greater share of substrate revenue but at lower prices than in Q4. As a result, we expect first quarter gross margin will be between 3 and 5 percent. We see opportunities for improving both substrate and raw materials revenue as the year proceeds. Our 2005 strategy is aimed at making this improvement happen and I want to share key elements of it with you. Our first priority is to continue to enhance our product quality and consistency. During the last 6 months, LED customers reported almost no problems related to haze, which has historically been our major product quality concern. The new automated cleaning system we installed is working well and we continue to improve its performance.

During the fourth quarter, we installed an automated cleaning process for 4-inch diameter gallium arsenide wafers and sent samples to several customers, all of whom reported that the substrates were virtually haze-free. We are implementing a similar capability for 6-inch diameter substrates and expect to provide samples of that material to selected customers later this month. We have several potential customers who are waiting to process these samples. While haze has been our biggest product quality concern, there are other opportunities to improve quality, such as producing more substrates with low edge pit density. We already make such products and have launched projects to increase our yield of these materials, which sell at premium prices.

Our second strategic thrust will be to regain market share. We are one of the leading producers of gallium arsenide substrates for the LED market, primarily because we offer the quality these customers require, can produce large volumes of wafers on short notice and offer attractive prices and terms. In January, we entered into two non-binding one-year supply agreements with major LED manufacturers. The volumes anticipated in these agreements are substantially greater than those we sold to these customers during the fourth quarter. As we predicted in our October conference call, prices are lower than in 2004, but these agreements improve utilization of our capacity. Just as the introduction of our new automated cleaning process helped us increase market share for LED wafers, we anticipate that introducing similar capabilities for our larger diameter substrates will enable us to regain share in these markets. Because several of these customers will need to requalify our product for their use, we expect that our progress will be gradual rather than sudden and that we will not see any significant improvements until the third quarter.

We also expect to regain share in the indium phosphide market during the year. We enjoyed an increase in sales during Q4 compared with Q3. We believe demand for indium phosphide is increasing and that we have now resolved many of the quality issues that plagued us last year. However, since we transferred all of our indium phosphide production capability to our China facility late last year, we must requalify customers before they can replace substantial orders. For the first time in several years, we are qualifying germanium substrates with a manufacturer of solar cells. If successful in our qualification, we expect to begin sales of these products in the third quarter.

The third element of our strategy is to further tighten controls around our processes, which will help us reduce costs and improve the performance of our substrates in our customers' processes. To capture this opportunity, we will purchase additional equipment, automate more of our production process, improve our process monitoring capabilities and increase our staff skills. The fourth element of our strategy is to reduce costs. During the past several years, we shifted our production to China, an effort that is now complete. During 2005, we will continue to reduce costs by qualifying new lower cost suppliers, moving more of our administrative functions to China and streamlining our organization structure and costs in North America and China to bring them in line with demand.

Turning to our joint ventures. We participate in 5 joint ventures in China that produce raw materials that we and others consume. Fourth quarter sales of raw materials to third parties, primarily of 99.99 percent pure gallium manufactured by our Ji Ya joint venture were approximately twice the third quarter value. Two of the joint ventures, which historically have sold the vast majority of their production to AXT, are now ready to solicit third-party customers. Already, our Jinmei joint venture which produces highly refined gallium has sent samples to two customers, Bo Yu, which produces PBN crucibles used in crystal growth and other applications is preparing samples for three customers. Both companies are low cost producers and potential customers appear to be interested in adding suppliers. While we expect the Q1 and Q2 revenue for raw material sales will be lower than in Q4, primarily because Ji Ya does not have much 4N gallium inventory on hand, we are optimistic about the joint venture's ability to contribute to our performance during the second half of 2005. In addition to growing these joint ventures, we continually seek new opportunities to expand our presence in China by entering new businesses.

The final element of our strategy is to build a strong foundation for quality and growth, which we will do by improving staff skills, maintaining adequate financial reserves and providing a safe workplace. We have made progress in each of these areas during the past 6 months. We reported to you in October that we had reached a tentative agreement regarding the intellectual property litigation and patent interference actions between Sumitomo Electric Industries and AXT regarding our substrate business. During the fourth quarter we completed the agreement and the litigation was withdrawn and the interference proceeding was settled in January. We also entered into a four-year cross licensing agreement with SEI for all of our intellectual property related to gallium arsenide and indium phosphide substrates. We believe that settling the litigation allows us to focus on the business and reduces the concerns that were expressed by some customers regarding whether we would be prohibited from selling substrates in Japan.

We've also added several engineers to our process engineering and R&D staff from China. They will be responsible for improving the quality of our products and for developing new products and features that will improve our appeal. Another part of our foundation is to maintain adequate cash resources, which we believe are ample. Having moved production to China, we no longer require our manufacturing facility in Fremont. During 2005, we expect to either sell or lease that facility so it can be a productive asset and increase our unrestricted cash reserves. We recently entered into an agreement to sell a building that was used in our discontinued Opto-Electronics business and expect that sale to close in the second quarter.

Like other public companies, we are required to comply with the aspect of the Sarbanes-Oxley Act concerning the review and out-of-station of our internal controls at the end of 2005. Our compliance effort is well underway. The cost related to compliance should not be higher than they have been during recent quarters. We have also augmented our new environmental and health and safety compliance programs in China and hold this among our top priorities. In conclusion, our long-term business strategy remains focused on leveraging our competencies in VGF technology, and creating and expanding joint ventures in China related to our core substrate business. We believe there are opportunities to grow our business profitably using each competency and are putting plans in place to do so. I look forward to reporting to you regarding our progress. Wilson will now provide guidance for the first quarter. Wilson?

Thank you, Don. For the first quarter of 2005, we are seeing an increase in orders for LED substrates. We also expect slightly increased sales of our larger diameter wafers. However, sales of raw materials are expected to decline as we have less inventory on hand. Therefore, we expect revenue to be between 7.4 and 7.8 million and gross margin to be between 3 and 5 percent. Sales, general and administrative expense is expected to be approximately 3 million and R&D approximately 400,000. We projected our net loss from continuing operations to be between 3.1 and 3.3 million, or between $0.13 and $0.15 per diluted share. We project that capital expenditures in Q1 will approximate 1 million. This concludes our prepared comments. We're now happy to answer your questions.

Thank you. The floor is now open for questions. If you do have a question, please press star, 1 on your touchtone phone. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound sign. Once again, if you do have a question, please press star, 1 on your touchtone phone at this time. Our first question is coming from Darce Laman [ph] from Delta Partners.

Yes, Don, I have some questions. [Indiscernible] comments on this slight improvements which are taking place and then utilization rates, first of all, what were the utilization rates and then related to it gross margins, are we over from those negative gross margin territories, or what do you see on the gross margin front especially as you're talking about 4-inch gallium improvements on the utilization rate front?

In terms of the utilization rate, it's still relatively low. We have a lot of excess capacity, which is one of the reasons that the current gross margin is at far lower levels than we want. As we look towards Q3, we know that increased revenue, if we achieve that, resulting from additional qualifications, will boost gross margins. We're still projecting a relatively low gross margin for the first quarter and don't see any significant improvements until the third quarter.

Got you. But one of the things you mentioned was raw materials, you do - - you guys don't have extra capacity to kind of furnish all the demand out there. Had you had those - - that extra capacity, where would you have seen the revenue run rate for next quarter?

We're selling the capacity we have, and so I must admit we haven't really solicited sales we can't fill, so it's a hypothetical question I don't have an answer to. It's conceivable we could have matched the sales that we achieved in Q4, which was about 2.6 million.

Sorry? How much is that?

Well, I'm saying, I mean, first, it's a hypothetical question. What we're focused on is selling the capacity we have, not trying to figure out how much demand is out there. It's conceivable that there would be demand out there for 2.6 million, which is what we sold in Q4. We certainly believe there's going to be demand for the product we'll have available for sale this quarter.

Got you. And just finally, on the cash break-even bit, what sort of revenue level, can you achieve that with the current SG&A and all? And then Finisar, how much shares do you still own there?

Well, let me take the Finisar question and I'll ask Wilson to answer the question about cash break-even. We hold about 1.1 million Finisar shares, which is the same number we've held for some time.

Got you.

And as far as GAAP break-even, you're really - - assuming that we're using the current expense profile. You're looking at revenues above $14 million with a gross margin of about 20 percent, to get into GAAP break-even.

Now, cash flow break-even would be a different number given depreciation.

Exactly. Great, thanks.

Thank you.

Thank you. Our next question is coming from Chang Qiu of Forun Technology.

Yeah, hey, Tom and Wilson.

Hi, how are you?

I have a question for your forward guidance. Looks like your revenue, you know, if you take the mid-point that's about flat with the Q4. On the other hand, somehow your [Indiscernible] income the mid-point, you know, 3, $3.2 million loss, that's another $1 million more than the loss for the fourth quarter of '04 and I wonder what's the reason?

Let me let Wilson answer that.

Well, I think just looking at the Q4 gross margin we had about 8.2 percent and we're only projecting between 3 to 5 percent for Q1. So the difference in that gross margin is already about $0.02 out of my EPS calculation. And then I - - we don't expect that my G&A or operating expenses are going to go down in Q1 because we still have the Sarbanes-Oxley work that we need to do, which is, you know, well underway right now, so, you know, I think that explains the difference between, you know, what you have and what we project for the net loss for the quarter.

Also just to clarify, what we reported as loss from continuing operations for Q4 was 2.7 million.

Mm hmm.

And what Wilson counted on as loss from continuing operations for our projection for the first quarter would be between 3.1 and 3.3 million. So while it is an increase in the loss, I think I heard you say you thought it was a million dollar increase. It's not that large.

No. The difference is on the gross margin.

Well -- I , no, I think it maybe one part of that difference is the gain on the discontinued operations. So next year, I mean for Q1 you won't have any gains from discontinued operations or for the disposal, you don't have any of those items?

It depends on, you know, for example, whether we receive any more of the escrow funds back in Q1.

I see.

But, again, we didn't forecast net income, we didn't forecast the discontinued operations line. We only discussed in the call loss from continuing operations. So, if we compare that with loss from continuing operations in the fourth quarter, there's - - you're looking at 2.7 million loss in the fourth quarter versus a forecast of 3.1 million, roughly 3.2 million in the first quarter.

Okay. Okay. I understand now. For the product quality improvement, you mentioned that right now the 4-inch basically needs qualified by most of your customers.

What I said was we've been sending samples out recently and that the reports we're hearing back from the customers are that the samples are testing very well. I think a number of the customers are still in the middle of their qualification period because not only do they have to produce [Indiscernible] then they sometimes have to send it to their customers, the y have to have lifetime tests performed, things like that. So we didn't say that the qualifications were all complete.

I see. So there are still more customers in the qualification process?

Correct, and there are other customers to whom we have not yet sent samples to who would begin their qualification process only after they receive samples.

Okay, and for the 6-inch, you mentioned the quality per your own judgment has improved and then right now it's in the process of sending out for customers' qualifications.

What we said is we've installed a - - some new equipment to improve the cleaning of 6-inch samples - - or 6-inch substrates, that our expectation is we will send the first samples of material cleaned using this new equipment out later in February.

Okay, and in terms of order, new orders, you mentioned looks like the order is somewhat stronger than same time in, say, December quarter.

It's comparable. I mean, we're again, we're projecting overall revenues to be approximately flat, so there's no significant difference.

Okay, and in terms of the third quarter sales to Key Cobb [ph] or grow more substantially from current level, how confident are you in terms of that, you know, [Indiscernible - accent] or view?

You know, it's not a guarantee. It -- it's based on conversations we've had with a number of customers over the past few months and coupled with an expectation that the improvements we're making in the cleaning process will enable more customers to qualify our 4- and 6-inch products, and an expectation that the overall markets will remain fairly strong.

Mm hmm. Mm hmm. Okay.

So, you know, if all of those things happen, then we would expect that our revenues would increase. But we've not given a forecast for Q3 or Q4 revenues.

Mmm. Okay. All right. Thank you, Don. Thank you, Wilson.

Take care.

Thank you. Our next question is coming from Manoj Nadkarni of ChipInvestor.

Hi, good afternoon. Can you talk about outlook in your two primary markets, LED substrates and substrates for wireless segment, and what your competitive position is?

Let me take the LED substrates first. We expect that there will be modest overall growth in demand for that product. As I mentioned in the call, we think we have one of the leading positions worldwide as a supplier. At this stage, we believe we can maintain that position this year if we keep our quality up and our service good and have competitive prices. With regards to the wireless segment, our market position there at this point is pretty weak and what we understand about the market that we're essentially reading from third parties is that there's expected to be some weakness in wireless in the first half of this year. But what really is going to govern our business in that segment is our ability to qualify with some of the customers that have stopped buying with us over the past 18 months. And there we believe that, you know, efforts are underway to do that. If those are successful, then we believe that we can grow our revenues regardless of what the market does.

So in the wireless segment, do you need 6-inch wafers qualified? Would they also buy 4-inch wafers?

It depends on the customers. Some buy 4 and some buy 6.

Okay. Secondly, the orders you received for the 4-inch wafers in the current quarter, were they from LED customers or wireless customers?

Both.

Okay. So some of your wireless customers have looked at your new material.

Right, but the orders - - I mean, I'd say the 4-inch orders we received from wireless customers are still relatively small as we said, we expect improvements to be gradual rather than sudden.

Okay. Don, can you please describe road map to profitability, how do you plan to improve gross margins?

Well, basically the things we talked about, one is to get product quality high and make sure it's consistent. Then with product quality that allows us to compete for every order to go out and be aggressive about regaining market share. And doing that will, in itself, drive up gross margins and push us towards profitability. And then the third component is to focus on improving our internal process control, which will allow us to reduce costs, to do less rework, to operate with fewer staff, those things, so that it's a combination of high quality can drive revenues and at the same time we're going look to trim costs during the year.

Okay, and you have some internal road map to profitability?

Yes, yes.

Okay, and finally, how much stock buyback have you had so far?

Well, at the end of December, we haven't repurchased anything, but in January we purchased about 10,000 shares back.

Okay, and what's your strategy in that regard?

Well, the Board had laid out a program that we announced last year and that program runs for a year and then at the end of that we'll take a look and see if we want to renew it.

Okay, but right now, your stock is creating net cash levels, so would you - - would we expect some aggressive buying at this juncture?

Well, announced that we had the program. We don't announce exactly when we go into the market.

Okay.

That's set by policies that the Board adopted last year.

All right. Thank you.

Thank you.

Thank you. Once again, if do you have a question, please press star, 1 on your touchtone phone. Sir, there appear to be no further questions.

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

Thank you. This does conclude today's conference. You may disconnect your lines at this time and have a wonderful day.