AXT Inc (AXTI) 2005 Q1 法說會逐字稿

Good afternoon, and welcome to the AXT's First Quarter 2005 Conference Call. At this time, all participants have been placed on a listen-only mode, and the floor will be opened for questions following the presentation. It is now my pleasure to turn the floor over to Dr. Phil Yin, Chief Executive Officer of AXT.

Sir, the floor is yours.

Thank you. Hello, and welcome to AXT's first-quarter 2005 conference call. I would like to thank you for taking the time to be with us this afternoon. I am Phil Yin, Chief Executive Officer. With me today is Wilson Cheung, our Chief Financial Officer.

This being my first opportunity to speak with our shareholders, I would like to begin by briefly introducing myself. Wilson will then give you a detailed financial review of the first quarter. Following that, I will provide other comments about my initial observations of AXT's position and are the strategy we'll pursue, going forward. Wilson will close by providing guidance for the second quarter.

Then, we will open up the call for questions and answers.

I am honored to have been selected as AXT's Chief Executive Officer. And I've pledged to our shareholders, customers, and employees that I am dedicated to regaining AXT's formal position as the leader of the compound semiconductor substrate market.

I view this opportunity as a culmination of my 30-plus-year career in the semiconductor industry. During that time, I've held a series of increasingly responsible technical and sales and marketing positions.

Most recently, I was General Manager of North America for AIXTRON, the world's largest manufacturer of MOCVD equipment used in the compound semiconductor industry. As a result, I know AXT's current and potential customer base very well -- both the companies and the individuals who manage them and make decisions about which suppliers to choose.

From 1999 to 2002, I was President of ATMI Epitaxial Services, which uses substrates as a key material in its production processes. So I know how customers evaluate substrates suppliers, and what is important to them.

Previously, I held both technical and marketing positions with Crysteco, Mitsubishi Silicon America, Monsanto Electronics Materials, and IBM Thomas J. Watson Research Center where I conducted research on compound semiconductors. I believe that understanding customer's needs and responding to them in a timely and effective manner is a core requirement for business success.

In fact, I will spend nearly two-thirds of my first month with AXT, visiting customers to personally understand their needs and requirements and what it will take to regain the market share and credibility that AXT once enjoyed.

I am results-oriented and have no patience for poor performance in any part of the organization. Also, I demand full accountability. I am not afraid of making changes to processes, structure or people. I took this position because the Board of Directors gave me authorities to make the changes that I believe are required and encouraged me to act decisively. I have already begun to do so and expect the rate change to accelerate in coming months.

I would now like to turn the call over to Wilson to discuss our first-quarter performance, and then I will then provide my perspective on the AXT's future. Wilson?

Thank you, Phil.

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, turning to our financial results. Revenue for the first quarter of 2005 was 6.6 million compared with 7.6 million in the fourth quarter of 2004. Total gallium arsenide substrate revenue was 5.2 million for the first quarter of 2005 compared with 4.7 million in the fourth quarter of 2004.

The increase in gallium arsenide revenue compared with the fourth quarter was largely the result of our recent success in smaller diameter wafer sales, given the improved quality. Approximately, 80% of our gallium arsenide revenue was for optoelectronic applications, including light emitting diodes and laser diodes.

Indium phosphide substrate revenue was 137,000 for the first quarter of 2005 compared with 325,000 in the fourth quarter of 2004. The decline in indium phosphide substrate revenue was due to our relocation of crystal growth operations to China. We are now preparing samples of indium phosphide substrates with China-grown crystals for distribution to customers for re-qualification. We do not expect a significant increase in indium phosphide sales, until these samples are tested and accepted, a process that could take more than three months.

Sales of raw materials, primarily 99.9% pure gallium, were 1.3 million in the first quarter of 2005 compared with 2.6 million in the fourth quarter of 2004. The decline in raw materials revenue for the first quarter is primarily attributable to lower inventory on hand compared with the fourth quarter.

However, raw materials sales in the first quarter were made at higher margins than those made in the fourth quarter of 2004.

In the first quarter of 2005, North America revenue was 14.6%, Asia-Pacific was 58.5%, and Europe was 26.9% of total revenue. One LED-focused customer generated 12.9% of our revenue during the first quarter. Gross margin was 4.2% of revenue for the first quarter of 2005 compared with 8.2% for the fourth quarter of 2004.

Please recall that gross margin in the fourth quarter of 2004 included one-time year-end adjustments, primarily related to a reduction in regular sales return reserves and inventory evaluation adjustments that comprised approximately 5 of the total 8.2% of quarterly gross margins.

Selling, general and administrative expenses were 4.3 million for the first quarter of 2005 compared with 3.1 million for the fourth quarter of 2004. The 4.3 million included 1.3 million of expenses we expect to incur for decommissioning our Fremont facilities in the second and third quarters of 2005. Research and development costs were 362,000 for the first quarter of 2005 compared with 391,000 for the fourth quarter of 2004.

Restructuring charges were 125,000 for the first quarter of 2005 compared with 73,000 for the fourth quarter of 2004. The 125,000 charge reflects primarily our severance cost associated with the Beijing manufacturing facility restructuring effort, which took place in early March.

Net interest income for the quarter or for the first quarter of 2005 was 119,000 compared with 89,000 for the fourth quarter of 2004, reflecting overall lower interest expense due to the pay down of debt in the fourth quarter.

The loss from continuing operations for the first quarter of 2005 was 4.5 million compared with a loss of 2.7 million for the fourth quarter of 2004. The increase in losses was attributable to reduced gross margins from the prior quarter and the additional provisioning of decommissioning expenses.

During the first quarter, we incurred a gain on discontinued operations of 358,000, primarily as a result of the release of escrow funds established upon the sale of the discontinued opto-electronics business.

Net loss in the first quarter of 2005 was 4.1 million, or 18 cents per diluted share, compared with a net loss of 2.3 million, or 10 cents per diluted share, in the fourth quarter of 2004.

Let's now turn to the cash flow statement and the balance sheet. Operating cash outflow consumed by operating activities was 3.4 million for the quarter ended March 31, 2005, compared with operating cash outflow of 918,000 for the quarter ended December 31, 2004. The 3.4 million operating cash outflow includes the payment of approximately 1.9 million to Sumitomo Electric Industries. Of this $1.9 million charge, 1.4 million was for royalty payments due as a result of the lawsuit settlement in the third quarter of 2004 and 500,000 was for the prepayment of royalties due through 2008.

Operating cash flow in the first quarter of 2005 also included 500,000 in pre-paid insurance. Cash and cash equivalents with maturities of less than three months, short-term investments, and other investments and high-grade debt maturities with maturities of less than two years, including restricted deposits worth 35.4 million at March 31, 2005, compared with 40.4 million at December 31, 2004. Of this amount, 8.2 million is held as restricted deposits and 1.5 million is the value of shares we hold in Finisar Corporation at March 31, 2005.

Accounts receivable, net of reserves, was 4.5 million at March 31, 2005 compared with 4 million in the prior quarter. DSO was at 61 days for the first quarter compared with 49 days in the prior quarter when we had better than expected collections. Our DSO in the first quarter returned to our normal historical levels, as more than half of our customers are based in Asia.

Net inventory decreased 500,000 from 16.5 million at December 31, 2004 to 16 million at March 31, 2005 as we continue to utilize our current inventory. However, we expect net inventory to increase in the second quarter as we begin to build InGaAs for summer demand because we may be affected by temporary power outages in Beijing.

Capital expenditures in the first quarter were 217,000 and depreciation was 1.3 million. During the quarter we paid 150,000 in long-term debt principal.

At March 31, 2005, we had 990 employees in total, of whom, 831 worked in production compared with 1010 employees in total, of whom, 854 worked in production at December 31, 2004. At March 31, 2005, 64 employees worked in the US and 926 are abroad.

During the first quarter, we reduced our staff at our Beijing facility by approximately 100 positions, which will all be phased out in the second quarter. This concludes our review of our financial performance. Let me now turn the call back to Phil.

Thanks Wilson. Well, I have been Chief Executive Officer for only three weeks, I have had enough time to recognize that AXT has great assets that can be used to substantially improve performance. Don Tatzin, the former Interim CEO and the management team have made significant changes in the past 10 months that will lead to improved results, and I expect to continue these changes.

Our main focus is to restore the reputation and credibility of AXT and to move aggressively to improve our performance and enable AXT to perform at its highest potential.

Having met with many of our customers during the past three weeks, let me now summarize our market position. In short, we are doing well in the LED market segment and have substantial opportunities for growth in three other current market segments, including gallium arsenide substrates for electronic devices, for power amplifier applications, and germanium and indium phosphide substrates. I will cover each briefly.

AXT is a leading supplier of gallium arsenide substrates for LED market due to the combination of product quality, capacity, response time, and price. However, despite these advantages, there are still a few large customers in this segment that we would like to add. We have, therefore, launched an aggressive sales campaign to obtain orders from these customers and while it might take time to qualify, we believe we will finally be successful.

The other opto-electronics market for gallium arsenide substrate is laser diodes. This market was historically a source of strength for AXT's low defect density VGF grown InGaAs. Although, we have lost share in that market and experienced price decline, as to let competitors introduce their own VGF like products, we have recently seen improvements in the product performance.

While we expect that margins will decline from their levels of a few years ago, customers are responding positively to our improved product quality and commitment to high production standards. I expect to see increased revenue from this market segment.

We announced last quarter that we were distributing samples of our auto-cleaned four-and six-inch diameter gallium arsenide wafers. Many samples are now with customers and the feedback has been positive. During the first quarter, we received orders from several customers for large diameter substrates and are working to gain orders from other customers.

Increasing our current market share in large diameter substrates is critical to our success. The power amplifier market segment and other wireless communications products manufactured on these substrates represent more than 50% of the total gallium arsenide market, and offer a greater opportunity to us given our low current share of this market. We will aggressively pursue these customers, located primarily in the United States, Japan and other parts of Asia.

The effort we announced in February to qualify germanium substrates with a manufacturer of solar cells for satellite applications is proceeding well. If qualifications are satisfactory completed and we are officially certified as the supplier, this product could generate significant revenue. We are also responding to inquiries for germanium substrates from other customers, albeit small, for smaller volumes.

AXT retains substantial reserve inventories of germanium substrates and raw materials so an opportunity exists to increase our gross margins by developing a market for these types of products.

Turning to indium phosphide, we are completing the first round of China-grown InGaAs that we will send as samples to several customers for evaluation and qualification. During 2004, demand for indium phosphide increased worldwide and we want to participate in that market. To our knowledge, we are the only company that offers VGF, indium phosphide InGaAs, which have relatively low defect densities compared with InGaAs process using older technologies.

While our raw material sales declined in the first quarter compared with the fourth quarter, we successfully launched qualification efforts for our high-purity gallium, arsenic and paralytic boron nitride crucibles with multiple customers. The raw materials we sold were generally at higher prices than we enjoyed during 2004. During the first quarter, we appointed Steve Kent to assist our joint venture partners in penetrating international markets, a move that we believe will boost our sales.

Now, turning from the market to our strategy, we remain focused on improving product quality and quality systems, and then selling our products aggressively to improve market share. We are also working to improve our production processes. We have a good manufacturing facility, and over the next several months we will enhance and realign our production processes and further strengthen our incoming and in-process quality control procedures.

We are considering adding staff to augment our current skills and equipment, and when additional technical capability is required to meet customer demands. We remain focused on improving our consistency and level of product quality while boosting our efficiency. In fact, the staff reductions made in the first quarter resulted in product efficiency improvements during 2004.

We will also continue to develop new markets for our joint ventures and develop new joint ventures that we believe offer low entry cost and promising opportunity. As all of these head through 2005, I am excited by the opportunities in front of us. We have an outstanding VGF core technology and are upgrading other parts of our production processes.

Our low-cost China based manufacturing and joint ventures give us additional advantages over our competition. With these factors coupled with the changes that we are making to the organization, we are moving towards rebuilding and restoring the confidence of our customers, and our shareholders. I look forward to sharing our progress in the future with you.

I will now turn the call over to Wilson to provide guidance for the second quarter. Wilson?

Thank you, Phil. We project that our revenue for the second quarter will be between 6.7 million and 7.1 million. While many product qualifications are underway, we do not expect these to result in significant orders until the third quarter. Also, we project our net loss per diluted share to be between $0.13 and $0.15.

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

Thank you. The floor is now open for questions. [Operator instructions]

Our first question is coming from Darce Laman (ph) of Delta Partners.

Hi, Phil. First of all, welcome to the AXTI, and I had some questions regarding just overall market and now that you have met the customers, help us understand the overall opportunity, as well as challenges, which you feel need to be done -- dealt with in order to bring this company to a break-even level, please?

Well, as you know, the challenge is continuing to improve our quality and quality systems, to gain our credibility back and our reputation back. The business is out there. There are many, many opportunities. Our customers have been very, very positive in our product, in our new cleaning technology, so we feel that in a short period of time, hopefully, the reputation will return.

Got you. And just overall on that comment that the business is out there, have you - and looking at the processes about the company -- have you overall seen the bottom for the near future as far as revenue is concerned or there might be more shake up looking at the demand and supply scenarios the market is based overall?

Are you saying the market -- the gallium - the compound semiconductor market itself?

No, overall revenue for the company, I mean, in the near future, looking at the broader kind of market space.

Well, I think, Wilson has already gave a little guidance for the second quarter, we see our...

Not so much quantitatively, but more qualitatively, I mean, just looking beyond the three months time horizon, just overall, qualitatively, do you see the trend improving as far as companies', processes and ability to kind of garner that overall demand which is out there?

Yes. I think we're on our way. We've, as I stated, we've improved our cleaning process, our low-cost manufacturing in China. So, I do see down the road that our revenue will increase.

And just finally, overall on the guidance this year, have you changed any processes, and, just overall, as far as coming up to the guidance, were there any processes you changed for this quarter's guidance compared to last quarters' or otherwise?

No.

Got you. Thanks.

Sure. Thank you.

Thank you. Our next question is from Manoj Nadkarni of ChipInvestors.

Good afternoon.

Good afternoon.

Yes. And also, Dr. Yin, welcome to AXT.

Thank you very much.

Can you folks please give us more color on product qualification of larger substrates? Are these for wireless customers or LED customers and any more color you can offer?

Sure. I think whether the qualification for larger diameter, are you specifically saying 6-inch and 4-inch?

Yes.

Okay. The application is for both. It is for both wireless and LED customers. We are in the process of qualifying them with our new cleaning process. So it's just a matter of time. We are waiting for the results.

Okay. And how long do you think it will take to gain business from these activities, or, typically, how long is the selling cycle?

Okay. Well, in the qualification cycle, usually, there is -- some customers have multiple steps, some customers have few steps. Usually, it's taking a small quantity, looking at the material, running the process through their line, and then, the final test is lifetime test, which could take a 1000 hours or 1500 hours lifetime testing.

So, it could take anywhere between, I would say, a month up to three months in qualification. And then, obviously, from that time, they will start you with lower production quantities, and as confidence levels build up, they will increase their quantities accordingly.

Okay. And if I may ask, are any of these large customers based in North America, or any color geographically?

Some of them are in North America, some of them are in Asia, some of them are in Europe.

Okay. Very good. Let's see. Now, what do you see as the microenvironment for gallium arsenide substrates for wireless applications and for LEDs?

Well, I think, if you look at the consulting firms such as Strategy Analytics or Dataquest, I mean, they are usually very, very optimistic. However, you always got to take those numbers with a grain of salt. If you look at LEDs, obviously, the application for LEDs have slowed down a little bit except for high brightness LED; obviously, that's continuing at a very, very fast pace.

For our cell phone applications, the compound annual average growth rate through 2008 is about 8%. From 2003 to 2004, the handsets grew about 130 million units to 674 million units, and they're expected to grow to about 780 million units in 2006. And obviously, as you know, with the cell phones, the power amplifiers, really, the bread and butter for our products. So, if you look at it from that standpoint, it's not -- very, very aggressive market demands, but it's not slow.

Okay. And question for Wilson. What are your expectations for operating expenses in the current quarter?

The guidance that we are giving out in Q2 with respect to revenue, we believe that it's going to be perhaps just a modest increase from the actual 6.6 to the 6.7 to 7.1. Currently, our company do not give out specific guidance on the operating line items, but we do expect that our EPS would range between 13 to $0.15. The comment I can make is that in the Q1 actual results, the operating expenses did include a onetime 1.3 million provision that we expect to incur for the decommissioning for the properties. That would happen in Q2 and Q3, and this should not be -- we don't expect there's a repeat in Q2 and Q3.

Okay. So, there will not be any expenses related to decommissioning at all?

Right, right. We basically took all the accrual and the estimates and we put them all in Q1.

Okay. And any comment on expectations for the cash flow?

Well, if you look at our Q1 operating cash flow, it's up to 3.4 million. This number included some of the onetime payments that we have to make, for example, the 1.9 million settlement payment to Sumitomo. In Q1 we also made some pre-paid insurance of about 500,000.

If you exclude these two items out of the 3.4 million, you're looking at the normal operating cash flows of about $1 million. And we don't expect to deviate that a lot from Q1.

Okay. And finally do you -- does the company have any target for gross margin and of course eventually profitability during 2005 and beyond?

Well, currently, we only give out guidance for gross margins for the following quarter. And given the revenue expectation, would only be a slight improvement. We also expect gross margins to be about the same level as Q1.

Then that -- but that is just for the second quarter?

That is just for the second quarter. And, we -- if our revenues started to ramp up in Q3 then, we would expect some modest increase in the gross margins, as well.

Okay. Alright. Thank you very much.

Thank you.

Thank you.

Thank you. Our next question is coming from Lucy Lee (ph) of Forun Technology.

Hi. Question pertaining to the business (inaudible) can you talk about the -- by generally the business -- do you think the business is coming back?

Could you repeat your question? I think some of your words are cutting out.

Do you think the semiconductor business is coming back?

Coming back?

Do you believe the semiconductor business is coming back? Is that your question?

Semiconductor or compound?

Yes.

Are you saying semiconductor business or compound semiconductor business? A big difference there.

I mean...

AXT is in the compound semiconductor business, which means three, five materials on the periodic table. Not semiconductor, which is only silicon.

On the compound semiconductor.

Okay. Is it coming back did you say?

Yes.

We see a modest growth in the industry. I mean if you look at all the data that's out there, they basically say it's a single-digit growth.

Okay. Second question. Can you talk a little bit about the new order, from the press release, we received some - on the order, is that new order come from current customers, or you are gaining new customers?

Yeah, it's really a combination of new customers and old customers.

Okay. I mean, look forward for the next quarter in the next couple of quarters. Do you think that potentially we'll get -- gain more new customers or...?

We are actively, as I stated in my talks in the morning, we are actively pursuing and qualifying new customers.

Okay. Thank you very much.

Thank you.

Thank you.

Thank you. Our next question is coming from Goel Mukherjee (ph) State Wisconsin Investments.

Hi. Could you talk about where your breakeven level is at this point, and maybe about EBIDTA breakeven?

Well, I think its best that I talk about the GAAP breakeven.

Alright.

Information. Based on the current expense profile, we believe that we need to reach our revenue at the $14.5 million level with gross margins of about 20% in order to breakeven.

You mentioned about the cash breakeven, if you take out the depreciation element of it that would get you to the cash breakeven. And like I stated in my notes, our current depreciation per quarter is about 1.2 to $1.3 million a quarter.

In terms of CapEx, what is your estimate for 2005?

We-- the board has actually recently approved the capital budget of $1.1 million. We expect to spend about 700,000 next quarter.

Okay. Now your first quarter book-to-bill was under one. But, you are suggesting that the second quarter there will be slight improvement in revenues. Have you seen more of an improvement in March or April to suggest that there is this improvement?

As I stated, we are in the middle of qualifying new customers.

Right.

How long will that take? It really depends on the customers. So, we are qualifying new customers. Whether that will turn into production quantities -- really cannot comment.

Okay.

It's the function of time.

Alright. Thank you.

Thank you.

Thank you.

Thank you. At this time, I'm showing no further questions. I would like to turn the floor back over to management for any closing comments.

Thank you for participating in our conference call. We will be presenting at the AeA Micro Cap conference at Monterey next month. Wilson and I look forward to seeing many of you there. And we thank you for your continued interest in AXT. Thank you, and bye-bye now.

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