AXT Inc (AXTI) 2005 Q2 法說會逐字稿

Good afternoon and welcome to your AXT second 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 your host, Phil Yin, CEO. Sir, you may begin.

Thank you. Good afternoon, everyone and welcome to AXT's second quarter 2005 conference call. I am Phil Yin, Chief Executive Officer, and I would like to thank you for taking the time to be with us. With me today is Wilson Cheung, our Chief Financial Officer. Wilson will begin the call by giving you a detailed financial overview of our second quarter. Following that I will give my perspective on the company and our progress towards rebuilding our business and regaining AXT's former industry leading position. Wilson will provide forward-looking guidance then we will open up the call to your questions. 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 and our ability to control costs and improve efficiency, including improvements in our facilities expenses and manufacturing costs, improvements in our competitive positions including our technology development, the impact of customer qualification of our products, new opportunities for our China joint ventures, improvements in our production processes, product quality and yield 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.

Now, turning to our financial results. Revenue for the second quarter of 2005 was 6 million compared with 6.6 million in the first quarter. Total gallium arsenide substrate revenue was 4.5 million for the second quarter of 2005 compared with 5.2 million in the first quarter. The decrease in gallium arsenide revenue compared with the first quarter was largely the result of extended customer qualifications. Approximately 67 percent of our gallium arsenide revenue was for opto-electronic applications including light emitting dials and laser dials. Indium phosphide substrate revenue was 280,000 for the second quarter of 2005 compared with $137,000 in the first quarter.

Sales of raw materials, primarily 99.99 percent pure gallium, were 1.3 million in -- in the second quarter of 2005, same as the prior quarter. In the second quarter of 2005 revenue from North America was 21.7 percent, Asia Pacific was 38.4 percent and Europe was 29.2 percent of total revenue. One LED focused customer generated 14.6 percent of our revenue during the second quarter. Gross margin was 2.1 percent of revenue for the second quarter of 2005 compared with 4.2 percent for the first quarter.

Our cost of revenues in the second quarter of 2005 included a $765,000 charge as a result of a reduction in inventory valuation due to improved yields and labor costs. Selling, general and administrative expenses were 2.7 million for the second quarter of 2005 compared with 4.3 million for the first quarter. SG&A in both quarters included charges for the decommissioning of the AXT's Freemont facilities for the remainder of 2005. Those charges were 548,000 in the second quarter of 2005 and 1.3 million in the first quarter of 2005.

Research and development costs were 423,000 for the second quarter of 2005 compared with 362,000 for the first quarter. Restructuring charges were 237,000 for the second quarter of 2005 compared with 125,000 for the first quarter. The 207 -- 237,000 charge included the close down of our Japan office and revised estimates to our restructuring accrual.

Net interest income for the second quarter of 2005 was 131,000 compared with 119,000 for the first quarter. Loss from continuing operations for the second quarter of 2005 was 3.3 million compared with a loss of 4.5 million from the first quarter. Net loss in the second quarter of 2005 was 3.3 million or $0.14 per diluted share compared with a net loss of 4.1 million or $0.18 per diluted share if the first quarter.

Let's now turn to the cash flow statement on the balance sheet. Operating cash out flow consumed by operating activities was 1 million for the quarter ended June 30th, 200,5 compared with operating cash outflow of 3.2 million for the quarter ended March 31st, 2005. The 1 million cash outflow included 1.3 million of proceeds received upon close of escrow of the sale of our Monterrey Park, California property. Cash and cash equivalents with maturities of less than three months short-term investments and other investments in high grade debt securities with maturities of less than two years including restricted deposits were 33.2 million at June 30th, 2005 compared with 35.4 million at March 31st, 2005. Accounts receivable net of reserves was 5 million at June 30th, 2005 compared with 4.5 million at March 31st, 2005. Given the lower revenues in the second quarter, DSO was at 76 days for the second quarter compared with 61 days in the prior quarter.

Net inventory decreased 700,000 from 16 million at March 31st, 2005 to 15.3 million at June 30th, 2005. The 700,000 reduction in net inventory primarily reflects our 765,000 inventory valuation charge as a result of improved yields and labor costs as mentioned earlier. Capital expenditures in the second quarter was 512,000 and depreciation was 756,000. During the quarter, AXT repaid 150,000 in long-term debt principal.

Turning to our stock repurchase program, during the second quarter of 2005 we repurchased 135,000 shares of our common stock. Since July 2004, we have repurchased 158,000 shares of our common stock.

At June 30th, 2005, the company had 881 employees in total, of whom 729 worked in production compared with 990 employees in total up from 831 worked in production on March 31st, 2005. At June 30th, 2005, 59 employees work in the U.S. and 822 are abroad. This concludes our review of our financial performance. Let me now turn the call back to Phil.

Thanks, Wilson. As I told you in April, my 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. Since joining the company at the end of March, I have spent a significant amount of time meeting with our customers and discussing one on one their specific needs and issues. These discussions, coupled with my internal analysis, confirmed that making -- we are still making steady progress. However, there is still work to be done in several key areas.

Let me now address them: First, the quality issues that we have faced continue to require our focused attention. Clearly, we have made great strides but we still have issues to resolve. As a result, the requalification of our products with some customers has been extended and will continue to impact our revenue results through the end of the year. However, I fe -- I firmly feel that we can resolve these issues and improve our product quality and I am very committed to achieving the highest standards in this area.

Therefore, I was pleased to announce the appointment of Mr. M.S. Lin as Chief Operating Officer. M.S. has significant expertise in designing and implementing systems and protocol for quality control. He is responsible for all the company's day-to-day operations including the facilities in both Freemont, California and Beijing, China. His focus will be to enhance AXT's manufacturing processes to ensure consistency, efficiency and the highest level of quality and to develop and implement enhanced quality systems and controls. Among his first key assignments is to assemble a cross functional task force to examine the issues that we continue to face and to plan and execute our strategies to resolve them.

M.S. is highly qualified in these areas, having delivered outstanding results for several major silicone companies and having been schooled in Deming (ph) and Six Sigma quality principles. In addition, he has hands-on experience in manufacturing disciplines. I have known and worked with him for more than 25 years and I believe that he can quickly have a positive impact to enhance our quality, quality systems and our manufacturing operations. The creation of the Chief Operating Officer's role will allow the Company to have tighter integration of our two facilities in the U.S. and China and will allow us to further focus on manufacturing, quality and quality system improvements.

Our China operation gives us a significant competitive advantage. Therefore, we must ensure that we are utilizing it with highest potential. In addition to quality improvements, M.S. will focus on lowering our costs by improving our efficiency. The two key areas for cost reduction will be in materials and facilities. Within the materials area, we believe that improving both our manufacturing processes and our technology for crystal growth, we can be much more efficient in amount of materials we use to fill -- fill our demand. Second, we expect to see a positive impact to our results by reducing our facilities costs in Freemont. We expect that the changes we are making in these areas will begin to benefit AXT in the latter part of the year.

The competitive landscape has changed dramatically in the last several years and VGF is now the industry standard. So we know that our success will come from providing the highest quality product at the cost advantage that our China facility can offer. Our mandate is a significant reduction in manufacturing costs, 100 percent on time delivery and zero defects. By achieving these goals, we believe we will be able to position ourselves well for the current and future share market growth.

Now, turning to the secondary of focus for AXT, the development of our core technology. Under the guidance of Morris Young, AXT was the first to the commercialize vertical grade into freeze crystal growth, the technology has -- that has become the compound semiconductor industry standard. We are also the leader in providing large diameter VGF grown substrates. In this highly competitive market, it is important for us to focus on continuing the enhancement of our excellent core technology.

Thus, I am extremely pleased to announce that Dr. Morris Young is heading up our efforts in this area as our Chief Technology Officer. I believe that Morris's enhanced focus in this area will result in benefits to our manufacturing efficiency, product quality and competitive positioning. In a highly competitive market such as this, it is important that we distinguish ourselves by providing our customers the highest level of quality, flexibility and cost effectiveness. Morris will now be able to focus all his energy on his area of expertise and do what he does best.

Our third area of focus for AXT is our unique opportunity with our raw material joint ventures. Currently, we are parties to five joint ventures in which we own between 25 and 88 percent. Our investments in these joint ventures have been relatively small but the benefits of integrating vertically could be significant, particularly in a stronger and more competitive marketplace. To this, I was pleased to announce that Davis Chang is heading up our efforts to develop these joint ventures and to look for additional opportunities that would compliment our current product portfolio. Davis is a co-founder of AXT and it has been through his continued and concerted efforts that AXT has this unique competitive advantage. Excuse me.

Finally but not least, our focus is to strengthen our sales efforts both domestically and internationally. We believe that opportunities exist both within our current customer base and with new customers. To this, we have recruited Mr. Bob Oklin (ph) to join AXT as Senior Sales Director, responsible for expanding North American and European sales markets and increasing revenues. Bob joins the AXT sales organization with more than 25 years of experience in compound substrates, raw materials and device sales.

I am extremely pleased to make the announcement of all these changes to our organizational structure. They will enable AXT to fully maximize the expertise and skill sets of our team while placing enhanced focus on the areas of manufacturing and quality that require immediate attention. The structure also allows us to focus more closely on two important elements of our future business: AXT's core technology development and growing our joint venture operations.

As we look ahead to the come -- to the coming quarter, we expect that our customer qualifications in gallium arsenide will continue through the end of the year and that our revenues will begin to recover accordingly. I am pleased to report that in addition to the requalifications that are ongoing, we are for the first time in several quarters in the process of qualifying some new products with existing customers and we hope to have orders from those customers later this year.

Now turning to our germanium business. We are pleased by the progress of our qualifications and we hope to see some sales in the latter part of this year. However, it is unlikely that germanium sales will have a material impact on our revenues until early 2006.

In conclusion, I have pledged to our customers, our shareholders and our employees that I am extremely dedicated to regaining AXT's former position as the leader of the compound semiconductor substrate market. I truly and earnestly believe we have the right tools to make that happen including excellent core technology, low-cost manufacturing capability, a unique joint venture opportunities and most importantly, an experienced and dedicated team. Further, I believe that several of the changes necessary to achieve our goal are already on the way. As you know, success will not happen overnight, but rather in measured, meaningful steps. I thank you now for your continued support and I look forward to sharing our progress with you next quarter. I thank you now for your continued support and I look forward to sharing our progress with you next quarter. I will now turn the call over to Wilson to provide guidance for the third quarter. Wilson?

Thank you, Phil. We project that our revenue for the third quarter will be between 5.8 million and 6.2 million reflecting the ongoing customer qualifications. Also, we project our net loss for diluted share to be between $0.11 and $0.13. This concludes our prepared comments. We are now happy to answer your questions.

Thank you. The floor is now open for questions. (OPERATOR INSTRUCTIONS) Please hold while we poll for questions. Our first question comes from Pierre Maccagno from ne -- Needham.

Hi, I'd like to know, what -- what is the percentage of gallium arsenide was it six inch?

Is that from a revenue standpoint or from a volume standpoint?

Well, I guess from both if you have the information.

Wilson, I'm pulling this information right now. For the six-inch gallium arsenide you're looking for revenues of about 470,000 for Q2. Dollar wise.

And so that -- your strategy is, I guess, to be growing that -- that business, right?

Correct.

For the wireless?

Correct.

Okay. And what is the strategy that you're going to, I mean, use to -- to compete against -- I mean, the established market right now? Semiconductor market.

Well, obviously the strategy is -- is VGF technology from a -- from a defect standpoint. However, as I mentioned before, the competitive landscape has changed. There are competitors using the same crystal growing process. So the strategy obviously is customer service, support, engineering applications support and quick response.

So you said that 67 percent was opto and what -- the rest was wireless? Is that right? Or --

That's correct.

Okay. And what is the [INAUDIBLE - accent] for ASPs? How are those developing?

ASPs?

Yes.

Well, from a market standpoint, we have seen about a 3 percent per quarter decline starting in Q4 of '04, beginning of Q1 of this year, more aggressive on the 4- and 6-inch and less aggressive on the 2- and 3-inch. We see that probably progressing down the road, specifically again in the larger diameter. But stabilizing in the 2- and 3-inch.

Okay. Well, thank you very much.

Thank you.

Thank you. Our next question comes from because man of Delta Partners.

Hi, Phil. Yes. First of all on the break even, if you -- when do you expect to see that now that it has almost closed down -- come down to 1 million range? What -- what -- what's your expectations on that?

Wilson?

Yeah, we can take that. This is Wilson. Currently, we don't give out the -- the timeline as far as the breakeven point, but like I said in previous quarter and I can repeat to you that looking at our current quarter's expense profile, you're still looking at about a $14 million revenue with about a gross margin of 20 percent in order to break even or from the GAAP perspective. And from EBITDA perspective, you take out the depreciation charge of about 800 -- $800,000, so you're looking at $14 million in gross margin of about 15 percent, you get into EBITDA breakeven

14 millions per quarter?

Yes, that's millions per quarter.

And how much confidence you to say in the -- the guidance? Like what are the major drivers in order for you to achieve this guidance?

Well, I -- I think as -- as I mentioned, in my -- in my opening statement we -- we have quality issues and -- and I'm putting all my efforts and Company resources to look at that. You've probably seen the major reorganization change. We're -- we're -- we're trying to divert our skill sets into the proper areas, recruit the proper talent into the organization. I feel pretty confident that eventually we will be able to meet breakeven

Got you.. And just on the -- you mentioned the second half, you may see some more customer qualifications and maybe revenue ramps as well. Can -- can you throw some more light on that for us?

Sure. Well, again, as I mentioned in my -- in my beginning statement, we are in the process of requalification. A lot of those requalifications have not been completed, and as they do complete, get completed successfully, the customers will be ordering production quantities and if -- if our quality is consistent, so obviously the production volumes will ramp up accordingly.And -- and also I mentioned there's a good possibility that we'll have some revenue contribution, albeit very little, this year in our germanium portfolio. However, I don't -- I don't see we'll see significant revenue contribution for that particular product until next year of 2006.

Got you. And just few clarifications. You also -- you mentioned that there's a $765,000 charge in inventory valuation on COGS. And what exactly is that? And then the cash flow used, you said -- what is included? Something of Monterrey facility charges included in that cash flow used. Can -- can you help me better understand that?

Sure. Let me just answer your first question about the inventory adjustment. Basically, every quarter, we go and look into our standard cost and in this second quarter, we are able to conclude that we are using less materials and the labor costs that we have in our standard cost system is higher than the actual, so what we have decided to do is to take a charge and reduce our inventory valuation by $756,000. So my other side of the entry is that as you take a charge on my P&L but the good news is we're going to use the lower cost basis when we start to increase our manufacturing going forward.

To answer your second question about cash flows, our operating cash outflow is at 1 million in Q2. Now, this number included cash proceeds of $1.3 million, but the actual cash we received by selling the property when we closed the escrow. So if you -- so basically, if you don't have that 1.3 million cash proceeds, my operating cash outflow would be at $2.3 million.

Got you. And, well just on the cash fund, you mentioned something for 33.2 million. What was that? And that's going it be it, thanks.

That number included my restrictive cash of $8.2 million and all my investment securities portfolio.

Got you. So the total cash of -- including the restricted is 33.2 million?

That is correct.

Great. Thanks.

Thank you. Our next question is coming from Joy Mukherjee of State Wisconsin Board.

Good afternoon. I was curious as to what kind of milestones we can look forward to over the next couple of quarters to see what kind of progress you are making.

Okay. Well, I think the key milestone is resolving our quality issues is -- is -- is key, because without that, we will did definitely not get revenue contributions or increasing our sales revenue. That's -- that's a key milestone and again my announcement of M.S. Lin who is schooled in quality principles, I think he will make a major contribution to that. Secondly, the other milestone is obviously to gain more market share by increasing sales revenues by qualifying new products, new customers and also pursuing our germanium sales down the road because we see a -- a big market in regards to terrestrial solar sales application.

In terms of the quality issues, is there a time factor that you have established by which you expect to see improvement.

Well, M.S. Lin basically started about two -- two weeks ago. He has formed a -- a -- a task force to investigate this issue and based on their investigation I am hoping, or anticipating, that this whole issue would be revolved towards the end of this year, latter part of this year.

Now, I -- I see that your DSOs have improved. Could you talk a little bit about why that is and what's going on?

Well, the -- the DSO number for the quarter actually did not improve. We had 76 days versus a little over 60 days --

Okay.

Yes, it did not improve but basically that was just a strict arithmetic calculation when you were looking at DSOs on a per quarter basis. When my denominator gets to strength just using the -- the revenue number that when you compare that with the 6.6 million, my -- my numbers just going to fall. However, if you look at the DSO on an accumulated basis, I think we're still within the general range of about 60 something days, so we're still within our -- our target.

Now, your inventory seemed -- your inventory still seemed kind of high. Is -- is there an intention to bring it down? What -- how do you expect to improve your working capital?

The -- the inventory time, we're on -- right now at approximately 2.5. And -- but bear in mind that we -- we are preparing to increase that number, our target at least to get to 3. But bear in mind that to build -- to grow turn it really costs about 10 days and so we can't really compare apples to apples when we compare our inventory turn number with some of the other semiconductor company.

The -- the other, excuse me, the other reason for the inventory build would be in Beijing this is the time where there's a lot of storms and so we are building inventory for electrical shutouts. It's a been a practice all in China for that, especially in the Beijing area.

All right, thank you.

Thank you.

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

Hi. Can you give us some more details on the qualification work for the 4-inch and the 6-inch wafers from the new plant. Are you seeing issues with one particular substrate size versus others and if you can elaborate on what have been the reserves of your automated clean process you implemented some quarters ago?

Well, as you know, the -- the entire quality issue is really -- is post epi-haze (ph) and we resolved many of those issues with many of our customers. However, as you know, the epi customers they have their own epi processes, so the process is different depending on -- on customers. So we are working extremely hard to -- to address those issues. And with M.S. Lin there, he has evaluated all these processes and we're -- we're working basically on developing one single process to do -- reduce the manufacturing complexity, so we'll address that issue for all our customers

Okay, but are you facing the same level of issues on 4-inch and 6-inch both or are you --

Well, as a matter of fact, that's -- that is a good question. It's more -- it's more associated with the 4-inch. We don't see our 6-inch diameter customers that have these issues.

Okay. And revenue of 470,000 for the 6-inch wafers will that from the new plant?

Oh, yes, everything -- everything is -- is -- is from the new -- from the China plant. We do not have any manufacturing the U.S. anymore.

Okay.

So all our customers are qualified at the new facility .

And what do you see as the biggest challenge now to successfully completing qualifications, especially on 4-inch wafers?

Could you -- could you repeat that question, again, sir?

So what do you see -- what is your biggest challenge or biggest -- what are the main one or two factors that are holding you back from achieving success in completing the qualifications?

Basically two-fold. One is, obviously, the customers themselves finishing the qualification. As -- as you know, the customers' first focus is their production and qualification is basically secondary. And as -- as -- as I mentioned earlier, the qualifications have -- have been delayed not because of us but due to customers, so that's -- that's number one. And number two, obviously, is -- is for us to come up with one cleaning process that will be able to use for our entire customer base. So those are the two challenges that I see down the road.

All right. Thank you.

Thank you.

Thank you. Once again, that is star 1 to ask a question on your touch tone phone. Our next question comes from of Pierre Maccagno of Needham.

Yeah, I wanted to know on a pro forma basis, am I right in assuming that you have an $0.08 loss this quarter?

I'm -- I'm sorry. Can you -- can you repeat the question again?

Yes, on a pro forma basis, without taking account of these charges that you mentioned, should this be a loss of $0.08?

No, I think --

Without taking the cost of goods sold charge and the SG&A charges?

That's correct. That's correct. Approximately, yes.

Okay. So for next quarter, I mean, you're giving a GAAP --

Yes, well, we are looking into a couple of factors when we project our 2, 3 P&L. One is that we -- we -- our revenue number's going to be slightly lower than our actual 6 point million this quarter.

Isn't it going to be up?

No, we're at 6 but the range we're giving is between 5.8 to 6.2.

Okay.

So we -- we -- the -- the range is -- is -- it's lower and then in the lower range, we think.

Okay. But let's assume that you're just flat. Okay. Because --

Okay. Oh, we're flat.

Okay.

Secondly, we're also looking into our manufacturing and we don't believe that we're going to manufacture as much as in Q2. If you'll recall, last quarter we mentioned that we are increasing our production slightly in anticipation of the power shortage in Q -- really during the summertime. So our manufacturing production levels would be less in Q3 and because of that, my unabsorbed cost would be higher than my Q2 and I would have less for me to capitalize into inventory and therefore I need to charge those costs into my period costs for Q3.

Your gross margin will be le -- less?

Right, my gross margin -- my gross margin -- well, if you -- the -- the pro forma gross margin, you're looking at about 14 percent for Q2. But our projections is that it -- it's going to be less than that.

14 point -- I have 14.8 for you.

Right, it's going to be about 14 -- 14 percent for my pro forma.

Okay. So, I mean -- but I mean -- so it's not going to be loss of 11 -- I mean, on a pro forma basis, better than 11 to -- or 13 percent, correct?

I'm sorry. I -- I am not following you.

On a pro forma ba -- basis, it's basically you're -- you're expecting a loss of $.011 to $0.13?

Yes, for -- for -- for Q3, yes.

So is it gross margins that is dropping significantly? Or, I mean is there --

Well, revenue -- well, revenue is go -- revenue is going to go down and so is my -- so is my gross margin. And my gross margin we expect to be more than the actual 2.1 percent. But it won't be the -- it won't be the -- the pro forma 14 percent for -- for Q2. It's not going to be that high.

And operating expenses is kind of flat or --

Well, operating expenses -- well, we don't really give that out, but I can tell you that we're at approximately between 2.8 to $3 million range.

Thanks.

Thank you. Once again, that is star 1 on your touch tone phone to ask a question. There appears to be no further questions.

Thank you for participating in our conference call and we thank you for your continued interest in AXT. See you all next quarter. Bye-bye now.

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