AXT Inc (AXTI) 2005 Q3 法說會逐字稿

At this time I would like to welcome everyone to your AXT Q3 2005 earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer period. (OPERATOR INSTRUCTIONS). It is now my pleasure to turn the floor over to your host, Dr. Phil Yin, Chief Executive Officer. Sir, you may begin your conference.

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

Since we last reported we have made many important changes in our organization. Today I will share with you those changes and the corresponding improvements in our quality, efficiency and cost. I will also give you my perspective on our markets and our future opportunity. But before I begin, Wilson will take you through a detailed financial overview of our third quarter. Following the conclusion of my comments, Wilson will provide forward-looking guidance, and 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 cost and improve efficiency, improvements in our facilities expenses and manufacturing costs, improvements in our competitive position, 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 yields, as well as market conditions and trends. We wish to caution you that such statements dealing 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 third quarter of 2005 was 6.2 million compared with 6 million in the second quarter. The 6.2 million revenue included sales of approximately 686,000 of gallium arsenide wafers which were previously fully reserved, and a 205,000 reversal of our sales returns reserve established in 2004. Total gallium arsenide substrate revenue was 5.4 million for the third quarter of 2005 compared with 4.5 million in the second quarter. Approximately 45.5% of our gallium arsenide revenue was from optoelectronic applications, including light-emitting diodes and laser diodes.

Indium phosphate substrate revenue was 234,000 for the third quarter of 2005 compared with 280,000 in the second quarter. Sales of raw materials, primarily 99.99% pure gallium, were 578,000 in the third quarter of 2005 compared with 1.3 million in the second quarter of 2005. The reduction in raw materials sales was primarily due to the timing of certain customer orders that fell into the fourth quarter.

In the third quarter of 2005, revenue from North America was 24.1%, Asia-Pacific was 54.3%, and Europe was 21.6% of total revenue. Two customers generated 21.2% of our revenue during the third quarter.

Gross margin was 18.6% of revenue for the third quarter of 2005 compared with 2.1% for the second quarter. Gross margin was positively impacted by the sales of fully-reserved gallium arsenide wafers and the reversal of sales returns reserve, which comprised 13.8% of the third quarter gross margin.

Selling, general and administrative expenses were 2.9 million for the third quarter of 2005 compared with 2.7 million for the second quarter. The increase in SG&A expenses was due to severance payments related to our organizational changes.

Research and development costs were 472,000 for the third quarter of 2005 compared with 423,000 for the second quarter, as we transitioned Dr. Morris Young to focus on R&D on a full-time basis.

Net interest income for the third quarter of 2005 was 136,000 compared with 131,000 for the second quarter. Loss from continuing operations for the third quarter of 2005 was 2.3 million compared with a loss of 3.3 million for the second quarter. The reduction of loss from continuing operations was the result of gross profit improvement. Net loss in the third quarter of 2005 was 2.1 million, or $0.09 per diluted share, compared with a net loss of 3.3 million, or $0.14 per diluted share in the second quarter.

Let's now turn to the cash-flow statement and the balance sheet.

Operating cash outflow consumed by operating activities was 684,000 for the quarter ended September 30, 2005 compared with operating cash outflow of 2.3 million for the quarter ended June 30, 2005. The decrease in operating cash outflow in the third quarter was the result of both gross profit improvements and improved accounts receivable collections.

Cash and cash equivalents with maturities of less than three months, short-term investments, and other investments in the high-grade debt securities with maturities of less than two years, including restricted deposits, was 31.8 million at September 30, 2005 compared with 33.2 million at June 30, 2005.

Accounts receivable net of reserves was 4.9 million at September 30, 2005 compared with 5 million at June 30, 2005. Our DSO was at 73 days for the third quarter compared with 76 days in the prior quarter. Net inventory increased 300,000 from 15.3 million at June 30, 2005 to 15.6 million at September 30, 2005.

Capital expenditures in the third quarter were 884,000 and depreciation was 806,000. During the quarter, AXT repaid 150,000 in long-term debt principal.

Turning to our stock repurchasing program, during the third quarter of 2005 we repurchased approximately 43,000 shares of our common stock. Since July of 2004, we have repurchased approximately 202,000 shares of our common stock. At September 30, 2005 the Company had 854 employees in total, of who 713 worked in production, compared with 881 employees in total, of who 729 worked in production at June 30, 2005. At September 30, 2005, 56 employees worked in the U.S. and 798 abroad.

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

Think you, Wilson. For those of you who have known and followed AXT for many years, you know that this is a company with a rich and proud history. AXT was founded nearly 20 years ago and was a dominant player in the compound semiconductor market for many years. In fact, AXT was the first company to commercialize vertical gradient freeze technology, the technology that has become the industry standard. AXT was the first to introduce six-inch gallium arsenide wafers and remains the only company to commercially-produce indium phosphide and germanium substrates using VGF technology.

Today, our manufacturing facility in China is the largest compound semiconductor substrate manufacturing facility in the world, encompassing 190,000 square feet of manufacturing space with an additional 100,000 square feet for future expansion. However, over the last several years, we have faced both internal and external challenges that have affected our reputation and our market position.

When I spoke with you in April, I pledged to you that my primary focus was to restore the reputation and credibility of AXT, and to move aggressively to enable AXT to perform at its highest potential. I am extremely pleased to come before you today with meaningful progress.

One of the most significant achievements of the last three months has been our progress in identifying the surface morphology issue that has affected our product quality over the last two years. Under the direction of MS Lin, our manufacturing quality teams have identified substantially all of our quality issues and are producing high-quality substrates. We have shipped samples of our products to our major customers for testing and the results have been very positive so far. Our customers will continue to test larger quantities over the next several months to ensure that we can deliver high-quality products on a consistent basis. As we continue to meet their requirements, we expect to see increasing shipments and revenue growth.

We have made many important changes in structure and processes of our manufacturing and quality systems. Key among them, we relocated personnel responsible for quality, applications engineering, and production planning leadership to China, where they now have a far closer working relationship with the manufacturing teams. We have significantly increased our communications with our customers so that we can resolve any customer satisfaction issues that arise in a timely manner. Improvements in quality and customer satisfaction are two of our most key growth drivers over the next several quarters.

Another key change made in the last three months has been restructuring of our sales organization. This restructuring has allowed us to improve the skill sets of our team as well as our coverage in strategically-important markets that will drive our revenue growth.

In July, we announced that John Cerilli had joined AXT as Vice President of Global Sales and Marketing. John, along with Bob Ochrym -- who joined AXT in June as Senior Sales Director, North America and Europe -- brings vast experience and deep customer relationships to our sales team. With the talents of our new sales management and those of our entire team, we hope to increase sales to our new customers and are better responding to the needs of our current customer base.

In addition, we are working with several customers that have in the past reduced or cancelled shipments of our products. These relationships are tremendously important to us and we are deeply committed to restoring them.

Another benefit of the changes made in the sales organization is our being invited to submit our germanium substrates for qualification in three separate programs. These invitations come as the result of our relationship that our new sales team had in the industry and they are likely to yield additional revenue for us in 2006.

With all of these changes in place, many investors are asking us what is our potential and where can we find leverage in our business to improve our margins. Certainly, resolving our quality issue is the most significant step. That opens many doors for AXT and allows us to increase our utilization and drive revenue growth.

Beyond that, the market itself holds exciting possibilities for AXT. We believe that the market for compound semiconductor substrates for semi insulating and semiconductor applications was about 325 million in 2004. Strategy Analytics, an independent research firm, estimates that although growth in the gallium arsenide market will slow in 2005, it will grow at a compounded annual rate of 12% for the 2006 and 2007 timeframe.

A key reason for this growth is the strong consumer demand for applications of all types, specifically high brightness LEDs and handsets which are moving in the direction of increasing functionality and low power consumption. With the market demanding higher speeds and low power consumption, silicon and silicon germanium will not be able to meet these requirements. Thus, we believe that the device manufacturers will have no choice but to turn to compound semiconductor materials in the future.

Though the competitive landscape has become more challenging in the last several years, AXT is one of only three producers to use VGF technology. Further, we commercialized VGF and many of our customers tell us that, intrinsically and despite the surface morphology issues, we still produce the best material in the market. We believe that market growth, together with an increase in shipments to some of our existing and former customers, will drive our revenue growth in the coming year.

From a cost standpoint, we expect to continue to reduce our headcount in Fremont to approximately 20-plus down from 58 currently. We are also in the process of decommissioning our Fremont facility and are considering a sale of that building sometime in 2006 that would necessitate a move to a location nearby that is more suitable for our current size.

Finally, over the next several years, we believe that our joint venture operations will be beneficial to our business. We currently have five joint ventures in which our ownership interest is between 25 to 88%. These joint ventures supply all of our critical raw materials. In the past, we have seen a steady increase in the price of some of these materials as demand is increasing. We expect that prices will continue to go up and supply will tighten. AXT is the only substrate manufacturer that has secured its own source of these critical materials. This is a major competitive advantage for us because we are provided with some protection from significant price fluctuations and supply shortages. As other opportunities arise, we expect that we will continue to invest in strategically important joint ventures that complement our product portfolio.

In conclusion, we believe that AXT is at an important turning point. Our financial results for the third quarter ended a year and a half long trend of declining sequential revenues. We are aggressively addressing the quality issues that we have experienced with our products and we are deeply committed to restoring the confidence of our investors and our customers. Over the next several quarters our success will be measured by our ability to consistently deliver a high-quality product by moderate but steady growth in our revenues and by improvements in our bottom line.

I appreciate your continued interest and support of AXT and I look forward to reporting to you on our progress. I will now turn the call over to Wilson to discuss our forward-looking guidance. Wilson?

Thank you Phil. We project that our revenue for the fourth quarter will be between 6.2 million and 6.6 million. Also, we project our net loss per diluted share to be between $0.13 and $0.15, which takes into account the restructuring charge of 330,000 for an anticipated headcount reduction and approximately 200,000 for Sarbanes Oxley implementation and professional fees.

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

(OPERATOR INSTRUCTIONS). Pierre Maccagno, Needham.

A couple of questions here. How is your capacity utilization and how does it compare with last quarter?

This is Phil Yin. Our capacity utilization is around 45%. Actually it's around 55%. It's gone up about 10% from last quarter.

Last quarter was 45%?

About 45%, right.

What are your expectations? Are you going to go to 100%? Are you going to leave the capacity as is, or are you going to change that?

The capacity will be a function of our revenue sales.

Does that mean you will maintain the level of capacity as is?

Well, no; as I mentioned, we are the largest manufacturer in the world. We have plenty of capacity for any kind of uptick in business currently.

As a percent of revenue, the wafers for electronic (indiscernible) was about, what, 45%?

About 45.5% for Q3.

How did that compare to last quarter?

It's about the same. On average you're looking at about 50-50 in the past, I would say, three to four quarters.

So, do you see -- are there any major customer renegotiations, whatever, that would indicate that this would increase? Because that's what is going to really drive your revenues (indiscernible) the electronic -- wafers for electronics.

It's really hard to comment now. We're just going into the fourth quarter. You know, it's too early to tell. Obviously, tomorrow we could have a big request. Right? You know how sales is.

So, if I understand, will this surface problem -- has it been fixed or not yet?

We have made significant progress in those areas. As I stated, all our customers are testing material. They want to see consistency of the material. And orders should go up appropriately.

But some work still remains, I would imagine.

Some work is still being continued, correct.

The final question is five-inch and six-inch wafers -- how much of that versus two, three, and four?

In the Q3 we actually have been doing much better in the larger-diameter wafer sales. Five-inch and six-inch sales in Q3 comprised about $1.6 million of the total quarterly revenue. If you're looking at Q2, your five and six-inch was only a little over $500,000 in sales. And we are expecting that the larger-diameter sales would continue with this volume in Q4.

Which is the -- I mean, that's the electronic -- wafers for electronics mostly?

Right. Correct.

Samir Sanghani, Sanghani Investment.

I missed a little bit about -- you had said you had repaid some debt this quarter. How much was that?

150,000.

Okay, 150,000. You purchased you said 43,000 shares --

In Q3.

In Q3. What was the average price?

We have been buying back on an average of about $1.22.

Just one other question. You were saying something about sales restructuring. Is that just having the extra bodies that you hired? Is that what the restructuring is, or did you do any other significant change?

No, the sales restructuring, actually that was announced in a press release in July. We completely revamped our entire sales organization starting from the Vice President of Global Sales and Marketing.

So, how is that making the sales more effective or better? I mean, what did you do differently?

First of all, the two gentlemen that we recruited have about 60 years of experience. Their relationships, their credibility, their reputation in the market all open doors. Prior to that, I hate to say that the sales organization at that time did not have those credentials and the skill sets to do that.

So, just a big upgrade in the quality --?

Absolutely, right.

What's the total size of the sales team?

Seven. That's inside sales, customer service and all of those. Applications.

Seven people; okay. So, we're talking about a small group.

Manoj Nadkarni, ChipInvestor.

Can you give us some details about how your qualification activities are proceeding for six-inch wafers?

Qualifications on existing customers or new customers?

Let's say both.

Both? Obviously, with new customers they've never used our materials. That's obviously going to take a little longer. The other existing customers where we had the surface morphology issue, that is coming along very well. As I mentioned, they're just monitoring us to see how consistent we are. And orders actually have been ramping up.

So, between four-inch substrates and six-inch substrates, are you ahead in terms of fixing quality issues on the four-inch substrates compared to six-inch?

They're basically the same, at the same level right now.

Secondly, do you expect to sell more of previously reserved inventory?

Definitely this quarter we have sold about $700,000 worth of fully-reserved wafers. We may not expect to have this huge extent for Q4, but we definitely do believe that a majority -- a significant percentage may come back in the fourth quarter.

And that's because you have less remaining or you see less opportunities?

The mix is not as robust as it was before.

You had talked a little bit about this. The fourth quarter or the current quarter; where do you expect the growth to come from compared to the just-completed quarter?

It's basically we see growth the same. We don't see any, for instance, jump in let's say six-inch or a jump in semi-insulating versus semiconducting. We see about the same type of trend.

Finally, Dr. Yin, are you participating in any investor conferences?

Well, we participated in the ADA in May. We just did a road show. And we plan to participate next year, absolutely.

Chang Qiu, Forun Technology.

For the headcount reduction, you mentioned from 58 down to 20-plus. What's the timeframe? That's before the end of the year, or will it be stretched out through more quarters?

It's going to be stretched out from November through at least the end of March 2006.

So, in that way for the reorganization or the restructuring charge, the 300,000, should we factor more of that in the first quarter of '06?

No, this 330,000 included all the headcount reductions that would take place in both periods.

You took the charge all in the fourth quarter?

Right, because the plan -- because we already have the plan now, we know by individuals whom we are going to reduce those numbers.

Right, okay. For the quality problem, if it's all fixed, (indiscernible) you passed the qualification (indiscernible) existing customers and maybe some new customers. Are you confident you will gain back some market share (ph)?

Absolutely. Our customers even tell us that. As I mentioned before, they say that even though with our morphology issues they still think that intrinsically our material is still one of the best in the market. That's why they have stuck with us still.

Okay, that sounds great. Keep up the good work.

Thank you for encouraging as.

There appear 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 next quarter.

This concludes today's AXT conference call. You may now disconnect.