AXT Inc (AXTI) 2006 Q1 法說會逐字稿

At this time, I would like to welcome everyone to the AXT first-quarter 2006 earnings results 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. Sir, you may begin your conference.

Good afternoon, everyone, and welcome to AXT's first-quarter 2006 conference call. I am Phil Yin, Chief Executive Officer, and I would like to thank you for taking the time to be with us today. With me is Wilson Cheung, our Chief Financial Officer. Wilson will take us through a detailed financial overview of our first-quarter results, and then I will give you my perspective on our markets and future opportunities. 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 costs 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 use; cost and supply of raw materials; the impact of technology developments providing new markets for gallium arsenide substrates, as well as market conditions and trends.

We wish to caution you that these 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 via a 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, I am very pleased to report that we had a strong first quarter, with revenue results exceeding our first-quarter outlook provided on our previous earnings call. Revenue for the first quarter of 2006 was 8.5 million, up 10% from 7.7 million in the fourth quarter of 2005. Total gallium arsenide substrate revenue was 6.8 million for the first quarter of 2006 compared with 5.8 million in the fourth quarter of 2005. Sales of 6 inch diameter wafers alone totaled 2.8 million, compared with 2.2 million in the fourth quarter of 2005.

Indium phosphide substrate revenue was 296,000 for the first quarter of 2006, compared with 255,000 in the fourth quarter. Sales of raw materials, primarily 99.99% pure gallium, were 1.4 million in the first quarter of 2006, compared with 1.7 million in the fourth quarter of 2005.

Raw material sales in the fourth quarter of 2005 benefited from the timing of certain customer shipments that fell from the third quarter into the fourth quarter.

In the first quarter of 2006, revenue from North America was 23.1%, Asia-Pacific was 60.3% and Europe was 16.6% of total revenue. Two customers together generated 26.4% of our revenue during the first quarter.

Gross margin was 17.8% of revenue for the first quarter of 2006. This included a benefit from the sales of approximately 569,000 in fully reserved wafers, which comprised 6.7 percentage points of the first-quarter gross margin. By comparison, gross margin in the fourth quarter of 2005 was 8.4%, which included sales of approximately 642,000 in fully reserved wafers, which comprised 8.3 percentage points of the fourth-quarter gross margin, offset by year-end inventory valuation adjustments of 573,000, which comprised 7.4% of the fourth-quarter gross margin.

Selling, general and administrative expenses were 3.2 million for the first quarter, compared with 3.1 million for the fourth quarter of 2005. Research and development costs were 534,000 for the first quarter of 2006, compared with 466,000 for the fourth quarter. With the implementation of FAS 123R beginning in 2006, we incurred stock compensation expense of 258,000 for the first quarter of 2006, which was spread between the cost of revenues, SG&A and R&D numbers.

Loss from operations for the first quarter of 2006 was 2.3 million, compared with a loss of 3.4 million for the fourth quarter. The improvement in loss from operations was primarily due to the increase of gross profit and the absence of restructuring charges from prior quarter.

Net interest and other income for the first quarter of 2006 was 366,000, compared with net interest and other expense of 286,000 for the fourth quarter. Other income included our gain on sale of 100,000 shares of Finisar stock totaling 376,000. At the end of March 2006, we held approximately 1.1 million shares of Finisar.

Net loss in the first quarter of 2006 was 2.2. million or $0.10 per diluted share, compared with a net loss of 2.7 million or $0.12 per diluted share in the fourth quarter.

Let's now take a look at our cash and the balance sheet. 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 29.5 million at March 31, 2006, compared with 30.5 million at December 31, 2005, resulting in change in cash and cash equivalents balance of 1 million.

Our cash used in operations for the first quarter was actually 3.9 million for paying down accrued liabilities, foreign taxes and prepaid insurance. However, this was offset by 2.9 million increase in value of our Finisar stock holdings, which is included in our short-term investments.

Accounts receivable, net of reserves, was 5.9 million at March 31, 2006, compared with 5.2 million at December 31, 2005. Days sales outstanding was at 33 days for the first quarter, compared with 62 days in the prior quarter. Net inventory decreased to 15.8 million at March 31, 2006, from 16.2 million at December 31, 2005.

Capital expenditures in the first quarter were 98,000 and depreciation was 838,000. At March 31, 2006, the Company had 847 employees in total, of whom 679 worked in production, compared with 842 employees in total, of whom 680 worked in production, at December 31, 2005.

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

Thank you, Wilson. During the first quarter, we continued strong execution of our growth plan, with good revenue growth and positive feedback from our customers on the quality and consistency of our products. As a result, we posted revenue growth in a quarter that has historically been seasonally down.

The intensive efforts of our operations group has resulted in a significantly improved product quality and manufacturing processes. Most importantly, as each month progresses, we are demonstrating to our marketplace that we're able to continue delivering a high-quality product in volume quantities.

We are energized by the goal of regaining our stature in the industry and becoming the number one compound semiconductor substrate supplier in the world. Much of our growth in the first quarter came from an increase in the demand for gallium arsenide wafers used in semi-insulating applications such as power amplifiers and switches for the mobile handset market.

The mobile handset market is a key market for us, and according to Strategy Analytics, it is estimated to grow from 823 million units in 2005 to an estimated 1.22 billion by 2010. This year alone, it is expected to increase 13% over 2005, so approximately 945 million units.

Further, the content of gallium arsenide in each handset is also increasing because consumers continue to demand handsets that can offer more functionality, such as Internet access, music downloads and enhanced digital camera capabilities.

Other markets for electronic devices are also experiencing strong growth, such as the laser diode market for optical storage and printers, which is estimated to grow from 9.2 million in 2003 to approximately 270 million in 2008.

The merchant and captive market for semi-insulating materials grew 25% year over year from 2004 through 2005, driven mostly by handsets. The strongest subset of this market was 6 inch substrates, which now makes up 47% of the total merchant market, nearly equal to the market for 4 inch substrates.

AXT is positioned very well in both 4 and 6 inch markets because our VGF technology produces substrates that have the mechanical strength required for the larger diameters and because, unlike our competitors, we can rapidly and cost-effectively scale up our manufacturing facility to accommodate increased market demand.

This is an important advantage because the availability of 6 inch substrate in particular is tightening, and several market leading companies such as RFMD, IQE, Sony and Matsushita have completed conversions to 6 inch diameter wafers. In fact, RFMD just announced a 40% expansion of their 6 inch fab in Greensboro, North Carolina. We expect that over time, other companies will follow suit, and we are well-positioned for the capacity to meet the market demand.

On the semiconducting side, where our substrates are used in applications such as LEDs, Strategy Analytics estimates that the merchant market is estimated to grow at 11% compounded annual average growth rate from 10.9 million square inch equivalents in 2005 to approximately 17.5 million square inch equivalents by 2010, with a move to large diameter substrates now progressing quite rapidly. The end market for LEDs grew to 4.1 billion in 2005, with 51% gallium arsenide-based and 39% nitride-based.

In another highlight of the quarter, we are pleased to report several positive developments in our germanium qualifications. To start, we have been officially qualified by OSRAM for use associated with an optoelectronic application. Also, our substrates are at the final stages of qualifications at EMCORE for use related to its DARPA contract for space and terrestrial solar cell applications.

With these qualifications, we will have three customers in volume production, as last quarter we announced we're shipping volume production to the [Tianjin] Institute Number 18 in China.

With a shortage of polysilicon and its inherent inefficiency, germanium is becoming the material of choice for photovoltaic applications. EMCORE has recently announced they have subcontracted to participate in the Defense Research Projects Agency very high-efficiency solar cell program to more than double the efficiency of terrestrial solar cells within the next 50 months.

In fact, EMCORE's photovoltaic division was selected by the University of Delaware, the prime contractor for the DARPA VHSEC program, to develop advanced III-V multi-junction solar cells in Phase I of the program effort. In later phases, EMCORE expects to develop a technology roadmap to enable lower fabrication costs for the very high-efficiency solar cells.

We're watching this development carefully because we believe that it is a positive indicator of germanium substrates becoming increasingly more widely used due to its better convergence and higher efficiencies.

The use of mirror or lens concentrators will increase germanium-based solar efficiencies to approximately 35%. In fact, because of this, 80% of satellite solar cells are germanium-based. Strategy Analytics report that one of the biggest drivers for germanium-based photovoltaics is satellite applications. They report that the number of satellite launches is expected to grow from 12 in 2005 to 24 by 2010.

These launches will generate germanium substrate demand from 4.1 million square inch in 2005 to an estimated 8 million square inch by 2010. This is a market in which we believe we have strong competitive advantages. We are one of just two suppliers in the world and we are the only supplier of germanium produced with VGF technology. Furthermore, we are the only supplier with a germanium joint venture that guarantees us the raw materials at predetermined cost.

Now turning to our raw materials business, while AXT has been investing in joint ventures for several years, our product offering was not well-known among our customers, especially on the international level. During the first quarter, we focused announcements on the availability of these products as a way to further differentiate our value and competitive advantage in the market.

I am pleased to report that the response from our customers has been very positive. Our customers are enthusiastic about the prospect of being able to work with one supplier for all of their substrate and raw material requirements.

Today, we have five joint ventures through which we offer raw material such as gallium, 4N, 6N and 7N pure; arsenic, 4N and 6N pure; germanium, 6N pure; and pyrolitic boron nitride components, crucibles and other related MBE parts. In addition to providing a strong competitive advantage, they also provide us a key strategic benefit because they allow us to have more control over our own raw material costs and supply. As demand increases, these joint ventures will provide critical materials at predetermined costs and ample supply.

In closing, this is a very exciting time for AXT. 2005 was a year of transition as we significantly enhanced our focus of quality and customer care, made major critical changes in our management team and better organized our functional teams so that we are operating more efficiently and cost-effectively.

These positive changes are reflected in our sequential revenue growth since the third quarter of 2005, new qualifications with existing customers on additional part numbers, qualifications with new potential customers and requalifications with former customers.

We expect 2006 to be an exciting year for us. We are participating in a growing market that is full of opportunities. We have the most experienced and demonstrated leadership in VGF technology and we are capable of producing a high-quality product in a lower-cost environment.

Further, our sales efforts are gaining momentum and significant competitive advantages such as rapidly expandable capacity and raw material joint ventures. Our prospects for continued growth are very strong.

Our goal is to bring enhanced value to our customers, shareholders and employees through revenue and margin increases and operating expense reductions that will ultimately lead us to profitability. We thank you for your interest in AXT and we look forward to reporting to you again 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 second quarter will increase to between 8.6 million and 8.9 million. Also, we project our net loss per diluted share to be between $0.06 and $0.08, which takes into account stock compensation expense of 275,000.

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

(OPERATOR INSTRUCTIONS). Chang Qui, Fortune Technologies [sic].

Actually, Forun Technology Research. Congratulations, Wilson and Phil. I have a few questions. Maybe let's start this way. In this quarter, Q1, what's your book-to-bill ratio?

It is difficult for us to discuss this because we are a public company and all our competitors are not public. So that information would be confidential, obviously.

Okay, fair. You mentioned you are qualifying gallium arsenide wafers to new customers, requalifying to former customers. But in that case, can I ask the big guy in the space like RFMD, [Esaka], your customer yet?

Very good question. In fact, we have visited them. We've just signed an NDA. They are interested in requalify us in both gallium arsenide material, and in fact, they're even interested in our raw materials business as a one-stop shop -- for instance, they're reclaiming the gallium and looking at our pyrolitic boron nitride material for their MBE applications.

Did I answer your question, sir? I think it dropped off.

Joy Mukherjee.

In terms of -- you mentioned the EMCORE opportunity. When does that get settled and could you quantify for us how big an opportunity that could be?

Let me answer it this way. There were two parts -- one was for space application and one was for terrestrial application. Basically, our qualification for the terrestrial application met their spec. For the space application, we didn't meet their spec to their expectations. And the reason -- what they want to do is they want to use one spec, one wafer for both applications.

So they think it might be a process-related issue, a substrate-related issue. They are investigating it. So when you say the timing, obviously it's very hard to pinpoint the timing. But perhaps maybe late Q2, somewhere in Q3, I would estimate.

As far as the volume is concerned, right now, we don't know what the share would be to us. Obviously, there's only two suppliers in the world, us and somebody else, right? We would like to get, obviously, 50% or more. But I guess it all depends upon pricing and how well our product performs.

You mentioned the handset content for gallium arsenide has been going up. How has the pricing for handset been -- your dollar content been doing?

The dollar content for handsets or for the gallium arsenide semi-insulating material?

We can do both.

Well, obviously, the semi-insulating material for let's say HBTs or PMs for the switches -- there was a time -- in fact, it has leveled off. But the pricing was really going down. But I think with the capacity constraint for 6 inch, it has leveled off. In fact, we hear that some of our competitors are increasing price on 6 inch.

So that is from a materials standpoint. Now, from a market standpoint, as you know, Strategy Analytics reported that by 2010, the handset market, the units will reach approximately 1.22 billion units. Now, the other thing that they have not factored in is that if you look at the world's population, 80% of the world's population, which is let's say about 5 billion people, have access to cellular networks. But only about 2 billion of this are subscribers right now.

And the reason for this is there are emerging countries such as India and Africa that are potential customers. But the problem is the current handsets are a little bit more expensive. So companies like Skyworks is developing a module where there is I believe two blocks of HBTs on a single gallium arsenide die that also supports PM switches. Now, they expect that module to sell for about $2.50 in large quantities. And the target cellphone price that they are forecasting will be $30 to $40 per handset.

So if you look at that, you say, wow, there's another potential of 2 billion handsets being sold once this gets into the marketplace.

Wilson, any new thoughts on when you get to cash flow breakeven or profitability, for that matter? You are growing at a pretty rapid clip, and I'm trying to figure out maybe at what [technical difficulty]?

Joy, well, we actually did come up with a very strong quarter in Q1 and certainly we are very optimistic about our business. But in terms of guidance for both cash flow breakeven or even GAAP breakeven, we try to be on the conservative side because our revenue growth is in part dependent upon our customers completing their qualification processes.

And how fast that they complete those processes is really up to them. And we would certainly like to see them move more quickly, but our plan is to make a conservative estimate at this point. And we only give guidance 90 days in advance. But as we move closer to the breakeven point, I think we can kind of refine both the GAAP breakeven numbers and also the cash breakeven numbers.

(OPERATOR INSTRUCTIONS). Peter Trapp, Bifrost Partners.

I just wanted to get an idea here of what your target gross margins are. You went into some fairly good detail on the comparison of gross margins between the fourth quarter and the first quarter. Looking at '06 in general, you may or may not want to say what your gross margins are, but what I'm trying to get is just a general target gross margin in the next year or so.

Well, what our direction right now is that we're hoping to get into the breakeven gross margin right now, which is at about 22% now. Historically, we have been operating in the single digits. In 2005, you see that our gross margins are mostly around I would say 6, 7% average.

We are doing a little better in Q4 and again in Q1. Our target right now -- again, although we don't give out the specific margin number, we're really looking probably at the low to mid-teens at this point. But we are really trying very hard to get to the 22%.

So low to mid-teens. So if you get to low to mid-teens and you continue growing at your general level, it looks to me as though that breakeven is possibly a late-fourth-quarter '06 event, then.

Internally we have done our projections, but we don't give out that information.

That was a good quarter, so keep up the good work.

Joy Mukherjee, [Native Wisconsin] Investment.

In regards to the end markets that you're seeing right now, how strong are the end markets and what is your outlook on them?

Well, end markets, again, you're talking about really handsets, right, and you're talking LEDs. Obviously, I already talked about the handset market, which is really HBTs and PMs. LEDs, again, they are exploding because of all the different applications. I think LEDs -- the holy grail for LEDs is obviously to replace commercial lighting. But if you look at the applications now, for instance for cars, headlights or traffic lights or stoplights, signages -- I mean, the use of LEDs is basically endless. So we see the market to be extremely strong for both of our semi-insulating and semi-conducting material going forward.

Karen Payne, Pacific Edge Investments.

I wanted to delve into the gross margin issue a little bit more and ask about your sale of the fully reserved wafers, which you gave good detail on. It looks like you have a pretty large inventory reserve as of the end of last year. It was something -- almost 17 million. So is it fair to assume that that inventory reserve are the fully written-down wafers and that that is something that we would continue to see gross margin -- a positive gross margin impact from going forward?

The fully reserved wafers -- actually, we only have about a little over $10 million. I guess the $17 million number you are referring to was our total population of the reserve amount.

We have historically been selling those fully reserved wafers in a range of between 2 to $300,000 a quarter. It's now starting to ramp up a little bit. We do currently have a program in place where we will try to match the specs of the customers to these inventory and try to offer these inventory at effective pricing. So we are working on getting these inventory out of our warehouse.

But the fully reserved portion of the reserve is about $10 million?

Yes, they are all at -- basically, all written down.

Yes, but 10 million of the 17 million is wafers?

Exactly. It is the fully reserved wafers. It is the old inventory that I was referring to.

And you think most of those are salable in the market?

Well, that is kind of hard to say, because that's really what our sales team needs to do right now, is to go and match what we have and try to compare those with what the customer reqs are, and then we can then decide how much we can try to sell and at what price.

Peter Trapp, Bifrost Partners.

At the risk of not speaking ill of the imminently departed, can you give us some kind of general sense as to how your competitor Freiberger finances are holding up and if indeed it make sense at this stage for you to be looking at more cooperation with them, or is that not appropriate? Or can you not comment?

Really no comment. Again, that is a private company; they're not public. So the only information we have on them is they are a very excellent company, a strong competitor.

Yes, well, in talking to your customers and when you are putting in proposals, I'm sure you must glean information on their competitiveness or on what people are saying in general about their financial strength. Are you not able to make any comments at all?

That is correct, yes.

Okay, so other than Freiberger, then, who else do you view as either important to watch or a potential competitor, then, in the field eminently?

Right, there is Sumitomo, there is Hitachi, basically. You have the big three -- Freiberger, Sumitomo and Hitachi.

(OPERATOR INSTRUCTIONS). Sir, there appears to be no further question at this time.

Well, thank you for participating in our conference call. This quarter, we will be participating and sponsoring the Compound Semiconductor MANTEC Conference in Vancouver, Canada. We will also be presenting at the AeA Microcap Conference in Monterey, California, and the SG Cowen Technology Conference in York. We hope to see many of you there. Until next quarter, so long, now.

This concludes today's AXT first-quarter 2006 earnings result conference call. You may now disconnect.