AXT Inc (AXTI) 2006 Q2 法說會逐字稿

Good evening, ladies and gentlemen. My name is Manisha and I will be your conference facilitator today. At this time, I would like to welcome everyone to the AXT Second Quarter Earnings Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there'll be a question-and-answer session.

[OPERATOR INSTRUCTIONS]

Thank you. It is now my pleasure to turn the floor over to your host, Phil Yin, Chief Executive Officer. Sir, you may begin your conference.

Thank you. Good afternoon, everyone, and welcome to AXT's second quarter 2006 conference call. I'm 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 take you through a detailed financial overview of our second quarter results and then I will give you my perspective on our markets and our 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?

Thanks, 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 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 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 through August 16, 2006.

Now, turning to our financial results, I am very pleased to report that we had a strong second quarter, with revenue results exceeding our expectations. Revenue for the second quarter of 2006 was 10.4 million, up 22% from 8.5 million in the first quarter of 2006. Total gallium arsenide substrate revenue was 8.1 million for the second quarter of 2006, up 20% from 6.8 million in the first quarter of 2006.

Indium phosphide substrate revenue was 613,000 for the second quarter of 2006, compared with 296,000 in the first quarter. We expect indium phosphide substrate revenue to return to the 300,000 range in the third quarter. As we started to manufacture and ship germanium wafers in larger quantities in the second quarter, germanium substrate revenue was $169,000 compared with 36,000 in the first quarter. Finally, sales of raw materials, primarily 99.99% pure gallium, were $1.4 million in the second quarter, same as prior quarter.

In the second quarter of 2006, revenue from North America was 26.1%, Asia Pacific was 52.1%, and Europe was 21.8% of total revenue. One customer generated 11.4% of our revenue during the second quarter while the top five customers generated 40.6% of our second quarter revenues. Gross margin was 26.6% of revenue for the second quarter of 2006. This included a benefit from the sales of approximately 802,000 in fully reserved wafers, which comprised 7.7% of the second quarter gross margin. By comparison, gross margin in the first quarter of 2006 was 18.2%. This included a benefit from the sales of approximately 569,000 in fully reserved wafers and a $53,000 reversal of sales returns reserve, which positively affected the first quarter gross margin by a combined 7.3%.

Selling, general, and administrative expenses were $3.9 million for the second quarter compared with $3.2 million for the first quarter of 2006, primarily due to increased sales commissions as a result of higher revenues, additional professional and legal fees, decommissioning charges to close out our US property, and severance payments. Research and development costs were 571,000 for the second quarter of 2006 compared with 534,000 for the first quarter. Included in cost of revenues and operating expenses was stock compensation expense of 185,000 for the second quarter of 2006.

Loss from operations for the second quarter of 2006 was 1.7 million compared with a loss of 2.3 million for the first quarter. The improvement in loss from operations was primarily due to the increase of gross profit, offset by higher operating expenses.

Net interest and other income for the second quarter of 2006 was 925,000 compared with net interest and other income of 366,000 for the first quarter. Other income in the second quarter included a gain of 1 million on the sale of 300,000 Finisar shares compared to a gain of 376,000 on the sale of 100,000 Finisar shares in the first quarter. Net loss in the second quarter of 2006 was 876,000 or $0.04 per diluted share compared with a net loss of 2.2 million or $0.10 per diluted share in the first quarter.

Let's now look at our cash on 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 24.6 million at June 30, 2006 compared with 29.5 million at March 31, 2006. The change in balance was due to a combination of cash used in operations of approximately 2.6 million, capital expenditures of approximately 1.2 million, decrease in value of our remaining Finisar shares of 1.3 million and payment of our long-term debt of 0.2 million, offset by proceeds from employee stock options exercised.

Accounts receivable, net of reserves, was 7.4 million at June 30, 2006, compared with 5.9 million at March 31, 2006. Days sales outstanding was at 65 days for the second quarter, compared with 63 days in the prior quarter. Net inventory increased to 16.2 million at June 30, 2006, from 15.8 million at March 31, 2006. Depreciation and amortization in the second quarter was 923,000. At June 30, 2006, the Company, including our consolidated joint ventures, had 893 employees in total, of whom 708 worked in production compared with 847 employees in total, of whom 662 worked in production at March 31, 2006. The increase in work force is mostly production workers in anticipation of our capacity increase in Beijing.

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

This has been an excellent quarter for AXT. Once again, we are pleased to report revenue and earnings that exceeded our expectations. Our sales efforts continue to gain momentum, and we are actively engaged in a number of new and returning customer qualifications. Gross margins in the quarter were also above expectations, driven by growing volume, favorable product mix, and the benefits of innovative cost cutting measures, including improvements to our slicing, lapping and polishing processes.

Our recovery signals are success in providing high-quality products to our customers and is strengthened by the healthy and growing market for our products. Sales of gallium arsenide substrates were particularly encouraging in the second quarter, increasing 20.3% from the first quarter. Of our 8.1 million in gallium arsenide sales, 63% was for semi-insulating substrates used in electronic devices and 37% came from semiconducting substrates for LED applications. We continue to be encouraged by the growth in both areas of our businesses.

In semi-insulating applications, such as HBTs and pHEMTs used in cellular handsets, we are seeing very strong demand. Our qualifications are progressing faster than we expected and we are now in volume ramp at several of our customers. Also, demand for larger diameter substrates continue to rise as the number of device manufacturers are moving from 4 inch to 6 inch for manufacturing cost benefits.

For example, companies such as RFMD, IQE, Sony and Matsushita have completed conversions to 6-inch diameter wafers with RFMD recently announcing that it was expanding capacity of its 6-inch manufacturing by 40% at its Greensboro, North Carolina facility. We are encouraged by this growing market demand because we believe that we are in an excellent position to benefit from the opportunity it creates.

In addition to having high-quality products produced with VGF technology, we have two significant advantages. First, our substrates are produced in low-cost environments. So, we can reach an economy of scale at lower volumes. Also, while demand is increasing, capacity for manufacturing 6-inch substrates is constrained. Our largest competitors appear to be operating at or near capacity. Unlike our competitors, we can rapidly and cost effectively scale our manufacturing facilities to accommodate increased market demand. We have both the manufacturing space and the furnaces required to increase capacity without significant capital expense.

In fact, during the second quarter, we increased our capacity for 6-inch substrates by 50% and we are planning to add an additional 40% to our 6-inch capacity by the end of the first quarter of 2007. We are seeing that the pricing environment is for semi-insulating gallium substrates is holding firm, also. And in fact, if the wireless handset market continues to grow and there is no indication that our competitors are adding more capacity, we would expect that prices would begin to increase slowly, particularly in the large diameters.

In the semiconducting gallium arsenide substrate segment used primarily for LED applications, we saw significant growth in the second quarter. Demand increases and tightening of supply caused a 17.8% increase in our revenues during this quarter. We currently have ample capacity to meet this demand, and we believe that we are therefore able to offer shorter lead times than our competitors. While we have been seeing significant decreases in past quarters, pricing for semiconductor substrates appear to be stabilizing.

Now, turning to germanium, we are very pleased to report that a major German manufacturer has qualified our germanium substrates for an optoelectronic application. We have begun production shipments to them of our 2-inch product, and expect that they will begin to convert to 4-inch substrates later this year. This brings the number of qualified germanium customers to two with a third customer in qualification. As a result, our revenues for germanium in the second quarter increased threefold from the first quarter.

It is also interesting to note that the cost of germanium raw materials has risen from $720 per kilo earlier this year to approximately $900 per kilo currently, primarily due to the shortage of polysilicon. This rise in cost underscores the strategic value of our raw material joint ventures. It gives us a price and volume guarantee on the raw materials that we buy for our own use. And in fact, as a result of our demand for germanium raw materials, our joint venture is increasing its capacity by 20%.

Now, on a corporate level, we had two significant events this quarter. In June, we co-hosted a one-day symposium in Shanghai in cooperation with the Shanghai Optoelectronics Association, knows as SOTA. The symposium was designed to bring together government, academia and business leaders to discuss industry-related topics, such as the development of new energy sources, the future role of compound semiconductor substrates and epitaxial technologies. The event attracted more than 120 attendees and facilitated a discussion of timely issues within our industry and highlighted the capabilities of local businesses. Among our key goals was to utilize this forum to reach out to and expand our base of customers and partners in China for both our substrates and raw materials product line.

Secondly, we made an important change this quarter to our sales and development efforts. We created a Vice President of Business Development position and appointed Mr. Bob Ochrym to that post. Bob is now focusing on enhancing AXT's joint venture operations and worldwide sales efforts and he will continue to maintain selected high-level substrate customers in North America and Europe. In addition, he is exploring possible investment opportunities into complementary businesses where there are product synergies with AXT's current compound substrate and raw materials product offerings. This is a significant change for AXT.

Over the past year, we have focused tremendous energy into restoring and growing our customer base. The positive results are beginning to show in our sequential revenue growth. Having resolved the quality issues and put in place key programs for improved customer care, manufacturing, and administrative efficiency, we can now begin to focus on driving market share gains and accelerating our revenue growth.

As we move forward, we believe that there are several areas that can yield considerable growth opportunities. First, we believe that our core business can grow substantially through capacity expansion in areas where the industry is severely constrained, such as 6-inch semi-insulating substrates. Second, we believe that our raw materials business is increasingly becoming a key strategic differentiator and thus, we will expand our raw material sales efforts and explore new investment opportunities. And finally, as device requirements become more demanding based on product innovations and applications, we will continue to explore complementary businesses to our core product lines that we believe would allow us to serve, as the increasing demand for compound semiconductor substrates now and in the future.

I am very pleased to be able to leverage the considerable talent and experience of our entire team towards turning these opportunities into tangible results. I will now turn the call over to Wilson to discuss our forward- looking guidance. Wilson?

Thank you, Phil. We estimate our revenue for the third quarter will increase to between 10.5 million and 11 million. Also, we estimate our net loss per diluted share to be between $0.05 and $0.07, which takes into account stock compensation expense of 600,000, as we prepare to give out annual grants to employees.

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

[OPERATOR INSTRUCTIONS]

Your first question comes from Pierre Maccagno from Needham & Co. Please go ahead.

Congratulations on the quarter, Phil and Wilson.

Thank you.

Thank you.

Let's see a couple of questions here. The breakdown between, in the gallium arsenide, in terms of 6 inch versus 4 inch or less, do you have that?

Yes. This quarter, for the 6 inch, we have about $3 million in revenues for the 6 inch. The 2 inches, we are at about 2.7, 2.8 million, and that's actually a pretty big growth for us on the smaller diameter wafers given that last quarter, we only had about 1.9 million for the 2 inch.

Last quarter was how much for the 2 inch you said?

1.9.

1.9, okay.

We are now at 2.7.

Okay. But, 6 inch was somewhat flat, isn't it?

Well, you still looking at about 8% growth from last quarter.

Okay. And capacity utilization?

The capacity utilization currently is about 80%.

Okay. That is with the added increased capacity?

No. That does not account for the added capacity.

Okay. So, this added capacity was finished by the end of the second quarter, I guess?

Yes. We are getting towards the end of it. Correct. We have an additional capacity increase again going on, and this is all based on customer requirements.

Okay. What I mean -- so, you do not think this is going to hurt gross margins? You think you [want to fill out] this capacity.

We meet with some of these customers, we meet almost on a weekly basis and we talk obviously about their forecast, their business, and so, we are adding capacity accordingly to our customers' requirements.

When you say you increased 50% capacity, it's only for 6 inch, correct?

That is mainly for 6 inch, absolutely correct.

Okay. And you are -- capacity utilization for 6 inch, is there a --?

That's actually -- that's a good question. It is about 85, 90%, correct.

I see. Have you had any new customers that are driving 6 inch or any new customer engagements that you can talk about?

Well, that's a good question, Pierre. In fact, I think I stated that one of the reasons for revenue increase is the qualifications for some of the parts, as new and existing customers came about much quicker than we expected. And many of those, and I would say, probably, over 90% of those were all 6-inch related.

Could you characterize like how many customers did you have during the quarter and how many customers do you expect to have like next quarter? Just kind of give us an idea of how it will grow.

I can. Let's see, I will just tell you some of our major ones that really affected our volume and revenue in 6 inch was, let's see, three of them. Three of them really affected our major increase and they qualified us sooner than expected.

So, these are like three new --

No, no, no. These were not new. These were existing customers. However, some of them were new parts, new part numbers within an existing customer.

Okay. But any new customers that might have qualified or --

I am thinking now. There was two in Taiwan, and there was one in Europe. And I mentioned that there was a major German customer that completed qualification and we are shipping production quantities.

But that's for germanium growth?

That is correct.

I was wondering for --

For gallium arsenide?

Yes.

In Europe, no. But, some of the existing customers have increased have increased their volumes.

Okay. So, it's not -- for the 6 inch, you would say it is increasing volume with existing customers.

It is, yes. And like I said, some of them were brand new part numbers with existing customers.

Okay. And most of these customers are -- are they located geographically in the US or in --

Some of them in US, some of them in Taiwan and one of them was actually in Europe, the existing customer.

Okay.

And it's all -- it is basically all semi-insulating 6 inch, too.

6 inch?

Yes.

And the pricing was somewhat flat maybe this quarter, but then you say that it might increase going forward?

One of the things that's helping pricing is the industry constraint in 6-inch capacity of volume. So, we are seeing where -- for instance, our competitors, obviously, they have major, major level one-type customers, right. And they would obviously support those customers at expense of their lesser or smaller customers.

And this is where we are seeing some of the market share gains that we are gaining because those customers are coming to us and asking, "Hey, can you give us this type of volume?" And we say, "Sure, we can. Here is the price." They come back to us and say, "Well, this is kind of high." We say, "Well, hey, if you need the material, this is the price." So, they hmm and haa. But eventually, they are coming back because they need the volume to run their product because they have made commitments to their customers also. I think you are probably clear on that one, just emulate the semiconductor industry.

All right. And then going on to the germanium, you say that this qualification was for optoelectronic application. Is that for portable tapes?

No, it is not for portable tape.

Okay. But --

I cannot discuss it due to an NDA.

But you said that there was some relationship regarding your growth in germanium related to the, probably, silicon pricing increase?

We are seeing that. It is not just from our standpoint. I think if you look at the market, you are saying, why is the requirement for germanium, let's say, in the last eight months or maybe even a year started to come into woe? And germanium is obviously used for portable tapes. And I think I do not have to tell you, you know better than I do, what has happened to polysilicon, which is also -- was a big material for portable tapes. And as you know, the polysilicon shortage is a big, big problem in semiconductors right now.

But still, this germanium is like ten times more expensive than polysilicon.

Sure. It's ten times expensive. But, however, look at the efficiencies at the game.

Okay.

Just look at triple junction solar cells using germanium.

Regarding your prior guidance, have you included this benefit, the 800,000 benefit from the wafers?

Yes, we have.

You have included that? Okay. And also the Finisar gain?

Yes, we have.

Okay. Okay, last question is, what was the depreciation again?

The depreciation and amortization was 993,000.

Okay, thank you.

Thank you, Pierre.

Your next question comes from Jim Kennedy with Marathon Capital. Please go ahead.

Hi, Phil. Hi, Wilson.

Hi, Jim.

Hi, Jim. How are you?

Good. Congratulations on continued progress.

Thank you very much.

Couple of questions for you. Did I hear that indium phosphide was up so much this quarter?

Yes, you are correct. But that's going to be a one-time shot and it's mainly due to a government funded program. They needed this material and it's going to last them for probably till the end of the year.

Okay. That was going to be my question. Can you discuss whatever the end application was for that material?

No.

Okay.

I am sorry.

It's all right. Secondly kind of ask a question that was asked by the previous caller a little differently. In terms of requalifications, it appears as though you are requalifying on certain lines, but then there are certain customers too that end up being brand new as a requalified customer, if you will. Do you break that down at all? I mean, where are we now compared to where we entered the year in terms of these requalifications? Are you kind of in the second or third inning of getting that business back?

Yes. Let me try to explain that in maybe some quantitative terms. This year-to-date, we have -- obviously, in the past, we had a lot of customers that just went to zero, okay. So, this year-to-date, we had, let's see, nine gallium arsenide, both semiconducting and semi-insulating customers, that have successfully requalified us, okay.

So, they have requalified us and we are shipping production volumes to them, not obviously at the same rate as in the past. They are starting out slow. Now, also, the existing customers that stayed with us have ramped up their volumes tremendously. And the existing customers also, because we've only been shipping to them, let's say, one or two different part numbers, we have successfully qualified our new part numbers and starting to ship production volumes to them also.

Right.

The most promising or exciting part is that in the last two years, AXT had no new customer qualifications. So, year-to-date, we have had six new customers that qualified with AXT.

Got you.

Brand new customers that were not even in our portfolio.

Excellent. And where do you -- can you give us a ballpark as to where you feel like you are in that process? Have you -- are there just as many out there that you are still trying to get up to speed?

Well, let me put it this way, Jim. Obviously, there are many, and there are still customers, existing customers with new part numbers that we are meaning to qualify.

Okay.

In the current environment, you got to remember is the market is so strong, it is difficult for people to qualify because their main concern is getting product out.

Right.

However, one of the driving forces is this constraint, too, right?

Right.

So, we do have something working for us.

Good. And then, switching gears just a little bit. On your pick up in LED business, are those vary across more broad-based applications or is there anything specific to LED development that you see driving this demand?

No, it's just the standard jellybean. It's [allan gap] on gas basically.

Okay. And then, your DSOs were 65 days?

Yes, that's correct for the current quarter.

Is that -- what are you comfortable with kind of on a run rate basis?

To give some perspective, we are gaining a lot of these new orders coming in from the Asia-Pacific customers. And, as you know, doing business in Asia -- the normal terms that you are giving out there is net 60, net 90, some of them even net 120 days. So, you take into account that on an overall basis, we are able to collect our money at about 65 days, we are probably doing pretty damn good.

Okay. So, it would not surprise us to see that move up slightly in the long run?

If the geographic allocation changes more to the US, that might improve my number a little bit. But I would say that you should expect to see DSOs between 60 to 65 days as the norm.

Okay. Very good. And then, one last question. On 6-inch capacity, when you say you're running at about 85% and 90%, what is your capability of increasing your capacity there?

Well, we are going to increase it another 40%.

Okay. And how?

By Q1 of next year.

Okay. And how does that occur, Phil? I mean, is that a major capital investment or --?

That is a good question, Jim. In fact, that is only an increase in VGF crystal growing furnaces because we have enough or sufficient capacity in slicing, in lapping, in polishing and edge grinding. So, this is all increase in crystal growing.

And those are growing in [new] existing facilities?

No. This is all in the current facilities, as we are saying, we have all the infrastructure in place for all this expansion.

Good.

And then, as the market progresses, we still have plenty of infrastructure available to go even more.

Excellent. Any comments on the availability of the joint ventures in terms of their capacity and where they are? Are any of those constrained?

Yes. In fact, they are maxed out. And as we speak, every one of them is increasing capacity, every one of them.

Got you.

And Jim, let me just supplement what Phil had to say about the revenues and sort of the constraints because we haven't really stressed enough about the leverage in our business model. I mean, you just look at our PL right now, and I can tell you that, on the revenue side, you are seeing revenues coming in higher and higher every quarter because of the improved quality.

We are getting, all these [inaudible] business from the industry because of the constraints and as Phil just said, ASPs are stabilizing if not higher in certain products and also we have got a good sales force in place. Now, when you look at the gross margins, we were operating in the single digits, but now because of all the favorable product mix, all the improvements that we have in our manufacturing efficiencies, and also raw materials prices that have been stable, like Phil has mentioned, and also the expansion plans that we have, that gives us the higher utilization, which results in high absorption, my gross margin is going to be sustainable versus single digits in the last year.

And then, you go even further down, you look at the operating expenses and you said, well, my cost structure is really fairly fixed right now to support breakeven revenues. And if you have really looked at the operating expenses trend in the last few quarters, we're at $6 million quarter just a year ago. But my operating expenses has been relatively stable if you take the unusual items out. So, and like Phil has said, we were expanding and we do not really require a lot of capital expenditures because we already have the furnaces in place. So, hopefully, we are able to give you some good perspective as to the leverages that we have in our business model right now.

Very much so. Okay. Thanks and congratulations again.

Thanks, Jim.

Next, we have a follow-up question from Pierre Maccagno with Needham & Co. Please go ahead.

Yes. Can you give us an idea of the CapEx that you expect to have for 2006?

Right now, cumulatively, I believe our CapEx is around 1.5 million. I would think that you probably expect another 1 million of 1 million plus for the next six months.

So, 2.5 for the year?

I would say, yes. A little less than 3 million. That would be our expectation.

2.8, yes.

Okay. And then what about your breakeven -- for your breakeven EPS, what type of revenue and gross margin do you expect to have?

Well, it's good that you bring up this point, Pierre, because I think now we are now much closer to breakeven. We have the opportunity to look very closely at our expense profile. And this is an opportunity to tell you that we are adjusting that breakeven point just slightly upward to about 15.5 million in revenues at about 23% gross margins. And the reason for that was because we are seeing higher stock compensation charges and additional R&D expenses, which we believe it's going to be a good trend for us.

Are you including in this the benefit of the wafer?

Yes. But again, in the model, we don't have $800,000 worth of fully reserved wafer cells in our breakeven model. It is significantly less.

Okay. Okay, thanks.

Sir, there appear to be no further questions at this time.

Okay. Thank you everyone for participating in our conference call. This quarter in commemoration of our 20th anniversary, AXT will be closing the NASDAQ Stock Market on August 9. This is a very proud occasion for us and we will showcase it on our website at axt.com. So, thanks everyone and we will talk to you next quarter. Bye-bye now.

This concludes today's AXT second quarter earnings results conference call. You may now disconnect.