AXT Inc (AXTI) 2006 Q3 法說會逐字稿

Good afternoon. My name is Eduardo and I will be your conference operator today. At this time I would like to welcome everyone to the AXT third quarter 2006 earnings conference call. [OPERATOR INSTRUCTIONS] Thank you. 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.

Thank you. Good afternoon everyone and welcome to AXT third quarter 2006 conference call. I am Phil Yin, Chief Executive Officer. 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 third quarter results, and then I will give my perspective on our markets and future opportunity. Following the conclusion of my comments, Wilson will provide forward-looking guidance, and then we'll 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 impact to us of new China value-added tax and custom duties; the future financial performance of the Company and our ability to control costs and improve efficiency; improvements in our 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; 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 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 through November 6, 2006. Also before we begin, I want to note that shortly following the close of market today we issued a press release reporting financial results for the third quarter of 2006. This press release can be accessed from the investor relations section of AXT's website at axt.com.

Now turning to our financial results, I'm very pleased to report that we had a very strong third quarter, with the revenue result exceeding our expectations. Revenue from the third quarter of 2006 was $12.5 million, up 21% from $10.4 million in the second quarter of 2006. Total gallium arsenide substrate revenue was $10.6 million for the third quarter of 2006, up 30% from $8.1 million in the second quarter of 2006.

Specifically, 6-inch diameter wafer sales increased to $4.9 million for the third quarter from $3 million in the prior quarter. Indium phosphide substrate revenue returned to a more normal level of $340,000 for the third quarter of 2006, compared with $613,000 in the third -- in the second quarter. The increase in the second quarter was the result of a one time purchase related to a customer's government contract. As we continue to manufacture and ship germanium wafers in larger quantities in the third quarter, germanium substrate revenue was $387,000 compared with $169,000 in the second quarter.

Finally, sales of raw materials, primarily 99.99% pure gallium, were $1.3 million in the third quarter of 2006, compared with $1.4 million in the second quarter. In the third quarter of 2006, the revenue from North America was 24.2%, Asia-Pacific was 59.8% and Europe was 16% of total revenue. One customer generated 18.4% of our revenue during the third quarter, while the top five customers generated 44.1% of our third quarter revenue. Gross margin was 27.7% of revenue for the third quarter of 2006, which included a benefit from the sales of approximately $802,000 in fully reserved wafers, which comprised 6.4% of the third quarter gross margin.

By comparison, gross margin in the second quarter of 2006 was 26.6%, which included a benefit from the sales of approximately $818,000 in fully reserved wafers, which positively affected the second quarter gross margin by 7.9%. Additionally, our third quarter gross margins also benefited from $172,000 less of depreciation expense, as some of our manufacturing equipment reached to the end of their useful lives.

General, selling and administrative expenses were $2.6 million for the third quarter, compared with $3.9 million for the second quarter of 2006, primarily due to insurance carrier legal fee reimbursement, and to bad debt collection, coupled with a reduction in charges incurred to prepare our U.S. facility for sale and, to a lesser extent, to severance payments from prior quarter. Research and development costs were $392,000 for the quarter, for the third quarter of 2006, compared with $571,000 for the second quarter. The decrease was due to lower product testing costs.

Upon the final cleanup and completion of the commissioning, our U.S. facility in the third quarter of 2006, we recognized a $1.4 million impairment charge to write down the facility from book to net realizable value. The facility is now being prepared for sale. Included in cost of revenues and operating expenses was stock compensation expense of $207,000 for the third quarter of 2006. This was lower than we had anticipated, as issuance of our annual stock option grant was shifted from the third quarter to the fourth quarter. Loss from operations for the third quarter of 2006 was $971,000 compared with $1.7 million for the second quarter.

Net interest and other income for the third quarter of 2006 was $744,000, compared with net interest and other income of $925,000 for the second quarter. Other income in the third quarter included a gain of $650,000 on the sale of 300,000 Finisar shares, compared with -- to a gain of $1 million on the sale of 300,000 Finisar shares in the second quarter.

At the end of September, we continue to hold 474,000 shares of Finisar Corporation. During the third quarter, the Company recognized an income tax benefit of $862,000 due to a reversal of tax liabilities no longer required as the statute of limitations has expired. Accordingly, the Company reported net income in the third quarter of 2006, of $639,000 or $0.02 per diluted share, compared with net loss of $876,000 or $0.04 per diluted share in the second quarter.

Let's now 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 security, with maturities of less than two years including restricted deposits, were $23.1 million at September 30, 2006, compared with $24.6 million at June 30, 2006, a decline of $1.5 million for the quarter. Accounts receivable net of reserves were $8.8 million at September 30, 2006, compared with $7.4 million at June 30, 2006. Day sales outstanding was at 64 days for the third quarter, compared with 65 days in the prior quarter. Net inventory increased to $17.4 million at September 30, 2006, from $16.2 million at June 30, 2006.

Depreciation and amortization in the third quarter decreased to $604,000 as some of our manufacturing equipment reached to the end of their useful lives. At September 30, 2006, the Company, including our consolidated joint ventures, had 990 total employees, of whom 789 worked in production. The sequential increase in head count of 97 employees was primarily in production workers hired in anticipation of increasing our manufacturing facility in Beijing. This concludes our financial review. Let me now turn the call back to Phil.

Thanks very much, Wilson. We are extremely proud today to report another strong quarter of our growth in our revenues, as well as several exciting developments regarding our customer base. Third quarter was a very productive and rewarding quarter, as we began to reap the benefits of the changes we have made over the past 18 months. As Wilson mentioned, our gallium arsenide revenue grew 30% in the second quarter. This tremendous growth was driven by increasing demand for our 4-inch and 6-inch semi-insulated gallium arsenide substrate, used primarily for HBTs and PHEMPT devices for wireless handset applications.

In fact, semi-insulating gallium arsenide represented 64.5% of our total gallium arsenide revenue in the third quarter, and increased by 37.7% from the prior quarter. We are very pleased to report that we have been asked to qualify our 4-inch semi-insulating gallium arsenide substrate at one of North America's industry leading providers of high performance analog and mixed signal semi-conductors.

This former customer represents a meaningful part of the merchant market for semi-insulating gallium arsenide substrates. They are particularly important to AXT because their invitation to requalify our substrate indicates that our marketplace is reporting positive results from AXT's products and services. We have shipped wafers for qualification to this customer and are waiting for final device results to move into volume production in early 2007.

The pricing environment for semi-insulating gallium arsenide substrates continues to hold firm. We are seeing that the demand for larger diameter substrates, in particular, continues to grow amidst a very tight industry-wide capacity constraint. In fact, strategy analytics reports a 27% compounded annual growth rate for 6-inch semi-insulating gallium arsenide substrates through 2010.

If this trend continues, we would expect the prices to stabilize and perhaps even to increase slowly in both 4-inch and 6-inch diameters. In order to accommodate the increased demand that we expect from our customers, we added 50% more capacity for 6-inch substrates in the third quarter, and we expect to complete an additional 40% capacity growth by the end of the first half of 2007. All this additional capacity will be accomplished with minimum CapEx, since the facility infrastructure is already in place and the crystal growth furnaces available.

In a semi-conducting gallium arsenide substrate segment, used primarily in LED applications, our revenue also continued to show meaningful growth, increasing 17.9% over the prior quarter. We are very pleased to report that we are in discussions with one of the world's largest providers of high brightness LEDs and a pioneer in the use of solid state lighting solutions, and we are thrilled that this tier one provider has requested us to qualify as one of their substrate suppliers. This demonstrates the positive perception of our products in the marketplace, and with ample capacity going forward, we are poised to gain market share in this important market segment.

Turning to indium phosphide, we are beginning to see some evidence of renewed growth in the optical networking industry, which uses indium phosphide to manufacture telecom lasers. According to the strategy analytics, one of the biggest drivers for this market is for the optical network systems at the 40 gig rate, although we have not seen a wholesale move towards that system at this speed.

The future, however, looks very promising, and indium phosphide is considered to be a disruptive technology, due to its ability to achieve higher frequency, data rates, and efficiencies. The reported market for indium phosphide is about 400,000 square inch equivalents in 2005, with an estimated growth of about 550,000 square inch equivalents by 2010, generating about 25 to $31 million in revenues, respectively. AXT with its BGF technology is well positioned to benefit from this market growth and to regain some of its market share loss.

Now turning to germanium. This continues to be a very interesting part of our business. While our revenue in this area is small comparatively, it has experienced significant growth over the past several quarters. We are pleased to report that in the third quarter, we received very encouraging results on the qualification of our multi-junction solar cells for [directional] application, at a major North American supplier. We have begun working with this customer to further enhance our technology and process, and we expect that this partnership will eventually lead to volume production.

In addition, we have also been asked to supply germanium substrate samples to a European photovoltaic customer - supplier. They've seen our samples in most continents of the world, with volume production in Asia. We believe that the great efficiency of triple junction concentrator solar cells, together with the current shortage of poly silicon, are driving germanium substrates to become this material of choice for photovoltaic applications. Silicon-based solar cells offer power in the tens -- in the hundreds of watts, with efficiencies of about 20%, while germanium-based solar cells can produce output up to 10,000 watts, with efficiencies of about 28%, and with the concentrator type technologies, receiving efficiencies of about 35%.

Based on strategy analytic study, the germanium-based direction of photovoltaic market, assuming a conservative 1% multi-junction type solar cell penetration by 2010, is expected to grow on the order of 215%, from basically 0 revenues in 2005, to an estimated $3.4 billion by 2010. With our own raw materials sought for germanium, as well as our proprietary crystal growth process, we are poised to become a significant substrate supplier to the photovoltaic industry. It is also interesting to note that the cost of germanium raw materials has risen from about $600 per kilo about four months ago, to approximately $900 per kilo recently.

This rise in raw materials pricing underscores the increasing demand for germanium in the marketplace, and it also gives strong validation of the strategic value of our raw materials joint ventures. These joint ventures supply 100% of our critical raw material needs across all of our product line, and provides us with considerable protection from the raw material pricing increases and supply constraints. In fact, as a result of demand for germanium raw materials, our germanium joint venture is increasing its capacity by 20%.

In closing, this is a great time for AXT. We are enormously proud of the substantial improvement that we have made in our business in the past 18 months, and we are energized by the opportunities in front of us. As I mentioned last quarter, we believe that there are several areas that can yield considerable growth potential.

First, we believe that our core business can grow substantially with capacity expansion in the areas where the industry is constrained, such as 6-inch and 4-inch semi-insulating substrates, and through continued development of our customer base. Second, we believe that our raw materials business is increasingly becoming a key strategic differentiator and thus, we'll expand our raw materials sales effort and explore new investment opportunities. Finally, as device requires us to become more demanding based on product innovations and applications, we will continue to explore complementary businesses to our core product line that we believe will allow us to serve the increasing demand of compound semi-conductor substrates, now and in the future.

We look forward to exploring each of these opportunities over the coming quarters. We believe there is much room for growth ahead of us, and we are focused on enhancing the value of AXT to our shareholders, our employees, and our customers. 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 fourth quarter will increase to between $12.9 million and $13.6 million. Also, we estimate our net loss per diluted share to be between $0.02 and $0.05, which takes into account two unique items: first, stock compensation expense of approximately $950,000 as we prepare to give out annual grants to employees; and second, approximately $500,000 in accrued severance payments as we expect an executive management change by year end, details of which will be provided in a press release as soon as the terms and conditions are finalized.

Before we conclude, in September 2006, tax authorities in the People's Republic of China announced their intention to impose custom duties on, and to reduce or eliminate refunds of value-added taxes that companies pay when they purchase certain raw materials, including gallium and arsenic. The combination of these actions could significantly increase our costs.

Implementing regulations will not be published before late November, and it is possible that these regulations will not be adopted or that changes will be made in their outline before adoption. Lobbying efforts are being made to remove gallium and arsenic from the list of affected materials, but there's no way to know if these efforts will have any impact on the final form of the regulations.

There appears to be a possibility that the value-added tax refund on gallium will not be completely eliminated, but merely reduced. If the regulations are adopted as currently proposed, they would not have a material impact on our fourth quarter results because they would only be in effect for a portion of the quarter. They may, however, potentially have a significant adverse impact on our gross margin and net income or loss in 2007, although we do not have the facts necessary to estimate its magnitude at this time.

We are also exploring ways of restructuring our operations in China in order to mitigate the impact of these regulations, if and when they are adopted. We will not know the exact impact of any restructuring or the amount of time that it may take to accomplish, until toward the end of this year. This concludes our prepared comments. We are now happy to answer your questions.

Thank you. [OPERATOR INSTRUCTIONS] We'll pause for just a moment to compile the Q&A roster. Thank you. Our first question is coming from Dave Kang, of Roth Capital. Please go ahead.

Yes, thank you very much. Regarding your capacity -- gallium arsenide capacity expansion, I just wanted to clarify that it's for semi-insulating 6-inch? Not 4 and it's not 4 and 2 inches?

Yes, that's correct, Dave. It's all 6 inch.

Okay. Does that mean that there-- that you have ample capacity for 2 and 4, or those two are not growing at this point?

No, absolutely. We have ample capacity in all diameters, basically.

Okay. And then for fourth quarter of guidance, how much should we assume for fully reserved inventory in the fourth quarter?

Dave, in my break-even model, I have always assumed no more than 250,000 of fully reserved wafer sales.

Thank you, got it. And, as part of -- on the OpEx line, how much was the legal expense and what is the status on that?

In the OpEx on a quarterly basis, you're probably looking at about between 300 to $500,000 a quarter, normally no more than that. Or are you asking me about the refund that we got this prior quarter?

No, actually it is about the legal expense.

Yes, legal expense I would say, it range from $500,000 - approximately $500,000 to -- $250,000 to $500,000 a quarter.

And is that going to go on for quite a while, or is that going to start to come down sometime in the next couple of quarters?

Well, that has been our run rate for the last few quarters, but if we were able to resolve our litigation, that number will go down.

Okay. And then on this new tax situation, I guess that is still ongoing process, but do we have any idea what your gross margin would have been, if that happened at the beginning of the quarter?

Dave, it is really difficult for us to quantify the exact impact at this time, but I just want to be certain to tell you that we're not trying to be coy or evasive in answering this question, but really the announcement is very recent, and its terms are not laid out very clearly. So, what I can tell you right now, is that in conjunction with our lobbying efforts to reduce or eliminate the effect on us, financially and in the gross margin area, we are really exploring ways to restructure our operation in China to mitigate the impact, if and when these regulations are adopted.

Can you share some of those strategical alternatives that you are thinking about or -- it sounds like you do have some maneuvers, some maneuvering capabilities at this point.

Yes, we do have a few ideas in mind at this point, but we want to go through those exercises internally before we disclose further information to the public.

And just lastly for Phil, this is more of a technical question. I think we talked a couple of times in the past, but according to strategy -- what is it, strategy analytics, I guess, it comes across as wireless [inaudible] chips went forward. But it doesn't sound like it's just gallium arsenide, there are some other solutions out there including gallium nitride and in gaP, in which you guys don't have. I mean, is that something that you guys are looking at? Or can you just share your thoughts on this?

Hey, Dave, looking at it from a band gaP standpoint, obviously we know what those three materials are, [inaudible] gallium arsenide, you got gan, you got silicon carbide, then you got diamond like way, way out there. And hey, we're always looking at any opportunities that might be available for us, so.

Is this something you can do internally or it will be more of a -- through an acquisition?

Probably more of an acquisition because we don't have -- we wouldn't -- we don't have that expertise here internally.

Got it. All right. Thank you.

Thanks, Dave.

Thank you. Our next question is coming from Pierre Maccagno of Needham & Company. Please go ahead.

[Inaudible.] Congratulations for the quarter.

Thank you.

Thank you.

Could you give a little bit of color regarding the growth, sequential growth of gallium arsenide? Was it driven by a specific customer or, I mean, one specific one or several or, just if you could add some more color there?

Sure. Well, there are many, many reasons. Many of our customers increased their requirements. That's one. Two, we have completed qualifications on some customers, and they resulted in production volumes. Three, I would have to be honest, the constraint in the industry, specifically in 6-inch, has also been a boom for us, where our competitors couldn't supply and some of those customers came to us for a quick return on whatever they wanted. So, in a nutshell, those were the areas that resulted in our increase in gallium arsenide.

Let me just add, Pierre, that actually the increases comes from all sizes. From the 2 inches to the 6 inches we see improvement in all size, and in particular the 6. I mean, we just particularly had a very good quarter from a Taiwanese customer, and we're pleasantly surprised to see this rate of revenue growth.

And then this new customer, this customer you are talking about going forward, that qualified your product, that's for 4-inch?

You got it.

And that was previously, it was a customer and I mean --

They were a customer way back, right. And then we had the quality issues, so.

Okay. Is this a epitaxial customer, or is it --

Yes, it was -- well, yes, they would be growing epi on our substrate, correct.

Okay. And maybe you can talk a little bit about the SG&A and R&D lines. So SG&A next quarter, do you think is going to go back to the normal levels, around three, or?

I can tell you that has been our run rate in the last few quarters. If you look at this past quarter, we are at 2.6 and the big one was the refund that we get from the insurance carrier, which is about a little over $300,000. So absent that in next quarter, that should be our expectation.

So it was a refund of $300,000?

Yes, 300 and -- somewhere around $320,000.

Okay so I mean, if we include -- if we exclude that, then it would be in the normal range of about three or above?

You're correct.

And what about R&D? Is that going to go back or --

Well, R&D, we have always been on a normalized basis at about $500,000 per quarter.

Okay, so that probably will go back.

Yes.

Okay. And what do you consider to be the break even EPS revenue level and gross margins?

Well, Pierre, I think I have mentioned that in last quarter, that the break even number is $15.5 million or 23% gross margins. Now -- but again, bear in mind that this model does not include $800,000 worth of fully reserved wafer sales. In my model it is only at $250,000. So, it is correct for you to assume a lower revenue than $15.5 million in order to break even, if we continue to sell the fully reserved wafers at this rate.

Okay. Thank you very much.

Thank you, Pierre.

Thanks, Pierre.

Thank you. Our next question is coming from Jim Kennedy of Marathon Capital. Please go ahead.

Hi Phil. Hi Wilson.

Hey Jim.

Hi Jim.

How are you doing?

Good. Congratulations on another good quarter.

Thank you.

Phil, I hope the compensation severance package you alluded to was not your own.

No. I hope not either.

I just wanted to make sure. Because you wouldn't identify it. So, I just wanted to make sure we know it isn't you. Two questions for you. Can you just briefly describe if there is a difference between the requalification/qualification process for an LED customer, versus a different type of customer, when you talk about the beginning of a relationship or at least trying to qualify with a very large LED manufact -- or a eventual end market LED manufacturer? Does that qualification process look different or take longer than your traditional requalification or qualification processes?

Okay. Jim, let me make sure I understand your question. So the question is if we had an existing customer, let's say, that disqualified us years ago, compared to a brand new customer, is that the question?

Well, not only that but also the LED market versus different markets.

Oh, okay. Yes, so let me answer it this way: if we were disqualified, and we had to requalify again, the qualification regardless, whether it's LED, whether it's HBT's or PHEMPTs or telecom lasers, whatever, it would have to start from scratch, meaning that they would have to grow epi on it.

And if they were an epi foundry guy, they would have to send that to their end customer, which would have to make devices, and then perhaps even burning, live testing, so regardless of what kind of customer, it would still have to go through all those processes. Now, from a technology standpoint, whether it's a solar cell or whether it's an HPT or PHEMPT or an LED, obviously those areas, as far as when you get down to the device level, is going to be different, and it would take longer, different times.

Got you. Okay.

But most -- let me also make a comment. If these customers are just epi foundry guys, the epi process itself is usually the same. As long as the -- after the epi growth is completed and the surface is without any defects, then that's not an issue.

I was just wondering if that end customer, if you will, on the LED side does not need the amount of time to evaluate something, vis-a-vis your other --

Yes, it's the same. It has to go through device parametrics.

Okay. And then the last question for you, relative to the VAT tax refund or tax, do you know what percentage of exports you represent in the gallium arsenic area for China?

No, I don't know right now, Jim.

Okay. I mean is it -- are you a small portion of that, or you just don't have a feel for it?

Gee, I really don't have a feel for it.

Okay. And then if you do some see some capacity expansion at the subs or at the joint ventures, are those things that you as a joint venture partner would necessarily have some sort of CapEx item for, or is that handled differently at the joint venture level?

Well, that's what we're evaluating right now. I mean, that's the only thing I can say. We're evaluating that right now.

So as to what your commitment may or may not be?

Exactly.

Very good. Thanks guys.

Okay, Jim. Take care.

Bye Bye.

All right, bye.

Thank you. Our next question comes from Dave Kang of Roth Capital. Please go ahead.

Yes, just a clarification. How much capacity did germanium JV increase last quarter?

I thought I gave you that number.

It's 20% increase in their capacity.

That was sequentially, right?

Yes, sequential, right.

Okay. And then on the building --

Dave just to make -- that's the JV germanium guy, right?

Right. JV.

Yes, right.

And then on the building sale, how much do you expect to get for that facility?

Well, we have marked that to the net realizable value, which is plus or minus $5 million.

All right. And then lastly, on the fully reserved inventory, it sounds like there's a pretty significant gap between the actual versus your model of $250,000. I mean, what dictates that number? I thought that was something that you guys control, no?

No, well, Dave, there was all of this material that was left over, obviously. And as that material diminishes, because they won't be able to meet a lot of the customer specifications, therefore, we took that lower number. Because we're going to hit a wall, bottom line is, going to hit a wall, and eventually we won't be able to sell any of it, because it won't meet any customer specs any more. So all -- in other words, all of the good stuff has been culled out already.

Okay. So I think you guys had about like 10 million --

Yes, 9 something.

At the end of Q3, we had a little over $9 million left.

So we should probably -- what you are saying is that we shouldn't expect all of this 9 million to be used up going forward?

Definitely.

Oh, definitely, right.

Any idea how much of this might be good?

Well, that really depends on how fast and how well that we can match the customer specs based on the PO's that we receive in the quarter, so it's really difficult for us to do a projection, and that's why in the break-even model, we use a conservative 250,000.

Got it. Thank you.

Okay, Dave.

Thank you. [OPERATOR INSTRUCTIONS] Our next question comes from Chang Tiu of Foreign Technology. Please go ahead.

Alright. Good afternoon, Phil and Wilson.

Hi, good afternoon.

Yes, I have a few questions. One, you mentioned the gallium arsenide right now is kind of like high in tighter supply situation. What is the price trend, maybe, in terms of different size of wafers right now?

Well, when I mentioned it was in tight constraint, it was more specifically in 6-inch, and we see that 4-inch is also becoming constrained because, based on our understanding and some of the intelligence from our competitors, we don't see anyone increasing capacity in 4-inch semi-insulating. In regards to pricing, if this trend continues, and we see that it will, we think that the price is starting to stabilize, and hey, hopefully it will start to go up.

So far what you see is here the price still going down?

No, it's beginning to stabilize, actually. And in fact, we have actually refused some orders because we didn't get the margins that we wanted, so we basically declined those orders, and then many times, the customer came back.

I see. Okay. In terms of new qualifications or requalifications, maybe I'd like to have some clarifications here. Looks like you have two major qualifications here, and with shipment likely in early 2007, is that right?

That's correct.

And so one of this is an early LED customer, and one of that is in HBT. Two major --

No, that's not correct. One of them is a solar cell photovoltaic customer, and the other one is a, basically, an epi-type guy.

Okay. Epi-type guy for LED, right?

No. No. For HBT's and PMs.

Oh, okay. But you did mention the requalification for --

Right. I did.

So in that way you have three new qualifications, major qualifications going on?

Yes, I mentioned that we are in discussions with a major LED customer, did not mean that we are in qualification. They've been -- they have asked us to come in and discuss qualifications. So we have been -- we haven't started to qualify with that LED customer yet.

Okay.

We're just discussing with them.

Okay. That's good. Another clarification is for the germanium raw materials. What is the price you mentioned? I just missed that number.

Yes, the price originally about, maybe, four or five months ago was around $600 a kilo, and it has jumped up to about $900 a kilo, and that was based on the U.S. Department of Commerce releasing the stockpile for sale for people to bid at, and the price wound up to be about $600 a kilo.

What is the purity for this raw material?

The purity of this? I think it's like around 6-9s.

6-9s?

Yes.

Okay. And another few issues is I kind of remember, maybe a few months ago, you guys filed kind of like a shelf registration for stock sales. What is the situation for that stock sales?

Well, Chang, it's still sitting on the shelf. The shelf is still on file and effective. We don't know when we plan to issue the shares off the shelf, but we wanted to have it available to provide the flexibility to fund the working capital including any CapEx and possible investments or acquisitions in the future.

I see. In case of a tight gallium arsenide or maybe germanium supply, we know in the silicon area some of the material supply, they basically ask their customers to advance payments to them to guarantee their needs or their demands. Can you do that in case the situation become tighter?

I have been in semi-conductors for 30 years, so I know exactly what you are talking about. This is a little different market from my standpoint, but we had one customer that was actually willing to give us an advance payment, but that was not for our substrate business, that was for our joint venture business. Whether we can do it or we can't do it, I think it depends on many, many things.

Obviously if the constraint in this industry continues, if no one increases capacity, and if our competitors jump on this bandwagon, of course. But if we are the only ones that are going to be requesting this, I don't think the customers will agree to that.

I see. Okay. All right. Thank you.

Thank you.

Okay. Thank you.

Thank you. Your next question is coming from Karen Payne of Pacific Edge Investment Management. Please go ahead.

Hi, thank you. I know it's all so rather uncertain, but I wondered if there was any way you could quantify sort of a worst-case scenario of the proposed tax changes.

No, we're unable to do that.

Okay. How about your other competitors in the industry, are source -- that this would not impact them because they are sourcing outside of China. Is that correct?

Right.

Okay. All right. Thank you.

Okay, Karen.

Thank you. Our next question is coming from Joseph To of Spinner Asset. Please go ahead.

Thanks. I don't know if this has been asked or not, but can you talk about your utilization in the quarter?

Yes, sure. Yes, it's -- in Q3, you are saying?

In Q3 and then maybe going ahead in Q4, and also --

Yes, in Q3, we're hitting in the 90 percentile, and going forward into Q4, we'll be at the same rate.

Okay. And I think you guys have talked in the past about adding new furnaces to capacity.

Right.

How much did you add in Q3, and how much are adding going forward, because if you're running at 90%, it doesn't seem like --

Yes, we're adding, as I stated, we're adding about 50% capacity, to be effective this quarter, Q4. And an additional 40% capacity to come on line somewhere in the first half of next year 2007.

Okay. And I guess do you have the demand to support that added cost?

If we didn't have the demand, we wouldn't be doing it.

All right. Thank you.

Thanks, Joe.

Thank you. And I'll turn the floor back to management.

Well, thanks very much for participating in our conference call. And this quarter we will be presenting at the AEA classic in Monterey, California. And in early January we'll present at the Needham Growth Conference in New York. So we look forward to seeing you again next quarter, and take care, everyone. Talk to you then. Bye-bye now.

Thank you. This concludes today's AXT third quarter 2006 earnings conference call. You may now disconnect your lines and have a wonderful day.