AXT Inc (AXTI) 2007 Q2 法說會逐字稿

Good afternoon. My name is Raquel, and I will be your conference operator for today. At this time, I would like to welcome everyone to the AXT Incorporated quarter two 2007 earnings release conference call.

All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer period. (OPERATOR INSTRUCTIONS)

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

Thank you.

Good afternoon, everyone and welcome to AXT's second quarter 2007 conference call. I am Phil Yin, Chief Executive Officer, and would like to thank you for taking the time to be with us. With me today is Wilson Cheung, our Chief Financial Officer.

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 future opportunities. Following the conclusions 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 maintain profitability, control costs, and improve efficiency, improvements in our manufacturing costs, improvements in our competitive position and 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, costs and supply of raw materials, the impact of technology developments providing new markets for gallium arsenide and germanium 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 August 1, 2008.

Also before we begin, I want to note that shortly following the close of market today we issued a press release recording financial results for the second quarter of 2007. This press release can be accessed from the investor relations section of AXT's website at AXT.com.

Now turning to our financial results. Revenue for the second quarter of 2007 was $13.6 million compared with $12.5 million in the first quarter of 2007. Total gallium arsenide substrate revenue was $9.3 million for the second quarter of 2007 compared with $8.8 million in the first quarter of 2007. Specifically, six inch diameter wafer sales were $2.8 million for the second quarter compared with $3.3 million in the first quarter of 2007. The transition in BIFET technology continued to impact our six inch sales in the second quarter, however approximately 70% to 80% of the qualifications have now been completed and we received some large six inch orders in late June with shipments scheduled for the third quarter.

Indium phosphide revenue was $660,000 for the second quarter of 2007 compared with $518,000 in the first quarter. This increase is largely due to a one time sale of approximately $250,000 in scrap indium phosphide materials. We no longer hold any of this material and do not expect to have additional sales of this nature in the future.

Germanium substrate revenue was $402,000 compared with $541,000 in the first quarter due to slightly lower demand from a major Chinese customer. Finally, sales of raw materials, primarily 99.99% pure gallium, were $3.3 million in the second quarter of 2007 compared with $2.6 million in the first quarter as a result of two new European customers and continued increases in the pricing of raw materials, particularly pure gallium.

In the second quarter of 2007, revenue from North America was 20%, Asia-Pacific was 61%, and Europe was 19% of total revenue. No customers generated more than 10% of our revenue during the second quarter while the top five customers generated 35% of our second quarter revenue.

Gross margin was 36.9% of revenue for the second quarter of 2007. This included a benefit from the sale of approximately $387,000 in fully reserved wafers which positively affected the quarterly gross margin by 2.8 percentage points. By comparison, gross margin in the first quarter of 2007 was 43.2%, this included a benefit from the sales of approximately $785,000 in fully reserved wafers, which positively affected first quarter gross margin by 6.3 percentage points.

In addition to the reduction in gross margin attributable to the reduction in sales of fully reserved wafers, our gross margin was also impacted by higher proportion of smaller diameter semiconducting substrate sales with lower margins for LED products in the Asia-Pacific region which Phil will address more later in the call.

Selling, general and administrative expenses were $3.7 million for the second quarter of 2007, same as the first quarter, however, our SG&A expenses this quarter included a bad debt expense of $574,000 representing some slow paying customers mainly in Asia. We continued to aggressively pursue collections on slow paying customers. Research and development costs were $330,000 for the second quarter of 2007, compared with $460,000 for the first quarter, due to less testing materials used to--and one-time personnel rearrangements.

During the second quarter, we also entered into a sales agreement with an independent third party buyer to sell our manufacturing facility in Fremont for $5.35 million. Accordingly, we recognized a recovery of impairment on assets held for sale totaling $481,000 based on our estimated net proceeds from this transaction. We expect to close escrow sometime in the third quarter pending timely sign-off on the closure report by the fire department.

Included in cost of revenue and operating expenses was stock compensation expense of $92,000 for the second quarter of 2007. Income from operations for the second quarter of 2007 was $1.4 million, compared with $1.2 million for the first quarter. Net interest and other expense for the second quarter of 2007 was $47,000 compared with net interest and other income of $213,000 for the first quarter primarily due to foreign exchange losses as a result of--with the weakening U.S. dollar to the Chinese Renminbi and Japanese Yen.

Net income in the second quarter of 2007 was $1.2 million or $0.04 per diluted share. By comparison, in the first quarter of 2007, we reported net income of $1.3 million or $0.04 per diluted share.

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, and high grade debt securities with maturities of less than two years including restricted deposits were $40.5 million at June 30, 2007 compared with $43.6 million at March 31, 2007.

Our cash used in operations for the second quarter was approximately $2.4 million. Accounts receivable net of reserves were $9.9 million at June 30, 2007 compared with $8.6 million at March 31, 2007. Days sales outstanding was at 66 days for the second quarter compared with 62 days in the prior quarter.

Net inventory increased slightly to $24.9 million at June 30, 2007 from $24.4 million at March 31, 2007. Depreciation in the second quarter was $349,000, and capital expenditures were $1.4 million. As of June 30, 2007 the Company including our consolidated joint ventures had 1,033 total employees, of whom 828 worked in production.

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

Thank you, Wilson.

This has been a very interesting and gratifying quarter for AXT. Shortages in gallium raw material and increasing interest in emerging applications such as photoable tags are illuminating the unique competitive positioning that AXT is likely to benefit from over the coming years. Several years ago we undertook a strategy to move our operations to China in order to cost reduce our manufacturing, invest in joint ventures in order to supply our own critical raw material needs and broaden our product offerings to include complementary products such as germanium that would expand our addressable market.

These strategic moves are each returning significant value to the Company and over the next several years we believe that they will be among--will be a strong competitive differentiator as the market continues to evolve in our favor. While softness continue in the Q2 in the handset market, particularly with specific customers, strength across other areas of our business such as semiconducting gallium arsenide and raw materials allowed us to resume growth in our revenues of nearly 10% from the prior quarter.

The product mix shift to small diameter gallium arsenide impacted our gross margin in Q2 but we believe that resumed growth in six inch semi-insulating substrates will continue to change our revenue mix in the coming quarters. Beginning with our semi-insulating gallium arsenide market, as many of you know our industry is going through a major transition in which a number of handset manufacturers are moving from the usage of in gap HBT and [Peham] transistors to the use of a BIFET, which combines the two into one smaller footprint chip. This device architecture will allow advanced bias control features to be embedded in the same PA dye, thus eliminating the need for additional external bias control circuits and also thus reducing costs.

It may also increase battery life and reduce the RF loss between the integrated components, and in addition, increase functionality and simplify designs. We believe that while the industry moved through the qualification process, all the companies that supply compound semiconductor substrates to this market including AXT experience revenue delays in their six inch substrates.

We now estimate that about 70% to 80% of the industry BIFET qualifications have now been completed. As a result, there is to be--there seems to be pent-up demand for six inch gallium arsenide substrate that will be exercised over the next two quarters. As evidence, we have begun to receive some large orders for six inch substrates from several of our customers and have indications that additional sizeable orders are coming.

At the same time that many of our customers have been transitioning to BIFET modules, the handset industry has been somewhat soft as a result of weak--weaker sales at certain handset manufacturers. This has also affected our six inch substrate sales, however, we believe that demand will improve as the bulk of the handset inventory is digested and manufacturers prepare for the holiday season build. Accordingly, we are pleased to report that our additional 40% expansion of our six inch gallium arsenide capacity will be completed this quarter in time to accommodate increased six inch demand.

Our four inch semi-insulating gallium arsenide substrate business is also doing well. In the second quarter, revenues increased more than 34% prior--from the prior quarter, and due to recent new four inch qualifications, we expect to see continued growth.

Now turning to semiconducting gallium arsenide, this area of our business is the first to truly underscore the success of our raw material strategy. Because demand has been so strong, LED manufacturers are the first to really feel the impact of the gallium shortage. As a result, several of these customers are placing large orders with us because they cannot get enough substrate material through other sources.

In fact, during the second quarter, we completed the first phase of qualification with a major North American manufacturer. We have begun the second phase of the qualification to demonstrate our consistency and expect to complete that by the end of Q3. Our substrates have been performing well and we are looking forward to the opportunity to expand our customer base with this tier one player.

While the LED business is very competitive and margins on our semiconducting substrates are lower than other areas of our business, the volumes are extremely high. Our focus currently is to find ways to improve our cost structure to make this area more profitable.

During the second quarter, we are very pleased to announce the appointment of Chia-Li Wei as Senior Director of Technology. His experience in liquid encapsulated Czochralski crystal growth technology will allow us to provide lower cost alternative to VGF grown semiconducting substrates in which a very low (inaudible) density is not required.

It will also allow us to broaden our product offering and increase our total market opportunity whereby providing an alternative technology for certain applications that are not currently addressed by AXT such as new applications for LEDs including gallium phosphide and small diameter semiconducting gallium arsenide. Chia-Li 's expertise in MOCVD will further enhance our understanding of the epitaxial and device prime metrics and thus strengthen our partnerships with our LED customers.

The Czochralski crystal growth technology will also provide us with an alternative method to grow germanium for concentrated photoable take applications. This will become increasingly important as the germanium area of our business grows.

In the second quarter, we received our first production order for concentrated photoable take multi-junction solar cells for terrestrial applications from a major North American supplier. We believe this relationship has very exciting prospects and we continue to work with them to improve our process and technology. We are also anticipating qualification space applications from the same supplier.

Across the board, qualification activity is strong. In Europe, we currently have four customers in various stage one qualifications in which they are evaluating the performance of our germanium substrates for concentrated photoable take applications.

We are also in qualification with a second major North American supplier, and we have delivered samples to a Taiwanese customer who recently announced a purchase of a MOCVD reactor for epitaxial growth for triple junction solar cells. Once their reactor is qualified by the customer, we expect formal qualification in the second half of this year. We believe that the greater efficiencies of concentrated photoable take triple junction solar cells are driving germanium substrates to become the material of choice for photoable take applications.

Now turning to indium phosphide, our revenues in this area benefited from this quarter from a one time sale of some unused scrap indium phosphide material. While we do not expect to see a rebound of the fiber optics market for some time, early in the year a large optical line amplifier and switch company conducted an audit of our facility in China with very positive results. We hope that this relationship will begin to contribute to our indium phosphide revenue as early as the third quarter.

Now turning to raw materials. As many of you know, we have been taking--talking for some time about the competitive advantages that our joint venture operations give us in terms of adequate supply of all our critical materials as well as discount to market pricing.

In the past several months, the market for raw materials has tightened dramatically, and as a result, gallium is becoming more difficult to obtain and the price of gallium has increased noticeably. For example, in January the cost of 4/9s gallium metal was approximately $350 to $400 per kilo. Currently, it is selling for $600 to $650 per kilo.

The 6/9 to 7/9 pure, which is used for the crystal growth, is currently selling for $700 to $750 per kilo, and in addition, the 5/9 germanium metal price has also increased substantially from $630 per kilo a year ago to the current price of a $1,000 to $1,100 per kilo. It takes approximately 1.3 kilos of 2/9s germanium dioxide to obtain 1 kilo of metal and then it needs further purification to 5/9s for crystal growth.

As a result of these material price increases, we understand that some of our competitors have increased the substrate prices, however, because of our unique raw material offering, we are working to maintain our prices unless raw material costs increase further. This raw material price increase underscores the importance of our joint venture operations and the competitive advantages that they give us. This is a significant and unique advantage that only we can offer.

Further, for the completion capacity increases of all our joint ventures, we expect to have enough raw materials to supply our growth plans and sell more raw materials on the open market. In fact, in the second quarter our raw material revenue increased to $3.3 million from $2.6 million in Q1.

We continue to investigate new joint venture opportunities that would allow us to expand our suite of offerings and further strengthen our international presence and competitive position. All of these areas offer exciting opportunities for AXT.

After an industry-wide pause to complete BIFET qualifications and digest some excess inventory, we are poised for renewed growth. Demand is returning across all areas of our core gallium arsenide business, and we are completing several strategically important qualifications that will begin to generate revenue in the second half of this fiscal year.

Further, we are very pleased to report that our strategy to vertically integrate our raw material needs has not only proven to be effective in regards to raw material pricing and volume, it has clearly become a major differentiator in our industry, and coupled with our diverse and unique product portfolio, extensive manufacturing capabilities and strong execution has resulted in significant advantages for our customers and our shareholders. I will now turn the call over to Wilson to discuss our forward-looking guidance.

Wilson?

Thanks, Phil.

We estimate our revenue for the third quarter will increase to between $14 million and $14.6 million. Also, we estimate that our net income per diluted share will be between $0.04 and $0.06, which takes into account stock compensation expense of approximately $100,000 and our diluted weighted average share count of approximately 31.2 million shares.

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

(OPERATOR INSTRUCTIONS) We'll pause for just a moment to compile the Q & A roster.

Our first question is coming from Avinash Kant from First Albany Capital.

Good afternoon, Phil and Wilson.

How are you doing Avinash?

Very good. A few questions. You talk about the six inch gallium arsenide wafer demand coming back up. Does that mean that in Q3 you would see it being higher sequentially?

Yes. In fact, I think I mentioned that at the end of June we did some--get some increases already.

So it's going to be sequentially higher from Q2 level, right?

Yes.

Okay, and you expect that throughout the year?

Yes.

Okay. Very good.

Q3 and Q4.

Okay, and do you have an idea where your market share may stand at this point all throughout the year given what you did last year compared to the competitors?

Oh, sure. In fact, Strategy Analytics just released a report in June. On the semi-insulating side, in 2005 our share was 8% and in 2006 it jumped up to 16%. On the semiconducting side in 2005 our share was 5% and in 2006 it increased to 9%.

Okay, and you seem to have seen some adverse margin impact because of the LED customers. Given the product nix seems to be shifting a lot more towards the six inch gallium arsenide now, do you expect that to go away in the second half?

You talk about the margins for Q3. I think you should expect the margins to stay relatively flat, and the reason for that is because if you just look at Q2, we've got indium phosphide revenue that was higher than the norm. We don't expect that to increase in Q3, so you'd get that--we expect the--the revenue to be lower, and, also, I think that the ASPs in certain small diameter substrates are still under pressure.

So the decrease in the indium phosphide revenue and the ASPs for certain products would be expected to offset the increase in the six inch substrate margins. So that's why we're expecting the product mix and the gross margins to be roughly in the mid to high 30% range.

And the materials revenue going higher on a quarter-over-quarter basis, is that because of higher volume, or higher--higher prices?

It's really both. Yes, because as I mentioned the price of 4/9 gallium has basically almost doubled and we were able to increase capacity in all our joint ventures, however, we're all maxed out right now. So I don't expect to go any higher, unless the pricing goes up higher in raw materials.

But the materials--but the materials margin, would they be better than the corporate average?

No. A little bit maybe, yes.

Okay. Perfect. Thank you.

Thanks.

Thank you. (OPERATOR INSTRUCTIONS)

Our next question is coming from Dave Kang from Roth Capital.

Thank you. Good afternoon. Wilson, first what was the stock compensation for last quarter--or June quarter?

92,000.

Okay, and then regarding BIFET. Who has yet to complete the transition since it's only 70% to 80%?

Well, when I said 70%, 80% I think I was more referring to us completing 70%, 80% of all our part numbers with our customers.

I see.

Yes.

I see, but in terms of an RIF chip vendors, can you--?

Yes, I think they're probably all done, basically.

Oh. I see.

Because I mean if you've read all the press releases on the--for instance, Anadigics, Skyworks, RFMD, they're all saying it's going to be very, very robust regarding cell phones.

Got it, and then I guess the excess inventory I guess you're referring to Motorola. How much Motorola inventories are out there in the channel and how long do you think it'll take for them to get fleshed out?

Well I really can't comment, I think, on that. I think you probably need to pose that question to Motorola directly.

Okay. Fair enough, and then--in terms of a capacity in both industry-wide as well as you guys. Where do you think the capacity utilization is right now for gallium arsenide?

We're probably in the low 80s.

Okay.

Yes.

Do you have a figure for industry? Are they still tapped out or--?

No. I don't think they're tapped out, and I think it's because of the BIFET, I think that's sort of--yes. I mean--we're the only public company so it's kind of hard.

Okay. Fair enough, and then just on the mix issue. Can you--what they were between semi-insulating versus semiconducting for first quarter and second quarter and what we should expect for third quarter? Roughly?

Well, if you just look at Q2 alone, this quarter--right now the semiconducting is about 45%.

Okay.

And my insulating about 55%.

Yes.

As we improve the sales on the six inches.

Yes.

You will start to see the mix will go in slightly higher on the semi-insulating. We would not be surprised if we get back to 60/40.

Got it, got it, and, lastly, regarding germanium. When do we see these germanium qualification activities translate to volume shipments? Is that going to happen this year, or is it more of a '08 story?

Well, I think I mentioned that we did get production orders from a major North American supplier. They're still evaluating the consistency of our product.

We think sometime in Q3 and Q4 they're going to start releasing production orders even though we've got the production orders but they're still not for release. We're qualifying with--we're actually in the first stage of qualification with four European suppliers. We don't expect that to probably generate any revenue until perhaps maybe late Q4, probably Q1 of next year, and then I--I think I mentioned there's one Taiwanese customer who just received an MOCVD reactor. Obviously he has to qualify that piece of equipment so again I don't see any production or major production orders from these guys until probably late Q4, Q1 type time frame.

So when these--just trying to gauge the opportunity here. When--when these programs get going, I mean are we going to see germanium in the seven figures, or are they still going to bounce around in maybe perhaps high six figures?

I think it could reach in the seven figures, yes.

Okay.

But I don't think--you're definitely not going to see it this year in the seven figures, no.

Got it. Got it. Thank you.

Okay, Dave. Thanks.

Thank you.

Our next question is coming from Richard Shannon from Northland Securities.

Hi, guys. How are you?

Hi, Richard.

Hi, how are you?

Doing just fine. Thanks.

The first question. You mentioned in your raw materials business you've got a number of European customers. It sounds like new customers this quarter. By chance are any of those competitors in your substrate business?

Yes. They are.

Any further comments you want to make on that, Phil?

No.

Okay. I didn't think so, but I thought I'd give you a chance anyway.

Okay. If you don't ask, you never no, right?

Exactly, exactly. The second question. I'm not sure if you answered this directly in your other commentary and questions, but looking at your gross margin of your gallium arsenide business in the second quarter, how did that trend quarter on quarter? I would assume that came down somewhat because there was more lower diameter?

Absolutely. I think that the reason why you see that we have an overall lower margin was because the proportion of my smaller diameter wafers, particularly in the two and three inches semiconducting, has--we had a large--larger proportion in terms of revenues, and, as I said, the majority of these customers that orders two and three inches from us, they came from Taiwan and the prices has not been very attractive.

Yes. I think--let me just comment. The challenge remains because this is basically LED guys, Taiwanese and the challenge remains. it's a very competitive market and we're all competing for the same market share. The suppliers are willing to accept low margins on their products and these competitors they just put pressure on the whole market.

Okay. That's fair enough. Next question. Trying to rationalize the guidance that you gave for the third quarter. With the revenue base that you're talking about and then trying to reach the EPS goals or guidance that you have, can you give us some rough idea of what you're thinking about in terms of gross margins and OpEx? If you don't want to specify absolute numbers, maybe give us a little bit of a nudge on direction.

Sure. I think at a 40,000 feet level. If you look at revenues, we do expect the majority of the increase to the 14 to $14.6 million guidance in revenues would come from the--the resumption of the six inch diameter wafers, and that would be offset by the four inch indium phosphide.

Margins, as I mentioned earlier, I think that you should expect that to be in the mid to high 30% range at least for the remainder of the year. In terms of OpEx, I think that you can almost imagine that given the infrastructure that we have set up as such that we could actually support between the 15 to $20 million business model, I would not expect my total OpEx to be inconsistent.

I think that you probably are looking at between 4 to $4.5 million in total OpEx for the next two quarters until we get to a point where our revenues would exceed the 18 to $20 million model.

And specifically on the gross margin comment there, Wilson. What's your expectation of reserved inventory sales embedded in that number?

Yes, of the 14 to 14.6 I'm only expecting about 250,000.

Okay. Great. Last question for you, Phil. We've looked at the--watched the six inch gallium arsenide number--revenue number come down.

Yes.

For obvious reasons here in the last couple of quarters, and if I'm reading my numbers correctly, you hit a high--a company high back in the fourth quarter last year. Is it possible to see you get to that kind of a number this year, or should we expect it after that time frame?

I mean obviously I can't say a hundred percent, but I anticipate to reach at least that number.

During this year?

Yes, as I mentioned it's all coming back now.

Okay. Great. Thanks. I'll jump out of line.

Thank you, Rich.

Thank you. (OPERATOR INSTRUCTIONS)

Our next question is coming from Pierre Maccagno from Needham.

Good afternoon, Phil and Wilson.

Hi, Pierre.

I had a question on the Czochralski method of growth. Could you expand a little bit more on that? You're planning, you said, to use this to grow gallium arsenide, is that right?

No, no. The Czochralski growth per se we're going--we're thinking about germanium because that's an element.

Okay.

For the gallium arsenide or maybe gallium phosphide, specifically gallium arsenide, small diameter semiconducting such as two inch and three inch, then we're talking about liquid encapsulation Czochralski because of the high vapor pressure of the material.

And so you're going to change the method of--of growth?

We are--that's one of the reasons we recruited Chia-Li Wei because that's his area of expertise when he was at HP and Phillips Allumaleds. We are definitely looking into that to be more competitive.

Because from an edge pit density it's not that tight, so we are looking into the LECCZ method of crystal growth because it's much more cost effective. Because you are pulling the crystal--the length of time, they cycle time is shorter. The, ingots are much longer. So we didn't have this expertise before because we are all VGF, obviously. So with Chia-Li coming onboard, we are definitely exploring that possibility.

But this is equivalent to VGF in terms of its locations?

No, no. The LECCZ from a dislocation standpoint is much higher.

Okay. But I mean isn't this for LEDs?

Yes, this is for LEDs. It's--it's for the low, low-end LEDs.

Yes. Okay. But I mean--but I mean you have to add CapEx, correct?

Oh, yes, yes, that's -- that's very true. But we've-- we've already looked at some equipment already.

Okay.

Yes, we're doing a cost evaluation and technology study right now. That's what Chia-Li is doing.

So overall, it seems there is more cost effective to migrate to this new method rather than use the VGF methods.

Absolutely. For small diameter semiconducting that does not require very low EPD density this is the way to go.

I see. Can you repeat again the amount of scrap indium phosphide material? I didn't quite get that.

We sold 251,000 in Q2.

That's the scrap?

That's scrap. Scrap metal.

Okay. Out of a total of?

Out of a total of 660.

650?

660.

Oh. 660. Okay, and then any comment on qualification at one of the two major PA suppliers of handsets?

Yes. I mean, we've been successful at one.

Okay. So is that a major--I mean qualification done and orders--?

Yes, it's done. It's done and we're going to see production orders.

Production orders.

Very soon, correct.

This quarter, or next quarter?

Most likely next quarter or towards the end of Q3, beginning Q4.

Okay.

To be conservative. Right.

Congratulations. That's very good.

Thank you. Thank you.

And then maybe the other one, the next one will also place orders. Who knows.

May be. Correct.

Okay. Great. Well, very good. Thanks.

Thank you, Pierre.

Thank you.

We do have a follow-up question from Richard Shannon.

Hi, guys. Just one quick question on costs and gross margins. The last couple quarters we had seen some pretty good amount of upside from gross margins, a lot of that was attributed to some of your cost reduction programs. I didn't hear a lot of commentary in this quarter. Just wondering, as I've asked in the last couple of conference calls, how predictable, how lumpy the improvements might be. Anything you can talk to us about, the success you had in cost reductions in this past quarter and what we could see over the next view?

Let me take that, Richard.

I think I've mentioned to you many times that we have a very, very aggressive cost reduction programs. In fact, I think we have, like, 52 cost reduction programs ongoing, and obviously we've made tremendous stride in cost reduction and it's been reflected in our margins, but sometimes you--you hit a wall for a while, and it's going to stay there until you see some--another big improvement in certain areas. Such as perhaps reduction in the cycle time in crystal growing, let's say you gained two more inches on a-- on a six inch ingot now that every ingot you're growing you're getting two more inches of usable material, you are slicing two more wafers per inch more.

So these are the things that we're working on. So, yes, I think down the road, obviously we're hoping to get more gains in our margins that would be a function of our cost reduction programs.

I don't know Wilson?

The only thing I want to supplement what Phil has said is that this quarter there may be some efficiencies that we were able to achieve but I don't think it's apparent as in previous quarters because the raw materials cost and all those things are rising. So that kind of offsets some of the--some of the savings that we are able to achieve in manufacturing, but, again, I think these technology improvements would come in waves, like Phil said. So the mix wave probably might come sometime in 2008 but right now we're still working on it.

I would certainly agree with you that those cost improvements on the surface look very impressive but I was just wondering perhaps maybe you've seen some of the low hanging fruit here over the last couple quarters.

Right.

And succeeding improvements will be a little bit more difficult and time consuming to come by?

Exactly. You hit it right on the head, Richard.

Okay, great. Thanks a lot.

Thank you.

Thank you.

Our next question is a follow-up from Dave Kang.

Hi, guys. I may have missed this but did you just quote how much capacity did your JVs add during second quarter and what their plans are going forward?

Yes, well, I did not disclose but I can be a little bit more specific for you. Gia, which does our 4/9s gallium, their all capacity was like 12,000 kilos and they went up to 23,000 kilos per year. This is all per year, by the way, okay.

Okay.

Gin May, which takes the 4/9s and purifies it to the 6 and 7/9s and even 8, 9, (inaudible) stuff they went from 12,000 kilos to like 15,000 kilos. Jau May, which is the arsenic supplier, they went from 8,000 kilos to 18,000 kilos. Tong Li, our germanium supplier, went from 6,000 kilos to 20,000 kilos with a new cyclone furnace. And then [Biu] which is a supplier of our PBN crucible went from 6 furnaces to 11 furnaces and room to add one more.

Okay. Okay, and then so in terms of a going forward, I mean is that going to be sufficient to provide incremental growth going forward, or do they need to go through another stage of capacity expansion?

Well, on the gallium side, again, I think I mentioned, we're completely tapped out.

Yes.

We're looking for other aluminum sources because that comes from the aluminum mine, the [baya lacure] so we're investigating that. We're looking at other opportunities in the raw material areas. We're looking to increase our ownership in the other two where we only have 25%. That's the arsenic and the germanium one. That--I guess that's the only comment I can make, yes, we're--from a gallium standpoint, we're maxed out.

Okay, and lastly, have you guys decided whether to increase JV's stake or ownership or to acquire new technology or something like Gan maybe?

Let me take that into two parts. I think I just mentioned that we are looking at increasing our ownership in the other two. Jau May which is the arsenic one we only have 25% there. Tong Li, the germanium one we only have 25% there so we're discussing--we're in discussions there to increase our ownership.

In regards to other products that would complement us--let's say our product portfolio. You've got to ask yourself what's after gallium arsenide, right? So I mean obviously it's a wide band gap material so when you're talking about wide band gap material, right, you got to look at the electron bolts. So what--what's next after the gallium arsenide, right? It's silicon carbide, gallium nitride, perhaps diamond. So, yes, there are--we're--we're investigating into those areas.

Got it. All right. Thank you.

Thanks, Dave.

Thank you.

Our next question is a follow-up from Avinash Kant.

Hi, just following up on the germanium side of the business. Could you highlight what would be your differentiation compared to your competition, especially some of the European ones?

The big--the big differentiator is really two. They grow their germanium using Czochralski method. We grow our germanium using the VGF method. That's one.

The other one is we have our own germanium source of raw materials. I don't believe they do.

So the current condition of the--of the LECCZ is happening only for the low end gallium arsenide LED applications, right?

That's correct. That's correct.

And that, if it were to be successful, what time frame do you assign to that?

I don't--I don't anticipate to see any of that product coming out from our facility until next year sometime.

Next year?

Yes.

Late or early?

At best in the second half.

Okay. Perfect.

Thank you.

Thank you. (OPERATOR INSTRUCTIONS)

Our next question is coming from Peter Trapp from [Byfrost] Capital.

Yes, hi, Phil.

Hey, Peter.

This is actually a little bit more for Wilson. In reading the press release, I noticed that you had net interest and other income for the quarter of $47,000 which compares to last year's income of 925, and when I read this, it looks to me as though you had a foreign exchange loss here that's got to be at least $250,000, and I'm wondering if--well, first of all, am I correct in that assumption? And, secondly, I'm wondering, given the fact that your revenues are in dollars and your expenses theoretically are in Renminbi whether if this is part of the hedge in which case are you long the Renminbi in which case you should be making a foreign exchange gain?

Let me take that answer--let me try to take your question into two parts. The first part when you compared it to previous quarters, bear in mind that we were selling Finnesar stock until the end of last year, and we were recognizing the gain from the sale, which was also in the other income line.

Okay. That's a good point.

Right. So that's one. So we do have foreign exchange gains and losses pretty much every quarter, but depending on the fluctuation of the currency. But you are correct. When you look at this particular quarter, there's a little over $200,000 in foreign exchange losses. But it's difficult to answer the question in a few sentences but I can just give you two examples. So there are customers--there are Asian customers including in Taiwan who conducts business with us in Japanese Yen.

Oh. I see, okay.

And this quarter, for example, we would invoice the customer and the rate says it's--let's say it's 1 to 117. But by the time we collect the Yen the rate already went up from 1 to 123 so we're actually end up collecting less U.S. dollars when it gets converted. The other--the other portion is that for our China joint ventures. Our customers would get invoiced in U.S. dollars, given their customer base, and let's say this quarter when we invoiced the customer, the rate is at let's say 1 to 7.7 but by the time we collect the U.S. dollars the rate went down to 1 to 7.6. So when the joint venture's converted collection to their local operating currency they ended up collecting less Renminbi.

Now, having said all that. It is a little more difficult to use hedging strategy for the Renminbi for two reasons. One is because it's not a freely traded currency, and when I was talking to some of the banks here they just don't have that offering with that particular currency, and, secondly, if we were to enforce it, it's not us, it's the local joint venture that they have to do it by themselves, and then you got to deal with regulatory issues.

I'm not exactly sure right now whether Chinese companies can actually allow to do hedging. So the--but to try to get to your point, we are looking into this issue right now. We don't think it's a huge issue that we've got to deal with but we are trying to look for solutions in case that this becomes a bigger problem to us.

But to the extent that the Renminbi remains strong and gets stronger which seems to be the general--

Right.

--wisdom, it would seem to me that by definition then that you are going to continue to have foreign exchanges losses from a conceptual basis of U.S. dollar revenues and Renminbi expenses. So--

Yes.

I understand what you're saying about not being able to necessarily hedge it because it's not freely traded.

Well, I'm not --

But there's got to be some conceptual way of resolving that problem because there's no reason why you should be losing $250,000 a quarter.

I can't disagree with you Peter like I said, but we are looking into this issue because there might be some regulatory issues that we need to deal with from the local joint venture's perspective because we can't do it from here, it has to be the--because they are--they are losing--they are losing the money, not AXT, it's's the joint ventures. It's down at that level.

So can they--can they do hedging activities? We have to find out. That's what we're doing right now.

I'm not sure I heard during the conference call if you broke out revenues geographically as to what percentage were U.S. versus Taiwan or China or any other area or Europe. Do you provide that kind of information, and is it significant enough for us to be asking about?

We actually disclose the geographic revenues every quarter. We also post the additional information on our website, and I did mention earlier in the call that for the second quarter North America revenue was 20% and Asia-Pacific was 61% and Europe was 19%.

So 20%, 61% and 19%?

Yes.

So that was U.S., Europe, and the rest of the world?

That was North America, Asia, and Europe.

Oh. I'm sorry. North America, Asia, and Europe. Okay. And how is that--how has that changed over the last three or four quarters?

I think in general you are actually seeing more and more business coming from the Asia-Pacific region. Three or four quarters ago you're probably looking at about 50% and it's now reached 60%.

And what would you say if you had to guess on the trend going forwards?

Well, I think that with a lot of the qualifications coming in, you--we actually do expect the North American portion to go up.

Well, when you started talking about photovoltaic and terrestrial, and spacial, I'm assuming that that's M core because they are the only ones I know that do both, and they are a U.S. corporation. I mean how big a--how big a win is that?

Well, it's--it's substantial, we--hopefully going--going forward.

Okay. So if you were breaking semis versus--versus solar or energy--alternative energy, how would you see those percentages changing in the next couple of quarters then, Phil?

Well, as--as we complete qualifications in these concentrated photovoltaic companies you will see sequential increases from a volume standpoint--from a revenue standpoint you've got to remember a six--a six inch is our highest ASP. So with--with all the BIFETs being completed we're seeing larger volumes on six inch. So from a ratio standpoint you might not see it immediately but going forward a year from now, I--I expect that our germanium business is going to be quite--quite significant.

Well, as you talk to these solar guys, I mean--and they're looking at parabolic growth, I've got to believe that that's going to tick down to you all.

Yes. I mean the germanium substrate forecast is like over 200% growth.

Yes.

Yes.

So if you had to put a kind of a general percentage on--on communication, semi versus--versus alternative energy today and a couple of quarters out, I mean how would you--how--what kind of percentages would you put on them?

A couple of quarters out?

Well, yes, or towards the end of the year. Is it going to be any--any change? Any significant growth before the end of the year, or is this all into '08 and '09?

So when you say communication, you mean semi-insulating material?

Yes, I'm talking percentage going into the semi-insulating business as opposed to going into the photovoltaic and the alternative energy space.

I don't see any significant differences going.

Okay.

Yes.

All right. Thanks a lot.

Thank you.

Okay. Nice quarter. Well done, guys.

Thank you, Peter.

Thank you.

There appears to be no further questions at this time. I would now like to turn the floor back over to management for any closing remarks.

Well, thank you, everyone, for participating in our conference call. During the third quarter we will be presenting at the Roth Capital 2007 New York conference. As well as visiting investors in several cities around the country. So I look forward to seeing you again in Q3. Take care now. Thanks very much.

Thank you. This does conclude today's AXT Incorporated conference call. You may now disconnect, and have a wonderful day.