AXT Inc (AXTI) 2008 Q4 法說會逐字稿

Good day, and welcome to the AXT fourth quarter and fiscal 2008 earnings release. Today's call is being recorded. I would now like to turn the meeting over to Dr. Phil Yin, Chairman and Chief Executive Officer. Please go ahead, sir.

Thank you. Good afternoon, everyone. Welcome to AXT's fourth quarter and fiscal 2008 conference call. I am Phil Yin, Chairman and 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 fourth and fiscal 2008 results, then I will give you my perspective on our markets and future opportunities. Following the conclusion of my comments, Wilson will provide forward-looking guidance, then we will open up to your questions. Wilson?

Thank you, Phil. Before we begin, I would like to remind you that during the course of this conference call including comments made in response to your questions we will provide projections or make other forward-looking statements regarding, among other things, the future financial performance of the Company and our ability to control costs and improved efficiency, our success in qualifying additional opportunities, our ability to continue to drive future businesses in 2009 as well as other mark 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.

These uncertainties and risks include but are not limited to overall conditions in the markets in which the Company competes, global financial conditions and uncertainties, market acceptance, and demand for the Company's products, and the impact of the factory closures or other delays by our customers on the timing of sale of products. 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 on-line 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 February 25, 2010. 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 fourth quarter and fiscal 2008. 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 fourth quarter of 2008 was 15.6 million compared with 17.9 million in the third quarter 2008. Gallium arsenide (GaAs) substrate revenue was 9.1 million for the fourth quarter of 2008, compared with 13.6 million in third quarter 2008. The decline in revenue in the fourth quarter of 2008 was primarily due to an overall market slowdown with lower than expected demand from customers and some push-out of schedules shipments to the first and second quarters of 2009, which also resulted in lower production levels.

Indium phosphide substrate revenue was 473,000 for the fourth quarter of 2008 compared with 484,000 in third quarter 2008. Germanium (Ge) substrate revenue was 684,000 for the fourth quarter of 2008 compared with 795,000 in the third quarter of 2008. Sales of raw materials primarily 99.99% pure gallium (Ga) were 5.3 million in the fourth quarter of 2008 compared with 3 million in the third quarter 2008.

Recall in the third quarter our raw materials sales were restricted due to the Beijing Olympics and ParaOlympics, which ended in early October. In the fourth quarter of 2008 revenue from North America was 24%, Asia Pacific was 45%, and Europe was 31% of total revenue. Two, greater than 10% customers generated 17.5% and 12.8% respectively of our revenue during the fourth quarter while the top five customers generated 52.2% of our fourth quarter revenue.

Gross margin was 4.8% of revenue for the fourth quarter of 2008. This included a benefit from the sale of approximately 703,000 in fully reserved wafers which positively affected the quarterly gross margin by 4.5 percentage points. By comparison, gross margin in third quarter of 2008 was 25.4%. This included a benefit from the sales of approximately 778,000 in fully reserved wafers which positively affected the third quarter gross margin by 4.4 percentage points.

The deterioration in gross margin in the fourth quarter of 2008 from the previous quarter was primarily due to the follow. First, our gallium (Ga) joint venture, Jia, in China is housed in and we received services from an affiliated aluminum plant. Our joint venture ceased production for five weeks during the fourth quarter as a result of a supply shortage of raw materials from the aluminum plant, which had reduced production and halted operations due to dropping aluminum prices in the second half of 2008. Accordingly, in order to meet customer supply obligations, Jia had to source a 4Ns gallium (Ga) from another independent third-party supplier resulting in low gross margin for the quarter. Jia had also sourced 4Ns gallium (Ga) from this independent third-party supplier when demand has exceeded the joint ventures capacity and will continue to source 4Ns gallium (Ga) from this independent third-party supplier despite lower gross margin, if, it again, experiences supply shortages or if customer demand again exceeds its capacity. However, our joint venture, Jia is currently getting up to full capacity and expects to build some inventory in an effort to minimize the impact of potential future shutdowns. Further, our purchases of 4Ns gallium (Ga) from a second source are allowing us a potential partnership for diversification of our raw material sourcing.

Fourth quarter gross margin was also negatively impacted by lower production volume, high warranty expense as a result of warranty reserves from certain customers resulting from our failure to meet specification requirements and higher unfavorable variances due from lower yields from a particular gallium arsenide (GaAs) product line that does not typically make up such a high percentage of our overall sales. Excluding stock compensation expenses, selling, general, and administrative expenses were 3.5 million for the fourth quarter of 2008 compare with 4.8 million in third quarter of 2008. Recall our SG&A expenses for the third quarter included a rental formature of 700,000 in terminating an old lease, a bad debt provision of 280,000 and bank fees of 147,000 in connection in connection with our paydown of the 6.4 million revenue bond in early July. Also excluding stock compensation expenses, research and development cost were 501,000 for the fourth quarter of 2008 compared with 537,000 for the third quarter of 2008. Total stock compensation expenses was 167,000 for fourth quarter of 2008 of which 14,000 was in cost of revenues, 125,000 in SG&A, and 28,000 in R&D.

Loss from operations for the fourth quarter of 2008 was 3.4 million compared with loss from operations of 926,000 in the prior quarter. Net interest and other income for the fourth quarter of 2008 was 656,000 compared with net interest and other income of 89,000 for the third quarter of 2008. Our fourth quarter other income included 475,000 in unrealized foreign exchange gains. Our tax benefit for the fourth quarter of 2008 was 349,000 compared with a tax provision of 177,000 for third quarter 2008. Net loss in the fourth quarter of 2008 was 2.4 million or $0.08 per share. By comparison, in the third quarter of 2008 we reported net loss of 1 million or $0.03 per share.

Let's now look it at 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 34.3 million at December 31, 2008, up from 32.5 million at September 30, 2008.

Account receivables, net of reserves were $11.5 million at December 31, 2008 compared with 13.3 million at September 30, 2008. Day sales outstanding was at 68 days for the fourth quarter same as prior quarter. Net inventory was 35.1 million at December 31, 2008, down from 39.2 million at September 30, 2008. In the fourth quarter, we generated approximately 2.7 million in cash from operations. Depreciation and amortization in the fourth quarter was 691,000 and capital expenditures were 1.4 million. As of December 31, 2008 the Company, including our consolidated joint ventures, had 1,120 total employees of whom 902 worked in production.

Now turning the results for fiscal year 2008. Revenue for fiscal year 2008 was 73.1 million compared with 58.2 million in fiscal year 2007, representing a more than 25% growth year-over-year. Gross margin for fiscal year 2008 was 24.6% compared with 34.8% for fiscal year 2007. Net loss for fiscal year 2008 was 689,000, or $0.03 per share compared with net income of 5.3 million or $0.16 per diluted share for the fiscal year 2007.

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

Thanks very much, Wilson. 2008 was a very challenging but productive year for AXT. We recorded more than a 25% increase in our revenues from 2007. Successfully negotiated a new 2009 contract worth nearly $15 million with IQE one of our largest customers. Concluded a major qualification with a leading germanium (Ge) customer resulting in significant first order for delivery beginning in the second quarter. Continued to qualify customers in the new inverted metamorphic solar cell technology which will potential further expand our gallium arsenide (GaAs) business. Expanded our customer base to include several top tier companies and laid important ground work for growth when the macro environment improves. Still, the economic downturn in 2008, coupled with the inventory overhang in the industry and customer-specific issues that we continued to work through put pressure on our financial performance and will have a significant impact on our first quarter 2009 results.

To begin, according to ABI Research, the global onset market declined significantly in the fourth quarter of 2008 and is expected to remain soft through much of 2009. This weakened demand environment continues to have a meaningful effect on our results both in terms of our revenue and our gross margins. We have seen a steep decline in orders across our gallium arsenide (GaAs) product line and we will have successfully negotiated several exciting contracts with major customers where are commonly airing that releases on those contracts will not begin until the second quarter. In addition to a decline in new orders, some of our customers have requested push-outs of their orders into 2009. We are proactively addressing these requests on an effort to help our customers digest inventory of our wafers and prevent further build up. We believe that the majority of the inventory that exist with our customers will be digested in the first quarter with some overhang possibly into Q2.

In addition to marketplace challenges, we have put significant effort into resolving issues with product specifications for two major customers that impacted our Q3 and Q4 results. We are very pleased to report that we have successfully worked through the issue with our gallium arsenide (GaAs) customer that is a result of close collaboration and begun to ship product to them that meets their new production specifications. For our germanium (Ge) customer, we are also pleased to report positive progress. We have completed the requalification process that is required as a results of our customer bringing up new equipment in its line. We expect to see germanium (Ge) revenue increase modestly in Q1 as a result of this prequalification and slowly ramp in Q2 and going forward.

The final challenge we faced in Q4, was the significant drop in our raw material margins that had a sizable impact on our gross margins in that quarter. In a unexpected result of the global nature of the economic crisis, Jia, our primary gallium (Ga) raw materials joint venture was forced to shut down for five weeks during the quarter when the aluminum processing plant which houses Jia, closed temporarily in response to a significant drop in the band for aluminum raw materials. Accordingly, in order to meet customer supply obligations our joint venture had to source 4Ns gallium (Ga) from another independent third-party supplier. This is a highly unusual event, and we are not aware of any other time in the history of Jia when this has occurred. Nonetheless, as the economic backdrop continues to be volatile, Jia is currently getting up to full capacity in order to offset any impact from potential future shutdowns.

On a positive note, this situation has allowed us to be in contract negotiations with a second source of 4Ns gallium (Ga) diversifying our sources of raw material and expanding our total potential capacity. As we look forward to Q1, the continued weakness in the demand environment, coupled with some inventory overhang and customer-specific issues, is expected to cause a strong decline in our revenues in the first quarter. However, we expect to see a market improvement in our gross market performance as the issues that affected our fourth quarter gross margins have diminished in their effect on our results going forward. Further, in addition to a number of cost savings programs that we have discussed over the past quarters we have taken meaningful steps to reduce our expenses including an overall reduction in headcount of approximately 70 people, a reduction in work hours in our manufacturing and operations group, elimination of per diem for our epitaxial , the elimination of non-essential contract workers and renegotiation of vendor contracts. We believe that these steps will allow us to improve our cost structure and bottom line performance and will be reflected beginning in Q2.

Now looking beyond Q1, we believe there are some bright spots of opportunity in 2009. One of the most interesting is the projected growth of WCDMA and CDMA 2000 handsets to support the new 3G and 3G plus networks around the world. We expect to see particular growth in China as the government has begun to issue 3G licenses and has also broaden the subsidy policy dor its consumer electronic purchases. Global Smart Phone sales are also expect to grow throughout the year as many new phones have been release by many manufactures such as Apple, Motorola, Nokia, [REM] and Samsung among others. These phones are expected to comprise more than 30% of the market by 2013. The benefit to AXT from the sales of more feature-rich sophisticated handsets is that they require a greater content of gallium arsenide (GaAs) in order to meet the speed and functionality requirements that consumers have come to expect. Even with the steep decline in spending associated with 2G legacy networks carriers continue to invest in 3G in order to remain competitive and attract new subscribers. This network upgrade enables full performance capability of the video, gaming, and Internet browsing capabilities of these next-generation handsets.

Another interesting area of us is the LED market. Driving by rising demand for LED televisions and consumer products, iSupply expects that the LED market will grow in 2009 by about 3%. A sharp contrast to the expected 9.4% decrease in the overall semiconductor market. The recent declines in ASPs of high-brightness LEDs have allowed LED backlift sets to become more price competitive with comparable CCFL sets. In addition, while individual markets for LEDs may decline in 2009, the number of applications continued to broaden across a wide array of consumer, industrial, and automotive products. We are excited to report that we have begun receiving orders from two major suppliers to these markets and have not been -- that have not been AXT customers for quite some time.

Finally, we continue to monitor closely the market for gallium arsenide (GaAs) substrate in concentrated photovoltaic. Late last year a team of researchers from the US Department of National Energy Lab set a world record for solar cell conversion efficiency of 40.8%. This new triple junction solar cell is a great candidate for both the space satellite market and (inaudible) concentrated solo take market. One of the most exciting part of this news is that it has grown on gallium arsenide (GaAs) wafers representing a potential new market for our substrates. The CPV market for germanium (Ge) is also continuing to grow albeit from a smaller base. In fact, Deutsche Bank is expecting a growth of 20% for the global solar industry in 2009 as there is a worldwide need to replace fossil fuel resources. With sustainable alternatives such as solar power and solar modules. In fact, the current US administration is talking at length about a focus on investment in renewable energy technology as a way of advancing US energy policy.

European countries such as Spain and Germany have been leading the renewable energy technology development for years and recently a new conversion efficiency record for germanium (Ge) was set at 41.1% by European Research Institution. These improvements in conversion efficiency are significant because they enabled this technology to become more affordable and therefore more widely utilized.

In terms of our own germanium (Ge) business we are very pleased to report that we have successfully qualified with a large European CPV solar cell company for space applications with further qualifications continuing for terrestrial applications. This is a very exciting opportunity for us and it is the culmination of a year's close collaboration with this customer.

Finally, I wanted to note in that in February, I attended the first annual meeting of the CPV Consortium and the First International CPV Trade Show and Technical Conference held in San Diego. The attendance was conservable with representation from nearly every CPV related equipment manufacturer, government entities, technical institutions and Universities. It is clear from the success of this event that the interest and concentrated photovoltaics is very strong, and that despite challenging new term economic conditions a tremendous amount of investments is currently occurring in order to bring CPV technology to main stream applications. Further more, I'm pleased and honored to have been elected to the Board of Directors for the consortium and look forward to seeing the consortium membership continue to grow overtime as more organizations investigate CPV for solar related applications.

So in closing, while the volatile business environment is expected to cause a strong decline in our Q1 revenues, the improved gross margins should offset some of this impact. Further, we believe that our business will begin to improve after Q1 as a result of pocket of strength in our gallium arsenide (GaAs) business. New qualifications of customers in the LED and photovoltaics market and our improved cost structure as a result of efforts to streamline our business in relation to current demand environment. We remain encouraged by the overall trends in our industry and we believe that we will successfully leverage our competitive advantages for growth and market share gains as the economy improves. I will now turn the call over to Wilson to give you more details on our first quarter guidance.

Thank you, Phil. We estimate revenue for the first quarter will decrease to between 7 million and 8 million. The drop in revenues is primarily the result of the weakened demand environment and inventory overhang particularly effecting six-inch semi-insulating gallium arsenide (GaAs) substrates. Raw materials revenue is also expected to decline materially from the prior quarter. With the expected return of gross margins to more normal levels, we do believe that the net loss per share will be between $0.05 and $0.08 which takes into account our waited average share count of approximately 30.5 million shares. Finally, we expect the business to continue to generate cash in first quarter 2009. This concludes our prepared comments. We're now happy to answer your questions.

Thank you. (Operator Instructions). First question from Richard Shannon with Northland Securities.

First question, fourth quarter gross margins, you talked about this as well as in your press release , curious as to what extent this outside sourcing of gallium (Ga) reduced your gross margins in the

As we have stated in the press release, one of the big contributors on the gross margin decline in Q4 is this joint venture Jia, given the shutdown and the big reason of that was it was triggered by the weak economy. The impact is relatively material but they have really done two things to alleviate this problem going forward, the first thing is that they have negotiated new agreements with the aluminum plant on the raw material supply, and they are getting up to full capacity which will allow them to build some inventory to offset the future potential shutdown.

While these efforts may not completely insulate us from the negative affects from a prolong shutdown, we do believe that this efforts will minimize the gross margin effect for future quarters. And at the same time, the other thing is that Jia is currently negotiating with a third-party supplier to secure a second source of the gallium (Ga) despite lower margins which would help alleviate this problem and will and to overall capacity when the economy improves. This whole Jia impact basically makes up more than half of the gross margin decline for the whole quarter.

Great. Let's see here. I guess in the guidance for the first quarter, revenues, you mentioned most of the impact coming from six-inch gallium arsenide (GaAs) semi-insulating. It seems like if that is most the impact that number is going to come down a very large percentage, can you help us understand that and maybe talk about it quantitatively to the extent you can?

What I can share with you right now, is that of the expected 7 to 8 million in Q1, I would say more than half of that drop is going to come from gallium arsenide (GaAs) substrates. Nearly, 75% of that would be related to one customer who is really working through an inventory rebalancing. And, of course, the remaining 25% would be the decline in raw material sales.

Okay. And then in terms of the comments, Phil, I think you made about ordering patterns and expectations in this quarter and perhaps in the next, do you expect improvement in either ordering patterns or revenues as you exit this quarter or when do you see your customers getting through this inventory , and any thoughts on the timing would be great to

Yes, what we are seeing is obviously, they are working through their inventory through this Q1 some of it might possibly overhang into Q2 but I think by the end of the Q2 it should be depleted by then.

Okay.

And as on the part of ordering, we have some customers on consignment inventory, some of them we have yearly contracts so we do have a number in other words, for their total use for the whole year, some of them have given us schedules. Basically, Q1 looks like -- I think that's going to be really the bottom.

If you continue to see any cancellations or push-outs in this quarter --

We did see one major push-out. Last question, if I did my calculations right it looks like your revenues from Europe grew quite nicely in the fourth quarter, kind of curious what went on there. Well, let's see. One was -- basically it's actually all been gallium arsenide (GaAs) small orders here and there. We had some germanium (Ga) customers here and there. Qualification or third phase of quale . So nothing really major. In other words, nothing major from one customer or a big chunk of a shipment or anything like that. It's been sort of a combination of the total territory. A lot of customers

Okay. And Wilson where, do you expect the inventories to pan out at the end of the first quarter?

Well, we continue to utilize our raw materials inventory as I mentioned in the previous earnings call, that's going to be our operating plan. And we believe that quarter after quarter we should continue to utilize our inventory and it is our target to even bring that inventory levels down probably to about 30 million at least by the end of 2009.

Okay. Great, I will jump out of line.

Thanks.

We'll take our next question from Jiwon Lee from Sidoti & Company.

Can you hear me?

Yes.

Oh, hi. You have highlighted some plans to save your operating expenses, can you give us some idea as to how we should quantify the savings for 2009?

Sure. I think it's really broken down into two pieces. One piece is the savings on the cost of revenues, about the reduction in force for some of the production workers and also reducing the shifts and the working hours of a lot of the production workers so that we can actually rebound on the gross margin side back to the low 20% or mid-20% range. Second part of the reduction in expenses would come from the R&D and SG&A, in last year we were probably running an average of 4 to $4.5 million in quarterly operating expenses, and we are already reducing some heads, certain services and negotiating contracts with our vendors and our operating goal is to have revised operating expense model of about 3.5 to 3.7 per quarter versus the 4 to 4.5 versus last year.

That's helpful. Then understanding pricing dynamics and internal operations, what should be the break-even point, in terms of the revenue?

Well, if you are able to return to return to the low to mid 20% range in gross margins we need about 15 million in quarterly revenues to break-even.

Low to mid 20%?

Yes, depending on the product mix.

Where do we stand in terms of your gallium arsenide (GaAs) capacity project?

As you remember we were increasing our six-inch capacity. That was completed last year, around the end of October, so it is just waiting for orders. We have plenty of capacity.

All right. And then finally two, questions for Wilson. What was on the three items that was in the SG&A for the fourth quarter? Some of that went through, $700,000 to term at the capital lease.

I was referring to the Q3 SG&A because it was higher than Q4. I wanted to point out it was because of the absence of rental forfeiture. Also, the bank fees, and also the absence of the bad debt expense.

And that rental was to save you couple million dollars.

Right. The goal is to have savings for the remainder of the new lease because we actually don't need 55,000 square feet of space and we are only using 22,000 right now. to --

Fair enough and lastly what was the last quarters operating cash flow and the capital spending that you did?

Last quarter, meaning Q4?

Correct.

We generated about 2.7 million in operating cash flow and we expect to continue to generate cash in 2009.

Thank you.

Thank you.

And we'll take our next question from Avinash Kant from DA Davidson & Company.

A few questions. Did you break down your gallium arsenide (GaAs) revenue for th current quarter based on semi-conducting and semi-insulating?

Yes. This quarter our semi insulating is only 48%, and semi-conducting is 52 and normally our run rate is about 55/45. Again, this is really because of one of our big customers is trying to rebalance their inventory so we have a lot less revenues coming from the six-inch.

You made some comments about the LED market that could be stronger in '09, did you say there will be growth in '09?

We see some moderate growth.

So in that case should we expect this change in semi-conducting and semi-insulating for the full year working in the same direction; right?

No, because when you look at it from a revenue standpoint the semi-insulating is all six inch; right, and the semi-conducting for LED is all two and three-inch diameter, so when you look at it from a revenue standpoint you need to ship a lot more small wafers to equal the big wafers. It might improve a little bit on the percentage wise, the 55/45, the 45 might go up to 47% but we do see a moderate growth in LEDs, small-diameter semi-conducting.

And is there much of a difference in margins between those two?

Yes.

Six inch --

Not that much. Not significant.

Now we're getting a lot closer.

It's getting closer now. It's getting closer now.

On the semiconductor side you said that you have started to ship into one of the customers where you had some qualification issues. Now, would you say that at current levels now you are back to the same market share at that particular customer where you were before these issues?

What I was mentioning is, it's actually two customers that AXT has not done business for many, many years. We are back in. We're not obviously back in as we were, let's say, five or six years ago, but we were able to requalify with this customer. We started to ship production wafers. Obviously we're trying to gain market share there. We're not the number one supplier there. But I'm really pleased that we have requalify with this customer that has not been a customer of AXT for long time.

Another customer you had some issues, there was some flatness issue. Has that been dissolved?

Oh, yes, that's been resolved.

So you are back to normal levels?

No -- when you say normal levels, it's not normal levels when the economy was good.

On a percentage basis.

In a percentage basis, yes.

Okay. Then a little bit about the germanium (Ge) side. Germanium (Ge) was a lot more stronger in the first two quarters. Of course, everything has come down, but given the new qualification that you have how should we think of germanium (Ge) on a full year basis in '09?

I definitely expect our germanium (Ge) business to increase going forward every quarter. As I mentioned, we successfully qualified with a European CPV customer. We received our first order. We're going to get -- start shipping in Q2 and going forward. So we -- and we're still in qualification with two more other European customers. So we expect those qualifications to be completed sometime this year. So bottom line is, we definitely see that our germanium (Ge) business increasing as Wilson always says this is our bluebird.

Right. And on the CapEx and depreciation side, should we expect much of a change CapEx compared to what we saw in the December quarter? I'm talking full year '09 basis. Do you have any target there?

Obviously given what's going on in the market right now we are going to reduce our capital expenditure requirements in '09 and based on the current operating plan CapEx probably won't be more than a $1 million a quarter.

$1 million per quarter.

Talking about no more than $4 million for '09.

Okay. And one final question, of course. You talked about Q1 could likely be the bottom. Now, I was just trying to figure out, you have seen some push-outs. Is that based on what you are hearing from your customers or based on what you have seen historically or which levels you are at? What's the basis of that?

Definitely not historic because we have not seen anything like this before. So it's really based on some of their forecasts, speaking with the customers, visiting customers. So, you know, we think that Q1 is really the bottom.

Although what kind of recovery do you expect? A significant recovery or mild?

No, no, it's going to be a slow ramp.

You just said that we may not fall any further. Have you seen any monthly pattern within the quarter if were to take a month to month basis in the March quarter, in materials sales maybe you can see graduality, have you seen much?

No, there's no like set pattern. I think the market is so volatile right now, it's really -- we don't see any kind of pattern at all.

And one final question. Of course, we are talking a lot about Smartphones here, and I remember you were also talking the about going into the low-end phones last year, increased gallium arsenide (GaAs) content. Comparatively, what's the level of -- that you say content that you have in terms of gallium arsenide (GaAs) on the low-end and the Smartphones what is the difference there?

When you say low-end phones, that's not up to us. We're just the substrate supplier. That's up to the end market user such as Nokia of them dictating the specifications, for instance, to the (inaudible) how do they want their HPT and the TMs. That is from a device standpoint -- our substrate is the same specification whether it's for a high-end phone or whatever. It's the -- that's made on top of that.

Is it that they need more gallium arsenide (GaAs) in the Smartphones?

As phones increase in sophistification and functionality, that's going to require more gallium arsenide (GaAs).

Perfect. Thanks so much, Phil.

Thank you.

And we'll take our next question from Michael Bertz with Kennedy Capital.

Good afternoon, gentlemen.

Hi, Mike.

Hey, I wanted to follow up with -- I know you gave a little bit of detail but it wasn't quite clear to me. You talked about the impact of the drop from Q4 to Q1, half of it coming from gallium arsenide (GaAs) substrate; right?

Yes.

The 75% from one customer with a inventory rebalance, 25% from raw material sales. Was that raw materials from gallium (Ga)?

Let me clarify. I was responding to a a question about how that compares to the Q1 guidance compared to my Q4 actual. And of the 7 million to 8 million guidance in Q1, with the drop of basically about $7.5 million from Q4, half of that drop is going to come from gallium arsenide (GaAs). And of that half of the drop, 75% would come from one customer. The remaining 25% that would probably be from the raw material sales.

Okay. What I'm confused on, Wilson, if the 75% of the half or 75% of the total from one customer that is taking both substrates in raw materials.

Basically the majority of the 75% is related to just one customer.

Okay. Now, obviously you've -- probably connecting dots, but that would suggest that one customer is the guy you have a renegotiated contract with and would suggest there's some push, depending on other customers pushing things out so I'm sure there's a bunch of inventory involved with. That would that be fair to say?

We really can't comment on that.

Let's talk about the renegotiated contract anyway. So if it's 15 million for 2009, clearly not a bunch of that is going to fit into the Q1 outlook, so it it's going to have to come back up some over the course of the year. So if we could think about that, how do you see that laying out over the course of the year?

Well, as I said earlier, we expect Q1 is the bottom. We expect most of our customers would have digested most of their inventory. There might be some more overhang possibly into Q2, but we should see -- we should start to see a slow ramp in Q2, and again, one of those customers is the customer you are thinking about.

Okay. So then on the yield issue in terms of how much that hit the gross margin in Q4, obviously a big chunk from the raw materials piece, but from the yield side of the raw materials --

Other than the Jia issue, probably about 40% of that decline is the combination of the other reasons that we actually pointed out on the press release. So that will be the combined impact of the lower production volume and the lower yields and the warranty expense. That all makes up the client.

Mike, I can be a little bit more specific, but not that much. When we say low yield, the -- it was a product mix, and that particular low yielding product, we've made -- it's a continuing order. But the volume increased on that particular product tremendously. So coupled with the decrease of all the other products and the increase of this product that had low yields, it affected the margins quite a bit.

Okay. Obviously what I'm driving at is trying to understand how much gross margin recovery we can see into Q! and where the components of that sort of come, from and in a way, how do we not see this thing hitting quite so extensively, frankly both from the yield side as well as the supply side. Sounds like the supply side is more straightened out, but the yield side, not sure about.

One of the reasons you are seeing this yield having a larger impact on our margins was because we really after lower revenue base in Q4. As we starting to ramp up our revenues, and we have a larger proportion of six-inch gallium arsenide (GaAs) sales and shipping more, then the impact on the yield issue would diminish significantly.

You are talking about cash flow being positive for Q1 which is great given the environment, and CapEx being pretty minimal. As you look out over the course of the year is there a point in time you see needing to build inventory or build product, where would you not be running positive cash flow in Q2, 3, or 4?

Well, what I will share with you is that cash flows would also be proportionate to the timing of the collections. So we may not be every quarter generating. What I will share with you, for the whole fiscal 2009, more cash compared to December 31, 2008 is what we anticipate.

Okay. Thanks, guys.

Thank you.

Once again if you would like to ask a question please press star 1 on your telephone at this time. We will take a follow-up question from Richard Shannon.

Phil, you talked a little bit about today but obviously more in past conference calls regarding potential qualifications with new and reemerging customers for wireless or semi-insulating galium arsenide (GaAs). In this environment when your customers are running low utilization in their fabs and shutting down lines and things like that does that improve the environment by which you can attempt to increase your share and get qualifications, or does that hurt it? What does this environment do to those goals of yours?

Well, I will tell you what it really does, with the current -- environment and the wat it is and everybody hungry for business, it's a price. It's a price thing. When you say everything is equal, it's really a price thing. You've been around this industry quite awhile. We're basically mirroring the silicon industry, and I've always been preaching that this industry has to do something about it. We need to consolidate or else we're going to kill each other. That's the only comment I guess I can say. I don't know if I answered your question. If I didn't, ask me again.

I guess I was maybe more wondering about qualification cycle with your customers rather than competition.

No, I understand. I can say this. The qualifications in, let's say, when I say new customers, is really old customers that we're trying to get back. It has not affected our qualification status or the need or the interest of these customers to -- I say, quote, requalify AXT back as their supplier. These qualification are not complete but they haven't stopped, in other words.

But they haven't been accelerated in this environment?

What, I'm trying to think. The customers -- no, hasn't been accelerated, no.

Okay, great, thanks a lot, Phil.

Okay.

And we'll take our next question from Jiwon Lee.

I may have missed your comment on the fourth quarter breakdown between semi-insulating versus semi-conducting.

Semi-insulating for Q4 is about 48%, and 52% for semi-conducting.

Out of the simi-conducting what was the six-inch portion?

All six-inch are semi-insulating.

100%? Okay, thanks.

It appears at this time there are no further questions. Dr. Phil Yin, I'd like to turn the conference back over to you for any additional or closing remarks.

Well, thanks, everyone, for participating in our conference call. As always, if you have any questions please contact our Investor Relations person , Leslie Green, or Wilson Cheung, our CFO, or call me direct if you want to meet with us. So we look forward to speaking with you next quarter. Thanks very much,

That concludes today's conference call. Thank you for your attendance. Have a wonderful day.