AXT Inc (AXTI) 2009 Q2 法說會逐字稿

Good afternoon, everyone and welcome to AXT Second Quarter 2009 Conference Call. Leading the call today is Dr. Morris Young, Chief Executive Officer and Wilson Cheung, Chief Financial Officer.

(Operator Instructions).

Today's call is also being recorded and I would now like to turn the call over to Wilson Cheung, Chief Financial Officer.

Please go ahead, sir.

Thank you, Nicole. And good afternoon, everyone.

Before we begin, I would like to remind you that during the course of this conference call including comments made in response to your questions, we will provide projections or make other forward looking statements regarding, among other things, the future financial performance of the company and our ability to control costs and improve efficiency, the improvement of our competitive position as the market improves, the recovery of gallium raw materials inventory levels, the impact of our customer qualifications as well as other 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. 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 delays by our customers and the timing of sales of products.

In addition to the factors that may be discussed in this call, we refer you to the company's period 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 July 30th, 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 second quarter of 2009. This press release can be accessed from the investor relations section of AXT's website at AXT.com.

Now, to the financial results.

Revenue for the second quarter of 2009 was $13.1 million, compared with $7.7 million in the first quarter of 2009. Gallium arsenide substrate revenue was $10.1 million for the second quarter of 2009 compared with $5 million in the first quarter of 2009. The increase in sales of gallium arsenide substrates in the second quarter reflects in particular an improvement in sales of six-inch substrates.

Indium phosphate substrate revenue was $684,000 for the second quarter of 2009, compared with $490,000 in the first quarter of 2009.

Germanium substrate revenue was $1.2 million for the second quarter of 2009, compared with $622,000 in the first quarter of 2009.

Sales of raw materials, primarily 99.99% pure gallium were $1.0 million in the second quarter of 2009 compared with $1.5 million in the first quarter of 2009 as a result of lesser demand since late 2008.

In the second quarter of 2009, revenue from North America was 18.6%, Asia Pacific was 64.1% and Europe was 17.3% of total revenue.

Two greater than 10% customers generated 16% and 11.6% of our revenue during the second quarter, while the top five customers generated 43.4% of our second quarter revenue.

Gross margin has improved to 19.3% of revenue for the second quarter of 2009. This included a benefit from the sale of approximately 633,000 in fully reserved wafers, which positively affected the quarterly gross margin by 4.8 percentage points.

By comparison, gross margin in the first quarter of 2009 was negative 3.1%. This included a benefit from the sales of approximately 414,000 in fully reserved wafers, which positively affected first quarter gross margin by 5.4 percentage points.

Selling, general and administrative expenses were $3.5 million for the second quarter of 2009 compared with $4 million in the first quarter of 2009.

Research and development costs were $355,000 for the second quarter of 2009 compared with $460,000 for the first quarter of 2009.

Total stock compensation expense was $121,000 for the second quarter of 2009, of which $10,000 was in cost of revenues, $93,000 in SG&A, and $18,000 in R&D.

Loss from operations for the second quarter of 2009 was $1.3 million compared with loss from operations of $5.2 million in the prior quarter.

Net interest and other income for the second quarter of 2009 was $355,000 which included an unrealized foreign exchange gain of $212,000 compared with net interest and other loss of $378,000 for the first quarter of 2008, which included an unrealized foreign exchange loss of $409,000.

Net loss in the second quarter of 2009 was $1.3 million or $0.04 per diluted share.

By comparison, in the first quarter of 2009 we reported net loss of $5.5 million or $0.18 per diluted share.

Let's now look at our cash on the balance sheet. Cash and cash equivalents with maturities of less than three months, short term investments and other investments in high grade debt securities with maturities of less than two years, including restricted deposits were $33.6 million at June 30, 2009, compared with $32.5 million at March 31st, 2009.

Accounts receivables, net on reserves were $12.9 million at June 30th, 2009 compared with $8.4 million at March 31st, 2009.

Day sales outstanding were at 90 days for the second quarter compared with 99 days for the second -- for the first quarter of 2009.

Net inventory was $28.3 million at June 30th, 2009 compared with $33.5 million at March 31st, 2009.

Depreciation and amortization in the second quarter was $770,000 and capital expenditures were $216,000.

As of June 30th, 2009, the company including our consolidated joint ventures, had 123,000 total employees, of whom 822 worked in production.

This concludes our review of the results for the second quarter. I will now turn the call over to Morris.

Morris?

Thank you, Wilson.

Before I begin, I would like to say that I'm very pleased and excited to once again serve as AXT's Chief Executive Officer. I believe that AXT is in an excellent position to emerge from this economic climate stronger than ever and I look forward to working with our very talented management team to continue to move forward on our mission.

Over the past two weeks I began the process of reaching to our valued customer base and looking forward to meeting with many more in the coming months.

I've also met extensively with our employees, both here in the United States and in China and was very impressed and gratified by their commitment to excellence and their dedication to providing the highest quality products and support to the market that we serve.

I'm very excited to lead such an outstanding team and grateful to their extra effort during this period of transition.

Now, turning to our markets. Following very challenging industry conditions early in the year, we are very pleased to report that the improvement we began to see at the end of last quarter continues through the second quarter, resulting in stronger sales and improved gross margins.

We believe that inventory in the supply chain has improved from the first quarter, with the exception of raw materials that are not expected to begin to recover until later in 2009 or early 2010.

We saw a healthy increase in gallium arsenide substrate customer releases, particularly in six-inch substrates and are once again building consignment inventory in anticipation of stronger demands. Our qualification effort in both gallium arsenide and germanium substrate have been very successful and we are pleased with our increasing diversification in these areas.

Beginning with semi-insulating gallium arsenide. Sales in the quarter increased by approximately 102% as a result of improved demand for six-inch gallium arsenide substrate for the high end cell phones and netbook applications and as well as very low inventory levels in the channel.

While we do not expect to see sales continue to increase at the same pace going forward, we do expect to see continued moderate growth throughout the year. This growth is expected to be driven by two factors, first according to strategy analytics, AXT continues to gain market share in the semi-insulated gallium arsenide market. We believe that this is the results of significant competitive advantages, particularly in the six-inch substrate.

As demand begins to turn -- return, six-inch capacity will again become an issue. Likely before capacity is constrained in the smaller diameters.

AXT has adequate capacity to support healthy growth in demand for six-inch substrates and we can scale as we need it.

Further, our China based manufacturing facility allows us to maintain a low cost structure than our competition, resulting in a better value for our customers. We continue to demonstrate high quality and consistency at a reasonable price and this coupled with the ability to scale our business according to the demand and our access to critical raw material is creating a strong value proposition for our customers.

Second, we're benefiting from continued demand for sophisticated 3G enabled phones and Smartphones as well as other wireless handheld devices that require heavy content of gallium arsenide based [PN] and [HVT] devices.

The popularity of these products is being fueled by the worldwide upgrades to 3G capable infrastructures that support the enhanced functionality of these devices as well as the explosion of new applications that attract new subscribers and drive to upgrade cycle.

In fact, AT&T has indicated more than half of its wireless data traffic is generated by its iPhone subscribers.

Further, in the second half of 2009, there will be more than 20 new Google [nrad] based Smartphones available as well as new offerings by Palm, Sony, [Ream], Nokia, Samsung, Motorola and many others.

Smart phone penetration is expected to be approximately 13% of sales this year and tripling by 2013 to nearly 38%.

We're also hearing from our customers that increasing interest in netbooks is also beginning to positively impact demand for gallium arsenide.

IDC recently sharply increased their projection for global shipment of netbooks to 21.5 million units in 2009 growing to more than 100 million units in 2013.

In terms of our own customers, we experienced increases in sales across our semi insulated gallium arsenide substrate base, including our largest customer who renewed his contract with us late last year.

We were also encouraged to see gallium arsenide substrate orders from our Japan based customers as geographically that area has been down for quite some time.

For semi-conducting gallium arsenide, sales in the quarter increased by approximately 91% as a result of strong demand for LEDs across all diameters. However, we continue to see substantial pricing pressure, particularly in smaller diameters and we are focused on improving our cost structure in order to offset a portion of the decline so that we can expand our market penetration in this particular market.

We believe that the demand for LEDs will continue to grow as this technology becomes increasingly mainstream. Japan, China and Taiwan has all highlighting LEDs as a focus industry, with particular interest in the general illumination application.

Also, Samsung is aggressively marketing its new LED flat panel television and is projecting strong growth in the sales of this product, despite the general weakness in consumer spending.

We are excited about this potential of this market and believe that our competitive advantage will allow us to expand our presence in key geographic regions and our strategic accounts.

Turning now to germanium substrates. During the second quarter, we experienced a strong increase in our revenue as a result of our qualification and first product order from a major European manufacturer of [satellite solar cell] for space and terrestrial applications.

We're very excited about this qualification, it not only increases our germanium substrate volume in a meaningful way, it also validates the performance of VGF technology for satellite and CPV applications. A market that has been dominated by Czochralski technology.

On my recent visit with our new customer, this year's very positive information on how our material performed in the qualification process including the strength and surface morphology of our substrates. Their openness allows us to further refine our processing order to optimize our substrate for satellite and [CPV markets].

With two new recent qualifications from European customers we now have three photovoltaic customers in production. These qualifications are the result of many quarters of collaborative works and expand our presence in this important geographic market.

Europe continues to lead the rest of the world in investments into solar energy development. But government subsidies in the United States, Asia, and Australia are promoting the development of this technology around the world. We believe we will continue to see growth in our revenue in the solar market as it continues to mature.

In addition, our germanium substrate also used [in up to] electronic applications such as LEDs or automotive brake lights and dashboard panels. While this application has been strongly affected by the economic downturn, we do expect it will recover and look forward to a rebound in germanium substrate revenue from the electronic application over in the next several quarters.

Moving forward, one of our major R&D initiatives in germanium substrates is the development of six-inch wafers. Among the advantages of our VGF technology is its superior strength, which enables us to grow wafers that performs well in large diameters. Our germanium customers are expressing a strong interest in our developing large time into substrates as it will provide them a better cost structure for their products, addressing one of the most significant barriers to the widespread adoption of solar technology.

We are very excited about this area of our business and are committed to being a technology leader in order to support next generation alternative energy solutions.

In total, we're seeing meaningful improvement in our key markets, resulting in higher sales and an improved outlook. We're pleased to report that our capacity utilization is now above 70%, positively affecting our gross margin performance.

We'll continue to model our business conservatively as the economic environment remains volatile but we are expecting continuing growth through the balance of the year.

Therefore, turning to our guidance for the third quarter, we expect total revenue of between $14 million and $15 million. This takes into account a modest improvement in gallium arsenide and germanium substrate sales and fairly stable raw material revenue. Therefore we're expecting a net loss in the third quarter of between $0.03 and break even based upon approximately 30.5 million common shares outstanding.

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

Thank you.

(Operator Instructions)

And we will take our first question from Richard Shannon with Northland Securities.

Hi, guys. How are you?

Good. How are you, Richard?

Good.

Good, and Morris, finally good to meet you, if only in person. I look forward to meeting you in person at some point too.

Thank you. Thank you, Richard.

I guess maybe I'll ask a question, just quickly on the third quarter guidance. Obviously the second quarter numbers are pretty good and good progression of the third quarter. Wilson, if you could, help us understand your thoughts on some of the interim numbers there, specifically on gross margins and OpEx, please.

Sure, I think if you look at our top numbers, Morris has mentioned earlier that we should expect to continue to see modest growth in two areas, the gallium arsenide substrates, both in semi-insulating and semi-conducting, but also in the germanium substrate business. We're not foreseeing any improvement so to speak, for the raw material sales at least until Q4 or maybe even early 2010.

When you look at our gross margins, even though we do not really give out margin predictions, given that we have been filling up the factory, we're looking at very closely a lot of the cost cutting measures that Morris has asked a lot of the executives to look into it with a fresh new look. We're very hopeful that we do want to get back and attain our old corporate average of gross margins in the mid 20% range. That is our ultimate goal.

Operating expense wise, I actually answered this question similarly last quarter, that with the restricting charge that took place in March of 2009, we're expecting our run rate for operating expenses to be in the $3.5 million to $3.75 million range.

Morris came on board only about two weeks, he already gave initiatives to all the senior executives that we have to look at our expense profile again and I'm sure that there's a lot of room that we can actually look into where we can achieve the low end of that $3.5 million operating expense rate.

Great, if I may add, we have our first all hands meeting two days ago, in there I asked everybody to look at our expenses and where can we cut, where can we be more effective and also, on top of it is -- I want everybody to look at what are the areas that we can penetrate our market to where its more profitable.

I mean where -- is there any low hanging fruits we can make our filling up our factory more effectively as well as cost cutting measures and more effective in doing some manufacturing processes so that we can be more effective serving our customers with high quality products.

So there are several fronts we will definitely be looking at. Some of them are short term, but I don't think it will be effective short term, but long term we do expect to drive our gross margin back.

Okay, great. Next question for me, obviously there's some nice commentary on the germanium business, revenues were a little bit higher than I was expecting, looks like you're expecting more growth here. You talked about production orders from one customer and qualifications with three. Wondering -- kind of two questions on this line, how many more customers are out there that you're working with that are possible and what do you foresee for that revenue stream over the next say two to four [inaudible].

Okay, I'm going to have Bob Ochrym, our Marketing VP to answer that question.

Hello, Richard.

Hi, Bob.

Okay, regarding your question, we are working with some other folks regarding qualifications at this point in time. They are somewhat smaller. They're in the early R&D stage at this point in time so their -- their major requirements will not occur until the end of 2010 timeframe or early 2011, that's the outlook at this point.

Okay, and my next question is on raw materials, you made a couple of comments about your expectations.

Richard can -- before you go to that, can I give you all the highlights -- I think the germanium is a very exciting market. I mean as Bob said, they are of interest. And I do see pick up activities in germanium. I mean, also there are other approaches of achieving the CPV concentrated solar cell via the semi-insulating market. So I think this area is very exciting, but however the qualification may be slow to come, but definitely it's a very exciting growth market.

And there's other area which is opto-electronic applications for using germanium and that has been down because of the automobile market is down, but we do expect that market to come back. So we do expect germanium to pick up in two or three different fronts. I mean one is more new qualifications and continued demands for our existing customers as well as the opto-electronic applications coming back. Yes.

Okay, great. Thanks for that detail. And maybe my last question on raw materials, you made some comments about that might not return much before -- hopefully in the fourth quarter, maybe not until next year. Also curious, whether that's an area where you can see revenues that can get back up to the levels that you saw in 2008, kind of the $3 million to $4 million to $5 million range, is that going to be possible even as you ramp back in from inventory replenishment there?

Well, regarding that question, Richard, there has been some decline in the average ASPs for the raw materials that we will have to take into consideration. I mean the prices that we were selling at, I'd say [gallium metal] and metal last year are certainly not the number that we're going to see in the fourth or the first quarter. They have -- the average selling price will be down, so that will have an impact. Right now what we're trying to do is to contact all our major customers and see what - how much inventory they do have at this point in time, and again, we're still projecting that in the fourth quarter or early 2010, these customers will return, but when they do return, the average selling price will be lower.

Yes, well as they say, CEO is always have this fatal fault of being too optimistic but I want to put an optimistic twist to this. Everything goes down will go up. Okay? Who ever expected gallium to be $200 a kilogram or $300 a kilogram, and whatever goes down will go up because natural resources, there are just so much of it. As demand picks up and so will the price.

So it's very difficult for us to predict where it's going to go, but it's not going to stay down forever and in our own inventory as we see, as we pick up our sales in six-inch gallium arsenide, we start to replenish our gallium reserve, right? So we do expect our competitor to do the same thing. So whereas everybody exhausted their inventory, then demand will come, but hopefully not to increase price in a drastic way so we can serve our substrate -- substrate customer in a fair [value].

Okay, great thanks, I will jump out of line.

Thanks, Richard.

(Operator Instructions).

And Mr. Cheung, there are no more questions in the conference -- excuse me. Richard Shannon has re-queued and we'll go back to him.

I thought we'd hear one or two other participants, but maybe a couple other questions, Morris you made some comments about the LED markets, I'm talking about some drivers in the TV area, I've seen some press reports about a lot of interest in that kind of a technology. You've also mentioned and I think it's pretty well understood that pricing is somewhat difficult in that area.

Do you see -- do you ever see the instance in the next I guess the foreseeable future that demand from that technology could reverse some of those pricing pressures and we could see that become a little bit more attractive business for you.

Well, I think in my experience once price goes down, I don't think it will ever go up. I think the only area which would go up in price, perhaps, is in raw material.

In technology, I think the demand for us is to sharpen our skill, improve our technology, we do have a lot of areas we can improve our efficiency to make that area of business more exciting for us.

I mean of course, in the total LED area, not everything's cheap either. I mean there are certain area where high brightness or certain customer demand, very uniform in brightness or wavelengths and they pay us a premium in price. But they are to say the least, it's the minority of their market. The big huge market for general illumination, price, price, price is the most important thing.

But if you look at the competitive landscape, I mean AXT is the major -- the only major player in this field who has the manufacturing facility in China, so we can definitely leverage further our ability to cut our costs to serve that market better. I think that's a key.

As the volume increases we can fill up our factory, I was so happy to see our controller telling us once we're filing our capacity to 95%, we can increase our gross margin substantially. So it's one hand washes the other.

And right now we only used up about a little over 50% of our total factory space.

Yes.

So we do have brownfield facility out there, we don't have to start from scratch. If the demand is out there and we can easily scale up the operations.

Right, right.

Okay. Another question for me, related to your handset business, would love to hear any comments about the competitive environment there. you talked a little bit about six inch, maybe speak more generally and also love to understand your efforts to try to get into the larger RF component suppliers out there that we don't really do much business with today, what are the opportunities there and the chances of getting in at some point?

Well, I mean, we do have very good business in the six inch area. I mean we have demand coming back from a lot of customers who is signaling very strong business in -- the four key RF device makers. I mean Richard, you are definitely right, there are certain areas we are not serving at this point and Bob, John and I are constantly reviewing, is this the time for us to knock on the door again? I mean those are areas -- I mean but then there are other areas that we are not serving the full penetration. I mean our market share definitely can improve and that depends upon how competitive our price is and how we can better present ourselves in terms of better quality, consistency as we deliver high quality consistently to our customers, then customer will really give us more orders, I mean as recently evidenced by one of the recent visits by one of our -- John visiting our [kapowang] customers. But as far as some of the areas that we have not qualified into, we will review those and as the proper moment present itself we will definitely, we'll knock on the doors again.

Okay, great. I think that will do it for me. Thank you.

And we'll take our next question from [Dale Kitschell] with [Millrace].

Thank you. Can you hear me?

Yes, sir.

Yes, Bill.

Great quarter, guys. Could you maybe elaborate a little bit on the utilization, how that you said you ended, I think at 70%, what was the progression through the quarter and maybe where you're running at this point in July?

The improvement in the capacity utilization is very encouraging news to us. I can tell you that last quarter when we reported the first quarter earnings, we're probably only in the 40% range. That has grown by the day. We're now starting to see more shifts coming into the factory especially towards the end of June. I would say that we're likely at that moment we would be probably close to 70% capacity utilization.

Obviously, I don't have an exact number because of the different product mixes for different production lines but we could easily see that exiting the year we could be going above 80%, given where the forecast is.

Yes, that's very good analysis, but also I want to emphasize that we do have extra spaces for us to expand and we're constantly looking at certain areas where we have perhaps more demand than we can fulfill, we will strategically put in the investment to expand our capacity.

Great, thank you. And I wonder if you could just expand a little bit on the germanium offering that's made inroads in the satellite market. I didn't quite hear the technology that it has displaced, maybe elaborate on that a little bit and what the scale of that business could be for you.

Sure. You know AXT -- AXT went into the germanium satellite solar cell business back in 2001, but we have been out of that business for quite some time, we reentered that market perhaps maybe a year, year and a half ago. But I think last quarter when we first saw our new European customer qualified our germanium solar cell, we were very, very pleased to share a lot of this qualification data with them. They showed us that our substrate is as good or better than the existing technology out there, which is namely Czochralski. We were very pleased, because we are the new kind on the block and they showed us our strength actually is better than our competition. The surface morphology, which translates to better efficiency of the solar cell is better than our competition. But they also told us there were certain areas we need to do some improvement.

But there's -- to say the least, there's no show stopper they told us, specifically for us to get into this market in a major way. Also this germanium solar cell maker is one of the world's largest solar cell maker. So once they have put us on the map, so to speak, we can show other solar cell makers, hey AXT is a definitely a good alternative, a better supplier in the world to service our customers. So we do have -- we do have not only a qualified good customer in this area, but also give us a lot of good data as well as confidence to compete in this market.

Great, and maybe if you could just refresh our memory on the relative gross margin of germanium versus the gallium offerings. Thank you.

Dale, we have in the past let shareholders know that we actually don't specifically comment on the individual product gross margins. What I can share with you is that the germanium substrate gross margins are slightly below our corporate average, that's what I can tell you right now, but also bear in mind that as far as volume is concerned, we're only talking about a very small portion of that business, so the improvement in the margins will take place once we scale up the operations and as we continue to increase our production volume.

Obviously different product has different specs.

Specs as well.

Specs as well. And also if we were to try to be serving just one [phonic] area the end efficiency of the factor manufacturing can be justified even with the lower margin in certain markets. And as Wilson was saying that we are just ramping up the germanium market. So as we increase our volume we will definitely look at -- take a fresh look at our gross margins.

Thank you.

Thanks, Dale.

(Operator Instructions).

And Mr. Cheung, there are no more questions in the queue at this time. I'd like to turn the call back over to you for any additional or closing remarks.

Thank you for participating in our conference. As always, feel free to contact me, Wilson or Leslie Green directly if you would like to meet with us. We look forward to speaking with you in the near future.

And that concludes today's conference, thank you for your participation.