AXT Inc (AXTI) 2009 Q3 法說會逐字稿

Good afternoon, everyone and welcome to the AXT's Third Quarter 2009 Conference Call. Leading the call today is Dr. Morris Young, Chief Executive Officer and Raymond Low, Chief Financial Officer. My name is Melody and I will be your coordinator for today. Today's conference is being recorded. I would now like to turn the conference over to Raymond Low. Please go ahead, sir.

Thank you, Melody. 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 increase in orders in succeeding quarters, the utilization of excess inventory, and the improvement of our competitive position as the market improves, 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 and 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 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 October 29, 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 third quarter 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 third quarter of 2009 was $16.8 million compared with $13.1 million in the second quarter of 2009. Gallium arsenide substrate revenue was $13.3 million for the third quarter of 2009 compared with $10.1 million in the second quarter of 2009.

Indium phosphate substrate revenue was $688,000 for the third quarter of 2009 compared with $684,000 in the second quarter of 2009.

Germanium substrate revenue was $1.8 million for the third quarter of 2009 compared with $1.2 million in the second quarter of 2009.

Sales of raw materials, primarily 99.99% pure gallium were $1.0 million in the third quarter of 2009 compared with $1.0 million in the second quarter of 2009.

In the third quarter of 2009, revenue from North America was 17.7%, Asia-Pacific was 63.8%, and Europe was 18.5% of total revenue.

Two greater than 10% customers generated 16.5% and 10.1% of our revenue during the third quarter, while the top five customers generated 46.9% of our third quarter revenue.

Gross margin has improved to 32.9% of revenue for the third quarter of 2009. This included a benefit from the net sale of approximately 94,000 fully reserved wafers, which positively affected the gross margin by 0.6 percentage points.

By comparison, gross margin in the second quarter of 2009 was 19.3%. This included a benefit from the net sale of approximately 311,000 in fully reserved wafers, which positively affected second quarter gross margin by 2.4 percentage points.

In the past, we reported the gross sale of fully reserved wafers and its effects on gross margin without taking into account the charge to cost of goods sold and its effects on gross margin for wafers that were added to fully reserved wafers. We are now reporting the net sale of fully reserved wafers and its effects on gross margin. The net sale is derived from the gross sale of fully reserved wafers less the charge to cost of goods sold for wafers that were added to fully reserved wafers.

Selling, general and administrative expenses were $3.3 million for the third quarter of 2009 compared with $3.5 million in the second quarter of 2009.

Research and development costs were $360,000 for the third quarter of 2009 compared with $355,000 for the second quarter of 2009.

Total stock compensation expense was $98,000 for the third quarter of 2009, of which $8,000 was included in cost of revenues, $84,000 in SG&A, and $6,000 in R&D.

Income from operations for the third quarter of 2009 was $2.1 million compared with a loss from operations of $1.3 million in the prior quarter.

Net interest and other income for the third quarter of 2009 was $677,000, which included an unrealized foreign exchange gain of $304,000 compared with net interest and other income of $355,000 for the second quarter of 2009, which included an unrealized foreign exchange gain of $212,000.

Net income attributable to AXT Inc. in the third quarter of 2009 was $2.1 million or $0.07 per diluted share. By comparison, in the second quarter of 2009, we reported net loss attributable to AXT Inc. of $1.2 million or $0.04 per diluted share.

Now let's look at the 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 $37.8 million at September 30, 2009 compared with $33.6 million at June 30, 2009.

During the third quarter, we generated cash flows of $4.2 million. During the second quarter, we generated cash flows of $1.2 million.

Accounts receivables, net on reserves were $14 million at 30 September, 2009 compared with $12.9 million at June 30, 2009.

Day sales outstanding were 76 days for the third quarter compared with 90 days for the second quarter of 2009.

Net inventory was $28.8 million at September 30, 2009 compared with $28.3 million at June 30, 2009.

Depreciation and amortization in the third quarter was $740,000 and capital expenditures were $591,000.

As of September 30, 2009, the Company including our consolidated joint ventures had 1,022 total employees, of whom 820 worked in production.

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

Thank you, Raymond. This is an encouraging time for AXT. The continued recovery taking place in our end markets coupled with the ramping volumes for our new qualification resulted in revenue growth in the third quarter of more than 28%. Further, the improved margin performance, manufacturing efficiency and cost control allowed us to exceed our earnings expectation and return the Company to profitability.

We're very pleased to see continued diversification of our customer and our revenue base as well as many positive trends in our markets that highlight our competitive advantages and are likely to provide further growth opportunities in the quarters ahead.

To start, the wireless device market that uses our semi-insulating gallium arsenide substrates continue to strength. Our sales of the substrates increased 31.5% in Q3 following very strong growth in Q2. Further, we continue to see demands from geographies such as Japan that have been weak for some time. This growth in our revenues is fueled by the increasing demand for a new generation of Smartphones and other sophisticated Internet connected devices such as netbooks that support more advanced features and access to a host of new web based applications and services.

In addition to strong unit sales growth of these devices, we're also benefiting from the fact that these devices require performance levels that are substantially higher than previous generations and, therefore, utilize more power amplifiers and switches. This results in higher content of gallium arsenide substrates per unit. The increasing popularity of these devices coupled with significant worldwide investments in the advanced network to support them indicate that this market has long-term growth potential.

In the last several years, our market share in a wireless device market has increased from mid single-digit to more than 20% through our strong focus on quality, consistency and customer service.

As we continue to grow, we're uniquely positioned to accommodate the increasing demand. With our manufacturing base in China, we have adequate space and facilities to expand our capacity as needed. In fact, since 2006, we've more than tripled our six-inch gallium arsenide capacity and continue to expand as new qualifications and increasing demand require greater production volume. Further, lower labor costs and our ability to build our own crystal growth equipment allow us to grow our business far more cost-effectively than our competitors.

We currently supply either directly or indirectly nearly all the key customers in this market. However, tremendous opportunities still exist to increase our market share within our customer base and to penetrate new customers that may require additional sources of substrate, particularly as industry capacity tightens.

Our sales and marketing efforts continue to be focused in this area and we are also placing increased emphasis and genuine efforts to further strengthen our product performance and ability to accommodate additional customer specification.

Turning to LED market that utilizes our semiconducting gallium arsenide substrate, we are also seeing the signs of continued recovery, driven by improved demand for applications such as automotive lighting and signages and displays. Our sales of two, three and four-inch substrates grew in the third quarter and were approximately half of our gallium arsenide substrate sales.

In addition to growth on our current customer base, we are also qualifying for a number of new emerging LED applications that require specific substrate characteristics and, therefore, are less subject to pricing pressures. We believe there are many such opportunities for us and are focusing our engineering team to optimize our product to match the requirements of these applications.

We are encouraged to see continuing emphasis particularly in Europe and Asia on the use of LEDs in a variety of lighting applications such as street and traffic lights. Further, the European Union's ban on the sales of incandescent light bulbs began in September in order to improve energy efficiency of lighting standards. Many countries are scheduled to follow suit over the next three years, a move that will place further focus on the commercialization of LEDs for general lighting applications.

Turning to germanium substrate, we're very excited about the interest we're experiencing in this area of our business. Following very strong growth in the second quarter, we continue to see healthy demand in Q3 across our customer base. The majority of interest for our germanium substrate continues to be for satellite solar cell applications. In expectation of increasing demand across of our customer base, we are adding substantial capacity for germanium substrate.

Similar to gallium arsenide, we are able to complete this increase with modest capital expenditure and with a scale as the need arise based on customer demand. We are also qualifying for the emerging terrestrial solar cell market where the volume could be substantially higher when terrestrial application achieved the cost structure and efficiency to gain wider adoption. We believe that as this market develops, our technology will provide important differentiators from our competition.

AXT is the only germanium substrate supply to offer VGF technology. III-V technology has historically been the dominant method of crystal growth. However, our close collaboration with our customers has revealed that our VGF technology produced germanium substrates with more strength and better surface morphology than competing technologies. These characteristics are particularly important in the development of six-inch germanium substrates as larger diameter substrates are more prone to breakage.

Our customers are showing strong interest in our development of a larger diameter germanium substrate, particularly for terrestrial applications. Larger wafers would help to lower the cost of producing solar cells, making the technology more commercially viable. AXT has advantage with tremendous expertise in large diameter substrate production as we were one of the first manufacturers to introduce six-inch gallium arsenide substrate in our industry. This is a major R&D initiative for us, and we are committed to being a technology leader in next generation energy solutions.

Turning to raw materials, although our own usage increased, we saw no meaningful change in demand outside AXT for raw material in the third quarter. However, beginning this quarter, we experience the first signs of recovery in raw material demand. While near-term sales are expected to remain close to the current level, we should see some pickup over the next -- the course of 2010.

In addition, we believe that our joint venture continue to represent a tremendous value to AXT. As I've been discussing, positive trends in all of our end market as well as our continued focus on strategic accounts is expected to result in significant growth opportunities for AXT over the next several years.

Our joint ventures provide us with unique advantages over our competition in terms of cost structure for our critical materials as well as availability to secure enough material to accommodate our customer requirements. With relatively small investment, we've been reaping over the last five years tremendous financial and strategic rewards. We will continue to explore opportunities to expand our joint venture portfolio both for current and new materials.

With so much opportunity for growth, we were very pleased to announce today new roles and responsibility for several members of our executive team.

First, Davis Zhang, a founder of AXT and formerly our joint venture President, has been appointed President of AXT's China operations. Davis will continue to focus on the management and development of our joint ventures. He will also assist me in the management of our joint Beijing manufacturing facility. The bringing together of these two critical functions helps us to better plan and respond to the present and future needs of our customers. Davis has been instrumental in the success of our joint venture programs and his knowledge of our business and customer needs made his new position a natural fit.

Second, we have also expanded the role of Bob Ochrym from Vice President of Business Development to Vice President of Business Development and Strategic Sales and Marketing. Bob has a wealth of contacts and experience, and we're excited to leverage his knowledge to further enhance our sales and marketing efforts. In this role, Bob will be responsible for our sales effort on North America's East Coast, and he will continue to work closely with John Cerilli, Vice President of Global Sales and Marketing to maximize our customer support around the world.

He will also be responsible for developing our sales and marketing strategies, major sales contact negotiations, major market identification and other strategic sales and marketing function. We believe that we will have great opportunities to expand our market shares with a number of our customers that we currently serve as well as with new customers that we do not presently supply to. Further, we're continuing to explore new applications in wireless devices, LEDs and photo voltaics where we believe our product has a great fit.

And lastly, Raymond. Raymond Low who has served as our Vice President and Corporate Controller since February 2005 and as our acting Chief Financial Officer for the past two months has been confirmed as Chief Financial Officer. Raymond has a strong financial background and a deep understanding of our financial structure, which has made for a smooth transition into this role. He is a tremendous asset to AXT and the Board and I are very pleased to work with him in this new position.

Finally, before we close, I want to say a few words about our gross margins, which are an important area of focus for our organization. As Raymond mentioned, we achieved significant improvement in our margins in the third quarter. This has largely been driven by increases in our capacity utilization, favorable product mix, and a focus on cost control and efficiency. We are very committed to maintaining a healthy margin in our business going forward despite the competitive nature of the market we serve. We believe that this is possible as a result of key factors.

First, AXT is the only provider that can leverage the cost advantage of China-based production. We're just beginning to realize substantial benefits of this facility, including lower cost of manufacturing and expansion capability and proximity to critical raw materials. As the economic climate improves further and as we continue to expand our presence in the market, we expect this facility will become an even more critical component of our competitive position.

Further, in addition to product development, our research and development efforts are focusing on significant programs that we believe will provide meaningful improvement to our manufacturing cost and efficiencies over time. Our goal is to develop innovative manufacturing and crystal growth techniques that will allow us to maximize our cost structure and provide sustainable margin performance. We believe that we're making major progress in this area and that this progress will contribute to our long-term competitive position.

In conclusion, this is a very encouraging time for us. We're seeing renewed growth across all of our primary market we serve fueled by the long-term positive trends in wireless devices, LED lighting and photo voltaics. We've been successful in our diversification efforts with key qualifications of new customers and new qualifications, new applications that are strategically important to AXT. We're excited to see our hard work result in ramping production volumes and higher revenues. Further, careful and conservative management of our business has resulted in return of our Company to profitability giving us a solid financial foundation for our continued success.

As we look ahead, coming off of two quarters of strong growth, we're planning for modest increases in fourth quarter with positive indications for continued growth in 2010. Therefore, turning to our guidance for the fourth quarter, we expect total revenue of between $17 million to $17.5 million. This takes into account improvement in gallium arsenide and germanium sales and stable raw material revenues. Therefore, we are expecting net income in the fourth quarter of between $0.03 to $0.05 per share based upon approximately 13.7 million common shares outstanding.

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

[OPERATOR INSTRUCTIONS]. And we will go to Richard Shannon with Northland Securities.

Hi, Morris and Raymond. How are you?

Great. Hi, Richard.

Hi, Richard.

Hi. I guess my first question is on gross margins, a very good result for the quarter, but even more importantly the faults look pretty good. Morris, in your comments you mentioned higher utilization and product mix. Can you kind of handicap for us which one of the bigger drivers here and to the extent of which they are sustainable?

Well, I think utilization definitely is very important. As you know we have a certain fixed cost of our manufacturing and as our revenue goes to a certain threshold, then a gain of utilization of our capacities starts to contribute tremendously to our gross margin. I think product mix is important, but as our revenue coming from, for instance six-inch gallium arsenide as well as some of the germanium product and even LEDs are giving us good margin contribution. And as far as sustainability is concerned, well, I think as long as the revenue continues to be strong as we project it to be next quarter that I think that should carry to the next one.

Okay. And specifically, Morris what was your utilization in the third quarter and how do you expect that to trend in the fourth?

The utilization we saw in the third quarter is north of 70% and as we project the next quarter revenue to be above this quarter, so I would expect the utilization to be similar.

Okay. I guess one of the things I am trying to get to here is that you just reported very nice earnings number in the third quarter, revenues are going up and your EPS guidance is a little bit down. I am wondering if you are kind of telling us that gross margin would be a little bit lower because of lower utilization, but you just indicated that's going to be higher. So I guess I'd love to figure out how you're arriving at earnings guidance for the fourth quarter was a little bit lower?

Okay. Let me take a first crack at it and then Raymond probably. First of all, we do guide our number conservatively. And Raymond, do you have anything to say?

Richard, it is sometimes in the area of the other income, this time we had a $340,000 foreign exchange gain unrealized. We don't know what's going to happen in that market. The other things on income taxes, we actually got one of the joint ventures had a tax refund this time, which obviously we're not expecting again next quarter.

Okay. That's helpful. And Morris, can you give us an idea of how much your six-inch gallium arsenide sales grew in the third quarter? You indicated that there was a good area of growth, but how fast did those grow?

Raymond just handed me the number, 42.8%.

Up 42.8 sequentially.

Yes.

That's great. Okay. I guess the last thing for me, maybe I will jump out of line here. And Morris, I know one of the things that you would kind of focused on as you ascended to the CEO role here last few months is working on AXT's cost structure. Can you talk to us a little bit about kind of what ideas you've got about making AXT a little more efficient and where do you think it can go over the next one to two to three quarters or so?

Sure. I think since the last financial downturn, AXT took quite a big few steps to make our organization more efficient, so we're also seeing some of the benefit from that and we're also looking internally what are the areas that we can afford and where are the areas that we can spend less money and be even more efficient in terms of turning more to our bottom line. And some of these measures that Raymond and I are working on have not shown any results yet. I think it will start to show going forward in 2010 budget. But obviously we do have one last layer of management in terms of the COO position, I mean that has benefitted us somewhat, but I don't think in a very substantial way. But, I think going forward I do look forward to see a lean and more compact structure for us to have going forward in 2010 and beyond.

Okay, great. I appreciate that, Morris. I will step out of line. Thanks.

Next, we'll go to Amy Norflus with Pilot Advisors.

Hi, good afternoon. Raymond, congratulations on your promotion, well deserved. Can you talk about the joint ventures and try to maybe quantify how we look at them, I mean if we know that they are really good, they're strategic, and kind of open it up a little bit, and let us know a little bit more about them?

Sure. Basically, the joint ventures we have, we've got three non-consolidated -- two non-consolidated joint ventures. And then we've got three that are consolidated. Obviously, the ones that are consolidated on the books (inaudible) at cost and everything else is all eliminated. But, just to give an idea, we've got the 46% gallium producer. That return on investments has been almost three times our original investment, and that return has come in the form of dividends. Secondly, we have the second joint venture that's consolidated, that total processor, and they in fact have returned one and half times our original investment of almost $600,000. And thirdly our pBN crucible's raw material supplier and manufacturer, they have actually returned nine times our original investment. So, obviously on the books, you don't see that because all you see is actually the original investment at cost.

Let me add another example. Raymond just mentioned about this pBN crucible that returned nine times our original investment, and yet our other great return benefit for us is that this pBN, we used to pay almost 2.5 times to buy the same crucible when we were buying from other suppliers. And since we have this joint venture that they not only return profitability to us, they also reduced our cost of manufacturing from 2.5 times to 1. So, those are some of the great benefits that we have these joint ventures with.

Okay. Now, what about the non-consolidated joint ventures?

Yes, the non-consolidated, all their returns are actually in our equity accounting, and you will see that in other income. Just to give an idea, we invested in the germanium mine, that we have a 25% interest in the germanium mine in the Mongolia. We invested originally almost about $1 million. We've actually received $1.8 million return on our investment. But, that's already shown in the books as equity. And then the second joint venture that we have is also 25% in an arsenic operation. We've received only about a third of our investment back as a return.

Okay. Are you going to look to do more joint ventures or anything like that, or kind of what you have in the North?

Yes, absolutely. The promotion of Davis John, as I said before, he is going to -- we are going to put renewed focus into looking into new possible joint ventures to save our costs as well as establishing AXT as a major business opportunity in China, as the China economy is very robust going into the future.

So, basically you will have all of these products such that some of your competitors, if they want it, they would have to basically come through your joint venture because you have all of the supplies that ultimately...?

Yes, I think I can say that. I mean as far as, I mean, obviously our competitors not necessarily want to help us.

Obviously.

But, in terms of gallium, gallium is gallium, it has no face. So, when it is sold into the open market, it does -- part of it definitely flows into our competitors' supplies.

Okay. Is the germanium market how far away from any sort of real revenue, or ramping up of revenue?

Say it again.

The germanium market and the solar satellite?

Yes. Well, our joint ventures in the germanium are supplying major portion to us, well, not a major portion, but we do buy a lot of germanium from the -- well, I didn't quite catch your question.

I am sorry.

Can you repeat it again?

Well, okay. We added some capacity and there is some increased demand. I guess we are at the gestational part of the solar cell business and industry, and when does it really ramp up to become a meaningful part of our revenue stream? Is it months, years?

Yes, well, we are very happy to see the germanium market really expanded. Our revenue went from $1.2 million in Q2 to $1.8 million. So, that's a 50% increase. But, we see that most of these applications are still with satellite solar cell applications. I mean, that's good in terms of the high -- the satellite solar cell are high quality material and our customers are first tier solar cell makers. But, the terrestrial solar cell, however, has much greater potential for volume expansion. But, as I see it, we are still in the beginning of that cycle. And the terrestrial solar cell I think took a whack from the financial crisis loss because the credit starts tightened, and that slowed down the progression of the adoption of CPV market. But as I see it, the world is now focusing on green energy. I think CPV market will start to take off again as indications from our customers, they're seeing major increases in 2010 and 2011.

Okay. I'm sorry, can you repeat the capacity utilization you said in quarter three, and what was that for just the -- which business was that for? Was that just for the gallium business or that was for the total Company?

Well, we were seeing north of 70%, but it's probably an indication of average Company utilization. But, obviously for germanium, it's higher than 70%. But we're also expanding the capacity as we speak.

Okay. And capacity utilization for fourth quarter should be what?

It should be around 70% as well.

Perfect. I'll get back in queue. Thank you, and congratulations on your promotion, Raymond.

Thank you.

[Operator Instructions]. And we will go to -- for a follow-up from Richard Shannon.

Hi, guys. Let's see here, next question, a very quick one is just wanted to get a sense of in your gallium arsenide revenues for the third quarter, how much was semi-conducting versus semi-insulating.

It's roughly 50/50, right, Raymond.

Yes.

Yes, roughly, it's 50-50 semi-insulating and semi-conducting.

Okay. And what's your expectation for cash change in the fourth quarter?

Richard, I think if we continue to execute, we should look round about the same.

You mean, the cash should be flat with third quarter?

We generated $1.2 million in Q2 and $4.2 million in Q4. Obviously, if we just can continue operating at the same pace, we should generate cash again.

Richard, I think you know, since I've come on board, I have a directive to our manufacturing arm and saying that we have -- we should have a better control of our inventory. So, I have set directives to say what's the ratio, optimum ratio, of our inventory versus our revenue. And I think the third quarter has shown very good results. I mean although our revenue has increased substantially while our inventory stayed about flat.

And going forward, I still believe we still have room for improvement. But, what is going to be done this quarter or over the longer term, I think giving us some time, I believe we can increase our inventory turns to run this business. So, I do expect the cash to be positive. On the other hand, I think going forward, for next year, I do have a major initiative. I want to increase our capacity as well as improve our facilities to accommodate better engineering and better quality assurances to our customers. So, I do have a major budget going through the Board of Directors through next year, but even then I don't expect major usage of our cash. We should have plenty of cash.

Okay. And I guess last question from me is on IQE. Is Bob on the call with us today?

Yes, Bob is there.

Yes, Richard.

Hi, Bob, and congratulations on your promotion as well.

Thank you.

I guess kind of a two part question here is I know that you signed a contract from last year for I think a set revenue amount. Is that a contract you think will be fully realized this year, and what's your thoughts on...

Well, that contract goes out to the first quarter of 2010. So, we still have a net of five months in front of us or four months.

Okay.

So, things are looking pretty good on that contract, yes.

Okay. And then, what are your thoughts on being able to sign a follow-on contract with them?

Well, we haven't started the negotiations, but certainly that's something we will proceed with.

Okay. Is that something you are initiating negotiations some time this quarter, or is that getting closer to the completion of the contract next year, or how should we think about that?

Near the -- when it's nearly complete, that's when we have the negotiations on the contract. So, again, like I said, I still have another four, five months before I have to finalize it.

Okay. And generally, you feel like your relationship with IQE is strong, if not getting stronger?

It's still strong, no problem.

Okay, great. That's all I have. Thank you.

Okay.

Thank you, Bob.

[Operator Instructions]. And with no further questions in the queue, we will turn it back over to our speakers for any additional or closing remarks.

Thank you for participating in our conference call. We will be presenting at AeA financial conference in San Diego. I look forward to seeing many of you there. As always, feel free to contact me, Raymond, or Leslie Green directly if you would like to meet with us. We look forward to speaking with you in the near future.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation.