AXT Inc (AXTI) 2009 Q4 法說會逐字稿

Good afternoon, everyone, and welcome to AXT's fourth quarter and fiscal 2009 conference call. Leading the call today is Dr. Morris Young, Chief Executive Officer, and Raymond Low, Chief Financial Officer. My name is Nancy, and I will be your coordinator today. As a reminder, today's call is being recorded. I would now like to turn the conference over to Raymond Low.

Thank you, Nancy, 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, increase orders in succeeding quarters, improve 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 on 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 periodic reports filed with the Securities and Exchange Commission and are available online by link from our Web site for additional information on risk factors that could cause results to differ materially from current expectations.

This conference call will be available on our Web site at axt.com through February 23, 2011. 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 2009. This press release can be accessed from the investor relations section of AXT's Web site at axt.com.

Now, to the financial results. Revenue for the fourth quarter of 2009 was $17.8 million, compared with $16.8 million in the third quarter of 2009. Revenues in the fourth quarter included an $842,000 reclassifying entry that had no dollar effect on gross margin or net income. This entry had been previously classified as warranty expense instead of sales returns. As a result, gallium arsenide substrate revenue was $12.6 million for the fourth quarter of 2009, compared with $13.3 million in the third quarter of 2009.

Indium phosphide substrate revenue was $513,000 for the fourth quarter of 2009, compared with $688,000 in the third quarter of 2009. Germanium substrate revenue was $1.9 million for the fourth quarter of 2009, compared with $1.8 million in the third quarter of 2009. Sales of raw materials, primarily 99.99% pure gallium, were $2.8 million in the fourth quarter of 2009 compared with $1 million in the third quarter of 2009. In the fourth quarter of 2009, revenue from North America was 22%, Asia-Pacific, 61% and Europe was 17% of total revenue. Only one customer generated more than 10% of our revenue during the fourth quarter, while the top five customers generated 39.5% of our fourth quarter revenue.

Gross margin was 33.9% of revenue for the fourth quarter of 2009. This included a benefit from the net sale of approximately $727,000 in fully-reserved wafers, which positively affected the quarterly gross margin by 4.1 percentage points. By comparison, gross margin in the third quarter of 2009 was 32.9%, which included a benefit from the net sale of approximately $94,000 in fully-reserved wafers, which positively affected the quarter gross margin by 0.6 percentage points.

Selling, general and administrative expenses were $2.6 million for the fourth quarter of 2009, compared with $3.3 million in the third quarter of 2009. Research and development costs were $394,000 for the fourth quarter of 2009, compared with $360,000 for the third quarter of 2009. Total stock compensation expense was $89,000 for the fourth quarter of 2009, of which $8,000 was included in cost of revenues, $77,000 in SG&A, and $4,000 in R&D.

Income from operations for the fourth quarter of 2009 was $3.1 million, compared with an income from operations of $1.9 million in the prior year quarter. Net interest and other income for the fourth quarter of 2009 was $152,000, which included an unrealized foreign exchange loss of $140,000, compared with net interest and other income of $638,000 for the fourth quarter of 2009, which included an unrealized foreign exchange gain of $302,000. Net income in the fourth quarter of 2009 was $2.8 million, or $0.09 per diluted share. By comparison in the third quarter of 2009, we reported net income of $2.1 million or $0.07 per diluted share.

Let's now look at our cash and the balance sheet. Cash and cash equivalents with maturities of less than three months, short-term investments and other investments in high-grade debt securities with maturities of less than two years were $35.4 million, at December 31, 2009, compared with $37.8 million at September 30, 2009. During the fourth quarter, we generated cash flows of $624,000, but had scheduled paying down our $3 million line of credit. Accounts receivable, net of reserves, were $15.4 million at December 31, 2009, compared with $14 million at September 30, 2009.

Days sales outstanding was 76 days for the fourth quarter, compared with 76 days for the third quarter of 2009. Net inventory was $27.7 million at December 31, 2009, compared with $28.8 million at September 30, 2009. Depreciation and amortization in the fourth quarter was $749,000, and capital expenditures were $1.4 million. As of December 31, 2009, the Company, including our consolidated joint ventures, had 1,091 total employees of whom 867 worked in production. This includes our review of our results for the fourth quarter. I will now turn the call over to Morris. Morris?

Thank you, Raymond. The fourth quarter was another positive quarter for AXT. While we experienced a modest drop in our reporting substrate revenue in the fourth quarter as a result of the accounting reclassification that Raymond mentioned, our substrate sales actually increased in Q4 from the prior quarter. In addition, our successful restructuring efforts and ongoing manufacturing efficiency improvements resulted in solid financial results that were ahead of our expectations.

Further, our qualifications with our new customer and returning customers continue to progress very well, as we have committed increase funding to our engineering and customer support efforts. We are also seeing positive long-term trends in each of our key markets that are likely to support our growth in 2010 and beyond. AXT is well positioned to accommodate this increasing demand with minimal capital requirements and we believe that our unique structure will further separate our capabilities from our competitors as all our markets develop.

Since taking over as CEO in July of last year, a key focus of mine has been to better leverage the benefits of our unique structure and lower our cost manufacturing -- the lower cost manufacturing capability. I'm very proud to report that in the last six months we have succeeded in reducing our total operating expenses while focusing our spending on strategy carriers that would generate revenues and reduce costs over time. For example, we are now well on our way to increasing our engineering team in China by nearly 30% while still lowering the overall cost structure for AXT. These additional engineers are being utilized to strengthen our effort in three strategic areas, customer qualification, manufacturing improvements and new product development.

In customer qualification, we are working to respond more quickly and effectively to customer specification requirements so that we can take part in a greater portion of the market we serve. While we have been effective in delivering consistent quality and performance, it is the unique aspect of our customer specification that can require additional engineering support on our part. Our ability to scale our engineering organization cost-effectively to enhance our customer support is a tremendous advantage for our China-based facility. Our effort in this area are already benefiting AXT in terms of overcoming issues that have kept AXT from competing in certain customer qualification in the past.

In terms of our manufacturing, our focus is on enhancing our efficiency and the yields in every step of our process, including crystal growth, slicing, polishing, among others. We believe that we have strong leverage in this area and improvement in our process allowing us to offset normal ASP declines while maintaining appropriate corporate margin for our business.

And finally, we are very excited about our engineering efforts in new product development. We believe that one of the most significant product that we are expecting to develop this year is a 6-inch VGF germanium product to serve the terrestrial solar cell market. Not only was this product set -- can set us apart from our competitor, it will also help us to significantly lower the cost of CPV solar cells, making the technology more commercially available. Our customers are telling us that the development of a 6-inch germanium substrate is a key step in the process of opening up the terrestrial solar cell market, which has potential to far exceed the side of -- the size of satellite solar cell market. We believe that VGF technology is a significant advantage in producing large diameter germanium substrates, because VGF technology produces substrates with better mechanical strength, a critical characteristics in making substrate breakage -- in minimizing the substrate breakage.

In addition to reorganizing the Company and strengthening our engineering team, we have also put in place employee retention programs to ensure that we not only attract the highest quality employees but also retain them. China is an increasingly competitive market for talent. We believe that strong incentives and career path opportunities are essential to maintaining employee enthusiasm, productivity and longevity. Here again, being located in China allows us to provide meaningful programs for our employees at a rate that is cost-effective for the company. We are very encouraged by the quality of talent that we are able to recruit, and we believe that we have a great team in place to take AXT to the next level of success.

Turning now to our markets. We are very encouraged to see growth potential across every area of our business in 2010. With semi-insulating gallium arsenide substrates, in the past year and a half we have seen tremendous growth in the end market applications for our product as the wireless market is beginning a major upgrade cycle from 2G to 3 and 4G networks. A flood of new wireless-enabled products that require HPT and PM devices are being introduced, including not just handsets but smartphones, netbooks, smartbooks, personal entertainment units and other wireless devices. The worldwide infrastructure upgrades to 3G and 4G networks coupled with expo - - potential growth in available mobile applications and services will likely drive the popularity of all these devices for many years to come.

Strategy Analytics said last month that the smartphone market alone grew 32% year-over-year in December quarter, and according to Infomatics, smartphones are on track to post a 21% compounded annual growth rate through 2013. In addition, the nation's netbook and smartbook markets are expected to see strong growth over the next several years. Our exposure to all of these applications is very broad based, as we supply directly or indirectly to virtually all major players in our space.

In addition to the growth of the market, we are also continuing to gain market shares through increased penetration at existing accounts and new positions at accounts that may not have used our product for some time. Our enhanced engineering support as well as our competitive value proposition is likely to continue to drive our market share throughout the year. Our ability to ramp capacity is a very beneficial to both larger accounts that needs to be assured of adequate supply as well as smaller account that see increased volume and needs to ramp accordingly.

Turning now to semiconducting gallium arsenides. The LED market is experiencing tremendous growth in a broad range of applications such as backlighting, signage, general illumination and automobile. LED-based products are becoming increasingly common, as the technology offers tremendous benefits in terms of costs, efficiency and performance over other technologies. We continue to hear news that manufacturers of blue and green LEDs are reporting strong demand, and these data points are supported by estimates from Strategy Analytics that more than 500 MOCVD reactors are likely to be shipped in 2010. The strong demand for blue and green LEDs also bodes well for red LEDs, as most applications require all three colors. Red LEDs are most cost-effective when produced on semiconducting gallium arsenide substrates such as ours.

AXT has historically focused its effort in high-end market, and while we are continuing to do so, we are exploring opportunities to participate in the low-end markets as well. This billion-dollar market is geared today toward novelty products and is therefore very margin constrained. However, volumes are very high and growing very rapidly. In the future, we believe that this market will provide the entry into general illumination applications, as these applications will need lower cost LED devices in order to gain critical mass. Significant product development is underway for industry leaders such as OSRAM and others to create affordable LED-based light bulbs, and we believe that will be important to have a presence in this market as it develops.

Providing that our business remains as robust as expected in higher-margin market such that our fixed costs are covered, we may take the opportunity to selectively participate in the lower-end market as a way of establishing our presence as well as driving volume and incremental dollars to our bottom line. Once again, our unique lower-cost manufacturing capability in China gives us the option to explore opportunities in this area. We remain committed to maintaining a corporate gross margin of the low to mid-30 percentage range and will therefore continue to evaluate the business potential of this new market and how it might fit into our overall strategy.

The market for our germanium substrate continue to develop into a very exciting growth market for AXT. We were very pleased to do -- to be able to announce last month our five-year multimillion dollar contract with Azur Space, one of the top three solar cell manufacturers in the world. This contract is the result of a collaboration of our two companies that has enabled Azur Space to obtain a industry leading 40% conversion efficiency rate in CPV terrestrial solar cell and a 30% conversion efficiency rate in space solar cells. Azur's desire to commit to a substantial contract demonstrate that quality and consistency of our germanium substrates underscores the market potential for solar cells over the next many years.

We believe that it will also open doors for us with other major customers, allowing us to develop market share in these emerging markets. To date, the solar cell market has been driven primarily by satellite applications and is currently valued at approximately $50 million annually. Our market share in this space is relatively small, leaving us plenty of room for growth. In addition, over the next several years we expect to see a shift in this market towards the emerging terrestrial solar cell market. Strategy Analytics estimate that the terrestrial market will see significant growth in the next several years. This represent meaningful total addressable market expansion for AXT, and given the limited competitive landscape, our strong product portfolio and our unique joint venture agreement with germanium raw materials, we have strong confidence that this market will present significant opportunity for AXT.

Further, we are very committed to the development of 6-inch germanium substrates this year and believe that this product will come to market at a ideal time when the terrestrial CPV market was just reaching early commercial viability. AXT has always been a leader in the development of larger diameter substrates, and our VGF technology and significant technical experience will allow us to drive our product road map to meet industry demand.

Finally, turning to raw material. During the fourth quarter, our raw material revenue grew to $2.8 million from approximately $1 million in the prior quarter. This growth was primarily driven by the demand recovery outside of what AXT, consumes as we believe that inventory levels at our joint ventures customers has become fairly low. Going forward, we expect to see strengthening demand in 2010, but quarter-by-quarter our revenue is expected to be some what lumpy.

In closing, this is a very encouraging time for our Company. For the first time in many years all our markets are primed for growth in 2010. Further, we have been very disciplined in our spending and are focusing our resources in areas that would allow us to develop our business and maximizing our opportunities today and in the future.

I want to extend my sincere gratitude to our employees, who have managed the business through a lot of changes this year, and those dedications and commitment to common goals of excellence made 2009 a very successful and productive year. I would also like to thank our customers and our investors for their continued support and interest in AXT. I will now turn the call back to Raymond to discuss forward-looking guidance. Raymond?

Thank you, Morris. As Morris mentioned, we are expecting to see growth in our substrate revenues in the first quarter, despite the fact that Q1 is traditionally a seasonally weaker quarter for substrates. This growth in substrate revenue will be partially offset by sequentially lower expected raw materials revenue. Therefore, we expect total revenues of between $17.8 million and $18.5 million. We are expecting net income in the first quarter of between $0.04 and $0.07 per share based on approximately 31.7 million common shares outstanding. This concludes our prepared comments. We are now happy to answer your questions.

Thank you, sir. (Operator Instructions). We will take our first question from Richard Shannon from Northland Securities

Hi, Morris and Raymond. How are you?

Very good.

Great, Richard.

Great. Congratulations on the very nice numbers and guidance here. A few questions for me. First of all, Raymond, in your initial comments you said something about gallium arsenide being down in the fourth quarter for reclassification. Could you repeat that? I missed part of the explanation there.

Okay, it's -- we just had a reclass between warranty expense and sales returns. There no dollar effect on the gross margin nor net income.

Okay. But was there an effect on revenues then?

Yes - -.

Okay. How much was that?

- - so as a result - - in total it was $842,000.

Okay. Great. And then also in the fourth quarter in raw materials. Interested in the difference between the growth there as it comes from either units or ASPs. Have you seen much improvement in pricing, or is this largely a unit-based growth here in the fourth quarter?

It is mostly a unit growth. And pricing is sort of stable.

Okay. You see any prospects for that pricing increasing here in the near future, or are you kind of viewpoint flattish for the time being?

Well, I think it is probably leveled, but we think it is poised to grow, because I think the demand is starting to pull the price up. But, however, I think it is stable right now.

Okay. Great. And then the very nice guidance for the first quarter, even despite your comments about raw material being down is very nice. Kind of curious what's the driver of that? Are we seeing this mostly coming from the gallium arsenide, or what is the source of this improvement?

Right. I mean - - the raw material obviously -- the business itself probably will grow, but because we are going to consume more of this raw material ourselves, which doesn't count as revenue, such that the raw material reportable in our guidance is down sequentially. But substrate business we do expect it to grow.

Is that coming from gallium arsenide or --?

Yes, just about every [segment].

Okay. And would it be fair to assume that both semi-insulating and semiconducting are contributing to that?

Yes.

Okay, well very nice. Next question, on raw material access, do you feel like that you are getting -- you are going to have enough raw materials to supply your growth plan, as you go throughout 2010, from your joint ventures or other sources you have lined up, or --?

Yes.

So there is no near-term need for you to acquire any other sources?

Well, we usually have at least two suppliers, other than our joint ventures. So we don't put all our eggs into one basket.

Okay. And I guess my last question maybe, and I'll jump out of line here. Morris, this question is mostly regarding your gallium arsenide business, and if you could differentiate between semi-insulating and semi-conducting, that would be great. Kind of curious about your prospects, your viewpoint on being able to gain some more share. You referenced the nice growth that exists in both of those markets in 2010, but also curious about the extent of which you think you can gain some share in either of those markets as well?

Well, as I pointed earlier, I think gallium arsenide semi-insulating we do definitely see a upward trend towards all the 3G and 4G and all the smartphone devices, and everybody saying they gonna need more power amplifiers. So I -- we believe that this market is going to grow for many years to come - - this upgrade cycle. And I think we also can expect to gain market share because we have advantage that we have lower cost base, and AXT is the only company who have consistently throughout the years increased the capacity, especially on 6-inch products. So we have been able to gain market share. We do expect to continue to gain market share.

Okay, great. I will jump out of line again. Congratulations, once again.

Thank you.

And we will take our next question from Amy Norflus from Pilot Advisors.

Hi, guys. Great quarter. Can you talk about the SG&A in the quarter and explain, I mean, is it because we sold so much raw materials there was not SG&A associated with it? Or are these just costs that have come out of the business? Or --?

No, Amy, it is actually a concerted effort to drive down the SG&A.

So going -- (multiple voices) -- so what does that mean going forward, and how should we view SG&A? And can you maybe talk about some of the things that you have done that are not going to come back?

I think the SG&A in total we definitely looking at approximately $3.5 million. We actually had reported SG&A before; however, there were certain items that will not be repeated in the future.

Okay. And then can you go into a little bit more details about the qualifications and the new customer, the returning customers committed? Can you kind of give us a little bit more on that? Which businesses they are in, what we might expect, the time frame, all of that?

Well, Amy, it is really very difficult to talk about customers specifically. But also, Amy, really, I'm not trying to avoid the question, but there is a lot of activities going on, including -- germanium obviously is a very active market. We are also getting into new -- well, I mean they are not new gallium arsenide customers, but they used to be our customers and now we are getting back to them. So that is the other front. And indium phosphide, believe it or not, is starting to heat up. We have not talked about in our conference call, but -- because basically the revenue base is relatively small, so we save it for next quarter or next year perhaps. But that market is also growing. So we do have a lot of activities, but customer specific it is really difficult to talk about.

Well, so I mean maybe you could talk about it, whether in the gallium arsenide business, is it going to be more in the handset business growth or more in the LED growth?

In LED growth we definitely have a specific target there. We are targeting the China sort of low-end market. We have committed to part of our capacity to address that market, and we said in our conference call that although the margin of the selling price may be a little bit lower and the gross margin is lower than corporate average, but because that we have been able to take care of the fixed costs by other higher-margin businesses, so the incremental margin contribution or profit contribution to our bottom line is there. So that we do see it to start to make a revenue contribution and bottom line contribution, starting from next quarter and more significantly towards second half of this year.

And in handsets, well, we obviously are very focused in that market. We are also seeing quite a few potentials, but of course it is difficult to estimate how big or how much incremental is going to be. We do have going forwards what next quarter's revenue is going to be, but it is very difficult to break it down to say, hey, customer X is going increase by how much and because of a qualification effort.

Okay.

I don't know if I answer most of the question you asked.

Okay. And when you talk about the gross margin and you talk about like the fully-reserved wafers affecting the gross margin. Are you going to give us that every quarter, or what -- I mean, how do we factor all this in, and what does it really mean to us?

Amy, as I said many times before, if you look at our past record, we have been doing this business for, I don't know, maybe 10 or 15 quarters. Every quarter it is between $400,000 and $700,000, depending upon the quarters. Part of the interesting business is also that we keep on putting into this fully-reserved pot anyway. And this fully-reserved pot is relatively large, and of course there is no guarantee what the value is going be, but by now I think every investor should know that we will have a fully-reserved revenue contribution for our bottom line. So we do expect that to come, but it is difficult to estimate what it is.

Okay. Perfect. I'll get back into queue, thanks.

(Operator Instructions). We will take our next question from Bill Kitchel from Millrace Asset Group.

Thank you. Great quarter. I wondered if you could just expand a little bit on the cost controls and the tremendous work you have done on containing costs. You've made much -- achieved much more leverage this quarter than I would have thought. You talked a little bit about the move to China with 30 engineers, and maybe, Morris, if you could just kind of elaborate on the direction or target margin structure that you are directing the business to?

Bill, thank you. Absolutely. I think we are committed to at least -- well, not at least, but we are maintaining good margin for our business, because it is very healthy for us to maintain our business. And we are having a lot of programs, including our cost structure in terms of how many engineers are based in America versus in China. As we demonstrated to you before, one engineer here probably will worth something like seven or eight China-based engineer. And with proper training, with proper guidance, they are just as productive or even more.

And so last year we made the transition. I think we increased our China-based engineer tremendously. And we believe that we will continue to do that, because we see that not only we can save money, but also it will actually drive revenue and get our customer qualification process more quicker and get more business for us.

We also have a lot of program to reduce our cost. VGF is our core competence. We invented VGF 25 years ago. I keep on saying to our investors our VGF is different from a lot of our competitors' VGF. We have been able to leverage every step of the way to reduce costs, and we have still been able to reduce our costs. As you know, most of our product gallium arsenide, the price do go down. The ASP do -- we do expect a normal decrease, but we have been able to maintain our gross margin. It's because we have been able to improve our yield, improving our efficiency, and we believe we have more to come. And in order to meet competitive demand our customer always want cheaper product with better capacity and better quality, and we have been able to do so.

I think it is overall. We do need to look at overall areas of expenses, and yet our other area is consultants. Specific areas of consultants are okay, but usually consultants are very expensive, and Raymond has a very good program to cut costs in some of those area for me. Those are not gross margin items, but they are much rather SG&A items.

That is great. I wonder if you might expand a little bit on the proprietary position you have with the VGF technology, and how that enables you to lead the industry to lower costs?

Sure. Maybe I'm preaching to the choir. I mean you know AXT has moved to China and that is a great advantage. I mean first of all, the labor cost is lower. It shows that we can have 30 engineers that is probably equivalent to maybe four or five Japan- or Germany-based engineers. And those 30 engineers can be very productive in terms of tweaking the processes to increasing yield and improving efficiencies for our processes. So that in turn would drive our cost down lower.

And yet our other cost advantage is that, Bill, that we do make our VGF furnace ourselves. That is a tremendous opportune -- advantage for us, because from what we know that the European VGF furnace sells for somewhere around -- over EUR350,000 per piece. And we last checked, the Japanese VGF furnace ranges from $250,000 to $350,000. Our cost of VGF is a fraction of that. I mean, way below. And yet the facility costs.

So all this is showing that VGF is better. The fact that we moved to China is better. The fact that we are China based, that we have JVs, which can give us leverage in terms of lower cost of raw materials is better. And yet, another example is that Azur, who recently showed such a good faith in AXT. That AXT used to be nothing in the germanium market. They are the world-class number three or two germanium player. They came to AXT, recognizing VGF technology is better. And they selected AXT to be a partner to going forward, not only for their space application, but also in their terrestrial applications.

Well, congratulations and thank you.

Thank you, Bill.

(Operator Instructions). And we will take our next question from [Steve Hube], who is a private investor.

Hi, I have a question regarding the competitive situation. I notice you have a few large Japanese competitors. Have you seen like smaller competitors whose - - like a major they sell like mainly in like gallium arsenide and like germanium - - like smaller competitors and also based in like China or lower-cost countries?

Yes, I mean there are, everybody knows that gallium arsenide, especially for LEDs, has a very strong demand, and germanium is heating up very fast. So people are interested in these markets. And there are Chinese competitors developing. But as we see at this time now, they are relatively small. And it will take them quite some time to develop the technology and their market.

And at this time it appears there are no further questions. Dr. Young, I would like to turn the conference back over to you for any additional or closing remarks.

Thank you. Thank you for participating in our conference call. We will be presenting at the Jefferies 4th Annual Global Technology Conference on March 8th and looking forward to seeing you -- many of you there. As always, please 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.

That concludes today's presentation. Thank you for your participation.