AXT Inc (AXTI) 2011 Q1 法說會逐字稿

Good afternoon everyone and welcome to AXT's first quarter 2011 financial conference call. Leading the call is Dr. Morris Young, Chief Executive Officer, and Raymond Low, Chief Financial Officer.

My name is Abraham and I will be your coordinator today. As a reminder, today's meeting is being recorded. I would now like to turn the call over to Leslie Green, Investor Relations for AXT. Please go ahead.

Thank you Abraham and good afternoon everyone. Before we begin, I would like 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, among other things, regarding 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 on management's current expectations, and are subject to risks and uncertainties that could cause actual events or results to differ materially. These risks and uncertainties include, but are not limited to overall conditions in the market in which the Company competes, global financial conditions and uncertainties, market acceptance and the demand for the Company's products, the impact of delays by our customers on the timing of sales of products.

In addition to the factors that may be discussed on this call, we refer to you the Company's periodic reports filed with the Securities and Exchange Commission and available on-line by link from our website, for additional information on risk factors that could cause actual results to differ materially from our expectations. This conference call will be available on our website at AXT.com through May 3, 2012. 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 first quarter of 2011. This press release can be accessed from the Investor Relations section of AXT's website at AXT.com.

I would now like to turn the call over to Raymond Low for a review of the first quarter results. Raymond?

Thank you Leslie. As expected, revenue for the first quarter of 2011 was $24.6 million, compared with $26.9 million in the fourth quarter of 2010. Total gallium arsenide substrate revenue was $15.9 million for the first quarter of 2011, compared with $18.7 million in the fourth quarter of 2010. Indium phosphide substrate revenue was $1.3 million for the first quarter of 2011, compared with $1.1 million in the fourth quarter of 2010.

Germanium substrate revenue was $3 million for the first quarter of 2011, compared with $3.4 million in the fourth quarter of 2010. Raw materials sales were $4.4 million for the first quarter of 2011, compared with $3.5 million in the fourth quarter of 2010.

In the first quarter of 2011, revenue from North America was 15.4%; Asia-Pacific was 63.5%; and Europe was 21.1% of total revenue. Only one customer generated more than 10% of our revenue during the first quarter, while the top five customers generated 36.5% of our first quarter revenue.

Gross margin was 43.4% of revenue for the first quarter of 2011 as a result of favorable revenue mix and strong execution in the quarter. By comparison, gross margin in the fourth quarter of 2010 was 39.8% of revenue.

Selling, general, and administrative expenses were $3.7 million for the first quarter of 2011, compared with $4.2 million in the fourth quarter of 2010. Recall in our last conference call our fourth quarter 2010 had onetime charges associated with severance costs and legal fees.

Research and development costs were $505,000 for the first quarter of 2011, compared with $911,000 for the fourth quarter of 2010. Fourth quarter 2010 research and development costs were unusually high, as one of our joint ventures embarked on research and development projects that required additional investment.

Total stock compensation was $207,000 for the first quarter of 2011, of which $20,000 was included in cost of revenues, $176,000 in SG&A and $11,000 in R&D. Income from operations in the first quarter of 2011 was $6.5 million, compared with income from operations of $5.7 million in the fourth quarter of 2010.

Net interest and other expense for the first quarter of 2011 was $276,000. Net income in the first quarter of 2011 was $4.2 million or $0.13 per diluted share. This compares with net income of $4.9 million or $0.15 per diluted share in the fourth quarter of 2010.

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 $38.5 million at March 31, 2011, compared with $41 million at December 31, 2010. Accounts receivable net of reserves were $19.2 million at March 31, 2011, compared with $23.1 million at December 31, 2010. Days sales outstanding were at 70 days for the first quarter, compared with 79 days for the fourth quarter of 2010.

Net inventory was $39.7 million at March 31, 2011, compared with $36 million at December 31, 2010. The increase in inventory was largely driven by raw materials. Looking forward, we expect to reduce our inventory by the end of the year.

Depreciation and amortization in the first quarter was $815,000 and capital expenditures were $2.7 million. As of March 31, 2011, the Company, including our consolidated joint ventures, had 1,342 total employees, of whom 1,044 worked in production.

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

Thank you Raymond. Our first quarter revenue results reflected the seasonality that we had guided for. However, optimal revenue mix and our successful raw material purchasing strategy allowed us to achieve our highest gross margin performance in many years.

As we move into Q2, we're very pleased to see solid demand for our semi-insulating and semiconducting gallium arsenide substrate from our traditional markets and we are making good progress in our plans to further penetrate strategically important emerging markets for our products.

Our unique business model continues to provide us with exciting growth opportunities, positioning us well for continued expansion in 2011.

Before I begin discussing each of our key markets, I would like to take a moment to update you on the potential impact we see from the earthquake and tsunami in Japan. I want to first extend my sincere condolences to all those who have been affected by this tragic event.

From a business perspective, most would agree that this continues to be a somewhat fluid situation. AXT typically derives approximately 12% of our revenue from Japan, although we believe the end markets for these products are global. Four of our competitors and several raw material suppliers are also located in this region and it is not clear yet the extent to which their business may be affected.

In Q1 we believe that our semi-insulating gallium arsenide revenue from Japan were negatively impacted by this event, while our semiconducting gallium arsenide and indium phosphide businesses may have been experiencing some increased order activity. AXT has ample capacity to accommodate increased orders from any customers who may be affected by the destruction.

On the supply side, the majority of the raw material used in manufacturing of our products are supplied through our China-based joint ventures and we do not expect any effect at all on manufacturing.

Now turning to our markets. In semi-insulating gallium arsenide, as we discussed, we have experienced a seasonality in our sales in Q1, as well as some impact from Japan as I mentioned. However, heading into second quarter we are seeing a pickup in our order activity across all product lines, leading to our sequential growth expectations. Our customers are indicating that they are planning for meaningful growth throughout 2011 and may have announced capacity increases to accommodate continued strong demand for wireless components.

As we have discussed, a key driver for this market is the rapid adoption of 3G and 4G LTE phones, which utilize more gallium arsenide content in order to provide greater speed and more capability to accommodate bandwidth-hungry applications such as video. In addition, many tablets also have wireless components that utilize gallium arsenide. According to Gartner's Research, worldwide tablet sales are expected to increase from approximately 20 million units in 2010 to more than 200 million units in 2014.

The strong adoption rate of smart phones, tablets and other wireless devices should continue to drive gallium arsenide usage for years to come as there's no other material that can meet the performance over cost ratio.

In semiconducting gallium arsenide, sales to Taiwan in the first quarter finished approximately flat from the prior quarter with sales to the rest of the world coming in stronger. As I mentioned, we believe that we likely experienced some benefit from the competitive landscape as the result of events in Japan.

In addition we also believe that we are making progress in one of the key geographic targets for semiconducting substrates; China. The market in China for substrate used in red LEDs is currently valued at approximately $35 million and are growing very rapidly as the result of government support for LED manufacturing and strong domestic demand for a variety of LED applications. We believe that over the coming years, China will become an increasingly strategic market for us and we're committing significant resources to strengthening our competitive position.

Earlier this year we formed a cross functional LED team specifically focused on China. We now have dedicated engineering, sales, manufacturing resources that are working closely together to address the stringent product specifications and requirements of this geographic region.

With our VGF expertise, China-based manufacturing and raw material joint ventures we believe we are in a very strong position to take an early lead in this emerging market. Further, we believe that we can leverage these products and cost improvements to address additional exciting opportunities in the Taiwanese and Japanese market as well.

Unlike the market for semi-insulating gallium arsenide which is primarily used in wireless devices, the applications for semiconducting gallium arsenide are much more diversified. The largest applications that we sell into include traffic lights, automobile instrumentation, automobile tail lights, cell phone backlighting, coffee machines, remote controls, signage, display and novelty products.

In addition, we sell into many other applications that are more specialty in nature such as printers and night vision goggles. And we sell into a number of emerging applications such as LED TVs and general illumination. This wide range of application results in a wide range of product specification.

We're currently focusing our R&D efforts on conforming our semiconducting gallium arsenide substrate to additional products and customer requirements in order to maximize our competitive positioning. We believe that the number of red LED applications and their volume will continue to grow over time.

In total, we believe that we will continue to see healthy growth in our semi-insulating and semiconducting gallium arsenide substrate business as the secular trend that we play into remains strong and we are executing very well to build and diversify our customer base and product applications. We have nearly doubled our capacity over the past two years, which allows us to continue to scale our business with market demand across all product lines.

Further, I am very pleased to report that we are in the final signing stage of our new 80,000 square foot building in our Tongmei property and expect to break ground in the next few months. This will give us significant room to grow over time, supporting additional demand for years to come.

Turning to germanium. We continue to see solid revenue contribution from solar cell customer from satellite programs throughout Europe and Asia, as a number of countries are investing in geopositioning and communication systems. We're continuing to focus on expanding our geographic qualifications and are very pleased by customers' response to our substrates.

In the terrestrial CPV market, many of the largest customers in this space have indicated an interest in our six-inch germanium substrates, which we successfully brought to market in 2010. The migration to six-inch germanium is a critical part of making CPV commercially viable as it significantly improves the cost structure for this emerging technology. While we do not view the terrestrial market as a major growth driver for this year, we believe that 2012 will be a pivotal year for terrestrial solar technology; and VGF-based six-inch product will position us very well for growth when the market begins to take hold next year.

In raw materials we experienced an increase in our third-party sales in the first quarter. This came primarily as a result of higher raw material prices and the capacity increase at JiYa, our largest gallium joint venture, which allowed for more product to be sold on the open market. With the growing demand for raw materials, all of our joint ventures are adding capacity this year.

Currently the price of raw gallium is close to $1,000 a kilogram and germanium is approaching $1,500 a kilogram. Our joint ventures allow us to mitigate some of the effect of the increasing raw material pricing which is likely to continue throughout this year.

However, many of our investors have asked us at what point do raw material prices begin to negatively affect our gross margin. Therefore, I want to take a moment to talk about our business model.

There are many factors that contribute to our gross margin performance, including demand environment, revenue mix, raw material costs, the substrate pricing environment and strategic decisions that we make from time to time to improve our competitive positioning within a specific market, customer or application. No single factor drives our model. Rather all of these factors play a role in the equation.

But since many of our investors are particularly interested in the raw material pricing, I want to explain how we are impacted both negatively and positively in this environment. As you may know, raw materials are the single biggest cost in manufacturing of our products, so a dramatic increase such as we have seen for the past year has the potential to be disruptive to our gross margin. Therefore, having an effective strategy to manage fluctuation in this cost is essential for our margin protection.

Our five joint ventures which supply all of our critical raw materials are a key component of this strategy, as they provide us, among other things, with great visibility into raw material pricing trends. By being able to see early pricing trends, we can increase or decrease our inventory in strategic ways that allow us to mitigate some of the effects of large pricing fluctuations. You've seen this in our inventory levels over the past few quarters.

In addition, the raw materials that we do not consume ourselves are sold on the open market, benefiting our financial results. When raw material prices go up, we benefit from good revenue and margin contribution from the third-party sales of these materials. When prices go down, we benefit from lower raw material cost for our substrate business. The bottom line is, the price of raw materials is not as impactful to our margin performance as our success in executing strategic buying practices.

In addition to this unique raw material strategy, our model also benefits from low-cost China-based manufacturing and proprietary crystal growth furnace that we built internally. This allows us to manufacture our product in a lower cost environment and scale our business more quickly and cost effectively than our competitors. These factors, coupled with strong sales success and outstanding operational execution, continue to drive positive margins for our Company. We believe that we should be able to continue to achieve our target gross margin of high 30% range or better.

In closing, we are very encouraged to see growth indicators across all of our businesses. As predicted, our semi-insulating gallium arsenide sales are strengthening again and we're seeing continued growth in semiconducting gallium arsenide. We continue to execute well in the operation of our business, exemplified by our excellent manufacturing efficiency and strong margin performance. As a result, we believe we are well positioned for revenue and earning expansion in the quarters and throughout 2011.

I will turn the call back now to Raymond to discuss the forward-looking guidance. Raymond?

Thank you Morris. As a result of expected growth in semi-insulating and semiconducting substrate demand in the second quarter, we expect total revenues of between $26.5 million and $27.5 million. We are expecting net income in the second quarter of between $0.13 and $0.16 per share, based on approximately 33.4 million shares outstanding.

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

(Operator instructions) We will take our first question from Richard Shannon with Northland Capital Markets.

Congratulations, some nice numbers and guidance. I guess I've probably got a few questions on gross margins and Morris, thanks for addressing some of that proactively. Maybe a two or three-part question here.

I guess in the first quarter obviously gross margins looked very good and raw materials seem to be a strong driver of that. Were there any additional improvements coming from any lower cost inventory flowing through there or other efficiencies that might have driven that as well or can we attribute that almost entirely to raw materials?

Let me take that first and Raymond can definitely add on to the numbers. But I really think, Richard, you shouldn't discount, as we said in our prepared segment, our margin is a combination of many things. I can't help to tell you how much we're increasing the length of the crystals and the efficiency in our slicing operations and our cost effective way of doing a lot of our businesses; as well as our customers are liking our products; and opportunistically we're increasing price because raw material is really having a big increase in price.

So I think it's a combination of things. Yes, you're right; raw material did increase in price which benefited us from the joint venture point of view. Raymond, you want to add on to that?

Richard, I think there's so many different factors that play a part in gross margins and all of them just collectively put together makes up our business model of gross margins.

Okay. Another question on gross margins, I think Morris we have talked in the past; you have talked about this in terms of your proactive purchases of inventory at lower prices last year. It seems like you've done that even a little bit more in the first quarter.

But I guess in terms of the inventory that you purchased last year, when does this finish flowing through the COGS and when could we start to see -- at least on your substrate side of your business, start to see some impact from that? Is that starting in this quarter or is it in the third quarter or any sense of when that will come out?

Again Richard, you have to remember, if we're going to buy more material, I mean gallium is $1,000 a kilogram and that is definitely a negative. But remember, we have strategically purchased quite a bit of raw material and if we can manage this raw material correctly, we should be able to protect our margins going forward.

And if any more materials when they're purchased is going to be into the average of the low-cost material in the pool already. And hopefully that we can actually do this program right and we can start to bleed some of this inventory as we see if the prices will start to stabilize.

Fair enough. A couple of questions on gallium arsenide. Do you have a split of the semi-insulated versus semiconducting in the first quarter?

Yes. This time it was semiconducting to semi-insulating of 54% to 46%.

Okay; all right. And then you also mentioned an impact in the first quarter on your semi-insulating side in the negative way from the events that happened in Japan. Is there any way you can quantify that for us?

No.

Okay. Did you mention the geographical splits? If you did I missed that one; if you have that in front of you, that'd be great too.

Let me add on to that while Raymond is looking for that number. Although I said no, but I think it's a temporary postponing of that order. The customer decided that they would start to take it later on.

Okay.

Revenue from North America was 15.4%; Asia Pacific was 63.5%; and Europe was 21.1%.

21.1%, okay, great. Then just last question and I'll jump out of line. In terms of your revenues implied in your guidance for the second quarter, any particular line of business going to be growing better or worse than the average? Specifically I'm interested about raw materials. Any thoughts along those lines would be great.

Just about every segment we're seeing renewed interest and strong demand. The raw material definitely will increase as well.

Okay. Great. I will jump out of line. Thank you, guys.

All right, thank you very much. Moving on we will hear from Edwin Mok with Needham & Company.

Congrats for great margins and good guidance. First question I have is on your capacity. I think last quarter you talked about adding around 20% capacity in the gallium arsenide operation and you have also talked about adding new capacity in raw material. Can you update us where you're at on that; is that behind you?

You talked about this new facility; I was just wondering when we expect that to come in and how much incremental capacity you expect to get from that.

First of all our raw material business, they are all increasing. Our joint ventures, they are all increasing capacity as we speak and we're seeing some of the benefits last quarter and we're going to continue to see the benefits from increased capacity throughout the year.

Our increase of 20% capacity in our gallium arsenide crystal growth, we certainly didn't utilize it in the first quarter because the first quarter was a seasonally soft quarter and we didn't utilize it. But we expect that to be filled up gradually throughout this year.

And 80,000 square foot building we already talked about for quite a while, but I think it's now finalized and we will start the building on that 80,000 square foot beginning the next couple of months. But remember that 80,000 square foot building, we don't have any specific plans for how we're going to utilize it yet, so it's not in the equation of capacity expansion, but we're just making the progress.

Because as you know, building a building takes quite a while, even in China it will take about nine months to build and when we have specific needs for capacity expansion, we will then add on to the clean room, DA, water, etc. to facilitize it to utilize it.

Great. Very helpful color there. On the semiconducting side, I think last quarter you guys talked about something on the ratio at the Taiwanese customer and on your commentary you said that your Taiwanese business has been flattish; do you think those issues are behind you now and that leads you to a more robust outlook for the LED space in the second quarter?

We certainly see that the ordering pattern is picking up.

I see. So you believe their inventory issue is behind them?

Well, we see their order picking up.

Okay, that's fair. Then on the semiconducting GaAs substrate business, I think previously you guys talked about going after an incremental customer and trying to gain some more share. It looks like you expect to have a pretty decent recovery in the coming quarter. Is that a function of share gain that you guys were able to capture or was it more just customers coming back after a seasonally weaker first quarter?

I think both, as well as I think there's other things. The customers are very aggressive adding their capacity. As we said, I don't know if you know the China customers; one customer is adding 8 MOCVD reactors; another one is adding 22 MOCVD reactors. They are all making the four-element red LEDs. So if you add all this together, that's a great market forming.

And we are certainly not counting on them, putting them into our target, but definitely they are buying all these machines. They definitely cost between $2.5 million to $3 million each copy and they won't buy these for toys; they are planning for capacity expansion. So I think if this market were to all coming on line later this year or early next year, it's a great booming market for the red LEDs.

I see. But I was actually more referring to our space. I think you previously talked about we actually gained share at Skyworks and places like that. I was wondering if you have (multiple speakers).

That's the semi-insulating market.

Semi-insulating; sorry about that.

Semi-insulating market? Yes, I think we are. I think we definitely have a great chance to gain some market share there.

I see; great. One last question I have regarding the model. If I take the midpoint of your revenue guidance, assuming you maintain the same level margins, like the operating margins, it seems like the earnings are somewhat conservative, right?

Can you help me out? Was that an increase in operating expense, or you are just a little bit more conservative about gross margin because you don't want to be too aggressive? How do I think about that?

I think Edwin that's basically our own internal model. What you build in and what I build in might be two different things.

Okay, maybe I'll ask it differently. Do you expect your gross margin to come down in the coming quarter or do you expect operating expense to go up in the coming quarter?

Gross margin going forward we would expect to continue in the high 30s to low 40% range.

And then on your OpEx?

OpEx should be pretty much level at $3.7 million -- sorry, for SG&A.

I see. Great; that's all I have. Thanks for all your help.

All right, thank you very much. Moving on we will go to Dave Kang with B. Riley.

Morris, I was wondering if you can help me out and explain the dynamics as to how SI was negatively impacted while indium phosphide and SC actually benefited from the Japan quake? I thought all would be kind of moving as a group.

First of all, the impact of Japan earthquake we already said in our prepared conference; but I think going into the future I don't think it's going to be that meaningful. And while I think the market share gain that we have successfully executed in the last few quarters, the last few years, has been very successful, we can gain -- we expand our market on our own.

So the earthquake, it's a tragic event and I think as we said, some of our customers are in Japan, which are negatively impacting us and some of the semi-insulating and indium phosphide we think potentially we got more activity from that and that's what we have seen so far.

Right. Then I think Raymond you said the mix between semiconducting and semi-insulating was 54/46?

Correct.

Semiconducting, right, 54?

Yes.

Okay. If that is the case then you say it was a favorable product mix that drove gross margin, can you help me understand that? Because unless the margin structure for those two changed, how can you say there was a favorable product mix? Wouldn't that be unfavorable product mix?

It's product mix of basically all the components, whether it's indium phosphide and indium raw materials or the two sectors of gallium arsenide.

Well first of all, I think you assume that semiconducting has lower margins, which is not necessarily correct. I mean, our margin is not very -- you can't divide it very straightforwardly, say semiconducting is lower margin or semi-insulating is lower margin. I think it's very specifically depending about what application it is and what specific customer it is, what region it is and how stringent that product specification is written.

So, we have over 400 customers and that's the other thing, so you can see the margin actually all over the map. I think as we said, you've got to give us some credit on the great execution, our engineering, our manufacturing, we have been able to really save the cost on manufacturing.

Right. I mean, I give you that. I was just a little bit perplexed as to you said favorable product mix but then it was 54/46, so that's why I was a little bit confused and just wondering whether the margin structure between those two changed or not. So it's clearer now.

Morris or maybe Raymond, what's your CapEx budget for this year?

$11 million.

$11 million? Okay. Just a couple more. Remember many years ago you guys used to have inventory reserves as part of gross margin; is that all gone now or is it not meaningful anymore?

That reserve? No, it's not meaningful anymore.

Okay. Got it. Then lastly on germanium, maybe it's a little premature, but any change in terms of activities especially from China, now that they're reviewing their green energy policy in the post Japan and the radiation scare and all that?

I think in China there's definitely a lot of rumors and activities going on. I don't know whether you can really take it to the bank and then bank it. But definitely there's a lot of hope and in fact, we normally don't comment on speculations and rumors before we start to see an order pattern or customers specifically talk to us about ensuring capacity.

But definitely a lot of people in China are building very large production capacity for CPV solar cell manufacturing, that's for sure, but we haven't seen any order yet. But they are all our qualified customers by the way.

Got it, got it. All right. Thank you.

All right, thank you. We'll go back to Richard Shannon from Northland Capital Markets with a follow-up.

A few quick ones. First of all, do you have a number for six-inch gallium arsenide in the quarter?

Richard, we don't break that down.

Okay. You're not going to do that any longer?

No.

Okay. Second question, regarding the joint ventures' added capacity, you mentioned that they're all adding capacity; will we see an additional impact from that full quarter's benefit coming in the second quarter and perhaps beyond throughout this year that we should be expecting?

I think if the market continues to be robust, I think definitely we will start to see more benefit from those joint ventures.

But your current plans for adding capacity, those have been completed as of the end of the first quarter?

No, they have not. We are keeping on adding capacity as well as finding more joint ventures to add on to that portfolio.

Okay, so we could see benefit just from a full quarter of additional capacity or JVs in the second quarter then?

Yes.

Okay. Third question, Morris, you made some comments regarding the gallium arsenide business specifically the semiconducting side from your focus in China. Curious if you can relate to us the extent -- the percentage of your business that comes from LED in China?

And then as these projects you have -- you have increased your R&D and sales and marketing specifically focused on China; where do you think that that percentage could go in say a year or two, kind of bigger picture, longer term, how should we think about that?

I don't have that. We are having meaningful market share in China but because that market is so dynamic, it's growing so fast, I think depending about most of the customers materialize in their capacity expansion, if we can capture a majority share of those markets, then definitely it will be a very large percentage of our revenue stream coming from the China market.

Okay, great. Thanks a lot, guys. I'll jump out of line again.

(Operator Instructions) We'll go to Eugene Auh with Grunion Capital.

Good quarter. Thanks for taking my inquiry. My question pertains to the growing value of your JVs and in particular the JiYa gallium mine. With higher raw material prices, can you give some color on how much cash flow or profits are being generated there at the JV level but not captured on your balance sheet?

Well, Raymond this is probably the best for you to handle that question. I think we always carry our JV on our book value as how much we invest in them but never the business value of those JVs, correct?

Yes. So basically all the cash is already consolidated in the top line cash number.

Okay.

So it is very hard to value those JVs because years ago we invested, for instance, the JiYa gallium mine that we invested about $2 million and so they are doing a lot of business so they have returned many times our original investment. But how to value that particular JV is hard to say until you go for IPO or some other event, which we don't plan as of now.

Okay. Thank you.

Now we'll go to [John Margolis] with [Spectra].

When you were talking about the raw material cost and how they affect your bottom line and what not, you got into how when prices are going up that it's a positive that you have raw material sales. But I guess I'm trying to understand better how much of the cost increases you pass on to customers and will there ever be a time when you can fully pass on the cost to customers?

Gallium or indium phosphide all these businesses are tough businesses. I mean it's very difficult to -- customers are not very much willing partner of yours to take on higher prices. And there's price pressure just about always.

So I think our model is such that we have all these joint ventures to help us to see the raw material pricing coming on so we can pre-purchase at a lower price to protect our margins. And as we see the prices of these raw materials stabilize, we start to ease off and bleed some of this inventory through so we can protect our margin again as the price decreases, as eventually it will. Because as the capacity is added on to this business, then the price of this raw material comes down and that will give benefit as well because ultimately substrate is our business. So we say we can benefit both ways on the upside as well as the downside.

Okay. But how much of the cost increase can you guys pass on? And you keep talking about you're increasing capacity, there's obviously a lot of demand here, so it's a tough business but it seems like the supply/demand is going in your guys' favor so it seems that you could pass on more of the cost?

When we have a margin sensitive customer or product, we try to pass along some of the price increase to them, but yes, we have been successful, but not the full extent.

Okay, thanks.

(Operator Instructions) We'll go back to Edwin Mok with Needham & Company.

Just quickly in terms of the split between semi-insulating and semiconducting on the GaAs substrate business, can you remind us what was that split in 2010, roughly at least? I think Morris previously you talked about that business potentially growing like at a 30% rate. Do you still expect to get that kind of rate growth this year?

Firstly, the split used to be semi-insulating to semiconducting 60/40. For this particular quarter it's actually flipped almost the other way around; 54% to 46%.

That was because wireless had a soft quarter.

Then in terms of the 30% target growth that you talked about?

That's still my target, yes.

I see. Okay. Great. Very helpful there. And then second question I have is, if I look at your raw material revenue this quarter it's kind of similar to what you guys did in Q in September of last year. But it's sounds like all these prices have gone up so if you were selling the same amount or if your JV was selling the same amount that you were selling back in those two quarters you would have a high number. It's just because you're keeping some of the material because of the growth on the [RPs] of your business.

So do you look at it that way, right? When do you think you can go back to the volume that you were selling in the June and the September quarter of last year in terms of your raw material business?

That's exactly how the question goes. If we consume internally, we don't count it as revenue; and when we sell it outside, we do. That is totally based upon business demand. As we build our inventory level to such extent, we think it's safe for us and we don't see raw material pricing goes up too much, then we start to bleed some of our inventory out, then our joint venture will be able to fully sell their full output to the open market.

Maybe a different way to ask is do you quantify second and third quarter of last year as almost close to the maximum level of shipment that you're shipping from your joint venture to the outside market?

It really just depends. I know you're looking at $4.4 million now versus $4.4 million the prior year, quarters of June 2010 and September 2010, but it's a dynamic equation.

I think, Edwin, it's a question that if the prices went up three times, then you should take that $3 million times 3 and it becomes $9 million. It's not that easy, no. It's not that simple.

I see; okay. That's fair. One last question just on longer-term how do you think about your tax rate? As you sell more to China does that benefit you on taxes?

No, it goes the other way around because you have to pay the tax over there. We pay tax on processing fee income, so the more we produce, the more they actually pay over there.

I see. You have a tax rate that you think you'll achieve in the coming quarter?

Edwin, the best way to model it is 15% of your income before tax; that's probably the best way.

Great. That's all I have. Thank you.

It appears no further questions are in queue at this time. I'd like to turn things back over to Dr. Morris Young for any additional or closing remarks.

Thank you for participating in our conference call. This month we will be presenting at the Jefferies Global Technology Conference in New York and the B. Riley Conference in San Diego. Also, we will be marketing tours at the end of the month in Boston and Chicago. We look forward to seeing many of you then.

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 today's conference.