AXT Inc (AXTI) 2011 Q2 法說會逐字稿

Good afternoon, everyone, and welcome to AXT's Second Quarter 2011 Financial Conference Call. Leading the call today is Dr. Morris Young, Chief Executive Officer; and Raymond Low, Chief Financial Officer. My name is Camille and I will be your coordinator today. Today this call is being recorded.

I would now like to turn the call over to Leslie Green, Investor Relations for AXT.

Thank you, Camille, 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 and 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 market 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 available online by link from our website for additional information on risk factors that could cause actual results to differ materially from our current expectations.

This conference call will be available on our website at axt.com through July 27th, 2012.

Also, before we begin, I want to note that shortly following the close of the market today we issued a press release reporting financial results for the second 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 second quarter results. Raymond?

Thank you, Leslie.

Revenue for the second quarter of 2011 was $30 million compared with $24.6 million in the first quarter of 2011.

Total gallium arsenide substrate revenue was $18 million for the second quarter of 2011, compared with $15.9 million in the first quarter of 2011. Indium phosphide substrate revenue was $1.6 million for the second quarter of 2011, compared with $1.3 million in the first quarter of 2011. Germanium substrate revenue was $2.7 million for the second quarter of 2011, compared with $3 million in the first quarter of 2011. Raw material sales were $7.7 million for the second quarter of 2011, compared with $4.4 million in the first quarter of 2011.

In the second quarter of 2011, revenue from North America was 21.4%, Asia-Pacific was 58.5% and Europe was 21% of total revenue.

Only one customer generated more than 10% of our revenue during the second quarter, while the top five customers generated 36.9% of our second quarter revenue.

Gross margin was 46.7% of revenue for the second quarter of 2011, as a result of favorable revenue mix and strong execution in the quarter. By comparison, gross margin in the first quarter of 2011 was 43.4% of revenue.

Selling, general and administrative expenses were $3.7 million for the second quarter of 2011, compared with $3.7 million in the first quarter of 2011.

Research and development costs were $699,000 for the second quarter of 2011, compared with $505,000 for the first quarter of 2011. The increase came mainly from research and development project costs by one of our joint ventures.

Total stock compensation expense was $214,000 for the second quarter of 2011, of which $20,000 was included in cost of revenues, $183,000 in SG&A and $11,000 in R&D.

Income from operations for the second quarter of 2011 was $9.6 million, compared with income from operations of $6.5 million in the first quarter of 2011.

Net interest and other income for the second quarter of 2011 was $519,000.

Net income in the second quarter of 2011 was $7.1 million, or $0.21 per diluted share. This compares with net income of $4.2 million or $0.13 per diluted share in the first quarter of 2011.

Let's now look at our cash on the balance sheet. Cash and cash equivalents with maturities of less than three months, short-term investments and other investments in high-grade debt securities with maturities of less than two years were $36.3 million at June 30th, 2011, compared with $38.5 million at March 31st, 2011.

The decrease in cash was mainly as a result of a $2.2 million investment in our joint venture portfolio and a $3.5 million cash expenditure for the expansion of our Tongmei manufacturing plant in support of our expected future growth, partially offset by cash generated from operations.

Current receivables, net of reserves, were $23 million at June 30th, 2011, compared with $19.2 million at March 31, 2011. Days sales outstanding were at 70 days for the second quarter, compared also with 70 days for the first quarter of 2011.

Net inventory was $39.7 million at June 30th, 2011, compared with $39.4 million at March 31st, 2011.

Depreciation and amortization in the second quarter was $848,000 and capital expenditures were $3.5 million.

As of June 30th, 2011, the Company, including our consolidated joint ventures, had 1,278 total employees, of whom 1,010 worked in production.

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

Thank you, Raymond. This was another strong quarter for AXT.

Revenues exceeded our expectations, driven by double-digit growth in our substrate business and record revenue from third-party raw material sales. We are experiencing healthy demand across all of our product categories and are pleased to see that our competitive positioning continues to strengthen.

Further, our strong business model and solid operational execution are resulting in healthy growth in our bottom line. We believe that the trends fueling our growth are substantial and we are well positioned to benefit with the capacity, raw material access and attractive cost structure that are totally unique in our industry.

Our semi-insulating gallium arsenide substrate business for wireless applications was strong in the second quarter, increasing more than 18% from Q1. A substantial portion of this growth was in flexing substrate where we're seeing solid demand across all of our customer base.

The largest industry driver for semi-insulating gallium arsenide continues to be smart phones, but there are many other applications that are also growing within consumer electronics, computers, communications and automotive products. Many of the major customers in this space have announced capacity expansions that will begin to come online in the second half of the year and throughout next year.

Further, we believe that the recent event in Japan has caused some changes in the competitive landscape and may also be prompting customers to qualify additional sources of the material. This is working in our favor, as customers are taking a fresh look at AXT as a result of our solid reputation for providing a consistent, high-quality product and customer-friendly focus.

In semiconducting gallium arsenide, which is used in the manufacture of red LEDs, we continue to see healthy growth. During Q2, our sales to nearly every major geographic region increased, increased broad-based demand. We have placed additional emphasis in this area of our business, dedicating incremental resources to further enhancing our products to meet the particular specifications of our customers in Japan, China and Taiwan.

While specific growth rates for the red LED market are somewhat difficult to define, as a result of the diverse range of products that red LED goes into, the market is clearly expanding at a healthy pace. This is evidenced by the 56% growth in our semiconducting gallium arsenide revenue since the beginning of 2010.

Further, we believe that we are gaining market share as a result of some consolidation in the market, as well as our strong focus on enhancing our product quality and expanding the range of specifications that we can serve.

Contrary to what many believe, the red LED market is not low-margin business for AXT. We tend to focus on the mid- to high-end of the market, where the product specifications are tighter and, therefore, not addressable to some of the other substrate providers. These include applications such as automotive, signage, display and device backlighting, among others. The requirements of these applications, coupled with our excellent cost structure, allow us to achieve margins that are consistent with our corporate targets.

Further, we can leverage our model to selectively participate in high-volume opportunities that we believe are strategic in nature. This gives us great flexibility to increase our presence in the red LED market and to position ourselves as the key player as new opportunities emerging.

In total, we feel very good about our gallium arsenide substrate business. We continue to add additional crystal growth capacity in anticipation of the increasing sales. We're very pleased to report that we will be breaking ground in the second half of this year on a new building on the Tongmei campus in Beijing which will provide us with substantial growth capabilities over the coming years.

Further, we are close to selecting a new site for a second campus near Beijing, which we expect to begin to construct in 2012. This will allow us to support our customer requirements for many years to come.

Turning to indium phosphide substrates, we continue to see renewed demand for these substrates as the investment in high-speed optical communication is increasing worldwide. Though still at a small percentage of our revenue, our sales in the second quarter increased more than 20% from Q1 and by more than 80% from the beginning of 2010.

We've been placing strong emphasis on the technical requirements of current and potential customers and we believe that we can continue to grow this area of our business in 2011 with more significant revenue coming on in 2012.

In germanium substrates, our revenue was down slightly from Q1, but we expect continued growth in the back half of the year. The primary activity is coming from investment in geo-positioning and communications satellite systems throughout Europe and Asia.

Further, there continues to be a host of positive news regarding new CPV terrestrial solar cell projects worldwide, including, most recently, a 150-megawatt plant to be constructed in the San Diego area. We believe that the terrestrial market will continue to develop over the coming years and that AXT is well positioned with a production-ready 6-inch germanium product, ample capacity and the positive cost structure to support increased demand.

Finally, our third-party sales of raw material posted record revenue in the quarter as a result of strong demand and a positive pricing environment for our joint ventures. We believe that raw material pricing for gallium and germanium are stabilizing, albeit at a high level.

All of our joint ventures are increasing capacity in response to expected strong demand. We expect to have additional capacity coming online in the second half of the year.

As we have discussed, these joint ventures that directly own the natural resources that we sell are an important part of our business model, because they give us ample capacity and valuable visibility into pricing trends in the market, as well as providing us with additional margin-friendly revenue. This will allow us to weather significant fluctuations in raw material pricing without experiencing disruptions in our gross margin performance or necessitating large price increases to our customers. This is also giving us the ability to target specific customer opportunities that we believe are highly strategic to our business and support the volumes and cost requirements of these opportunities.

For these reasons, growing our portfolio of raw material joint ventures is a primary focus area for AXT. In the second half -- in the second quarter, we made further investments into our portfolio and expect to continue to pursue additional opportunities to expand within the materials that we currently have, as well as adding other materials that are essential to our manufacturing process.

As we look ahead, we believe that the substrate market is evolving in our favor and we -- and our ability to provide high-quality products at a reasonable price with ample capacity will continue to afford new opportunities to increase our market share and drive our growth.

Therefore, we filed a shelf registration statement that will give us the flexibility to raise additional capital in order to fund the expansion in our business that will support further market growth and our increasing market position.

We are seeing great returns on the investment we have made into enhancing our product portfolio, product quality, manufacturing efficiency, customer care and cost structure and we are very excited to continue to build upon these successes, further enhancing our business opportunities.

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

Thank you, Morris. As a result of expected growth in semi-insulating and semiconducting substrate demand in the third quarter, we expect total revenues of between $30.5 million and $31.5 million. We are expecting net income in the third quarter of between $0.18 and $0.20 per share, based on approximately 33.4 million common shares outstanding.

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

Operator?

(Operator Instructions). And our first question comes from Richard Shannon with Northland Capital Markets.

Hi, guys. How are you?

Very good, Richard.

Very nice numbers. Congratulations to you and everyone at AXT.

Maybe a couple questions on the second quarter, first off. You obviously exceeded your guided revenue for the quarter by a fair amount and on the surface it looks like most of it came from raw materials. I'm kind of curious what drove that upside here. Did you add more capacity during the quarter? Kind of back-end loaded quarter or can you give us an idea of how that strength came from raw materials?

Well, Richard, I beg to differ. I think although raw materials do give us a strong growth, but I think in every area of our product offering, they are growing. Gallium arsenide grew and semiconducting gallium arsenide also grew. Indium phosphide showed very good growth of 20%. And so I don't think it's all from raw material only.

Okay, well, I wasn't saying that you didn't have growth in those areas. What was the split of gallium arsenide semiconducting versus semi-insulating in the quarter?

51% semiconducting, 49% semi-insulating.

Okay, perfect. And then, as we look into the third quarter here, any thoughts on how fast we might see raw materials grow again here in the quarter? Are we seeing additional -- any additional annualizing of capacity or anything like that, that suggests strong growth like we saw in the second quarter?

Well, in raw material, we do expect to increase our capacity, however, we do expect to use more of our raw material inventory, thus we do expect slightly lower revenue from our joint ventures in the third quarter. So that translates to more growth from the substrates.

Okay. And how should we think about gross margins here in the third quarter and as I think many people are maybe struggling to figure out the mix shift here in gross margins as raw materials versus the rest of your substrate business moves around, how should we think about that? What -- can we think of the difference between your general substrate business and raw materials or any way that you can suggest how we think about that as we judge how raw materials will grow at a different rate than the rest of your business?

Yes. Richard, I think the margin is probably the most frequently talked about subject in our conference calls and I think I'm happy to report that we were happily surprising our investors that we are performing very well. But I think if you look at the business environment, our margin -- there's no major factor which is going to influence our margin in a major way. Let me put it this way.

However, we have always been consistently guiding that we should -- you should look at high 30s to low 40s as our target, but from time to time we do perform better than the expectation. So that's a nice surprise for outperforming the target.

There's certainly no doubt about that. Maybe I'll ask you more specifically on gross margins in your substrate business. How has that trended so far in the first half of the year and is that, in and of itself, how do you see that trending in the second half? I mean, I think we've talked in the past about some advance purchase of raw materials last year at lower prices. Have those flowed through and should the substrate business by itself be flattening or maybe even declining here in the second half of the year?

No, I don't think the substrate business will decline in the second half of the year. We actually -- as we guide that next quarter, although -- we will still continue the growth and because we expect less revenue from JVs, so substrate -- that implies substrate is going to grow further.

But as far as individual product areas of gross margins, as we have explained many times, our gross margin is a complicated issue. I mean, first of all, we have 300 customers. Some customers pay a higher gross margin, a higher price than the others, okay? And depending on the focus area we want to get into, sometimes we have lower margins than the others.

And yet, as you pointed out, raw material is a very important part of what goes into gross margin. However, because of our joint venture protection, that also offsets some of the raw material increases, as we've demonstrated in the last few quarters.

And yet, the other very important element is we continue to improve our production efficiency. We pointed out last quarter, in the last five, six quarters, in the face of the increasing raw material costs, we continued to improve efficiency. That means we have the ability to increase, let's say, crystal life, the production efficiency and lowering our shared fixed costs on depreciation, et cetera.

So it is a complicated issue. And also when we start to address more markets as more customers come to us looking for a lower price or a more friendly price, we may want to decide to give them a better price to get into a very strategic area we want to address.

So, that -- all those play into the total gross margin we're reporting. So, I would say there's nothing which is on the horizon which we see as a pending effect which is going to affect our margin up or down in a major way, but you can look at the raw material price is still high. That will be margin friendly, because our joint venture makes more money.

Our substrates, we have efficiency improvement programs. We're increasing our revenue base so that will decrease our depreciation cost. So, all those are giving you the 43% last quarter and 46% this quarter. Next quarter I will leave it to Raymond to give projections.

Yes, unfortunately, we don't give forward-looking gross margin guidance, Richard.

Fair enough. I know that's consistent with your past practice. I'll ask one question and then jump out of line. I appreciate the thoughts there, Morris.

In terms of the capacity expansions you mentioned, both with your joint ventures as well as the new building on your current campus and then the future campus, what are the timeframes for completing that capacity and may start to see revenues from those come online?

Well, we continue to add capacity. The one that we talked about, 80,000 square foot, we're going to break ground. That building should be completed sometime next year.

And we're facilitizing the 30,000 square foot. We're still doing that and that should give us added capacity as we talked about in our conference call script that we are adding more crystal growth capacity to fulfill the added opportunity for second half of the year.

And for our new campus, we are still down to the wire of deciding when to pull the trigger, as well as where to put it. But we are just making all the preparations to make ourselves ready for that decision.

Okay, great, guys. Thank you very much for the detail and congratulations on nice results.

Thank you, Richard.

Our next question comes from Edwin Mok with Needham Company.

Hi. Thanks for taking my question and congrats for the great quarter.

So, Morris, first question on what do you guys seem on the substrate market, especially on the gallium side? I remember previously you talked about you guys were going to gain share because of the capacity expansion and part of it is because of your cost advantage you have over your competitors?

Have you seen your competitive response to that or are they still kind of restricted from adding capacity and, therefore, your new capacity is enabling you to gain more share?

Well, Edwin, actually, that's a great question. However, I don't really have a whole lot of clear answer to that, because my competitor doesn't come to me and say, Morris, I added capacity.

Of course.

So, a lot of these are -- actually, I gave that assignment to our analysts. You guys find out.

I see. Maybe a different way to ask it, of the customers that you are selling the substrates to you right now, are they coming with more requests from you guys, leading you to believe that you might be gaining share of those customers?

On a long horizon, I believe so. Obviously, our -- quarter to quarter it's difficult to say. We had a soft quarter in Q1, but we blamed it on the industry. But our substrate revenue grew more than 50%, but by far reaching expectation of smart phones, it didn't grow 50%. So the result has to be, the conclusion is that we're growing faster -- we were growing faster than the industry. That means we're taking shares from our competition.

I see. That's fair.

And then one quick question on the germanium side. It declined a little bit, I think, not a big surprise, giving the strong quarter over -- strong revenue over the last two quarters. I was wondering, have you guys started to see someone else's germanium substrate going to the CPV application? Or are you still thinking that's more like '11, '12 or beyond sales opportunity?

Well, we definitely see there are real projects bidding on the CPV market. We are also seeing some of our -- the major customers are coming to us and taking a fresh look at us and they're wanting us to give them substantial quotes which we believe are CPV focused. But when it's going to come online, are we going to get that job or not, it's still up in the air.

I see.

We believe the activity is there, the interest is there. It's getting started.

Are you seeing new customers on the germanium side coming to you to at least ask for quotes for CPV-type applications?

Yes.

I see. That's really good. And then one question on the raw material side. So, my understanding previously is that your two gallium joint ventures have a combined capacity of around 70 metric tons. Is that correct?

And you talked about expanding capacity there. I was wondering if you can quantify the timeframe, as well as how much you're expanding?

No, Edwin, it's not right. We have one joint venture, which has the nature resource -- it's called Ji Ya -- which used to have about 20 tons of capacity, that extracts gallium from alumina, aluminum mine. And we have a second joint venture you may have to get confused with, Jia Mei, which refines the four nines to seven nine gallium, but that's not a raw gallium producer, okay? So they buy raw gallium, let's say, four nines gallium and refine it to seven nines, six nines or seven nines. So you cannot add this capacity together.

And yes, we did have capacity increase from Ji Ya, which is the four nine gallium producer recently. So they increased their capacity from roughly 20 tonnes to 30 tonnes.

I see. But it's fair to say that if market demand is a little bit moderated on the substrate side and you don't need to buy those products, then you might be able to channel that to sell more of the material then?

Yes, I guess what you're saying is right. But I think the actuality is the last quarter we had very strong revenue coming from JVs. That's mainly because we had built enough inventory for our own consumption, so we didn't have to buy from our JVs. So they -- their product can be sold to third-party customers. That becomes our revenue, okay?

But we also said that those JV gallium we probably would start to buy more from them in next quarter, so the recognizable revenue from these JVs will be down next quarter, although pricing is still firm.

I see. Very, very helpful there.

One last question, just a quick one, on the shelf filing. So, is that more for the CapEx for internal investment? And I think in your prepared remarks you talked about investing in the JV, either in the existing JV or new JVs. How do we kind of think about that and any kind of idea if you guys would need to come to the market quickly or is it some time? Just current, on a guess, there?

Well, as we said in the file registration, we will use this funding for expansion, as well as general construction of a new factory and general purposes. So -- but as far as I'm concerned, I think we have been holding off on this offering for a long time and to me I think we need the market to be very strong, okay?

And our cash flow is positive from our operations. We don't need cash, more cash coming into operations, except if we see very strong demand from the industry that continues to grow will prompt us to think long term, in the next 18 months, that we definitely need a lot more capacity coming online. Then we will build a new factory. That will require the extra cash.

Exactly. So that actually leads to my final question. Sorry to ask a extra one. Just -- I was just curious, based on your current business run rate at this, Raymond, a plus or minus range, how much cash do you actually need to run your business?

We have plenty. I think, Raymond, we're generating cash.

Yes, we generate cash on its own. If we didn't have the CapEx that we have this -- 2011 it's -- we slated $11 million. We spent $6 million so far. Without that, we could actually generate our own cash.

I see. So this $20 -- oh, sorry, this $36 million total cash plus investment level is more than adequate to run your business right now?

Yes.

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

(Operator Instructions). Our next question does come from Dave Kang with B. Riley.

Thank you. Good afternoon. Nice quarter. Speaking of cash, so how much cash outlay do you expect or budget for the Asian plant?

Well, the budget for this year is $11 million now?

Yes.

We've said that many times.

Maybe he meant the new?

The new factory? We can't talk about it now. I mean, the plan is not solid. I mean, so --

Okay. Okay, fair enough.

And then, if there's a new JV, what kind of materials would you be interested in? Would GaN be included -- be on your list?

GaN? Gallium nitride?

Yes.

Well, I mean, it's difficult for us to talk about not-finished project in any way. But we have been saying that we are focusing on our JV activity mainly in China, mainly on the line of business that goes into the products that we are currently manufacturing. We're exploring other materials which could be beneficial to strengthening our position.

Okay. And speaking of raw materials, could you talk about their pricing? Have they been kind of stable for the last few months?

Yes, it's kind of stabilizing, yes.

So, obviously, the growth must have come from the volume. So can you talk about some key end markets that's driving your raw materials business?

Key end markets? Let's say for gallium it's mainly coming from gallium arsenide. Of course, that includes smart phones, red LEDs, as well as blue LEDs and also the gallium will be used for making trimethylgallium for making the LEDs, which is the GaAs source material.

And gallium is also used for CIGS, the solar cell structure, which is gallium, germanium and some other compounds.

And gallium also is used as the doping to make very strong magnets, so the high-speed trains, from what I understand, also use gallium.

Okay. And then just booking, was that fairly linear or what is fairly back-end-loaded for Q2 and how much are you booked for September quarter?

We don't normally break down the quarter by month, Dave.

Okay. All right. But can you comment or color as far as visibility or bookings for Q3?

Well, Dave, we have a sort of a formula. When we give you the guidance, we don't have everything into our book. But we have expected turns every week. From now until the end of the quarter we have seven weeks to take in orders.

So with that expectation, then we would put some estimated numbers and that turning business, unless there's a drastic change in the market environment, it could even be drastically up or drastically down, okay? That's how it goes. And we have a sort of a fixed formula how we do that.

And then mixing with our management feeling of what the market is.

Got it. And the last question is regarding your semiconducting gallium arsenide. You said you're expecting growth in Q3. If you look at industry data, it certainly has been very mixed, mostly negative. So what do you -- where do you expect your growth will come from for your semiconducting business?

The red LEDs. Well, I mean, we didn't say that our red LED will grow in the third quarter. We didn't guide that. We said our substrate revenue overall will grow.

Okay. I thought you said both semiconducting and semi-insulating will grow this quarter.

No, we didn't say that.

Oh, okay.

We said that it grew. I mean, we were saying -- perhaps describing what our LED semiconducting substrate business grew something like 50%, 60% in the last year. So it's -- if you look at it from the long-range point of view, our LED business definitely grew very substantially from last year into this year, although everybody remember we had a bad quarter the fourth quarter of last year.

But if you look at five quarters in a row, then we are growing substantially.

Okay, great. Thank you.

All right.

(Operator Instructions). Our next question comes from Michael Chapman with Altimeter Capital.

Good afternoon, gentlemen.

Yes, sir?

I was wondering, when you have customers, especially larger significant customers, say, top five, and they utilize both semiconducting and semi-insulating applications, is it easy to get them qualified on both your types of substrates or is that a long process?

I'm taking a pause thinking about who are using both types. I think the fact that if they are familiar with AXT's quality system and they trust it, they are a trusted customer, they probably trust us more. However, for any specific part qualification, I would say it's the same rigorous qualification process we have to go through. They will not just take our product on its face value.

Because there's a lot of product matching we have to go through, small details has to be comfortable both to them, as well as to us. Because to take on a very large production order, we don't want to be -- to have surprises.

All right. And of your top five, are there any that are qualified on both currently?

No.

Oh, wait a minute, yes. Raymond? Well, there are, actually. The fact is, there are customers who use both.

Okay.

I am sorry. I shouldn't contradict you.

I appreciate the time. Thanks.

(Operator Instructions). As we have no further questions, I would like to turn the call back over to Dr. Young for any closing comments.

Thank you for participating in our conference call. This quarter we'll be marketing on the West Coast in September. We look forward to seeing many of you soon. 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.

And that does conclude today's conference and we appreciate your participation.