AXT Inc (AXTI) 2012 Q1 法說會逐字稿

Good afternoon, everyone, and welcome to AXT's first quarter 2012 financial conference call. Leading the call today is Dr. Morris Young, Chief Executive Officer, and Raymond Low, Chief Financial Officer.

My name is Matt, and I will be your coordinator today. Just a reminder, today's call is being recorded.

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

Thank you, Matt, 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 on 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 and products.

In addition to the factors that may be discussed in this call, we refer you to the company's periodic reports filed with the Securities and Exchange Commission and available online by link from our website, for additional information on risk factors that could cause actual results to differ materially from our current expectations.

This conference call will be available on our website, at axt.com, through May 2nd, 2013.

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 first quarter of 2012. This press release can be accessed from the Investor Relations section of AXT's website at axt.com.

I would like to turn over to Raymond Low for a review of the first quarter 2012 results. Raymond.

Thank you, Leslie. Revenue for the first quarter of 2012, was $23.5 million, compared with $21.2 million in the fourth quarter of 2011.

Total gallium arsenide substrate revenue was $12.2 million for the first quarter of 2012, compared with $11.1 million in the fourth quarter of 2011.

Indium phosphide substrate revenue was $1.5 million for the first quarter of 2012, compared with $724,000 in the fourth quarter of 2011.

Germanium substrate revenue was $2.7 million for the first quarter of 2012, compared with $3 million in the fourth quarter of 2011.

Raw material sales were $7.2 million for the first quarter of 2012, compared with $6.4 million in the fourth quarter of 2011.

In the first quarter of 2012, revenue from North America was 22%, Asia-Pacific 58.6%, and Europe was 19.4% of total revenue.

One customer generated more than 10% of our revenue during the first quarter, while the top five customers generated 42.5% of our first quarter revenue.

Gross margin in the first quarter was 34.9%, compared with 36.9% of revenue for the fourth quarter of 2011. The drop in gross margin was the result of lower raw material pricing and a strategic decision to accept a lower gross margin on certain business opportunities in order to strengthen our competitive positioning with certain customers.

Selling, general, and administrative expenses were $3.8 million for the first quarter of 2012, compared with $3.9 million in the fourth quarter of 2011.

Research and development costs were $835,000 for the first quarter of 2012, compared with $657,000 for the fourth quarter of 2011. This increase is attributable to the addition of our new Chief Scientist, as well as higher costs on new product testing and development.

Total stock compensation expense was $281,000 for the first quarter of 2012, of which $18,000 was included in cost of revenues, $238,000 in SG&A, and $25,000 in R&D.

Income from operations for the first quarter of 2012, was $3.6 million, compared with income from operations of $3.3 million in the fourth quarter of 2011.

Net interest and other expense for the first quarter of 2012, was $247,000.

Net income in the first quarter of 2012, was $1.6 million, or $0.05 per diluted share. This compares with net income of $2.6 million, or $0.08 per diluted share in the fourth quarter of 2011.

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 $46.1 million at March 31st, 2012, a strong increase from $40.6 million at December 31st, 2011.

Account receivable net of reserves were $16.6 million at March 31st, 2012, compared with $18 million at December 31st, 2011.

Days sales outstanding were at 59 days for the first quarter, compared with 78 days for the fourth quarter of 2011.

Net inventory was $42 million at March 31st, 2012, compared with $46 million at December 31st, 2011. Of this, approximately 53% is raw materials, 35% is work-in-progress, and 12% is finished goods. We believe that we will continue to see a decline in our inventory over the coming quarters.

Depreciation and amortization in the first quarter was $907,000, and capital expenditures were $1.2 million.

As of March 31st, 2012, the company, including our consolidated joint ventures, had 1,295 total employees, of whom 1,002 work in production.

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

Thank you, Raymond. The first quarter was a somewhat mixed quarter for AXT. After a difficult start to the year, the demand environment in March showed steady improvement and appears to be holding as we move into the second quarter.

We are pleased to see a strong increase in our semi-insulating substrates for wireless devices, after two challenging quarters in the second half of 2011. We saw similar rebounds in the market for semiconducting and indium phosphide substrates, placing us at the high end of our revenue guidance range.

However, gross margin declined to the bottom of our target model as a result of a strong decrease in raw material pricing, as well as strategy [decision] to leverage out profit margins in order to strengthen our competitive position for certain business opportunities. Therefore, while we did underperform our earnings per share expectation, we remain profitable, cash positive, and well-positioned to take advantage of market growth as the demand environment improves over the balance of the year.

So let's take a little closer look at the dynamics of our business in Q1. As I mentioned, sales of our semi-insulating substrate used primarily for manufacture of wireless devices, increased by more than 20% in the first quarter, following a challenging second half of 2011. Bookings for our semi-insulating substrates got off to a slow start in Q1, but showed a marked improvement late in the quarter and have continued to improve in Q2. We believe this is the result of both strengthening general market conditions, as well as increase in sales to our largest customer.

Bookings for April have been solid. We are on track to show growth in this area of our business in the second quarter, providing that the demand environment holds. [Our checks] with our direct customers indicate that demand will continue to be solid, but some mixed market news is prompting us to take a more conservative approach in our forecasting.

Looking beyond the immediate quarter, our ongoing qualification with perspective customers are progressing and we're optimistic that they will contribute to our results in future quarters.

Similar to semi-insulating substrates, sales of our semiconducting substrates used primarily in the manufacture of LEDs, got off to a slow start in Q1 as a result of weaker demand environment. However, sales increased quite significantly late in the quarter, finishing approximately flat with Q4. We are particularly pleased with the success of our strategy to expand our business in Asia, which has resulted in growing revenue and expanding our customer base. This area will continue to be a focus for AXT in 2012, and we are optimistic for continued growth and diversification.

In general, gallium arsenide market appears to be poised to gain strength again this year. According to (inaudible) Development, a market research firm focused on semiconductor and other high-tech industries, double-digit growth is expected to resume in 2012, driven by increasing gallium arsenide content in [handsets] and increased penetration of the LEDs in general lighting and automotive applications.

The capacity expansion of our direct and indirect customers further support this expectation. And although recent growth has been more muted, secular growth industry trends and a growing number of applications for gallium arsenide substrate should drive demand in the coming years.

Turning to germanium substrates, while we experience a decline in our revenue in the first quarter, the [demand in our] environment for satellite solar cells has remained fairly steady. The decline in Q1 is more related to the timing of orders based on the normal ebbs and flows of the solar cell industry.

In terms of the CPV market, we continue to see progress in the development of the CPV technology for using the terrestrial solar cell applications.

As we mentioned last quarter, the conversion efficiency for CPV, using germanium substrates is increasing meaningfully, and this, coupled with the growing body of evidence supporting the reliability of CPV, will continue to drive its adoption over the next several years.

Further, we're participating in a new solar cell technology that leverages gallium arsenide substrates as a critical component in CPV-based solar cells. The efficiency of this new technology rivals that of germanium-based solution and reinforces the possibility that CPV as a technology will eventually succeed. Whether germanium or gallium arsenide becomes the ultimate winner, AXT is poised to benefit either way.

Finally, turning to raw materials. Several raw material suppliers, including our own joint venture, have been expanding their capacity over the last several quarters in preparation for strong future demand. In the short term, this has caused a increasing supply of raw materials and, in turn, is contributing to lower pricing for these materials.

While the drop in pricing over the last few quarters has been substantial, the alternative for greater future production will be highly beneficial, as the demand environment strengthen. During the first quarter, our third-party sales of raw material increased over the prior quarter. This was a function of greater capacity at our joint ventures and because with AXT working down our own inventory of raw materials, there was more raw material available for our joint venture to sell on the open market. However, the profit margin declined as a result of the decreasing raw material pricing.

Looking to Q2, we're expecting a decline in raw material sales to more normal customary level, as well as a more modest decline in raw material pricing. Additionally, we expect to work through the remainder of the higher priced raw material in our own inventory through the balance of the second quarter. This is expected to allow us to begin to see the benefit of [current] lower raw material prices in our substrate costs beginning in Q3. This should provide us with positive leverage to our model in the third quarter.

In closing, while we are approaching the current business environment with measured conservatism based upon mixed industry data points, we're optimistic that the market will improve in [Q2] 2012, as a result of positive demand trends in our space. We believe that we are well positioned competitively to benefit from the strengthening wireless market, as well as the proliferation of LEDs and [a number of] applications, including solid state lighting.

Further, we continue to execute well our diversification strategy and are making good progress in [the many] ongoing qualifications across the portfolio.

As we approach a new cycle, we're encouraged by our growth potential in 2012, and we are actively preparing our company to take advantage of the many opportunities ahead.

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

Thank you, Morris. In the second quarter, provided the demand environment holds to what we are currently experiencing, we are expecting to see an increase in our sales of gallium arsenide substrate, offset by a decrease in third-party sales of raw materials. It is likely that gross margins may decrease to the low to mid-30% range as a result of both lower raw material pricing and the flow-through of our strategic decision to accept a lower gross margin on certain business opportunities.

Therefore, we expect total revenues of between $23 million and $25 million. We are expecting net income in the second quarter of between $0.04 and $0.06 per share, placing approximately 33 million common shares outstanding.

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

Thank you. (Operator Instructions) Edwin Mok with Needham and Company. Please go ahead.

Thanks for taking my question. So my first question, just to clarify your commentary there, Morris. You guys are taking a little more conservative approach on the gallium arsenide business, because you heard some of these negative data point from like TriQuint and some of those customer end customer. Is that correct? But then you direct (inaudible) customer sounded more positive. Did I hear that correctly?

Yes.

I see. So is your direct customer, what if their feedback from you turns out to be true, there could be upside for that part of your business. Is that correct?

Yes.

That's fair. Great. And then I have a question around your kind of raw material inventory that you talked about, right. If you produce your own raw material, why would you have higher price raw material in your inventory?

Well, if you buy the raw material in the open market, whether we buy it from our own JV or -- remember, Edwin, this is a joint venture. So we buy these -- it's a arms-length transaction. We work [out] the price with them. So whatever that market price is, and if we enter a contract, a long-term contract or whatnot, we have to uphold the [promised] price we purchase, and they have to uphold the [lower] price purchase in case price went up.

I see. So you said that on your prepared remarks you said that you think that you can probably work down that high-cost inventory throughout the second quarter.

Yes.

Does that mean that -- and for gross margin guidance, you talk about kind of the mid- to low 30% in this coming quarter as a result of high-cost inventory, right. Does it mean that you think your margins can bounce back in the September quarter? And I know it's a very complex question regarding gross margin. But what level of gross margin you think you can get back to?

Well, Edwin, yes, you are absolutely right. The gross margin is a complex question, especially we deal with so many different products. As far as particular, gallium arsenide and if we were to work down our high-priced inventory, then our margin should improve. But don't forget the raw material, if the price keep on dropping, then that will negatively impact our gross margin there. But it depends upon what total revenue is more on gallium arsenide and obviously the impact of [gross margin positive], improvement is going to benefit us more there.

I see. And then if I take your guidance right, if I take kind of a mid- to low 30% gross margin and put it in the model, I get a slightly higher operating expense sequentially. Can I ask why? Did I get it correctly?

Raymond?

Just repeat it, please, Edwin.

Yes. Sorry. If I take your mid-point of your guidance and then pluck in the low, lower gross margin like 32% or something like that, I get -- in order for me to hit the midpoint of your EPS guidance, I think your OpEx would have increased?

No, OpEx is going to remain the same. There's another line item right at the bottom there called minorities. That just depends how profitable the joint ventures are. And, of course, since we don't own 100% of those, we have to cater for the outside minorities. So the more profitable they are, the higher that expense is to the outside minorities.

Okay. So that's probably why my assumption there is probably different from yours. One last question then I'll go away. On [conduit] there is a market maybe you talk about germanium is more just timing and then you also talk about gallium arsenide (inaudible) both semi-insulation, semiconducting. Can I ask you just to clarify for us, that is directionally, what are you baking in your assumption for a guidance in terms of these end markets? Where I think you talk about raw material being down, then what about the other markets? Thank you.

No, I think raw materials being down is a function of the pricing, because we still think the volume of raw materials is going to increase.

I think substrates, yes, you are right. I think if market condition doesn't change drastically, I think both semi-insulating and semiconducting should go up, yes, and germanium is sort of flattish.

I see. Sorry, one more question, I'll go away. You talk about being a little aggressive in pricing that result in the low gross margin for the current quarter. Can you clarify that a little bit? Is it just your competitor -- are you trying to be more competitive or is it a specific business you have gone after that leads you guys to do that or is that more across the board?

No, it is not across the board. But there were some opportunities that were decided that we should be more aggressive and then take the business opportunity. And looking forward, if we can recover our margin because of increased business, because don't forget in the first two months of Q1, business was quite dismal and it really drives us to be more aggressive in terms of pricing.

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

Avinash Kant with D.A. Davidson.

This is Eric Ramos in for Avinash. Just a few questions. Why did your shareholders equity decrease in Q1 from Q4?

It was, particularly if you're looking at the non-controlling interest -- is that what you're looking at?

No, just specifically the shareholders equity minus the --

Oh, shareholders equity. Yes, there are two components in it. The total shareholders equity actually went up, and then the non-controlling interest, which is also part of total stockholders equity, that went down, and that was due to the dividends declared by those minority JVs.

Okay. And then I as wondering if you can update us on your new qualifications, when do you expect those to start to ramp up?

Well, in the last quarter, we don't have any new qualification results that we can report to you. I mean, Q1, obviously we reported to our shareholders that we had [two] qualification [wings], and we continue to work on other qualifications. And as long as we have good results, we will report to you.

Okay. And then what was the split between semiconducting and semi-insulating for the quarter?

It's [certainly not] 50/50 this quarter.

And what percentage of your sales goes directly or indirectly to TriQuint?

Well, TriQuint is not a direct customer, so it's very difficult for us to assess. But we know they are one of the large end customer of ours, but we don't know exactly the percentage.

Is it greater than 10%, would you say, or --?

Well, I mean, our customer, direct customer, is IQE who is more than 10%. But to what extent they supply into TriQuint, it's difficult for us to estimate.

That's all I have.

Richard Shannon from Craig-Hallum.

Just follow up on one of the previous questions regarding the second-quarter revenue guidance, so just to encapsulate all this in terms of directional movement. It sounds like wireless is up, raw materials is down. And I think I missed the other ones. Is LED, is that something that might be growing?

Yes, LEDs, we expect it to be up.

And I think you said germanium down. Is indium phosphide also flat to down?

No, germanium sort of flattish.

Flattish. And indium phosphide?

Probably sort of flattish.

Fair enough. On raw materials pricing, I guess specifically on gallium, what was the price that you saw on average during the quarter and ending the quarter? And, Morris, what's your view on where that can go over the next few months or however far out your crystal ball goes?

Well, the gallium price is -- you can look of the metal pages.

Yes.

As I also refer everybody to looking to. But of course, that pricing is more of a smaller [lot] pricing. But it does give you a good indication where it goes. As we've indicated, gallium prices keep on going down. Still, hopefully it's stabilizing a bit.

And where does it go? I wish I know, because if you know for sure, you can take a position on it and you can make tons of money on it. And so I would cautiously say nobody really know. And the dynamics of the gallium pricing, I will say this way, gallium is a very diversified usage in the whole industry. [There] were talk about gallium being used as a petroleum catalyst. I mean, people are talking about using up to 10 tons. And obviously, gallium arsenide usage is a big portion. And yet, other big application is gallium nitride. The general lighting and LED industry, other than gallium arsenide, but also gallium nitride, is a big demand. And also, gallium used as a catalyst or a [dopen] for a magnet.

So, but on the negative side, as far as pricing influence is concerned, is because of the high pricing in the last few quarters, it drove a lot of capacity expansion happening. And that's why they say oversupply or more than the demand. But when will it be balanced? Who knows.

I think the other dynamics -- I'm thinking out loud -- is also -- not everybody, not every gallium producer's cost is the same. In some area, your gallium producing cost is higher than the other. And I think, fortunately, for our joint ventures, is that we believe that we have the most cost-effective producing facility in China. And so long before many other high-cost producer of gallium will quit their production, and our gallium will keep on cranking it out.

So it's a balance of when the price of gallium dropped to a certain point, certain gallium producer would just not produce it anymore because they lose money when they produce more.

Is the price that we're sitting at today, is that below the point where you think it's uneconomic for some of these guys and some [capacity might fall off]?

Oh, absolutely, I think so. I mean, the magic number not long ago, the less [common] metal, they have a confidence. They were proclaiming somewhere around $400 is the critical support point. And I believe when I was -- 10 years ago, there was (inaudible) were still in the business. They were talking about $500 was the bare minimum for (inaudible) gallium. So I think depending upon different company and different region, not everybody's cost is the same.

Okay. Regarding your joint ventures' gallium capacity, you've talked about adding capacity, at least last quarter and over the last couple of quarters. What's their overall viewpoint? Are they still adding capacity at the same rate? Is your expectation of volume this year higher or lower than last quarter? And is there any way to quantify in percentage terms how much approximate volume growth you might have this year in gallium?

Richard, that is a very difficult question to answer, because AXT take a position on gallium, not only our direct joint venture, but we have other joint ventures who owns the other joint venture who controls gallium.

The key to the gallium, we believe is that gallium is a natural resource. Today you may think it's too much. But a year from now or six months from now, you think it's too little. And it's a natural resource which you cannot reproduce it. So while you can, you should try to get hold of it and create ownership of it as much as we can, especially -- [that's in] our strategy.

But whether that's going to be too much, I think part of the problem in the industry is when the price went up so high and the demand seems to be -- there's no end for increasing demand, then everybody's going to increase their capacity as if they're owning the whole market. So if everybody thinks the same way, then you obviously have over capacity.

But I think, fortunately, Richard, gallium is not like iron or copper. It's not over abundant. I mean, it's limited resource. I mean, pretty soon you're going to be out of capacity and it's very much dependent upon [aluminum] producing and also the content of the -- gallium content in the aluminum oxide. So I think it's going to reach its equilibrium pretty soon.

One last question from me, I'll jump out of line. You mentioned being strategically more aggressive in pricing with certain customers. Can you identify which end market or markets that was occurring in?

No. No, Richard. I think for competitive reasons we don't want to say.

Okay, that's fine. I will jump out of line, guys. Thanks a lot.

Dave Kang with B. Riley and Company.

Morris, the first question is, so your top-end customer expects -- they expect Q2 sales to decline 18%, and, yet, you're expecting your semi-insulating business to be up in Q2. So are they building inventory then? Then can you just -- I know you don't give guidance for Q3 and Q4. But can you qualitatively talk about what we should be expecting in second half if that is the case?

Well, Dave, we already said in our script we took that data point into our consideration. We did check with our direct customer. The demand (inaudible - technical difficulty) solid, and we took even some haircut on that and took some conservatism. But we can't really tell. You have just as much information access to TriQuint or whoever, the industry as a whole what the demand environment look like.

And so for us to be able -- it's difficult for us to maneuver and predict how much inventory build and how much is the usage.

Got it. Just any update on activities with potential [new] customers, especially any major ones in the pipeline?

Well, as I said, we don't have anything to report this quarter. We had two qualification wins last quarter that are contributing to our revenue stream. And if we have more good news to report, we will definitely be happy to report back to you.

And then on the LED side, I mean, are you now a little bit more diversified? Before you were heavy exposure to the Taiwanese market. And what about like China, Japan, and Korea, and even Europe?

I think, as we said, we were glad to say that we have diversified into China market. We have took a very strategic move to capture part of the Asian market. We think we're enjoying the fruit of those market. They're growing fairly nicely today, so --

So how big is China right now?

China, I think from what I see is their growth rate is probably the highest, but percentage-wise they're still not that big yet.

And I know someone asked already, but is China -- I mean, is that where a lot of pricing -- you're being aggressive with pricing, especially in China?

No, not necessarily. I think China market is -- we are aggressive, but, again, it depends upon what customer and what particular market we're addressing.

I see. And the last question for me is, if I look at the metal pages, gallium price right now is around $400, down from $500 just a couple of months ago. But do you remember what the lowest point in the last four or five years? I mean, what's the downside from $400? I looked at the last four or five years, and it seems like, I don't think it's ever been this low. I mean, do you recall? Can you recall what the lowest point is?

Yes. I think I recall the lowest I ever seen was $320.

$350.

$320. And when was that?

I think it's around 2008.

2008. So like right before financial crisis then.

Yes.

Or during the financial crisis.

Yes.

Yes.

I see. Thank you very much.

(Operator Instructions) Tom Sepenzis with Northland Securities.

I think most of my questions have been answered at this point. But can you tell us, other than IQE if you had any other 10% customers in the quarter?

No, only the one.

And can you just talk a little bit about the solar market and the expectations maybe for the next year there, because that one seems to be a rollercoaster ride? So any kind of insight you could give us as to what you expect that business to do over the next year would be helpful.

Sure. I think there are two components of the solar market. One is the satellite market. I think that is sort of steady. And the most dynamic segment of the market is the CPV market. And it's not lacking of innovation or high efficiency of the germanium solar cell or even gallium arsenide as a substrate of the solar cell. They are performing extremely well. But because of the uncertainty in the financing market, the whole industry seems to be pushing the implementation of this better technology ever further.

But the latest we heard, I mean, not long ago we have a major customer talking to us about a huge project, they are trying to implement to generate power for some Mid-Eastern countries. And we're still in negotiation or talking to them about it, but who knows when it's going to be implemented, because it depends upon not only the technology, but also because of the funding, available funding, and a proven track record, et cetera, to get it going.

But I would definitely say, although the solar cell industry, especially silicon, and they even recently more (inaudible) solar cell as everybody is aware is very ugly these days. But I think the CPV solar cell, it never took off, so you can never write it down that much. But on the other hand, there's a lot of activities, I can tell you, talking about the possibilities. As I said, including using gallium arsenide as the substrate for CPVs. And the main benefit is it's so darn efficient. The efficiency can be increased by almost 100%, [that's] again silicon. So knowing silicon [and all] solar cell industry, one percentage efficiency improvement is a great deal, so not to talk about doubling it.

That would definitely be impressive. So do you expect growth then this year in that market?

No, it's definitely not baked into our projections, let me put it this way. Although, we don't give -- we only give projections quarter-to-quarter. But we are guardedly optimistic, but we don't count it until we get orders from our customers.

Great. Thank you. And similarly, the LED market, you added the two customers at the end of the last quarter.

Yes.

And what are you seeing there? You said that the first two months of the March quarter were terrible. Does that go through to the LED market as well or was that mainly from some of the other markets that you serve?

The LED didn't recover until the third month of the first quarter, so, yes.

And that looks to be a little bit firmer now going forward?

Yes, I think so. And that, perhaps, doesn't have [the uncertainty] data point as the wireless market [was].

Great. And just a broader question. You have all the gallium arsenide component makers, Skyworks and Avago and TriQuint, et cetera, talking about the increased gallium content within the handsets and obviously tablets and other devices. There just seems to be a little bit of a disconnect with that and the pricing for gallium. So I'm just curious as to how quickly you think that could change or why there is supposedly increased demand for gallium products and, yet, still we're seeing lower prices for the raw material itself?

Well, I think the raw material, it has its own dynamics. It doesn't care whether you have more demand, because gallium arsenide, after all, is not the only demand. And also, you have to enter in the increasing of supply, even though the demand increases tremendously, let's say if you were to double or triple the capacity of supply, then, obviously, there's a [glut] in terms of supply. And also depending, well, the selling price. When gallium was selling $1,000 a [kilogram], some unexpected mine becomes active and then they were not competitive when the price is low. And now all of a sudden they become producers. But when the price normalized and those we expect to get out.

Great. Thank you very much.

Colin Rusch with ThinkEquity.

This is Noah Kagan in for Colin. Thanks for taking the question. I wonder if you could touch on what the regulatory looks like -- environment looks like in terms of environmental regulations for a material supply chain in China. How does that look to you? Is there anything that we should be thinking about going down the pike?

Sure. As the world is ever more increasingly cautious about environmental protection, and let's just touch upon one regulatory issue in Europe. There's a program called REACH. The European Union was talking about banning all gallium arsenide or any arsenic content devices and potentially because [there's a] carcinogenic. But, of course, it's still in the discussion phase. So hopefully we can convince the European Union that gallium arsenide is a very important part of the link of the modern world to use the wireless spectrum.

In China environment, yes, the regulation and requirement over there is getting tighter and tighter. In fact, arsenic was one of the 14 major heavy metal being regulated heavily in China. So, but, we, I say operation in China, we have a long history. We've operated there for 12 years. We carefully monitor all our outputs and we have always been operating under the law and well within, let me emphasize, the limit that is permitted by the Chinese government.

And looking forward, how do you expect this to evolve in China?

Well, I think China government, China will definitely always push for more efficient use of energy, less pollution in terms of [both] water, air, as well as utilization of power to produce more GTP. But I think, for instance, our new facility in [Shenzhen], the China government is very much appreciative of the high-tech industry AXT is bringing to the local economy, and they reckon that gallium arsenide substrate and indium phosphide, as well as germanium, are very important link to the whole health of the industry.

And so pollution is one thing, you need to spend money, effort, and technology to control it, but also you have to look at what benefit it will bring you. For instance, (inaudible) if you can produce very high efficient solar cells, you can cut down on the carbon output of generating power in exchange for the water you will use and electricity you will have to use to produce that germanium crystal.

Thank you for that color.

We will here a follow-up from Edwin Mok with Needham and Company.

Thanks for taking the follow-up. So, Morris, if I look at your first quarter results and your top line of $23.5 million, I went back to history and you look at second quarter in '10, you have a similar revenue run rate. But you are running a lower gross margin and OpEx [is around] -- it's higher now, right. Do you see a need to maybe think about [this as more a] financial model and maybe cut back a little bit on the OpEx level?

OpEx. How much did we increase in OpEx, Raymond?

Yes. I have to go back. I don't have 2010. I just got up to 2011, back. Sorry, Edwin.

I mean, we certainly are not giving everybody a huge salary increase, that's what you were -- we did hire a Chief Scientist. I think it's very much called for, because we can expand our capability, improve our service to our customers, improve our understanding of the material we sell and expand our business.

I think gross margin-wise, Edwin, I would bet to discuss this way, they are part of our business, which the customer always want a lower price - that's given, okay. But in the meantime, our raw material price depends upon raw material being high or low. At this point I would argue that we have hit a double whammy. In other words, the raw material price is low, which is bringing less bacon to home from our joint ventures. And, yet, our raw material price in our inventory for making substrate, is relatively high because we had some high inventory, high-price inventory, and we need this quarter to burn it off.

So when you look at next cycle, hopefully, beyond the second quarter, you will start to see the substrate largely improving. But I can't predict when the raw material price will start to go up again, but I can tell you it definitely will, I mean, because you don't make more gallium in the world. And it's a matter of when.

Then you're going to have the benefit from -- you're going to have deja vu again, from 2010. You can see how powerful our margin model looked like.

Great. That was good color there. One last question I have on the minority interest you mentioned that, at least on the balance sheet it came down because of this one-time dividend. Was that just a balance sheet event that impaired your cash or did it actually flow through in the P&L [at all]?

If you look, it was basically a non-cash item. It was basically just a balance sheet. We actually had two individual JVs declaring dividends. One paid out something in cash and the other didn't, it was just accrued on the balance sheet. The larger portion was non-cash.

Actually, Edwin, I'm just looking now, you're looking at Q2 2010, there [was selling] artificially low in Q2 2010, that's why the SG&A was off by about $300,000.

Great. That was helpful. Thank you.

Now we'll take a follow-up from Tom Sepenzis.

Let's just say that the raw materials pricing starts to go back up or best possible scenario doubles in the next three to four months or something like that. Would you expect the same unit volume of sales or would the volume slow down?

Well, obviously, when the price goes up, the volume goes up. In fact, it's the other way around, when volume dries up, then the price goes down.

But I don't think time, that doubling in a couple of months, that's too quick.

No, no. I know. I just meant if prices start to go up, you should see your margins then increase alongside that?

Yes. I would venture to say, compare us today versus the early 2009, our gallium capacity more than doubled, okay.

Yes.

And price is about the same or right now still slightly higher than what it was. But when it will work itself out to be equilibrium and to start dropping and then start to go up, you can't -- history usually doesn't repeat itself. I mean, look, in 2008, you didn't have this solid state lighting outdoors. And have you ever checked the LED light bulb recently in your local hardware store? It's $12, you can buy three.

And, in fact, I was in Beijing, went to a shopping mall, and they had a renovation of a huge shopping mall and everything inside was using LED lighting. I was really astounded in just how much LED.

In fact, there was other news, was that LED light bulb makers in Taiwan were out of inventory. They can't make it fast enough. But, of course, [knowing] how much it will contain gallium arsenide red LEDs. I know for sure on the other side making the blue LED (inaudible) phosphor, it's definitely very, very robust business.

Great. But we shouldn't expect then revenues to decline as the prices increase because it's just that the capacity that you have is higher now? So we should actually expect raw materials to increase as the prices go up?

Yes, I guess that's fair. But I'm not predicting that gallium price is going to go up any time soon.

Okay. Fair enough. Thank you.

This does conclude the question-and-answer session portion. At this time, I'll turn it back over to Dr. Young for any additional or closing remarks.

Thank you for participating in our conference call. This quarter we will be participating in the Jefferies Global TMT Conference, the B. Riley 13th Annual Investor Conference, the Craig-Hallum Institution Investor Conference, and the D.A. Davidson Technology Conference. We're looking forward to seeing many of you there.

As always, feel free to contact me, Raymond, or Leslie Green directly if you will like to meet with us. We look forward to speaking with you in the near future.

And that does conclude today's conference call. We want to thank you all for your participation. You may now disconnect.