AXT Inc (AXTI) 2012 Q2 法說會逐字稿

Good afternoon, everyone, and welcome to the AXT second-quarter 2012 financial conference call.

As a reminder, today's conference is being recorded.

Leading the call today is Dr. Morris Young, Chief Executive Officer, and Raymond Low, Chief Financial Officer.

My name is Lisa, and I will be your coordinator for today.

(Operator Instructions)

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

Thank you, Lisa, 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 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 SEC 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 August 1, 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 second quarter of 2012. 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 2012 results.

Raymond?

Thank you, Leslie.

Revenue for the second quarter of 2012 was $25.2 million, compared to $23.5 million in the first quarter of 2012.

Total gallium arsenide substrate revenue was $14.9 million for the second quarter of 2012, compared with $12.2 million in the first quarter of 2012. Indium phosphide substrate revenue was $1.3 million for the second quarter of 2012, compared with $1.5 million in the first quarter of 2012. Germanium substrate revenue was $2.5 million for the second quarter of 2012, compared with $2.6 million in the first quarter of 2012. Raw materials sales were $6.5 million for the second quarter of 2012, compared with $7.2 million in the first quarter of 2012.

In the second quarter of 2012, revenue from North America was 17%, Asia-Pacific was 64%, and Europe was 19% of total revenue. One customer generated more than 10% of our revenue during the second quarter, while the top five customers generated 39.3% of our second-quarter revenue.

Gross margin in the second quarter was 29.8%, compared with 34.9% of revenue for the first quarter of 2012. The drop in gross margin was largely the result of a new People's Republic of China value-added tax, or VAT, levied on foreign enterprises that import materials which do not form part of the final product. AXT recently received notice of the retroactive VAT, which applied for the period of July 1, 2011 to June 30, 2012, and amounted to $1.27 million expense in the quarter ended June 30, 2012, which resulted in a 505 basis point impact to gross margins. Excluding the effect of this VAT tax, gross margins in the second quarter would have been 34.9%. Going forward, we expect that this new VAT will negatively impact gross margins by approximately 150 basis points per quarter.

Selling, general and administrative expenses were $4 million for the second quarter of 2012, compared with $3.9 million in the first quarter of 2012. Research and development costs were $914,000 for the second quarter of 2012, compared with $835,000 for the first quarter of 2012. Total stock compensation expense was $292,000 for the second quarter of 2012, of which $18,000 was included in cost of revenues, $239,000 in SG&A and $35,000 in R&D.

Income from operations for the second quarter of 2012 was $2.6 million, compared with income from operations of $3.6 million in the first quarter of 2012. Net interest and other income for the second quarter of 2012 was $219,000.

Net income in the second quarter of 2012 was $1.3 million, or $0.04 per diluted share. Without the effect of the retroactive VAT, net income in the second quarter would have been $2.6 million, or $0.08 per diluted share. This compares with net income of $1.6 million, or $0.05 per diluted share, in the first quarter of 2012.

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 increased to $47.1 million at June 30, 2012.

Accounts receivables net of reserves were $22.3 million at June 30, 2012, compared to $16.6 million at March 31, 2012. The increase is the result of the increase in sales as well as timing of payments of certain customers.

Days sales outstanding were at 81 days for the second quarter, compared to 64 days for the first quarter of 2012 and 70 days for the second quarter of 2011. The increase in days sales outstanding in the second quarter of 2012 affected the timing of certain payments and is expected to return to normal levels in the third quarter.

Net inventory was $40.9 million at June 30, 2012, compared with $42 million at March 31, 2012. Of this, approximately 44% is raw materials, 42% is work in progress and 14% 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 second quarter was $933,000, and capital expenditures were $1.8 million.

As of June 30, 2012, the Company, including our consolidated joint ventures, had 1,298 total employees, of whom 1,087 worked in production.

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

Morris?

Thank you, Raymond.

The second quarter was a positive quarter for our gallium arsenide business, which grew more than 20% sequentially. Of that, our semi-insulating gallium arsenide business performed well in the quarter, posting 8% sequential growth. This was driven by growth at our largest customer as well as consistent performance across our base as a whole. We continue to make progress with new customer qualifications and are hopeful that we will begin to layer on additional revenue from new qualification in the coming quarters.

As we look ahead to Q3, we don't expect any major changes in the demand environment for semi-insulating gallium arsenide substrates, as customers are cautiously optimistic about demand and inventory appears to be at a moderate level.

Our semiconducting gallium arsenide sales grew by approximately 36% in Q2 as a result of strong demand from both our Taiwanese and Chinese customers. This growth was evenly distributed across 2, 3 and 4-inch substrates.

As we move into the third quarter, we are seeing consistent demand from Taiwan but a slowdown in the demand environment in China. We are expecting this slowdown to be negatively impacting our Q3 semiconducting revenue performance. We believe that the regional discrepancy is due to our customers in Taiwan primarily selling to certain high-end applications such as automotive and solid-state lighting that are more predictable and continue to see positive demand. Many of our customers in China, however, are selling largely into consumer applications, which are currently weak. However, it is important to note that consumer markets tend to be more fluid and can strengthen very quickly as economic conditions and buyer confidence increases.

Similarly, we are seeing a slowdown in China for our germanium substrates as a result of fewer planned satellite launches. This market grew very quickly in 2011 but has moderated somewhat in 2012. We continue to see healthy performance from our [key European] customers and therefore are expecting only modest decline in our revenue in the area of our business in the next quarter.

Finally, turning to raw materials, the price of gallium raw material has continued to decline, with spot pricing now at approximately $320 a kg and nearing historical lows. Our joint ventures are reporting strong volume demand and have benefitted -- and had the benefit of scale, with ample capacity and the lower cost structures. As such, they are able to maintain profitable, even in the current environment.

However, the current pricing environment is likely to cause smaller manufacturers to cease operations, as they may be selling material at or near their cost. This drop in raw material pricing is benefitting us on our substrate costs, but it's also the primary cause for the decline in our third-party revenue of raw materials. As such, we are expecting to see a further decline in our third-party raw material revenue in Q3.

In closing, given the current microeconomic environment, we are taking a measured approach to our business. We expect to see consistency in our semi-insulating gallium arsenide substrate business but are planning for a decline in our sales of semiconducting substrate using the manufacture of (inaudible).

We are also expecting a decline in third-party sales of raw material [as a result in] average price declines. However, fundamentally, our business is solid, and there is no indication that we have lost shares in any of our markets. Further, we continue to be optimistic about our new customer qualifications and believe that we are well positioned to ride out the current cycle and resume growth when the demand environment improves.

We are at work diligently to improve our operating structure and efficiency and are well positioned with key customers in each of our markets. We view improving market conditions, new customer qualifications and a bottoming of raw material pricing as key catalysts for our growth later this year and beyond.

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

Raymond?

Thank you, Morris.

In the third quarter, we are expecting to see total revenues of between $21 million and $23 million. We are expecting net income in the third quarter of between $0.02 and $0.04 per share, based on approximately 33.4 million common shares outstanding.

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

Thank you.

(Operator Instructions)

We'll take our first question from Avinash Kant, with D.A. Davidson & Co.

Good afternoon, Morris and Raymond.

Hi, Avinash.

A few questions. The first one, in the guidance that you are providing, I believe, of course, the impact from the Chinese situation is already incorporated, so if you could give us an idea about what kind of gross margins you are thinking about at the midpoint of the guidance.

Avinash, our target gross margins will still be in the mid 30s.

But I don't think you will have those margins in the third quarter, right?

Yes, I think the question is whether our margin will continue to be in the mid 30s. I think -- Avinash, I think we have to take into account to add the VAT tax layer onto us in the next quarter, but not as heavily as we did in the third quarter -- second quarter, because it was retroactive, in a way, in the second-quarter results.

All right. And your material sales, so what kind of pricing assumptions do you have for materials in the third quarter? You said that it will be down sequentially, but what kind of pricing (inaudible)? Like we are trying to figure out if the prices were to come up or go down from here we should be able to at least figure out what will be the impact on your guidance.

Raymond?

I think the pricing of gallium is really hard for us to predict, but we see it stabilizing at a low level right now.

Right. You know, Avinash, I think you're right, Raymond is right. I mean, gallium price is so difficult to predict. When it goes up, it goes up crazy. But I think it's really at historical low and is really below many analysts have predicted it can ever go to, but it's still at that low level. So I think -- I appreciate your wanting to analyze what we could have done, our gross margin and the rest of the business.

Let me say I think one thing which is going to negatively impact us is the VAT tax, which Raymond already said is going to be 150 basis points. But I think talking -- well, yes, the other possible negative is that we expect revenue to decline slightly for this coming quarter, so that should put margin pressure on us. However, the positive from us is that the raw material pricing of gallium should start to go through our [cost that we sold], which will benefit us.

Right. So, what I was trying to figure out is that of course there's some positive impact from lower gallium prices, and, of course, and then some negative impact from materials sales. The timing of the positive impact seems like it's going to be from Q3 onwards, but how much will be the help on margins if prices were to stay here versus the decline because of materials sales? Any way you can qualitatively, at least, give us some idea?

That's very difficult, Avinash. Part of the lower pricing cost of the gallium started to (inaudible) itself into our end-of-Q2 costs, so it's definitely going to be lower cost during Q3. We worked out the higher cost inventory through already. So we've taken that into account in our guidance for Q3.

Okay. And one final question, again getting to the same question, trying to figure out the margin impact, you thought there was a 150-basis-point margin impact going forward. Is that based on certain material sales volume assumptions or revenue assumptions?

No, that VAT is actually on purchasing inventory, so it's actually got nothing to do with our sales or volume or revenue.

Right.

It's actually purchasing raw materials.

Because the way I read it that purchasing raw materials that does not go into a product.

It's like a consumables type, if you want to look at it that way.

Okay.

It does not apply to gallium or arsenic.

It's to every material, right?

Right. Well, it's a change of the tax ruling that they have in China, that used to be that we don't have to pay tax on these consumables which we are using to manufacture substrate, but the new ruling happens to apply for retroactively the whole year, so any of the chemicals, quartz, pBN, that we are using to manufacture gallium arsenide substrates now needs to pay the extra VAT tax going forward.

Okay. Thank you so much. Yes.

Sure.

And we'll now go to Edwin Mok, with Needham & Company. Mr. Mok, your line is open. You might want to check your mute function to see if your line is in mute.

Hi, can you guys hear me?

Yes, sir.

Yes.

I apologize for that. So, yes, actually, congratulations for actually a decent job for top line considering a tough environment. So I have a few questions. First just kind of a follow up to the last questions. I notice your inventory, while it came down sequentially, still remained at the $40 million level, right? I was wondering why do you have such -- still such high level inventory, or are you starting to rebuild inventory because you think price is low now, or can you help me with that, especially on the raw materials side, where you say 40% of that is raw material, right?

Right. Edwin, I think our message is continue to work down on the inventory. But, you're right, I mean, the speed of working it down -- well, we consumed $2 million worth of inventory this quarter. So maybe it's not as fast as we expected, but I think the good news is we'll continue -- we will continue to work down our inventory.

This -- can you help me maybe a little bit with the cost of that inventory? Is -- you mentioned that you have worked down some of the high cost -- is that (inaudible) first in, first out, and as a result as price comes down [then all of] your cost of inventory comes down? Is that how we should think about that?

Yes. Basically it's on weighted average, but also on a first in, first out basis. And so we've also worked out through the higher cost of inventory in -- it's been decreasing over the last three quarters, Edwin, and about 44% or 45% of that inventory is raw materials, and quite a substantial portion is gallium.

So, given that price has come down to this level, assuming prices stay at this level for the rest of the year, I would suspect that you'll continue to work down that high cost and therefore it's actually having a drag of your gross margin in the near term. Am I correct on that?

Well, just because of the law of averages, sure.

Okay, great. Go ahead, sorry.

Edwin, I thought we have already worked down our high cost inventory, so why should it be still a drag?

Because prices continue to come down, unless (multiple speakers).

So if you're going to assume it's going to continue to come down, yes, sure.

Because, I mean -- I see. Okay. Okay. That's helpful. Yes, because even if you assume price stay the same as it is right now, I mean, it dropped -- if I look at gallium price it dropped quite a bit even in the month of July, right? So just from that vantage point it probably still have a drag on your margins, wouldn't you say so?

No, Edwin, I wouldn't say so, because, you see, when we buy gallium, I mean, you have to assume how smart we buy, and we don't buy at the point that you see if it is a continuous slide in the price, and hopefully we're smart enough to capture the low end of the price we buy.

Okay. Okay. I see. I see. I think I got what you're saying. That's very, very helpful. Going to the market, I was wondering, one of the larger semi-insulating GaAs substrate user, TriQuint, actually had a pretty positive outlook for the third quarter. I was curious why, if that's the case, that you still expect your business -- or that business to be flattish in the September quarter?

Well, I think we do expect -- we're not expect a -- we expect the semi-insulating business to be okay. I do believe that if our customer perform well we should gain the benefit of it.

I see. I see. But, I mean, the current level, based on my calculation, is still quite a bit below the level you were doing back in last year or the peak level that we have seen last year or the year before that, right, which is roughly around the $10 million level? So is it just pricing [all] those have come down or is it just customer more cautious about buying GaAs substrate inventory?

Well, Edwin, I think our semi-insulating gallium arsenide market business is mainly the challenge for us is to gain more new qualifications. Unfortunately, we've been saying that for the last three quarters, and so I don't know how many analysts or investors still believe us, but we certainly have a lot of confidence in ourselves, and we're still progressing well in that front. So I think, other than our major customer continue to do well, which will (inaudible) benefit to AXT's semi-insulating gallium arsenide business, but also the other major opportunity for us to improve our business in the semi-insulating side is the fact that if we can gain one or two more new qualifications going forward.

Great. That actually leads to my last question. So you mentioned (inaudible) your prepared remark that you're making progress on the qualification there, right, and I think the target is probably start shipping some time in 2013, right? In terms of getting qualified in these new customers, right, how do you kind of size that opportunity? Do you think by winning these customers in, let's say, two-year time horizon you might be able to double your business or at least your volume in the semi-insulating, or some kind of metric that you can give us, even a long-term metric, just to let us get a sense of that qualification?

Edwin, I think that's highly speculative. I think one way to look at it, so if I were to talk -- analyze the situation for you, is that you can look at the business size, Customer X and Y and Z, their revenue per year or per quarter, what are the target qualification we try to get into, so you can sort of try to figure out what's the potential for us. But obviously you've got to be patient. When these customers qualify us they're not going to switch 100% to us right away. So it would take a few quarters or maybe years before they start to be comfortable with us, and hopefully we can be their either number one or two supplier, then that will be -- the opportunity will be huge, for sure.

Great. That's actually useful color. That's all I have. Thank you.

Thank you, Edwin.

We'll go next to Richard Shannon, with Craig-Hallum Capital Group.

Morris, Raymond, how are you guys doing?

Good, how are you, Richard?

Not too bad, thanks. Maybe I'll follow up on one of the just recently asked questions regarding customer qualifications. I think the previous question was focused on semi-insulating potential qualifications. Any new and significant ones potentially happening in either semiconducting or your other product areas?

Yes, we actually did two successful qualifications earlier this year on the semiconducting side. However, the size of those customer qualifications is, well, slightly smaller, not as big as the semi-insulating ones, because that -- by nature the semiconducting customers are more diversified, and there's many of them. But those two new semiconducting customer qualifications has already benefitted us this year and giving us revenues.

Okay. Okay. Let's see here. Next question, how is the pricing environment looking like in gallium arsenide, maybe more so on wireless, but maybe overall? Are you seeing any more aggressive pricing from your competitors in any way?

Well, I would say I think it's a mixed signal. I think overall I would call it perhaps as usual. The price always comes down, and it never goes up, but it's nothing dramatic in changing price. But in each individual competitors, some of them will turn to be more aggressive and some of them will turn to be less aggressive, as you know that. But then there's not a whole lot of competitors in the space, anyway.

Right. Yes, that's true. Okay. On the value-added tax, is there any way that that can be avoided by using different materials, or is that kind of locked in and therefore there's not much you can do about it other than sort of changing the laws and policies of China?

There's no way you can avoid it. I mean, I think perhaps if I were to suggest one way to avoid it is that, which we have done quite a bit, is that if we were to use domestic source in China, then you can partially offset that by the fact that -- and if you can still get high-quality, good material, and so you get a lower price, and then -- but you still have to pay VAT tax.

Okay. All right. Fair enough. Then, Morris, in terms of gallium, I think one of your prepared comments was some smaller suppliers may have difficulty making money in this environment. Are you seeing evidence of any of those guys stopping production, or at least from what I'm aware of, some of these aluminum producers have stopped making raw gallium -- have you seen any activity like that occurring in the last quarter?

Oh, yes, I think so. I mean, we know of at least one. They are telling us its selling price is too low, they don't make money. However, there's another benefit is that the customers, if they don't have an in-house source, JV source like we are, when they start to see prices of gallium to be attractive, they may go out and just start to buy to build their inventory. And so those could be beneficial. But on the negative side, I mean, which we don't know, is how big the extra capacity was built during the peak time and so you have to sort of balance it all out. So, although I think optimistically the price of (inaudible) is well below analysts' predictions can ever go, but make a believer out of me, I mean, it is low.

Morris, based on your long experience dealing with multiple gallium pricing cycles here, the last couple of cycles, as you've seen, these types of competitors turn off supply. What's the time frame lag between that happening and eventually seeing that price start to bottom and increase again? Is that like a couple of months, six months? What's your past experience with that?

I would call it six months.

Six months? Okay. Is that an accurate reflection of your thoughts on when it could increase, then, from what you know right now?

I wouldn't tell you. Otherwise I think our competitor would start to buy gallium at the same time as I buy it.

Okay. Maybe just one last quick question and I'll jump out of the line. If I caught your comments in your prepared remarks, Morris, [like] some softness in the semiconducting side of your business. What are the causes really, just some overbuilt inventory, and do you expect that to improve in the fourth quarter, or is your crystal ball a little farther out than that?

Well, I think it is a puzzle. Q2 was fairly strong. Everybody was saying there's a big recovery on gallium LED business. And everybody says that cycle should last at least throughout the year and possibly into 2013. But we all of a sudden see the air pocket with some of the Chinese customers. So we did some analysis, and we think it's because they are probably more tied into the economic situation, the Christmas trees and kids' shoes and things like that, and if consumer demand or customers are pulling back a little bit to be cautious, then everybody reduce inventory, then it starts to affect us.

But, on the other hand, I also believe that things that can turn off so quickly potentially can turn on very quickly, too. I mean, if (inaudible) from China starts to want to invigorate the economy again it can come back up.

Okay. Fair enough. Thanks a lot, Morris and Raymond, and I'll jump out of line.

Thank you, Richard.

(Operator Instructions)

We'll go next to Dave Kang, with B. Riley & Company.

Thank you. Good afternoon. The first question is to Raymond. What was the depreciation and amortization? I missed that number.

$933,000.

$933,000. Got it. And then on your gross margin comments, just wanted to clarify, did you say the current quarter, Q3, gross margin will be mid 30s, and does it -- that's including VAT, I assume, or was it long-term gross margin target?

It's long term.

Long term. Yes.

So, for your guidance of $0.02 to $0.04, what is your gross margin assumptions?

You know, Dave, we don't normally give that, but, I mean, once you back into it you'll probably (inaudible) see how complex this gross margin actually is because of the lower price of raw materials, our customer joint ventures and then also our [net] benefits as in the lower costs of our gallium arsenide substrate revenue (multiple speakers).

Okay.

Yes, one thing for sure is that it's going to be higher than Q2 margins, which we just reported, 29-point-something percent, and because that's a retroactive tax we've been paying.

Right.

But I think specifically what that prediction is I'll let you guys work it out.

Okay. Fair enough. And then on your -- sticking with the guidance, the revenue guidance, about $3 million to $4 million sequential decline is expected. Can you kind of -- I mean, you kind of qualitatively went over already, but can you kind of categorize which segment is contributing to the decline? I am assuming semiconducting is your largest component there?

Yes, semiconducting -- semi-insulating, which is the [RF] application, Dave, we expect it to be stable.

Okay.

And semiconducting, which is making LEDs, we expect it go sequentially down. Germanium and indium phosphide, we believe they are probably stable, flattish.

Yes.

And lastly I think is the raw material we expect it to go down, mainly because of the pricing pressure of raw materials.

Right.

I think if I may also give a color on our business is that substrate business is at the beginning of all this food chain, so, as you know, the economy was to be a bit cautious and people are projecting business going forward to be a bit more cautious, then everybody tend to buy a little bit less and you tend to use up your inventory a little bit, it start to affect us.

Right.

So, when the business outlook is a little bit more better, then our business will perform better. So that's taking the inventory into account [kind of an issue].

And plus, I guess, TriQuint, even though their sales were down in Q2, I guess they kind of built up inventories, and that's why you're not expecting a jump in Q3 from TriQuint side?

No, I don't think I would read into that.

No?

I don't think it's -- that's too much of a fine analysis. I do believe if our customers are doing well we should benefit from it.

Okay.

But your assumption whether they have inventory or don't have inventory, we don't have that level of detailed analysis of knowing are they good in inventory or not. But, honestly, I don't think in this environment people are really building inventory, because people are more cautious.

Right. Plus I think their Q3 guidance wasn't that strong. I'm hearing that the iPhone 5 launch date has been pushed back to like September or October, so can we expect demand to get stronger from your -- from them as we get closer to the iPhone 5 launch date in September, October? Is that a fair assumption?

Yes, Dave, I think we're stretching it, because TriQuint is not a direct customer.

Right.

They will have to go through all the layers. So --

But, then, like IQE, they released their press release I think it was last week, and they were pretty bullish about second half. I mean, they didn't give a formal guidance, but then qualitatively speaking they were a lot more bullish than you, but of course they are more tied into TriQuint, whereas you have other business segments to deal with.

Right. I think specifically dealing with IQE, I mean, they are a very good customer of ours. I believe if their business is good it should benefit us. It should.

Right. Okay. And then sticking with IQE, so, RFMD, so the deal is that they have an exclusive supply agreement with Sumitomo until next March? Is that correct?

I don't know. I think -- is that -- you'd probably have to ask RFMD, I mean, what kind of deal they made.

Right. Right. I think that's what IQE told me, so, assuming that is the case, I mean, what are your plans to -- do you have some plans to penetrate RFMD? I mean, can you share some of that with us?

Well, again, I think IQE is a very good customer of AXT. If their business improves, we should get a good shares of that business. And that's because all the way from management, from quality, from the -- how familiar they are with using our product, and they obviously got not only good performance, good pricing, good overall delivery, and they have very good confidence in overall performance of our material, so if their business were to improve, whether it's through better TriQuint performance or they got a new business from RFMD, I do believe it improves our opportunity to improve our business.

Okay. I forgot to ask you this on the semiconducting side of gallium arsenide, but what's the rough split between Taiwan and China? It seems like China is the one that's causing this softness, whereas Taiwan seems to be doing fine. I mean, is China as big as Taiwan now, or even bigger now, or --?

They're pretty close. It's around about 15%. There are six geographic areas we service into semiconducting. Six of them are pretty much very similar in size. That's what makes the semiconducting more diverse. It's not one particular area.

Right.

China at one time was growing faster than Taiwan, but this last quarter they were both pretty strong.

Right. Right. And then, lastly, on the germanium side, can you go over the dynamics, why is it slowing down? I mean, I thought the satcom industry was pretty healthy. And is it, once again, China that's slowing down and everywhere else is fine, or --?

Well, we think Europe was doing very well on their satellite launches. China, I think, up till last quarter was doing well, but last quarter we hear from our customers, they're saying some of their satellite launches got delayed. Whether it's through -- because of they have less planned satellites to be launched or is there a problem in one of the manufacturing channel we don't know.

Okay.

But we just know that we don't plan business for -- from last quarter, and then for next quarter it's probably going to be slow, as well.

Got it. All right. Thank you.

All right.

And we'll now go to Edwin Mok, with Needham & Company. Mr. Mok, your line is open.

I think you're mute.

Hi. Thanks for taking my question. I guess something's wrong with my mute function on my phone, but just quickly on operating expense, how do you think about operating expense in the coming quarters, in the next few quarters?

It should be pretty similar, round about $4 million for the SG&A and about $915,000, that area, for R&D.

What drove the increase in SG&A last quarter?

It was only $100,000 more than the previous quarter. We were talking about $4 million versus $3.9 million.

Okay. All right.

So we [had] it a little higher, right? One or two.

Okay. That's fair. And then how should we think about tax going forward?

Tax you would normally use around about I would say an average of about 12% of EBIT. Sometimes it ranges 11% to 13%, never much higher, so it's pretty much in that ballpark.

Oh, I see, so last quarter the tax rate was high because we have this one-time (inaudible) VAT, which makes the tax rate (inaudible) higher then?

No, not in that particular case.

The last quarter if you calculate it the tax rate was 14.5%.

It hovers around about between 11% and 13%, Edwin. You could probably just use that to model.

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

And we'll now go to Avinash Kant, with D.A. Davidson & Co.

Hi, I just had a follow-up question, actually, and more regarding your LED business. So, really, the weakness you seem to be seeing at this point in China, but as far as the Taiwan and the [leading edge] business is concerned, where do you see strength in that business?

Well, as I said, I think our large customer, who we believe are serving the more -- better quality or needs more reliability requirements customer seems to be doing well. But then, on the other hand, as we look back, they also seem to be more predictable, as well. So, whereas China business I think when they come they come in a rush, but sometimes when they decline they decline precipitously for difficult-to-predict reasons. And the best we can make out is because those consumer products, they are more influenced by the economic mood of customers.

Okay. And, Morris, again, I think this question may have been asked, but anything about Q4, again, given some of the product ramps that are on hand, we understand that late this year there could be some significant product ramps, you should be benefitting from that, so how should we think of the second half, maybe versus the first half, or anything you can give us about Q4 versus Q3? Do you see it qualitatively going up or down or --

Well, Avinash, we never give out more than one quarter's predictions, and given our business sometimes it's very much influenced by -- it's difficult to make a one-quarter prediction already. But you're right about what we think of the business opportunity. I think for us, although semi-insulating we are cautiously assuming that business is going to be sort of flattish, but, as many of you pointed out, our largest customer base, who are very bullish about their business prospects, and I think if they will have very good business, they need substrate to do that business, and where else to get it from other than their largest supplier? And obviously the next big, big opportunity is if we can ever get through these new customer qualifications.

Our semis, our semiconducting, I still believe this solid-state lighting as well as the adoption of LEDs are bullish. But we have to call it whatever it is for the coming quarter. I mean, it doesn't look that good. So we have a -- but whether that's going to turn back around in the fourth quarter, nobody knows. If European crisis deepens and if consumers start to buy less stuff, I mean, it's hard for us to buck the trend.

And as far as raw material is concerned, you can make all kinds of speculation on where the raw material price is going to be and when it's going to bottom, and all you have to do is draw a similar curve as we did in 2009. I keep on saying that. But nobody knows when that time will begin. And so it will be difficult for me to tell when that is going to be. But I think, as far as raw material is concerned, definitely the price will go up, because there's no shortage of demand for the raw gallium to be used in many of the applications such as solid-state lighting, not only gallium as well as gallium nitride and the strong magnets as well as some of the solar cell applications.

Okay, and --

So --

I had one final question, maybe, if you could give to us some color on what kind of pricing do you see, like for your gallium arsenide wafers, pricing today, where is it compared to last quarter or a year ago?

I don't think there's any unusual price move, I mean, but, however, the price, always people wants lower price, but there's no such thing as it drops out of the bottom, so to speak. And so there's no unusual price move.

So, if you were to model that, what kind of percentage decline can we put over a longer period of time, like over the last three to five years prices have been coming down every year by --?

Okay, yes, I say usually -- it's a good indication is that, let's say, let me give you a time frame, 2002 -- 2001 it was selling for $450, a six-inch wafer. Today you can probably assume maybe $150, $155. So you take the logarithm and you can figure out what's the decrease every year.

Perfect. Thank you so much, Morris.

All right.

We'll go next to Rob Ammann, with RK Capital.

Yes, the normalized margin at 34.9%, would that be the margin with zero VAT impact or would that represent one quarter's worth? I'm trying just to understand if that has a 150-basis-point impact in there or if this were a normal quarter without the retroactive impact we'd be looking at more like a 33.4% gross margin this quarter.

Correct. So that was a zero -- we just assumed that at zero.

(Multiple speakers).

Of course, going into Q3 we've got different factors coming in, lower price for raw materials from our joint venture sales and then also our lower cost benefit.

Right.

Yes, we're just like trying to balance that together.

It makes sense. And then in terms of the sequential decline in revenues, do you think it'll be a larger decrease in raw materials or in semiconducting gallium arsenide? Which one do you think sees a bigger decline either in dollars or in percentage terms?

Well, just mathematically the semiconducting is the larger portion, because raw materials really only is about maybe 15%, 20% versus semi-insulating and semiconducting together make about 65%, and each of those is probably about 45%, 55% split.

I'm sorry, what's the mix between semi-insulating and semiconducting this quarter?

This quarter it happens to be 55%-45% (multiple speakers).

In favor --

Yes.

55% larger on semiconducting, since that grew faster?

Correct.

Okay. Okay. Okay, so, I guess my question is more on just the semiconducting piece, which isn't that much larger than your raw materials, if it was a little over $8 million versus raw materials at $6.5 million on percentage terms, which will fall faster, would you guess, raw materials or semiconducting gallium arsenide?

Semiconducting.

Semiconducting, great. Thank you. And then I know it's not this simple just to look at the noncontrolling interest line to ascertain the complete profitability on the raw materials business, but maybe it's a decent proxy. I was pleasantly surprised to see that didn't really change all that much even with a modest decline in revenue there. It looks like the margins for the joint ventures that are consolidated held up pretty well, were pretty close to flat. Is that fair?

Yes.

Okay. Great.

I mean, the margin -- I mean, the selling price declined, but then we sell more.

Yes.

But as far as margin is concerned, yes, it had the negative impact, but then there are other things which are impacting. For instance, we got some benefit from the lower cost of selling material gallium from our gallium arsenide substrate for last quarter a little bit on the tail end; that benefitted us. And also the other, the final thing is product mix. Pretty soon I will be a CFO.

Thank you.

It appears there are no further questions at this time. Dr. Young, I'd like to turn the conference back to you for any additional or closing remarks.

Thank you for participating in our conference call. This quarter we will be marketing in various locations around the country and look forward to seeing many of you there. As always, feel free to contact me, Raymond or Leslie Green directly if you would like to meet with us and we'll look forward to speaking with you in the near future.

Ladies and gentlemen, this does conclude today's conference call. Thank you for your participation.