AXT Inc (AXTI) 2012 Q3 法說會逐字稿

Good afternoon, everyone, and welcome to AXT's third-quarter 2012 financial results conference call. Today's call is being recorded. Leading the call today is Dr. Morris Young, Chief Executive Officer, and Raymond Low, Chief Financial Officer. My name is Miranda, and I will be your coordinator today.

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

Thank you, Miranda, 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 on management's current expectations, and are subject to risks and uncertainties that could cause actual results or results --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 November 1, 2013.

Also before we begin, I want to note that shortly following the close of market today, we issued a press release reporting financial results for the third 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 full review of the third-quarter 2012 results. Raymond.

Thank you, Leslie. Revenue for the third quarter of 2012, was $20.8 million, compared with $25.2 million in the second quarter of 2012.

Total gallium arsenide substrate revenue was $12.9 million for the third quarter of 2012, compared with $14.9 million in the second quarter of 2012. Indium phosphide substrate revenue was $1.6 million for the third quarter of 2012, compared with $1.3 million in the second quarter of 2012. Germanium substrate revenue was $2 million for the third quarter of 2012, compared with $2.5 (sic - see press release -- $2.4 million) million in the second quarter of 2012. Raw material sales were $4.3 million for the third quarter of 2012, compared with $6.5 million in the second quarter of 2012.

In the third quarter of 2012, revenue from North America was 15.5%, Asia-Pacific was 59.8%, and Europe was 24.7% of total revenue. One customer generated more than 10% of our revenue during the third quarter, while the top 5 customers generated 37.3% of our third quarter revenue.

Gross margin in the third quarter was 26.3%, compared with 29.8% of revenue in the second quarter of 2012. The drop in gross margin for the third quarter of 2012, was largely the result of lower selling prices of raw material gallium, lower tonnage, and also lower capacity utilization.

Selling, general, and administrative expenses were $4.0 million for the third quarter of 2012, compared with $4.0 million in the second quarter of 2012. Research and development costs were $844,000 for the third quarter of 2012, compared with $914,000 for the second quarter of 2012. Total stock compensation expense was $300,000 for the third quarter of 2012, of which $19,000 was included in cost of revenue, $245,000 in SG&A, and $36,000 in R&D.

Income from operations for the third quarter of 2012, was $700,000, compared with income from operations of $2.6 million in the second quarter of 2012. Net interest and other income for the third quarter of 2012, was $544,000. Net income in the third quarter of 2012, was $933,000, or $0.03 per diluted share. This compares with net income of $1.3 million, or $0.04 per diluted share, in the second quarter of 2012.

Cash and cash equivalents with maturity of less than 3 months, short-term investments, and other investments in high-grade debt securities with maturities of less than 2 years, increased by $4.4 million to $51.4 million at September 30th, 2012. For the 9 months ended September 30th, 2012, AXT has generated $10.8 million in cash and cash equivalents.

Account receivable net of reserves was $16.9 million at September 30th, 2012, compared with $22.3 million at June 30th, 2012. Days sales outstanding were at 74 days for the third quarter, compared with 81 days for the second quarter of 2012. Net inventory was $39.9 million at September 30th, 2012, compared with $40.9 million at June 30th, 2012. Of this, approximately 43% is raw materials, 41% is work-in-progress, and 16% 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 third quarter was $990,000, and capital expenditures were $2 million. As of September 30th, 2012, the company, including our consolidated joint ventures, had 1,307 total employees, of whom 1,099 worked in production.

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

Thank you, Raymond. Business conditions in the third quarter were challenging and were in keeping with the expectations that we outlined where when we announced our results last quarter.

The compound semiconductor substrate market is currently experiencing a correction, largely driven by weaker demand and a moderate amount of excess inventory in the channel. The environment continues to persist in the fourth quarter. We do not expect that it will resolve itself before the end of the year.

We're strongly focused on the diversification of our revenue, and are actively laying the groundwork for our renewed growth as the market improves. We believe that continued strong execution and conservative planning will allow us to weather this downturn and emerge well-positioned as the new cycle begins.

Let's now begin with the market for semi-insulating gallium arsenide. The business environment continues to be challenging as a result of a lower overall demand and some inventory in the channel. As a result, we're projecting weaker sales of our substrates in Q4. However, long term, the market for gallium arsenide substrate remains bright, as the number of applications for wireless device continues to grow.

Further, we're continuing to progress on new customer qualification and are hopeful that we will begin layering additional revenue from new customers next year.

Turning to semiconducting substrates, the third quarter was quite challenging, as expected. We saw a greater than 15% drop in revenue. Geographically speaking, the weakness today is widespread. We do not expect this demand environment to improve in the fourth quarter and are taking a conservative view of our business expectations.

Having said that, while the market in China continues to be weak, we believe that we have some competitive opportunity there and are focusing our efforts on leveraging our quality and cost structure advantages to grow our presence in this strategically important geography.

Turning to germanium substrates, current demand is still almost exclusively for satellite solar cells. As expected, the market in China continues to be weak and is likely to remain so through the end of the year. Demand in Europe remains to be strong, and we are encouraged by the discussion with our customers there that suggest that we may see an increasing demand in 2013.

For terrestrial applications, the market is continuing to emerge with new megawatt facilities being built in the United States, Europe, China, and the Middle East. We're continuing to be very conservative in terms of our revenue expectations for these applications, but the industry is making great progress in the conversion efficiency of terrestrial solar cells.

Further, we are participating in new solar cell technology that leverages gallium arsenide substrates as a critical component in CPV solar cells. The efficiency of this new technology is currently at 44%, and companies in this space are showing roadmaps to achieve 50%, reinforcing the possibility that CPV as a technology will succeed. Whether germanium or gallium arsenide becomes the ultimate winner, AXT is poised to benefit.

Finally, in terms of raw material, the price of raw gallium is currently in the low $300 per kilogram range, which is the lowest it has been in many years. As such, we are beginning to see some strategic buying at these levels. For example, the Chinese government recently bought 10 tons of raw material for its inventory. While we certainly cannot predict the turning point, it seems likely that pricing is reaching its floor. As a result of low gallium price, the third-party sales of raw gallium dropped in the third quarter, and we are estimating that we will be moderately lower in Q4.

In closing, our solid execution over the past many quarter is allowing us to weather the current down cycle. We're using this time to support significant qualifications that are still ongoing, and to focus our resources on strategic geographies and applications that are likely to benefit AXT in 2013. We view improving market conditions, new customer qualifications, and the bottoming of raw material pricing as key catalysts for our growth in the coming years and beyond.

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

Thank you, Morris. In the fourth quarter, we are expecting to see total revenues of between $17 million and $18 million. We are expecting net income in the fourth quarter between a loss of $0.02 and breakeven per share, based on approximately 32.9 million common shares outstanding.

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

Thank you. (Operator Instructions). We'll pause for just one moment. (Operator Instructions). Richard Shannon with Craig-Hallum.

I guess my first question is on gross margins. You had a number of just below 27% just reported in the third quarter. And as I recall from the last call, you thought it would be up somewhat. Clearly volumes are a little bit lower, but even then it seems a little bit low given that perspective. Have there been any changes in the pricing environment in any of your substrates in addition to -- and to lower gallium pricing?

I guess it's mainly caused by the lower gallium pricing. I mean, substrate we haven't seen a drastic change in pricing, although that's a -- it's a moving target.

Right.

But we haven't seen a dramatic change.

Okay. And what is the starting point from the third quarter and your near-term outlook on gallium pricing lead you to believe what gross margins should do in, say the fourth quarter and then kind of a medium term target for a couple quarters after that? You talked last quarter about a longer-term goal of 35%. That seems difficult to achieve anytime soon, given the gallium pricing and the volumes that you're at here. But if you can give us a sense of where you see gross margins going in the fourth quarter and beyond that, that'd be very helpful.

Well, I think, let me take a crack first, and then gross margin, obviously is Raymond's territory. But I see at this plant utilization rate, we're not going to benefit a whole lot from the capacity issue. I mean gallium raw material price certainly is not contributing a whole lot. So we definitely need to see some turning points.

The demand environment for substrates, as well as -- product mix is the other very, very helpful sign. Some of the product we have better margin. But overall, I think it's utilization and gallium price. Raymond, what'd you --

Yes, that's right. Richard, obviously we don't specifically comment on a percentage of gross margin. But the overall targets that we had, sure, that has come down and it's a different ballgame with the lower prices of raw gallium now in our joint ventures and lower tonnage sold. And, of course, going within our factory the lower capacity utilization.

Okay. All right. Fair enough. Maybe one more question for me, I'll jump out of line. I guess in your wireless business here, you've given guidance for revenues downward somewhat. Morris, you and AXT have done a good job the last few years here in really gaining share in the wireless business. Wondering if this -- does this reflect any sort of challenges from either a market share perspective within gallium or do you see any other technological alternatives creeping in here and hurting your near-term outlook there?

Sure, Richard. Obviously, everybody knows that SOI is a very much talked-about technology, sort of showing its presence in the RF chip market. We don't deny that. A lot of our companies are talking about utilizing SOI. But I think overall the news is out there already, and gallium arsenide still has a stronghold, I think as far as power amplifier HPT market is concerned. In certain higher frequency market, we hear gallium arsenide is still king of the hill.

I think what is going to turn out to be ultimately in the future, I think gallium arsenide still has -- I would still say it's a dominant RF chip solution. But I think overall in the last few quarters, SOI certainly is making its impact. I think overall, I think I must say that we are, perhaps, losing some of the market share either through the fact that we're concentrating in certain markets and we're not gaining the -- the qualification effort has not given us a whole lot of help. But I think we are concentrating our efforts in those prospect, and I'm still hopeful that something will turn loose.

Okay. I appreciate the thoughts on that. I will jump out of line. Thank, Morris and Raymond.

Avinash Kant with D.A. Davidson & Co.

A few questions. So it looks like in your prepared remarks you talked about segment revenues in Q4 compared to Q3. In most of the segments you do expect some decline. Is there any particular segment where you see a more-than-average decline versus the others?

I think it's probably semiconducting.

Semiconducting?

Yes.

Okay. And then you talked about, in the material segment, also, you said revenues could be modestly lower from what they are.

Right.

But I believe that you do expect pricing to be kind of maybe slightly better. So does it mean that there's a bigger impact on volume in Q4 compared to Q3.

Not really. The estimation of the market going forward's always a estimate. I think so far we're not seeing great increase in pricing. But I think the volume is probably going to hold its present pace or slightly lower, at least not a whole lot.

Okay. And just some clarification of the comment you made just a little bit before that, this -- that the market share loss -- by market share loss, you mean losing market share to other technologies or other gallium arsenide case?

I would say both. The fact that we are concentrating our sales of semi-insulating to a smaller segment of the market, that perhaps if they're not selling well, then we're not selling well. Our customers are not gaining market share. That brings us to losing market share. That's one explanation I can think of.

And I am also very much aware that SOI's making its inroad into the RF chip market, and that could be a contributing factor to the fact that we're losing market share.

But would you say that the customers you are at, you're maintaining your share or you have lost your share?

I think we are maintaining our share.

Okay. And so the recovery, and in terms of -- the final question is, of course, on the side of new qualifications. When should we expect some news on that front, whether it be the 2 customers that you have talked about in the past?

I think it's going to be sometime in 2013. I think we are doing -- I think the good news is that we're still in there. We're still, to our satisfaction, I think we've done our due diligence or we've done our technological qualifications. But given the demand environment being very challenging today, I think it's taking some of the vigor from the customer side from switching to new suppliers, although we are still in the running.

And did you break down your gallium arsenide revenue by semiconducting and semi-insulating?

In the third quarter, did we?

Yes. Well, basically the split is almost the same as the second quarter. It's approximately 55%/45%, 55% semiconducting, 45% semi-insulting.

Perfect. Thank you so much, gentlemen. Thanks.

Tom Sepenzis with Northland.

You mentioned that there's excess inventory in the channel. I'm just wondering where that stands in terms of maybe weeks. And what has to happen and when do you expect that to be at normal levels?

I think that's our guesstimate. We see our customer are not pulling as much. And so we guess either they have inventory or the demand is not strong.

Do you know how much excess inventory is in the channel?

We don't. We don't know. We also listen to our customers' conference call, and they talk about inventory. So we're guesstimating.

And then just in -- I don't know if you want to take a stab at this. But based on what you're seeing out there and where your revenue run rate is getting to, when should we maybe expect a turn here? In March? Was March going to be up? I know that your customers are seeing pull-in in the March quarter. A lot of people in the wireless food chain are for handset ramps in March. And so that's going to be unseasonally flat to up. Are you seeing the same thing or do you expect continued or a normal seasonal weakness in the March quarter as well?

We are very -- we are at the end of the food chain. So we always admit that we don't have much visibility. So if we can see one quarter, that's great visibility already. So I think it's premature for us to speculate the Q1 environment. Although, normally Q1 is a down quarter among the whole year. But I just wonder how bad could it be compared to fourth quarter? I mean, fourth quarter is down sequentially, which we don't expect. I mean, even Q3, we don't expect to be down. But the environment out there is pretty tough. Customers are correcting inventory, and then so it is a tough environment out there.

Great. Thank you.

Dave Kang with B. Riley.

Thank you. Good afternoon. Morris, regarding your top-end customer, actually their numbers were pretty good and their Q4 guidance was pretty good as well, except that they announced that they're going to work down inventories to increase their inventory turns. So if that is the case, then shouldn't we see them come back in Q1?

I hope your analysis is correct.

But they're not giving you any kind of an indication in what's going to happen next quarter, meaning Q1?

But Dave, again, this is our customer's customer. So we don't have --

Right.

-- visibility. And also, from our customers' visibility, they just tell us how much they put into consignment. So that visibility is limited as well. So we're just working off one quarter at a time.

Right. Okay. Fair enough. And then on the LED side, I'm hearing that things are stabilizing, certainly some of the LED companies are indicating that the market is stabilizing, and, yet, you are still expecting a down quarter. Where's the disconnect here?

Well, I think we're looking -- we're scrubbing our future markets here. I think what we see, the Japan market doesn't seem to be that great. And we're talking to our Taiwan customers recently. They are sort of cautious as well. I think, as we said, I think the greatest potential for us is now perhaps China, I mean, although we don't have a whole lot of hope, but then that market can turn very fast.

Can you just give us a little bit of flavor how big these countries are? Like Taiwan, China, Japan, how do they stack up?

I think we normally have evenly distributed. It's characterized by a lot of smaller to median-size customers, $0.5 million a quarter kind of customers. And they are equally distributed in China, Japan, Taiwan, United States, and Europe. Right, Raymond?

Yes. Dave, the 5 or 6 geographies that we do sell regularly these into, each of those countries range between like 15%, 18%. There's not one that dominates like a 40% geography. So it's (multiple speakers)

Got it. Got it.

-- pretty much evenly distributed.

Okay. Sure. But it sounds like, though, China seems to be the weakest region. Is that a fair statement?

Yes.

Okay. And that's more just their economy or any other factors behind that?

Yes, I think overall, I think we see some weakness. And also, I think in this, going into the Q4, we do see Japan not doing as well. Raymond?

I think the China, we originally said before, we seem to participate in the lower end, which is more affected by the general economy.

Okay. All right. Thank you.

Edwin Mok with Needham & Company.

Thanks for taking my question. So first question, going back to gross margin. If I take your guidance, the implied gross margin will be down a little bit in the coming quarter? Is that -- did I read that correctly? And was that, again, due to raw material pricing or some other factors there?

That's always a very complex question. The gross margin has so many dynamic factors. But largely, from the lower selling price of raw material gallium and then also the lower tonnage sold in it, and then again overall on the substrate side, it's just lower sales volume obviously then leads to lower capacity utilization and production in the factory.

I see. That's helpful. And then can I touch on substrate pricing? Have you seen any kind of pricing change over, let's say the last 2 quarters, or baked into your coming guidance in terms of substrate pricing, maybe pricing pressure because of kind of the weaker demand?

Edwin, we have not seen dramatic change in the pricing. Gallium arsenide, it's normally down, as we always say, 5% to 8% per year. I think we're still seeing it's the same pattern. I think the weakness right now is no demand rather than price pressure.

I see. But in terms of the substrate margins, right, the lower utilization has impact there, but it sounds like pricing is not really a factor there. Is that correct?

That's what we think.

I see. Great. That's very helpful. And then just going back to semiconducting gallium arsenide. You talk about China being a little bit weak. And I understand the main end market for that is the LED space. Is that more to do with just customer slowing down towards the end of the year because of where those [red] LEDs are going into, the kind of application they're going to? Or is it just because customer, your customer in China is struggling? Or what end market factor is driving that lower demand?

We thought it was -- last quarter we were saying our customers in Taiwan and Japan and Europe was doing well, and, yet, our China customers were not doing well. And we attribute that to the fact that China market economy was turning down, as well as a lot of our China customers perhaps are focusing on the lower end market. And as the Christmas shopping season for Christmas lights or toys, perhaps being weaker. So that may drive their business down. So that was our explanation.

But this coming quarter, Q4, we are seeing general weakening all across the board, so. And China, although as we said in our prepared statement, we do see potential for it to come back. But we haven't seen a great demand coming back up yet.

I see. Great. That was helpful. And then finally on the raw material side. Given the weak pricing that we implied, there was an oversupply of raw material production in the marketplace. Have you guys taken any steps to compare [value] production there? And have you seen any competitor done anything like that?

I would not -- I think, obviously, the demand and supply is dictating the pricing out there. And I think the silver lining of all these is that the gallium price, although it came down from $1,000 a kilogram about 6 to 8 quarters ago, now down to somewhere around $300 a kilogram. But our revenue from those raw material actually held constant. That is to say that our volume of tonnage that we sell compared to last year is more than doubled.

So the good thing is that demand is still out there. It's just that because there's a whole lot of supply, it drives the price down. And as I said, right now it's in the low $300s. And I hope it's finally finding its bottom. In fact, in last 2, 3 weeks it's ticking up just so slightly. But no, I am not going to venture out to say that it's going to turn up from this point on. And so that's where the demand and the supply is.

And the other good thing is that we believe that we have the lowest cost of producing gallium without joint ventures. So we will probably be the last one to get out of this market from the --

I see. So your point is that the demand is -- the volume is there --

Yes.

-- so it doesn't make sense for you to pare back on your production?

Right.

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

(Operator Instructions). West Whittaker with Carmel Capital Management.

This is Eric Lofgren for West Whittaker. So, Morris, your stock is trading around the value of your networking capital, has continued to generate cash in this current weak environment. Why wouldn't you consider doing something to take advantage of your stock price, like a share repurchase program?

Sure. I mean, this is a subject we do discuss with our Board of Directors and to benefit our shareholder. And we also hear a lot of urging to request for us to buy back our stock. But we're still talking about it. But given the very challenging overall world economy out there, I think the prudent thing to do, at least in the short term, in the next few months, is still look after cash and then making sure the company is going to be able to weather the storm well.

And so again, we're constantly talking about it. But again, as we see the world economy being very challenging, so we are perhaps not pulling the trigger still yet.

You have, I think $45 million of cash and short-term investments on the balance sheet.

$51 million.

$51 million, yes. How much do you need to run your business and keep a buffer for the downturn? And how much excess cash do you think you have right now?

Eric, also, what you don't see there is that the $51 million cash, about $15 million is actually within the joint ventures. Although we do control them and consolidate their results, that is actually at the joint venture level. So the AXT cash is about $36 million.

Raymond, I think Eric is right. I mean, we do have a lot of cash and we feel, I mean, even though the environment is very challenging, we're not seeing a whole lot, even for the guidance going forward it's still breakeven approximately. So it is a great question of why we're not buying shares back.

But I think, as I said, I think we have been considering it, and we are talking to our Board of Directors. And I think the decision right now is that I think given the uncertain environment out there, we think in the short term the best course to take is to hunker down and not buying the stock at this moment. But we are considering it.

Right. All right. Thanks, Morris.

And we have no further questions from the phone audience at this time. I'll turn things back over to Dr. Young for any additional or closing comments.

Thank you for participating in our conference call this quarter. We will be marketing in various locations around the country and we 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. We look forward to speaking with you in the near future. Thank you.

Thank you. Ladies and gentlemen, that does conclude today's conference call. We'd like to thank you all for your participation.