AXT Inc (AXTI) 2013 Q3 法說會逐字稿

Good afternoon, everyone, and welcome to AXT's Third Quarter 2013 Financial Conference Call. Today's conference is being recorded.

Leading the call today is Dr. Morris Young, Chief Executive Officer. Also joining the question-and-answer session is May Wu, Controller for AXT. My name is Kelsey, and I will be your coordinator today.

I will now turn the conference over to Leslie Green, Investor Relations for AXT. Please go ahead, Ms. Green.

Thank you, Kelsey, 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 trends and conditions.

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, the global financial conditions and uncertainties, market acceptance and demand for the Company's products, and the impact of delays by our customers on the timing of sales of products.

In addition to the factors that may be discussed in this call, we refer you to the Company's periodic reports filed with the Securities and Exchange Commission and available online by link from our website for additional information on risk factors that could cause actual results to differ materially from our current expectations. This conference call will be available on our website at axt.com through October 30, 2014.

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 2013. In addition, while we will discuss highlights of the third-quarter results on today's conference call, we have also posted the full summary of these financial results on the Investor Relations portion of our website at axt.com.

I would now like to turn the call over to Morris Young for a brief review of the third quarter 2013 results as well as a full market update. Morris?

Thank you, Leslie. As many of you know, we announced early this month the departure of our CFO, Raymond Low, who has left AXT to take another executive position. The Board of Directors currently has a search underway for a new CFO. We are pleased to report that we are seeing some excellent candidates already.

In the meantime, our finance organization remains in the capable hands of May Wu, our Controller of 12 years, with oversight by me and AXT's Board of Directors. We look forward to updating you on the results of our CFO search as soon as we have news to report. Therefore, for the purpose of our call today, we have posted a full financial summary on the Investors Relations portion of our website.

While I will cover third quarter highlights, we refer you to our press release and financial summary as well as SEC filings for a complete discussion of our third-quarter results.

Revenue for the third quarter of 2013 was $20.5 million. Of this, total gallium arsenide susbtrate revenue was $9 million, indium phosphide substrate revenue was $1.4 million, germanium substrate revenue was $5.5 million, and raw material sales were $4.6 million.

Gross margin in the third quarter was 12.2% compared with 12.9% of our revenue for the second quarter of 2013. The slight decline in the quarter was primarily the results of sales mix. However, we believe our margins have stabilized as many of the factors that have negatively impacted our business over the last several quarters have been absorbed, and we are beginning to see improvements.

Net loss in the third quarter of 2013 was $2.2 million or a loss of $0.07 per diluted share. And finally, cash and cash equivalent at September 30 increased by $3 million to $48.4 million. We are pleased that we were able to generate positive cash flow despite our GAAP loss in the quarter, highlighting our commitment and focus on maintaining a healthy balance sheet. Now let's turn to a review of our markets.

The market for gallium arsenide semi-insulating substrate revenue remains softer than typical for this time of year. This assessment seems to be in keeping with the financial announcements in the wireless space thus far in the earnings season. Some modest improvement is expected in the fourth quarter, but below what we might normally see.

In addition, the technology transition that we have discussed continues to weigh in the semi-insulating and substrate markets. We believe, though, the impact to our industry has largely been absorbed, and companies in our space are adjusting to accommodate the presence of SOI.

During 2013, we saw a sizable decline in our revenue from pHEMT devices as SOIs encroached many of those designs. As a result, we have focused significant effort on ramping up our market presence in the HPT devices. These have largely been unaffected by SOI and represent new opportunity for AXT. We hope to see revenue growth for this application in 2014.

Finally, we made significant progress during the quarter with one of our larger customers for which a technical issue has impacted our sales this year. We expect to begin building our revenue base late this year into 2014.

Now turning to semiconducting gallium arsenide substrates, the market in Asia, and China in particular, for these substrates continues to be weak, and we don't expect much of a change in the fourth quarter. By and large this market has seen strong demand swings over the last two years as a result of global economic factors, competitive landscape changes, over capacity.

Going forward, in addition to market improvements, we have two catalysts that we expect will drive the improvement in our revenue. First, we're beginning to aggressively go after the low end of the market, which represent a new opportunity for AXT.

Historically there was a sizable discrepancy in gross margin between the higher end, where we have focused, and the lower end of the market. But today that discrepancy is considerably less, and we believe that the potential volume can make this business attractive.

In addition, we're actively qualifying into some sizable customers in which we have little or no business with currently. We expect to see additional revenue from both of these catalysts in 2014.

Turning to germanium substrate, we have had a strong quarter of revenue this quarter. Our traditional germanium substrate applications, including satellite solar cells, continue to perform well across all geographies that we serve.

Germanium raw material prices, however, continued to rise as a result of limited sources of this material. We are working with our germanium substrate customers to help us offset some of the burden of the price increases, as they have a significant impact on our germanium substrate margins.

We continue to see increased demand from CPV applications for terrestrial solar cell applications. This has largely been germanium based to date, but semiconducting gallium arsenide substrates are also being tested for this purpose. The efficiency of CPV technology in general continues to improve both at the cell and module level, which is a major step towards reducing the cost of CPV installation.

Further, we're seeing more frequent news of major installations getting funded, which indicate that the technology is being viewed as more mature and competitive with other forms of energy production. For example, one of the major CPV players, Soitec, this year has secured a $110 million bond from the French government to finance the construction of a 44 megawatt CPV solar cell plant in Touws River, South Africa, which is scheduled for completion by June of 2014. This is the first publically listed project bond ever issued to finance a solar power plant based on CPV technology.

In addition, there are significant installations under construction worldwide in areas such as Southwestern United States, South America, Africa, the Middle East, Australia and China. AXT is one of two germanium substrate supplier for this market and are well positioned to benefit from its growth. Interestingly, as germanium based CPV becomes increasingly accepted, there is a concurrent development of semiconducting gallium arsenide substrate based CPV solar cells technology.

Today the efficiency of these solar cells actually exceed germanium based solar cells. However, this gallium arsenide based technology is less tested and proven as a result of its relative new development. Therefore, it remains to be seen which technology will ultimately be successful. AXT is well suited to be a supplier to the CPV technology either way.

Turning to the indium phosphide substrates, our revenue were down a bit in this quarter, primarily as a result of some inventory digestion at one of our larger customers. We believe that revenue from this customer will increase in the fourth quarter. Fiber optic applications continue to dominate our indium phosphide substrate revenue, as our technology is well suited for this application. But we also want to note an interesting development in this quarter in the area of silicon photonics.

Intel introduced its rack scale architecture that incorporates its new silicon photonics transceiver. Intel has announced that it is currently sampling the product and expects to go into production by the end of next year. This could be a significant achievement for the industry, as it applies high-volume semiconductor manufacturing practices to optical networking. We'll be watching this development with interest in the coming quarters.

Lastly, our raw material business had another solid quarter, with our run rate now around $5 million a quarter. Our joint ventures have developed a sizable customer base apart from AXT and are seeing the benefit of our last year's capacity expansion. Gallium raw material prices have stabilized, and we're hopeful that they will begin to rebound in the coming quarters.

In closing, while this has been a tough year, we believe that we are reaching a turning point in our business. The market for wireless devices has undergone significant transition from consolidation and new technology.

While certain end markets are showing growth, we have historically had little or no market share in these customers. But as we are near the end of the year, we're getting more clarity on the landscape and opportunity and are executing on a strategy for growth which includes penetration of key customers.

In addition, the news that the semiconducting gallium arsenide substrate market is poised for a turnaround and our aggressive pursuit of new opportunities at the low end of the market is expected to provide growth catalysts in the coming year.

Further, we're demonstrating success in both the indium phosphide and germanium substrate markets and expect continued expansion in these areas. We'll continue to take a conservative approach to the planning and management of our business, working diligently to control expenses and maximizing our cash.

We remain cautiously optimistic about our prospect for the coming year and believe that we're doing the right thing to take advantage of business opportunities in our key markets.

Now to turning to guidance for the fourth quarter, at this point we're expecting our gallium arsenide and germanium substrate businesses to be about flat from the third quarter, with a modest improvement in both indium phosphide substrates and raw materials. As such, we are expecting to see total revenue of between $20.5 million to $21.5 million and a net loss of between $0.06 to $0.08 per share, based upon approximately 32.3 million dollars (sic -- see press release, 32.3 million shares) common shares outstanding.

This concludes my prepared comments. May and I will be glad to answer your questions. Operator?

Thank you, Dr. Young. (Operator Instructions) Avinash Kant, D.A. Davidson & Company.

Good afternoon, Morris and May.

Hi, Avinash.

I think you already talked about the guidance a little bit, just needed some clarity. You said raw material and indium phosphide will be up slightly, and gallium arsenide and germanium kind of fell flattish. So we should expect margins to remain pretty similar to what we had in Q3?

I think it should stabilize and uptick a bit.

One slight difference I saw in the press release -- did you talk about gross margins of 11.9%? I think in the prepared remarks, you talked about 12 point --?

Yes, Avinash, thank you for making the note of that. It was actually 11.9%. When we prepared the script, we forgot to change in the last minute.

Okay. So it's not 12.2%; it's 11.9%.

Yes, it's 11.9%.

Okay. And any changes we should expect in tax rate in 2014? And also, CapEx -- what should we think about CapEx? What was the CapEx in the quarter and depreciation in the quarter?

What's the CapEx for this quarter and next quarter, May?

The CapEx for this quarter is about $1.6 million, and next quarter we are expecting maybe less than $1 million (multiple speakers).

For next year, I think we have a budget between $4 million to $5 million CapEx.

And in Q4 you said --

The depreciation for the quarter is what?

About $1.4 million.

$1.4 million?

Yes.

Okay.

So we should expect less than $1 million in Q4 CapEx?

Yes.

Yes.

And then for the full year, $4 million to $5 million, right?

Yes.

And the depreciation was $1.4 million, depreciation and amortization both combined.

Right.

$1.4 million. So I want to start talking a little bit about the dynamic of the business; you talked about semiconducting and semi-insulating. Could you talk first a little bit about just the pricing of gallium? And then how has that been tracking?

Well, gallium price has kind of stabilized. I think it's on the bottom end for almost 2.5 quarters, three quarters now. But you can track those prices, the open quote. But of course the actual transaction -- I think that the good news out of that, as I see it, is that the volume is not declining. So we are selling quite a bit of those gallium at those low prices, and I hope by having such low prices, quite a few of these higher manufacturing cost gallium producers are shutting their door down. So I think the market is adjusting itself to stabilize.

Okay. And the growth that you see in semiconducting next year, is it based on the qualifications you have had thus far? You've had customer wins in that? Are you selling into those customers? How do you --.

Yes, well, I think both. We are saying, you know, traditionally some of this low-end market, because its margin was lower, and we didn't really aggressively going after those market, as you can see the average gross margin that AXT is having. So we have turned our aggressiveness towards those market.

I think we should have a good success in those market, although you cannot just literally turn it down overnight. But I think we have some initial success. And so we expect that segment to grow, as well as -- we do have a few of these major customer qualifications going on with the semiconducting side. So we expect the revenue starting from 2014.

So, when you get those wins, would you announce them?

Usually, no. The reason, Avinash, is that when a customer qualify us, they usually takes a modest amount of volume, and they won't commit; but as we start to ship more and more, then they just increase the volume of shipment.

Okay.

So there is not a whole lot you announce anyway.

Okay. And any progress on the quantification on the semi-insulating side at the key customers?

On the semi-insulating side, as we said, that we resolved the issue with our major customer, and hopefully that will open up some of the doors so we can go in there. So I think we're guardedly optimistic that we have -- trying to rebuild the balance between AXT and our customer.

So this is the existing customer, or the customer you're qualifying at?

It's an existing customer.

Okay. So you should see them come back in Q1.

We hope so.

And looks like the SOI thing has stabilized; you're not losing any more share to SOI?

That's right.

Perfect. Thank you so much.

(Operator Instructions) Edwin Mok, Needham & Company.

Hi. Thanks for taking my question. First question just on the gas business, can you break down between the semiconductor and semi-insulating?

I think it's 54% semiconducting, 46% semi-insulating. Is that right, May?

Yes, 54%, 46%.

Yes.

I see. Okay. That leads to the next question. On the semi-insulating side, you talk about this HPT as new opportunity as you guys are targeting, and that area doesn't see as much SOI impact, right. Is this something that you guys already been selling, and that it will be pretty quick customer ramp? Or is this something that is going to need a long qualification process at the customers?

We've been working on the qualification, and we've been trying to get back into. You see, the substrate used for both the pHEMT and HPT are the same substrates. They are all 6-inch semi-insulating substrates. However, the customer grouping are different.

AXT traditionally has been stronger in the pHEMT market, and as the pHEMT market were being affected by SOI, so in fact we lost more business. But when we tried to get into the HPT market, since now that we are a newcomer; so we have to do still the qualification. But that we have been doing for the last year. So hopefully that we are going to start to have some business for the HPT going forward into 2014.

Okay. Last thing that you can help clarify -- I saw your largest customer actually acquired some capacity that is HPT, right? My question, I guess, is do you need to through a qualification with that customer? Am I correct on that?

Anytime you are getting the new product, obviously you need to go through to go through qualification, yes.

I see. Okay. Thanks. Just wanted to get through that. And then on the low-end semiconducting gas business that you guys -- you have highlighted, what kind of module profile do you think those businesses can get to? Is it similar to the copper runway, which is I guess in the teens percentage? Or is it closer to the historical level, which is 20%, 30% kind of range?

Well, I don't know if you have a good memory; I think several years ago we have been always defending that in semiconducting, the average gross margin is similar --- I mean, in the overall AXT. But I think specifically we're talking about the low-end market for LED. Traditionally it's in the low teens, and because we used to have much higher average margin, so we sort of leave that segment of the market alone. So we are turning more aggressive towards those. I mean, they can help us in two sides. One is that our capacity utilization is much lower now, and so filling up the factory definitely will help us. And as we also -- you know, time goes, we start to be able to tighten our yield, increase our yield, and to be more competitive in these markets; that should also enable us to get into that.

So, for me to give you a quoted gross margin, I think it's different, because every customer is different, for every size is different. So I would just leave it as to say they are on average lower than what we used to do, but because of the filling up the factory capacity, that should help us, both in terms of our revenue as well as gross margins.

I see, okay. I understand the logic now; that's very, very helpful. On the material side of your sales, I notice that sales has been coming down the last two quarters, even though you're using less gallium on your GaAs substrate business, right. I would think that you're using less, then you have more volume to sell to your customer. And you mentioned that over the last few months, pricing has been pretty stabilized. So why is volume coming down?

Well, you see, our material business is not gallium alone; it also includes PBN as well as refining of gallium. I mean, I can tell you one of the factor is that one of our joint ventures, which makes 69, 79 gallium to sell into China, and they are actually LED companies in China which went out of business. That affected our revenue. And so it's a good news, bad news. Good news is that there are China LED substrate manufacturers who cannot compete and got out of business, and yet it affects our raw material revenue business.

Great. Thanks for clarifying that. And lastly, on the germanium side of business. It has been very strong this quarter, and for the last quarter you guys were flattish, right. How much of that is -- how much do you think of that is due to some kind of near-term pickup in business versus kind of long term trend? I'm trying to think, as part of that business goes to (inaudible) industry which could become lumpy, right, I am trying to sense if there is any kind of lumpy risks going through 2014?

I think we always say that in the germanium business, you can think of it as two segments. The satellite solar cell is most steady, higher price; and yet the limited potential for growth is very limited. You don't expect any growth, maybe 5% to 10% at most.

And for us to increase our revenue, we have to penetrate a new geographic region such as United States, which we do supply today; and we have a good presence in Europe and China, Asia, et cetera.

So the other segment of the business is the CPV. As we said in our script, that we do know there is quite a bit of up-ticking in CPV installation as well as loan guarantees. So that segment seems to be very, very busy. But however, I think I don't have a crystal ball whether it's going to continue. I mean, normally, industry -- when they develop, they don't just go into a scratching halt. So I think it's a good sign that the industry is firming itself up. And then as you can see, our revenue almost doubled. All of those growth are actually from CPV.

Great. Thanks for clarifying that. That's all I have.

All right. Thank you.

Richard Shannon, Craig-Hallum.

Hi, Richard.

Hello, Morris, how are you doing?

Good.

I guess just a few questions for me. Again, I'm going to address a couple to the semiconducting low-end initiatives that you have going on. By my calculations from one of your responses, it sounds like the semiconducting is about a $5 million per quarter run rate. Can you give us a sense of what kind of share you think you have in the market, and then what kind of opportunities for dollar growth you might be able to see within one or two years from these initiatives?

We only usually predict out one quarter at a time, but I think if I were to wear a more aggressive hat, the semiconducting market itself should be a $150 million market. That's traditionally been said. If you take our revenue -- when we were running good, we were around $8 million to $9 million a quarter. Now it's only down to $5 million.

Our shares is not a whole lot. I think if we were to turn more aggressive, and with the new customer qualifications, gee, we could look at a pretty sizable growth opportunity for us. But, on the other hand, I got to caution myself by being too optimistic is that some of these aggressive in the lower end will help us for us to fill up the capacity, and that should be helping us in terms of gross margin, and revenue and everything else. But as the capacity utilized it is better; and if we were to have better business to do such as semi-insulating versus CPV, A, we may then need to switch that off, because if capacity utilization is the main focus for us right now, as you can see. We've got to sort of allocate the allocation, but that's a good problem to have. I won't think about that now.

Okay. A couple more questions from me. I think I ask this pretty much every quarter, and I'll ask you again, Morris, to ask about your crystal ball on gallium pricing -- especially, you made some comments earlier about seeing some higher cost producers perhaps falling off. Have you specifically identified specific ones that you are seeing come offline or having a material impact on capacity, or is this --?

Absolutely. I mean, I know there is a company -- actually, one of our competitors in China. I mean, he has a factory -- actually two factories, absolutely shut down, and it's for sale. So there are. And of course, we don't actually keep track of each one of them, but some of them -- the one in Germany I don't think is operating, either. So there is quite a few of them which are the high-cost ones, and the industry is saying that somewhere --- gallium around $400 a kilogram is a cut-off point for a lot of factories to operate profitably.

So we're down to very low, and then I think our joint ventures are fairly tough and competitive in those arena. And so we hope it will stabilize and start to go up.

Okay.

But about the specific question of when it's going to go up -- Richard, really I don't know; I can't tell.

Okay. Fair enough. I like to ask because you've been following this market for a number of years. So I appreciate your thoughts.

I'll have to call you, if really know that.

Maybe just one more big-picture question from me, Morris. Clearly you have been in a loss situation for a few quarters here. You have clearly chosen a growth strategy to increase utilization. Any thoughts you've given to perhaps paring down in capacity and getting to a breakeven in a faster way? Has that been contemplated? And if not, how do you see your path to breakeven getting, how do you see yourself getting there?

That's a good question. I mean, we always ponder around that. And as you know, that the industry of SOI getting to gallium arsenide --- it's impacting the whole industry for the last year. I mean, hopefully stabilized; and so you know, we now perhaps even start to see maybe PNB is not there forever. There are certain applications we still use them. So I think definitely we are making the budget, and we're trying to, as you know, stabilize the situation there. Hopefully we can get some growth opportunity to utilize the capacity. And if not, we definitely can look at alternative strategy to make AXT profitable.

As you know, that one of the things which I have been reviewing with May -- and now I am acting as a CFO right now -- is that everything since the beginning of 2012, we have increased our cash position from $40 million to $48 million, right.

So as you can see, this downturn, although it is affecting us -- but when we in 2010 and 2011, we were making $18 million and $20 million profit per year; and now we're down to losing of $6 million or $7 million a year. I think next year we shall see. My goal is to turn this ship around.

Okay. Appreciate this help. That's all for me, Morris. Thank you.

All right.

We have no further questions. Dr. Young, I'll turn the conference back to you for closing or additional remarks.

All right. Thank you for participating in our conference call. As always, please feel free to contact me or Leslie Green directly if you would like to meet with us. We look forward to speaking with you in the near future.

And again, ladies and gentlemen, that concludes our conference for today. We thank you all for your participation.