AXT Inc (AXTI) 2014 Q4 法說會逐字稿

Good afternoon, everyone, and welcome to AXT's fourth-quarter and fiscal 2014 financial conference call. Leading the call today is Dr. Morris Young, Chief Executive Officer, and Gary Fischer, Chief Financial Officer. My name is Robert and I will be your coordinator today. As a reminder, today's call is being recorded. I would now like to turn the call over to Leslie Green, Investor Relations for AXT. Please go ahead.

Thank you, Robert, 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 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 uncertainty, market acceptance and the 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 expectations. This conference call will be available on our website at AXT.com through February 23, 2016.

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 fourth quarter and fiscal year 2014. This information is also available on the Investor Relations portion of our website at AXT.com.

I would now like to turn the call over to Gary Fischer for a review of the fourth-quarter results. Gary?

Thank you, Leslie, and good afternoon. Revenue for the fourth quarter of 2014 was $19.6 million compared with $23.1 million in the third quarter of 2014. In the fourth quarter of 2014, revenue from North America was about 16%, Asia-Pacific was 60%, and Europe was about 23% of total revenue. No customer generated more than 10% of revenue during the fourth quarter and the top five customers generated approximately 34% of total revenue.

Gross margin in the fourth quarter was 25.4% compared with 23.0% of revenue for the third quarter of 2014 as a result of product mix, continuing efforts on cost reduction, and favorable yields. Total operating expenses in the fourth quarter were $5.6 million compared with $4.7 million in the prior quarter. Of our total operating expenses, SG&A expenses were $4.3 million for the fourth quarter of 2014 compared with $3.5 million in the third quarter. The increase in operating expenses in Q4 was largely driven by $613,000 in incremental professional fees.

During the fourth quarter, our audit committee received an email concerning possible related party transactions implied to have resulted in beneficial gains to one of our named executive officers, Davis Zhang, or his immediate family members. Our audit committee took the matter very seriously, conducting a thorough investigation of the assertions. As noted in our 8-K filing today, the audit committee identified some historical related party transactions that were not previously disclosed. However, the investigation did not conclude that there was any intentional misconduct by Mr. Zhang or that he received any improper benefit from these transactions and the matter was closed this month. Excluding the $613,000 for legal expenses, SG&A in Q4 would have been $3.7 million or about $200,000 over Q3.

R&D costs were $1.2 million for the fourth quarter of 2014, slightly above Q3, which, with rounding, was also $1.2 million.

Total stock compensation expense was $268,000 for the fourth quarter of which $4,000 was included in cost of sales, $222,000 in SG&A, and $42,000 in R&D. This is $4,000 lower than Q3 so it is basically flat.

Operating costs for the fourth quarter -- operating loss for the fourth quarter of 2014 was $592,000 compared with an operating profit of $653,000 in the third quarter. If you filter out the $613,000 for legal expenses, our operating line would show a profit of $15,000.

Net interest and other for the fourth quarter was a gain of $260,000. This is about what we had in Q3 as well. This net number consists of four categories -- foreign-exchange loss of $618,000; sales of IntelliEpi stock for a gain of $637,000; net interest earnings on our $49 million in the bank of $123,000; and fourthly, equity earnings of our unconsolidated joint ventures, a gain of $26,000. This equity earnings number in Q3 was $390,000 and the drop to $26,000 is primarily a result of year-end accruals.

Net loss in the fourth quarter of 2014 was $311,000, or $0.01 per diluted share. This compares with a net income of $644,000 or $0.02 per diluted share in the third quarter of 2014.

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 was $48.9 million at December 31. This is up slightly from Q3 and year-on-year it is up $1.3 million.

Accounts receivable, net of reserves, were $17.9 million at December 31, compared with $21.1 million at September 30. December 2013 accounts receivable was $14.9 million.

Net inventory was $38.6 million at December 31 compared with $36.6 million at September 30. Of this, approximately 49% is raw materials, 42% is work in progress, and 9% is finished goods.

Depreciation and amortization in the fourth quarter was $1.4 million and CapEx was about $620,000.

For the fiscal year 2014, revenue for the whole year was $83.5 million, down slightly from $85.3 million in fiscal 2013. Gross margin for fiscal year 2014 was 20.6% of revenue, a significant improvement from 13.9% for fiscal year 2013.

Net loss for the year 2014 also improved to $1.4 million, or a loss of $0.04 per share, compared with a net loss of $8 million or $0.25 per diluted share for fiscal year 2013.

Okay. This concludes our financial statements. Now I will turn it over to Dr. Morris Young for a review of our business.

Thank you, Gary. Coming off of a stronger than expected Q3, several customers across our product portfolio adjusted inventory late in the fourth quarter, resulting in revenue that was lighter than our previous expectations. Adjustments were not concentrated in any particular substrate category or customer, rather appears to be a general softness, some of which we expect to recover in the first quarter. However, with continued costs and the yield improvement coupled with favorable product mix, we improved gross margin meaningfully. As Gary noted, excluding the incremental legal expenses, we would have recorded a profit in the quarter despite lower than expected revenues. We view this as a testament to our solid business model and the success of our customer and revenue diversification efforts.

As we discussed last quarter, the environment in semi-insulating gallium arsenide substrates appears to be stabilizing following two years of dramatic changes. The applications that were most vulnerable to the industry's transition to SOI, such as P AMPS which seems to have largely moved on to that technology and those still dominated by semi-insulating gallium arsenide substrates such as HBT devices, radar, defense, and Wi-Fi do not appear to be making a change. We have made significant investment in refining our technical certifications for the HBT market and are working to overcome the business impediment of growing our market share in this application.

As expected, we saw industry consolidation in the fourth quarter, leaving three primary players in this space. This development underscores the challenges faced by all suppliers in recent years from the SOI transition and ASP degradation. AXT is the only pure play substrate supplier in this market. As such, I am proud of the way that we have weathered a very difficult market dynamic through continued diversification in our overall product portfolio and our customer base as well as strict expense management and leverage of our unique low-cost and vertically integrated business model.

In terms of our semi-conducting gallium arsenide substrate business, revenues were also a bit weaker than the prior quarter with lighting, display, printer and laser applications all coming in somewhat lower than expected. CPV remains a small portion of our revenue currently for the area in which we expect to see growth this year as a result of ongoing research in CPV efficiency improvements.

We are continuing to make a blended approach to our sales effort, participating in the growing low-end market so long as we retain the higher-end sales opportunities.

Our germanium substrate revenue also trended down modestly in the third quarter. In general, sales into the satellite solar cell application have been fairly consistent with the last many quarters. CPB revenue, however, has come down as a result of the industry's consolidation and the lack of new CPB installation. Recently, a major installation in San Diego was canceled, prompting a leading supplier to move to sell its CPB division. Therefore, we do not expect meaningful growth in our germanium revenue for the next couple of quarters, but we do believe that it will continue in a stable fashion at these current levels.

Turning now to indium phosphide, we continue to see strong demand from core applications such as fiber optic lasers, detectors, as far as emerging opportunities in solar and data center connectivity and we expect this area of our business to continue to see healthy growth in 2015. It is difficult to size the opportunity at this time because it is being driven by new applications that we are still -- that they are still in its infancy. However, it is an interesting market for us as even relatively small growth can move the needle for AXT.

Further, competition in this market is limited primarily to three players, including AXT. We don't expect to see additional suppliers enter the market in the near term as indium phosphide is a very difficult material to work with. It is manufactured under very high pressure conditions and, therefore, has barriers to entry beyond that of gallium arsenide. AXT is a strong competitor with a core competency in this material, a healthy cost structure and industry-leading technical support capabilities.

Finally, with regard to raw material business, our revenue was down slightly in the fourth quarter. We expect both sales volume and pricing to remain stable in the coming quarter.

In closing, this has been a positive year for AXT on a number of levels. While the fourth-quarter demand weakness contributed to a modest decline in our annual revenue for the prior year, meaningful improvement in our cost structure and the positive shift in our revenue mix resulted in a significant improvement year-over-year to our bottom line. Further, we grew our cash and the investment by $1.3 million, ending the year with a balance of $48.9 million.

As we enter 2015, we are well-positioned to drive growth in our business and to continue executing our strategic priorities. Further, I am pleased with the team I have in place to leverage the opportunities ahead. That includes our addition in 2014 of Gary Fischer, who is Chief Financial Officer. I want to thank our customers, partners, and investors for their continued support, and our employees for their ongoing dedication to the success of our company.

This concludes my comments on the business. I will now turn the call back to Gary for our fourth-quarter guidance. Gary?

Thank you, Morris. Looking to the first quarter of 2015, we are expecting a modest improvement in sales in Q1. Therefore, we are expecting total revenues of between $19.5 million and $20.5 million. We expect approximately $1.2 million in additional professional expenses in Q1 as the audit committee review was completed in February. Therefore, we are expecting a loss of $0.02 to $0.04 for the quarter based on 32.5 million diluted common shares outstanding, roughly equivalent to the professional fees that we will pay.

This concludes our prepared comments. Morris and I will be glad to answer your questions now. I'll turn it back to the operator.

(Operator Instructions). Richard Shannon, Craig-Hallum.

Just a few questions from me, maybe start with the guidance for the first quarter. Gary, you're modeling for slight improvement in revenues here. I wonder if you could give us a general sense of the direction you expect in kind of the major product categories you talk about, doubt, flat, or up. Any way you can characterize those would be helpful.

Yes. I think -- we think material will probably be flat. I think indium phosphide will probably improve and the other two substrates probably are going to be flat.

Okay. And I couldn't do the math fast enough in my head to get the bottom line here, kind of implying what your gross margins, you are expecting there. But I would imagine it would be somewhere maybe a little bit below fourth quarter, but still in the 20s% range somewhere. Is that a fair assessment, Gary?

Yes. Yes. That is reasonable.

Okay. Fair enough, then. Morris, a couple of questions, looking a little bit farther out this year. Wondering about your wireless business, whether you think that can grow this year and does it require you to gain some share in the HBT business to make that happen?

Well, I am always optimistic. But --

Yes, I know.

Of course, we had a pretty down -- substantially down year down last year. But, looking at a few positions that I can definitely try to improve from the level of 2014, we -- but, however, nothing is concrete as of this moment. But I do expect the wireless to come back this coming year, 2015.

And, actually, I meant to ask a question right before that. Gary, can you give us a sense of how wireless grew in 2014 on a yearly basis?

Let me check my notes because I don't have it memorized.

Okay. Should I throw another question out while you are searching, Gary?

Yes. Go ahead.

Okay. Morris, another question. I ask this one of you periodically. I just want to get your general sense of the gallium pricing environment. It seems like kind of a steady stable environment. Is there anything you are hearing out there in terms of the supply base that might drive some improvements or are you expecting it to be kind of flattish for the foreseeable future?

Well, just as a comparison, 2014 was not a very good year. I think we started the year at $260 a kilogram, and ended the pricing at $220. And so I think, although the amount of decrease was not substantial, but it was a down year for gallium in 2014.

I mean, at this point, I don't think I want to speculate. I think we are happy to sell everything we can. We are happy with on the positive territory, but whether it is going to go up or down. But, I think I still want to remind everybody that we have been increasing our volumes substantially. Just, we don't make a whole lot of money out of it.

Okay. All right. Fair enough. Maybe just one last kind of big picture question. And, Gary, when you find that number, please let me know. But, as you look at your entire business this year, Morris, any way you can provide us a thought process around what you think you can grow your topline revenues? Is this going to be a flattish year or I hope a modest growth year? Can you grow 10%? What is your best guess as you look at the year right now?

Well, let me go take a crack at it. I think, again, I hope Gary will be more conservative and I will be more gung ho. I mean, that is always the dynamics between us, I think. Definitely, I like to see growth and for the reason that I think indium phosphide is a growth opportunity for us. I mean, definitely. I think raw materials, I think we hit the bottom and I think we are selling everything we can. So I think revenue is not the issue, but rather it is the profitability.

I think semi-insulating gallium arsenide -- I mean, the way I sense is that it definitely has to hit the bottom. But, again, we still have to really dig in very hard, try to be innovative and gain market share from some of our competitors.

I think semi-conducting, however, I think, on the low end, I think it is very difficult. The pricing is very, very competitive and we are not banking on that. But I think we are trying to gain some market share in the more lucrative markets such as [Prinder] had such as CPV, as well as lasers. And those should give us the opportunity for growth. Gary?

I think that is good. And, Richard, your question was year-on-year between 2013 and 2014, how did the substrate revenue (multiple speakers).

No gallium arsenide trend.

Or wireless.

Semi-insulating wireless. Yes.

I only have gallium arsenide as a group in this room. So I don't have it broken out.

My thinking is that it is probably coming down a bit.

As a group, gallium arsenide is down.

Yes. Well, it is coming from both. SOI started the year in 2013 and beginning of 2013 was still strong, and also with the pricing pressure as well.

Okay. Fair enough. I think that's enough questions from me.

(Operator Instructions). Kim Donovan, Needham and Company.

Sheldon Grodsky, Grodsky Associates.

This quarter was both a pleasant surprise and a big disappointment because it should have been profitable. Now, the investigation cost money in the fourth quarter and apparently cost even more money in the first quarter. What is the outcome of the investigation?

The outcome has been released in a separate press release filed with the 8-K today, so the best way for you to get the gist of it is to just grab that either now or after the call. But the outcome was basically that there was some very old third-party related party transactions that should have been disclosed in our disclosures and were not, so we are disclosing them in the 8-K that we filed today. But there was -- the investigation did not conclude that there was any intentional misconduct or that there was any improper benefit from those transactions. So, we are relieved of that and we have your same feeling that the quarter actually was shaping up nicely, but we have to take -- our committee has to take these things very seriously and so it is expensive to do the research.

Did you have to send American lawyers to China for this?

I think the short answer is yes. But, I think the bottom line is it is finished and we are glad that we now know the number, what it will impact us on Q1. But nothing more in the future.

Okay. Now, the margin improvement, the gross margin improvement in the fourth quarter -- and I am looking at it, of course, on a year-to-year basis. For whatever reason, you chose to compare the fourth quarter to the third quarter, but I am looking at the fourth quarter versus the fourth quarter. And the gross profit improvement was rather dramatic going from $4.97 million from $2.81 million. So do you think you have that going forward? Is this part of your operations now or has it just worked out certain things have a fell into place for this quarter that won't be there for coming quarters?

Well, there is obviously some variables that we don't control like ASP and, to some degree, the product mix. But, in aggregate, when I am running models for internal in the Company, I think we will be in the low 20s%. And so, hopefully, we can be even above that, but I think it is realistic to assume that we will be in the low 20s%.

Yes. I think year-to-year comparison, there are several key comparisons. You remember back in the first quarter of 2014, we instituted a forced reduction programming our production. We also picked up some yield improvement -- yield efficiency improvement in our factory. So I think that helped. I think the product mix, as Gary mentioned, definitely helps. I mean, going forward, we just see that product mix should be in our favor. So those are the two big things.

I am really looking forward to see if we can pick up more volume as well. I think quarter-to-quarter comparison, I think fourth quarter of 2013, and I think the revenue number also improved slightly, too, right?

Yes. This fourth quarter versus 2013 fourth quarter. Revenue improved, yes.

One other question, if I may. I believe that you had indicated in the last conference call that one of your competitors in Japan -- I don't know your business that well, so I don't know if they compete across the board -- but that one of your competitors in Japan had left the business or was leaving the business. Has that resulted in the business improving, as far as you can tell?

Yes. I think so. I think in general -- but, of course, that's negated by the fact that the business environment continues to be very difficult.

It is relatively a recent event, so it is too soon to say that it has been up or down because of that, but common sense for us is that we are going to benefit from that decision that they have made.

Are they out of the market at this point or are they still unloading inventory?

They are out of the market.

Thank you.

Kim Donovan, Needham and Company.

This is Kim Donovan on for Edwin Mok. I was just wondering if you could give a little color around the indium phosphide business, how much that grew year-over-year in 2014 as well as the gallium arsenide, how much that declined in 2014?

Well, we don't have that number right off-hand. I think we can -- I mean, I think two quarters ago, we also decided not to report in a different category. But I think we can give you color and say, overall, indium phosphide probably grew year-over-year and gallium arsenide was either flat or decreased slightly.

Gallium arsenide came down in the hundreds of thousands of dollars, not millions of dollars. So it is slightly down. But it was offset by growth in indium phosphide and we actually grew also in our raw material business in 2014. So there is some fluidity between the product lines. It is a good question to ask.

Okay. And then, Gary, now that you have been with the Company for several months, you have seen more operating improvements going forward. How should we think about the longer-term, like gross and operating margin profiles for the Company?

Well, for OPEX, the Company did a big restructure before I arrived back in Q1 of 2014, so I think OPEX will remain relatively flat and better, we have to set aside these special professional expenses that we are going through because of the investigation. But, other than that, it will probably move up slightly as the year goes on, but nothing material. And then, as we said in terms of gross margin, which also has our manufacturing overhead costs in there, that might move a little bit, but we don't think it will move too much, either. So we think that margins, as we said, will still be hopefully in the low 20s%.

Okay. And do you have any idea what revenue would achieve operating breakeven?

Well, we used to have this model, I think, published. We said some time ago was, what, $22 million in revenue and 25% margin, we would have break even. But I think we can probably improve that slightly because of the factory efficiency improvement. But, again, I think it does depend on revenue mix as well.

Yes. ASP and product mix make a difference, but you can kind of back into some numbers. If you take Q4 and back out the professional expenses for the investigation, you get pretty close to breakeven. So that is probably a good benchmark.

Okay, great. Thank you.

Dave Kang, B. Riley & Co.

What was the expected OPEX or professional fees in the first quarter? Did I hear it correctly? Is it $1.4 million?

$1.2 million.

$1.2 million. Got it. Thank you. And then, regarding the inventory correction, it sounds like -- well, Morris, you said some of that is done, so does that mean there is still some softness in first quarter? Or can you provide more color on that situation?

Well, basically, we said it is going to improve slightly because you see the guidance is -- we are going to up that guidance. If you take the midpoint, about $500,000 more, right?

Okay. And is it primarily in your phosphide that is providing some growth and everything else kind of being flat?

Well, we would much rather take it as a total. But I do -- I think you read from our script, I think we did say indium phosphide is strong.

And then, just lastly, on the gallium industry, overall industry, what is the capacity? I mean, it sounds like there is still some capacity. Is that why pricing remains pretty challenging?

I would think so. I think if you take the overall PM business, I always estimate it to be about 40% of the overall gallium arsenide business. If you take that down, I think it is down 70%. That is substantial.

Okay. All right. Thank you.

And this does conclude our question-and-answer session. I will now turn the call back to Dr. Young for closing remarks.

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

And this does conclude today's conference call. Thank you again for your participation and have a wonderful day.