AXT Inc (AXTI) 2015 Q3 法說會逐字稿

Good day everyone and welcome to AXT's third-quarter 2015 financial conference. Leading the call today is Dr. Morris Young, Chief Executive Officer, and Gary Fischer, Chief Financial Officer. My name is Derek and I will be your coordinator today. Today's conference is being recorded.

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

Thank you, Derek, 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 events to differ materially.

These uncertainties and risks include but are not limited to overall conditions in the market 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 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, 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 third quarter of 2015. This information is 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 third-quarter results. Gary?

Thank you, Leslie. Good afternoon. Revenue for the third quarter of 2015 was $18.4 million compared with $21.0 million in the second quarter of 2015. This is below our expectation of $19.5 million to $20.5 million and the shortfall was largely in our raw materials business which dropped from Q2 by over $1.3 million.

As Morris will describe in a moment, our gross margins were stronger than Q2 and the shortfall did not ripple to the bottom line.

In the third quarter of 2015, revenue from North America was 10%, Asia-Pacific 66%, and Europe 24%. In the third quarter we had two customers that generated more than 10% of revenue and the top five customers generated about 45% of total revenue reflecting again our diversification of both product and customers.

Gross margin in the third quarter increased to 25.1% from 20.9% for the second quarter of 2015 as a result of favorable product mix. Total operating expenses in the third quarter were $5.3 million compared with $5.2 million in the prior quarter. Total stock comp expense was $311,000 of which $5000 was included in cost of revenues, $260,000 in SG&A and $46,000 in R&D.

The operating loss for the third quarter of 2015 was $711,000 compared with $780,000 operating loss in the previous quarter. Other income for the third quarter was $753,000. This net number consists of four categories, foreign exchange gain of $359,000, equity earnings of our unconsolidated joint ventures of $167,000 gain, net interest earnings on our $45 million in the bank of $102,000 and other items that add up to about $125,000.

For Q3 of 2015, we are pleased to show a profit of $42,000 which compares with a net loss of Q2 of $3000. Accounts receivable net of reserves were $17.1 million at September 30, 2015, compared with $19.3 million at June 30, 2015.

Net inventory decreased in the quarter and ended at $38.1 million compared with $38.9 million at June 30. Ending inventory consisted of approximately 53% in raw materials, 40% in work in progress and 7% in finished goods. This is very close to the spread in Q2 as well.

Depreciation and amortization in the third quarter was $1.4 million and CapEx was coincidentally also $1.4 million. We also used cash in Q3 to repurchase our stock and this amount of cash used was $733,000. Through the end of Q3, we have now spent approximately $2.3 million this year and have repurchased a total of 891,000 shares.

Cash and cash equivalents with maturities of less than three months short-term investments and other investments in high grade debt securities was $45.4 million as of September 30, 2015 compared with $46.3 million at the end of June 30, 2015.

This concludes the financial review. I will now turn it over to Dr. Morris Young for a review of our business.

Thank you, Gary. This is an interesting time for AXT. As many of you know, our business has undergone a tremendous transformation over the last several years, a direct reflection of the transformation in our industry. This has been particularly true in the wireless segment.

Today our revenue composition is vastly different than it was three years ago and it continues to evolve with the rise of new technologies, new applications for compound semiconductor substrates and more stringent customer requirements.

In fact, over the last four quarters, our total revenue has appeared relatively flat but these results belie a growing shift within our base towards indium phosphide, which has surpassed both semi-insulating and semi-conducting gallium arsenide substrates as the single largest segment of substrates in our sales.

Our overall year-over-year revenue growth rate for the last two years in indium phosphide has been more than 50% per year. This shift is significant because indium phosphide is a specialized material used in strenuous environments and requires tight specifications. The competitive landscape is limited with a number of meaningful barriers to entry. As a result, it commands a premium value and a stable pricing environment.

This growth as a percentage of our revenue has a disproportionally favorable impact on our results. This was evident in Q3 as softness in other parts of our business caused us to fall short of our revenue guidance but we outperformed our bottom-line guidance to achieve break even.

In the last two years, the primary driver in the demand for indium phosphide [has been] electronic devices or fiber-optic communications and [passive] optical networks.

More recently, datacenter connectivity is gaining momentum as a strong driver for indium phosphide demand. With the massive transformation occurring in the datacenter to accommodate the growing requirements of cloud, mobility, big data and Internet of Things, silica photonics is rapidly emerging as a key enabler for high-speed, high-performance connectivity within server racks, (inaudible) and across the datacenter.

Intel, Cisco, HP and IBM are all actively investing in the technology and its ecosystems and making significant progress in bringing it to market.

We also see a driver for six-inch indium phosphide substrates in the next generation of wireless communications. The 5G networks which the industry believes could come as soon as the year 2020 promise speeds of up to 40 times faster than 4G to enable among other things ultrahigh definition video on mobile devices. It is also likely to offer greater network intelligence to manage the emerging complexity of the Internet of Things.

As such, we expect to see frequencies up to 28 gigahertz which will be challenging for silicon and or even gallium arsenide to support.

Indium phosphide is a natural choice because it has the properties to enable the increasing requirements of 5G and this lower end cost and power consumption than gallium nitride.

Over the last two years we have invested in both our technical capabilities and our in-house expertise in order to expand our competitive differentiation, provide cost benefits and help our customers to optimize the benefit of indium phosphide. In addition, with our acquisition of Crystacomm, we are the only company in the industry to offer both VGF and LEC crystal growth technologies which is giving us the flexibility to serve customers with varying technical requirements.

The Crystacomm equipment is being installed in our Fremont, California facility and we are currently in the process of bringing up the crystal growth and poly-synthesis processes.

With quality products and deep expertise, we continue to grow our indium phosphide customer base among a number of customers who have recently had major wins in Taiwan and we are ramping up shipments with some of the largest indium phosphide (inaudible) customers in Europe. We are also in qualification with a major customer in Japan and we are just completing qualification with a large account in the United States.

We expect to see revenue layering on over the coming months from these customers and many of whom are expanding their own capacity in anticipation of growing demand and new applications. In total, our indium phosphide pipeline is robust and we are confident in our ability to continue to drive healthy revenue growth.

Turning to gallium arsenide, we are pleased to announce today that we have acquired production equipment for gallium arsenide wafer polishing and processing and handling equipment from Hitachi Metals which exited its compound semiconductor substrate business in April. The deal also includes a license of Hitachi Metals proprietary wafer processing technology that we will leverage to further enhance our product quality and consistency.

So for semi-insulating gallium arsenide, we continue to focus on developing our presence in both mobile and [noble] applications. We believe that the market is relatively stable around its current levels. Having made a major transition in the past several years, though we are conservative anyway we forecast this area of our business, we are making strategic investments such as Hitachi Metals equipment purchase that we believe will position AXT to benefit from the new opportunities and new applications for our products.

Now for semiconducting gallium arsenide, the market remains challenging. We continue to pursue higher end applications such as backlighting, signage and automotive. However, we have made a conscious decision not to pursue certain lower end applications as a result of fierce competitive landscape and corresponding pricing environment. As a result, we are planning for continuing softness in this area in Q4.

Similarly, as Gary noted, our raw material business was down meaningfully in Q3 as a result of both price and volume decline.

As we look forward into Q4, we expect to see other meaningful declines as the reflection of general weakness worldwide in commodities such as copper and oil. Though revenues from our joint ventures have come down this year, they continue to provide us with profitable revenue and additional benefit to our vertically integrated business model.

In closing, AXT has undergone a very important transformation which is a direct reflection of the evolution of our industry. We have been able to adapt to a changing environment as a result of our diversified product portfolio as well as our ability to scale our products as demand requires.

We are actively investing in our future through focused R&D, technology M&A, the upgrade of our manufacturing infrastructure and the continued buildout of our leadership team.

Dr. Hong Hou, who joined us at the beginning of Q3, I am very pleased to see significant contribution that he has made in the short time he has been with AXT. He and Gary have added tremendous depth and experience to AXT's management team. I believe that the exciting business opportunity ahead has allowed us to attract top talent like this and we are just beginning to leverage the full benefits of their expertise.

As we move forward, investors can track our progress in key areas that will ebb and flow over any given quarter but in total will illustrate our progress towards our strategic direction. Those include total revenue growth, continued growth in indium phosphide, margin expansion and new customer qualifications.

We believe we are making the right investment in our technology, operations and management team to maximize our business opportunity and drive increased value for our shareholders.

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

Thank you, Morris. As we look ahead to Q4, we expect to see continued weakness in certain areas of our business in keeping with the near-term trends that Morris just discussed. As such, we believe that revenues will be in the range of $17 million to $18 million. We are expecting the bottom line to be in the range of a loss of $0.01 to a loss of $0.03 per share based on 32 million common shares outstanding.

However, the longer-term shift in our business towards indium phosphide coupled with potential new opportunities across our portfolio gives us confidence in our renewed growth in the coming year.

This concludes our prepared comments. Morris and I would be glad to answer your questions now. Operator?

(Operator Instructions). Edwin Mok, Needham & Company.

This is Arthur filling in for Edwin. Sorry he couldn't make it. But first question is about your indium phosphide. It sounds like you guys are getting a lot of traction here with some major wins in Taiwan and shipments in Europe. And then last year you provided sort of this target of half over half growth of 50%. Wondering if you had sort of a different trajectory or view on the growth going out with all of your success in indium phosphide?

Overall we are very confident of our growth trajectory. But obviously we don't want to throw a number out there but as we announced in our core script, that we have in the last two years our growth rate has been more than 50% year-over-year for the last two years so now the base is larger and the number of customer wins coming on and we see the environment is really robust.

Great. Sounds good. So then following up on your press release for your acquisition of the automated processing equipment from Hitachi Materials, is there any you can help us quantify the financial impact of it? I saw there was a licensing agreement and potentially manufacturing benefits.

We've generally guided that in this calendar year we would spend between $4 million and $6 million in CapEx and so we still think that is about the window that we are coming in at, that includes some construction in Beijing because we are adding square footage for indium phosphide as well as other kinds of equipment. So this fits into the normal kind of capital expenditure for equipment.

It is very good equipment, it is going to really add a lot of automated capability for us. It should increase the cycle time, speed it up and we were very fortunate to be selected by Hitachi Metals as the company that they wished to sell this to. They wanted to be able to make sure that the equipment went to a company that could use it in production and use it to produce wafers for people that they used to provide wafers for.

Very good point, Gary. Let me also add onto it is that Hitachi Metals although they have exited the substrate business but they want to remain in the gallium arsenide epi business, so they want to ensure that their good technology although they are not doing that part they want to give it to somebody or sell it to somebody like AXT who is a competent substrate survivor in this business who will then become their supplier for the substrate for their epi business.

Great. My last question is regarding your gross margins. Great gross margins this quarter. I saw it increased a lot relative to the last quarter. Is there a way you can help us think about how gross margins may possibly trend in the coming quarters if this manufacturing equipment could probably give a little bit of a boost? Also maybe I saw OpEx is normalizing a little bit. Is there -- should we expect it to kind of trend in that manner going forward?

Well, we do believe that as indium phosphide becomes a greater percentage of total revenue that the gross margin will move upward and to the right. But any specific quarter can be impacted by product mix so what you are really trying to understand is what to do in your models and what I'm doing on my financial models here at the company is I'm keeping it relatively conservative. I want to see some more quarters go by before I feel confident that it is trending upward and to the right.

So in the mid-term to long-term, definitely we expect it will expand. In the near-term, because of some of the other issues in the business such as the raw materials business, we need to be a little bit more conservative.

That is all I have. Thanks.

Good questions, thanks.

Richard Shannon, Craig-Hallum.

Thank you for taking my questions here. Maybe a couple of quick questions on the September and December quarters here. I guess just to help trying to model the revenue segments here, I know you are not giving out specific numbers like you did in the past, but did the indium phosphide, did that grow sequentially in the quarter?

You mean from Q2 to Q3?

Correct.

Yes.

It did. Was it a meaningful number or just trying to get a sense of the modeling here, is it a meaningful number or kind of just above zero?

You know as we said, in the last year and four quarters in a row, it was more than 50% and compared to two years ago, it was another 50% growth. But quarter to quarter because when the business is growing very fast, you cannot just track on one quarter alone because sometimes the customer will over order and then the next quarter they will slow down. And then if I were to tell you how meaningful the growth of last quarter was, and you are going to make a trajectory that is going to even have more meaningful growth in Q4, then that is a [round] projection we want to give you.

Okay, that is fair enough. On the gross margins obviously you've talked for many, many quarters about indium phosphide being good, a good gross margins. But I think historically raw materials have been and that was obviously down substantially and yet your gross margins went up. Have the prices come down and specifically I guess in gallium to the extent to which raw materials is no longer accretive to gross margins?

Raw material, gallium itself is very hard. You know the gallium price I don't know if you are checking on pricing, it is coming down very significantly.

But in aggregate, these companies are still contributing so you're saying are they accretive? The answer is yes. And to add a little more color about the indium phosphide growth, it was meaningful growth and I would say it was meaningful enough that even though total revenue was off we still achieved breakeven.

That is great results so congratulations on that by the way.

Let's see a couple of more questions. Morris, if you could talk a little bit more about some of the initiatives and engagements you have going on with the indium phosphide, I'm sure I missed some of the detail in your prepared remarks. And also can you tell us whether you expect these initiatives to help you gain some share at all in the market? That would be great to know.

Sure. I think we have been saying that all along. I think we have invested very heavily in indium phosphide both in terms of recruiting the right people. We have built a fairly sizable technology team in indium phosphide which will enable us to do the right technical sales. We have invested very heavily in terms of our sales network also. That is why it is giving -- landing us the big wins and customer wins and also I think the overall environment of the indium phosphide business I would say just robust. What we see not only we are growing but also our customers are really having very optimistic future outlooks. Of course that is sort of in a certain way it is very difficult to get your numbers around it because you say are we gaining market share because the published number of the indium phosphide market is really lacking. We don't really know where the overall market is. I believe we are one of the leading indium phosphide producers.

I think if I may add, now we have the LEC technology although it is not contributing to our bottom-line yet but we are really a very complete substrate provider for all indium phosphide requirements for whatever a customer wants.

It is a little difficult for us to know the TAM because we are part of the TAM so competitors won't necessarily reveal much to us. Anecdotally we do have a lot of evidence of wins, of awards, of design ins and qualifications. So we know the TAM is growing and we are growing with it. We may be gaining market share but what we really need is something you guys who are in the endless field to get out there and figure this out because we can't do it by ourselves but I think now might be a good time for people to look at it.

Absolutely. And I think the indium phosphide field, we are growing very, very handsomely. But I think again, we have an advantage in VGF. That gives the advantage of the low [EPD] and the better quality and it is the deja vu on gallium arsenide again. Remember we only have three major players in this field and we have a better weapon I believe.

Okay. Appreciate those thoughts. Maybe one last question for me. You mentioned having two 10% customers. Curious whether either of those are new 10% customers to you and whether either of them is your long-time 10% customers from years past?

We don't know at this point. Gary should find out. Maybe we will find that out.

I'm not familiar with who they were in the past so that is why I can't answer that part.

IQE.

IQE used to be. They are one of the large indium phosphide customers but I don't know whether they have -- get into the 10% customer yet.

Great. I think that is all the questions for me. I will jump out of line, guys. Thank you.

(Operator Instructions). Tom Sepenzis, Northland.

Thanks for taking my question. I think you mentioned just at the tail end of the call that you expect to return to growth next year. So is that something that would start in March and would it be linear throughout the year? Or how are you seeing next year in terms of overall growth?

Well, I think it is going to accelerate through the second half of the year. The way I would view this is that indium phosphide, we have been saying for years -- I mean that business was growing, growing but the pace was so small. Now it has built a base but let's say if we achieve -- I'm not promising -- if we achieve another 50% growth for indium phosphide, holy cow, that is a very meaningful growth but it will take time.

And did you say that had grown 50% a quarter for the last year?

No, year on year.

Not quarter to quarter, no, nobody can grow that fast.

Right, but each quarter was up -- so basically it grew 50% over the last year?

Over the year, yes.

So gallium arsenide must have been falling off a cliff I guess is the fair way to look at that?

Yes.

Because it was the vast majority of your revenue a couple of years ago. So where else have you made --?

You are touching on a key theme there. That is part of what we are trying to describe today was the transformation that has gone on within the product mix so even though the numbers for the last few years have been relatively flat, what Morris has tried to describe is the change within the numbers and dominated by the indium phosphide progress.

At what point does gallium arsenide get to be so small that it is no longer a factor?

I think that will take time.

We don't have any sense it is going to get that small, Tom. In fact we are still investing in it. The Hitachi Metals equipment is still a bit weak and improved the cost structure.

But on the other hand, I must say, indium phosphide by far, we are excited about it. So you can do this if you want to do a model, let's say you take 40 and 35 and 15 as your mix of revenue of gallium arsenide -- indium phosphide versus gallium arsenide and metals and whatnot and you assume this 40% is going to grow 50% next year and the other 35% revenue is going to grow let's say 5% or stay flat. Then you can see what the end of the next five year -- year is going to be.

So all I'm saying is but it will still take time. But that 35% is still meaningful revenue which will come in. Plus the investment we made with Hitachi Metals, I think we are not going to drop that business after we have invested so heavily and we certainly have a made very strong commitment to continue our gallium arsenide business.

Let me give you a couple of facts. We've got a facility outside of Beijing that has 300,000 square feet. We have about 675 employees there now so we have a lot of room to keep running the gallium arsenide business it is not like we are out of space of out of capacity so we welcome to continue to be in the gallium arsenide business. As Morris said, not so much on the LED side but on the wireless side there is a future there. We are proud of it and we are excited about it.

I guess that begs the question then why invest that heavily and have 675 employees and a 300,000 square foot facility when your revenue is going down so significantly every quarter. What gives you confidence that that business is going to find a floor at all at this point?

Well, it is not going away as a TAM. So we can be competitive in it. We know Hitachi Metals decided to step away from it but that actually became an opportunity for us both on the equipment side and the market side.

I think you also need to look at this in perspective. As we grow our indium phosphide revenue, some of this equipment and some of the trained guy who we trained in polishing gallium arsenide, cleaning gallium arsenide wafer can be transferred to indium phosphide processing. So you can see our number of employees in China actually has decreased significantly I would say last year or two it is almost like 20%, 25% decrease.

So as we transform further, we will make further adjustment and so also let me clarify, the Hitachi Metal line that we bought is not -- I mean it is a very good investment but in terms of dollar amount, it is not a big amount. We are leveraging the know-how and getting all of the automated equipment and to be able to sustain at this position in the gallium arsenide substrate supply but it is not a major investment in terms of dollar amount.

Okay, great. Thank you.

We have no additional questions at this time. I would like to turn the call back over to Dr. Morris Young, Chief Executive Officer, for any additional or closing remarks.

Thank you for participating in our conference call. As always, please 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.

That does conclude today's conference. Thank you for your participation.