AXT Inc (AXTI) 2015 Q4 法說會逐字稿

Good afternoon, everyone, and welcome to AXT's fourth-quarter 2015 financial conference call. Leading the call today is Dr. Morris Young, Chief Executive Officer; and Gary Fischer, Chief Financial Officer. My name is Catherine and I will be your coordinator today. Please be advised today's call is being recorded. (Operator Instructions). I would now like to turn the call over to Ms. Leslie Green, Investor Relations for AXT.

Thank you, Catherine. 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 events or results 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 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 February 24, 2017. Also before we again, I want to note that shortly following the close of market today, we issued a press release reporting financial results for the fourth 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 full review of our fourth quarter and fiscal year results. Gary?

Thank you, Leslie. Good afternoon. Revenue for the fourth quarter of 2015 was $18.1 million compared with $18.4 million in the third quarter of 2015. This is slightly above our expectation of $17.0 million to $18.0 million. In the fourth quarter of 2015, revenue from North America was 9%; Asia-Pacific, 66%; and Europe was 25% of total revenue. We had one customer that generated more than 10% of revenue and the top five customers generated approximately 42% of total revenue, reflecting again our diversification of both products and customers.

Gross margin in the fourth quarter was 17.1%. This includes a charge from one of our gallium raw material subsidiaries to write down its inventory to market level pricing. The write down amount reduced our consolidated gross margin by about 3 percentage points. In addition, the historically low gallium pricing today also affected our gross margin on the consolidate sales from our gallium subsidiaries, and this accounted for an additional hit to our consolidated gross margin of about 2.5%. The balance of the difference compared to last quarter is related to product mix.

Total operating expenses in the fourth quarter were $4.8 million compared with $5.3 million in the prior quarter. This improvement was led by a reduced level of R&D spending in one of the raw material subsidiaries as compared with Q3, as well as improvements in a number of line items in AXT's SG&A. Total stock compensation expense was $298,000 for the fourth quarter of 2015, of which $5,000 was included in cost of revenues, $246,000 in SG&A, and $47,000 in R&D.

Operating loss for the fourth quarter of 2015 was $1.7 million compared with $711,000 operating loss in previous quarter. Here again the gallium pricing had an impact. Other income for the fourth quarter was a net number of $59,000. This consists of four categories: a foreign exchange gain of $148,000; equity earnings of our unconsolidated joint ventures, which was a loss of $316,000; net interest earnings on our $44 million in the bank of $105,000; and number four, other items just adding up to about $122,000.

For Q4 of 2015 we had a net loss of $1.2 million or a loss of $0.04 per share. This was approximately $0.01 outside of our guidance range, attributable to the raw material write-down in the quarter. By comparison, we had a net profit of $42,000, or $0.00 per share in the third quarter of 2015.

Accounts receivables, net of reserves, were $18.5 million at December 31, 2015, compared with $17.1 million at September 30, 2015. Net inventory decreased slightly in the quarter and ended up at $38.0 million. That compares with $38.1 million at September 30. Ending inventory consisted of approximately 51% in raw materials, 42% in work in progress, and 7% in finished goods. And this is very close to the spread that we had in Q3.

Depreciation and amortization in the fourth quarter was $1.3 million and CapEx was $500,000. We also used a small amount of cash in Q4 to repurchase our stock. Through the entire calendar year of 2015, we have spent approximately $2.3 million in stock repurchases, for a total of approximately 908,000 shares. Cash and cash equivalents with maturities of less than three months, short-term investments and other investments and high-grade debt securities with maturities of less than two years was $44.0 million as of December 31, compared with $45.4 million at September 30, 2015.

For the fiscal year 2015 revenue was $77.5 million, and that compares with $83.5 million in fiscal year 2014. Gross margin for fiscal year 2015 improved to 21.7% of revenue, up from 20.6% of revenue for the year 2014. Net loss for fiscal year 2015 was $2.2 million, or $0.07 per share, compared with a net loss of $1.4 million, or $0.04 per share, for fiscal year 2014.

Okay, this concludes our financial review. I'll now turn the call over to Dr. Morris Young for a review of our business.

Thank you, Gary, and good afternoon. 2015 was a year of transformation for AXT as we continued to realign our business with the trend that we are driving growth in compound semiconductor substrates. This process began in earnest two years ago, following the significant customer consolidations and technology transition in our industry. As we began to pivot our business in 2014, we made meaningful improvements in our cost structure and began to see a positive shift in our revenue mix. In 2015, we focused our strategic investment in our technology and manufacturing capability that would position AXT to benefit from the growth in indium phosphide and enable us to drive improved consistency and efficiency across our substrate portfolio.

We are very pleased with the investment we have made and the early results of our efforts. Today, indium phosphide substrates are our single largest product revenue category, having grown more than 50% from the prior year. And although raw materials are providing a headwind for us, for our business in the near term, we expect to continue our positive revenue mix shift in 2016 and beyond. One of the reasons we are so excited about the opportunity in indium phosphide is that AXT is the market leader. And we're now clearly in the early stages of the increased market adoption. In the fourth quarter, indium phosphide sales equaled nearly 30% of our revenue, placing us in the sweet spot of growing demand and positive margin contribution.

As we have noted, the primary driver in the demand for indium phosphide has been optoelectronic devices, in this case, fiber optic telecommunications and passive optical networks. These devices have tight specification requirements, limiting the field of competitors that can address them. In particular, optoelectronic devices require very low etch pit density, or EPD, a specification in which AXT's VGF technology strongly excels. In fact, we know from discussions with our customers that our VGF-produced substrates are orders of magnitude better than our nearest competitor in etch pit density, resulting in a meaningful difference in device reliability and yield.

For these indium phosphide-based devices performance is a much larger driver than price. This contributes to a better substrate margin profile and pricing stability than we see today in gallium arsenide. Further, AXT's superior performance has allowed us to take a market-leading position and enjoy healthy growth as customer demand continues to increase.

In addition to growth in sales from fiber optic telecommunications and passive optical devices, data center connectivity continues to gain momentum as a strong driver for indium phosphide demand. As such, silicon photonics is becoming increasingly prevalent. [New] research reports that at least seven foundries can now support full device production, enabling the technology to more quickly approach mainstream adoption.

And finally, announcements coming out of Mobile World Congress this week in Barcelona suggests that the shift towards 5G will likely require changes in the RF front-end of a cell phone. Today, RF front-ends are moving towards multimode, multiband power amplifiers that with 5G will require operating -- to operate at frequencies up to 28 gigahertz. This will be challenging for silicon or even gallium arsenide to support. Indium phosphide is the natural choice and it has the properties to enable the increasing requirements of 5G.

Over the last two years, we have invested in both our technical capabilities and in our in-house expertise in order to expand our competitive differentiation, provide cost benefits, and serve a wide range of customers with varying technical requirements. Further, we continue to focus on helping our customers optimize the benefit of indium phosphide. And we are actively in development of the industry's first 6-inch indium phosphide substrates. We're confident that we will be able to drive continued growth in the indium phosphide sales and an increasing shift in our revenue mix towards this emerging material.

During 2015 our (technical difficulty) gallium arsenide substrate revenue reached a relatively stable level, having weathered a major technology transition in previous years. This area of our business now requires comparatively modest ongoing investment but holds certain upside potential to qualify with leading customers in the RF device market. With our recent purchase of the production equipment for gallium arsenide wafer polishing, processing, and handling from Hitachi Metals, we believe we can improve our manufacturing capability through quality and consistency, and enhance our ability to pursue growth opportunities in both mobile and nonmobile applications.

With semiconducting gallium arsenide we continue to play modestly. As we have said, while we are pursuing higher end applications such as backlighting, signage, and automotive, we have made a conscious decision not to participate in certain lower end application as a result of the fierce competitive landscape and corresponding pricing environment.

But the most significant near-term headwind in our business is raw materials, which were down meaningfully in Q4 as a result of both price and volume decline. In particular, gallium raw material has continued to reach historical lows largely as a result of oversupply. These resulted in a one-time write-down at one of our joint ventures in the quarter as well as lower consolidated gross margin in the quarter.

Germanium pricing has also dropped significantly in recent months. Our germanium joint venture incurred a loss in Q4. Overall, raw material pricing is reflective of the continued general weakness worldwide in commodities, such as oil and copper, and was the single largest factor in the decline of our corporate gross margin in the quarter. However, these joint ventures have been a positive contributor to our business model for more than 15 years and we believe that they continue to represent an important part of our value proposition and competitive differentiation.

Now in closing, we're entering an important year for 2016 for AXT in which we expect to see a meaningful shift in our revenue mix. Over the past two years, we have realigned the size of our operation and the allocation of our resources with the current market trend in substrates, including a significant growth opportunity in the indium phosphide substrate market. This market has many barriers to entry and AXT has taken a leadership position, driving more than 50% growth in our indium phosphide substrate revenue over the previous year.

How we invest in technology, talent, and manufacturing capability would help to position us for continuing success. I want to thank our customers, shareholders for their continuous support of AXT and our employees worldwide for their ongoing dedication to our mission. This concludes my prepared comments. I will now turn the call back to Gary for our first quarter guidance. Gary?

Thank you, Morris. As we look ahead to Q1, 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 $17.5 million to $18.5 million. We're expecting the bottom line to be in the range of a loss of $0.03 to a loss of $0.05 per share based on 32 million shares of stock outstanding.

However, the longer-term shift in our business towards indium phosphide, coupled with the potential new opportunities across our portfolio, gives us confidence in our renewed growth this year. This concludes our prepared comments. Morris and I will be glad to answer your questions now. Operator?

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

So, first question I have on indium phosphide. It sounds like, Morris, from your (inaudible) soon, and in the industry there's a lot of driver for adoption of this technology. Just curious, however, want to kind of get better understanding on the market. Do you have any kind of color you can provide in terms of size of the substrate market that you think it is right now, at least for 2015? And where do you stand on a competitive front? Do you see large competitor in the space, or it's more fragmented? And I think from what we can gather, your business has been growing over 60% per year over the last two years. Very, very strong growth. Is that growth rate sustainable do you think for this year?

Wow, you have many [fractured] questions. So first, let me comment on the size of the indium phosphide substrate market. This market is very dynamic. It's growing very rapidly, as we believe. There's a not lot of new adoption of using this technology. The growing demand for fiber to home for GPON and EPON, there's certainly very take demand across the world. And more recently is the silicon photonics, I think it's going to come on. So, I think we are estimating this market size to be around $50 million to $60 million for substrates overall, but I think it's growing rapidly.

But I believe that AXT's position is such that we have grown more rapidly than the market growth itself. So we definitely have taken some market share, but to place us -- we think we are either number one or number two in the world. And there are only three competitors other than AXT. There are two Japanese competitors in the indium phosphide substrate world. And what's your other question, is there anyone else coming into the market?

No -- yes. I think you answered the question there. So it sounds like you believe it's a three player space off which you guys have similar market share, is that a way to think about the space now? You guys are fighting for all these multiple opportunities, right?

Yes, we think we are either number one or two. I think that the third one is probably a distant third.

I see. Okay. That's very helpful. Moving on to gallium arsenide, on your commentary you said that business is stabilizing. Just wanted some clarification; you were saying semi inflation has been stabilizing and semiconducting, if I hear your comment correctly, is also stabilizing at least in the last quarter. So your overall gallium arsenide business is roughly similar in 3Q and 4Q?

Well, last quarter semiconductors declined. Semi-insulating increased slightly but not very significantly.

I see. Okay. That's helpful. And then on the raw material side, I'll ask two more questions and let the other guys ask questions. Can I have some clarification? If I listen to your commentary it sounds like pricing decline was a big negative factor you have on your raw material and therefore on your gross margin side. Are we seeing oversupply in the industry, or is it just general commodity price coming down impacting raw material pricing? And I will follow on that.

Well, the pricing of gallium definitely took a very severe hit beginning last October to November time frame. As you recall, that in the beginning of 2015 we thought the gallium price had hit a bottom. At that time it was selling for about $200 a kilogram. And now the gallium pricing is quoted at somewhere around $140 a kilogram, so it is a fairly significant drop. But whether it's because of the world commodity price collapse or -- I think it's simply perhaps the oversupply and then people are not working rationally. And we know because we have many, many joint ventures in gallium, so we know we are the low-cost producers. And even us we are losing money, so I would tend to think everybody is losing money in the gallium business. How low can it go? I really cannot speculate. Some of these markets -- it's strange.

All right. That's helpful. One last question. Just Gary, a mechanical question on the model, if I may. So, because you have this inventory write-down on the fourth quarter which impacted your gross margin in the fourth quarter, is that a reason why you have a pretty big positive minority interest in the quarter? Because I guess you've a loss on that, that you're kind of countering to that? Is that how mechanically why you have a positive minority interest of $460,000 in the quarter?

That's correct, Edwin. That's correct.

Great. Very, very helpful. That's all I have. Thank you.

Tom Sepenzis, Northland Securities.

Morris, I was wondering if you could talk a little bit more about the 5G, specifically indium; you think that that's going to be relevant for the power amps? How the set compared to gallium nitride and why do you think people would choose indium over gallium nitride?

From what I understand, Tom, there are two technology will compete for the sockets for the power amplifier for 5G cell phones -- is either high performance pHEMT gallium arsenide devices or HPT indium phosphide. Although gallium nitride can operate at that frequency, but it's more modeled as a power device. It doesn't operate at the low voltages where a cell phone needs to operate at. So gallium nitride is probably more used for base stations or more towards power end rather than on the individual cell phone.

Okay. So the indium phosphide really is going to be more for just the cell phones themselves, not the base stations? So that's something that probably doesn't impact you much until 2018 -- is that fair?

Well, I think when would be the adoption? It's everybody's guess, but World Congress in wireless is held in Barcelona; I don't know if there's any incremental news, but at least two weeks ago I read a news announcement that AT&T, they have announced that they're going to have a demonstration model as early as next year. So I would tend to think as the early adoption of the 5G will start to work, then there will be some pilot line productions and there will be some sampling. So you will probably start to see some -- well, actually there are people buying indium phosphide for that purpose, but although very, very small quantity, but it will start to increase as time goes. And I would even say 2020 would not be the full production of this 5G but it could be a significant contributor to the RF front-end business.

Great. Thank you. And then just in terms of -- I know you don't break anything out, but just in terms of once we exit March in the different businesses, how should we be thinking about gallium arsenide raw materials, silicon germanium and indium phosphide in terms of growth for the year?

In terms of growth. That I can definitely comment. I think we would definitely expect growth for indium phosphide for sure. On raw material, I think it's hard for us to predict. I think the price is very ugly. We don't know when it's going to start to recover, so we model it to be flat or slightly down. Gallium arsenide wireless actually for this year we model it going up slightly. And semiconducting gallium arsenide we model it sort of flat or slightly down. And for germanium for solar cells I think we expect it to grow, because last year was a very difficult year for germanium substrates.

So taking $18 million, which is the midpoint of your guidance for March, then top line you would expect to see growth year-over-year in fiscal 2016?

Yes. That's at least our model where we are trying to drive that. I think we are modeling sort of modestly is really on the raw material. Last year we had almost $5 million a quarter, now it's down to $3 million, $3.5 million.

And then lastly before I let you go, just in terms of the gross margins. I think you said that the charge was about a 3% impact to the gross margins, is that correct?

Yes, the lower of cost or market write down was a cost of 3 percentage points. And then the lower ASP for gallium cost us another 2.5%. So in my math, 5.5% of our gross margin problem was because of the gallium pricing issue.

Okay. So the gallium probably stays with you here until raw material pricing bounces back, right? So are we looking at around --?

The ASP might still be hard on us, but we hope we don't have further lower of cost or market reductions. That's the GAAP accounting rules. I think most of you guys understand how that works, I won't explain it. But we're not factoring that in again and we're hoping it won't happen.

So 20% or so is probably a good target for Q1?

As a matter of fact, yes. I think we might cross the 20% level or we might be just south of it.

Great. Thank you very much.

Jorge Rivas, Craig-Hallum Capital Group.

I want to start off first with indium phosphide and digging a little bit more how that's going to change your models going forward, given you've taken some initiatives to reduce costs on your OpEx line. It seems that -- I may have heard that gross margins could go back to 20% in the March quarter. Is there any change to your breakeven model, or your breakeven in terms of revenues?

There's no big change. The more we can grow indium phosphide, the more all the numbers look better. And we're not quite at breakeven yet, but we think that -- so it's pretty easy to guesstimate where we need to get to be breakeven. And we're not giving guidance past next quarter, but we do internally -- are pretty confident that we'll cross that line this year.

Okay. Then wondering if you can provide any update on Crystacomm. I believe there was some significant qualification activity during the year, and just wondering if we can expect any revenue contribution in calendar 2016?

Yes, we are working on that Crystacomm acquisition, and we are trying to -- first of all, using it internally. Using its poly-synthesis capability. And as far as crystal growth is concerned, it probably would take a little while longer. So I would expect towards maybe later this year or maybe even 2017 event for that to work. But we are a powerhouse for VGF, so the VGF growth is something that we are also developing six-inch with VGF for indium phosphide. And I expect that to mature earlier than the Crystacomm acquisition.

Okay, great. Appreciate your thoughts. And then one last question for me. I think you guys mentioned a one 10% customer. I'm just wondering if this is your typical and traditional 10% customer or if it's a new one?

It's a customer that's been a customer for a number of years.

Okay. I guess I was trying to get to whether this was a typical 10% customer that AXT has had in the past?

Yes, they've been 10% more than once before.

Okay. Great. All right. That's all for me. Thanks, guys.

David Kang, B. Riley & Co.

First of all, just wanted to clarify. Morris, I think you were talking about indium phosphide; fourth quarter you said something about 30% of -- did you say the 30% of sales or I think I missed that point?

Yes, close to 30% of our sales, right.

Got it. And then I assume it was up year-over-year, but can you say it was up sequentially as well?

Do you mean indium phosphide?

Yes, indium phosphide.

No, no. Last quarter we had a --

Year on year, he means.

No, I'm talking about from third quarter to fourth quarter, was it up or down?

It was sort of flat and slightly down.

Okay. Got it. And then can you just talk about the customer base, how many customers you have, and did you add any new customers during the quarter? I'm talking about indium phosphide, by the way.

Yes, I know. We have -- I think last count we must have over 100 customers, Gary, on incoming order, big ones and small ones. While I would say the largest five customers, probably a good 50%, 60% of the revenue.

Got it. Okay. And then can you just talk about -- well, in third quarter call you said that the pricing was very favorable. Actually I think you implied that you're commanding a premium? What about fourth quarter? Can you just talk about pricing?

No, there's no erosion.

Okay. And then what about capacity, how is your capacity situation?

We are growing capacity. We have internal plans, as you know, that we have been growing over 50% year-over-year for the last two years now. So we definitely have growth plans but we just don't want to disclose that.

Okay. As your indium phosphide is growing rapidly, have you thought of doubt maybe perhaps pruning some low margin business?

That is always a very nice thought. I think, Dave, I think AXT is in a transition time. Although indium phosphide we are all excited about it, but as I was talking to Leslie earlier in preparation for this conference call, two years ago we didn't even want to talk about indium phosphide because the revenue representation was too small. But now after two years of growth it's significant. But still, look, if you have a business which is 30% of your revenue; if you grow let's say 50% and you have to divide it by one-third so it becomes 16% growth, given everything else is the same. And so you can't really giving up all the other businesses. So they are your fixed cost contributor, so we don't want to give it up, especially there are some business which potentially have the growth opportunity. So I think be patient with us. I think we have a growth engine in our indium phosphide, but other business we will look at it until we are all filled up and we say 80% of our business is indium phosphide and then we can afford to --

We have said before, David, we have turned away from some of the very low end gallium arsenide LED pricing and customers. But I would say, other than that, the bigger focus for us is continued yield improvement, continued cost reduction. We're very excited about the Hitachi Metals equipment which we're installing now, and we think that there's some ways to push the costs down that will help the margin. So that's more of a focus than shedding customers.

Got it. All right. That was it for me. Thank you.

Thank you. And with no additional questions, I would like to turn the call back over to Dr. Morris Young.

Thank you. 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.

Thank you. And ladies and gentlemen, again, that does conclude today's conference. Thank you all again for your participation.