AXT Inc (AXTI) 2018 Q1 法說會逐字稿

Good afternoon, everyone, and welcome to AXT's First Quarter 2018 Financial Conference Call. Leading the call today is Dr. Morris Young, Chief Executive Officer; and Gary Fischer, Chief Financial Officer. My name is Sarah, and I'll be your coordinator today. (Operator Instructions) As a reminder, this call is being recorded.

I would now like to turn the call over to Leslie Green, Investor Relations for AXT. Ma'am, you may begin.

Thank you, Sarah, 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, improve efficiency, increase orders in succeeding quarters, increase our competitive position in the market, our schedule and timeliness regarding our relocation plan, our thoughts on air pollution in Beijing, our ability to meet demands for our products as well as other market conditions and trends, including expected growth in the markets we serve.

We wish to caution you that such statements that 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 market in which we serve, global financial conditions and uncertainties, increased environmental regulations in China, 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 April 25, 2019.

Also, before we begin, I want to note that shortly following the close of the market today, we issued a press release reporting financial results for the first quarter of 2018. 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 our first quarter results. Gary?

Thank you, Leslie. Good afternoon. Total revenue for the first quarter of 2018 was $24.4 million. This compares with $26.3 million in the fourth quarter of 2017 and $20.6 million for the first quarter of 2017. As we announced on April 11, the shortfall to our guidance given on February 21 was a result of government ordered mandatory factory shutdowns in Beijing caused by severe air pollution that occurred late in the quarter. In spite of this, the year-on-year comparison shows growth of 18% in Q1 of 2018 over Q1 in 2017.

Our total revenue substrate sales were $19.4 million compared with $20.5 million in the prior quarter. Revenue from our raw material joint ventures was $5.1 million in Q1 compared with $5.8 million in Q4 2017.

In the first quarter of 2018, revenue from North America was 8%, Asia Pacific was 66%, and Europe was 26%. Two customers generated more than 10% of revenue in Q1. And the top 5 customers generated approximately 38% of total revenue, reflecting, again, our diversification of both products and customers.

Gross margin in the first quarter was 39.2% compared with 37.2% in the prior quarter. Total operating expenses were $5.6 million in the first quarter of 2018 compared with $6.1 million in the fourth quarter. Total stock compensation expense for the first quarter of 2018 was $466,000. Operating profit in the first quarter of 2018 was $3.9 million compared with $3.7 million in the previous quarter and $1.4 million for Q1 of 2017.

Interest and other income for the first quarter was a net charge of $407,000. This net number consists of 4 categories: one, net interest earned of $142,000; two, equity accounting on our unconsolidated joint venture companies of a loss of $334,000; thirdly, foreign exchange loss of $224,000; and fourthly, other items equaling a gain of $9,000. The tax provision for the first quarter was $334,000 compared to the $131,000 in Q1.

For Q1 of 2018, we had a net profit of $2.9 million or $0.07 per share. By comparison, we had a net profit of $3.1 million or $0.08 per share in the fourth quarter of 2018 and $700,000 in Q1 of 2017. The diluted share count in Q1 was 40.364 million shares. Cash and cash equivalents and investments closed at $67 million as of March 31. By comparison, at December 31, it was $77 million. The reason for the decline was the new facility and equipment.

Depreciation and amortization in the first quarter was $1.1 million, and capital expenditures were $11.8 million.

Accounts receivables net of reserves were $21.3 million at March 31, 2018, compared with $22.3 million at December 31. Net inventory at March 31 was $51.1 million compared with $45.8 million in inventory at December 31. Ending inventory consisted of approximately 50% in raw materials, 47% for work in progress, and 3% in finished goods. Both WIP and raw materials increased, and this is intentional as we see raw material prices increasing and as we build inventory during the relocation.

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, everybody. The disruption of our Q1 revenue from mandatory pollution-related factors, factory shutdowns was disappointing. As we indicated in our April 11 release, these shutdowns between February 27 to March 31 affected more than 300 manufacturing companies, which were intermittently shut down for a total of 10 days or 30% of the calendar days in this period.

Periodic shutdowns are not uncommon, but the concentration of shutdowns at the end of the quarter was unusual. To help mitigate the issue going forward, we're adjusting our operating procedures to build more units to forecast, rather than building to order.

There's no new Chinese New Year holidays in China in Q2, so we're getting off to a good start. We're also adding capacity in indium phosphide and gallium arsenide to allow us more flexibility to ramp production as needed.

And finally, we are working closely with the local government in Dingxing and appreciate their responsiveness.

Despite the shortfall in revenue, Q1 was a positive quarter in many aspects. We continue to see positive demand for our products. In addition, favorable quarter mix and good manufacturing yields combined for increased gross margins.

We also completed the first phase of facilitation of our Dingxing facility, installed wafer processing equipment and produced initial wafers that can be used for qualification.

In total, AXT continues to execute to our plans, supported by a healthy market environment and solid customer relationships. We continue to be encouraged about opportunities across our product line as well as our readiness to participating in there.

Now let's begin with indium phosphide. We posted solid revenue in the first quarter though it was down slightly from the prior quarter, as the shutdown affected our sales in every substrate categories. As we mentioned in our February earnings call, we are seeing a recovery in the PONs market. This is likely due to growing international demand particularly in China as well as new technologies in the PON and [Arena] and emerging new applications, such as business loops, 5G backhaul and in building networks.

Based on current customer demand and market indications, we believe that 2018 will be a growth year for PONs. Our indium phosphide substrates are universally well-suited to PON technologies and applications, providing a very low defect density or EPD for the most challenging environment.

In addition to PONs, silicon photonics for data center connectivity remains an exciting opportunity for our business. Consistent with recent market commentary, we expect to see some softness in this application in Q2 as a result of near-term market dynamics in the data center.

As a result, our indium phosphide revenue are still expected to grow slightly in Q2 over Q1, but not as strongly as we have seen in the recent quarters.

Looking forward, our own data points, coupled with new -- news and opinions in the market, that suggest that we are likely to see a stronger second half for our indium phosphide business with data center applications.

Our market position and customer relationship in this application remains solid, and we're encouraged by the fact that most experts see a long and bright future for silicon photonics. In fact, by many analyst account, the technology has passed the tipping point where silicon photonics-based products are now shipping in volume and successfully competing with more established technologies.

Silicon photonics resolves key issues, such as latency, bandwidth, power dissipation and signal integrity, which is critical in hyperscale cloud and large enterprise data centers.

We believe that silicon photonics will continue to see increasing role in the optical component market with most of the key components and module suppliers actively participating and the growing interest for our semiconductor foundries.

In addition to data center connectivity, 5G wireless applications are also likely to provide opportunities for silicon photonics. At Mobile World Congress this year, several key suppliers demonstrated 100G optical transceivers designed specifically for 5G in short haul and (inaudible) deployment.

Other potential meaningful applications for indium phosphide include high-performance computing, medical, autonomous cars, aeronautics and defense. We have always maintained that a certain amount of lumpiness in our revenue is to be expected.

And we're selling into many emerging applications that are working towards volume production or are in the early stage of it.

Now turning to gallium arsenide. We continue to focus our effort on high-end applications, where our VGF process technology can produce substrates for the most challenging specifications, including wireless device, (inaudible) solar cells, infrared sensors, virtual and augmented reality, retinal recognition, automotive sensing as well as our more traditional market for high-end lighting, for example, in automobiles, signage and display.

We continue to provide strong support to one of our LED customers during the quarter. They rewarded us with order above our expectation. That increases our shipment to them over the next 6 months.

Low EPD requirement in many of these applications limit the number of competitors. There can be inherently stringent specifications. This low EPD applications also provide us an ongoing opportunity to refine our process and improve our yields, as we prepare our business for the market adoption of 3D sensing. We're currently selling into a number of development progress, which are steadily increasing in their contribution to our revenues.

We view this as a positive indicator of the opportunity with a number of end customers. While AXT is not yet participating in the largest example of mass production for consumer commercialization of 3D sensing technology, we view the increasing adoption of 3D sensing as an opportunity for high-end substrate manufacturers because of the stringent technical requirement of the technology. That provide a stronger barrier to entry to new or lower end players.

Today, only 3 competitors, including AXT, are capable to provide low EPD substrates in sufficient volume for production ramp.

We were pleased to report that we have wafers from our new facility in Dingxing, China for qualification. This was a much anticipated milestone for our investors and an important indication of our progress in the relocation of our gallium arsenide manufacturing.

It is important for investors to understand though that from this point forward, the speed and timing of any qualification is dependent on the sense of urgency within a supply chain or a new supplier. Our focus now is to -- on to further enhancing our own readiness to support increasing demand for very low EPD wafers, as the technology is commercialized by multiple end customers in the mobile market and beyond. As a result, we are taking the appropriate conservative view that our revenue for 3D sensing applications in 2018 will come primarily from development programs.

However, we believe that opportunity for selling into production level 3D sensing programs beginning in 2019 is very exciting.

AXT will continue to ramp up our capacity for this application over the course of 2018, preparing our business to support raw-based customer demand.

Now turning to germanium substrates. The demand environment for satellite solar sales remains positive. We continue to believe that we will see growth in this area of our business in 2018 over the prior year.

AXT is one of only 2 suppliers into this market. And our VGF substrates perform very well in one of the most unforgiving environment for specialty materials.

Now finally, with our raw materials. Revenue slowed in Q1 from the prior quarter, primarily as a result of weakness with one of our raw material joint venture business.

We are now factoring continued weakness from this business into our expectation in -- for Q2. Overall, we are seeing a price increase in raw gallium, but because of the prolonged decline in raw gallium material pricing, this particular joint venture has continued to struggle.

In conclusion, our continued operation execution allowed us to achieve profitability in the range of our original Q1 guidance despite the shortfall in revenue.

In addition, we continue to make progress with our strategic plan, preparing our business with a number of exciting opportunities unfolding in 2018 and beyond. We are expanding indium phosphide capacity to meet future demand for our products, and we are executing a methodical staged relocation of our gallium arsenide manufacturing.

Our process technology has enabled us to produce low EPD substrates for the emerging 3D sensing application, signifying an important early step in a long-term opportunity for our business.

We are pleased with these accomplishments and believe our continued progress positions us very well for the balance of the year and beyond.

This concludes my prepared comment. I will now turn the call back to Gary for our second quarter guidance. Gary?

Thank you, Morris. As we discussed, we're encouraged to see upside potential across our portfolio and believe we are positioned well in many applications that will drive our business growth in 2018 and beyond.

As such, we expect to see revenue in Q2 between $25.5 million and $26.5 million. We believe our profit per share in Q2 will be in the range of $0.07 to $0.09 based on 40.364 million diluted common shares outstanding. This concludes our prepared comments. Morris and I will be glad to answer your questions now. Operator?

(Operator Instructions) Our first question comes from Edwin Mok with Needham & Co.

First, I guess, just kind of think about directionally, looks like you guys are guiding up a little bit and you said that indium phosphide is kind of flattish up. So most of the growth, we should expect, come from gas, it sounds like. Did I get that correctly? Or is that something I'm missing?

Well, I think we said indium phosphide, we should see some growth. Gas will have some growth as well and also germanium.

I see. So basically across the board, you see some modest growth, and okay. On the first quarter, you guys reported very strong gross margin. How much has that come from the just stronger raw material pricing? And baked into the guidance, you have some margins at a similar level or are these in the high 30s, is that correct?

Well, there's a couple of reasons that the gross margin was as good as it was. One is that indium phosphide was pretty good for Q1, and the weight that it had on the overall performance in terms of revenue, was higher than normal because the other product lines dropped more than indium phosphide dropped in terms of not making the original guidance and plan. So that's the product mix and the richness of indium phosphide is one element for the upside. And the second is, the -- is in the raw material business and the refined gallium company, which showed improved margins and also, in the PBN Company, but not in the raw gallium company, which has just, I think, struggled. So...

Gary, let me remind you also that in the germanium business, we used to lose a lot of money because of that joint venture. And the germanium price has increased quite a bit. So I think, instead of losing a lot of money, we lose the less money on germanium business. That also helped them.

So based on your guidance, am I correct that we should assume high 30s in gross margin then?

Well, I think it's -- what we had said all along is we wanted to see some consistency north of the 35% level before we felt it was safe to nod to being above 35%. And I'm okay to go past 35%. I don't know if I want to say high-30s, but maybe halfway in between, I think, is reasonable.

Okay. That's great. On the Dingxing facility, maybe just kind of look beyond, you guys already issued the first wafer as you suggest, which is great progress there. Just kind of maybe if you can give us roughly a road map, kind of what should we expect the progress there? How much capacity you expect to have been moved by, I don't know, let's say, second half of this year? I know this year -- 2019, just kind of give us a road map in terms of how we think about the capacity ramp, not this month, but in the longer term?

Sure. The Dingxing facility that we built out and we facilitized is what we -- which we announced is only the first phase. We'll have a second phage be completed sometime in the middle of July. And we have a third tranche, which is almost doubling what we have, which we will build almost equivalent of the capacity that we have in Beijing to be finished by the end of the year. So it's going to be continual building as well as the facilitation as well as get them qualified for future production for gallium arsenide in Dingxing facility.

I see. So by the end of the year, you should have similar capacity in Dingxing that you can basically fund through your process there if you need to?

Yes.

All your process there? I see. Okay. That's helpful color there, just kind of give us some yardstick to think about. Last question I have, there was a ban kind of issued by U.S. government on selling products to CTE in China. Does that have any impact on your business?

So far we've seen not a direct impact on us. We've seen some market indication that may affect some of our customers, but we have not seen any direct impact on us so far.

I see. You don't sell directly to CTE. You may sell to your customer that sell to them, that may have impacted you, I see. Okay.

(Operator Instructions) Our next question comes from Richard Shannon with Craig-Hallum.

Let's see here. Maybe I want to ask a question. Make sure I heard your prepared remarks right today. Did I hear you say that you're expecting some relative weakness in your raw materials revenues in the second quarter? And I think you described some struggles there. Can you describe what exactly is going on there?

Sure. Yes, we were talking specifically about one of our joint ventures. That joint venture was producing gallium and traditionally, has been the large contributor for our revenue for joint ventures. But because of the prolonged low gallium price that has produced some problems in -- both in terms of organization as well as cutting costs. So we are sort of uncomfortable. And we've seen the revenue coming down in the first quarter already. And so we are taking the projection of continued revenue growth for this particular joint venture. So that's why we're taking the expected revenue down from this particular joint venture. That affected our overall revenue perspective for Q2 as well.

So is it a revenue issue or because it doesn't sound like it can be a pricing one. So is it a revenue issue?

No, it's not a revenue issue per se, but as I said, this -- the gallium price has been down for almost like 3 or 4 years. So this company has been losing money for quite a while. So we have a, should I say, organization issue with the company that requires a lot of attention and needs to install new management structure and hopefully that we can right this ship, and so that we can deliver good revenue growth, again.

Question on silicon photonics. It sounds like you're -- you could see a little bit of softness in the second quarter, but you see some good long-term opportunities here. Maybe you can talk about the breadth of customer base. I think your revenues are driven at least from an end customer point of view, largely by a single guy out there. Are you seeing a broadening of that customer base? And if so, could you describe where you're seeing that?

Actually, Richard, I think, we have more than 1 customers in silicon photonics. I mean, I think the dynamics is such that, as you know, back in 2017, and even in 2016, our PONs business was really weak. So we were really very appreciative of the very rapid growth of the silicon photonics business. And in fact, we were expecting it to continue to grow into this year, but then late last year and early this year, we started to see some softness in this business. But we were hoping that they can correct themselves, but while we're doing the market check preparing for the guidance for this second quarter, we started to see maybe they had more inventory to rebalance themselves. So at least for Q2, we're going to have a problem selling into this particular account. And actually, this plus -- yes, the other account -- the second account is not very, very robust either on data center silicon photonics. But on the other hand, we do read from the industry analysis saying data centers continue to grow and they will go to high speed 400G, which really fits very well for overall silicon photonics as well as indium phosphide. That's why we have the high hopes for it to come back. But for this second quarter guidance, we are taking a conservative view because I think this -- it will have a rebalancing of inventory issue.

Okay. Fair enough. Maybe a couple more questions from me. One to maybe follow up on a prior question regarding 3D sensing and your expected qualification process. Do you have any communication channels to the end customer about their sense of urgency to use your words of bringing on you as a supplier at some point during the product cycle here, later this year?

We always communicate with our customers. But I don't know which one you are talking about, but then we are working with -- closely with our end customers and with the new facility opening up, we are very hopeful that they will take a favorable view of our capability as well as capacity going forward. But I really think for this particular customer, I think, maybe we're guessing who we are guessing about, it's probably more of a 2019 event, rather than 2018. But as we said in our prepared comments, we are having many, many -- well, not many, many, but quite a few other customers, which are serving the 3D sensing applications, they are in development stage, and we are seeing a steady increase in revenue for the last few quarters now. So we are hopeful it's not going to be a single customer event, but I know that all investors are eyeing on this one particular customer, but we think that this is not a one-arm bandit issue. I think there are many, many opportunities for us. But we're not giving up on this large customer opportunity either.

Okay. Fair enough. One last question from me. I think you said you had 2 10% customers in the quarter. I know you typically don't identify those on the call. Can you give us a sense of what product areas they're involved with gallium arsenide, indium phosphide, et cetera?

Gary?

One is gallium arsenide and the other is indium phosphide.

Our next question comes from Gus Richard with Northland.

Can you just give us a little color on what you're seeing in the LED market? Is that continuing to be strong? Or how do you see that playing out right now?

I think the LED market is pretty healthy. As we said, we were -- we had a good customer that -- with telling us that they continue to see growth in the area, in the automotive applications. And so we are seeing -- they're telling us that they probably will see double-digit growth for the rest of the year. I mean, they're giving us this expense order, which is higher than what we expected. They're also telling us they are expanding the capacity. They took for a tour for their new factory expansion, which is very impressive. So we think that LED is going to see continued growth.

And is the euro versus the dollar having any impact on that customer? Or should I go ask them?

No. So far, we have always dealt with them based on dollars.

Our next question comes from Hamed Khorsand with BWS Financial.

So first up, can you just clarify between Q1 and Q2, especially the Q2 guidance. I mean, I'm going to assuming there would be some spillover as far as orders that you could not fulfill in Q1 into Q2. And based on your commentary, it seems like that could be more gallium than indium phosphide. Some I'm just trying to dissect here how much is softness are you seeing in indium phosphide, is my first part of the commentary is correct.

Well, Hamed, there is some carryover, but the bigger question for us isn't how much carried over, it's what's the cumulative weight of the rest of the customers in the quarter in the new orders. And as Morris said, we're seeing softness for some of the silicon photonics because of the data center. And that -- and that's why we've taken maybe a more conservative viewpoint as well as some softness continuing in the raw materials business. So...

So is this softness that you're seeing more because your customers have too much inventory on their hands because I mean, you are still at -- you're literally at the beginning stage of the product cycle, so what's leading to the softness?

Well, I believe that we have shipped that for almost 6 quarters now, I think. It was not the beginning of the cycle, I mean, they supported our indium phosphide growth in 2017 for sure, and even second half of 2016. But I think, it's just -- I mean, there are speculations. One is that we heard data center may be, they're adjusting inventory or whatnot, and then the other is that maybe the 100G, 400G transition we're hearing our customers is developing the new 400G product. But is that slowing down the 100G implementation, that's typical for us to tell. But we just know that they have inventory. They have to rebalance the inventory for the second quarter.

Okay. And then as far as just Q2 having more gallium in there, how comfortable are you with the shift in product mix, providing you that gross margin stability that's giving you the EPS guidance?

I think we're comfortable. I mean, indium phosphide is not going to go down, it's just -- the PON market is still good. But we really have never had a quarter where both data center and the indium phosphide and the PON are both strong. So for most of 2017, the PON market was weak, but the data center was strong. In Q1 of 2018, the PON market was strong and the data center was little bit down. And our high-end LEDs also have good gross margin. And even our -- although it's a smaller contribution, germanium has good gross margin. Our PB crucible company has good gross margins and our high-end gallium refining companies has pretty good gross margins also. So in the course of the last couple of years, the company -- sometimes it's been a little bit choppy, but the company has improved its cost structure, its yields and its capacity utilization and the product mix.

So all of those are converging to, I think, give us reasonable confidence of the gross margins. So -- it, of course, is the hardest thing for us to predict accurately, internally because there are so many variables. But I think our confidence is growing. So...

All right. Last question. Do you think this issue with your joint venture is a 1-quarter event? And is it really reliant on gallium pricing continued to go up or is it okay at current prices?

Yes, this joint venture issue, I think, it's although the gallium price has recovered, but as you know, the gallium price historically has not reached the level to make it very, very profitable as well as the prolonged loss of the joint venture is creating problems in the organization. So it really needs our attention and hopefully, we can resolve it. And obviously, the higher price would help, but perhaps it's not -- we're seeing gallium price. I think it's fluctuating between $110, it's now up to $180 and recently is coming back slightly. But I think it does need attention before we can feel comfortable that will become a good growth joint venture, again.

There are no further questions at this time. This does conclude today's question-and-answer session. I would now like to turn the call back over to Dr. Morris Young for any further remarks.

Thank you for participating in our conference call. And we'll be participating in the 15th Annual Craig-Hallum Institutional Investor Conference on Wednesday, May 30, in Minneapolis. We look forward to seeing many of you there. 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.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a great day.