AXT, Inc. (AXTI) Q1 2013 Earnings Report, Transcript and Summary

Good afternoon, everyone, and welcome to AXT's First Quarter 2013 Financial Conference Call. Leading the call today is Dr. Morris Young, Chief Executive Officer; and Raymond Low, Chief Financial Officer. My name is Deanna, and I will be your coordinator today. [Operator Instructions] I would now like to turn the call to Leslie Green, Investor Relations for AXT. Please go ahead.

Thank you, Deanna, 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 that deal with future events 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 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 May 1, 2014. Also before we begin, I want to note that shortly following the close of market today, we issued a press release reporting financial results for the first quarter of 2013. This press release can be accessed from the Investor Relations section of AXT's website at axt.com. I would now like to turn the call over to Raymond Low for a review of the first quarter 2013 results. Raymond?

Thank you, Leslie. Revenue for the first quarter of 2013 was $22.4 million compared with $18.9 million in the fourth quarter of 2012. Total gallium arsenide substrate revenue was $11.7 million for the first quarter of 2013 compared with $11.4 million in the fourth quarter of 2012. Indium phosphide substrate revenue was $1.8 million for the first quarter of 2013 compared with $1.6 million in the fourth quarter of 2012. Germanium substrate revenue was $2.6 million for the first quarter of 2013 compared with $1.7 million in the fourth quarter of 2012. Raw material sales was $6.3 million for the first quarter of 2013 compared with $4.3 million in the fourth quarter of 2012. In the first quarter of 2013, revenue from North America was 15.5%, Asia Pacific was 63.5% and Europe was 21% of total revenue. No customer generated more than 10% of our revenue during this first quarter. The top 5 customers generated 33.9% of our first quarter revenue. Gross margin in the first quarter was 15.6% compared with 19.5% of revenue for the fourth quarter of 2012. The drop in gross margin in the first quarter of 2013 was expected, as announced in our last earnings projection. Selling, general and administrative expenses were $3.9 million for the first quarter of 2012 compared with $3.7 million in the fourth quarter of 2012. Research and development costs were $827,000 for the first quarter of 2013 compared with $875,000 for the fourth quarter of 2012. Total stock compensation expense was $332,000 for the first quarter of 2013, of which $6,000 was included in cost of revenues, $284,000 in SG&A and $42,000 in R&D. Loss from operations for the first quarter of 2013 was $1.3 million compared with loss from operations of $900,000 in the fourth quarter of 2012. Net interest and other expense for the first quarter of 2013 was $512,000. Net loss in the first quarter of 2013 was $2.4 million or a loss of $0.08 per diluted share. This compares with the net loss of $756,000 or a loss of $0.02 per diluted share in the fourth quarter of 2012. Cash and cash equivalents with maturities of less than 3 months, short-term investments and other investments in high-grade debt securities with maturities of less than 2 years decreased by $725,000 to $49.4 million at March 31, 2013. Accounts receivables, net of reserves, were $17 million at March 31, 2013, compared with $17.9 million at December 31, 2012. Day sales outstanding were at 68 days for the first quarter compared with 87 days for the fourth quarter of 2012. Net inventory was $38.8 million at March 31, 2013, compared with $40.4 million at December 31, 2012. Of this, approximately 49% is raw materials, 39% is work in progress and 12% is finished goods. Depreciation and amortization in the first quarter was $1.3 million, and capital expenditures were $1.6 million. As of March 31, 2013, the company, including our consolidated joint ventures, had 1,264 total employees, of whom 1,053 work in production. This concludes our review of the results. I will now turn the call over to Morris. Morris?

Thank you, Raymond. Revenue trends in the first quarter came in largely as expected in each of our product categories, although our performance in germanium substrate and raw material outperformed our plan. With our industry continuing to evolve, both in terms of the customer landscape and technology trends, we experienced a continuation of the softness in semi-insulating gallium arsenide substrates that we began to see in second half of 2012. However, we are seeing renewed growth in our semiconducting gallium arsenide substrates, as well as improving demand for our indium phosphide substrates. Germanium substrates, too, was seeing a very good growth, as well as raw material. While the changes to the wireless side of our business have been challenging, we remain optimistic that new opportunities, coupled with improving market conditions in other product lines, will allow us to drive improved results in 2013. As expected, we saw a decline in our wireless revenue in Q1, as we've seen seasonally normal, and also in keeping up with the customer behavior who we have been monitoring over the past few quarters. For the first time in many years, no customer represented 10% or greater of our revenue in Q1. However, we were pleased to see solid performance from a returning customer and better revenue diversification in this area of our business. As we discussed last quarter, the customer base for wireless RF devices is undergoing major changes and consolidation. We have been very focused on working with customers to complete ongoing qualifications and positioning AXT for greater penetration in strategic accounts. We're pleased by our performance in customer qualifications where our substrate have had some key successes but continue to work through the business impediments that have limited ourselves to this point. In addition to the landscape change, the wireless industry is undergoing some technology transition that are also having an impact on near-term demand. We're seeing adoption of BiHEMT technology that combines the pHEMT and the HBT devices into one package that offers both cost and space savings for the customer. We have made adjustment in our own substrate manufacturing process that are allowing us to perform quite well in the qualification of our substrate for these new devices and believe that this could present additional opportunity for us as this technology becomes more widely adopted. Now turning to semiconducting substrate business. We saw a nice pickup in our revenue in Q1, although coming off a low base in the first quarter of 2012. Regionally, Taiwan saw the most growth, but we also experienced stronger sales out of Europe. China continues to be somewhat soft. The application driving our sales continue to be signage, display and automotive uses such as tail lights and panel illuminations. To that end, we were very pleased to report during the first quarter that we have successfully been certified as having met the international ISO's automotive standards, currently the most stringent quality management system standard for the worldwide automotive industry. This certification is a demonstration of AXT's commitment to serving our automotive customers with the highest level of excellence and is important for our continued penetration of strategic automotive applications. Turning to germanium substrates. As expected, we saw a healthy increase in our revenue in the first quarter. Satellite solar cells continue to make up the majority of our demand, but other applications also performed well. Regionally, we saw strengthening demand from customers in Europe and China and expect that these regions will continue to generate healthy demand in the coming quarters. In terms of other applications, we also are beginning to see a ramp in the CPV activity. While this application is still nascent, terrestrial solar installations are growing in both size and number, and we are monitoring this opportunity with interest. Raw material sales were also a strong contributor to our revenue increase in Q1. While prices have been increased modestly, volume has picked up meaningfully. With our sales increasing 45% from the first quarter, the additional volume at historical low prices negatively impacted our gross margin in Q1. However, if the demand continues to rise, as prices recover, we should see a healthy recovery in our overall gross margin. Over the past year, we've continued to build our portfolio of raw material joint ventures, which now total 9. We recently added an additional joint venture, and 2 more were added by our joint ventures. This portfolio has tremendous value in terms of our cost structure and supply and is a unique benefit of our China-based operation and relationships. In closing, while the wireless market remains challenging as the customer and technology shifts continue, the rest of our business is showing signs of improvement. We're hopeful that the LED device market will strengthen over the course of the year and that we will continue to see growth in the phosphide and germanium substrates, as well as raw materials. In the meantime, we are currently controlling our expenses and are continuing to drive efficiency improvements throughout our operations. Further, the window for our stock repurchasing program will open in early May, and we believe that will be representing other opportunity for us to improve our shareholders' value in the quarters to come. I will now turn the call back to Raymond to discuss our forward-looking guidance. Raymond?

Thank you, Morris. In the second quarter, we are expecting to see total revenues of between $22 million and $24 million. We are expecting net loss in the first -- in the second quarter of between $0.05 to $0.07 per share based on approximately 32.4 million common shares outstanding. This concludes our prepared comments. We're now happy to answer your questions.

[Operator Instructions] We'll hear first from Edwin Mok with Needham & Company. Edwin Mok - Needham & Company, LLC, Research Division: So first question I have is regarding your comment, Morris, on semi-insulating gas substrate, and you mentioned that customers are kind of changing technology. Are you referring to customer or end customers trying to adopt more silicon-based wireless front end? Or are you talking about this BiHEMT change? I'm just trying to be very clear on that.

Well, I think it's both. Actually, there's all of shifts in technology. I think there's no denial that SOI is encroaching the gallium arsenide space, and we're taking a very close look at that. And also, there are -- I think BiHEMT is a good technology counterpunch from gas to SOI, I believe. And so I think the battle is not over, definitely. And we are seeing the changes. Edwin Mok - Needham & Company, LLC, Research Division: So we had, first, some of the front-end guys talk about BiHEMT for a while, right? And I haven't seen a lot of adoption. Is this something that you start to see changing here? And my understanding is BiHEMT still use gas substrate, right? So that should actually benefit you, right, if they're going to adopt that, yes?

Yes. That will actually save the day for pHEMT because it uses gallium arsenide. And this is also we hear from our customers. And they use the same substrate, by the way, whether they're building pHEMT or HBT or BiHEMT. BiHEMT is just a combination of pHEMT and HBT. But the good thing for us is that they need a slight adjustment for our substrate surface, but basically, it's a 6 inch substrate, they can use whatever the technology they use. Edwin Mok - Needham & Company, LLC, Research Division: Great, yes. So just to be very clear, on BiHEMT, I thought that, that technical product as been out for a while, right? Has it just finally gotten to a point where you start to see adoption in the customer or at the end customer side?

That's what we hear. That's what we hear from our customers. They are saying that it's going very nicely, although we need to see more confirmation. But we do hear there's some activities in here and they're growing in demand and performance. Edwin Mok - Needham & Company, LLC, Research Division: Cool, okay, that's great. And then just quickly on semiconducting, you mentioned that you guys have a nice pickup. Is it possible for you to give us some breakdown in terms of how much of your revenue was semiconducting versus semi-insulating for the first quarter? And do you expect that trend to continue into the second quarter and to the second half as well?

Yes. Edwin, it was actually 50-50 split this Q1 and the prior quarter because we had such a low base on semiconducting. It was 44%, 56%. So the trend going forward, going forward, I think semi-insulating probably is going to see some softness in Q2, but we expect it to recover in second half, although famously speaking, we don't have a very good visibility 2 quarters out. But we hear from our customer's customer, they're seeing a ramp-up in the demand in second half. Edwin Mok - Needham & Company, LLC, Research Division: Are you talking about semi-insulating or semiconducting just to be clear?

We're modeling modest growth for our semiconducting. You probably have a little bit better visibility on semi-insulating because the customers are fairly vocal on their forecast of their business conditions. Edwin Mok - Needham & Company, LLC, Research Division: Right. That's great. Two more questions, and I'll jump back in the queue. So first one, based on the guidance, you kind of implied that your gross line and OpEx is still running on the similar level that you did in the first quarter. Did I get that correctly? And as you look longer term, do you see room to either reduce on OpEx or improvement on gross margin?

I think we are expecting just slight increase in gross margin in Q2.

Edwin, I think the question is that it definitely depends upon the product mix. That's for one. And we are modeling off, obviously, a very low raw material cost. That's the other. And the volume definitely drives our fixed cost, depreciation cost. So think if we were to see continued revenue growth, then I think we should improve. Edwin Mok - Needham & Company, LLC, Research Division: Okay, that's helpful. And then last question just on raw material. You mentioned that you've kind of expanded your portfolio raw material joint venture. I was wondering, are those new investments? Or are you contributing to the revenue line? And -- or should we expect some kind of ramp coming from those new investment? And then are those kind of the same type of material that you guys are using like gas, germanium, et cetera, or is it some other type of materials?

They are basically the same raw material we're supplying to our substrate making line. Are they new investment? I don't think we expect to put more money in. They're already in our joint venture. We established them. But as you noticed, we have now 3 joint ventures. Our joint ventures, joint ventures. So they're already established, and they already put their investment in. And mainly, they are improving our joint venture operations by having other joint venture to cut their cost down. So that's the joint ventures, joint ventures.

Yes. Edwin, let me just expand on that. We have 3 joint ventures that we consolidate. Those are still the same 3. The others are the unconsolidated joint ventures that we expanded some time ago, and they are -- you'll find that in the other income line. So that's not part of the total consolidated revenue line. Edwin Mok - Needham & Company, LLC, Research Division: So that explains why your equity in earnings of unconsolidated joint venturer increased this quarter?

Sorry, Edwin, just repeat that, please? Edwin Mok - Needham & Company, LLC, Research Division: Yes, so -- because you have more of those unconsolidated -- not consolidated joint venture, right, that explains why the equity earnings that you reported this quarter has increased, is that correct?

No, that decreased this quarter.

We'll take our next question from Avinash Kant with D.A. Davidson & Co. Avinash Kant - D.A. Davidson & Co., Research Division: A few questions. So if you could give us some clarity about the guidance that you're giving. On revenue terms, sequentially up from Q1. So how should we think of various businesses? Like do you think materials will be up meaningfully or semiconducting, semi-insulating? Where is the growth coming from?

The revenue of Q2 is probably mimicking what we did in Q1. In other words, healthy increase we expect from germanium. Some increase in indium phosphide. Raw material, I think, we had a very nice increase in Q1 already. So we are expecting to see it stay flat. And semiconducting, I think, it should grow a little bit, but I think semi-insulating, we may see some decline because of the changes we encountered in Q1. That should continue for another quarter. Avinash Kant - D.A. Davidson & Co., Research Division: The quarter, okay. And now in terms of the semi-insulating side, in terms of the inventory of your wafers at the customers, how is it right now?

Well, most of our customers are on consignment. So we don't have any inventory to speak of. I think -- if you mentioned inventory, it's probably our customer's customer probably have inventory. Avinash Kant - D.A. Davidson & Co., Research Division: Right. So do you have some visibility into that?

We don't. We just know that they're not ordering right now. Avinash Kant - D.A. Davidson & Co., Research Division: Still? Okay. And in terms of cash burn, how much was the cash burn during the quarter? And where do you think is your breakeven at current levels or as you cut cost?

The cash burn was only $725,000. It was a small decrease from the prior quarter. Avinash Kant - D.A. Davidson & Co., Research Division: What's the EPS breakeven at this point?

Actually, I don't have a calculation on that one, Avinash. But I can take this offline with you. We do not have that calculation. But that is -- it is some calculation. I think the breakeven is somewhere around $25 million given -- if mix of product doesn't change a whole lot and raw material stays at this point, right?

Yes, it would be roughly $25 million to set that level. We'd hope then that gross margin would improve and everything else lines up with the joint ventures and the minorities and foreign exchange to get down to breakeven EPS. Avinash Kant - D.A. Davidson & Co., Research Division: And in the EPS guidance for Q2, you assumed some share count. What was that? I didn't get it right.

32.4 million. Avinash Kant - D.A. Davidson & Co., Research Division: 32.4 million, okay. And any trends on the raw material? It looks like you have seen some improvement in raw material pricing. Could you give us some idea in terms of the magnitude of that and where do you see it going on to this quarter?

Well, in fact, in the beginning of the quarter, it continued to decline until about the last 2 or 3 weeks of the quarter and the price stopped and firmed. I think the other good sign, I believe, is the volume. You see, the volume has just increased tremendously. So we don't have any inventory at our joint ventures. So I think that's a good sign. I think whether it's going to -- well, I hope it's going to firm up, but whether it's going to go up from this point on, I can't really tell because it's always a function of how much demand there is and how much capacity there is. I keep on saying the same thing. I believe the silver lining out of all of these is that we have a low-cost manufacturing, so we're still making money, I mean, even at this low price level. And second is that I think the demand is fairly healthy. You can see that the volume that we're selling now compared to 1 year, 1.5 years ago is almost doubling. Actually, it's more than doubling. So hopefully -- well, I think that phase, that demand, is definitely growing, growing very nicely. Avinash Kant - D.A. Davidson & Co., Research Division: So then that begs the question, Morris, that if you have seen a ramp in volumes lately and you don't expect prices to go down, what makes you think that material sales will be flat on a sequential basis in Q2?

Well, we want to be conservative. I don't want to assume it's going to go up. I mean, that would be nice. But then on the other hand, I'm not going to assume the price is going to go down further.

We'll take our next version from Richard Shannon with Craig Hallum.

I guess just a few questions for me. Most of mine have been answered here. And maybe I'll ask a couple of different ways. I don't know if they're already asked here, but just talking about gallium pricing again. Maybe I'll just ask you directly, Morris, just like I did last quarter. Any time frame by which you might expect to see pricing materially improve from the levels we've seen here around the $300 per kilogram level and anything that drives that to happen?

I don't know. I really don't know. I think we can analyze this into that because there's a lot of moving parts, Richard. You've got to count down how many speculators there are, and I think the good news is that I've been checking, we've been mostly selling to real customers from our joint ventures, we think. So I think the demand is really firm, although there are speculators out there. And when they start to jump in, that's going to firm up the price and drive up the demand.

Okay. Are you seeing any sources of supply coming to take capacity offline? It seems like pricing at this level for this line would have forced that off, but I haven't been able to detect any. Are you seeing any movement for less industry capacity?

Well, absolutely, Richard. I think you just don't know about it, because we know we have a competitor in China, they took quite a substantial capacity offline because they can't make money. I think the cost is somewhere around $350. That's roughly 15 tons. But they just go sort of quietly on the sideline because it doesn't make any sense for them to produce anymore when their cost is -- and also, this gallium producing factory is such that if they shut it down, it doesn't take them a whole lot more to restart it. So it's easy for them to shut it down. So I think it's already happening, but when it's going to reach equilibrium, I don't know.

Okay, fair enough. And I appreciate your thoughts on that, Morris. Next couple of questions on gross margins. How did the gross margins for the other raw materials business compare to the corporate average?

It's currently below the corporate average.

Okay. And do you expect that to cross over anytime soon here?

Well, that's the same question you asked about raw material pricing.

A little bit, yes.

Yes. It's a simple math. I mean, right now, we're selling for $280, and if they sell for $400, that's 40% margin.

Okay. I guess just last question. Morris, you alluded to qualifications in the last couple of calls in the wireless side. I want to get your sense of any further progress there, whether there are any decisions made or they're still outstanding, just your overall thought process there.

I think unfortunately, my answer has to be the same as I said last time. I think we're still working on it. Although we have some good news, some parts, I believe that would qualify. And yet, it's a business decision. There are other things that we've got to negotiate out before they have to convince their customer to use our wafer. So it's a long drawn process, and I hope that eventually, our customers and our customer's customer will see the value of using AXT's good quality wafer with competitive pricing. We're still working on it.

We'll hear next from Tom Sepenzis with Northland Securities.

I just want to clarify, I believe you said that the semiconducting business was going to be flat, the semi-insulating will be down and materials flat in the June quarter. Was that correct?

No. Semiconducting is going to improve slightly in our model. I think raw material, we think, is going to be flat. Right, Raymond? And I think germanium and indium phosphide should improve.

Right.

Should improve?

Yes.

Okay, all right. So I definitely got that wrong. And just in terms of the raw materials business. Given that you've seen some signs that the market is trending, and even in Q1, why would you sell so much and increase the volume to such a degree with the gross margins where they are? Why not just hold back?

Why not just pull back? Well, first of all, it's our joint venture. We have other business partners. I mean, they make the decision on their own business. I mean, we cannot really tell them to shut down. And second of all, they still make money. I think that's a good answer. And yes, I think that's probably it. And they don't manipulate the market.

Is there a price point where they can't make money themselves, I mean, gallium arsenide...

Right, yes. But fortunately or unfortunately, they are one of the low-cost manufacture leaders. So they are really tough.

We'll take a follow-up question from Edwin Mok with Needham & Company. Edwin Mok - Needham & Company, LLC, Research Division: Yes, just kind of quickly go through the numbers. If you pick your first quarter numbers, which you did -- your joint venture did a payout on the dividend, right, which actually had an impact on your earnings in the first quarter. Without that you actually had a loss of around $0.05 based on my calculation, but your guidance, you guide in the midpoint for the loss of $0.06 even though you're guiding for higher revenue. Am I missing something there?

You mean going forward? Edwin Mok - Needham & Company, LLC, Research Division: Yes, I mean, basically, if I take the first quarter numbers, right, and back out the joint venture dividend, you would have lost of just $0.05. But on the second quarter, you guided for a higher revenue, but you are guiding at the midpoint for a loss of $0.06, which is a higher loss, right? So that would imply that you either have lower gross margin or higher OpEx, right? Or there's some other onetime item that I'm not aware of. Can you help us out in terms of reconciling those 2?

Yes, I think for Q1, we made a loss of $0.08. The difference in that dividend on that withholding tax is only $0.01. It's like $314,000. So then it would just take you to $0.07.

We'll take another follow-up question from Richard Shannon with Craig Hallum.

Just one quick follow-up. You mentioned share repurchase window opening up here later this quarter. Can you tell us how many shares you bought back last quarter? And then what are you thinking about in terms of the buyback for this quarter, what kind of size, what would you commit to?

Richard, the program is only going to start opening next week, Monday, May 6. So Q1, we actually didn't have a purchase program in place. The hedge started at the beginning of this open window period.

Okay. Any thoughts on how much you're going to commit to the program?

Well, I think the board authorized, what, $6 million?

$6 million.

And management has the discretion of making -- because we're doing it in an open window. So we're going to make a judgment whether the pricing is too low, we're going to do aggressive buying, and if it is okay, then we obviously don't want to change the price. It can't be with our shareholders buying the stock. Well, I think it's a board decision that they do believe that they're solid valuing AXT's business. So that's the main purpose of the share repurchase thing.

And at this time, I show there are no further questions. I'd like to turn the call over to Dr. Young for closing remarks.

Thank you for participating in our conference call. This quarter, we will be presenting at the Jefferies Conference in New York and the D.A. Davidson Conference in Minneapolis. We do look forward to see many of you there. As always, feel free to contact me, Raymond, Leslie Green directly if you would like to meet with us. And we look forward to speaking with you in the near future.

This does conclude today's conference. We thank you for your participation. You may now disconnect.