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AXT, Inc. (AXTI)

Q2 2015 Earnings Call· Sun, Aug 2, 2015

$68.19

-2.79%

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Transcript

Operator

Operator

Good afternoon everyone and welcome to AXT's Second Quarter 2015 Financial Conference Call. Leading the call today is Dr. Morris Young, Chief Executive Officer and Gary Fischer, Chief Financial Officer. Also available for questions if Dr. Hong Hou, AXT's Chief Operating Officer. My name is Robert and I will be your coordinator today. As a reminder, today's conference call is being recorded. I would now like to turn the call over to Leslie Green, Investor Relations for AXT.

Leslie Green

Management

Thank you, Robert, and good afternoon, everyone. Before we begin, I would like to remind you that during the course of this conference call, including comments made in response to your questions, we will provide projections or make other forward-looking statements regarding, among other things, the future financial performance of the company and our ability to control costs and improve efficiency, increase orders in succeeding quarters, improve our competitive position as the market improves, as well as the 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 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 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 30, 2016. Also before we begin, I want to note that shortly following the close of today, we issued a press release reporting financial results for the second quarter of 2015. The 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 second quarter results. Gary?

Gary Fischer

Management

Thank you, Leslie, and good afternoon. Revenue for the second quarter of 2015 was $21.0 million compared with $20.1 million for the first quarter of 2015. This represents approximately 5% sequential increase in quarterly revenue. In the second quarter of 2015, revenue by geography, from North America was 14%, Asia Pacific was 59% and Europe was 27% of total revenue. In second quarter we didn't have one customer that generated more than 10% of revenue and the top five customers generated approximately 36% of total revenue reflecting again our diversification of both products and customers. Gross margin in the second quarter was 20.9% compared with 23.7% of revenue for the first quarter of 2015. This decline was primarily due to product mix. Total operating expenses in the second quarter were $5.2 million compared with $6.5 million in the prior quarter. This sequential decrease was largely the result of the decline in professional fees. During the first quarter, AXT included $1.2 million in fees related to the internal investigation of certain potential related party transactions. The investigation was completed during the first quarter and there were no charges associated with it in Q2. Total stock compensation expense was $466,000 for the second quarter of 2015, of which $5,000 was included in cost of revenues, $417,000 in SG&A, and $44,000 in R&D. Operating loss for the second quarter of 2015 was $780,000 compared with $1.7 million operating loss in the first quarter. Other income for the second quarter was $1.1 million. This net number consist of four major categories. Number one, foreign exchange gain of $30,000; number two, sales of IntelliEpi stock for a gain $491,000; number three, net interest earnings on our $46 million in the bank plus other items adding upto $213,000; and number four, equity earnings of our unconsolidated…

Morris Young

Management

Thank you, Gary, and good afternoon. In addition to posting solid second quarter results, we continue to receive AXT to focus our resources money in new emergency business opportunities in the fiber optics, solar cell and RF communication markets. One of our key priority this year is to ensure we are well positioned in certain strategic areas of our businesses where we believe we have a competitive fleet. As such we are actively investing in our substrate technology across all four of our product groups, including internal R&D development, the upgrade of our manufacturing infrastructure, the increased automation. These investment should enable us to reduce costs, improve the efficiency and competitiveness, and to ensure long term consistency and our product quality and technical specifications. We also continue to build strength in our management team attracting some of the highest caliber talent in our company history. We are very pleased to announce this quarter that Dr. Hong Hou has joined AXT as Chief Operating Officer. Hong has extensive technical and executive level experience in our industry. Having previously served as CEO of EMCORE Corporation, he has a demonstrated record of success, and he brings the vision and skills necessary to drive further improvement in our operations, and to help us prepare the business for this next level of growth. I look forward to work closely with him and to leveraging his expertise and industry knowledge and a long standing relationships. Now turning to our markets, indium phosphide continues to be a strong contributor to our business for both new and existing applications, including optoelectronic devices for fiber optic communications, passive optical diverts, and data center connectivity, as well as solar cells and next generation wireless amplifiers. In the first half of 2015 our indium phosphide revenue have grown well over 50%…

Gary Fischer

Management

Thank you Morris. Looking to the third quarter, we are expecting some near term lumpiness in our germanium substrate revenues as well as continued pricing weakness in our raw material joint ventures. As a result, we believe that revenues will be in the range of $19.5 million to $20.5 million. We are expecting the bottom line to be in the range of a loss of $0.03 to a loss of $0.01 per share based on 32.2 million diluted common shares outstanding. This concludes our prepared comments. Morris, Hong, and I would be glad to answer any questions now. Operator?

Operator

Operator

Thank you. [Operator Instructions] We will take our first question from Richard Shannon with Craig-Hallum.

Richard Shannon

Analyst

Hey guys, thank you for taking my questions. I guess I've got a few of them. Let's start with the second quarter, Gary; I missed if I cut all your comments regarding the growth profile by segments, and especially as it relates to gross margins which were down couple of hundred basis points. Did I hear you right that the raw material segment was the only one that was down sequentially?

Gary Fischer

Management

Raw material was down sequentially but the general gross margin decline was basically product mix.

Richard Shannon

Analyst

Okay. And then as we get into the third quarter here, it sounds like basin raw materials declining, we could see gross margin similarly to slightly down, is that a fair guess?

Morris Young

Management

Yes, I think that's a fair guess. We hope it can be better but I think it's wise to be conservative when we have these discussions.

Richard Shannon

Analyst

Okay, I agree, that's a helpful effort from that perspective. You gave a nice number for your indium phosphide in the first half of the year, I think you said greater than 50% growth year-on-year. What do you think that could look like for the second half of the year on a year-on-year basis?

Morris Young

Management

That's a great question. I think – first of all, I haven't looked at our last year second half numbers. I think safely say, I think year-over-year we do – we definitely expect good growth, 50% could be a good convoy as you asked.

Richard Shannon

Analyst

Okay, fair enough. Maybe a couple of questions on your acquisition of Crystacomm, you mentioned you're not expecting revenues here in the near term. Maybe I'll just throw a couple of quick ones at you. When do you expect the 6-inches wafers to be ready? What kind of OpEx error should we expect here as you bring the group on here? And then, it was interesting that you're dealing with in at least CEO technology here versus your VGF, what are the merits of that, the advantages and disadvantages versus VGF?

Morris Young

Management

It's a whole bunch of –

Richard Shannon

Analyst

Sorry, Morris.

Morris Young

Management

Okay. I love to answer this question, and I think you know AXT has always been focused on VGF. We were proud of the fact that VGF can deliver great product and with low defect density and in fact, as you know, with VGF we really conquer the world on the gallium arsenide, nobody wants LEC based product no more. But I think the challenge for VGF sometimes is that it's little bit difficult to make the diameter larger, although we have been very successful in bringing up 4-inch VGF base, the indium phosphide, but LEC definitely gives us another view of delivering larger diameter substrates. And as you know that wireless things, they already gone to 6-inches I believe is difficult for them to switch back to 4-inch. So we hear rumors out there, they always want 6-inch product. So this will enable AXT not only to provide 6-inch VGF but also give us a crack at 6-inch LEC. So it's a very good compliment to us. To answer your question, what OpEx is concerned, this acquisition is very, very nice. Let me describe it this way, it has – the first part is actually easy, it has a very unique technology to synthesize indium phosphide material. And fixes a polymaterial for indium phosphide that actually turns out to be a significant part of our cost of goods sold and with this acquisition we believe we can drive the cost of our indium phosphide poly [ph] and that we expect to utilize that capability, learn from there in the short term. And we don't expect to spend a lot of money and facility increases to get that done. As far as the crystal growth development is concerned, that's a very evolved process. And believe me, even with Crystacomm's LEC acquisition, 6-inch for wafer development is a tall order. So let me give you an analysis. When AXT was developing the 6-inch gallium arsenide, actually we got some help from United States government in the tune of $8 million. So make at the time each got $13 million and $18 million to develop a 6-inch gallium arsenide. An indium phosphide is lot more difficult than gallium arsenide can ever see. So that's a challenging job. I tell you that I won't say it's a very job and we only have to spend a few million dollars to get that into the market but the reward is definitely just as great as well.

Richard Shannon

Analyst

Okay, I appreciate those precisely Morris. I will jump out of the line. Thanks a lot.

Operator

Operator

And we will take our next question from Edwin Mok with Needham & Company.

Arthur Su

Analyst · Needham & Company.

Hey guys, this is Arthur filling in for Edwin Mok. Thanks for taking our questions; I just had a few quick ones. So we recently heard some data points about some weakness in China Mobil, possibly some excessive inventory. I was wondering if that had any effect on your gas business and if you could provide some color on that?

Morris Young

Management

Well, as you know that the wireless business in our total revenue contribution right now is relatively small. I mean although it's still there, but I would not expect it to – I mean we didn't enjoy the write up. So I do expect it to hit us that hard. I mean, but then of course, as the world economy, we probably got hit more because of the raw material slump. Pricing of gallium is coming down; we are very diversified by the way. So the wireless itself has hurt us as much.

Arthur Su

Analyst · Needham & Company.

Okay, great. Thanks for that. And then regarding indium phosphide, can you see any stronger demand pull from any sort of various drivers you had mentioned, whether it's fiber optics, datacenter connectivity or solar, any specific segment providing stronger pull?

Morris Young

Management

Well, to answer that question I think it's all the above, I mean with the exception of solar, I think solar is slowing down. We are one of the companies which is really driving for the solar application, it has difficulties. So other segment I think – I would say if the optoelectronic application is really the driver now. I think the datacenter connectivity is emerging application which will potentially be a big driver but it's not a main driver yet. We commented also might up – the mobile application actually is going to be a few years away but you can see – you can start to see development requirements coming soon.

Arthur Su

Analyst · Needham & Company.

Great. Thanks for that breakout as sort of the timing of how things come in. But did you see any stronger – I just noticed you added Australia and New Zealand as demand markets also for network deployments for your indium phosphide. Are you seeing similar growth as you would see in China or is it although behind or further ahead? Just trying to get a color on the demand a little bit.

Morris Young

Management

Let me turn this question to Hong. Hong, is really an expert on understanding this driver for the optoelectronic application for indium phosphide. Hong, you want to take that question?

Hong Hou

Analyst · Needham & Company.

Sure. Hi, Arthur. So, for indium phosphide right now the market driver is primarily fiber to the whole. For the US market, the deployment largely completed for the telecom carriers a couple of years ago. But a deployment in China was primarily for multi-driving units in the past but now with the increase of the internet speed, it's an activity demand, so the optoelectric [ph] is going to each apartment unit and we opt to our customers, they all commented they could not make manufacture enough components to service their customer needs. And also that you couldn't have manufacturers basically in China, now only it is a service the Chinese market but also the global market, we talk about Australia, New Zealand, and Taiwan, and Singapore, Indonesia. It is not necessary they have service providers, out there you have equipment manufacturers out there but the equipment manufacturers, basically in China are servicing this market as well. Early on we had a big question about the China mobile slowdown. We paid attention to that as well but the rumors slowdown is on, the infrastructure build up, but in China the service has largely been 3G, and the migration owned by HAN site [ph], it's just starting. So they build the highway right now and they need to build the current run in the highway to comply with that standard. I think the demand for power amplifier in the new generation for 4G LTE is going to be increasing. But right now as Morris commented, our market share in that segment is limited, and that means we have potential to grow. So it's to be a good news for us rather than negative because as I said, the highway is viewed, and now is the time to build the cost in this case in the handset to run at 4G LTE standard.

Arthur Su

Analyst · Needham & Company.

That's just great. And then just one last question and I'll hop out of the line. Last quarter you gave us some guidance on the target cost structure reducing breakeven revenue down to $21 million to $21.5 million. Do you think that's still a good assumption going forward and to expect some improvements in the second half?

Morris Young

Management

I guess you caught me there. In a way I think the fluctuation of the targeted breakeven revenue target for us – it does depend upon several things. For one, we didn't expect the gallium price to keep on eroding, that will hurt us. Even if we sell all the gallium we can produce, but the price decreases, right now it does hurt us, but on the other hand, the rumors can be true if the gallium price were to increase. Yet, other very, very important factor is obviously indium phosphide, if we grow that segment, product mix thus help us. The factor where you did the utilization, of course we've already said $21 million, it does depend whether it's coming from raw material or not. So, I would say in general, $21 million to $22 million could be a breakeven point revenue target for us but I think it does still depends upon like few other loose ends we have to close. Yes, the judgment is predicting a goods variable, so if we knew for sure we would tell you for sure but we have some uncertainty because we are – we don't have full visibility to answer those variables.

Arthur Su

Analyst · Needham & Company.

Great. Thanks, that's all of my questions.

Morris Young

Management

Thank you, Arthur.

Operator

Operator

[Operator Instructions] We will go next to Dave Kang with B. Riley.

Dave Kang

Analyst

Thank you, good afternoon. Just two questions regarding first Crystacomm. What was the purchase price, I was assuming it was somebody material? Just trying to figure out where your cash will be by end of this quarter.

Morris Young

Management

Right now we didn't disclose it and it was – as we said, it was mainly a technological and knowhow acquisition, and yes, we got a good deal.

Dave Kang

Analyst

Got it, got it. And then regarding your decline in gross margin in the second quarter, use of product mix, so it sounds like maybe your germanium and semi-conducting gallium arsenide grew more than the other segments, is that fair assumption?

Morris Young

Management

Are you seeing projecting out into the third quarter?

Dave Kang

Analyst

No, no, no, I'm asking what happened in the second quarter. I mean, is it because of germanium and semi-conducting gallium arsenide grew faster than the others?

Morris Young

Management

No, actually we think it's the product mix mainly. And also the raw material price decline didn't help us that much either.

Dave Kang

Analyst

Got it, okay.

Morris Young

Management

The leader was raw materials.

Dave Kang

Analyst

Sure. And then it sounds like your indium phosphide is doing well, I mean, can you just give us a rough estimate where that is – about 20% of the sales or just any ballpark figure just so we can understand? I think before it was like 15% maybe high teens, is it 20% now or –

Morris Young

Management

Yes, Dave, I'm sorry we decided not to break up the product mix almost a year ago. And we did give color that it grew year-over-year, well over to 50%. I think that's a good number to work. And you know how much we did last year first half.

Dave Kang

Analyst

Okay, okay. And then, which is bigger between SI and SE gallium arsenide?

Morris Young

Management

Semi-insulating is bigger.

Dave Kang

Analyst

It's still bigger, okay. Got it. And then lastly on Crystacomm again, what's their end market, it doesn't really – I'm looking at their website, it doesn't have a whole lot of information there, is that still up come or is it some different markets?

Morris Young

Management

Well, you know Crystacomm is a very interesting technology. George Antypas, who is a very great technologist, he has actually pioneered in the indium phosphide industry, he did own 2-inch, 3-inch, 4-inch first and he was really good at the LEC crystal growth. But on the other hand, it's not a secret that he trying to keep maintained operation relatively small, so it's relatively a technology acquisition rather than business acquisition.

Gary Fischer

Management

Because of his engineering background, he had a lot of interaction with universities, as a matter of fact, Hong, you want to comment about the indium phosphide experience with him, George?

Hong Hou

Analyst

Hi, I graduated with the substrates supplied by George. He is a very specialized – special orientation and it was very hard to grow. So I think his technology, LEC, certainly complement to our VGF technology, it was a combined technology base, it will be able to address a greater market applications that both up come as we said, and also potential in electronics and solar cell applications.

Morris Young

Management

So Hong Hou's PhD in Material Science at UC, San Diego, basically is substrate that he used for the research was from Crystacomm. So that's the kind of places that Crystacomm have revenue to, it's not huge and that's why we said in reduction that we don't expect any near term big swing in revenue but we think it opens up a lot of doors. I want to make one other clarifying comment because somebody asked earlier, I think Richard did about operating expense, there really is not going to be any material change in the operating expense lines or because of the acquisition. We're not adding any headcount, Dr. Antypus will help us as a consultant but we don't have a need to hire more employees because we have employees that can operate the equipment. So it's not going to have a notable impact right now on the OpEx.

Dave Kang

Analyst

Got it, thank you.

Operator

Operator

And we will take our next question from Greg Roger with Adorandek Funds [ph].

Unidentified Analyst

Analyst

Good afternoon. I have a question on Crystacomm in terms of the technology, this LEC based technology, just as curious as to when you would think it could be put into commercial production as it's something that's a year, two years out?

Morris Young

Management

Well, Greg I think you can say the benefit is this way, we used to say that AXT is using VGF only but now we know even the enemy camp, there is only three indium phosphide provider in the world. We think we're either number one or two, and the second competitor is from Japan who uses LEC. So I think we're competing with them very well with our VGF but by having the very confident LEC technology will open up the doors for us. And I think that to put it in other way, I'm sure our competitor doesn't have the knowhow of VGF. So that gives us an advantage. So I think the pieces – but there is other part of the acquisition which is, as I said in the entering article, we can use this technology to synthesize polycrystal material for indium phosphide which happens to be not a trivial technology, and because it's an important part of our cost of good material cost. So to turn this technology arm to synthesize the material will enable us to lower our cost overall and increase our ability to improve our quality. On the long term I think with this acquisition we can serve a broader customer, whoever wants VGF we can give it to them and whoever wants a different application where the LEC may have advantage, we can turn that as well. So I think that's the good thing for us. So I think to answer your question in a short way, I think to turn this sadly coming now is a matter of few months.

Unidentified Analyst

Analyst

Okay. And in terms of – do you have any guidance on CapEx for the remainder of the year?

Morris Young

Management

We don't normally give CapEx in any hard guidance. We will continue to invest but I don't think you're going to see any big swings up or down that would be a surprise. But Gary, I think we made a commitment in the past that we said this year's CapEx fee – it's about $6 million rightly. [Cross Talks] Yes, so this could be in the budget.

Unidentified Analyst

Analyst

Okay. And for the future of gallium, you're in this situation, you and your competitors where the industry is just hovering at – I would imagine a breakeven level. And I'm just curious as to how long that stake can go on – how long you can basically hover around breakeven on gallium and not – there not be really any major action by any of your competitors to reduce capacity or –

Morris Young

Management

Yes, so I guess this is a very interesting question. I think we have all – as openly said, because of the SOI it hurts the gallium arsenide wireless industry tremendously but thank goodness it's over with, I mean it's now stabilized. But I think the wireless still needs gallium arsenide for sure but the trade is much smaller now for the three of us to enjoy. But I think obviously it's difficult for us to view into our competitors head but I can only present AXT's case is that, we think we're stabilizing because we have the diversification. We are into something which is exciting, indium phosphide which is growing, we are investing very heavily there. We have a germanium with Hong coming on board, it's going to be up able to open up some more doors for us. We have some niche markets that we are serving, we want the advantage for AXT compared to our competitor. I'm sure they are listening now, but we have a lot of customers which are smaller diameter, they have a low location density requirement. And we are using those to breakeven. I'm not saying it's writing but I think we're getting through this very difficult time and hopefully also to demonstrate to the end customer that AXT is a reliable customer/supplier they can count on in the future. Although they use less gallium arsenide but in the future somebody is going to be supplying this wireless industry with 6-inch capacity. And so we are – to be honest, we are less relying to revenue from the 6-inch wireless industry now but we are knocking on doors since they don't forget us.

Gary Fischer

Management

Yes, this is Gary. Let me answer that in terms of the cash balance. So I think there is two ways to answer your question. One is about the macroeconomic deal of the market and the other is about AXT. So from an AXT standpoint, we are absolutely here for the long run, we have over $46 million in cash, we have very diversified product line, and we are confidently mapping out a road map since business strategy which we believe is going to help us be very successful. As for the industry on a macro level, I think we would agree with you that some companies maybe feeling the pain and may not have the resources and the diversification that we do and we actually think that's okay that might open up some doors and advantages for us if other people back off.

Unidentified Analyst

Analyst

Thanks, and good luck.

Morris Young

Management

I know but we are not adding capacity for sure.

Operator

Operator

And this concludes today's question-and-answer session. I will now turn the call back to Dr. Morris Young for closing remarks.

Morris Young

Management

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. And we look forward to speaking with you in the near future.