AXT, Inc. (AXTI) Q4 2015 Earnings Report, Transcript and Summary

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 Katherine 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, Katherine. 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 begin, 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 was 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 24% 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 the charge from one of our gallium raw material subsidiaries to write-down this inventory to market level pricing. The write-down amount reduced our consolidated gross margin by about three percentage points. In addition the historically low gallium pricing today also affected our gross margin on the consolidated 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 a 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 the number of line items in AXT’s SG&A. Total stock compensation expense was $298,000 for the fourth quarter 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 the 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; foreign exchange gain of $148,000, equity earnings of our unconsolidated joint ventures which was the 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 have a net loss of $1.2 million or a loss of $0.04 per share this was approximately a penny outside of our guidance range attributable to the raw material write-downs 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 in 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 will 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 continue to realign our business with that trend that we are driving growth in compound semiconductor substrates. This process began in earnest two years ago following the significant customer consolidation 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 will position AXT to benefit from the growth in indium phosphide and will improve us to drive improved consistency and efficiency across our substrate portfolio. We are very pleased with the investment we have made and in the early results of our efforts. Today, indium phosphide substrates are our single largest product revenue category and growing more than 50% from the prior year. And although raw materials are providing a headwind for our business in the near-term, we expect to continue a 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 increased market adoption. In the fourth quarter, indium phosphide sales equal 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 demand for indium phosphide has been optoelectronic devices. In this case fiber optic communications and telecommunications and passive optical networks. These devices have time specification requirements limiting the field of competitors they can address that. In particular, optoelectronic devices require very little etch pit density or EPD a specification includes AXT's VGF technology strongly excess. In fact, we know from discussions with our customers that our VGF produce substrates, our orders are magnitude better they are our nearest competitor in etch pit density. Resulting in a meaningful difference in device reliability and year. For these indium phosphide based devices performance is a much larger driver than price. This contributed to a better substrate margin profile and pricing stability that we see today is 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 for fiber optic telecommunications and passive optical devices, data center connectivity continues to gain moment as a strong driver for indium phosphide demand. As such Silicon photonics is becoming increasingly prevalent. Your research reports that at least seven time lease can now support two device reduction enabling the technology to more quickly approach mainstream adoption. And finally, announcements coming out of Mobile World Congress this week in Barcelona suggest that the shift towards 5G will likely require changes in RF [indiscernible] of a cell phone. Today, RF [indiscernible] moving towards Multi-Mode Multi-Band Power Amplifiers that with 5G will require operating - to operate frequencies up to 28 gigabits. These will be a challenging for Silicon or even gallium arsenide to support. Indium phosphide is a natural choice it has the properties to enable the increasing requirements of 5G. Over the last two years, we’ve 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 who inspiring 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 are confident that we will be able to drive continued growth in indium phosphide sales and an increasing shift in our revenue mix towards this emerging material. During 2015, our semi-insulating gallium arsenide substrate revenue reached a relatively stable level having whether a major technology transitioned in previous years. This area of our business now requires comparatively modest ongoing investment that holds upside potential to qualify with meeting customers in RF device market. With our recent purchase of the production equipment for gallium arsenide wafer processing and handling for Hitachi Metals, we believe we can improve our manufacturing capability, for quality and consistency and enhance our ability to pursue growth opportunities in both mobile and number application. With semi-conducting gallium arsenide we continue to playing 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 applications as a result of the serious competitive landscape in corresponding pricing environment. But the most significant near-term headwind in our business is raw material, which were down meaningfully in Q4 as a result of both price and volume decline. In particular, gallium raw material has continued to reach historic lows largely as a result 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 reflected of the continued general weakness worldwide in commodities, which is RO and corporate. And with 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 rally proposition and competitive depreciation. Now in closing we are 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 aligned, realigned the size of our operation and the allocation of our resources with the current market trend in substrates including the significant growth activity in indium phosphide substrates market. This market has many barriers to entry AXT is taken a leadership position driving more effective present roles in our indium phosphide substrate revenue over the previous year. We mentioned a new technology, talent and manufacturing capability would help to position us for continuing success. I want to thank our customers, shareholders for their continued support of AXT and our employee world-wide for our 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 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?

Thank you. [Operator Instructions] We’ll go first to Edwin Mok with Needham & Company.

Hey guys thanks for taking my questions. So first question I have on indium phosphide, it sounds like Morris from your [indiscernible] an industry there is a lot of driver for that option in this technology. Just curious however we want to come get there and understand your market. Have you kind of get - do you have any kind of colleague and provide in terms of size of the substrate market that you think it is right now or at least for 2015 and where do you stand on a competitive front do you see large competitor in the space or it just more fragment and I think from what we can gather your business hasn’t grown over 60% per year over the last two years, very, very strong growth is that growth rate sustainable you think for this year.

Well, you have many bunch of questions. So first let me comment on the size of the indium phosphide substrate market. I mean this market is very dynamic, it is growing very rapidly as we believe, the lot of new adoption of using these technology, the growing demand for fiber-to-the-home it for [GPAL and EPAL] there is certainly very big demand across the world and more recently is the Silicon photonics I think is going to come on. So I think we are sort of estimating this market size to be allowing $50 million to $60 million for substrates overall, but I think it’s growing rapidly. But I believe that AXT’s position was such that we have grown more rapidly than the market grows itself. So we definitely have taken some market share, but to place us we think we are either number one or number two in a row. 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 I mean is there anyone else coming into the market?

Yes. I think you answered the question there. So it sounds like is that three player space, you believe it’s a three player space of which you guys have similar type market share, is that a way to think about the space right now? And 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 just incurred.

I see. Okay, that’s very helpful. Moving on to gallium arsenide. On your commentary you said that business is stabilizing. Just want some clarification, you are saying semi installation has been stabilizing and semi-conducting material coming correctly is also stabilizing at least in the last quarter or so the overall gallium arsenide business is roughly similar in 3Q and 4Q?

Well, last quarter semiconductor 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 question, I’ll let the other guys to ask question. 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 new gross margin side, right. 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 gallium definitely take a very severe hit beginning last October to November time frame. As you recall in the beginning of 2015 we thought the gallium prices hit the bottom at that time we’re selling for about $200 a kilogram and now it’s the gallium pricing is quoted somewhere around $140 a kilogram. So it’s a fairly significant drop, but whether it's because of the world commodity price collapsed or I think it’s typically perhaps they are both with supply 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 it can go I really cannot speculate I mean some of these market is strange.

All right. That’s helpful. One last question just Gary a mechanical question in the model if I may. So because you have this write-down - inventory write-down in the fourth quarter, which impacted your gross margin in the fourth quarter. You said the reason why you have a pretty big positive minority interest in a quarter because. I guess you have a loss on that you kind of countering to that, is that how mechanically why you have a positive minority interest of 600,000 in the quarter.

That's correct Edwin.

Great. Very helpful. That’s all I have. Thank you.

Thank you. We will go on to Tom Sepenzis with Northland Securities.

Hey, thanks for taking my question. Morris I was wondering if you could talk a little bit more about the 5G specifically indium. You think that’s going to be relevant for the power amps. How does that compare to gallium nitrate and why do you think people would choose indium over gallium nitrate?

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

Okay. So the indium phosphide really is going to be more for just the cell phones and serves for the base stations. So that’s something that probably doesn’t impact you much until 2018 is that fair?

I think where was the adoption I mean it’s everybody guess, but World Congress in wireless is held in Barcelona. I don’t know if there is any incremental news, but at least two weeks ago I read a news announcement that AT&T they have announced that they going to have a demonstration model as early as next year. So I will tend to think as the early adoption of the 5G will start to work then there will be some parallel line protections and there will be sampling, so you would probably start to see some, actually they 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 will not be the full protection of this 5G, but it could be a significant contributor to the RFMD 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 and the different businesses how should we be thinking about gallium arsenide, raw materials, Silicon and indium phosphide in terms of growth for the year?

In terms of growth that’s I can defiantly comment. I think we would definitely expect to grow fully in 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 where it’s going to start to recover so we model it’s to be flat or slightly down. Gallium arsenide wireless actually for this year we model it going up slightly, right Gary and semi-conducting gallium arsenide we model it sort of flat or slightly down and germanium for solar cells I think we are expecting to grow, because last year was a very difficult year for germanium substrates.

So taking $18 million which is a midpoint of your guidance from March then topline you would expect to see growth year-over-year in fiscal 2016?

Yes, that’s at least our models we’re trying to drive that. I think we’re modeling sort of modestly is really is on the raw material. I mean that was last year we had almost $5 million a quarter and now it’s down to $3 million, $3.5 million.

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

Yes. The lower cost of market write-down was cost of three percentage point and then the lower ASP for gallium cost is another like 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 here until raw material pricing bounces back right. So we are looking at around…

The ASP might still be a bit hard on us, but we hope we don’t have further low of cost of market adjustments and that’s the GAAP accounting rules. I think most of you guys understand how that works, I’ll explain that, but we are not factoring bad and again and we are hoping it more happen so...

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

As matter of fact yes, I think we might cross the 20% level where we might be just out of it.

Right, thank you very much.

You’re welcome.

Our next question comes from [indiscernible] with Craig-Hallum Capital Group.

Hello guys. Thanks for taking my question. I want to start first with indium phosphide and digging a little bit more how that’s going to change your model going forward. Given that you’ve taken some initiatives to reduce cost on your OpEx line it seems that I may have heard that gross margin could go back to 20% in the March quarter is there any change to your breakeven model or you’re breakeven in terms of revenues?

No big change. I mean the more we can grow indium phosphide, the more all the numbers look better. And we are not quite to breakeven yet, but we think that - so it’s pretty easy to guess I mean where we need to get to be breakeven, we are not giving guidance past next quarter, but we do internally pretty confident that we will cross that line this year.

Okay and then I am wondering if you can provide any update on Crystacomm I believe it 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 will take a little while longer. So I would expect to its maybe later this year or maybe even 2017 event for that work. But we are a power house for VGF, so the VGF growth is something that we are also developing 6-inch with VGF for indium phosphide and I expect that to mature earlier than the Crystacomm acquisition.

Okay great. I appreciate the thoughts. And then one last question for me I think you guys mentioned a one 10% customer I am just wondering if this is your typical and traditional 10% customer 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% customers that AXT has had in the past?

Yes, they have been 10% more than once before.

Okay great. All right that’s all from me. Thanks guys.

Thank you. We will go to David Kang with B.Riley & Company.

Yes, good afternoon. 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 30% of sales or I think I miss that point.

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

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

You mean indium phosphide?

Yes, indium phosphide.

No, no last quarter we had year-over-year innings…

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

It was sort of flat and slightly down.

Okay. 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 am talking about indium phosphide by the way.

Yes, I know. We have I think last count we must have over 100 customers, Gary and incoming all the big ones and small ones, while I’d say the largest five customer probably put 50%, 60% of the revenue.

Got it. Okay and then can you just talk about - in third quarter call you said that the pricing was very favorable actually I think you implied that your commanding premium. What about fourth quarter? Can you just talk about pricing?

No, there is no erosion.

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

We are growing capacity, we have flash, internal flash 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 allowed to disclose that.

Okay. As your indium phosphide is growing rapidly I mean have you thought about maybe perhaps kind of pruning some low margin business?

That is always very nice thought. I think Dave I think AXT’s within your transition time although indium phosphide we are all excited about it, but as I talking to lastly earlier in preparation for this conference call. Two years ago we didn’t even want to talk about indium phosphide because the revenue presentation was too small. But now after two years of growth is significant, but still look if you have a business with 30% of your revenue in growth, let’s say 50% and you have to dividend by one-third. So it because 16% growth. You are giving anything else as the same and so you can’t really, really giving up all the other business. So they are the fixed cost contributor so we don’t wanted to give it up. Especially there are some business which potentially have the growth opportunity. So I think be patience. So I think we have a growth in indium phosphide, but other business we will look at it until we are all filled up and we say 80% of business indium phosphide and then they will care for it.

We have said before, we have turned away from some of the very low end [indiscernible] LED pricing in customers. But I’d say other than that the bigger focus for us is continued yield improvement, continued cost reduction, we are very excited about the Hitachi Metals equipment which we’re installing now and we think that there is some ways to push the cost down that will help the margin. So that kind of more of a focus than sharing customers.

Got it. All right, that’s it for me. Thank you.

Thank you. I have 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’d like to meet with us. We look forward to speaking with you in the near future.