AXT, Inc. (AXTI) Q1 2020 Earnings Report, Transcript and Summary

Good afternoon, everyone and welcome to AXT's First Quarter 2020 Financial Conference Call. Leading the call today is Dr. Morris Young, Chief Executive Officer; and Gary Fischer, Chief Financial Officer. My name is Victor and I'll be your coordinator today. [Operator Instructions] I would now like to turn the call over to Leslie Green, Investor Relations for AXT.

Thank you, Victor, 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, market conditions and trends including expected growth in the markets we serve, emerging applications, using chips or devices fabricated on our substrates, our product mix, our ability to increase orders and succeeding quarters to control costs and expenses, to improve manufacturing yields and efficiencies, to utilize our manufacturing capacity, the schedule and timeliness regarding our relocation, the growing environmental health and safety and chemical industry regulations in China, as well as global economic and political conditions, including trade tariffs and restrictions. 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 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, COVID-19 and other outbreaks of a contagious disease; potential tariffs and trade restrictions; increased environmental regulations in China; market acceptance and demand for the company's products; the financial performance of our partially owned supply chain companies; and the impact of delays on our customers on the timing of sales of their 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. These are available online by link from our website and contain 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 22, 2021. 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 2020. 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, everyone. Total revenue for the first quarter of 2020 was $20.7 million. By comparison, revenue in the fourth quarter of 2019 was $18.4 million, and revenue in the first quarter of 2019 was $20.2 million. Of our total revenue, substrate sales were $16.9 million compared with $14.5 million in the prior quarter and $16.7 million in Q1 of 2019. Revenue from our raw material joint ventures was $3.8 million in Q1, approximately flat from Q4 and up from $3.4 million in Q1 of 2019. In the first quarter of 2020, revenue from Asia Pacific was 62%, Europe was 30%, and North America was 9%. In the first quarter, two customers reached 10% of revenue, and the top five customers generated approximately 49% of total revenue. Gross margin in the first quarter was 27%, up from 21% in the prior quarter. The improvement in gross margin was primarily due to product mix and volume, as well as incremental improvements in manufacturing efficiency. Total operating expenses in Q1 were $6.2 million down from $6.7 million in the prior quarter. Total stock compensation expense for the first quarter of 2020 was $643,000. Operating loss for the first quarter of 2020 was $634,000 compared with an operating loss of $2.8 million in the previous quarter and an operating income of $626,000 for Q1 of 2019. Other income net for the first quarter of 2020 is a gain of $1.2 million. This includes a net loss of $120,000 from the partially owned companies and AXT supply chain accounted for under the equity method. Foreign exchange loss of $43,000 and a net loss of $29,000 interest income in other and other income of $1.4 million from a provincial government agency grant as an award for relocating to their province. And Morris can give a little color about that when he speaks. Income tax for the first quarter of 2020 was a charge of $366,000 compared with the benefit of $214,000 in Q4. Our Q1 results included approximately $190,000 in tariffs as a result of the 25% tariff charged on importing wafers into the United States from China. For Q1 2020, we had a net loss of $178,000 or a loss of $0.01 per share. By comparison, we had a net loss of $2.0 million or a loss of $0.05 per share in the fourth quarter of 2019 and a net loss of $1.1 million or $0.03 per share in Q1 2019. The basic and dilutive share count in Q1 was 39.813 million shares. Cash, cash equivalents and investments were $28.8 million as of March 31. By comparison, at December 31 it was $36.3 million. We did have a higher than expected accounts receivable, and I estimate that we undercollected by about $4 million which would have brought ending cash-in at about $33 million. We do not view this $4 million to be impaired as a credit risk, and we're confident we will collect it. We think it's a result of both Chinese New Year and the coronavirus. Some companies are slowing down cash disbursements due to work disruption and also being cautious and conservative. This is probably especially noticeable with our customers in China. We currently forecast that our net cash burn in 2020 will be similar to our cash burn in 2019 which was only about $3 million. So we feel we have a strong cash position which is important in light of the uncertainties resulting from COVID-19. We also still have an untapped line of credit with Wells Fargo Bank, and a second bank in China is arranging another line of credit for us as we speak. We do not anticipate tapping all of this, but it is a prudent path for today's environment. Depreciation and amortization in the first quarter was $1.0 million and capital expenditures were $2.1 million. Net inventory at March 31 decreased by $900,000 to $48.3 million compared with $49.2 million in inventory at December 31, 2019. Ending inventory consisted of approximately 43% in raw materials, 52% in work in progress and only 5% in finished goods. Okay. This concludes our financial review. I'll now turn the call over to Dr. Morris Young for a review of our business. Morris?

Thank you, Gary, and good afternoon, everybody. I want to first say to our listener that I hope you and your family are well amidst this global pandemic. I'm also grateful to report that AXT employees and their families have remained healthy so far. I’ll begin today with a brief update on the impact of the coronavirus on our branches and then move on to our market conditions. As we reported to you in February, we have been taking strict protective measures in our facilities in accordance with best practices and local laws. The safety of our employees remain our number one concern. For most of the first quarter, our manufacturing facilities in China were operating at reduced staffing levels to limit the risk of exposures for our employees. While this did have an impact on our productivity, we were able to meet customer demand in the quarter, posting revenue and earnings results that were slightly ahead of our expectations. In recent weeks, the government mandate have evolved allowing us to return to full staffing levels at all three manufacturing locations. Other provisions we implemented remain in place, including employee temperature screening, protective gear, including face masks, limited group meeting and changes in our cafeteria food provision, among other precautions. The biggest challenge to productivity remains the limited travel between our three facilities in China, as well as travel restrictions to and from China. In addition, shipping and delivery has slowed which has implications for obtaining parts and services needed for our manufacturing, as well as our ability to ship rush orders to our customers. Finally, like most companies, we prefer to find great value in face-to-face interactions with our customers. While online collaboration tools have been proven very useful, particularly in the last several months, we look forward to the day where we can strategize and problem-solve with our customers in person. On a positive note, we're not experiencing any noticeable disruption in our supply chain of raw materials required to maintain our substrate manufacturing. We are also able to obtain everything we need. As we enter into Q2, visibility remains limited. As such, we are taking appropriate conservative view of our markets. However, demand for our substrate is holding fairly steady amidst the difficult global conditions with pocket of strengths, across our portfolio. In indium phosphide, demand for data center connectivity and passive optical networks was stronger than anticipated in Q1, growing nearly 25% from the prior quarter. We believe this is due in part to the timing of orders from certain customers. As such, we’re not expecting indium phosphide revenue to be strong in Q2. More broadly though, we continue to see a trend towards higher speed networks and increasing bandwidth requirements that is likely to drive growth in both of these applications for years to come. Customers of these applications are providing positive, straight signals about their demand requirements. Although it is typical to predict how business conditions would evolve over the balance of the year. Gallium arsenide revenue increased in Q1 from the prior quarter, primarily driven by increase in LED applications as we move into Q2, we’re expecting weakness in automotive applications, offset by strength in wireless applications. Lead time for some orders have been short but we have been able to adapt and respond quickly to support customer demand. With our new Kazuo and Dingxing facilities now in the operation, we are in a strong position to be able to support customer requirements across new and emerging applications. During Q1 we were pleased to announce that one of our largest gallium arsenide customer completed its qualification of our site for volume production, an important milestone for manufacturing relocation. Over the balance of the year, we expect to ramp production from Beijing. Turning germanium substrates, we have seen an uptick in demand in recent quarters driven primarily by growth in satellite solar cell applications. Our revenue in Q1 reached its highest level since Q3 of 2018 and we expect to see continued improvement in Q2. And finally, raw material revenue were essentially flat from our prior quarter but this is expected to grow in Q2. Most of our joint ventures are back to full production following the reduced staffing precautions put in place for employee safety early in the year. In closing, in the midst of a very difficult environment, we will continue to prioritize the well-being of our employees, the support of our customers and accessibility to our investors. Knowing the business climate is challenging to predict, the application we serve that centers on connectivity and communication are more important than ever. Further, we have successfully transformed our business capability with the completion of our relocation to highly scalable and state of the art facilities which are now ready to serve the need for our customers. We believe AXT has a healthy balance sheet and we will continue to emphasize strong fiscal discipline as we navigate these unusual times and plan and prepare for better days ahead. These conclude my prepared comments. I will now turn the call back to Gary for second quarter guidance. Gary?

Thank you, Morris. As Morris discussed the demand environment for our products remains steady to improving with a number of growth drivers intact. However given the macro economic uncertainty caused by the global pandemic, we’re taking an appropriately modest view of Q2. We're also widening our typical guidance range a bit to allow for unanticipated effects from the coronavirus. Therefore, we expect to see revenue in Q2 of between $20.5 million to $22.5 million. Also, given the expected product mix shift in Q2, we believe that the loss per share will be in the range of $0.01 to $0.03 based on 41 million shares outstanding. Okay, so this concludes our prepared comments. And Morris and Leslie and I would be glad to answer your questions now. Victor, you want to take it over for the Q&A?

[Operator Instructions] And our first question comes from the line of Richard Shannon from Craig-Hallum. You may begin.

And so a few questions from me, I guess first of all just on the guidance. I wasn't able to run the numbers fast enough, Gary. But can you give us a sense of what you're thinking of for gross margins built in your second quarter guidance?

Yes, that's a good question. I think the margins will be in the mid-20s again. So not much change. We are expecting another award from government agency and that's - if you're just running your straight model, you won't get to $0.01 to $0.03. But if you role in the award, then you get to $0.01 to $0.03.

That is helpful, thanks for that. Second question is Gary, on your comments about cash burn for this, expecting it to be a burn of about $3 million, same as last year. Wondering if you could tell us your assumptions built into this. First of all, kind of topline view on overall growth for this year which I think is necessary to understand, but second of all, how should we think about CapEx?

Yes. So what we've done is - literally I prepared two columns. The first column was 2019 key elements that would go into a cash flow such as revenue, CapEx, et cetera. And then we don't give annual guidance for 2020, but for this particular cash analysis, I made an assumption that revenue stayed the same. We hope it improves but we're not - we don't give that far out looking so. And CapEx is lower for this year than last year. And I don't remember some of the other key things, but basically it comes out. It's frankly quite remarkable for me as a numbers guy - but for us to accomplish what we did last year in terms of the relocation, capital expenditures and stuff, and then have the net burn be $3.05 million I think so its $3.0 million or $3.1 million is quite remarkable. And I think our team did a good job at cash control and managing things like that. So I don't see any reason why we can't continue to do that this year. I hope the numbers are even better than I'm saying today. But again, we don't give annual guidance especially in this environment. It would be a little bit foolhardy just to think that we can see that clearly. However, we remain pretty confident about this and very confident, in fact. And that's how I kind of - that's kind of the background for how we did it. So if you just look at - for if any reason you want to do it, just look at last year's beginning in any cash and you can sort of see the stuff that goes in and out of that. And we think this year would be at least the same, but we hope it’s better.

Okay. That’s helpful. I understand your assumptions both in there. Thanks Gary, for that. My last question.

You’re welcome.

My last question is for Morris - about the kind of qualification of customers into your new facilities. On your last call you talked about hopefully having at least half of the revenue space from customers who have qualified. You announced something late last quarter about a top customer qualifying. I wonder if you could kind of give us a broader update on how the qualifications have gone. And do you expect to hit kind of the number you also said last quarter for June, which is at 80%, 85%?

Sure. I think our progress in transferring qualification in wafer processing in Beijing [ph] is going very well. As we just said, that we have our largest kind of onsite customer qualified not only the product from Beijing but also qualifying the site. We are increasing as we speak of the delivery portion from the new facility to our largest customer as of now. We do have quite a few - I mean most of the customers are getting qualification samples. But some of them - a few of them are still waiting for the site to be ISO 9000 qualified as well as the other mobile TS 14,900 or something qualified as well that may take a little bit longer. But as we said that we expect the shift of the delivery of the product from the new site to continue for the rest of the year. Hopefully we can mostly complete it by the end of the year.

And our next question comes from the line of Hamed Khorsand from BWS Financial. You may begin.

So first off could you just talk about your receivables or are you in constant contact with your customers? What kind of timing are you expecting as they expand out these - the terms on you?

Gary?

Well, it’s on the - yes I'm glad to take that one. It’s on the front burner. I was a bit surprised at how it ended up but as I said you know during the prepared comments. I think the combination of the Lunar New Year, Chinese New Year and the coronavirus and the work stoppages and things like that plus cast conservatism on the part of the customers. I want to underline again what I said is that I don't view this as a credit risk. I view this as a collection opportunity. So we - if business the business world was normal in Q1, then I think we would have had and $4 million collected. So what I would say is that we're going - we do have constant contact with the customer that's not the issue but some customers are slow to pay. And we need to figure out ways on each account, make a plan for each - each individual account based with the sales person that's in charge of that account. I may be involved in making some calls. We're going to try some different experiments. I'm not worried about it. But I think it's just - it's just part of our job. You know - it's happening across the world right now people are slowing down on cash disbursements. And we got to be the squeaky wheel and get some of that back into our bank account, instead of their bank account, but I think we can do that still.

Yes I think I want to add also one more point. I think it's - our business model is such that these customers continue to need our product. So if they don't pay, we don't ship and that will interrupt their production as well. But this quarter yes, things did get extended out a bit and - but those customers obviously are very large customers, and I don't think there's any worry that they're going to go out of business and they continue to buy products from us. But as Gary explained, but because of the coronavirus and because of Chinese New Year, things got extended out a little bit. We will collect those money as - we get into Q2.

Okay. And then the…

Go ahead. Hamed go ahead.

Oh, I was just going to ask - it was mostly sales towards the end of the quarter or was it just - is it really just regular course of extended terms?

No over 40% was in March because we had Chinese New Year and then the shutdowns in China. So, even in our own group, we were short staffed because of the issues on the virus. So it was - we don't like to be back-end loaded. It's never a good practice for a manufacturing company to sort of have the hockey stick, and Morris and I have always discouraged that. We prefer to be like a horse race where you get out of the gate fast and then you can take it easy on the back end. In this case, we didn't get out of the gate fast and we had to run at the back end to get everything delivered, which we did. But a significant portion was in the back end. But the other comment I was going to make is a number of - in terms of credit worthiness, several of these customers that are behind are state-owned companies in China. And so there tends to be a culture to slow pay with state-owned companies. On the other end, they're basically backed - the equivalent of being backed by the U.S. Treasury. So that's why I don't worry about the credit risk. I just view it as a collection opportunity.

Okay. And then my last question was, are you managing the business on the headcount side, do you need to have everyone back to work given where revenue is right now, and how are you managing that?

Well, in the United States we have a small group here, just 25 people and we're all working from home quite hard. So the question really is, should we try and cut back in China because that's where we have over 700 people in China. So it's on the table, we talk about it. But our sales are going up. We're also in the process of handling a transition from the relocation. We've got people trained, more than half the employees in COSO are locals and - therefore they're relatively new. So, and they're not highly paid but it's - I don't think in my view as we've discussed it internally, it's not wise to sort of mess with those people's minds. They got a new job from a company like AXT and all of a sudden, they're cut back so. So, it is, we are considering at home. It's something that we, it's our fiduciary obligation to think through these things but we're not ready to announce anything either to the employees or to the investment community.

And our next question comes from the line of Dave Kang from B. Riley FBR. You may begin.

Thank you. Good afternoon. Morris, during the February earnings call, you estimated the coronavirus impact to be about mid-single digit, was it mid-single digit as you expected and are you expecting that to point to the current second quarter?

What did you say about single-digit coronavirus, what impact that?

Yes. I think during the February earnings call, I think you estimated the coronavirus impact to be about mid-single digit, like, 5%-ish. Was it - did it turn out to be that way or any comment there?

Dave, I'm sorry. I actually forgot. But, obviously, we deliver better than we expected revenue as well as earnings in the first quarter. So, whatever we expect, we were doing better. And especially our indium phosphide, I think the order was surprisingly strong. We think it's mainly prompted by one, we believe, is the phones market in China and that could very much serve into the 5G buildout for substations and our base datacenter - business actually is sort of flattish. So we do hear some of our customers in Taiwan has been telling us they are sort of overordering a bit to build some inventory because they have a worry that maybe - they're worried about shortage of supply. So we don't expect the second quarter being enforced by revenue to be as strong as Q1. But the good surprise is that we think both germanium as well as wireless gallium arsenide is going to have a continued second - it had a strong first quarter and will continue to have a second quarter - growing into second quarter. And also our joint venture raw material business is going to be better as well in Q2. So while the coronavirus is giving us reasonably a good perspective of business outcome in second quarter. However, we still want to put that caution because of uncertainties. We want a wide range of expectations out there.

Got it. So just to summarize, regarding second quarter assumptions, indium phosphide will be down, gallium arsenide for auto will be down, but then wireless will be up, germanium, and then raw materials will be up. So that provides about a $1 million-ish type of sequential growth. Is that correct?

Yes, correct. Yes, that’s correct.

Okay. All right.

Yes I think - and just to be clear David, the gallium arsenide LEDs, I wouldn't say it's going to be down; I'd say it’s about flat. And my second comment is just we kind of have a knock-on-wood feeling at AXT. Yes, just like everybody else, we were nervous and we were uncertain. I think we're fortunate that our numbers probably turned out better than we thought, yes on the revenue side.

So actually one more question on indium phosphide because there are two drivers, one is China and the other one is datacenters, the major datacenter - US datacenter customers. Can you just talk about regarding indium phosphide being not strong as in first quarter? Can you provide more color as far as China versus US?

The data center connectivity, I think data center is going to have good quarters to come, but perhaps the ordering a little bit more in the first quarter. So they build some inventory, but nowadays the other phenomenon is customers really give us a very short leash. They all expect, if they get this order we should deliver in two weeks which you know in the substrate business is very, very difficult. We normally ask for at least four weeks delivery. But then during this environment everybody has a very short view. But I think the particular overall order we think is happening in the China market where people are worried about substrate - supply. But again, the order pattern is such that they don't show very strong in second quarter. But again with very short order lead time, anything can turn up very quickly.

Yes and let me add a couple of things. We use this word sometime, it's not a very technical word but it's one that Morris refers to and we all get it. He calls it the fact that indium phosphide especially the order rate can be lumpy. So it's hard to discern, David. Is it down a little bit because of the virus or something else specific or is it just sort of some ups and downs that are lumpiness. My second comment as in China, we do think that there's a lot of activity for the international scope of 5G. And we recently - we’re advised to take a look at some studies and if any people - on this conference call is quite fascinating. If you take a look at what's going on in Korea, that's a great case study for the benefits of 5G. And I have to say - and I've always been a proponent 5G anyway because you know we're going to benefit from it. But it's significantly had got more bells and whistles and improvements and good things happening than I expected. So, some of the setting that's going on in China is going to go into 5G around the world so.

And our next question will come from the line of Gus Richard from Northland. You may begin.

Yes, thanks for taking the question. Just on the gallium arsenide market, you referred to strengthened wireless. And I was just wondering, is that infrastructure or is that handsets?

Gus again, it's difficult for us to tell. We typically are strong in PN market. And but then, nevertheless, our customers are usually the Epicors and they don't really tell us whether it's infrastructure or handset. Although I would guess it's more in the handsets because of the Wi-Fi. But I'm pleasantly surprised to see the strains. We have a good quarter - first quarter and we're going to have another good quarter, second quarter, and I hope we can continue. And the PN as you know used to be making the switches and because of SOI coming and PN lost a lot of business to that application. However, I think, as we go into 5G and as the frequency of operation gets higher and higher, PN may have a comeback. And I hope that's the beginning of that cycle, but I'm not sure. I mean we need to wait another quarter or two or three before we can make that conclusion.

Is the tri-band Wi-Fi in handsets requiring GaAs?

Yes.

Am I reading that right?

We don't think it's for switches but we think for Wi-Fi applications, yes, it could require gallium arsenide.

Got it. And then in terms of the inventory build in indium phosphide, is this a significant overshoot it sounds like goes up 25% sequentially. Do you have a sense of how much inventory your customers have built at this point? Is it a couple of weeks or a couple of months or a couple of days?

Honestly, we don't know. Actually we'll put that in because second quarter, we have a way of building our guidance and it collects all the information from the sales channel and then see what second quarter looks like and it was lower than first quarter. So, what was the reason? I mean we do have one customer in Taiwan in particular, told us that said that they're pulling a lot of short-term orders and they told us it's for inventory building. But that's only for one customer and our large datacenter customer, we don't think there's any - well, at least we don't hear, they have an inventory build. So, I really don't think we really know, but because second quarter is be shorter - lower than the first quarter, so we think inventory build could be one of the reasons.

And we have a follow-up from the line of Richard Shannon from Craig-Hallum. You may begin.

Guys, my question was asked and answered. I don't have any more. Thank you.

Thank you. I'm not showing any further questions at this time. I'd like to turn the call back over to Dr. Morris Young, CEO for any closing remarks.

Thank you for participating in our conference call. I'll be taking part in the Virtual Craig-Hallum Institution Conference and the B. Riley Institution Investor Conference Call - Conference in the second quarter. In addition, given the turbulent conditions in the market, we're committed to being as accessible to our investors as possible. So, as always, please feel free to contact me, Gary Fischer, or Leslie Green, directly, if you would like to set up a call. We look forward to speaking with you in the near future. Thanks, everyone. Stay safe.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.