AXT's (AXTI) CEO Morris Young on Q2 2014 Results - Earnings Call Transcript

Aug. 2.14 | About: AXT Inc (AXTI)

AXT Inc. (NASDAQ:AXTI)

Q2 2014 Earnings Conference Call

July 31, 2014 04:30 p.m. ET

Executives

Leslie Green – IR

Morris S. Young – Chief Executive Officer

May Wu – Senior Accounting Manager

Analysts

Avinash Kant – DA Davidson & Company

Richard Shannon – Craig-Hallum Capital Group

Dave Kang – B. Riley & Co

Andrew Lee – Needham & Company

Operator

Good afternoon, everyone, and welcome to AXT's Second Quarter 2014 Financial Conference Call. Leading the call today is Dr. Morris Young, Chief Executive Officer. Also joining the Question and Answer session is May Wu, Controller for AXT. My name is Jessica, and I will be your coordinator today.

I would now like to turn the call over to Leslie Green, Investor Relations for AXT Inc.

Leslie Green

Thank you, Jessica 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 deal with future events are based on management's current expectations and are subject to risks and uncertainties that could cause actual results or events 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 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 July 31, 2015.

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 second quarter of 2014. In addition, we will discuss highlights of our second quarter results on today's conference call, we refer you to our press release and financial summary, as well as the SEC filings for a complete discussion of our second quarter results. This information is available on the Investor Relations portion of the website at axt.com.

I would now like to turn the call over to Morris Young for a brief review of the second quarter results as well as a full market update. Morris?

Morris S. Young

Thank you, Leslie. Revenue for the second quarter of 2014 was $21.4 million, of this total gallium arsenide substrate revenue was $11.3 million, indium phosphide substrate revenue was $3 million, germanium substrate revenue was $1.7 million and raw material sales were $5.4 million.

Gross margin in the second quarter increased to 19.4% from 14.1% of revenue in the first quarter of 2014. The increase in the quarter was primarily the result of increased revenue, sales mix and cost saving activities.

I’m very pleased to report that AXT generated a profit in the second quarter of 2014 of $319,000 or $0.01 per diluted share. And finally, cash and cash equivalent at June 30 were $49.4 million up from $46.8 million at March 31, 2014.

Now let’s turn to review of our markets. Q2 was a positive quarter for AXT, through a combination of higher revenues, positive sales mix and the first full quarter of benefits from our cost saving measures, we’ve returned the company to profitability well ahead of our plan.

In addition, with continued focus on cash management we drove improvement in our balance sheet, growing our cash position and reducing inventory. While the business environment remains challenging, during the second quarter we experienced stronger demand in both of our semi-insulating and semi-conducting gallium arsenide substrate as well as continued strengths in indium phosphide. As we head into the second half, we remain guardedly optimistic that we will be able to drive further growth in our business.

Turning to our market segment: Our semi-insulating gallium arsenide revenue grew by 60% in the second quarter; partly driven by intentional inventory build as well of our customers. We do not view this growth as an indication of a turnaround in the market for semi-insulating substrates as the full effect of SOI is yet to be determined.

However, we do think that we will see consistent revenue in the third quarter. Further, we continue to work towards greater penetration in the HBT market while the semi-insulating gallium arsenide has shrunk considerably in the last 18 months. We believe that gallium arsenide will continue to serve a portion of both the switch market and the power amplifier market for some time to come.

Wireless continue to grow importance as the technology for the future and the increasing functionality in the next generation designs, may require the performance characteristics and adaptability that gallium arsenide offers.

Semi-conducting gallium arsenide sales also came in ahead of expectations, following strong growth in the first quarter, our sales increased by additional 14% in Q2. The increase came across several geographies and a number of applications including some non-traditional areas such as CPV solar cell and (inaudible).

The semi-conducting gallium arsenide market as a while continues to be fragmented and the competitive landscape if fierce. However, we have seen success in our effort to penetrate the lower end of hardened market with volume higher and we have the quality and the technical specifications to meet a wide variety of requirements. We would expect our results to be somewhat lumpy as is the nature of the business, but we are on track to see growth this year over 2013.

Turning to our indium phosphide business, we saw a 38% growth in our revenue in Q2. In fact, sales were up more than 34% year-to-date versus the same period last year. Lasers and detectors for fiber optic communications remain the primary application for these substrates, but we continue to see exciting progress in other areas as well. For example there is growing interest in testing of indium phosphide in CPV solar cells as this material offers very high conversion efficiency similar to semi-conducting gallium arsenide. Also, as we have mentioned in the past, indium phosphide is a key component in selective photonics, the technology that is gaining interest in next generation data center connectivity.

Turning to germanium substrate, as we had expected, revenues were down in the second quarter as a serial of a larger cell like solar cell customers work off excess inventory. However, we already beginning to see a rebound in ordering patterns and expect some improvement in the current quarter. In addition, the CPV market which uses germanium substrate for torrential solar cells appears to have taken a pause following the completion of a number of sizeable insulations over the last 18 months.

However, industry research group, IHS, is predicting strong growth in the coming years with worldwide insulation set to expand at double digit percentages every year through 2020. These represents 750% increase into the megawatt output between 2013 to 2020. The primary driver for growth in the CPV market is continued improvement in conversion efficiency making solar sales more cost effective for practical use.

With sizeable on-going investment, the industry is making major gains towards it free to go 50% efficiency. Germanium substrates are more widely used than any other material and offer proven reliability over years of testing, however, the high cost of raw material to limited usage over long term. Alternatively, semi-conducting gallium arsenide and indium phosphide appears to gain momentum as oppose offers a more favorable cost over efficiency ratio.

As I mentioned, CPV applications were drivers of our growth in both semi-conducting and indium phosphide substrate in the second quarter. The success of these materials in CPV applications will ultimately depend on their reliability and consistency over time. AXT is in a great position to take advantage of growth in this market regardless of which material is ultimately successful. As we are major suppliers of all three leading materials and we have the ability to cost effectively scale production as demand requires.

Finally, with regard to our raw material business, revenue came in higher than we expected. Raw gallium prices remain approximately flat in the quarter and raw germanium is also stabilizing. We expect to see some improvement in our raw material gross margins. In the coming quarters, a shuffle over our joint ventures are implementing their own cost savings initiatives.

In closing, though the business environment remains challenging, we see opportunities for improving our business. We are allocating our resources appropriately, concentrating our effort on those strategic areas in which we are seeing the strongest demands for our products. Our revenue base is diversified across a variety of materials and applications allowing us to weather weakness in a given area while we develop incremental opportunities in others.

In addition, we are pleased by the results of our cost cutting measures that helped us to deliver solid profitability and by our asset management strategy that has further strengthened our balance sheet. We believe that through all these efforts, we can drive improvement in our financial model and continue to enhance shareholder values.

Turning to guidance for our third quarter, we are expecting total revenue of between $20.5 million to $22.5 million. Therefore, our earnings per share for the third quarter of 2014 is projected to be $0 to $0.02 per share based on approximately 32.3 million shares outstanding.

This concludes my prepared comments. May and I will be glad to answer your questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And we’ll go first to Avinash Kant with DA Davidson & Company.

Avinash Kant – DA Davidson & Company

Good afternoon Morris.

Morris S. Young

Hi, Avinash.

Avinash Kant – DA Davidson & Company

So, you gave the percentage gains in semi-conducting and semi-insulating, but could you give us the exact revenue numbers in the quarter?

May Wu

The 51% and…

Morris S. Young

Yes, 51% versus the 49 %.

May Wu

Yes.

Morris S. Young

51% semi-insulating, no 51% came from semi-insulating and 49% came from semi-conducting and total revenue was 11 –

Avinash Kant – DA Davidson & Company

Yes 11.3. I got it.

Morris S. Young

Okay.

Avinash Kant – DA Davidson & Company

So, 51 is semi-insulating and 49 is semi-conducting, right?

Morris S. Young

Correct.

Avinash Kant – DA Davidson & Company

So, in the revenue guidance that you are providing for the next quarter, how are you thinking? You are thinking germanium comes back some and raw material is also up?

Morris S. Young

No, I think in our model we think – yes, germanium will come back some, but we didn’t count raw material to come, to be flat. Gallium arsenide, we think it’s going to be sort of flat. There are some uncertainties as I said in the script that could be lumpy. Indium phosphide probably will be up.

Avinash Kant – DA Davidson & Company

Majority of the upside seems to be being driven by the indium phosphide. Everything else seems to be kind of flattish. Is that how we should think of it?

Morris S. Young

No, as I said, germanium could be up a bit too.

Avinash Kant – DA Davidson & Company

And within the gallium arsenide while it may be kind of flattish, is there a growth in one and not growth in other one, like conducting or in insulating?

Morris S. Young

Well, in this quarter in Q3 it’s going to be okay. We expect sort of flattish revenue.

Avinash Kant – DA Davidson & Company

Okay and clearly you had some benefit in the quarter below the operating line given some of the fail of the stock and everything else, so how should we think of the JV earnings going forward and then trust income?

Morris S. Young

I think they probably will trend about the same as the last quarter.

Avinash Kant – DA Davidson & Company

Okay but you won’t have the benefit from the sale of the stock that you had and also the foreign exchange, of course, hard to predict.

Morris S. Young

Yes that could be correct.

Avinash Kant – DA Davidson & Company

Yes okay. And then any clarity from your one of the largest customers as they are going through the merger with another big player, have you had any chance to talk to them and see what your position will be after this merger?

Morris S. Young

We are receiving contact with them and I think they are going through the merger, but they are also sort of cautious by telling us, check with us, after I think the merger day sometime in October, correct?

Avinash Kant – DA Davidson & Company

Okay, perfect, thank you so much.

Morris S. Young

Okay.

Operator

We’ll go next to Richard Shannon with Craig Hallum.

Richard Shannon – Craig-Hallum Capital Group

Good afternoon Morris. Congratulations on the next revenues and gaining profitability, good job. A few questions from me, let’s see here, you talked about your semi-insulating doing well in the second quarter with inventory build from a single customer. Can you help us understand what was going on there? Is this with a historical customer or a new one, can you give us any details there, please?

Morris S. Young

It’s a old customer. They told us that specifically they are building inventory and so just like we said they are building inventory.

Richard Shannon – Craig-Hallum Capital Group

Okay, do you have any 10% customers in the quarter?

Morris S. Young

No this quarter.

Richard Shannon – Craig-Hallum Capital Group

Okay, can you give us a sense of how your historical 10% customer IQed has done, did in the second quarter and how it might do in the second half?

Morris S. Young

Below 10%.

Richard Shannon – Craig-Hallum Capital Group

Okay, alright, fair enough then. Let’s see here, you mentioned gallium arsenide semi-conducting to generally be lumpy. Is your comment about that based on a narrow customer base or just on short ordering pattern, give us a sense of why you call it lumpy?

Morris S. Young

Well, we have a very diversified customer base, but it’s just that some of these customers, we have good customers who gave us consistent orders. But, they are large customer who may come in one quarter and then take a rest for the next quarter. I think that’s the nature of the business for semi-insulating business, especially on the lower end of the market.

Richard Shannon – Craig-Hallum Capital Group

Yes, that totally makes sense. A couple of more questions from me and I’ll jump out of line. You mentioned some cost reductions, can you describe the nature of those, were they manufacturing efficiencies or headcount cuts or salary cuts or anything like that? Can you give a sense of what’s going on there? How much of that is sustainable?

Morris S. Young

Well, Richard I don’t know if you are aware, we had a headcount cut by the end of Q1 and last quarter we experienced a benefit of it for the first quarter and this quarter we are gaining full benefit of this cost efficiency drive and then we’ll also initiated some cost cutting program and bonus program for our production workers to see wherever they can gain efficiency and earn extra bonus by the end of the year and I’m happy to say that actually we are spending more money on there. The remaining people who are still with us to earn more money while we have reduction, in certain forces that we don’t need.

Richard Shannon – Craig-Hallum Capital Group

Okay good. Thank for that clarification. Now one last question from me Morris, taking the potential change in gallium pricing into the future, which obviously is very difficult to predict, is your outlook a crystal ball looking at a couple of few quarters or so, would you generally expect to maintain your profitability or maintain your net income above zero, same profit for few quarters or what’s your general sense of the trend here going forward?

Morris S. Young

Well, as you know we guided sort of flat for the next quarter our revenue, and if you think that the revenue will come in the same, we should expect to be profitable in the second quarter again. I mean third quarter. But we won’t, we don’t give guidance for fourth quarters, you know. Our business is such that we have short visibility.

Richard Shannon – Craig-Hallum Capital Group

Okay, that’s fair enough. I think I will jump as the line goes. Thank you.

Operator

We’ll go next to Dave Kang with B. Riley.

Dave Kang – B. Riley & Co

Thank you, good afternoon Morris. First of all can I get a few numbers? Can I get the stock composition, depreciation, amortization and CapEx, please?

Morris S. Young

CapEx, I think its $0.6 million.

Dave Kang – B. Riley & Co

0.6, okay. And what do you think that’s going to run in the second half?

Morris S. Young

Depreciation is 1.4 million and –

May Wu

Stock compensation 300k.

Dave Kang – B. Riley & Co

300k?

May Wu

Yes.

Dave Kang – B. Riley & Co

And then on CapEx question, you think they are going to run around that level in the second half?

Morris S. Young

Yes, I think we’re going to be tight fisted.

Dave Kang – B. Riley & Co

Okay. And then regarding going back to the guy, so what kind of a gross margin assumption are you making to get to that breakeven to positive 2 pennies?

Morris S. Young

Yes, we never guide gross margin days, but you can see with the same revenue, we do guide profitability so it’s sort of flat.

Dave Kang – B. Riley & Co

Okay, fair enough. I mean, so going back to the cost reductions is there anything else left or are you guys pretty much done with cost reductions?

Morris S. Young

We obviously, we try to drive it. I think, in the first quarter we were very successful and we would like to see, if we can get more momentum into the second half of the year. The first quarter was a good experience we had.

Dave Kang – B. Riley & Co

Sure. And then on the semi-insulating customer building inventories, if that is the case then should we expect some kind of a little bit of fall off in the third quarter, but you are expecting kind of flat?

Morris S. Young

We expect flat at least through the third quarter.

Dave Kang – B. Riley & Co

So, you are assuming other customers will kind of step up while the customer may come down a little bit?

Morris S. Young

No, that customer is building inventory, so we expect that customers to come in.

Dave Kang – B. Riley & Co

Okay. Well, how long will they be building inventories maybe rest of the year or just maybe third quarter?

Morris S. Young

Well, one quarter at a time.

Dave Kang – B. Riley & Co

Okay and then lastly under HBT, I mean, can you just give us an update, how close are you as far as the visibility to that?

Morris S. Young

You know Dave, we’ve been working hard on that and I think, part of our customer building inventory, part of it as I know it is going to HBT, but we have not successfully penetrated major comp. You know who I’m talking about this quarter yet and we are not making much of headway into penetrating those bigger comps. But the merger of the two second largest and third largest customer we would need to see how do they behave after the merger completed. So, we’re still optimistic about that but again, we don’t have anything major to report that we have penetrated big HBT account. But, I think we are qualified with certain HBT accounts for sure as far as technology is concerned.

Dave Kang – B. Riley & Co

So, as far as revenues are concerned then it sounds more likely it’s going to be 15 event not 14?

Morris S. Young

Say it again? Oh, they are revenues coming for HBT, as I said that customer who are building inventory, part of it goes into HBT.

Dave Kang – B. Riley & Co

Oh okay, got it. And then lastly, on the indium phosphide, I mean, can you just talk about the visibility because optical component industry seem to be sort of flat these days and yet your business seems to be certainly growing much faster than your customers, so just wondering if there is any kind of inventory build situation there as well?

Morris S. Young

Not that we know of. I don’t think there is any inventory build per se. I think we are successful I think because, you know, again we are using VGF.

Dave Kang – B. Riley & Co

So, you are displacing – you are gaining market share then?

Morris S. Young

I don’t think so.

Dave Kang – B. Riley & Co

Okay. Alright, I think that was it, thank you.

Operator

We’ll go next to Andrew Lee with Needham & Company

Andrew Lee – Needham & Company

Hi, Morris.

Morris S. Young

Hi.

Andrew Lee – Needham & Company

I’m speaking in for Edwin today from Needham. Congratulations on the good quarter. Actually I have a question about your comment regarding second half optimism for further growth, could you guys clarify that because I think you guys are guiding the third quarter to be relatively flat. I know you guys don’t want to talk about the fourth quarter but any color on what you mean by optimism for further growth on the second half? Hello?

Morris S. Young

Yes, I am thinking. You are right. I mean, in a way we guided flat and yes, we are optimistic, but these two things perhaps don’t conflict with each other and as far as guidance is concerned, we definitely take it very seriously. If we guide it then we will meet it. If don’t meet then that’s a big flop. So, we hope we can beat and nicely beat that guidance. So that is probably some of the optimism. I think, the business segment is concerned in phosphide it is definitely a growth engine. Semi-conducting material, I think is a fairly strong business segment although as I said, it could be lumpy. So, we don’t want to commit ourselves by saying oh, it’s going to be growing so many percent. But, we are guardedly optimistic, okay. And in germanium, I think we experienced lower than expected revenue in the first quarter and second quarter. I think, third quarter we should recover. So, if you take that as a sum, I think, second half should be better than first half. I mean, that’s our optimism. Although, I agree with you, we didn’t guide up 10% third quarter.

Andrew Lee – Needham & Company

I see. Thank you, great color. Just another question about your cost reduction program. Do you guys have any timeline in mind in terms of, I guess, ending the cost reduction program or is it just something that you guys started, I just wanted to see how far it will go and how you guys will perform using it?

Morris S. Young

The cost cutting program and the efficiency drive, it will continue. I mean, unless business is -- well, we reduced our workforce by almost 17% in China and as business pick up, sure we may really want to hire some back, but then hopefully deal with much better efficiency. The other cost program in terms of trying to improve yield, improve efficiency, we are still driving that. As I said, the second quarter versus first quarter we have very good success and we will continue that.

Andrew Lee – Needham & Company

I see, okay. Thank you.

Operator

And there are no further questions at this time. I will turn the conference back over for any closing or additional remarks.

Morris S. Young

Thank you participating in our conference call. As always, feel free to contact me or Leslie Green directly if you would like to meet with us. We look forward to speaking with you in the near future.

Operator

This does conclude today's conference. We thank you for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!