AXT, Inc. (AXTI) on Q1 2021 Results - Earnings Call Transcript
Operator: Good afternoon, everyone, and welcome to the AXT's First Quarter 2021 Financial conference call. Leading the call today is Dr. Morris Young, Chief Executive Officer and Gary Fischer, Chief Financial Officer. My name is Laurie, and I will be your coordinator today. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. And please be advised that today's conference is being recorded. And I would now like to turn the call over to Leslie Green, Investor Relations for AXT.
Leslie Green: Thank you, Laurie, 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 in 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.
Gary Fischer: Thank you, Leslie, and good afternoon, everyone. We are pleased to report that total revenue for the first quarter of 2021 was $31.4 million, up 16% from $27 million in the fourth quarter of 2020 and up 51% from the $20.7 million in the first quarter of 2020. As many of you know, we expected that the convergence of expanding markets, such as 5G, moving past the relocation program and overall growth in indium phosphide would push us past the $30 million mark, but we could not predict the exact quarter for this event. It is an exciting milestone and Morris is already pushing the team towards new goals. Of our total revenue, substrate sales were $23.4 million compared with $21.5 million in the fourth quarter of 2020 and $16.9 million in Q1 of 2020. The revenue from our two consolidated raw material joint company -- joint venture companies, was $8 million in Q1, up from $5.5 million in Q4 of 2020 and from $3.8 million in Q1 of 2020.
Dr. Morris Young: Thank you, Gary, and good afternoon, everybody. Q1 was a very important milestone quarter for AXT. We met and exceeded the $30 million revenue threshold, which has been a goal of ours and a challenge that I gave to our team. Our performance surpassed our expectations with growth in nearly all of our strategic products. We also drove improvements in our gross margin and achieved strong growth in profitability. What we are seeing today is the convergence of a number of trends across our portfolio that are beginning to have a meaningful impact on the demand for our products.
Gary Fischer: Thank you, Morris. As Morris discussed, the demand environment remains healthy in Q2. Indium phosphide coming off a very strong quarter, we believe we will see continued growth. We also expect growth in gallium arsenide revenues for LED and a modest increase in germanium. As Morris mentioned, we expect a pullback in gallium arsenide for wireless and a flat to slightly down for raw materials. As such, we expect to see revenue in Q2 of between $30.5 million to $31.5 million. We believe that our net profit will be in the range of $0.06 to $0.08 a share, and that's based on a share count of approximately 42.8 million shares. All right. This concludes our prepared comments. Morris and I will be glad to answer any questions. Operator, Laurie?
Operator: And we have a question from Dave Kang of B. Riley. Your line is open.
Dave Kang: This is Dave Kang on for Dave. I was wondering if you guys could comment on the effect of chip charges. Broadly, we're seeing chip prices increase. And we were wondering, are you guys also increasing prices as this phenomenon occurs? And the second question is, how long can you expect this raw materials pricing environment to stick around?
Dr. Morris Young: So let me take a crack at that first. In general, substrate business is difficult to increase price at a substrate level. However, on the raw materials side, yes, they do fluctuate with demand and supply. And the raw material, for instance, gallium price has increased from -- on the about $150 a kilogram last year and as late as last quarter was $400 a kilogram. So it's more than double. But recently, the price has come down a bit. But that not -- well, significantly, down to about $350 or $400 a kilogram for gallium. But I do believe that the demand is still very tight. And so however, there are more new suppliers coming into the production line because the price has gone up. In the substrate level, I believe it's more difficult to increase prices. However, the way I would describe it is this in terms of being indium phosphide, many times that we may increase price if the customer wants to tighten their specification. For instance, if you want material, let's say, with defect density in the neighborhood of $500, and that sort of set a price of X. And if all a sudden, the requirement is such that you want defect density, it would be half of that $200 versus $500, then the price may rise by a factor of 20%, 25%. So that's yet the other way of increasing price. In other words, drive your productivity up and increase the price. Did I answer your question?
Dave Kang: Yes. That's helpful. And I guess just a quick follow-up, are you broadly seeing customers trying to tighten specifications more like maybe the supply chain constraints are forcing them to be more with their solicitations or anything? Or…
Dr. Morris Young: Yes, that's an interesting question. Actually, I think in phosphide specifically, I mean, gallium arsenide is a lot more mature. So I think we see less of a change. But in indium phosphide, we do see consumer coming in with tighter specifications because they are mainly dealing with high-end products, such as lasers and very demanding performance level so that they want to tighten up the -- as they develop their next-generation product. Also -- what we were also seeing was that we start to see -- we deliver this better quality product to one customer. And all of a sudden, other guys are seeing the same thing. So the end customer starts to tighten their specification to the intermediate, let's say, . So yes, we do see that timing of the spec coming in indium phosphide.
Operator: Your next question is from Richard Shannon of Craig-Hallum. Your line is open.
Richard Shannon: Let me start with kind of a multipart question on gross margins. I had some very nice numbers here in the first quarter. I think you called out mix and volume as the drivers here. I didn't hear you talk anything about yields? I think you've alluded in the last call or two that the potential of seeing those improve as you kind of get more comfortable with the new facility. But -- and so I'd love to hear what you think about, not only for the second quarter and along those lines, but also, when you talk about buying some more inventory here at lower cost, but eventually that's going to start to bake in here. When do you see these -- the raw materials prices start to bake in and kind of level off, kind of provide a little bit of a headwind from gross margins?
Gary Fischer: Well, I would -- this is Gary. I'd say we've already taken advantage of some of that because we saw this happening early in the quarter, even as recently as last Q4. So I don't see that all of a sudden, we're going to have a huge benefit because the raw material price that we paid is going to be moving from inventory into cost of goods sold. It is a factor that we've taken advantage of, but it's difficult for you to be able to measure the impact. So --
Dr. Morris Young: Well -- so let me put my two cents, I'm not the CFO, Gary, but the way I see it is that the raw material price increase is difficult for us to pass along to our customers. Okay, especially in short-term. However, the benefit for AXT is our raw material supplier or joint venture who supplies gallium start to make a lot of profits, okay? So that's the benefit to us. But we don't write-up our inventory because we have a lower cost gallium in our inventory, right?
Gary Fischer: Right.
Dr. Morris Young: We don't write it up. The only time that it will impact this is actually, if our newly purchased gallium, which we pay the higher price, start to get into our inventory, then we sort of, in average, get our cost of goods sold up. And if that price remains to be high, then our cost of manufacturing that substrate becomes higher. And if we cannot pass along that increasing our cost to our customers, then our gross margin will decrease. However, we are probably still better off than our competitors because we have joint ventures to offset part of it. In a way, we have some insurance policy.
Richard Shannon: And I guess part of my question is when would that happen? I assume that's a relic of your cycle time of manufacturing. But I also want to bake in here the potential of seeing yield improvement on your substrate manufacturing as well and kind of get a multi-quarter view on what you think your gross margins can do. We've talked about in the last few quarters about the potential or kind of long-term goal of getting to 40%. It sounds like you got a lot -- a few tailwinds, maybe one or two headwinds here, and wanted to kind of look at that in a multi-quarter trend. Can you kind of help us out in the context?
Gary Fischer: Yes. I'd say, to be specific about yields, I think there's still some improvement that we can gain. And I think we will see the yields improve as things settle in and stabilize the new sites. Reciprocally, I think we probably see some push on cost -- goods sold because of raw materials. So they may have some offsetting effect. We -- we still think the prudent comment that we should make for today is that somewhere around 35% is very achievable, obviously. But Morris and I are not inclined to have everybody move the margins up after one quarter, you know, a one-quarter improvement. We'd like to see a couple more quarters before we think, okay, this is kind of what the pattern is going to be. So certainly, we're pleased with the margin from Q1. We think we'll probably be at or above 35% for Q2. But we're hesitant to sort of paint out the rest of the year and pick a new number.
Dr. Morris Young: So -- yes. Richard, maybe you and I are old-timers. I think you're probably thinking that with raw material price going up, it should help us on gross margin. And that was exactly what happened back in 2011 and 2012 when gallium price was going -- went from up to about $1000 a kilogram. However, the difference is that in 2011, we consolidate that joint venture into our revenue as well as our profits. So when the profit of that joint venture start to help us, we -- our gross margin jumped up as well. However, that joint venture, although we still own substantially, I think last I saw was 39% --
Gary Fischer: Correct, yes.
Dr. Morris Young: But we don't consolidate their revenue anymore. So although we do enjoy the profit they make, but we -- it doesn't help us in terms of gross margins. Does that sort of answer your question?
Richard Shannon: Yes. That's helpful. And I'll note the fact that you called me old, Morris, so thanks for that.
Dr. Morris Young: I am only speaking for myself.
Richard Shannon: My quick follow-on question is, Morris, you talked about indium phosphide, some new applications here, and you said there's going to be some contributions this year. Any way you can help us scale this contribution? Is it going to be noticeable, very small? How would you characterize that and help us think about that going forward in the next year?
Dr. Morris Young: I think it's going to be meaningful. Yes. I think not only this product, but I think I'm overall excited about this new approach, utilizing the UV spectrum of lighting as well as lasers, which can do a lot of wonderful things on healthcare monitoring and etc. So instead of just good telecommunication, which is great, I mean it just cannot escape from utilizing any phosphate for fiber optics. However, when you're dealing with consumer products, imagination is limitless. Everybody likes to take care of your health, and this is a great approach to help you monitor your health. I mean, I think it has a great future. I mean we are only starting the beginning of this. And I think there are other developments, which can follow-on this. So I think not only it's going to be meaningful, but also, I think it's going to be multiyear. And we just don't know how big it is going to be, whether it's going to be 500% or 1000%.
Operator: And your next question is from Gus Richard of Northland. Your line is open.
Gus Richard: Just going back to the new applications for indium phosphide, do you have a sense of whether it's a health monitor or some sort of other type of consumer product? Do you have any sense of the application at this point?
Dr. Morris Young: Gus, we really don't know. And if anything that we can only guess, but even if I know, I don't think I'm allowed to talk about it anyway. But because this is a very new, I would say, you wait out a quarter or two, eventually is going to go on the market. And if somebody is going to take it apart and then they're going to see what it is for. Look -- but I don't think we're kidding around. This is real. This is -- we working with this for almost more than two years. And we are seeing them ramping.
Gus Richard: And you expect this application to be -- you said it's going to be significant. Is it going to be a material part of the indium phosphide revenue? In other words, for the year, could it add up to 10% of your indium phosphide revenue?
Dr. Morris Young: Well, that's a hard question, because I don't know how fast the rest of them will grow. But is it significant -- yes, it could add a good 5% to 10%. Yes.
Gus Richard: Okay. And then, Gary, for you, just looking at the opex, it was quite a bit above what I was expecting in the quarter. And clearly, you've got a need to invest in R&D and SG&A was up. Can you give a little bit more color on what were driving those, particularly the SG&A in the quarter, and how should we think about that going forward?
Gary Fischer: Yes. I mean, the biggest driver from 20,000 feet up is we just have a lot of initiatives. There's a tremendous amount of activity, energy, implementation of the vision from Morris and the marketing team. So that drives down in lots of ways and touches and lots of general ledger accounts that expenses book to them. We are pleased that over half of its R&D, that's good. But to drill down another layer, there has been growth in headcount; both at our Tongmei company and also JinMei and BoYu. So stock compensation has increased. Wages have increased. The bonuses we paid more recently were larger-than-normal because we finished 2020 on a good note. So I'd say the biggest single component setting aside R&D versus SG&A is labor. Also, compensation for our reps, we pay commission to on sales. When sales are up, commissions are up. A fair amount towards what I would call permit still and licenses and things that have to do with facilities and continuing to layer in all the kinds of things that are required. Those are things that come to my mind extemporaneously. So it's all -- I mean, for me as a numbers watcher, what am I saying is there's a story behind every number. And the story for these numbers is about lots of exciting initiatives and good things happening. But the flip side a bit, myself and our sort of senior level controllers and stuff, we're watching it closely. I'd also -- I'd take some comfort for me as a business person that as a percent of revenue, it's actually lower in Q1 of this year than the average from all of 2020. So those are the kinds of things I can put around it. And I hope that's helpful in giving you some color. Maybe, Morris, do you want to add anything?
Dr. Morris Young: Yes. I think many times, I remember when our revenue was lower, people are asking us, well, if your revenue were to grow another good 30% or 50% would most of this drop down to your profit? And we'll say, absolutely. We're not going to get a higher raise, salary, and we're never to hire other -- some senior vice president, etc. However, now our revenue grew 50% year-over-year. And now well, you caught us being a liar about it. But then if we -- again, we dissect it, I think I'm happy to see that we're spending a lot of activities in terms of the new hire help us to go STAR Market listing. The 6-inch indium phosphide development, the aged gallium arsenide, I mean, all those are exciting initiatives, which will translate to even higher revenue or higher profits. So what I'm saying, I think, is this, if our revenue were to grow 50% and stay there, we don't have tremendous growth opportunity and start listing in China, then yes, sure, everything will come back because I don't expect to earn much more than what we do, and we don't need to add any more salesman or a person to do more revenue. However, when you prepare yourself for more growth, more opportunities, you need to spend a little bit more money. I think that's the way I see it.
Gary Fischer: I still think there's a tremendous leverage on our business model. So we're -- work -- We're proud of what we're accomplishing. We don't see it increasing a lot right now. So --
Gus Richard: Okay. And then just is variable comp pay quarterly or annually?
Gary Fischer: It's both.
Gus Richard: Bonuses.
Gary Fischer: Both.
Gus Richard: Got it.
Gary Fischer: Which -- which company we're talking about. So --
Operator: We have a follow-up question from Richard Shannon of Craig-Hallum. Your line is open.
Richard Shannon: I just wanted to ask about the STAR Market listing process here. And you mentioned the process that's more difficult than what normally happens here in the U.S. One reading the news might suggest that those have gotten more difficult even within -- even for companies who have started the process earlier. And so I wonder if you can comment on the degree to what you're seeing those getting more difficult just within China? It seems like there's some reticence about quality of companies on the STAR exchange that are in China and worry about whatever those due diligence requirements get even worse for U.S. companies like yourself?
Dr. Morris Young: So let me try that first. But definitely, Gary is more qualified. He's very much involved. I mean every day, there are many, many activities Gary is covering. But so let me give you the high-level comment first. I believe the timing process of the STAR Market listing, I heard it was because there are too many companies going public on STAR Market in China. That's why they want to tighten it up, otherwise, they're going to have hundreds and hundreds of companies that all want to go public. Okay? So as a result, I think that they are lengthening the process, for instance, let me give you an example. They're looking at senior management, they want to make sure there's no really the part of transaction. You want to make sure -- or revenue are real. There's no funky business. And they are tightening up. But I think to a certain degree, our investment bankers in China are telling us that part may be better for us because we have been a public company in the United States for the last, what, 20 -- 20-some odd year.
Gary Fischer: Twenty-three years. Yes.
Dr. Morris Young: So we scrub every one of our quarters. So we are really doing the right business. And we're also a real company delivering high-quality products. So I think all those speaks well for us. However, because China regulatory agency are more cautious, so they are tightening the screws, so they're slowing down the process. So I think as a result, we may see that there's a slight delay or every step of the way, they want to make sure it's doing the right thing; which we have been doing all along anyway. So I think it's a double edged sword. I mean, Gary?
Gary Fischer: Yes. I think Morris hit the nail right on the head. So we're not surprised at what's causing things to be a little -- raise the bar, if you will, to leap over, lengthen the time a bit more because they are trying to be very, very sure about who gets through that gate. So -- but if you take a step back and look at our Tongmei company, it was founded in 1998 by Morris and other leaders of the Company at that time. So what that makes it over 23 years old. It -- collectively now with adding BoYu and JinMei, it's over 1000 employees. They're all Chinese citizens. They all pay taxes in China. You drill down further into the supply chain. I doubt there's many other companies applying for STAR Market listing that have partial ownership of ten other companies in China. So we're -- we don't want to be cocky at all. But from a business standpoint, this is a very, very attractive company to take public. And we manufacture something, you can see it, we build things. It's not software. We've been audited since 1998 in -- or maybe in 1999 in China. So it's harder, it's more work, but the rewards are significant. And as we see things growing on the horizon, this is a wonderful opportunity to have a significant amount of capital set aside to take advantage of growth opportunities around the world. So yes, it's harder, but we're all in. And our -- the team is excited, and nobody is discouraged. They're just tired. So…
Operator: And there are no questions on queue, at this time. I will turn the call over back to Dr. Morris Young for his closing remarks.
Dr. Morris Young: Thank you. Thank you, everybody, for participating in our conference call. In June, we will be participating in Craig-Hallum's Institutional Investor Conference. 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.
Operator: And ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may all disconnect.
