AXT, Inc. (NASDAQ:AXTI) Q4 2022 Earnings Call Transcript

AXT, Inc. (NASDAQ:AXTI) Q4 2022 Earnings Call Transcript February 16, 2023

Operator: Good afternoon, everyone, and welcome to AXT’s Fourth Quarter 2022 Financial Conference Call. Leading the call today is Dr. Morris Young, Chief Executive Officer; and Gary Fischer, Chief Financial Officer. My name is Devin, and I will be your coordinator today. I would now like to turn the call over to Leslie Green of Investor Relations. Please proceed.

Leslie Green: Thank you, Devin, 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 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, 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 markets in which the company competes, global financial conditions and uncertainties, COVID-19 and other outbreaks of contagious disease, potential tariffs and trade restrictions, increased environmental regulations in China, the financial performance of our partially-owned supply chain companies and the impact of delays by 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 via link from our website and contain additional information on the 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 16, 2024. 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 2022. 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 fourth quarter 2022 results. Gary?

Gary Fischer: Thank you, Leslie. Good afternoon to everyone. Revenue for the fourth quarter of 2022 was $26.8 million, that’s down from $35.2 million in the third quarter of 2022 and down from $37.7 million in the fourth quarter of 2021. To break down our Q4 ’22 revenue for you by product category. Indium phosphide came in at $14.0 million, reflecting a market softening, particularly in the data center and telecommunications infrastructure. Gallium arsenide was $5.5 million, reflecting the overall slowdown across a number of applications, particularly in China. Germanium substrates were $1.3 million. Our germanium substrate revenue was up slightly from Q3 as we have resolved the payment issue that we described in the past quarters.

Finally, revenue from our two consolidated raw material joint venture companies in Q4 was $6.0 million. In the fourth quarter of 2022, revenue from Asia Pacific was 70% of sales, Europe was 15% and North America was 15%. The top five customers generated approximately 41% of total revenue and one customer was over the 10% level. Non-GAAP gross margin in the fourth quarter was 32.5% compared with 42.2% in Q3 of 2022 and 32.4% in Q4 of 2021. This was below our expectations and it is a result of significantly lower volume with revenue coming in at the lowest end of our guidance, more of an unfavorable shift in product mix than we had anticipated, and a significant drop in the price of raw gallium in Q4, which resulted in low margin contribution from our consolidated joint venture.

For those who prefer to track results on a GAAP basis, gross margin in the fourth quarter was 32.1% compared with 42.0% in Q3 of 2022 and 32.2% in Q4 of 2021. Total non-GAAP operating expense in Q4 was $9.0 million. This compares with $9.2 million in Q3 of 2022 and with $8.1 million in Q4 of 2021. On a GAAP basis, total operating expense in Q4 of 2022 was $9.6 million, down from $10.2 million in Q3. For comparison, total GAAP operating expense was $9.1 million in Q4 of 2021. Our non-GAAP operating line for the fourth quarter of 2022 was a loss of $252,000 compared with a non-GAAP operating profit in Q3 of 2022 of $5.6 million and $4.1 million in Q4 of 2021. For reference, our GAAP operating line for the fourth quarter of 2022 was a loss of $1.0 million compared with an operating profit of $4.6 million in Q3 and an operating profit of $3.0 million in Q4 of 2021.

Non-operating other income and expense and other items below the operating line for the fourth quarter of ’22 was a net gain of $2.2 million. The full breakdown is in our press release. This included a government grant of $1.2 million, and is a good example of the strength of our favorable reputation and (ph) for our presence in China. For Q4 of 2022, we had a non-GAAP net income of $2.0 million or $0.05 per share, compared with $6.8 million or $0.16 per share in the third quarter of 2022. Non-GAAP net income in Q4 of 2021 was $4.1 million or $0.09 per share. On a GAAP basis, net income in Q4 was $1.2 million or $0.03 per share. By comparison, net income was $5.8 million or $0.13 per share in the third quarter of 2022 and $3.0 million or $0.07 per share in Q4 of 2021.

The weighted average diluted outstanding shares in Q4 was 42.7 million. Cash, cash equivalents and investments were $52.8 million as of December 31 reduce it by approximately $10 million to $15 million this year. This concludes the discussion of our quarterly financial results. Turning to our plan to list our subsidiary Tongmei in China on the STAR Market in Shanghai, let me give you a brief update. Since the Chinese New Year, we have had active dialogue again with the China Securities Regulatory Commission, also called the CSRC. Their process is detailed and thorough, and they have asked us to respond to a couple of additional items. We are in the process of doing so now and remain optimistic that we will get CSRC approval in the coming months.

Photo by christian wiediger on Unsplash

We have posted a brief summary of the plan and the process on our website. With that, I’ll now turn the call over to Dr. Morris Young for a review of our business and market. Morris?

Morris Young: Thank you, Gary. During Q4, the softening of the macro environment continued as expected. We saw a step back in revenue across our portfolio as customers continue to digest inventory in the channel and evaluate their needs for the coming quarters. Overall, we believe they are approaching the 2023 demand environment with conservatism and will further reduce their estimated need in Q1. With that said, we’re continuing to see active development for new applications and technology investments using material. What this tells us is that while the near-term environment is working through a significant inventory correction, the mid-term and longer-term prospect for our markets are vibrant. In addition to the core applications that are driving our revenue today, new uses in automotive sensing consumer product, health sensing display and more are taking shape in a very real way.

For the last two years, we are focused on raising our readiness and business efficiency and have created a world-class operation, capable of supporting the current and future need of Tier 1 customers. To that end, I’m very proud of the work that we have done of the accomplishment of the entire AXT team. We have successfully completed the relocation of our gallium arsenide and germanium substrate manufacturing, continued to build out our capability to support a dramatic increase in demand for our indium phosphide wafers, made good progress on two major R&D projects to produce larger diameter wafers, and implemented a recycling program that benefit our cost structure and drive positive results in our ESG efforts. Collectively, our work today has positioned us more favorably than ever before, both with customers as well as competitive landscape.

This includes gains in our market share, particularly indium phosphide, as well as enhancement of our reputation for quality and innovation, and our ability to scale and our ability to deliver the specification that enable technology progress. For these reasons, we are optimistic about our return to growth when the market recovers. As we head into Q1, we’re seeing a business slowdown continue as customers across our portfolio are evaluating and reducing inventory. We believe that the effect in Q1 is exacerbated by the typical business interruption of Chinese New Year as well as the lingering effect of COVID shutdown in China. As such, we are planning for a major reset in Q1, but we do not — but we do expect that we could see improvement beginning in Q2 as China reopens more fully.

Indium phosphide was down in Q4, primarily as a result of continued cooling in the data center market as well as ongoing softness in 5G telecom infrastructure, particularly in China. The (ph) market was coming down off its peak, but was — has been fairly resilient. In addition, we continue to perform well in our consumer applications, but because of inventory digestions, we expect it to take a meaningful pause in the first half of 2023. We have two programs that are currently shipping and we are excited for the ability to build long-term relationship in this important development market. Our gallium arsenide revenue is down significantly off its mid-’22 highs, with customers in China having slowed significantly. We’re seeing a strong impact on applications using wireless devices for IoT and headset markets, as well as industrial lasers, LED lighting and display.

After such a strong decline, the gallium arsenide market appears to be stabilizing and we could see incremental improvement beginning in Q2. We are making good progress in our 8-inch gallium arsenide wafer development. This product will be a cornerstone for microLED adoption in a variety of consumer devices. While a meaningful revenue ramp isn’t expected to begin until sometime next year, product qualification at the substrate level are scheduled to begin this year. AXT is well positioned to be a prime player in this market. We view microLED as a breakthrough display technology for consumers as it is expected to deliver significant improvement in power efficiency as well as greater brightness and more brilliant colors. Tier 1 companies are advancing its development and we believe it has the potential to reshape the gallium arsenide substrate industry.

We’re pleased to report that we have resolved the payment issue with our germanium customers and we saw a small improvement in revenue in Q4. While the germanium substrate market has also been affected by the macro softness, we will be working towards sequential growth in the coming quarters. And finally, turning to our raw material supply chain companies. Consolidated revenue was down due to pricing pressure in Q4 and softer demand environment. We do continue to see a good contribution from our supply chain companies (ph) equity accounting below the operating line. While our increasing price of certain raw material can be negative for a company like Tongmei, which is offset by improved contribution below the line. Our supply chain strategy is unique as compared to our competitors and is attractive to our customers.

This is a strong focus for us in 2023. In closing, though a softening of macro environment has reset our growth trajectory, a trend that has been driven our revenue, customer and application expansions remain very much intact. Today, we are the world leader in indium phosphide and we are the company that Tier 1 customers come to when they are beginning their new innovation to market. We continue to raise the bar of technical capability, creating clear differentiation with our competitors. Further, we have worked hard to improve our efficiency and we’ll continue to focus on delivering profitability. As such, the fundamentals in our business are solid and we’re looking ahead to our future with optimism.

Gary Fischer: Thank you, Morris. Given the continuing inventory correction as well as the impact in Q1 from Chinese New Year and COVID shutdowns in China, we expect Q1 revenue to be between $19 million and $21 million. This lower revenue is expected to have a significant impact on our manufacturing overhead being spread over fewer units, which will have a negative impact on gross margin. Product mix is also less favorable and as a result of lower expected revenue for indium phosphide. As such, we expect our non-GAAP net loss will be in the range of $0.10 to $0.12, and GAAP net loss will be in the range of $0.12 to $0.14. The share count will be approximately 42.7 million. Okay, this concludes our prepared comments. Morris and I will be glad to answer your questions now. Devin?

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Q&A Session

Operator: Our first question comes from Charles Shi with Needham & Company.

Charles Shi: Hi. Good afternoon, Gary and Morris. Thank you for taking my question. Maybe first, I want to start, obviously, Q1 is a reset. But I did hear you had some relatively more positive commentary. For example, gallium arsenide, you’re seeing possibly some indication of improvement beginning in Q2. But what about the indium phosphide side? I did hear you, yes, that in Q1, there may be some slowdown related — as customer pause a little bit in the first half ’23. But if I tie all your comments together, hard for me to not to think, maybe Q1 or even, if I want to be more cautious, maybe Q2 seems to be the bottom of this down cycle for you. Can you share with us some color? What were your thoughts at this point? Yes, thank you.

Morris Young: Sure, Charles. I think — let me put this way. I think, although AXT is a small company, but our business covers a whole range of different products. As you know, germanium is in the solar cell, and gallium arsenide, not only covers the handsets, the wireless infrastructure, as well as high-brightness LEDs, and high-power lasers. And I believe every segment of the business goes into the prime demand in different stages. For instance, wireless handsets took a hit, I think inventory correction early in Q3. Infrastructure came a little bit later, and we hear that the HPT market device inventory is still quite strong there. But on the other hand, you can say that China is reopening up, with COVID problem out of the way, when will the consumer demand come back up, and that was the major driver for gallium arsenide HPTs. As far as indium phosphide is concerned, we didn’t see the softness in indium phosphide for consumer product until late in Q — let’s say, mid Q1.

So, significant downshift in indium phosphide demand in Q1, but will it recover and how much, and then it does depends upon the balance of different market segments, such as consumer, when will they start to sort out inventory they have, and the data center, will it recover soon enough to give us some significant business contribution. So, it is — right now, it’s hard to say. I used to say last year, throughout the last I think five, six quarters, we’ve been saying that AXT is having improved clarity of what is coming in the business pipeline. But because of the business interruptions or inventory corrections, I think we’ll lose that visibility. We just don’t have a whole lot of visibility of seeing what we can recover. I think it’s probably going to be flat in Q2, but definitely we hope, with consumer coming back in China, I think the market will start to bounce back in Q3 and Q4 of this year.

Gary…

Charles Shi: Thank you.

Gary Fischer: I think, it’s a good response. The short summary is, yes, we think Q1 is going to be the bottom, and we’ll all find out in another month or two. So, yes.

Charles Shi: Yes, thanks. So, maybe a little bit longer-term. You said that indium phosphide, two programs shipping, I mean, production products to your end customers. Do you have much visibility if there maybe a third program where you can get to the stage that you can ship production wafers to your customers this year? Or maybe this year is more about a continuation of the existing two programs, maybe expand the volume a bit when we get — really get to the second half of the year when those end products start to ramp again? That’s my second question.