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29 April 2019

AXT’s margins rebound despite revenue falling further in Q1

For first-quarter 2019, AXT Inc of Fremont, CA, USA – which makes gallium arsenide (GaAs), indium phosphide (InP) and germanium (Ge) substrates and raw materials – has reported revenue of $20.2m, down 0.9% on $22.2m last quarter and 17.2% on $24.4m a year ago.

Fiscal Q1/2018 Q2/2018 Q3/2018 Q4/2018 Q1/2019
Revenue $24.4m $27.1m $28.6m $22.2m $20.2m

In particular, substrate sales were $16.8m, down 2.3% on $17.2m last quarter and 13.4% on $19.4m a year ago. Revenue from raw material joint ventures was $3.4m, down about 32% on both $5m last quarter and $5.1m a year ago.

“The demand environment in Q1 was largely what we expected as a result of general economic slowdown around the world including the semiconductor industry plus the combination of trade relations, weakness in the LED market, a slowdown in growth in the data-center market as well as inventory rebalancing at several of our large customers,” says CEO Dr Morris Young.

“In gallium arsenide, revenue for both wireless and LED applications have seen setbacks in recent quarters and, as expected, were soft in Q1. This was related to both a weak global demand environment and customer-specific challenges,” he adds.

In indium phosphide, Q1 was the second-largest revenue quarter in AXT’s history. It is also the first time that InP surpassed GaAs as the firm’s largest sales contributor. “We received a large order from a customer in Asia that we believe relates to 5G telecommunication infrastructure,” notes Young.

The number of 10%-or-more customers hence grew to two, while the top five customers again generated about 35% of total revenue.

Of total revenue, 65% came from Asia-Pacific (down further, from 69% last quarter), 13% from North America (rebounding from 10%), and 22% from Europe (up further, from 21%).

Although it is still below 39.2% a year ago, gross margin has rebounded from 26.3% last quarter to 33.1%, despite the drop in revenue. This is due mainly to the shift in product mix (from GaAs to higher-margin InP) as well as favorable raw material pricing and good manufacturing discipline.

“We are taking the opportunity to strengthen our financial structure by controlling inventory, applying discipline to our spending, focusing on gross margin improvement, and making appropriate adjustments in our joint venture portfolio,” says Young.

Operating expenses have been cut from $6.5m last quarter to $6.1m. Operating profit was $0.629m, an improvement from an operating loss of $0.638m.

Net loss was $1.1m ($0.03 per share), level with last quarter but better than the expected $0.04-0.06. However, AXT would have been profitable without a charge of $1.7m comprising a quarterly loss assigned to AXT of $0.6m plus an impairment charge of $1.1m to completely write down its investment in germanium mining JV Tongmei (of which AXT owns 25%). “This mining company has been underperforming for some time and has been a headwind for the collective financial contribution to our joint venture portfolio,” notes chief financial officer Gary Fischer. “In early April, we learned of its continuing difficulties and have a forecast for losses throughout all of 2019, which are large enough to reduce the asset on our books to zero,” he adds. “Beginning in Q2, the net result that investors will notice from this change is that the equity accounting on our unconsolidated joint venture companies is likely to be breakeven or a little better as our germanium mining company has been the single largest underperforming investment in that portfolio.”

AXT also reduced its majority ownership in one of its consolidated JVs (gallium-based raw material firm Ji-Ya) to 39% by selling part of its stake to the investment partner (the landlord of the JV, and now the largest shareholder). The JV has been struggling for some time, due mainly to the industry-wide drop in raw gallium prices. “As a result, we will no longer be using the accounting method of consolidation to bring the results of this company to our consolidated results, including our revenue line,” notes Fischer. “Instead, we will use the equity method of accounting, where our ownership will impact to below the operating numbers in the line called equity in earnings/loss of unconsolidated joint ventures. The net result that investors will notice is that we will consolidate two raw material companies rather than three,” he adds. The no-longer-consolidated JV contributed only $0.2m in revenue in Q1/2019, so AXT’ revenue from raw material JVs going forward will hence likely remain at $3.5-4.5m per quarter.

Depreciation and amortization during the quarter was $1.5m. Capital expenditure (CapEx) was $4.2m. “We continue to execute the relocation of our [GaAs and Ge manufacturing] facility [from Beijing to Dingxing, China] on schedule and with positive customer qualification results,” Young says. Due mainly to the new facility and equipment, cash, cash equivalents and investments hence fell during the quarter from $39m to $34m.

Net inventory rose from $58.6m to $63m (41% in raw materials, 53% in work in progress and only 6% in finished goods). “Reduction in inventory is a focus for us in 2019. With relatively low revenue, we decrease inventory by almost $1m in the quarter, with the rest of the decrease resulting from not consolidating through our gallium company,” says Fischer. “With our programs we have in place, we would expect to be able to drive it below $50m and perhaps a bit more over the coming year,” he adds.

“With a strong performance in our indium phosphide business in Q1, we are building a solid foundation for its growth this year,” says Young.

“We do expect a moderate improvement in business conditions in the second quarter,” says Fischer. For Q2/2019, AXT expects revenue to rebound to $23.5-24.5m, driven by record InP revenue (largely due to Q1’s 5G-related order), as well as growth in GaAs for LEDs and a modest improvement for wireless applications. Gross margin should rise further. Earnings per share should be steady at $0.02-0.04.

“The percentage of revenue coming from the new facilities [in Dingxing] is relatively small, probably 15-20%,” says Young. “All our major customers have received qualification samples. A few of those largest customers have already qualified… We hope that the vast majority of our customers will take our product from the new facility by the end of the year,” he adds.

“Our primary expenditure will be focused on the completion of the facility-related items, for which we expect to spend approximately $21m [per quarter] over the course of the year, or an additional $60m over the balance of the year,” says Fischer. “Some of this cost will be offset in our cash balance by reduction in inventory, as well as our expectation of returning to positive operating cash flow,” he adds. “The current facility in Beijing has considerable value that we will be able to monetize in the future.”

“We are taking opportunity to strengthen our financial structure by reducing inventory, being careful of our spending, focusing on gross margin improvement and making appropriate adjustment in our joint venture portfolio,” summarizes Young. “We are encouraged by the significant technology trends that are likely to drive demand for our products over time,” he adds. “Our focus on the fundamentals of our model today will provide positive returns as the economic environment improves,” he believes.

See related items:

AXT’s revenue falls 22.4% in Q4/2018, due partly to weak China LED market

AXT cuts Q4/2018 revenue guidance from $26.5-27.5m to $22-22.4m after caution-induced order slowdown

AXT grows revenue an above-expected 5.5% in Q3

AXT’s revenue grows 11% in Q2

AXT’s Q1 revenue falls 7.2% after China government-ordered factory shutdown days

Tags: AXT GaAs substrate InP Germanium

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