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31 October 2006


GaAs inflates AXT’s Q3 revenue to $12.5m, but new tax regulations in China could burst bubble

Semiconductor substrates maker AXT Inc of Fremont, CA, USA has reported Q3/2006 (ended September 30) revenue of $12.5m, representing a 21% increase over the $10.4m in Q2/2006.

GaAs substrate revenue accounted for $10.6m in Q3, up 30% on the $8.1m in Q2. Phil Yin, AXT’s chief executive officer, said: "This growth was driven by increasing demand for our 4" and 6" semi- insulating GaAs substrates, used primarily in HBT and PHEMT devices for wireless handset applications. We have several significant customer qualifications going on for both semi-insulating and semi-conducting substrates with Tier 1 companies. These customer qualifications are particularly important to AXT because the invitations by these customers to re-qualify our substrates indicate that our industry is recognizing the improvements that we have made. We have shipped wafers to these customers for qualification and hope to move into volume production with these customers in early 2007."

Germanium substrate sales also increased in Q3, from $169,000 in Q2, to $387,000. "Germanium (Ge) substrates also continue to be a very interesting part of our business. While our revenue in this area is comparatively small, it has experienced significant growth over the past several quarters. AXT now has shipped qualification samples to customers all over the world and is in volume production with two customers in Asia. We believe that the greater efficiencies of triple junction concentrator solar cells, coupled with the shortage of poly silicon, are causing Ge substrates to become the material of choice for photovoltaic applications," said Yin.

However, Q3 revenue from indium phosphide (InP) substrate sales dropped from the $613,000 in Q2 to $340,000, and sales of raw materials were down to $1.3m, from the $1.4m in Q2.

Gross margin was 27.7% of revenue for the quarter. This includes a benefit from the sale of approximately $802,000 in fully reserved wafers, which positively affected the figure by 6.4%. Q2 gross margin was 26.6%. However, this also included a benefit from the sales of approximately $818,000 in fully reserved wafers, with a positive affect of 7.9%.

Operating expenses were $4.5m in Q3, compared with $4.4m in Q2. The company says the increase is primarily the result of a $1.4m impairment charge to write down the company's U.S. property, which has been decommissioned and is being prepared for sale. Q3 loss from operations was $1m, compared with $1.7m in Q2.

Net interest and other income for Q3 was $744,000, compared with net interest and other income of $925,000 for the second quarter. Other income in Q3 included $650,000 from the sale of 300,000 shares of Finisar Corporation, compared with a gain of $1.0m on the sale of 300,000 shares of Finisar Corporation in Q2.

The company recognized an income tax benefit of $862,000 for the third quarter, compared with an income tax provision of $138,000 in Q2. Net income in Q3 was $639,000 ($0.02 per diluted share), compared with a net loss of $876,000 ($0.04 per diluted share) in Q2.

AXT estimates Q4 revenue of between $12.9m and $13.6m. It also estimates a net loss per diluted share of between $0.02 and $0.05, which takes into account stock compensation expense of approximately $950,000 as the company gives out annual grants to its employees during Q4, and approximately $500,000 in accrued severance payments as the company anticipates an executive management change by year end. The company did not disclose details of the possible management team changes.

"As I mentioned last quarter, we believe that there are several areas that can yield considerable growth. First, we believe that our core business can grow through capacity expansion in areas such as 6 and 4-inch semi-insulating substrates where the industry is severely constrained, as well as through continued development of our customer base. Second, we believe that our raw materials business is increasingly becoming a key strategic differentiator, and thus we expect to increase our raw materials sales efforts and explore new investment opportunities. Finally, as device requirements become more demanding based on product innovations and applications, we will continue to explore businesses complementary to our core product line that we believe will allow us to serve the increasing demand for compound semiconductor substrates now and in the future," said Yin.

One possible difficulty facing AXT in 2007 is that tax authorities in the People's Republic of China (PRC) announced in September an intention to impose customs duties on certain raw materials, such as gallium and arsenic, and to reduce or eliminate refunds of value-added taxes that companies pay on these materials. These measures could significantly increase AXT’s costs. The new regulations will not be published before late November, and it is possible that they will be changed. Lobbying efforts are being made to remove gallium and arsenic from the list. If the regulations are adopted as proposed, they would not have an impact on AXT’s Q4 results, but the company warns that they may “have a significant adverse impact” on gross margins and net income (loss) in 2007. AXT says it is also exploring ways of restructuring its operations in the PRC in order to reduce the impact of the new regulations if they are adopted.