Axt Inc Q4 FY2021 Earnings Call

Good afternoon, everyone and welcome to AXT’s Fourth Quarter and Fiscal Year 2021 Financial Conference Call. Leading the call today is Dr. Morris Young, Chief Executive Officer and Gary Fischer, Chief Financial Officer. My name is Justin, and I will be your coordinator for today. Please be advised that this call is being recorded. I would now like to turn the call over to Leslie Green, Investor Relations for AXT.

Thank you, Justin 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 events or results 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 diseases, potential tariffs and trade restrictions, increased environmental regulations in China, market acceptance and the demand for the company’s products, 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 by link from our website and contain 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 February 2023. Also, before we begin, I want to note that shortly following the close of the market today, we issued a press release reporting financial results for the fourth quarter and fiscal year of 2021. 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 and fiscal 2021 results.

Thank you, Leslie and good afternoon, everyone. As a reminder, in response to investor requests and to align with our peers, as well as to provide better clarity on our operational financial results, we will be providing both GAAP and non-GAAP financial results. Non-GAAP results exclude stock-based compensation. Investors can find a GAAP to non-GAAP reconciliation tables in our earnings announcement. Today, we are pleased to report that total revenue for the full quarter of 2021 was $37.7 million, up 9% from $34.6 million in the third quarter of 2021 and up 40% from $27.0 million in the fourth quarter of 2020. Q4 marks our eighth consecutive quarter of growth and highlights the market expansion and increasing demand for our indium phosphide and gallium arsenide substrates. To break down our Q4 '21 revenue for you by product category, indium phosphide was $13.1 million, gallium arsenide was $11.3 million, germanium was $4.2 million and revenue from our two consolidated raw material joint venture companies was $9.1 million. In the fourth quarter, revenue from Asia Pacific was 74.9%, Europe was 16.7%, and North America was 8.4%. Again in Q4, no customers reached 10% of revenue and the top five customers generated approximately 29% of total revenue. Our continued revenue diversity demonstrates that our growth is not overly dependent on one large customer or application. This was another factor contributing to our confidence that our growth has reached a point of sustainability and will continue throughout 2022. Non-GAAP gross margin in the fourth quarter was 32.4% compared with 33.8% in Q3 of 2021 and 34.0% in Q4 of 2020. For those who prefer to track results on a GAAP basis, gross margin in the fourth quarter was 32.2% compared to 33.3% in Q3 of '21 and 33.9% in Q4 of 2020. Our gross margin came in slightly lower than the prior quarter. Contributing factors were increasing raw material costs within a constrained environment of demand, lower yields in some of our products and a decision to accept strategic, lower margin business in order to position ourselves competitively in advantageous markets and customers. These factors offset the improvements made to gross margin from expiring contracts, as well as a new and promising raw material recycling program that Morris will comment on shortly. Gross margin improvement is a top priority for AXT in 2022. Like most businesses, we have seen a steady increase in costs relating to everything from wages to the materials required to manufacture our products. Those increases will likely continue to create some near-term offset in 2022. However, we think we can get back to the 35% range this year. Improvement will come through growing volume, favorable product mix, better pricing and a strong focus on yield improvements and manufacturing efficiencies. We also believe that we will see some incremental gross margin improvements as we continue to work through some of the contracts that began creating a headwind in Q3. Total non-GAAP operating expense in Q4 was $8.1 million. This compares with $7.7 million in Q3 of 2021 and was $6.6 in Q4 of 2020. On a GAAP basis, total operating expense was sequentially flat at $9.1 million. For comparison, total GAAP operating expense was $7.2 million in Q4 of 2020. R&D remains one of the primary drivers of the increase in our OpEx. We have two major programs that are ongoing, the development of six-inch indium phosphide and the development of eight-inch gallium arsenide. Non-GAAP operating profit for the fourth quarter of 2021 was $4.1 million compared with a non-GAAP operating profit of Q3 in 2021 of $4.0 million and $2.6 million in Q4 of 2020. For reference, GAAP operating profit for the fourth quarter of 2021 was $3.0 million, up from an operating profit of $2.4 million in Q3 of 2021 and an operating profit of $1.9 million in Q4 of 2020. Non-operating other income and expense for the fourth quarter of 2021 was a net loss of $100,000. The full breakdown is in our press release. For Q4 of 2021, we had a non-GAAP net income of $4.1 million or $0.09 per share compared with $5.4 million or $0.13 per share in the third quarter of 2021. Keep in mind that the third quarter results included two local government grants totaling $1 million, which did not repeat in Q4. Non-GAAP net income in Q4 of 2020 was $2.8 million or $0.06 per share. On a GAAP basis, net income in Q4 was $3.0 million or $0.07 per share. By comparison, net income was $3.8 million or $0.09 per share in the third quarter of 2021 and $2.1 million or $0.05 per share in Q4 of 2020. The weighted average diluted shares outstanding in Q4 of 2021 was $42.8 million. Cash, cash equivalents and investments were $51.8 million as of December 31. By comparison at September 30, they were $56.0 million. Depreciation and amortization in the fourth quarter was $2.0 million and capital investments were $10.5 million, total stock compensation was $1.1 million. Net inventory at December 31 was $65.9 million. Okay. This concludes our discussion of the quarterly financial results. Now let me briefly highlight the total year of 2021, which is the fun part of my presentation because a lot of good things happened. For the fiscal year of 2021, revenue was $137.4 million, up more than 44% from $95.4 million in fiscal year 2020. It is important to note that this growth is all organic, driven by market expansion and market share gains. In 2021, we grew in every revenue category across our portfolio without the help of price increases. This underscores the momentum we are seeing in our business with new applications coming to the market, major technology trends and our own success in winning share at strategic customers. Gross margin for the fiscal year 2021 on a non-GAAP basis was 34.8% compared with 31.9% for fiscal year 2020. GAAP gross margin for 2021 was 34.5% compared with 31.7% of revenue for fiscal year 2020. Net income for the fiscal year 2021 on a non-GAAP basis was $19.1 million or $0.44 per diluted share compared with a net of $5.9 million or $0.14 per share for fiscal year 2020. This represents a more than 350% improvement in profitability and underscores the significant shift in our business over the last 12 months. GAAP net income for fiscal year 2021 was $14.6 million or $0.34 per diluted share compared with net income of $3.2 million or $0.07 per share for fiscal year 2020. I'll now give you a brief update on our plan to list our subsidiary Tongmei in China on the Star market in Shanghai. We are very pleased to announce last month that Tongmei submitted a formal application to list its shares in an initial public offering on the Shanghai Stock Exchange. The application was submitted in December and was formally accepted for review on January 10. The review of our application is now underway, and we have received our initial comment letter. As we have discussed, the process of going public on the Star market includes several periods of review and therefore is a lengthy process, and Tongmei does not expect to complete the IPO until the second half of 2022. Okay. That completes my comments and I'd like to turn the call over now to Dr. Morris Young for a view of our business and markets.

Thank you, Gary, and good afternoon, everyone. 2021 was a pivotal year for our business, with a 44% growth in just one year and over 65% compared to our 2019 revenue. We're at an inflection point where advanced applications are becoming more mainstream, and we're collaborating with customers on new innovations that push the boundaries of what was previously thought possible. To support this growth, we've modernized and expanded to meet the needs of tier one customers, successfully relocating and enhancing our facilities over the past four years. We've improved our business and manufacturing systems, expanded our supply chain for critical materials, and invested in our technology and customer success. The growth we're experiencing is not just a fleeting trend but the result of eight consecutive quarters of increased revenue with historically low customer attrition. Our indium phosphide segment grew by 41%, becoming our largest revenue source, while gallium arsenide substrates increased by 38% and germanium substrates grew by 18%. As noted, our revenue growth is organic, stemming from market expansion, share gains, and strategic wins, with ample opportunities for long-term growth ahead. In 2022, we anticipate continued momentum in indium phosphide-based optical applications, significantly driven by 5G and global infrastructure investments needed to handle surging data demand. Indium phosphide devices will be crucial in this next generation of infrastructure, and AXT is positioned to support this trend. We're also excited about a new design win involving a short wave infrared proximity sensor, which can detect substances like water and blood parameters. We believe this win opens the door for more applications in consumer devices, highlighting the versatility of indium phosphide for health monitoring and automotive sensors. Significant growth potential exists as tier one players enter the market, with expectations for a 35% to 40% revenue increase in indium phosphide in 2022. We see promising developments in gallium arsenide as well, particularly in high-end LEDs, solid-state industrial lasers, and WiFi for IoT applications, along with new demand for substrates in 5G headsets. While the gross margin for this application may be lower, the volume potential is appealing and could lead to healthy contributions in our business model. We're also witnessing numerous new application developments, ranging from health monitoring to innovative sensors, and micro LEDs could dramatically influence the gallium arsenide sector in the coming years. In 2022, our main focus will be ensuring customer success by aligning with current and future needs, and we've noticed improved customer communication, allowing us to scale effectively. Our ability to quickly and cost-effectively add capacity is a major advantage. We’re also prioritizing gross margin improvement through various strategies, including a new recycling initiative for indium phosphide that aims to reclaim valuable excess material from our manufacturing process. Additionally, we're concentrating on the development of large diameter substrates, an important R&D effort that will enable customer innovations across high-volume applications in both gallium arsenide and indium phosphide. In 2021, we successfully delivered pilot quantities of eight-inch gallium arsenide to customers, which generated substantial revenue and demonstrated our commitment to advancing technology. In 2022, we'll focus on expanding output and refining specifications to meet customer demands. In summary, 2021 was crucial for our business, characterized by significant revenue growth and a 350% increase in profitability. Looking ahead, we believe that our momentum will persist, projecting a revenue growth of 15% to 20% in 2022 compared to 2021, driven by market expansion, share gains, and customer wins. Our investment capacity, R&D for large diameter substrates, and our upcoming China IPO present significant competitive advantages for scaling our business to meet tier one customer needs in emerging high-volume applications. We have a strong foundation that sets us up for another year of meaningful growth in 2022. Now, I'll hand the call back to Gary for our first quarter guidance.

Thank you, Morris. As Morris discussed, the demand environment remains strong in Q1 coming off a very strong Q4. In fiscal year '21, we're expecting revenue to be between $38 million and $40 million in Q1 of this year. In accordance with our commentary on gross margin, we believe that our non-GAAP net profit will be in the range of $0.07 to $0.09 and GAAP net profit will be in the range of $0.05 to $0.07. Share count will be approximately 42.8 million shares. Okay. This concludes our prepared comments. Morris and I and Leslie will be glad to answer your questions now.

And our first question comes from Richard Shannon from Craig-Hallum. Your line is now open.

Well. Hi Morris, Gary and Leslie. Thanks for taking my questions. A couple quick ones on the guidance here. Obviously, very, very nice numbers on the top line, but let me focus on gross margins here. First, given the bottom line profit numbers here in EPS, it would suggest that gross margins aren't going to be improving much sequentially if at all. How would you characterize that and all the dynamics that hurt the gross margins in the second half of last year? Are they improving to a degree and then any effects of mix in there as well, please?

Well, I'll go first and Morris can follow. Actually, we think gross margin will improve quarterly this year. We think this coming Q1 is probably the bottom and we'll see things improve. So I would say that the cost of running the business all the way from raw materials to manufacturing, consumables like polishing pads, labor, they have gone up a surprising amount. So I think we're playing catch up on how to handle that. Now that we see the light, we don’t think it's going to get it magically turn back and get better. So we have to take other steps to handle that. But I think yield efficiencies can be improved. We're certain that product mix will continue to lean towards indium phosphide. We're certain about revenue growth, very confident there. So all of those combined to help the gross margin percentage, and as we move through the year, we'll take a look at perhaps if we should try and raise some ASPs.

Yeah. Richard, let me tell you from my perspective. Indeed, raw materials plus electricity, you name it, everything has gone up, and this has not happened in the last fifteen years or so. So it's very strong, and internally we are already talking among ourselves. We think it's time for us to ask our customers to work with us and see if we can do some adjustment to be part of the cost. So, that's question number one. I think we'll be successful in certain areas. We definitely are starting to do that already. And the second is that as Gary said, there are some efficiency improvements that we need to do to ourselves to lower our costs. And thirdly, I think, last year we started to get into some of the lower margin business just to get ourselves our foot into the door because we know that there's a substantial shortage in the HBT market, and this is quite a significant amount of shortage. So we took a lower margin business to get in there, but we think as we get qualified, we should be able to get not only the volume increase, but also improve our margin as we go into a more formal delivery to that market.

Okay. Some good stuff to think about there. While I ponder that, let me get to another question here Morris on your growth. The outlook for this year reiterated your belief of 15% to 20%, and you gave us a number for indium phosphide of 35% to 40%. I guess the first part of the question I'd like to ask is with the health sensing applications, how much of that application is contributing to that growth? Is it a small amount, medium amount and is this one customer or more than one customer contributing to that this year?

The design win we talked about in our script was one customer, and they start to ramp in the fourth quarter. The revenue is meaningful. But I think it's more meaningful in the sense that I believe there are two more products to be introduced sometime this year and we believe one is coming perhaps as early as Q3.

Okay. So just to make sure you see this as a meaningful contributor to the growth profile of indium this year or a meaningful amount, excuse me.

Yes.

Okay. Excellent. That's helpful. Maybe following back up on the growth margin topic here again, Gary, in your prepared remarks you talked about hoping to reach 35%. Do you require pricing increases to make that a reality or is that something you can do just with yields and maybe volumes and other things on the cost side?

I think we probably need some help on the pricing too.

Okay. Let's see here. Gary, I think you also mentioned a strategic customer that was, I think you're giving some good pricing that hurt gross margins a little bit. Is that specifically referring to the health sensing application or is this something else?

No, it was the HBT market.

HBT market. Okay. That's helpful. I guess last one question for me. I will jump off the line here. CapEx, I think you spent $10.5 million last quarter. What's the outlook for this year? When do we get to more of a normal run rate here? We still have heavy amounts of capacity and other investments to make here this year.

Yeah, that's a good question. We're trying to soft land some of the CapEx stuff and wind it down, but we really view this as an investment time as the market is red hot and we need to stay up with it. So normally we would do $4 million to $6 million in equipment. I think this year it could be between $7 million and $9 million. So that's the normal stuff. We'll probably have to do some facility work for indium phosphide, which will be several millions of dollars, maybe as much as $5 million. But again, we view that as an investment. The horizon looks very bright and we certainly have got the attention of the customer base because we're the ones that can move the fastest and grow capacity. So micro LED is being studied carefully. We don't know for sure where that's going yet. So if it heats up, then we may do some CapEx in that category as well, but that's to be determined. So, we'll keep you posted. So that's kind of our sense of that for that time.

Okay. Perfect. I think that's all for me. I will jump on the line. Thanks guys.

And our next question comes from Hamed Khorsand from BWS Financial. Your line is now open.

Hi. So first off, I just wanted to see you, you've usually in the historically not had so much clarity as far as growth is considered for throughout the year. What's giving you that clarity this year?

Yeah, that's a very good question. I'm glad you noticed that. We usually don't have visibility even to the next quarter, but we have, because of the increasing demand and from what we know, quite a few of this product. For instance, let me give you an example for indium phosphide. We are certainly sold out. We have extended our lead time. We normally call it four to six weeks; now it's up to eight to ten weeks. And also from our marketing checks, our competitors' lead time is even longer. And for the HBT for gallium arsenide, the lead time is extremely long and that was the reason why we have exited that market for many years, and now the customers are coming back to us and asking us if we can build some capacity for them. We are in close discussion with them to see if we want to get into that market. So we do have good visibility. We also have good visibility in terms of micro LED; however, because it's a new market, we are not counting it in until we see it clearly that it's going to come to fruition. But as you can see, we already started to generate revenue from gallium arsenide, so even that is giving us better visibility of how things will shape up. So yes, you're right. The visibility is better. In fact, we never thought we could say our indium phosphide will grow 35% to 40%. We think we have high confidence it will grow that fast.

Okay. And then what actions or processes are you taking to prevent double ordering as far as your customers are concerned?

That's a good question. I think maybe the confidence level from us is this way. You see some of these, let’s say the design win we had last fourth quarter of last year, we worked with this customer for almost 2.5 years. We finally got it and double ordering or whether they are building inventory could also happen, but we are not seeing it. We don’t see a big jump up in demand. In fact, our indium phosphide capacity as of now is all sold out. And that's why our lead time is getting up to 10 weeks. And from what we know, our competitors have even longer lead times, and I think our competitors are more reluctant, I believe, to build capacity. Building capacity these days is not an easy thing to do, especially in indium phosphide. It's a very difficult process to establish and we believe that we have the advantage of building the capacity quickly for them.

Okay. My last question was Gary, what's the adequate level that you think you could preserve cash? You've continuously burned cash throughout this growth process. When could we see a reversal of that?

I believe it relates directly to our capital expenditures. While I don’t have a capital expenditure plan for 2023, I am hopeful that we'll see a downward trend. I'm comfortable with our cash position. Inventory increased significantly last year, so I don’t anticipate a substantial rise from here. We're still evaluating bank borrowing options in China until the IPO takes place. Interestingly, following the acceptance of our IPO application on January 10, there has been a noticeable increase in interest from banks in assisting Tongmei with securing debt. This has created a positive ripple effect among various organizations and institutions in China that are enthusiastic about Tongmei and the IPO. Overall, I'm not overly concerned about cash; we are monitoring it closely. Although it decreased in Q2, I believe we are in a good position.

Well, I would add to this: look, 44% growth takes a lot more equipment facilities and inventory accounts receivable. I'm not a financial expert, but I know all that requires cash. But I think we are generating good cash flow. Gary, we did a cash flow analysis. We think we can handle it, but I think going forward, if you think some investors probably want to see the cash flow slow down. I think otherwise I think when we have cash flow over strongly, that means our business is growing. We need cash to grow our business. Since when we can get very close to $40 million a quarter. And my goal is sometime this year, we're going to break $50 million a quarter; that's unthinkable just a year or two ago. And that all means better organization, better foundation, which we're building. That all means cash.

Great. Thank you.

Thanks, Hamed.

And I am showing no further questions. I would now like to turn the call back over to Dr. Morris Young for closing remarks.

Thank you for participating in our conference call. As always, feel free to contact me, Gary Fischer, or Leslie Green directly if you would like to set up a call. I will look forward to speaking with you in the near future.

Thanks everybody.

This concludes today's conference call. Thank you for participating. You may now disconnect.