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.

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.

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 positive regard 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 were 42.7 million. Cash, cash equivalents and investments were $52.8 million as of December 31. 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. 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.

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 advanced materials. What this tells us is that while the near-term environment is working through a significant inventory correction, the mid-term and longer-term prospects for our markets are vibrant. In addition to the core applications that are driving our revenue today, new uses in automotive sensing consumer products, health sensing displays, and more are taking shape in a very real way. For the last two years, we have 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 and the accomplishments 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 benefits our cost structure and drives positive results in our ESG efforts. Collectively, our work today has positioned us more favorably than ever before, both with customers as well as in the 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 deliver the specifications 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 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 effects of COVID shutdowns in China. As such, we are planning for a major reset in Q1, but we 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 gallium arsenide market was coming down from its peak, but has been fairly resilient. In addition, we continue to perform well in our consumer applications, but because of inventory digestion, 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 relationships in this important development market. Our gallium arsenide revenue is down significantly from 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 displays. 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 is 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 the softer demand environment. We do continue to see a good contribution from our supply chain companies contributing our equity accounting below the operating line. While our increasing price of certain raw material can be negative for a company like Tongmei, it is offset by the improved contribution below the line. Our supply chain strategy is unique compared to our competitors and is attractive to our customers. This is a strong focus for us in 2023. In closing, though the softening of the macro environment has reset our growth trajectory, a trend that has 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 innovations 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 will 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.

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.

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

Hi, good afternoon, Gary and Morris. Thank you for taking my question. I want to start by acknowledging that Q1 is a reset. I heard some relatively positive commentary, particularly regarding gallium arsenide, where you might see signs of improvement starting in Q2. However, what about indium phosphide? I heard that there may be some slowdown in Q1 as customers take a pause in the first half of 2023. When I consider all your comments, it's hard for me not to think that maybe Q1, or perhaps Q2 if I want to be more cautious, seems to be the bottom of this down cycle for you. Can you provide some insights? What are your thoughts at this point? Thank you.

Sure, Charles. Let me explain it this way. Even though AXT is a small company, we offer a wide range of products. As you know, germanium is used in solar cells, and gallium arsenide is involved in handsets, wireless infrastructure, high-brightness LEDs, and high-power lasers. I believe each segment experiences peak demand at different times. For example, wireless handsets faced some challenges due to inventory corrections at the beginning of Q3. The infrastructure segment followed suit later, and we are noticing that the high-power transducer market's inventory remains quite robust. On the flip side, with China reopening and the COVID situation improving, the question is when consumer demand will return, which is a key factor for gallium arsenide HPTs. Regarding indium phosphide, we didn't observe a decline in consumer products until mid-Q1. We're seeing a notable decrease in indium phosphide demand in Q1, but recovery will depend on the balance of different market segments like consumer inventory management and data center recovery to contribute meaningfully to our business. At this point, it's difficult to predict. Previously, I mentioned that over the last five to six quarters, AXT was gaining clarity in our business pipeline. However, due to interruptions and inventory corrections, that visibility has diminished. We currently have limited insight into our potential recovery. I anticipate that it may remain flat in Q2, but we are hopeful that with consumer activity resuming in China, the market will begin to recover in Q3 and Q4 of this year. Gary...

Thank you.

I think, that'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.

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 really get to the second half of the year when those end products start to ramp again? That's my second question.

Yes. I would say, we don't see any new consumer product applications for indium phosphide this year. If there is any increasing demand after they count all their inventories and digest their inventory, it probably will be if the demand goes from the top-line phone sets to the lower sets, and then that may drive some increasing demand. I cannot tell, because the customers aren't giving us visibility. As far as future developments are concerned, Charles, we’re in a bit of a downturn amid the inventory corrections. So, things are fairly pessimistic. But if you were to ask me about what indium phosphide is used for, what's our marketing data gathering, I definitely think there are a lot of growth potentials, especially in sensors, in lasers where you need high safety as well as autonomous vehicles. I mean, we had customer interest in us delivering sizable products to that market. But that inquiry was late sometime last year, and it never materialized. When will it come back? I don't know. I think the other potential product is healthcare products. Again, the customer was picking our product for a beta site pilot production. Unfortunately, that is not materializing into a major production product demand now. When will it come back? I think the interest is there, but we just don't have visibility into the major production demand yet.

Thank you, Morris. I understand that the supply chain is such that your end customer may not be able to provide clarity on their decisions until the last minute. My last question pertains to the larger diameter gallium arsenide for microLED applications. One of your key customers mentioned they expect to see significant revenue in 2025, which suggests that is when they will begin shipping in volume. However, I'm unsure how much of your revenue will contribute to their revenue from the microLED application. Could you provide some insight into what the revenue ramp may look like? You mentioned you would begin shipping some volume this year, but how do you foresee the revenue growth for this year, next year, and 2025? Thank you.

Sure. We are shipping hundreds of wafers to customers. I think they are doing their pilot runs as well as looking at wafers in all different ways, including going epi and seeing how flat they need the wafer to be, and running through their pilot production lines. I think we agree with you that the earlier projection was that we're going to start to have a production ramp-up in 2024, but we think it's going to be late 2024 rather than early 2024. So that matches with your 2025 big production ramp. I'm very glad to see that this project is really taking shape and looks like it's going to be a major project. But I think the bigger unknown is how successful this project will be and whether it will spread to other applications. Our customer has told us that this is just the start of the program, and eventually, this could lead to something like five to ten times the volume as the initial demand. That depends on how well they can run this project, reduce costs, and how overall microLED performs. There are many different competing technologies eyeing this microLED applications, such as wearables and goggles. So, I think this is a significant opportunity for gallium arsenide. We are very well-positioned because we are not only in substrate making, but we are also supplying some other raw materials, which will benefit us since the demand for gallium arsenide is going to increase significantly. That's how I view the microLED opportunity.

Got it. It sounds like you may lead your customers' revenue ramp-up by a little bit, or that makes sense, right, because you ship the wafer first, you recognize revenue, they process the wafer, and then they recognize their revenue. But thank you very much, Morris and Gary. I hope to catch up more with you soon. Thank you.

Thanks, Charles.

Our next question comes from Matt Bryson with Wedbush.

Thank you for taking my questions. My first question is, when you consider the three factors you mentioned that are affecting gross margins, Gary, could you give us an idea of the significance of each of those factors for the quarter?

Well, I would say the lower revenue is the key part of the story, and the product mix wasn't as good as we expected. So, those are probably the two main things. A little bit below expectation from the raw material companies, but it’s really more around the substrate business.

But on the other hand, the guidance for Q1 indicates that the major impact on gross margin is shifting towards the product mix, because we expect indium phosphide to take a major hit on the inventory correction. So, that will drop significantly. That will impact our gross margin overall.

That's correct.

Understood. So when considering normal gross margins, if you're able to bring revenues back to previous levels, then you would still be looking at the gross margins that were experienced a quarter or two ago. Is that fair?

Oh, absolutely. Although there are price pressures from customers when business isn’t good, there’s not a significant overall margin drop. Our business is fairly stable, and we are also increasing our efficiency. We have new joint ventures taking care of the raw material supply. So we're confident. When business returns, I think we should be looking forward to mid-30s and even high 30s.

No. Understood. I just wanted to ensure that pricing wasn't a major factor, right, because that would be...

No, pricing is not really a key factor. Yes, there's price pressure from time to time, but really the big reason is what I just said. And we're confident that when things rebound, all the stuff that we've done for the last two years to improve gross margin is going to blossom again. It's just taking a pause because of the disruption in the marketplace right now.

Understood. And then, I guess my one other question is, you talked there's some programs potentially put on hold at your customers given the more difficult environment, which makes sense. But on the silicon photonics front, are you still seeing progress there? Or anything you can talk about as to how you see that market developing for AXT?

Yes, silicon photonics is doing fine, although the data center market appears to be struggling. Reports indicate that companies like Microsoft and Amazon are experiencing difficulties in their data center businesses, leading to corrections in their operations. As a result, when major data center players are not purchasing, it impacts our silicon photonics performance. However, I believe that in terms of the Internet and cloud computing, the demand for data transfer is increasing, necessitating the need for larger data centers and fiber optics to address bandwidth and speed challenges. Longer-term, I am confident in growth, although we will face inventory corrections in the short term. Microsoft’s business is currently soft, and many are anticipating a possible economic slowdown.

One of the strengths of our business model is that the lifecycle for some of our key applications differs significantly from the general semiconductor industry. Typically, companies must release a new chip every 18 to 24 months. However, the data center sector is a prime example of longevity, as it is expected to support silicon photonics and indium phosphide for the next five to 15 years. It's hard to envision any slowdown in this area. Additionally, our history with gallium arsenide shows that the lifecycle for some of those products lasted 12 to 15 years, highlighting a positive difference in our approach.

Got it. Thanks so much for the color.

Thanks, Matt.

Our next question comes from Richard Shannon with Craig-Hallum.

Well, thanks, guys, for taking my questions. I'm going to hit on the gross margin topic here and ask a very direct question, Gary, as I usually do. Trying to fit the guidance to get to the bottom-line and guessing on OpEx here, I was coming up with gross margins that are around a little bit below 20%. As I look back in history to the last quarter around $20 million per quarter, I saw a number of around 26%, 27%. Clearly, you've got a negative mix here with indium phosphide, but that difference seems fairly dramatic. So I wonder if you could tell us how close we are in doing our math here.

So, Richard, are you describing the Q4 results or the...

No, Q1.

Q1.

First quarter.

I think Richard wants to know how do we compare with the last cycle? I mean, when we had a $20 million quarter, Richard is saying our gross margin was better than what you telecasted or forecasted.

Yes. Is 18% approximately right, because it's a lot different than last time you were at this sales level? So, I just want to get a little bit more clarity there.

I'd say it's too low. I don't know for sure what it's going to be yet. Obviously, given the mix in the...

I think our model says more than 20%. I think around 21%. But that's our model.

Okay. Well, you clearly got some other parts to model, so we'll follow up offline there, but just wanted to get that one out of the way here. That is helpful. And just wanted to make sure I caught this correctly. On the first quarter, do you expect indium phosphide to be down more than 50% sequentially? And this was entirely due to consumer and data center? Were there other elements of it? Just want to make sure I caught all of them.

Yes. I think data center is not helping, but most significantly it is the consumer. The consumer part didn't take a big inventory correction until recently.

Yes, we are aware of their cycle, so that is not surprising. Gary, I have a multipart question regarding inventory, CapEx, and cash flows this year. You mentioned the intention to reduce inventory by $10 million to $15 million this year, which is encouraging given the recent changes. Could you also share your expectations for CapEx this year compared to last year? A lot of the CapEx increase relates to indium phosphide, and since there is a notable gap, albeit temporary, it seems there is less urgency to accelerate building immediately. I'd like to understand how much your CapEx needs to match last year's levels.

Okay. Well, the short answer is it won't be as high as last year. In addition to clamping down on inventory, we're going to put the brakes on CapEx as well. I would say, $3 million to $5 million. And we can modify that if things bounce back. We have investments we'd like to make. But Morris has already got his shotgun out, and if anyone talks about a lot of CapEx, they're going to be in trouble. So...

Well, even if business were to pick up, the spend that we did for last year was because customer demand was way outstripping our ability to deliver. That's why we were building very aggressively and even toward the second half of the year. Some of those builds are still hanging out there. So, even if the business were to recover, we can handle it. No problem at all.

Yes.

But it’s not we planned, but we built last year.

Okay, fair enough. And that’s a...

Yes.

Sorry, Morris, didn't mean to cut you off there. Please, finish.

Oh, no. I finished. I said, it's not we planned, but we built last year.

Okay, fair enough. Last question for me, kind of dovetailing off of one of those remarks in there, Morris, regarding just general sensing applications. I think in an earlier question asked about your large customer and I think if I got you correctly, said you don't expect any new programs in this current calendar year. How about kind of more broadly thinking about other customers and applications regarding sensing, and to what degree are they in early-stage versus late-stage development such as they could impact this year, or perhaps in following years? Maybe just kind of give us the big picture long-term there.

Yes, Richard, my focus has shifted. When considering indium phosphide, I believe healthcare remains a significant application, although its development seems to be on hold for now. In the automotive sector, we have a customer requesting 3,000 4-inch indium phosphide wafers each month, and we were in the process of calculating costs and preparing to expand our capacity for them, but they haven’t followed through. I don't think they are just wasting our time. Additionally, there are numerous other initiatives, like the Meta goggle, which reportedly requires an eye-tracking indium phosphide sensor. If that market gains traction, it could be promising, despite many development programs currently being stalled. Several users are interested in indium phosphide; one customer informed us of 12 ongoing projects aimed at enhancing consumer experiences and improving handheld devices. Last year, I considered that some of these might materialize in 2024, but I now have a more cautious perspective.

Let me add something to that, too. It's a big picture comment. Indium phosphide is taking on a life of its own, and it's robust. It's great to watch. It's exciting for us to be a leader in this kind of material. There's going to be stuff in gaming, automotive sensors, health, and well-being. So, it's definitely taken on a life of its own.

Yes. And I think if you're looking at the short term, I would say China is looking to pump up the economy. I think the government may want to do some infrastructure build. As far as I think the United States, I think the U.S. is considering a significant infrastructure build and wants to make internet connections available throughout. Materials used for fiber optic communications will likely benefit. But I think at this point, 5G base station construction is at a low point, and telecommunications are at a low point. But any government infrastructure build is going to help the demand for indium phosphide.

Okay. Perfect. That's all from me guys. Thank you.

Thanks, Richard.

Our final question comes from Hamed Khorsand with BWS.

Hi. Just wanted to really understand if you're talking about a reset in the business in Q1, why you're not considering resetting your business structure as it is? What's giving you the confidence that you will bottom out in Q1?

I think we're taking a reset, Hamed. I think...

I agree.

We're not buying material. We're shutting down most of our construction. Lower CapEx. We're looking at all possible ways to tighten our budget.

Lower inventory.

But when are we looking at cutting back on R&D? That's probably an area we're not cutting back yet. But we're going to take a cautious look because that's the future of the company, such as 8-inch gallium arsenide; we want to keep developing it. We can have a robust yield and the ability to deliver to our customers. That revenue is going to come if we can take care of that business. So it's not that we planned, but we built for last year.

Okay. And then, as far as the inventory is concerned, any risk that it becomes obsolete by the time the business turns around?

No. Fifty percent of our inventory is raw material, and raw material will never go bad. I mean, we can even sell the raw material, can't we? And the other 40% is work-in-process, which doesn't need cutting or polishing to any product specification. Gallium arsenide, indium phosphide has been around for 25 to 30 years, so it will never go away. Anything that is already cut to customer specifications is only 4% or 5%, and even then, I don't think we have lost customers. The most severe punishment is if the customer takes our product and doesn't pay and they go bankrupt, that's the only time we lost. I don't think there's a whole lot of risk for the inventory.

Yes, in this business model, which is different from the semiconductor industry where I have experience, we are a material science company that starts with raw materials. This means there isn't a significant need for management to closely oversee operations or worry about obsolescence and similar issues.

Okay. Thank you.

Thanks, Hamed.

There are no further questions at this time. I now turn the call back over to Dr. Morris Young for closing remarks.

Thank you for participating in our conference call. 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.

Thank you for attending today's presentation. You may now disconnect.