AXT - Q4 2023

Transcript

Operator (participant)

Good afternoon, everyone, and welcome to AXT's fourth quarter and fiscal year 2023 financial conference call. Leading the call today is Dr. Morris Young, Chief Executive Officer, and Gary Fischer, Chief Financial Officer. My name is Eric, and I will be your coordinator today. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, press star one again. I would now like to turn the call over to Leslie Green, Investor Relations for AXT.

Leslie Green (Investor Relations Contact and Owner)

Thank you, Eric, 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 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 and 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 22nd, 2025. 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 2023. 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 2023 results. Gary?

Gary Fischer (CFO)

Thank you, Leslie, and good afternoon to everyone. Revenue for the fourth quarter of 2023 was $20.4 million, up from $17.4 million in the third quarter of 2023, and down from $26.8 million in the fourth quarter of 2022. To break down our Q4 2023 revenue for you by product category, indium phosphide increased sequentially to $5.4 million, reflecting a stabilizing market with continued improvement in artificial intelligence, PONs, and data center applications. Gallium arsenide also grew to $6.0 million, with excess inventory largely worked down and certain applications showing improvement. Germanium substrates were $1.1 million, down slightly from the prior quarter. Finally, revenue from our consolidated raw material joint venture companies in Q4 was $7.9 million.

In the fourth quarter of 2023, revenue from Asia Pacific was 77%, Europe was 16%, and North America was 7%. The top five customers generated approximately 28% of total revenue, and no customer was over the 10% level. Non-GAAP gross margin in the fourth quarter was 23.2%, compared with 11.3% in Q3 of 2023 and 32.5% in Q4 of 2022. For those who prefer to track results on a GAAP basis, gross margin in the fourth quarter was 22.6%, compared with 10.7% in Q3 of 2023 and 32.1% in Q4 of 2022. The primary drivers of the sequential improvement in our corporate gross margin in Q4 were higher additional volume, product mix, and improved gross margins at both JinMei and BoYu.

Beyond the near term, we remain confident that we can get back to the mid-30% range as the environment strengthens through higher overall volume, more favorable product mix, and the benefits of our recycling programs, along with continued efficiency improvements throughout our business. Moving to operating expenses. With a reduction in overall revenue, we have maintained spending discipline in our operating expenses to align with the current environment. Total non-GAAP operating expense in Q4 was $7.5 million, down from $7.8 million in Q3 of 2023, and down from $8.9 million in Q4 of 2022. On a GAAP basis, total operating expense in Q4 of 2023 was $8.2 million, down from $8.6 million in Q3, and down from $9.6 million in Q4 of 2022.

Our non-GAAP operating income for the fourth quarter of 2023 was a loss of $2.7 million, compared with a non-GAAP operating loss in Q3 of 2023 of $5.8 million, and a non-GAAP operating loss of $256,000 in Q4 of 2022. For reference, our GAAP operating line for the fourth quarter of 2023 was a loss of $3.6 million, compared with an operating loss of $6.7 million in Q3 of 2023, and an operating loss of $1.0 million in Q4 of 2022. Non-operating other income and expense and other items below the operating line for the fourth quarter of 2023 was a net loss of $62,000. The details can be seen in the P&L included in our press release today.

For Q4 of 2023, we had a non-GAAP net loss of $2.8 million or $0.07 per share, compared with a non-GAAP net loss of $4.9 million or $0.12 per share in the third quarter of 2023. Non-GAAP net income in Q4 2022 was $2.0 million or $0.05 per share. On a GAAP basis, net loss in Q4 was $3.6 million or $0.09 per share. By comparison, net loss was $5.8 million or $0.14 per share in the third quarter of 2023. GAAP net income in Q4 of 2022 was $1.3 million or $0.03 per share. The weighted average basic shares outstanding in Q4 of 2023 was 42.9 million. Cash, cash equivalents, and investments were $52.3 million as of December 31.

By comparison, as September 30, it was $43.6 million. Depreciation and amortization in the fourth quarter was $2.2 million, and capital investments was about $4 million. Total stock comp was about $800,000, $800,000. Net inventory was flat quarter-to-quarter. 38% of the inventory is raw materials and WIP is 58%. Finished goods makes up approximately 4%. 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. In regards to the Tongmei IPO, we need to resolve one open item. Although it is moving slower than we expected, we are making progress and are confident that Tongmei remains an excellent candidate for listing. With that, I'll now turn the call over to Dr. Morris Young for a review of our business and markets. Morris?

Morris Young (CEO)

Thank you, Gary, and good afternoon, everybody. We believe that we are now beginning to see a recovery in our market. In Q4, we achieved 18% sequential growth in our revenue and a 43% sequential improvement in our non-GAAP net income. While the overall demand environment remains soft, somewhat soft, we are seeing increased orders for indium phosphide for both artificial intelligence and PON-related applications. Further, the gallium arsenide market, which was the first of our market to go into a correction, appears to have largely worked through excessive inventory. Looking individually at these product lines, our gallium arsenide revenue grew 42% sequentially in Q4, reflecting increasing strength in both wireless and LED applications, as well as depletion of excess inventory and our continued success in attaining export permits for most of our customers.

We're seeing new demand for HBT applications, where we historically have had very little market share. We believe this is the result of both improving market conditions and the desire among customers to diversify their supply base. We're also seeing improving demand geographically in China across a variety of applications, including LEDs, wireless switches, and high-power lasers. As we look forward, the Micro LED market continues to solidify. Several Tier 1 companies are driving this adoption, and a new product could come to market as soon as next year. As many of you know, we have been investing in our 8-inch gallium arsenide technology in support of these applications, and we have recently made groundbreaking advancements in both our defect density and yields. This innovation positions us strongly to gain a leading share in the market while efficiently supporting growing market demand.

Now, turning to indium phosphide. Sales grew 10% in the quarter, with early signs of recovery in the PON market and brand-new demand related to artificial intelligence. We view AI as an emerging new application for indium phosphide that will develop in exciting ways over the coming years. Today, AI applications are primarily using gallium arsenide VCSELs, which requires a relatively small amount of substrate material. But as the industry moves to 800 Gb and then 1.6 Tb speeds, we expect that there will be a necessary transition to indium phosphide. AI will drive up the need for massive data transfer requirements with increased bandwidth, low attenuation, and low distortion. We believe this will result in increased demand for indium phosphide as the best platform for rapid data transfer.

We're already seeing development work happening today with next-generation silicon photonics devices and electro-absorption modulated lasers or EML, EML, EMLs, for high-speed data center transceivers. Early revenue from these applications contributed to our indium phosphide growth in Q4 and will help drive our expected growth in Q1. This interest in indium phosphide for AI applications is intensifying the market demand for 6-inch indium phosphide. The speed, signal clarity, and long-distance capability of indium phosphide are optimal for AI applications. And as market grows, customer wants the scale and cost benefit of large diameter substrates. We're excited by the progress we are making in our R&D effort, and expect to continue to lead our industry with the best-in-class material.

While consumer and healthcare applications for indium phosphide today contribute only modestly to our revenue, we continue to see positive development, activities, and believe there is a great potential on the horizon. We are very early in adoption of this material across a multiple array of emerging applications, and our success in supporting Tier 1 customers proves our capability for large volume, high precision devices. Finally, sales from our raw material business grew 13%, with continued gross margin improvement. Overall, the pricing environment remains relatively stable, and we don't expect any major changes in Q1. In closing, we are looking forward to the coming year with optimism. We believe that the trend that we have driven our revenue and customer expansion remain very much intact, with new catalysts, such as AI, providing strong incremental opportunity.

In addition, I'm exceptionally proud of what AXT team accomplished in 2023, paving the way for exciting future. Not only did we successfully navigate the export license, export control license process on behalf of our customer, we delivered breakthrough innovation in the development of large diameter gallium arsenide and indium phosphide substrates, and we will set a new bar of excellence for our industry. In addition, we implemented a recycling program that both advances our ESG commitment and improves our efficiency. Finally, while the progress on our IPO may be less visible externally, I'm very grateful for the diligence of our team and confident that we can successfully bring it to fruition. In the meantime, we will continue to prioritize cost savings and efficiency, and we are focused on accelerating our return to profitability. Thank you to our customers, our shareholders, for their continued support.

I will turn the call back to Gary for our first quarter guidance. Gary?

Gary Fischer (CFO)

Thank you, Morris. In keeping with our comments today, we expect Q1 revenue to be between $20 million and $22 million. We expect our non-GAAP net loss will be in the range of $0.06-$0.08, and GAAP net loss will be in the range of $0.08-$0.10. Share count will be approximately 42.6 million shares. This concludes our prepared comments. Morris and I would be glad to answer your questions now. Eric?

Operator (participant)

At this time, I would like to remind everyone, in order to ask a question, press star, then the number one on your telephone keypad. We will pause for just a moment to compile the Q&A roster. Your first question comes from the line of Richard Shannon with Craig-Hallum. Please go ahead.

Richard Shannon (Senior Research Analyst)

Great. Thanks, Morris and Gary, for taking my questions, and congratulations on a good end to the year. I'm gonna start with a question for Gary, on your fourth quarter numbers here, specifically on gross margins. Well, obviously, volume helps here. The fall-through margin here was nothing short of excellent, I think it's about 90%, which seems unusual. Maybe you can delineate more of the dynamics here. Obviously, mix helps, but I wonder if there was some increase in utilization or unusual pricing in raw materials that helped you do this, and really want to get a sense of sustainability.

I haven't had a chance to run your guidance for the first quarter through and see what that implies for gross margins, but I want to get a sense of the fourth quarter as it leads into the first.

Gary Fischer (CFO)

Okay, well, it, as usual, the biggest items that contribute to these kinds of improvements are gonna be product mix. You know, indium phosphide was up Q-to-Q, and volume, and volume was up, you know, over $3 million. There was a better improvement from the two raw material companies, and that also contributed. I think in terms of sustainability, you know, we should be in about the same range in Q1, maybe plus or minus a little bit, but we'll see. Well, that's, I think that's how I just respond. Go ahead, Morris.

Morris Young (CEO)

Yeah, you know, I'm not a finance guy, but from what I know, is that when we have a policy of writing off material, which we didn't sell we don't sell for 12 months period of time. When the revenue come down, then the write-off for the excess inventory will start to impact us. But when we pick up the volume, not only the write-off becomes less, but also we will have the opportunity to pick up those write-off item to be on sale, thus improving our gross margin. That could be a impact on us.

Richard Shannon (Senior Research Analyst)

Okay, that would certainly make sense. Thanks for that clarification. And maybe I'll follow up here just on the guidance for the first quarter here. Obviously, a little bit of growth at the midpoint here. How would we think about the major segments that you report on, whether they're meaningfully different than that, you know, kind of average growth at the midpoint?

Morris Young (CEO)

Yeah, I think the significance is that indium phosphide will continue to grow. Gallium arsenide, I think will grow substantially again. Germanium is actually stable or insignificant in a way to the overall revenue contribution. Actually, raw material is gonna decrease quite substantially quarter-over-quarter. Not because their business is weak, but I think it's just that, you know, the raw material business had a great fourth quarter, and the first quarter it didn't pick up the large volume opportunity in Q1. So overall, although the revenue growth is modest, but actually come mostly from the contribution of indium phosphide and gallium arsenide.

Richard Shannon (Senior Research Analyst)

Correct. Yep. Okay, perfect. Thanks for that delineation. So let's jump into some of the product categories here in data center, you know, meaning indium phosphide here sounds like it's got some opportunities here. Clearly, you know this optical space where it seems like it's very nice here. Maybe you can talk about, you know, I think you've been a little bit limited in the kind of a narrow customer base in your past. I think you have one major customer there. Maybe you can talk about the efforts for diversification, and ultimately, how do we think about, you know, either data center growth this year versus last, or maybe just the overall indium phosphide category?

Morris Young (CEO)

I don't know where did you get that idea from? We have a limited, narrow customer base. I don't think we have a narrow customer base. I think we have a-

Richard Shannon (Senior Research Analyst)

Don't you just have one larger, a big contributor to data center and many other smaller ones, or some number of smaller ones then?

Morris Young (CEO)

Yeah, data center, silicon photonics, specifically, was very, sort of, narrow. They, they didn't grow. They are poised to grow. They've been telling us it should grow substantially in Q1 2024, but we haven't seen that yet. I think they are incrementally better in Q1 than Q4, but they're telling us, their visibility is still not good, but they overall, they're telling us that Q1 2024 should be substantially better than 2023. So I think, you know, from what we see on indium phosphide, the telecom business is not great. The data center actually still got some inventory to digest. PONs market in China actually is picking up a bit, okay, but it's still not robust compared to the peak time, but it's better than Q3, for sure, and it's continued to be better in Q1 than Q4.

What I think is surprising to us, I think, is the AI application. You know, it first started something like six months ago, and we thought it was... Well, first, the customer wouldn't tell us it's AI, and then they come back again, and they want more in Q4, and they now give us yet another bigger order in Q1. So cumulatively, literally, they—it's in the millions of dollars of range. So, and this time, they also admit to us that it's AI-related. So we are cautiously optimistic, although they are not giving us, you know, good visibility, how much they will grow in Q2 and Q3, but at least I think it's so far it's a very good sign. And I believe this, you know, indium phosphide solution for AI will come. It's a matter of time, but I think I'm glad to see it's coming already through.

Richard Shannon (Senior Research Analyst)

Okay, more some interesting detail there. It seems like you're splitting up, I guess, what I would call datacom, that you're kind of splitting up between silicon photonics and AI and others here, that perhaps there's more detail that we can take offline there, but that sounds good to hear here. Let's see here. Maybe just touching the other side of indium phosphide here, it sounds like you're generally more positive on the consumer electronics and healthcare side here. Maybe just get a sense of where that's coming from, and do you see any, you know, large customers kind of impacting your year this year?

Morris Young (CEO)

Well, Richard, we are cautiously optimistic. They are requesting a fairly sizable quote, and we're in qualification process to launch later this year, but we don't have no signal it will become reality. I mean, the volume is substantial. We know it's come for consumers, but it's still into qualification process. Whether what they will launch and will they launch later on this year, we don't know. But we have at least, let me see, two customers requesting for the same volume, for the same, you know, type of material that they request. I mean, from the volume of it, we know it's a consumer product.

Richard Shannon (Senior Research Analyst)

Okay, fair enough. Well, that's good to hear. Last question, I will jump out of line here. Just touching on the Micro LED topic here. I guess I wanna get a sense of your visibility and confidence in this market taking off. You know, I think you mentioned in your prepared remarks in sometime in calendar 2025 here, seems to be kind of a moving target in the space. I think it's you know, largely due to yields on the pick and place here outside of you know, your direct you know, scope of your work here, but just wanna get a sense of your level of confidence is that that can happen next year.

Morris Young (CEO)

Well, there, I think you probably know better than I do. I think from our end, our development of the 8-inch gallium arsenide program supporting this, both in terms of capacity, our yield, and our quality, now we have made great advancement in the last quarter, and we are now very confident. And we have customer visit, I think twice now, and the third attempt to visit us will happen next quarter, and we will soon see the qualification process. So I think, you know, what we can tell you is our customer are telling us they are ready to launch sometime in 2025, and so that's what we can believe. Whether it's gonna—I mean, right now, we're running hundreds of wafers per month, okay?

We continue to deliver now, but so I guess they are in pilot line production, and so far, so good. Our wafer performs very well, so I'm optimistic.

Richard Shannon (Senior Research Analyst)

Okay, fair enough. Thanks. That is all the questions for you guys. I'll jump out of line.

Morris Young (CEO)

Thanks, Richard.

Operator (participant)

Your next question comes from the line of Charles Shi with Needham & Company. Please go ahead.

Charles Shi (Senior Analyst)

Yeah. Thanks. Morris, and Gary, congrats on the fourth quarter results. Wanna ask you a little bit more details about the new opportunity you see in data center side. I believe you're referring to the datacom transceiver market, 800 Gb+ EML-based lasers. Obviously, Coherent, I believe it's one of your end customers, so we're very bullish about how much growth this part of the market is going to be. But for us, it's getting a little bit hard for us to think about how to translate their forecast of the 800 Gb+ optical transceiver opportunity growth to your indium phosphide wafers.

So have you guys tried to quantify how much of the PM this part of the applications are gonna drive for you guys? And the other related questions based on your knowledge today, are you single-sourced indium as an indium phosphide wafer supplier, or do you think the end customer may be sourcing from your competitor as well? Thanks.

Morris Young (CEO)

Ah, Charles, I think that's a little bit tough question, and it's a fairly long one. So, let me say this. I think right now, the data center, I do want to clarify one thing. There is. It's very hot. An item is called optical cable project, and we're not related to that project. That is mainly using VCSEL, using a plastic fiber. And I think there's a big company, data center, wants to change out coaxial cable with VCSEL, with plastic fiber. We're not in that. Whether that optical cable will move from 400 Gb, 100 Gb to 800 Gb or not, because they can use parallel paths, we're not in that at all.

And when we're talking about the 800 Gb, 1.6 Tb, I think we're talking about potentially for a little bit longer distance, perhaps, and more power, data transfer. So, you know, whether the customer is single source or not. So, to answer your question, can we quantify? And so, you know, if Coherent is gonna grow X percent, are we gonna grow with them? And so you have to take out, I mean, I believe Coherent is also doing VCSEL. The VCSEL, the problem with that market is it doesn't use a whole lot of gallium arsenide substrates. So the opportunity for us is much less than, you know, making the correct plastic fiber for VCSELs.

So as far as single source or not is concerned, I believe we are still the largest. I believe also best-in-class in indium phosphide supplier. So we have multiple, many customers, and some of them use us in majority of their supply. And in fact, I think the artificial intelligence customer that we recently engaged, I think we're a single source. But whether they're gonna develop into multiple source or not, we don't know. And but we are also very cautiously looking for other people wanting to do, participate in that development as well. So, so you know, we have a very good position in the phosphide marketplace, but you know, whether they are single source or not, it's difficult to tell.

Charles Shi (Senior Analyst)

Got it. So maybe a follow-up question. It looks like that for roughly two quarters, right? December last year, March this year, you are, for business level is now, I mean, returned to that $20+ million per quarter level. Looking out a little bit beyond the March quarter, what's your best assessment right now? Are you going to be maintained at the similar level? Are we going to revisit that high teens millions per quarter, that kind of level? Or, I mean, generally, want to get a sense how you feel about the run rate going through the rest of the year? Thanks.

Morris Young (CEO)

Sure. I think for next quarter, as I said, I think, although we only guided modestly higher, overall revenue for next quarter, but raw material is decreasing, so there's a substantial increase in substrate revenue to compensate for that. So, so I think for substrate revenue, it's gonna continue to grow, both in terms of indium phosphide and, gallium arsenide. And for raw material, I don't think it's gonna drop off, for the rest of the year. And we will have other joint venture joining in to contribute a revenue contribution as well, later on of the year. So I think this year, it's gonna be a continued growth, year for 2024 compared to 2023.

The question, I think, is how fast, how strong it's gonna be, whether we're gonna reach $90 million, but I think it's probably better than $85 million.

Charles Shi (Senior Analyst)

Got it. Thanks. So that'll be all for me, for now. Thanks.

Morris Young (CEO)

Thanks, Charles.

Operator (participant)

I will now turn the call back over to Dr. Morris Young for closing remarks.

Morris Young (CEO)

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

Operator (participant)

Ladies and gentlemen, that concludes today's call. Thank you all for joining, and you may now disconnect your lines.