AXT, Inc. 2020 Q3 Form 10-Q Summary
Business context and reporting period
AXT develops and manufactures high-performance compound and single-element semiconductor substrates, including indium phosphide, gallium arsenide and germanium wafers, and sells related raw materials such as purified gallium and pBN crucibles. Manufacturing is conducted in China, with strategic investments in Chinese raw-material suppliers. The unaudited filing covers the three and nine months ended September 30, 2020, compared with the corresponding 2019 periods.
Key financial metrics
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Revenue | $25.5 million | $19.8 million | $68.3 million | $64.8 million |
| Gross profit | $8.8 million | $5.8 million | $21.1 million | $21.0 million |
| Gross margin | 34.6% | 29.0% | 30.9% | 32.3% |
| Income from operations | $2.2 million | $(0.5) million | $2.0 million | $2.5 million |
| Net income attributable to AXT | $1.0 million | $(0.9) million | $1.2 million | $(0.6) million |
| Diluted EPS | $0.02 | $(0.02) | $0.03 | $(0.02) |
| Operating cash flow | Not separately provided | Not separately provided | $6.3 million | $7.3 million |
Q3 revenue growth was driven primarily by stronger demand for InP and semi-insulating GaAs substrates, refined gallium and pBN crucibles. Nine-month substrate revenue increased 1.4%, while raw-material revenue increased 23.8%.
As of September 30, 2020, cash and cash equivalents were $22.4 million, short- and long-term investments totaled $7.4 million, and total liquidity was approximately $29.8 million. Accounts receivable were $22.7 million and inventories were $48.4 million, including $16.9 million of excess and obsolete inventory reserves.
Total debt consisted primarily of $2.9 million borrowed by Tongmei and $0.4 million borrowed by BoYu. A separate U.S. secured revolving facility had been reduced to $7.0 million and had no outstanding borrowings or letters of credit at quarter-end. Total liabilities were $30.8 million, compared with stockholders’ equity of $201.9 million.
Capital expenditures were $12.1 million during the first nine months, and construction in progress totaled $72.7 million at September 30, 2020. Management stated that cash and investments were adequate for operating needs over the next twelve months.
Material changes versus the prior comparable period
- Q3 revenue increased 28.4% year over year; nine-month revenue increased 5.4%.
- Q3 gross margin expanded to 34.6% from 29.0%, reflecting higher revenue, improved product mix and more efficient manufacturing yields. The nine-month margin declined to 30.9% from 32.3% because relocation-related inefficiencies affected the first half of 2020.
- Q3 operating income improved from a $0.5 million loss to $2.2 million of income. Nine-month operating income declined modestly to $2.0 million.
- Research and development expense increased 36.5% in Q3 and 17.6% for the nine-month period, primarily due to product development, testing and personnel costs.
- Equity-method investment results improved in Q3 to $45,000 of income from a $204,000 loss. The nine-month loss narrowed to $243,000 from $1.7 million, partly because the 2019 comparison included a $1.1 million impairment charge.
- Nine-month other income included a $3.0 million grant from a Chinese provincial government related to relocation, making the item unusually significant to pretax income.
- Cash and investments declined from $36.3 million at December 31, 2019 to $29.8 million at September 30, 2020, primarily because of capital expenditures and net investing outflows.
- In August 2020, AXT sold an 8.5% interest in Chaoyang JinMei for approximately $396,000, reducing its ownership to 91.5%.
- Effective January 1, 2020, revised useful-life estimates reduced depreciation and manufacturing costs by approximately $0.3 million in Q3 and $0.9 million for the first nine months.
Guidance, outlook, risks and unusual items
No specific numerical revenue or earnings guidance is provided in the filing text. Management expects continued investment in relocated and expanded manufacturing facilities, including approximately $5 million of 2020 capital expenditures for the GaAs line, $3.0 million to $3.5 million for JinMei facilities and $4.0 million to $4.5 million for BoYu.
- GaAs crystal growth has been transferred from Beijing to Kazuo, while GaAs wafer processing is being ramped at Dingxing. Customer qualification and production transfer remain ongoing and could disrupt shipments, yields or revenue.
- COVID-19 created operating, staffing, transportation and customer-demand uncertainty. Management could not reliably quantify the pandemic’s ultimate impact.
- All manufacturing is located in China, exposing AXT to environmental shutdowns, hazardous-material regulations, power interruptions, geopolitical tensions, tariffs, trade restrictions and currency risk.
- AXT paid approximately $850,000 in U.S. tariffs during the first nine months of 2020. Approximately 10% of revenue was derived from importing wafers into the United States.
- Customer concentration remains material: two customers represented 11% and 10% of nine-month revenue, and the top five customers represented 33%. Two customers each represented 10% of accounts receivable at quarter-end.
- Product warranty accruals increased to $529,000 from $387,000 at December 31, 2019, primarily due to increased customer quality claims.
- The company had $2.9 million of cumulative unpaid Series A preferred-stock dividends. The preferred-stock terms restrict common-stock repurchases unless accrued preferred dividends are paid; management currently does not plan additional repurchases.
- A 2020 cross-license agreement requires fixed annual payments through 2029; the filing does not provide the annual payment amount.
- In October 2020, after quarter-end, Tongmei renewed and expanded borrowings to a combined $5.6 million, with repayment due April 8, 2021 and an option for a six-month renewal.
- Management reported effective disclosure controls and no material changes to internal control over financial reporting during the quarter. Ordinary-course legal proceedings were not expected to have a material adverse effect.
Important facts for investors to verify
- Whether Dingxing customer qualifications and GaAs wafer-processing ramp-up proceed without material yield, quality or shipment disruptions.
- The sustainability of the Q3 gross-margin improvement after relocation costs, product-mix changes and capacity utilization normalize.
- Whether the $3.0 million relocation grant is nonrecurring and how future relocation incentives or costs will affect earnings and cash flow.
- Cash requirements for construction, relocation and facility expansion relative to operating cash generation and available liquidity.
- Repayment or renewal terms for Tongmei and BoYu borrowings and the status of the U.S. revolving credit facility after its November 30, 2020 expiration.
- Potential effects of COVID-19, U.S.-China trade restrictions, tariffs, Chinese environmental rules and mandatory factory shutdowns.
- Inventory quality and reserves, warranty claims, customer concentration and collectibility of the $22.7 million accounts-receivable balance.