AXT, Inc. Form 10-Q Summary
Business Context and Reporting Period
AXT develops and manufactures compound and single-element semiconductor substrates, including indium phosphide, gallium arsenide and germanium wafers, as well as related raw materials. Manufacturing is conducted in China, with sales worldwide. The filing covers the unaudited three months ended March 31, 2019, compared with the three months ended March 31, 2018.
Key Financial Metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Revenue | $20.2 million | $24.4 million | Down 17.2% |
| Gross profit | $6.7 million | $9.6 million | Down 30.1% |
| Gross margin | 33.1% | 39.2% | Down 6.1 percentage points |
| Income from operations | $0.6 million | $3.9 million | Down $3.3 million |
| Net income (loss) | $(1.0) million | $3.2 million | Decline of $4.2 million |
| Net income (loss) attributable to AXT | $(1.1) million | $2.9 million | Decline of $4.0 million |
| diluted EPS | $(0.03) | $0.07 | Declined |
| Net cash from operating activities | $(2.9) million | $1.6 million | Decline of $4.5 million |
Substrate revenue was $16.8 million, down 13.4%, while raw materials and other revenue was $3.4 million, down 31.9%. Operating expenses increased to $6.1 million from $5.6 million, primarily because of higher selling, general and administrative costs. Equity losses from unconsolidated ventures increased to $1.5 million from $0.3 million, including a $1.1 million impairment charge.
At March 31, 2019, cash and cash equivalents were $21.1 million, short-term investments were $13.1 million, and total cash, cash equivalents and investments were $34.1 million. Total assets were $214.6 million and total liabilities were $18.6 million. No borrowings or letters of credit were outstanding under the $10 million secured revolving credit facility. Inventory was $53.0 million, including reserves of approximately $15.6 million for excess and obsolete inventory.
Capital expenditures were $2.9 million in the quarter. Construction in progress was $47.5 million, primarily related to new facilities in Dingxing and Chaoyang, China. Management expects approximately $21 million of AXT investment in new facilities during 2019, in addition to expected JinMei investment of approximately $2.5 million to $3.5 million.
Material Changes Versus the Prior Comparable Period
- Revenue declined 17.2%, reflecting weaker global and semiconductor-industry demand, trade and political tensions, and lower demand for GaAs and Ge substrates.
- Gross margin fell to 33.1% from 39.2%, due to lower volume and higher manufacturing costs, particularly for GaAs.
- SG&A increased 11.9% to $4.7 million because of new-location staffing, consulting, travel and subsidiary expenses.
- Operating cash flow shifted from $1.6 million provided to $2.9 million used, mainly because of the quarterly loss and reductions in accounts payable and accrued liabilities.
- Cash increased by $4.5 million, primarily because the company sold or received maturities of $9.8 million of investments, partially offset by capital spending and operating cash use.
- Effective March 11, 2019, AXT reduced its JiYa ownership from 46% to 39%, sold shares for $366,000, and deconsolidated JiYa. The retained investment is now accounted for under the equity method, and AXT recorded a $175,000 gain on deconsolidation.
- The company adopted ASC 842 for leases on January 1, 2019, recognizing approximately $1.1 million of operating lease right-of-use assets and liabilities without a material effect on earnings or cash flow.
Guidance, Outlook, Risks and Unusual Items
Management stated that it believes available cash and investments are adequate to meet operating needs for the next 12 months, but warned that further sales declines could increase cash usage and require additional capital. The filing does not provide a specific quantitative revenue or earnings outlook.
- AXT intends to complete relocation of its GaAs and Ge production lines to new Chinese facilities in 2019. Customer qualification, permitting, employee relocation, production continuity and manufacturing yields remain key execution risks.
- A 10% U.S. tariff applies to relevant China-manufactured imports. Management estimated an initial impact of approximately $150,000 per quarter but noted that tariffs could increase to 25% and that future trade restrictions are uncertain.
- Demand is exposed to semiconductor industry cyclicality, global economic weakness, customer inventory levels, competitive pricing, alternative silicon-based technologies and concentration among major customers. Two customers each represented at least 10% of Q1 revenue, and the top five represented 40%.
- AXT recorded a $1.1 million impairment of a 25%-owned Chinese germanium materials company after projected losses and environmental-related disruptions indicated that the investment was fully impaired.
- Preferred stock dividends of approximately $2.9 million remain accrued and unpaid. The Series A preferred stock carries a 5% cumulative dividend and restricts common-stock repurchases unless accrued preferred dividends are paid.
- The company faces risks from Chinese environmental and hazardous-material regulations, potential mandatory factory shutdowns, foreign exchange movements, supply-chain joint ventures, customer concentration, product quality, inventory obsolescence and competition.
- The royalty agreement with Sumitomo expired December 31, 2018; Sumitomo requested renewal, and AXT was evaluating the request.
- Management reported effective disclosure controls and procedures and no material legal proceedings expected to adversely affect the company.
Important Facts for Investors to Verify
- Whether GaAs and Ge relocation is completed on schedule and whether major customers qualify products from the new facilities.
- Whether demand recovers from the Q1 slowdown and whether revenue and gross margin stabilize.
- The sustainability of cash resources given negative operating cash flow, planned capital spending and accrued preferred dividends.
- The potential financial effect of higher tariffs, additional trade restrictions or Chinese environmental shutdowns.
- Future losses, funding needs or additional impairment charges involving AXT's Chinese supply-chain investments.
- Inventory quality and reserve adequacy, particularly given the $15.6 million excess and obsolete inventory reserve.