AXT Inc. 2013 First-Quarter Form 10-Q Summary
Business Context and Reporting Period
AXT designs, manufactures and sells compound semiconductor substrates, including gallium arsenide (GaAs), indium phosphide (InP) and germanium (Ge), as well as related raw materials. Manufacturing is conducted in China, with sales worldwide and strategic investments in Chinese raw-material suppliers and joint ventures. This unaudited Form 10-Q covers the three months ended March 31, 2013; comparisons are with the three months ended March 31, 2012. The company operates as one reportable segment.
Financial Performance and Position
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Revenue | $22.4 million | $23.5 million | Down 4.7% |
| Gross profit | $3.5 million | $8.2 million | Down 57.5% |
| Gross margin | 15.6% | 34.9% | Down 19.3 percentage points |
| Operating income (loss) | $(1.3) million | $3.6 million | Declined $4.8 million |
| Net income (loss) | $(2.0) million | $3.0 million | Declined $4.9 million |
| Net income (loss) attributable to AXT | $(2.4) million | $1.6 million | Declined $4.0 million |
| EPS attributable to AXT | $(0.08) | $0.05 | Changed to a loss |
| Net cash from operating activities | $1.0 million | $9.6 million | Down $8.6 million |
Revenue by product was $11.7 million from GaAs substrates, $1.8 million from InP substrates, $2.6 million from Ge substrates and $6.3 million from raw materials. InP revenue increased 27.4%, but GaAs, Ge and raw-material revenue declined. Taiwan revenue rose 84.7%, while North American revenue fell 32.9% and other Asia-Pacific revenue fell 43.1%.
The gross-margin decline reflected higher-cost raw-material inventory, lower average selling prices, weaker demand and lower raw-material pricing, particularly for 4N raw gallium. Selling, general and administrative expense increased 3.7% to $3.9 million, while research and development expense decreased 1.6% to $0.8 million. Foreign-exchange losses increased to $0.6 million from $0.2 million and were included in other expense.
At March 31, 2013, cash and cash equivalents were $25.8 million, short-term investments were $6.5 million and long-term investments were $17.0 million, for total cash, cash equivalents and investments of approximately $49.4 million. Approximately $12.7 million was held by consolidated joint ventures. The company had no borrowings under its $10.0 million secured line of credit and reported no debt financing outstanding. Contractual obligations included $0.9 million of operating leases and $3.9 million of remaining royalty obligations.
Operating cash flow was $1.0 million. Investing cash flow was $(5.6) million, primarily reflecting $1.3 million of capital expenditures and $4.3 million of net purchases of marketable securities. Financing cash flow was $(0.3) million, including $0.5 million of dividends paid by consolidated joint ventures, partly offset by $0.3 million from stock-option exercises. Cash and cash equivalents decreased $4.8 million during the quarter.
Material Changes Versus the Prior Comparable Period
- Revenue decreased 4.7%, primarily because of softer demand in wireless and LED markets and lower raw-material selling prices.
- Gross margin fell sharply from 34.9% to 15.6%, driven by pricing pressure, higher inventory costs and lower manufacturing utilization.
- The company moved from operating and net profitability to operating and net losses.
- Operating cash generation declined substantially, from $9.6 million to $1.0 million.
- Noncontrolling-interest income declined 66.5% to $0.4 million because of lower profitability at one Chinese joint venture.
- Equity earnings from unconsolidated joint ventures increased 83.1% to $0.3 million.
- Inventory declined to $38.8 million from $40.4 million, while the excess and obsolete inventory reserve remained significant at $9.7 million.
- Top-five-customer concentration decreased to 34% of revenue from 46%; no customer exceeded 10% of revenue in Q1 2013, compared with one customer at 17% in Q1 2012.
Outlook, Commentary, Risks and Unusual Items
Management stated that existing cash, investments and available credit are expected to meet operating needs for the next 12 months. The planned second manufacturing facility in Tianjin, China, involving a proposed first-phase investment of approximately $12.5 million by AXT and approximately $5.0 million by a joint venture, was delayed because of volatility in the substrate business. The company authorized a common-stock repurchase program of up to $6.0 million through February 2014, but repurchased no shares during the quarter.
The filing does not provide a clear numerical revenue, margin or earnings forecast for subsequent periods. Management cautioned that lower sales could reduce operating cash flow, accelerate use of liquidity and require additional capital. Key risks include semiconductor-industry cyclicality and oversupply, declining average selling prices, underutilized Chinese manufacturing capacity, product-quality and yield issues, customer order cancellations or delays, dependence on limited suppliers and customers, foreign-exchange exposure, Chinese regulatory and tax changes, environmental and hazardous-material liabilities, and potential impairment of inventory or private-company investments.
Unusual or notable items include $0.6 million of foreign-currency transaction losses, a $0.4 million unrealized foreign-currency gain recorded in other comprehensive income, related-party notes receivable totaling approximately $2.5 million, and significant operations and investments conducted through Chinese joint ventures. The company disclosed no material legal proceedings, no off-balance-sheet financing arrangements and no material purchase obligations.
Important Facts for Investors to Verify
- Whether demand in the wireless, LED, optical-networking and solar markets improves sufficiently to restore manufacturing utilization and gross margins.
- Whether average selling prices and 4N gallium pricing stabilize, and whether additional inventory write-downs are required.
- The availability and location of the company’s $49.4 million liquidity portfolio, including funds held by consolidated joint ventures.
- The effect of foreign-exchange movements, Chinese tax or regulatory changes and potential restrictions on Chinese manufacturing operations.
- The collectability and repayment timing of related-party notes receivable and the financial condition of invested joint ventures.
- Whether the Tianjin expansion remains delayed and whether the authorized $6.0 million repurchase program is ultimately implemented.
- The company’s exposure to customer concentration, product-quality claims, environmental matters and future litigation.