AXT, Inc. 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, and sells related raw materials such as purified gallium and pBN crucibles. All manufacturing is conducted in China. The filing covers the three and six months ended June 30, 2020, compared with the corresponding 2019 periods.
Key financial metrics
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Revenue | $22.1 million | $24.8 million | $42.9 million | $45.0 million |
| Gross profit | $6.8 million | $8.5 million | $12.3 million | $15.2 million |
| Gross margin | 30.6% | 34.3% | 28.7% | 33.8% |
| Operating income (loss) | $0.5 million | $2.3 million | $(0.2) million | $3.0 million |
| Net income attributable to AXT | $0.4 million | $1.5 million | $0.2 million | $0.3 million |
| Diluted earnings per share | $0.01 | $0.04 | $0.00 | $0.01 |
| Net cash provided by operating activities | Not separately provided | Not separately provided | $2.0 million | $5.9 million |
Q2 revenue declined 10.7%, while six-month revenue declined 4.8%. Substrate revenue fell 18.1% in Q2 and 9.7% for the six-month period; raw-materials revenue increased 25.3% and 19.1%, respectively. The decline in gross margin reflected lower revenue, product mix and manufacturing inefficiencies associated with relocating production.
Q2 net income included $1.6 million of relocation-related government grant income. The six-month period included $3.0 million of such grants. Without this unusual income, reported profitability would have been materially lower.
Financial position, liquidity and debt
- Cash and cash equivalents were $26.5 million at June 30, 2020, compared with $26.9 million at December 31, 2019.
- Short- and long-term investments totaled $6.0 million, down from $9.4 million at year-end 2019. Total cash, cash equivalents and investments were $32.5 million.
- Accounts receivable were $19.8 million and inventories were $49.6 million. Inventory reserves totaled approximately $16.7 million.
- Property, plant and equipment, net, was $101.0 million, including $66.3 million of construction in progress, primarily for new facilities in Dingxing and Kazuo, China.
- Bank loans totaled $6.1 million, consisting primarily of $5.7 million borrowed by Tongmei and $0.4 million borrowed by BoYu. Tongmei’s borrowings mature in August and September 2020, and management intended to seek renewals.
- AXT had an undrawn $7.0 million secured U.S. revolving credit facility expiring November 30, 2020.
- Management stated that available cash and investments were adequate for operating needs over the following 12 months, but warned that lower sales could accelerate cash usage and require additional capital.
Material changes versus the prior comparable period
- Revenue and gross profit decreased, primarily because a large 2019 customer order did not recur. Higher demand for GaAs substrates, refined gallium and pBN crucibles partially offset the decline.
- Operating results were pressured by relocation-related yield and efficiency issues. Research and development expense increased 10.3% in Q2 and 7.5% year to date, while SG&A was broadly flat.
- Operating cash flow fell to $2.0 million from $5.9 million, primarily reflecting less favorable working-capital changes.
- Capital expenditures were $6.5 million in the first six months, compared with $8.2 million in the prior-year period.
- Equity losses from unconsolidated joint ventures were $0.2 million in Q2 and $0.3 million year to date, compared with income of $8,000 and losses of $1.4 million, respectively, in the comparable periods. The 2019 year-to-date loss included a $1.1 million investment impairment that did not recur.
- Noncontrolling-interest income increased to $0.6 million in Q2 and $1.0 million year to date, reflecting higher profitability at consolidated Chinese joint ventures and reducing the portion of earnings attributable to AXT.
Guidance, outlook, commentary and risks
- Management expected approximately $5 million of 2020 capital expenditures for the GaAs manufacturing line, with potential additional investment in the InP line. JinMei expected to invest approximately $3.0 million to $3.5 million, and BoYu approximately $4.0 million to $4.5 million.
- GaAs crystal growth had been fully transferred from Beijing to Kazuo by December 31, 2019. Wafer-processing equipment had been moved to Dingxing, but volume production and customer qualification at Dingxing remained ongoing.
- COVID-19 reduced staffing and disrupted travel, transportation and supply-chain activity earlier in 2020. Management could not reliably quantify the pandemic’s full future impact.
- Approximately 10% of revenue was generated from wafers imported into the United States, and tariffs were approximately $0.5 million during the first six months of 2020. Future tariffs and trade restrictions remained uncertain.
- Customer concentration remained material: two customers represented 24% of Q2 accounts receivable revenue exposure based on the disclosed individual percentages, and the top five customers represented 30% of Q2 revenue and 39% of year-to-date revenue.
- Key risks include production relocation and customer requalification, manufacturing yields, COVID-19 disruptions, China-U.S. trade tensions, tariffs, environmental restrictions or factory shutdowns in China, foreign-exchange exposure, dependence on limited suppliers, inventory obsolescence and losses at raw-material joint ventures.
- The company entered a fixed-cost cross-license agreement with a competitor running from January 1, 2020 through December 31, 2029; the filing does not provide the annual payment amount.
- Management reported effective disclosure controls and no material changes to internal control over financial reporting during the quarter.
Investor verification points
- Verify the sustainability of demand for GaAs, InP and Ge substrates after the nonrecurring 2019 customer order and the Q2 2020 relocation grant.
- Monitor Dingxing customer qualifications, production yields, capacity utilization and the resulting gross-margin trajectory.
- Confirm renewal or repayment arrangements for Tongmei’s $5.7 million of borrowings maturing in August and September 2020.
- Assess cash conversion, inventory levels and the substantial inventory reserve relative to current demand.
- Review the effect of COVID-19, tariffs, China-U.S. trade restrictions and environmental regulations on shipments and manufacturing costs.
- Evaluate the financial condition of unconsolidated raw-material investments and the potential for future equity-method losses or impairments.
- Confirm the amount and duration of obligations under the 2020 cross-license agreement and the cumulative $2.9 million of unpaid Series A preferred dividends.