AXT, Inc. 2018 Q2 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, and sells related raw materials. Manufacturing is conducted in China through wholly owned and partially owned subsidiaries and joint ventures. The unaudited filing covers the three and six months ended June 30, 2018, compared with the corresponding 2017 periods.
Financial Performance and Position
| Metric | Q2 2018 | Q2 2017 | Change |
|---|---|---|---|
| Revenue | $27.1 million | $23.6 million | +15.1% |
| Gross profit | $11.0 million | $7.3 million | +51.7% |
| Gross margin | 40.6% | 30.8% | +980 bps |
| Income from operations | $4.5 million | $2.3 million | +97.1% |
| Net income attributable to AXT | $3.9 million | $1.9 million | +102.1% |
| Diluted EPS | $0.10 | $0.05 | +100.0% |
| Six-Month Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Revenue | $51.5 million | $44.2 million | +16.7% |
| Gross profit | $20.6 million | $13.5 million | +52.0% |
| Gross margin | 39.9% | 30.7% | +920 bps |
| Income from operations | $8.5 million | $3.7 million | +130.8% |
| Net income attributable to AXT | $6.8 million | $2.6 million | +161.3% |
| Diluted EPS | $0.17 | $0.07 | +142.9% |
Q2 revenue growth reflected higher unit demand, particularly for indium phosphide and germanium substrates, and stronger raw-material sales, especially pBN crucibles. Management attributed margin expansion to favorable mix, higher production volume, improved yields and manufacturing efficiency. Operating expenses increased 30.8% in Q2, including higher selling, general and administrative costs and research and development spending.
At June 30, 2018, cash and cash equivalents were $29.7 million, short-term investments were $18.8 million and long-term investments were $5.7 million, for total cash and investments of $54.2 million, compared with $77.0 million at December 31, 2017. The company reported no debt or borrowings on the condensed balance sheet. Total assets were $219.7 million and total stockholders’ equity was $193.5 million. Inventory increased to $57.0 million from $45.8 million at year-end, including a $13.7 million reserve for excess and obsolete inventory.
Six-month operating cash flow was negative $0.5 million, compared with positive $3.2 million in 2017, primarily because of a $11.9 million inventory build and other working-capital uses. Investing cash flow was negative $14.0 million, including $21.9 million of capital expenditures. Financing cash flow was essentially neutral at $15,000, versus $32.3 million in 2017, when the company completed a public offering.
Material Changes Versus Prior Comparable Period
- Revenue increased 15.1% in Q2 and 16.7% for the first six months, led by substrate and pBN-related demand.
- Gross margin expanded substantially to 40.6% in Q2 and 39.9% year to date from approximately 31% in both 2017 comparison periods.
- Equity earnings from unconsolidated joint ventures improved to $307,000 in Q2 from a $188,000 loss; the six-month loss narrowed to $27,000 from $1.1 million. The 2017 six-month period included a $313,000 investment impairment charge.
- Cash and investments declined by approximately $22.7 million from year-end, principally due to capital spending, inventory growth and operating cash usage.
- Property, plant and equipment increased to $65.2 million from $46.5 million, with construction in progress of $37.9 million related primarily to new Dingxing and Chaoyang facilities.
- On June 15, 2018, AXT increased its ownership of JinMei from 83% to 95% by agreeing to purchase an additional 12% interest for $1.4 million. $163,000 was paid and approximately $1.2 million was accrued.
- AXT adopted ASC 606 revenue recognition and other accounting updates in 2018; management reported no significant effect on accumulated deficit, cash flows or the statement of operations.
Guidance, Outlook, Risks and Unusual Items
Management stated that available cash and investments were adequate to meet operating needs for the next 12 months, but cautioned that lower sales or continued investment could accelerate cash usage and require additional capital. The filing does not provide a clear current-quarter or full-year numerical revenue or earnings guidance range.
AXT is relocating its gallium arsenide and germanium operations from the Beijing area to Dingxing and Kazuo, China. Management expected the relocation to be completed by the end of 2018 or the first half of 2019, with estimated company relocation costs of $40 million to $50 million, including amounts already spent. Additional joint-venture relocation costs were estimated at $2 million to $4 million and $3 million to $4 million. Customer requalification, environmental permits, zoning approvals, employee relocation and execution risk could disrupt production or delay sales.
Severe air pollution caused intermittent government-ordered shutdowns totaling ten days during the first quarter of 2018, delaying shipments and causing the company to miss the revenue range previously provided in its February 2018 earnings announcement. The filing also highlights potential U.S.-China tariffs and trade restrictions, foreign-exchange losses, semiconductor cyclicality, customer concentration, raw-material pricing, inventory obsolescence, manufacturing yields, environmental compliance and reliance on Chinese supply-chain affiliates.
Foreign-currency transaction losses were $116,000 in Q2 and $340,000 for the first six months. The company maintains short-term Japanese yen hedges, but the program is partial and does not fully offset foreign-exchange exposure. No material litigation was expected, and management reported effective disclosure controls with no material changes in internal control over financial reporting.
Important Facts for Investors to Verify
- Progress, total spending and remaining cash requirements for the Dingxing and Kazuo relocation projects.
- Customer qualification status and production capacity at the new facilities.
- Whether environmental shutdowns, permitting issues or trade restrictions affect future shipments.
- Inventory turns, reserve adequacy and the risk of additional gallium or other inventory write-downs.
- Conversion of reported earnings into operating cash flow as capital expenditures and inventory investment continue.
- Trends in gross margin, average selling prices and raw-material pricing across substrates and pBN products.
- Foreign-exchange exposure, cash held by Chinese subsidiaries and the company’s ability to repatriate or deploy those funds.
- The $2.9 million cumulative preferred-stock dividend liability and restrictions it places on common-stock repurchases or distributions.