AXT, Inc. 2019 Second-Quarter 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, with revenue generated globally. The unaudited filing covers the three and six months ended June 30, 2019, compared with the same periods in 2018.
Key Financial Metrics
| Metric | Q2 2019 | Q2 2018 | Six Months 2019 | Six Months 2018 |
|---|---|---|---|---|
| Revenue | $24.8 million | $27.1 million | $45.0 million | $51.5 million |
| Gross profit | $8.5 million | $11.0 million | $15.2 million | $20.6 million |
| Gross margin | 34.3% | 40.6% | 33.8% | 39.9% |
| Operating income | $2.3 million | $4.5 million | $3.0 million | $8.5 million |
| Net income attributable to AXT | $1.5 million | $3.9 million | $0.3 million | $6.8 million |
| Diluted EPS | $0.04 | $0.10 | $0.01 | $0.17 |
- Revenue declined 8.6% in Q2 and 12.7% for the six-month period. Substrate revenue declined 4.6% in Q2 and 8.8% year to date; raw-materials revenue declined 23.9% and 27.7%, respectively.
- Operating margin was approximately 9.4% in Q2 2019 versus 16.7% in Q2 2018, and approximately 6.6% for the six months versus 16.4% in the prior-year period.
- Attributable net margin was approximately 5.9% in Q2 versus 14.4% in Q2 2018, and approximately 0.8% for the six months versus 13.1% in the prior-year period.
- Management attributed weaker results primarily to a global semiconductor slowdown, trade and political tensions, lower GaAs and germanium demand, lower refined-gallium shipments and higher GaAs manufacturing costs.
- Six-month operating cash flow was $5.9 million, compared with cash usage of $0.5 million in the prior-year period. Working-capital improvements, particularly an $8.2 million reduction in inventories, contributed significantly.
- Six-month investing cash flow was $5.9 million, including $16.6 million of investment maturities and sales, offset by $8.2 million of capital expenditures and $2.5 million of investment purchases.
- Cash and cash equivalents were $28.7 million at June 30, 2019, versus $16.5 million at December 31, 2018. Cash, short-term investments and long-term investments totaled $37.5 million, compared with $39.4 million at year-end.
- Accounts receivable was $18.3 million and inventory was $50.3 million. Inventory reserves totaled $16.3 million for excess and obsolete inventory and $0.1 million for lower of cost or net realizable value.
- Total liabilities were $18.2 million, including $1.0 million of operating lease liabilities. No borrowings or letters of credit were outstanding under the $10 million secured revolving credit facility.
- Property, plant and equipment was $87.6 million, including $51.2 million of construction in progress. The company expects approximately $21 million of 2019 spending on its new facilities.
Material Changes Versus the Prior Comparable Period
- Revenue and profitability materially weakened because of lower demand and higher manufacturing costs. Europe, Japan and Taiwan experienced significant revenue declines, while China revenue increased.
- Customer concentration increased: two customers represented 33% of Q2 revenue and the top five represented 48%, compared with no customer above 10% and top-five concentration of 33% in Q2 2018.
- Equity in earnings of unconsolidated joint ventures declined to $8,000 in Q2 from $307,000 and became a $1.4 million loss for the six months, including a $1.1 million impairment charge on a Chinese germanium-materials investment.
- AXT sold part of its JiYa investment, reducing ownership from 46% to 39%, and deconsolidated JiYa effective March 11, 2019. The company recognized a $175,000 gain and now accounts for the retained investment under the equity method.
- AXT acquired the remaining 3% of JinMei for approximately $413,000, making JinMei wholly owned effective June 1, 2019.
- Adoption of ASC 842 on January 1, 2019 added approximately $1.1 million of operating lease assets and liabilities to the balance sheet without a material effect on earnings or cash flow.
- Accumulated other comprehensive loss attributable to AXT increased to $3.1 million, primarily reflecting foreign-currency translation losses.
Guidance, Outlook, Commentary and Risks
- No specific quarterly or full-year revenue or earnings guidance is provided in the filing text. Management states that it expects to have adequate cash and investments to meet operating needs over the next twelve months.
- AXT intends to complete the majority of its GaAs and germanium production relocation in 2019, while customer qualification of products from the new facilities is expected to extend into 2020.
- The new Dingxing and Kazuo facilities are intended to expand capacity and improve manufacturing capabilities. The relocation requires additional permits, customer requalification and successful employee transition.
- U.S. tariffs on products manufactured in China increased from 10% to 25% in May 2019. Management warns that additional tariffs or trade restrictions could require price increases, reduce demand and compress margins.
- Key risks include semiconductor cyclicality, weak end-market demand, customer order delays or cancellations, rising customer concentration, manufacturing yields, product quality, capacity underutilization and declining average selling prices.
- China-specific risks include environmental regulation, mandatory factory shutdowns, hazardous-material permits, power interruptions, transportation restrictions, tax changes and political or regulatory uncertainty.
- All manufacturing is in China and approximately 90% of revenue is international. Foreign-exchange exposure remains material, although the company hedges a portion of its Japanese yen exposure.
- The company has significant exposure to raw-material joint ventures and minority investments, including potential impairment, supply disruption and environmental or operating risks.
- The Sumitomo royalty agreement expired December 31, 2018; Sumitomo requested renewal, and AXT was evaluating the request. The filing does not provide a final resolution.
- Management reported effective disclosure controls and no material changes in internal control over financial reporting. Ordinary-course legal proceedings are not expected to have a material adverse effect.
Important Facts for Investors to Verify
- Whether demand, revenue and gross margins recover from the Q2 2019 downturn, particularly in GaAs, germanium and raw materials.
- Progress, remaining cost and timing of the GaAs and germanium relocation, including required permits and customer qualifications.
- The effect of the 25% tariff rate and any subsequent U.S.-China trade measures on pricing, volume and margins.
- Whether the $21 million planned 2019 facility investment and JinMei’s $2.5 million to $3.5 million relocation investment remain within budget.
- The adequacy of the $37.5 million liquidity balance given planned capital expenditures, operating losses at certain investments and potential demand weakness.
- Inventory quality and reserve sufficiency, given $16.4 million of total inventory reserves at June 30, 2019.
- Customer concentration and credit exposure, including the two customers representing 33% of Q2 revenue.
- Performance and carrying values of privately held raw-material investments following the $1.1 million impairment charge.
- Resolution of the requested Sumitomo royalty renewal and any related intellectual-property or royalty costs.