AXT, Inc. 2017 Form 10-K Summary
Business context and reporting period
AXT develops and manufactures compound and single-element semiconductor substrates, including indium phosphide (InP), gallium arsenide (GaAs), and germanium (Ge), as well as raw materials such as gallium and pyrolytic boron nitride crucibles. Products support fiber optics, data centers, wireless devices, 3-D sensing, LEDs, lasers, and satellite solar applications. Manufacturing is conducted in China through AXT and partially owned subsidiaries and joint ventures.
The filing covers the fiscal year ended December 31, 2017. Fourth-quarter 2017 revenue was $26.3 million, gross profit was $9.8 million, and net income attributable to AXT was $3.1 million.
Key financial metrics
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Revenue | $98.7 million | $81.3 million | +21.3% |
| Gross profit | $34.5 million | $26.4 million | +30.7% |
| Gross margin | 34.9% | 32.4% | +2.5 percentage points |
| Income from operations | $12.6 million | $6.4 million | +96.8% |
| Net income attributable to AXT | $10.1 million | $5.6 million | +80.1% |
| Diluted EPS | $0.26 | $0.17 | + $0.09 |
| Cash flow from operations | $8.6 million | $12.5 million | -$3.9 million |
Substrate revenue was $78.6 million, or 80% of total revenue, up 19.8%. Raw materials and other revenue was $20.1 million, or 20%, up 27.6%. Management attributed growth to higher unit volumes, higher selling prices, favorable product mix, improved yields and manufacturing efficiencies.
At December 31, 2017, cash and cash equivalents were $44.4 million, investments were $32.6 million, and total liquidity was approximately $77.0 million. Working capital was $117.9 million, total assets were $211.2 million, and current liabilities were $22.6 million. The company reported no outstanding debt and no off-balance-sheet financing arrangements.
Operating cash flow declined despite higher earnings, primarily because accounts receivable increased by $8.0 million, inventories increased by $4.7 million, and prepaid and other current assets increased by $2.3 million. Capital expenditures were $21.4 million, principally related to new manufacturing sites. Financing cash flow included $31.9 million of net proceeds from a March 2017 common-stock offering.
Material changes versus the prior comparable period
- Revenue increased 21.3%, with growth across the substrate portfolio and stronger raw-material sales.
- Gross margin improved from 32.4% to 34.9%; substrate gross margin rose to 37.4% and raw-material gross margin rose to 25.5%.
- Operating income nearly doubled, while SG&A increased 22.5% to $17.0 million due to higher legal, marketing, personnel and fire-related business-interruption costs.
- Research and development expense decreased 17.5% to $4.8 million, although substrate-related R&D increased approximately 8%.
- Equity losses from unconsolidated joint ventures improved to $1.7 million from $2.0 million but remained a drag on earnings because of low raw-material prices. A $313,000 impairment reduced one gallium investment to zero.
- Other income of $860,000 in 2016 changed to other expense of $553,000 in 2017, primarily reflecting a $602,000 foreign-exchange loss and lower investment gains.
- Accounts receivable increased to $22.8 million from $14.5 million, and inventory increased to $45.8 million from $40.2 million. Inventory reserves totaled $13.6 million at year-end.
- Property, plant and equipment increased to $46.5 million from $27.8 million, including $20.6 million of construction in progress.
Guidance, outlook, commentary, risks and unusual items
Management expects continued opportunities in InP for data-center connectivity and silicon photonics and in low-defect-density GaAs for 3-D sensing and VCSEL applications. The filing does not provide a specific numerical revenue or earnings forecast. Management stated that existing cash and investments were adequate for operating needs over the next 12 months, subject to sales performance and relocation spending.
AXT is relocating its GaAs production from Beijing to Dingxing and Kazuo, China, in response to government development and environmental pressures. The company expected to provide initial qualification wafers by March 31, 2018 and complete the relocation by the end of 2018 or the first half of 2019. Estimated relocation costs were $40 million to $50 million, extending into 2019, although costs could be higher. Customer requalification, permits, zoning approvals, employee relocation and production continuity remain material execution risks.
The company purchased and began developing the Dingxing and Kazuo sites. Capital spending in 2017 was substantial, and management is considering additional capacity, including a possible fourth Dingxing building, to support anticipated 3-D-sensing demand. A separate JinMei joint venture relocation was estimated at approximately $6 million; AXT provided a $768,000 intercompany loan for that project.
Other significant risks include cyclical semiconductor demand, price erosion, competition from silicon-based technologies such as SOI, customer concentration, limited suppliers, manufacturing yield and quality issues, environmental shutdowns in China, foreign-exchange volatility, raw-material oversupply, joint-venture losses, and potential customer qualification failures. A March 2017 electrical fire temporarily disrupted Beijing production, but management mitigated the impact and resumed operations.
AXT had $63.6 million of U.S. federal net operating loss carryforwards and $14.6 million of unrecognized tax benefits at year-end. The 2017 Tax Cuts and Jobs Act resulted in a provisional remeasurement of deferred tax assets and valuation allowance with no net tax expense impact. The company also recognized approximately $20.9 million of foreign earnings as a deemed dividend and incurred approximately $0.5 million of alternative minimum tax, offset by foreign tax credits.
The company adopted the new revenue-recognition standard on January 1, 2018 using the modified retrospective method and expected no significant effect on its statement of operations. Management and the independent auditor concluded that internal control over financial reporting was effective as of December 31, 2017, and the financial statement audit opinion was unqualified.
Most important facts for investors to verify
- Progress, cost and timing of the Beijing-to-Dingxing/Kazuo manufacturing relocation.
- Customer requalification and volume-order conversion for new GaAs facilities and low-EPD 3-D-sensing wafers.
- Whether operating cash flow improves as receivables and inventory normalize.
- Actual capital expenditures and remaining cash requirements relative to the $40 million-$50 million relocation estimate.
- Sustainability of the 34.9% gross margin amid raw-material pricing, product mix and capacity-utilization changes.
- Performance and carrying values of the seven unconsolidated joint-venture investments, including exposure to additional impairments.
- Environmental permits, potential production shutdowns and other China regulatory developments.
- Customer concentration, foreign-exchange losses and dependence on international markets.
- Accrued Series A preferred dividends of approximately $2.9 million and the related restriction on common-stock repurchases.