AXT, Inc. 2017 Second-Quarter 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, plus related raw materials and pyrolytic boron nitride crucibles. All manufacturing is conducted in China. The filing covers the three and six months ended June 30, 2017; financial statements are unaudited.
Key financial metrics
| Metric | Q2 2017 | Q2 2016 | Change |
|---|---|---|---|
| Revenue | $23.6 million | $20.5 million | +14.9% |
| Gross profit | $7.3 million | $6.0 million | +20.4% |
| Gross margin | 30.8% | 29.4% | +140 bps |
| Income from operations | $2.3 million | $0.9 million | +152% |
| Net income | $1.8 million | $0.8 million | +125% |
| Net income attributable to AXT | $1.9 million | $1.2 million | +67.7% |
| Diluted EPS | $0.05 | $0.03 | Increase |
| Six months ended June 30 | 2017 | 2016 | Change |
|---|---|---|---|
| Revenue | $44.2 million | $39.2 million | +12.7% |
| Gross profit | $13.5 million | $11.3 million | +20.1% |
| Gross margin | 30.7% | 28.8% | +190 bps |
| Income from operations | $3.7 million | $1.4 million | +160% |
| Net income attributable to AXT | $2.6 million | $1.2 million | +117.5% |
| Diluted EPS | $0.07 | $0.03 | Increase |
Q2 revenue growth reflected higher demand across wafer products and stronger raw-material sales. Substrate revenue rose 14.2% to $19.1 million, while raw-material and other revenue rose 18.0% to $4.4 million. Management cited higher unit volumes, lower substrate raw-material costs, improved yields and manufacturing efficiencies. Average selling prices were generally flat or slightly lower.
Q2 operating expenses were $5.0 million versus $5.1 million in the prior-year period. SG&A increased 15.3% to $3.9 million, while R&D declined 30.8% to $1.0 million. No restructuring charge was recorded in 2017; Q2 2016 included a $226,000 restructuring charge. Equity losses from unconsolidated ventures improved to $188,000 from $400,000, but other income declined because gains from sales of GHI stock were lower. Foreign-exchange transaction losses were $90,000 in Q2 2017.
At June 30, 2017, cash and cash equivalents were $56.5 million, short-term investments were $22.5 million and long-term investments were $8.6 million, for total liquidity of $87.5 million. Accounts receivable were $18.3 million and inventories were $40.6 million. Total liabilities were $18.1 million, and the filing reports no debt financing. Series A preferred stock had a $6.7 million liquidation preference and $2.9 million of cumulative dividends payable. Stockholders’ equity was $173.7 million.
Six-month operating cash flow was $3.2 million, compared with $3.0 million in 2016. Investing cash flow was negative $15.4 million, primarily due to $23.8 million of investment purchases and $1.8 million of equipment purchases. Financing cash flow was positive $32.3 million, mainly from $31.9 million of net proceeds from a March 2017 offering of 5.3 million common shares and $0.9 million from option exercises.
Material changes versus the prior comparable period
- Revenue, gross profit and operating income increased substantially, with gross margin improving to 30.8% in Q2.
- China, Europe and Japan generated higher six-month revenue, while Taiwan, North America and other Asia Pacific regions declined.
- On March 15, 2017, an electrical fire at the Beijing facility damaged power supply for certain gallium arsenide and germanium production and caused a four-day wafer-processing interruption. Production was mitigated through equipment rotation and use of six-inch capacity, but additional manufacturing and business-interruption costs affected the first half.
- The company completed a public equity offering, increasing common shares outstanding to 38.7 million at June 30, 2017 from 33.0 million at December 31, 2016.
- The company sold the remainder of its GHI stock during the first quarter and held none at June 30, 2017.
- The first half included a $313,000 impairment charge on one gallium-company investment, which was written down to zero.
- The company adopted inventory and equity-method accounting updates and share-based-payment guidance; management reported no significant financial-statement impact.
Outlook, commentary, risks and unusual items
Management stated that available cash and investments are adequate for operating needs over the next 12 months. The filing does not provide a clear numerical revenue or earnings forecast in the supplied text.
AXT is planning to relocate its gallium arsenide production line from the Beijing area. Land-use rights have not yet been purchased, and construction bids and third-party cost estimates were not available. Management estimated land, relocation and facility construction costs of $25 million to $35 million, potentially higher, with completion targeted by the end of 2018 or the first half of 2019. Management expects that some costs may eventually be recovered by monetizing the vacated Beijing property, potentially beginning in 2020.
Consolidated joint venture JinMei is also evaluating a relocation, with estimated land and construction costs of approximately $6 million. In July 2017, Tongmei provided JinMei a $738,000 intercompany loan at 4.9% interest, due June 30, 2023.
- Key risks include relocation execution, customer qualification of products from the new site, possible production disruption, employee retention and regulatory approval for gallium arsenide manufacturing.
- AXT remains exposed to semiconductor cyclicality, declining average selling prices, raw-material oversupply, inventory write-downs, manufacturing yields, customer concentration and lengthy qualification cycles.
- All manufacturing and most supply-chain investments are in China, creating exposure to Chinese regulation, environmental and safety requirements, political and economic conditions, transportation restrictions and currency movements.
- Foreign-exchange transaction losses were $75,000 for the first six months, and the company uses limited Japanese yen hedges.
- Contractual obligations totaled $1.5 million, consisting primarily of operating leases and royalty payments. No material purchase orders with cancellation penalties and no off-balance-sheet financing arrangements were reported.
- Management stated that ordinary-course legal proceedings are not expected to have a material adverse effect.
Important facts for investors to verify
- Whether the Beijing relocation receives finalized land-use rights, construction bids, permits and customer qualifications, and whether total costs remain within the $25 million to $35 million estimate.
- Whether the JinMei relocation proceeds and requires additional intercompany funding beyond the disclosed $738,000 loan.
- The sustainability of the 30.8% quarterly gross margin amid raw-material pricing pressure, inventory reserves of $12.3 million and potential future price declines.
- The effect of the Beijing fire, future operational disruptions and any insurance recoveries or additional costs.
- Customer concentration: Osram Opto and Landmark represented 12% and 11% of Q2 revenue, while the top five customers represented 37%.
- Liquidity after the equity offering, planned relocation spending, capital expenditures and the $2.9 million cumulative Series A preferred dividend obligation.
- The status of the outstanding gallium arsenide manufacturing permit and compliance with Chinese environmental and safety regulations.