AXT, Inc. 10-Q Summary: First Quarter 2017
Business Context and Reporting Period
AXT develops and manufactures compound and single-element semiconductor substrates, including indium phosphide, gallium arsenide and germanium wafers, as well as raw materials and pyrolytic boron nitride crucibles. Manufacturing is conducted in China, with a vertically integrated supply chain involving partially owned subsidiaries and joint ventures. The filing covers the three months ended March 31, 2017; financial statements are unaudited.
Key Financial Metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Revenue | $20.6 million | $18.7 million | Up 10.2% |
| Gross profit | $6.3 million | $5.3 million | Up 19.7% |
| Gross margin | 30.5% | 28.1% | Up 2.4 percentage points |
| Operating income | $1.4 million | $0.5 million | Up $0.9 million |
| Net income attributable to AXT | $0.7 million | $0.04 million | Improved |
| Diluted earnings per share | $0.02 | Approximately $(0.00) | Improved |
| Net cash from operating activities | $1.1 million | $(0.1) million | Improved |
- Substrate revenue was $16.6 million, up 4.8%; raw materials and other revenue was $4.0 million, up 40.1%.
- Operating margin was approximately 6.7%, compared with 2.7% in the prior-year quarter. Net income attributable to AXT represented approximately 3.2% of revenue.
- Cash and cash equivalents were $56.5 million at March 31, 2017, compared with $36.2 million at December 31, 2016. Total cash, short-term investments and long-term investments were $86.8 million.
- Total liabilities were $16.7 million, including $1.0 million of royalty obligations. The filing does not identify conventional bank debt.
- Net cash used in investing was $13.0 million, primarily reflecting $21.7 million of investment purchases, partially offset by $9.0 million of investment sales and maturities.
- Net cash provided by financing was $32.2 million, principally from the March 2017 public offering and option exercises.
- Total assets were $187.4 million and total stockholders’ equity was $170.7 million at March 31, 2017.
Material Changes Versus the Prior Comparable Period
- Revenue growth reflected stronger raw-material sales, higher gallium arsenide wafer demand and stabilization in purified gallium pricing as oversupply moderated.
- Gross margin benefited from lower raw-material costs, improved yields and manufacturing efficiencies, although manufacturing costs increased following an electrical fire at the Beijing facility on March 15, 2017.
- Selling, general and administrative expense increased 12.4%, primarily due to personnel costs and fire-related business-interruption expenses. Research and development expense decreased 18.6%.
- Equity losses from unconsolidated joint ventures increased to $0.9 million from $0.5 million, including a $0.3 million impairment charge that reduced one gallium investment to zero.
- The company issued 5,307,692 common shares in March 2017 and received net proceeds of approximately $31.9 million. Common shares outstanding increased to 38.6 million at May 1, 2017.
- Cash flow from operations turned positive, compared with cash used in operations in Q1 2016, while accounts receivable increased to $17.6 million from $14.5 million at year-end.
- Revenue mix shifted geographically: Europe, China and Japan increased, while Taiwan, other Asia Pacific and North America declined. One customer represented 11% of Q1 2017 revenue, and the top five customers represented 35%.
Guidance, Outlook, Risks and Unusual Items
- Management states that available cash and investments are adequate to meet operating needs for the next 12 months. No specific numerical revenue or earnings guidance is provided in the filing text.
- AXT is planning to relocate its gallium arsenide production line from Beijing, targeted for completion by the end of 2018 or the first half of 2019. Land-use rights have not yet been purchased, and management estimates land, relocation and construction costs of $25 million to $35 million, potentially substantially more.
- JinMei, a consolidated joint venture, may also relocate; estimated land and construction costs are approximately $6 million, and AXT may provide a loan.
- The March 15, 2017 electrical fire damaged power infrastructure supporting certain gallium arsenide and germanium production and damaged a wastewater pipe. Production was partially restored through repairs and use of other capacity, but future disruption remains a risk.
- Gallium arsenide production remains subject to Chinese regulatory permitting requirements. The filing states that the relevant permit application had been accepted but the required permit had not yet been issued.
- Key operating risks include semiconductor industry cyclicality, declining average selling prices, raw-material oversupply, customer concentration, production yields, product qualification requirements, reliance on Chinese manufacturing and suppliers, foreign exchange exposure, and potential environmental or safety restrictions.
- Inventory included reserves of $12.1 million for excess and obsolete inventory and $86,000 for lower-of-cost-or-market adjustments at March 31, 2017.
- Contractual obligations totaled $1.3 million, including $0.3 million of operating leases and $1.0 million under a royalty agreement. The company reported no off-balance-sheet financing arrangements.
- The company adopted accounting updates relating to equity-method investments and share-based payments effective January 1, 2017, with no significant impact reported. The effects of other pending revenue-recognition, lease and financial-instrument standards were still being evaluated.
- Management concluded that disclosure controls and procedures were effective at the reasonable-assurance level, with no material changes to internal control over financial reporting during the quarter.
Most Important Facts for Investors to Verify
- Progress, permitting, site selection, construction commitments and ultimate cost of the Beijing gallium arsenide relocation.
- Whether the March 2017 fire caused continuing production, yield, customer-qualification or shipment effects.
- Sustainability of purified gallium pricing, raw-material margins and the performance of the seven unconsolidated investment entities.
- Customer concentration, backlog, order cancellations and demand trends for gallium arsenide, indium phosphide and germanium substrates.
- Availability and repatriation constraints on cash held in China, including the approximately $7.9 million that may require U.S. taxes to be accessed domestically.
- Potential obligations associated with the 5% cumulative Series A preferred dividend, which totaled approximately $2.9 million in accrued dividends and has not been paid or declared.
- Additional inventory write-downs, investment impairments, regulatory actions or environmental and safety liabilities.