AXT, Inc. 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), plus related raw materials such as gallium and pyrolytic boron nitride crucibles. The company operates in one segment, manufactures all products in China, and sells primarily to international customers. This filing covers the fiscal year ended December 31, 2018, including fourth-quarter results.
- Substrates represented 79% of 2018 revenue; raw materials represented 21%.
- Approximately 90% of revenue came from customers outside North America.
- One customer represented 13% of 2018 revenue; the top five customers represented 35%.
Financial performance and key metrics
| Metric | FY 2018 | FY 2017 | Change |
|---|---|---|---|
| Revenue | $102.4 million | $98.7 million | Up 3.8% |
| Gross profit | $37.0 million | $34.5 million | Up 7.5% |
| Gross margin | 36.2% | 34.9% | Up 130 basis points |
| Operating income | $12.1 million | $12.6 million | Down 3.9% |
| Operating margin | 11.9% | 12.8% | Down approximately 100 basis points |
| Net income attributable to AXT | $9.7 million | $10.1 million | Down 4.9% |
| Diluted EPS | $0.24 | $0.26 | Down $0.02 |
| Operating cash flow | $3.2 million | $8.6 million | Down $5.4 million |
- Substrate revenue increased 3.0% to $81.0 million, driven mainly by InP and Ge growth, partly offset by lower GaAs sales.
- Raw-material revenue increased 6.7% to $21.4 million, including higher raw gallium and pBN sales.
- SG&A increased 11.7% to $19.0 million, primarily because of relocation-related hiring, travel and stock compensation.
- Research and development expense increased 22.2% to $5.9 million, focused in part on low-EPD GaAs and Ge performance.
- Equity losses from unconsolidated joint ventures improved to $1.1 million from $1.7 million, but one joint venture incurred a $1.1 million fourth-quarter charge associated with an environmental-mandated shutdown and manufacturing improvements.
- Inventory rose to $58.6 million from $45.8 million and included $14.8 million of excess and obsolete inventory reserves.
Fourth-quarter 2018 performance
| Metric | Q4 2018 | Q3 2018 | Q4 2017 |
|---|---|---|---|
| Revenue | $22.2 million | $28.6 million | $26.3 million |
| Gross profit | $5.9 million | $10.6 million | $9.8 million |
| Gross margin | 26.3% | 37.1% | 37.2% |
| Net income attributable to AXT | $(1.1) million | $3.9 million | $3.1 million |
| Diluted EPS | $(0.03) | $0.10 | $0.08 |
Management attributed the fourth-quarter deterioration to widespread political and economic instability, trade-war concerns, lower demand, product mix and other factors affecting utilization and manufacturing costs.
Liquidity, capital expenditures and debt
- Cash and cash equivalents were $16.5 million at December 31, 2018, compared with $44.4 million a year earlier.
- Short- and long-term investments totaled $22.8 million, resulting in total cash, cash equivalents and investments of $39.4 million, down from $77.0 million.
- Working capital was $99.8 million, compared with $117.9 million in 2017.
- Operating cash flow was $3.2 million; investing cash flow was $(30.8) million, including $40.5 million of capital expenditures; financing cash flow was $0.2 million.
- Property, plant and equipment increased to $82.3 million from $46.5 million, primarily because of construction and equipment for new China manufacturing sites.
- No borrowings or letters of credit were outstanding at year-end under the new $10 million Wells Fargo secured revolving facility, which expires November 30, 2020. A $1 million letter-of-credit sublimit is available.
- The company states that it believes cash and investments are adequate for operating needs over the next twelve months, but cautions that lower sales or continued relocation spending could accelerate cash usage.
Material changes versus the prior comparable period
- Annual revenue grew modestly, but fourth-quarter revenue declined sharply from both the preceding quarter and the prior-year quarter.
- Annual gross margin improved because of better raw-material and InP margins, although substrate gross margin declined modestly and Q4 gross margin fell substantially.
- Net income attributable to AXT declined despite higher revenue because operating expenses increased and noncontrolling interests received a larger share of consolidated subsidiary earnings.
- Operating cash generation weakened substantially as inventories, prepaid expenses and other operating assets increased.
- Capital spending nearly doubled to $40.5 million, supporting the relocation and expansion of GaAs and Ge production.
- Foreign-currency translation reduced accumulated other comprehensive income by approximately $5.7 million.
- The company adopted ASC 606 revenue recognition in 2018 with no significant effect on accumulated deficit or cash flows.
Guidance, outlook, risks and unusual items
- No specific numerical financial guidance is provided in the filing. Management expects to complete the GaAs and Ge relocation in 2019 and expects approximately $21 million of AXT investment in the new facilities; JinMei expects to invest approximately $2.5 million to $3.5 million.
- Customers were qualifying wafers from the new manufacturing sites before placing volume orders. Delays or failures in qualification could reduce revenue and damage customer relationships.
- The relocation requires additional permits and approvals and could disrupt production, reduce yields or cause loss of key employees.
- All wafer substrates are manufactured in China. A 10% U.S. tariff applied beginning approximately September 24, 2018, with an estimated initial impact of about $150,000 per quarter; management warns tariffs could rise to 25% and that broader trade restrictions remain uncertain.
- Severe air pollution caused intermittent government-ordered shutdowns totaling ten days in the first quarter of 2018. Similar shutdowns, environmental enforcement or hazardous-material regulations could affect AXT and its supply-chain affiliates.
- Raw-material pricing and supply-chain joint-venture performance remain volatile. Unconsolidated joint ventures generated a $1.1 million equity loss in 2018, and a $295,000 raw-gallium inventory write-down was recorded in the first quarter.
- The Sumitomo patent license expired December 31, 2018. Renewal was under review at filing, and 2018 royalty expense was $565,000.
- Series A preferred stock carries a 5% cumulative dividend. Accrued preferred dividends were $2.9 million, and the company has never paid or declared those dividends.
- U.S. federal and state NOL carryforwards were approximately $64.3 million and $0.3 million, respectively, but the related deferred tax assets were fully reserved. Unrecognized tax benefits totaled $14.6 million.
- Management and BPM LLP reported effective internal control over financial reporting and an unqualified audit opinion.
Important facts for investors to verify
- Progress, permits, customer qualifications, production volumes and cash requirements associated with the 2019 GaAs and Ge relocation.
- Whether fourth-quarter demand weakness, trade-war effects and lower utilization persist into 2019.
- Inventory aging, reserve adequacy and the risk of additional write-downs given the $58.6 million inventory balance and $14.8 million excess-and-obsolete reserve.
- Gross-margin recovery, particularly for GaAs substrates and raw materials, and the effect of tariffs and raw-material costs.
- Liquidity after planned capital expenditures, including the company’s ability to maintain adequate cash while operating cash flow remains modest.
- Renewal or replacement of the expired Sumitomo patent license and any related royalty or intellectual-property exposure.
- Environmental shutdown risk and financial condition of the ten China-based supply-chain subsidiaries and joint ventures.