AXT, Inc. Form 10-Q Summary
Reporting period: Quarterly and year-to-date periods ended June 30, 2015; comparisons are with the three and six months ended June 30, 2014. The filing is unaudited. AXT develops and manufactures compound and single-element semiconductor substrates, including GaAs, InP and germanium wafers, and sells related raw materials. Manufacturing is conducted in China.
Financial Highlights
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Revenue | $21.0 million | $21.4 million | $41.1 million | $40.8 million |
| Gross profit | $4.4 million | $4.2 million | $9.1 million | $6.9 million |
| Gross margin | 20.9% | 19.4% | 22.2% | 16.9% |
| Loss from operations | $0.8 million | $0.5 million | $2.5 million | $2.9 million |
| Net income attributable to AXT | $3,000 loss | $319,000 income | $1.0 million loss | $1.7 million loss |
| Operating cash flow | Not separately provided for the quarter | Not separately provided for the quarter | $252,000 | $2.6 million |
- Q2 revenue declined 2.0%, primarily because of weaker substrate demand, particularly in the LED market. Higher InP demand for fiber-optic lasers and data connectivity partially offset the decline.
- Year-to-date revenue increased 0.7%, driven by InP and raw-material sales, while GaAs LED-related demand remained weaker.
- Gross margin improved because of lower raw-material costs, product mix and cost-reduction initiatives.
- Operating expenses increased to $5.2 million in Q2 and $11.7 million year to date. Year-to-date SG&A included higher professional fees related to the related-party investigation; research and development also increased.
- Q2 net income benefited from $626,000 of other income, including gains on investment sales, but this was insufficient to offset the operating loss, taxes and preferred dividends.
- Cash and cash equivalents were $28.6 million at June 30, 2015. Short- and long-term investments totaled $17.6 million, producing total cash, cash equivalents and investments of approximately $46.3 million.
- Total assets were $158.2 million and total liabilities were $15.1 million. The filing reports no outstanding borrowings; liabilities primarily consisted of accounts payable, accrued liabilities and royalty obligations.
- Inventory was $38.9 million, including an $11.4 million reserve for excess and obsolete inventory. Accounts receivable was $19.3 million, net of allowances.
Material Changes Versus the Prior Comparable Period
- Q2 revenue decreased $439,000, while six-month revenue increased $280,000.
- Q2 gross profit increased $225,000; six-month gross profit increased $2.3 million, with year-to-date gross margin rising 5.3 percentage points.
- Year-to-date SG&A increased $1.9 million, including approximately $1.2 million of investigation-related professional services and increased stock-based compensation.
- Year-to-date research and development expense increased $868,000 due to higher product development, testing and personnel costs.
- Equity earnings from unconsolidated joint ventures declined to $410,000 in Q2 and $610,000 year to date, primarily because of lower raw-material selling prices.
- Other income increased to $626,000 in Q2 and $1.3 million year to date, mainly because of realized gains from sales of investment securities.
- Operating cash flow fell to $252,000 from $2.6 million, reflecting the net loss, investment gains and working-capital changes.
- The company repurchased approximately 353,000 shares in Q2 and 583,000 shares year to date for approximately $904,000 and $1.5 million, respectively. Approximately $3.5 million remained available under the $5.0 million program.
- Capital expenditures increased to $2.2 million year to date from $600,000 in the prior-year period.
Outlook, Commentary, Risks and Unusual Items
- Management stated that existing cash and investments were adequate to meet expected needs for the next 12 months, but weaker sales could accelerate cash usage and require additional capital.
- Demand remained pressured in LED-related markets, while InP applications were expanding. Semiconductor-industry cyclicality, pricing pressure, customer order delays or cancellations and facility underutilization could adversely affect revenue and margins.
- AXT relies substantially on international sales and China-based manufacturing and supply-chain operations. Foreign-exchange movements, trade restrictions, economic conditions and Chinese regulatory changes are material risks.
- China added gallium arsenide to its hazardous-substances list. A required permit to continue manufacturing GaAs wafers was under review at the Beijing municipal authority as of the filing. Failure to obtain the permit could require production stoppage, employee furloughs and customer losses.
- The company disclosed an Audit Committee investigation into historical related-party transactions involving former China Operations President Davis Zhang. The investigation found no intentional misconduct, improper benefit or financial-statement inaccuracies, but identified previously undisclosed transactions. AXT incurred approximately $1.8 million of related professional fees.
- Related-party exposures included approximately $1.7 million of long-term notes receivable and $2.0 million of payables to an equity-investment entity. Investors should review the nature and governance of these transactions.
- Contractual obligations totaled $2.8 million, including $639,000 of operating leases and $2.1 million under a royalty agreement. No purchase orders with cancellation penalties were outstanding.
- Product warranties generally extend for 12 months; accrued warranty liabilities were $668,000 at June 30, 2015.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Investor Verification Checklist
- Verify the status and potential operational impact of the pending Chinese GaAs manufacturing permit.
- Assess whether InP growth can offset continuing weakness in GaAs LED-related demand and declining raw-material prices.
- Review the sustainability of the improved gross margin and the effect of capacity utilization, product mix and pricing.
- Reconcile the sharp decline in operating cash flow and monitor inventory, receivables and the $11.4 million excess-and-obsolete inventory reserve.
- Review the disclosed related-party transactions, investigation costs, governance approvals and continuing related-party balances.
- Evaluate liquidity available in U.S. versus Chinese entities; approximately $10.6 million of foreign-held cash and investments would not be available in the United States without U.S. income-tax consequences.
- Consider customer concentration, foreign-exchange exposure, Chinese regulatory risk, semiconductor cyclicality, alternative silicon technologies and potential Nasdaq listing risk.
- Confirm the impact of investment-sale gains and other non-operating items on reported earnings and determine whether they are recurring.