AXT, Inc. 2019 Q3 Form 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, and sells related raw materials. Manufacturing is conducted in China, with customers primarily in international markets. The filing covers the three and nine months ended September 30, 2019, and was filed November 8, 2019.
AXT deconsolidated Beijing JiYa Semiconductor Material Co., Ltd. on March 11, 2019 after reducing its ownership from 46% to 39% and losing control; the retained investment is accounted for under the equity method. AXT also acquired the remaining 3% of JinMei in May 2019, making it wholly owned.
Key Financial Metrics
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Revenue | $19.8 million | $28.6 million | $64.8 million | $80.2 million |
| Gross profit | $5.8 million | $10.6 million | $21.0 million | $31.2 million |
| Gross margin | 29.0% | 37.1% | 32.3% | 38.9% |
| Operating income (loss) | $(0.5) million | $4.3 million | $2.5 million | $12.8 million |
| Net income (loss) | $(0.5) million | $4.1 million | $0.2 million | $11.9 million |
| Net income (loss) attributable to AXT | $(0.9) million | $3.9 million | $(0.6) million | $10.7 million |
| EPS attributable to AXT | $(0.02) | $0.10 | $(0.02) | $0.27 |
Q3 revenue comprised $16.0 million of substrates and $3.9 million of raw materials and other products. The top five customers represented 40% of Q3 revenue and 41% of nine-month revenue; Landmark represented 16% of Q3 revenue and 14% of nine-month revenue.
For the nine months, operating cash flow was $7.3 million versus cash used of $0.2 million in the prior-year period. Capital expenditures were $14.0 million, primarily for new facilities and equipment. Cash and cash equivalents were $27.8 million at September 30, 2019, and total cash and investments were $38.5 million, compared with $39.4 million at December 31, 2018.
Debt consisted primarily of a $5.6 million Bank of China loan outstanding at September 30, 2019, borrowed against a $5.8 million facility and due in August and September 2020 unless renewed. A separate $10 million secured U.S. revolving credit facility had no outstanding borrowings or letters of credit. Operating lease liabilities totaled $3.0 million, including $0.3 million current and $2.7 million long term.
Material Changes Versus the Prior Comparable Period
- Q3 revenue fell 30.7%, and nine-month revenue fell 19.1%, due primarily to lower semiconductor demand, global economic weakness and trade and political tensions.
- Substrate revenue declined 30.0% in Q3 and 16.4% for nine months; raw-material revenue declined 33.3% and 29.7%, respectively.
- Gross margin declined to 29.0% in Q3 from 37.1%, reflecting lower volume and higher manufacturing costs, particularly for gallium arsenide. Nine-month gross margin declined to 32.3% from 38.9%.
- Q3 operating results moved from $4.3 million of operating income to a $0.5 million loss. Nine-month operating income declined from $12.8 million to $2.5 million.
- Equity in losses of unconsolidated joint ventures was $0.2 million in Q3 and $1.7 million for nine months, compared with nominal income or losses in the prior-year periods. The nine-month amount included a $1.1 million impairment of a 25%-owned Chinese germanium investment.
- Cash flow improved year over year, aided by an $8.3 million reduction in inventories and $12.3 million of net proceeds from investment maturities and sales, but liquidity also benefited from $5.8 million of new borrowings.
- AXT adopted ASC 842 on January 1, 2019, recording approximately $1.1 million of right-of-use assets and lease liabilities without a material impact on earnings or cash flow.
Guidance, Outlook, Risks and Unusual Items
Management stated that it expected to spend approximately $21 million on new facilities in 2019 and intended to complete the majority of the gallium arsenide and germanium relocation during 2019, while customer qualification would extend into 2020. JinMei expected to invest approximately $2.5 million to $3.5 million in new facilities during 2019. Management believed existing cash and investments were adequate for operating needs over the following twelve months, but warned that lower sales could reduce operating cash flow and require additional capital.
- Relocation of gallium arsenide and germanium production to Dingxing and Kazuo could cause production disruption, higher costs, lower utilization, employee loss or customer qualification delays.
- All wafer substrates are manufactured in China. U.S. tariffs on Chinese imports increased to 25% in May 2019, with additional tariff and trade restrictions possible.
- Chinese environmental, hazardous-material and air-pollution regulations may lead to inspections, production restrictions or mandatory shutdowns.
- Demand is exposed to semiconductor industry cycles, economic slowdown, customer inventory levels, pricing pressure and competition from lower-cost silicon-based technologies.
- Supply-chain investments in Chinese raw-material companies remain exposed to commodity prices, operating losses, environmental compliance and impairment risk.
- Foreign-exchange exposure remains significant, particularly to the renminbi and Japanese yen. AXT recorded an $85,000 foreign-exchange gain for the first nine months of 2019.
- Inventory reserves for excess and obsolete inventory were $16.0 million at September 30, 2019, up from $14.8 million at year-end 2018.
- Preferred stock dividends accrued but unpaid totaled $2.9 million. The company has never declared or paid dividends on the Series A preferred stock.
- The Sumitomo patent royalty agreement expired December 31, 2018; Sumitomo requested renewal, which AXT was evaluating.
- Management reported effective disclosure controls and no material changes in internal control over financial reporting during the quarter. Ordinary-course legal proceedings were not expected to have a material adverse effect.
Most Important Facts for Investors to Verify
- Whether semiconductor demand and customer orders recover after the 2019 downturn, particularly for InP and GaAs products.
- Progress, costs, permits, production yields and customer qualifications associated with the Dingxing and Kazuo relocations.
- Whether gross margins recover from the 29.0% Q3 level as utilization improves and relocation costs moderate.
- The repayment or renewal terms for the $5.6 million Bank of China borrowings due in 2020 and the availability of the unused U.S. credit facility.
- Potential additional impairments or losses from AXT’s Chinese raw-material investments and the adequacy of inventory reserves.
- The financial effect of tariffs, trade restrictions, environmental regulations and potential Chinese manufacturing shutdowns.
- Customer concentration, including Landmark and the top five customers, and the collectibility of accounts receivable.