AXT, Inc. 2018 Q3 SEC Filing 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. All manufacturing operations are in China, supported by a partially owned supply-chain network. The Form 10-Q covers the three and nine months ended September 30, 2018; the filing was dated November 7, 2018.
Financial Performance and Position
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Revenue | $28.6 million | $28.2 million | $80.2 million | $72.3 million |
| Gross profit | $10.6 million | $11.1 million | $31.2 million | $24.7 million |
| Gross margin | 37.1% | 39.5% | 38.9% | 34.1% |
| Income from operations | $4.3 million | $5.2 million | $12.8 million | $8.9 million |
| Net income attributable to AXT | $3.9 million | $4.4 million | $10.7 million | $7.0 million |
| Diluted EPS | $0.10 | $0.11 | $0.26 | $0.18 |
Q3 revenue increased 1.6%, while nine-month revenue increased 10.8%. Substrate revenue rose 1.9% in Q3 and 9.8% year to date; raw materials and other revenue rose 0.6% in Q3 and 15.1% year to date. Nine-month growth was driven principally by higher demand for InP, Ge and semi-conducting GaAs substrates, increased pBN crucible volumes and improved purified gallium pricing.
Q3 gross profit declined 4.7% and gross margin fell 240 basis points, primarily because of higher fixed overhead and raw-material costs and lower average selling prices. For the nine months, gross profit increased 26.4% and gross margin expanded 480 basis points due to favorable product mix, higher volume, improved yields and manufacturing efficiencies.
Operating expenses increased 6.6% in Q3 and 16.7% year to date. Selling, general and administrative expense increased to $4.6 million in Q3 and $13.8 million for the nine months; research and development expense increased to $1.7 million and $4.6 million, respectively. Q3 operating margin was approximately 15.1%, versus 18.6% in the prior-year quarter; the nine-month operating margin was approximately 15.9%, versus 12.3%.
For the nine months, operating activities used $0.2 million of cash, compared with $8.0 million provided in the prior-year period. The principal working-capital use was a $14.6 million increase in inventories. Investing activities used $25.6 million, including $34.3 million of capital expenditures. Financing activities provided $0.1 million.
At September 30, 2018, cash and cash equivalents were $18.0 million, short-term investments were $21.9 million and long-term investments were $1.9 million, for total cash and investments of approximately $41.9 million, compared with $77.0 million at December 31, 2017. Inventories increased to $58.7 million from $45.8 million. Property, plant and equipment increased to $74.8 million from $46.5 million, primarily reflecting construction and equipment purchases.
Total liabilities were $25.7 million. Debt consisted primarily of a $0.3 million bank loan drawn under a secured $2.9 million ICBC credit facility, due in September 2019. The filing also reports a $10 million Wells Fargo revolving line of credit entered into on November 6, 2018; no amount had been drawn as of November 7, 2018.
Material Changes Versus the Prior Comparable Period
- Revenue growth moderated sharply in Q3 compared with the nine-month trend, while Q3 gross margin and net income declined year over year.
- China revenue increased 42.6% in Q3 and 46.4% year to date, while Japan revenue declined 44.2% in Q3 and 27.4% year to date; Europe revenue declined 21.2% in Q3.
- Cash and investments declined substantially because of capital spending, inventory growth and other operating uses. Capital expenditures for the first nine months more than doubled to $34.3 million from $16.6 million.
- AXT increased its ownership of JinMei from 83% to 97% through purchases of minority interests, including $1.2 million payable after completion of the subsidiary’s relocation.
- Equity losses from unconsolidated joint ventures improved to $21,000 for the nine months from $1.4 million in the prior-year period, which included a $313,000 impairment charge.
- Foreign currency translation generated a $5.5 million year-to-date other comprehensive loss, versus $2.4 million of other comprehensive income in the prior-year period.
- The company adopted ASC 606 revenue recognition and other accounting updates in 2018 without a significant effect on the financial statements.
Guidance, Outlook, Commentary, Risks and Unusual Items
Management stated that it believes 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 guidance range for the next quarter or full year.
- AXT is relocating its GaAs production line from Beijing to Dingxing and Kazuo, China, and also relocating its germanium production line. Management expects to complete the GaAs relocation in the first half of 2019.
- Estimated AXT relocation costs are $40 million to $50 million, including amounts already paid, with expenditures extending into 2019. Additional relocation costs for two joint ventures are estimated at $2 million to $4 million and $3 million to $4 million.
- Customers may need to re-qualify products manufactured at the new sites. Delays, failed qualifications, permitting issues, employee-retention problems or production disruptions could materially reduce revenue and margins.
- U.S. tariffs imposed in September 2018 created an estimated initial impact of approximately $150,000 per quarter; the filing states tariffs were expected to increase to 25% in January 2019. Further trade restrictions remain uncertain.
- Severe air pollution caused intermittent government-ordered shutdowns totaling ten days during the first quarter of 2018. Future shutdowns, environmental regulation, hazardous-material permitting and power interruptions remain material risks.
- Inventory included reserves of $14.4 million for excess and obsolete inventory. Management noted that lower gallium prices resulted in a $295,000 inventory charge at a consolidated raw-gallium company in the first quarter of 2018.
- Accrued preferred-stock dividends were $2.9 million. The Series A preferred stock carries a 5% cumulative dividend, although no dividends have been declared or paid.
- One customer represented 16% of Q3 revenue and 13% of nine-month revenue; the top five customers represented 39% and 36%, respectively.
- The company reported no material pending legal proceedings and no off-balance-sheet financing arrangements.
Most Important Facts for Investors to Verify
- Progress, total cost and timing of the Dingxing and Kazuo facility relocations, including required permits and customer qualifications.
- Whether inventory growth converts into revenue and cash, and whether additional inventory or warranty charges are required.
- Gross-margin trends after considering raw-material prices, tariffs, product mix, utilization and relocation-related overhead.
- Cash burn, capital-expenditure requirements, access to the Wells Fargo and ICBC facilities, and the ability to fund relocation commitments without additional equity or debt.
- Customer concentration, order trends and demand in InP, GaAs, Ge and 3-D sensing applications.
- Exposure to China environmental shutdowns, trade restrictions, foreign-exchange movements and regulatory changes affecting hazardous materials.