30 April 2018

AXT’s Q1 revenue falls 7.2% after China government-ordered factory shutdown days

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For first-quarter 2018, AXT Inc of Fremont, CA, USA – which makes gallium arsenide (GaAs), indium phosphide (InP) and germanium (Ge) substrates and raw materials in Beijing, China – has reported revenue of $24.4m, down 7.2% on $26.3m last quarter and below the initially forecasted $26-27m.

Fiscal	Q1/2017	Q2/2017	Q3/2017	Q4/2017	Q1/2018
Revenue	$20.6m	$23.6m	$28.2m	$26.3m	$24.4m

Of total revenue, $5.1m came from raw material, down 12% on $5.8m last quarter, due mainly to weakness with one of the firm’s raw material joint venture businesses. “We are seeing a price increase in raw gallium but, because of the prolonged decline in gallium raw material pricing, this particular joint venture has continued to struggle,” says CEO Morris Young.

Substrate sales contributed $19.4m, down 5.4% on $20.5m last quarter.

“The shortfall to our guidance given on 21 February was a result of government-ordered mandatory factory shutdowns in Beijing, caused by severe air pollution that occurred late in the quarter,” notes VP & chief financial officer Gary Fischer. From 27 February to 31 March more than 300 manufacturing companies were intermittently shut down for a total of ten days (30% of the calendar days in this period). “Periodic shutdowns are not uncommon, but the concentration of shutdowns at the end of the quarter was unusual,” comments Young.

The shutdown affected sales in every substrate category, although InP revenue was down only slightly, less than for GaAs and Ge.

In spite of this, Q1/2018 revenue was still up 18.4% on $20.6m a year ago. “We continued to see positive demand for AXT products,” notes Young.

Of total revenue, revenue from North America was 8%, Asia Pacific was 66% and Europe was 26%. Again, just two customers generated more than 10% of revenue (one for GaAs and one for InP), while the top five customers generated about 38% of total revenue, reflecting continuing diversification of both products and customers.

Due to good manufacturing yields and a favorable product mix (with higher-margin InP revenue falling less than that for GaAs and Ge), gross margin has risen further, from 30.5% a year ago and 37.2% last quarter to 39.2%.

Operating expenses were $5.6m, cut from $6.1m last quarter but up from $4.9m a year ago.

Net income was $2.9m ($0.07 per diluted share), down from $3.1m ($0.08 per diluted share) last quarter but up from $0.7m ($0.02 per diluted share) a year ago. This was within the $0.07-0.09 per share guidance range - despite the revenue shortfall – due to continued operational execution.

Depreciation & amortization was again steady at $1.1m. Capital expenditure (CapEx) has risen back up from $4.7m last quarter to $11.8m. Accounts receivable (net of reserves) fell from $22.3m to $21.3m.

During the quarter, cash and cash equivalents and investments fell from $77m to $67m, due to spending on the firm’s new GaAs manufacturing facility in Dingxing, China (about 90 miles south of the existing Beijing plant).

“Regarding our Dingxing facility, we completed the first phase of facilitization, installed wafer processing equipment and produced initial wafers that can be used for qualification,” says Young. “This was a much anticipated milestone for our investors and an important indication of our progress in the relocation of our gallium arsenide manufacturing [from Beijing to Dingxing],” he adds.

Net inventory rose from $45.8m to $51.1m (consisting of 50% in raw materials, 47% in work-in-progress, and 3% in finished goods). “Both WIP and raw materials increased, and this is intentional as we see raw material prices increasing and as we build inventory during the relocation,” notes Young.

Regarding further government-ordered mandatory factory shutdowns in Beijing: “To help mitigate the issue going forward, we are adjusting our operating procedures to build more units to forecast rather than building to order,” says Young. “There is no Chinese New Year holidays in China in Q2, so we are getting off to a good start,” he adds. “We are also adding capacity to indium phosphide and gallium arsenide to allow us more flexibility to ramp production as needed. Finally, we are working closely with the local government in Beijing and appreciate their responsiveness.”

Despite continued weakness from the gallium raw material joint venture, for second-quarter 2018 AXT expects revenue to rise to $25.5-26.5m (due to growth for all substrates – GaAs, Ge and InP), with net profit of $0.07-0.09 per share.

“We are seeing a recovery in the PON [passive optical network] market… 2018 will be a growth year. This is likely due to growing international demand, particularly in China as well as new technologies in the PON arena and emerging new applications such as business groups, 5G backhaul and in building networks,” says Young.

Despite this, InP revenue is expected to grow less strongly than recent quarters due to some near-term market softness in silicon photonics applications for data-center connectivity, after it became apparent that the main customer had more inventory to rebalance. “We are likely to see a stronger second half for our indium phosphide business for data-center applications,” believes Young. “Our market position and customer relationship in this application remains solid and we are encouraged by the fact that most experts see a long and bright future for silicon photonics,” he adds. “By many analysts accounts, the technology has passed the tipping point, with silicon photonics-based products now shipping in volume and successfully competing with more established technologies. Silicon photonics resolves key issues such as latency, bandwidth, power dissipation and signal integrity, which is critical in hyperscale cloud and large enterprise data centers. Silicon photonics will continue to see an increasing role in the optical component market, with most of the key components and modules suppliers actively participating and the growing interest for semiconductor foundries.”

“5G wireless applications are also likely to provide opportunities for silicon photonics,” believes Young. “At the Mobile World Congress this year, several key suppliers demonstrated 100G optical transceivers designed specifically for 5G in short-haul and metro deployment. Other potential meaningful applications for indium phosphide include high-performance computing, medical, autonomous cars, aeronautics and defense… we are selling into many emerging applications that are working towards volume productions or are in the early stage of it,” he adds.

Regarding gallium arsenide, AXT continues to focus on high-end applications where its vertical gradient freeze (VGF) process technology can produce substrates for the most challenging specifications, including wireless devices, thin-film solar cells, in processors, virtual and augmented reality, retinal recognition and automotive sensing as well as more traditional markets for high-end lighting (e.g. in automobiles, signage and displays). “We continue to provide strong support to one of our LED customers during the quarter [Q1],” says Young. “They rewarded us with an order above our expectation that increases our shipment to them over the next six months,” he adds.

“Low-EPD [etch pit density] requirement in many of these applications limits the number of competitors that can meet the inherently stringent specifications,” continues Young. “These low-EPD applications also provide us an ongoing opportunity to refine our process and improve our yields as we prepare our business for the market adoption of 3D sensing. We are currently selling into a number of development programs which are steadily increasing in their contribution to our revenues. We view this as a positive indicator of the opportunity with a number of end customers,” he adds. “While AXT is not yet participating in the largest example of mass production for consumable commercialization of 3D sensing technology, we view the increasing adoption of 3D sensing as opportunity for high-end substrate manufacturers because of the stringent technical requirements of the technology. That provides a strong barrier to entry to new lower-end players. Today, only three competitors including AXT are capable of providing low-EPD substrates in sufficient volume for production ramp.”

“Our focus now is to further enhance our own readiness to support increasing demand for very low-EPD wafers as the technology is commercialized by multiple end-customers in the mobile market and beyond. As a result, we are taking the appropriate conservative view that our revenue for 3D sensing applications in 2018 will come primarily from development programs. However, that opportunity for selling into production-level 3D sensing programs beginning 2019 is very exciting. AXT will continue to ramp up our capacity for these applications over the course of 2018, preparing our business to support broad-based customer demand.”

“Our process technology has enabled us to produce low-EPD substrates for the emerging 3D sensing application, signifying an important early step in a long-term opportunity for our business,” says Young.

“We are pleased with these accomplishments and believe our continued progress positions us very well for the balance of the year and beyond.”

Regarding germanium substrates, Young says that the demand environment for satellite solar cells remains positive. “We will see growth in this area of our business in 2018. AXT is one of only two suppliers into this market and our VGF substrates perform very well in one of the most unforgiving environments for specialty materials.”

“We continue to make progress with our strategic plan preparing our business for a number of exciting opportunities unfolding in 2018 and beyond,” summarizes Young. “We are expanding indium phosphide capacity to meet future demand for our products and we are executing a methodical staged relocation of our gallium arsenide manufacturing.”

See related items:

AXT lowers Q1 revenue forecast from $26-27m to $24-24.5m after China government-ordered factory shutdown days

AXT’s Q4/2017 revenue grows a more-than-expected 30% year-on-year, driven by InP and Ge

AXT’s revenue grows 19.5% in Q3, driven by record InP sales

AXT appoints Wilson Lin as chief operating officer

AXT’s revenue rises 14.6% in Q2

AXT’s Q1 revenue exceeds original guidance after faster-than-expected recovery from fire

Tags: AXT GaAs substrate InP Germanium

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