AXT grows revenue an above-expected 5.5% in Q3

For third-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 $28.6m, up 5.5% on $27.1m last quarter and up 1.4% on $28.2m a year ago (and exceeding the $27.5-28.5m guidance).

Fiscal	Q3/2017	Q4/2017	Q1/2018	Q2/2018	Q3/2018
Revenue	$28.2m	$26.3m	$24.4m	$27.1m	$28.6m

Of total revenue, revenue from raw material joint ventures (namely the three companies consolidated into AXT’s results) was $5.8m, level with a year ago but up modestly on $5.5m last quarter as raw material prices remained relatively stable (enabling a contribution to profitability). This has also enabled the seven raw material companies in which AXT has partial ownership (non-consolidated, accounted for using the equity method, and hence contributing to improved profitability) to collectively break even (after Q2 represented their first profit in ten quarters).

Substrate sales were $22.8m, up on $21.6m last quarter and $22.4m a year ago.

InP revenue was again a record, with relative strength in all primary applications, particularly for silicon photonics-based applications such as data-center connectivity as a result of a substantial increase in the volume of global network and data-center traffic that is driving the need for more cost-effective, energy-efficient and high-bandwidth solutions.

“Beyond silicon photonics, PON (passive optical network) applications contributed meaningfully to our record Q3 indium phosphide revenue,” says CEO Dr Morris Young. “As expected, PON sales were down from Q2 following a very strong first half and this is likely to continue through Q4.”

Germanium substrate revenue was a bit down, following several strong quarters.

GaAs revenue grew, driven by semi-insulating substrates, offset somewhat by weaker demand in LEDs. “We are beginning to see more meaningful contribution from Android-based 3D sensing,” Young notes. “To date, this year our revenue has reached nearly $1 from 3D sensing programs in Asia.”

Of total revenue, 72% came from Asia Pacific (up from 67% last quarter), 11% from North America (up from 8%), and 17% from Europe (down from 25%). One customer reached 10% of revenue and the top five generated about 39%.

Gross margin was 37.1%, down from 40.6% last quarter and 39.5% a year ago. “Our substrate products held their own in terms of gross margin, but our three consolidated raw material companies each had a quarter-to-quarter decline, plus the fact that Q2 had about a 1% incremental upside from the sale of material previously written off account for the change from Q2 to Q3,” notes VP & chief financial officer Gary Fischer.

Operating expenses (OpEx) were $6.3m, cut from $6.5m last quarter but up from $5.9m a year ago. “Operating expenses continue to be in line with our run-rate expectations for the year,” says Fischer.

Net income was $3.9m ($0.10 per diluted share), down from $4.4m ($0.11 per diluted share) a year ago but level with last quarter (at the top end of the expected $0.08-0.10 range).

“Revenue and profitability came in at the high end of our expectations, highlighting demand for our products across a diverse set of applications and our ongoing effort to drive efficiencies in our business,” says Young.

Depreciation and amortization was $1.2m. Capital expenditure (CapEx) was $12.7m. Due mainly to the new facility and equipment, cash and cash equivalent investments hence fell during the quarter from $54m to $42m. This was also partly due to net inventory rising from $57m to $58.7m, of which about 51% was in raw materials, 44% in work in process (WiP) and only 5% in finished goods. The increase in inventory is partly due to the ramp up of AXT’s new GaAs and Ge manufacturing manufacturing facilities in Dingxing (being relocated from Beijing).

For fourth-quarter 2018, AXT expects revenue to fall slightly to $26.5-27.5m, with raw materials flat but substrate revenue typically a bit down. “There’s a general softness on the LED side,” says Fischer. “Based on the discussion with customers in this space, we expect a softness in our traditional lighting, signage and display applications to persist in Q4,” says Young. “In semi-insulating things are a bit soft as well,” he adds.

“We remain confident in a gross margin going forward of around 37.5%,” says Fischer. “However, in this Q4 we believe we will be lower than that [about 35%] as a result of a drag from the three raw material companies that we consolidate, as well as some year-end inventory adjustments. Net income per share will be $0.05-0.07.

“In the tariff list that was released by the US government on 24 September it included wafer substrates that we manufacture and import to the United States. Therefore our Q4/2018 forecast will include approximately $150,000 for tariffs of 10% charge on the importing wafers into the United States from China,” says Fischer. “It has been said that President Trump might raise the rate to 25% in 2019,” he adds. “These amounts are not what we would consider to be dramatic hits, nevertheless they are real and will have an impact going forward unless the two countries can sort out and resolve the trade war issues.”

“Many of the key applications into which we sell appear to be in the early stages of a large and promising lifecycle,” says Young.

“The continued adoption of silicon photonics technology and hypercenter, hyperscale and enterprise data centers, as well as the transition over time to 100G and 400G technologies, will feed the need for indium phosphide for years to come,” believes Young. “In addition to data-center connectivity, the current infrastructure upgrade cycle and preparation for 5G in telecommunication applications are providing opportunities in short-haul, long-haul and metro deployments. As another data point for the expected growth in this application, Intel announced in Q3 that it has begun assembling a new portfolio of 100Gb/s silicon photonics transceivers that are optimized to meet the bandwidth requirement and the environment conditions of 5G communication infrastructure,” he adds. “The industry move to 5G, along with a ramp in existing network traffic for services such as video streaming, is likely to strain the existing communication infrastructure. As a result it will need to support an expanded spectrum range over time, driving demand for more efficient solutions.”

“PON applications should provide significant opportunities for our indium phosphide product over many years. Driving the demand is the ongoing need for faster broadband networks and increasing fiber-to-the-home [FTTH] requirements,” adds Young.

Regarding germanium substrate revenue, AXT say that, overall, the satellite industry is expected to continue its positive strength, providing upside opportunities in the quarters to come.

“We are also encouraged to see new emerging applications that could contribute to our growth for years to come,” says Young.

“Although the commercialization of the [3D sensing] technology in the Android ecosystem is still in its early stages, we expect that revenue will ramp slowly over the course of 2019 and into 2020, as new devices come to market,” says Young. “In addition with the technology performance of our wafer and the solid progress we are making in relocating our gallium arsenide production line, we're positioning ourselves to expand beyond Android in the coming years,” he adds. “Applications such as augmented reality and virtual reality (AR/VR), 5G wireless, LiDAR for autonomous cars, retinal recognition and many others are emerging and will require the performance characteristics adaptability [indiscernible] that offers.”

“Most recently we have seen rising demand for gallium arsenide in high-power fiber lasers that supplement traditional cutting, welding and drilling tools for industries, micro fabrication, aerospace and defense applications. The stringent technical specifications for these high-end applications continue to serve to severely limit the number of companies that can provide substrates to meet global demand. And importantly, as demand for these application increases, AXT will be uniquely positioned through our current capacity expansion to accommodate the growing requirement of our customers,” says Young.

“As such, the relocation of our GaAs manufacturing line is providing us the opportunity to plan for growth in our industry and to prepare our business to meet increasing customer demand. We continue to make good progress on the new facilities and are pleased by our success to date.”

By the end of 2018, AXT expects to have relocated about 60% of its wafer production and to be close to completion by mid-2019. “We are now well underway with customer qualifications including all of our major customers,” says Young. “Further, our internal qualification results to date demonstrate consistent specification across our sites, which gives us the confidence that those remaining customers who require qualification will find quality levels that are on par with substrates made from our current facility.”

See related items:

AXT’s revenue grows 11% in Q2

AXT’s Q1 revenue falls 7.2% 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

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