AXT Inc

Good afternoon, everyone, and welcome to AXT's third quarter 2021 financial conference call. Leading the call today is Dr. Morris Young, Chief Executive Officer, and Gary Fisher, Chief Financial Officer. My name is Catherine, and I will be your coordinator today. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you'll need to press star 1 on your telephone. Please be advised that today's conference is being recorded. I would now like to turn the conference over to Leslie Green, Investor Relations at AXT. Please go ahead.

Thank you, Catherine, and good afternoon, everyone. Before we begin, I would like to remind you that during the course of this conference call, including comments made in response to your questions... We will provide projections or make other forward-looking statements regarding, among other things, the future financial performance of the company, market conditions and trends, including expected growth in the markets we serve, emerging applications using chips or devices fabricated on our substrates, our product mix, our ability to increase orders in succeeding quarters, to control costs and expenses, to improve manufacturing yields and efficiencies, to utilize our manufacturing capacity, the growing environmental health and safety and chemical industry regulations in China, as well as global economic and political conditions, including trade tariffs and restrictions. We wish to caution you that such statements deal with future events, are based on management's current expectations, and are subject to risks and uncertainties that could cause actual events or results to differ materially. These uncertainties include but are not limited to overall conditions in the markets in which the company competes, global financial conditions and uncertainties, COVID-19 and other outbreaks of contagious disease, potential tariffs and trade restrictions, increased environmental regulations in China, market acceptance and demand for the company's products, the financial performance of our partially owned supply chain companies, and the impact of delays by our customers on the timing of sales of their products. In addition to the factors that may be discussed in this call, we refer you to the company's periodic reports filed with the Securities and Exchange Commission. These are available online by link from our website and contain additional information on risk factors that could cause actual results to differ materially from our current expectations. This conference call will be available on our website at AXT.com through October 2022. Also, before we begin, I want to note that shortly following the close of the market today, we issued a press release reporting financial results for the third quarter of 2021. This information is available on the investor relations portion of our website at AXT.com. I would now like to turn the call over to Gary Fisher for a review of our third quarter results. Gary?

Thank you, Leslie. Good afternoon to everyone. I want to begin by letting you know that in response to investor requests and to align with our peers as well as to provide better clarity on our operational and financial results, we will be providing non-GAAP financial results beginning with our Q3 reporting. Non-GAAP results exclude stock option compensation, stock-based compensation. Following commentary, I'll also include GAAP results for your reference. investors can find GAAP to non-GAAP reconciliation tables in our earnings announcement. Today, we are pleased to report that total revenue for the third quarter of 2021 was $34.6 million, up from $33.7 million in the second quarter of 2021, and up 36% from the $25.5 million in the third quarter of 2020. Q3 marks our seventh consecutive quarter of growth and highlights the increasing demand for indium phosphide and gallium arsenide substrates. Of our total revenue, substrate sales were 26.2 million in Q3, compared with 24.9 million in the second quarter of 2021, and 20.3 million in Q3 of 2020. Revenue from our two consolidated raw material joint ventures was 8.4 million in Q3, down from 8.8 million in Q2 2021, and up from 5.2 million in Q3 of 2020. In the third quarter of 2021, Revenue from Asia Pacific was 76%, Europe was 14%, North America was 10%. Again in Q3, no customers reached 10% of revenue and the top five customers generated approximately 25% of total revenue. Our continued revenue diversity demonstrates that our growth is not overly dependent on one large customer or application. This is another factor contributing to our confidence growth has reached a point of sustainability and will continue throughout 2022. Non-GAAP gross margin in the third quarter was 33.8% compared with 36.4% in Q2 of 2021 and 34.8% in Q3 of 2020. For those who prefer to track results on a GAAP basis, gross margin in the third quarter was 33.3% compared with 36.3% in Q2 of 2021 and 34.6% in Q3 of 2020. The sequential decline in gross margin was primarily driven by low margin sales at Gen May, one of our consolidated joint ventures. Gen May has been selling materials at a preset price to several customers under long-term contracts. The recent rise in galleon pricing eroded the gross margin on those sales. The overall impact to the consolidated gross margin in Q3 was approximately 220 basis points. At least one of those contracts expired in Q3, but we expect some continued pressure on gross margin in Q4 as a result of additional contracts that are coming to conclusion. The rise in raw material pricing also impacts our cost of goods sold on the substrate side of the business. However, this has been offset by the contribution to our profitability that our partially owned supply chain companies provide. It is a unique and important aspect of our supply chain strategy. As we look ahead, we believe that our increasing volume Improving product mix and continued improvement in manufacturing efficiency will allow us to drive continued gross margin improvement as we progress through FY22. This will be a primary focus for us over the coming quarters. Total non-GAAP operating expense in Q3 was $7.7 million. This compares with $7.4 million in Q2 of 2021 and with $5.9 million in Q3 of 2020. On a GAAP basis, total operating expense was 9.1 million. This included 1.5 million in stock comp, of which 518K is non-recurring. For comparison, total GAAP operating expense was 8.3 million in Q2 of 2021 and 6.6 in Q3 of 2020. R&D is one of the primary drivers of the increase in our OpEx. We have two major programs that are ongoing. the development of 6-inch indium phosphate, and the development of 8-inch gallium arsenide. In addition to R&D, we continue to make necessary investments to enable our IPO in China, which we believe will be significantly beneficial to AXT and our shareholders. Non-GAAP operating profit for the third quarter of 2021 was $4.0 million, compared with non-GAAP operating profit in Q2 of 2021 of $4.9 million, and $2.8 million in Q3 of last year. For reference, GAAP operating profit for the third quarter of 2021 was $2.4 million compared with an operating profit of $3.9 million in Q2 of 2021 and an operating profit of $2.2 million in Q3 of 2020. Non-operating other income and expense for the third quarter of 2021 was a net gain of $1.4 million. This included a net gain of $1.1 million from the partially owned companies in AXT supply chain accounted for under the equity method. It also included a tax credit in China, totaling approximately $960K in Q3. In addition, we continue to be very well regarded in KaZou and have positive relationships with the local government, which has been beneficial to our operations. In Q3, we received two grants from the local government, totaling $1.0 million for our facilities investment in the region. As we look ahead to Q4, we do not expect our results to benefit from either a tax credit or grants. As such, we expect our EPS in Q4 to come down from Q3. Our Q3 results included approximately $338K in tariffs as a result of the 25% tariff charge on importing wafers into the United States from China. For Q3 2021, we had a non-GAAP net income in the third quarter of 2021 of $5.4 million or $0.13 per share compared with $5.4 million or $0.12 per share in the second quarter of 2021. and with $1.0 million or $0.04 per share for the third quarter of 2020. On a GAAP basis, net income was $3.8 million or $0.09 per share. This is a bit lower than we forecasted as a result of the lower gross margin contribution from June-May. By comparison, net income was $4.4 million or $0.10 per share in the second quarter of 2021 and $1.0 million or $0.02 per share in Q3 of last year. The weighted average diluted shares outstanding in Q3 of 2021 was $42.7 million. Cash, cash equivalents, and investments were $56 million as of September 30th. By comparison, at June 30, it was $58.5 million. We do continue to feel good about our cash balance. Depreciation and amortization in the third quarter was $1.8 million, and capital investments were $6.1 million. Net inventory at September 30 increased by $1.8 million in the quarter and ended at $60.7 million. Ending inventory consisted of approximately 44% in raw materials, 50% in work in progress, and 6% in finished goods. This concludes the discussion of our quarterly financial results. Let me give you a brief update and comments about our plan to list our company in China on the star market in Shanghai. We are working closely with our China investment banker and our China law firm handling the IPO transaction. They have some experience in this, as they are also helping another NASDAQ listed company now. There are many details involved in this process. As compared to an IPO in the NASDAQ, the number of small details is greater. We hope to submit our application in Q4. That is a credible goal, but it is by no means easily accomplished. Our teams have been responsive and working hard on all topics, and we continue to make good progress. So in conclusion, we have now had three consecutive quarters of revenue over $30 million level, and we see continued opportunity on the horizon. I'll now turn the call over to Dr. Morris Young for a review of our business and markets. Morris has been in China since July and will remain there for five to seven months. So last year, he and I were both in China, for this call and I can tell you it's hard to get up in the middle of the night. So Morris was awake and at the office at his 3 a.m. and has been waiting for this call today. So Morris, take it over.