AXT, Inc. (AXTI) Earnings Call Transcript & Summary

Good afternoon, everyone, and thank you for joining us today. Leading today's conference call is Dr. Morris Young, Chief Executive Officer; and Gary Fischer, Chief Executive Officer. My name is Norma, and I'll be your coordinator today. I would now like to turn the call over to Leslie Green, Investor Relations for AXT. Please begin.

Thank you, Norma, 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 and risks 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 expectations. This conference call will be available on our website at axt.com through January 2023. Also before we begin, I want to note that this morning, before the market opened, we issued an 8-K regarding our formal application to the Shanghai Stock Exchange and an increase in our revenue guidance for Q4 2021. In the 8-K, we also submitted an English version of the Tongmei prospectus, which Tongmei filed with the Shanghai Stock Exchange. All of 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 Morris Young. Morris?

Thank you, Leslie. And good afternoon to everybody. We are very pleased to announce today that we submitted our formal application to list shares of Tongmei, our China subsidiary in an initial public offering on the Shanghai Stock Exchange, the STAR Market. Our application has now been officially accepted for review. This is a very significant achievement and a very important milestone for AXT. As many of you know, we began this process more than a year ago. It is a stringent and thorough process as it should be to vet the most qualified company for listing. Our team along with our Board of Directors has worked tirelessly to assemble what we believe is a very strong application. I am very grateful to each and every 1 of them for their efforts, particularly those both of here as well as in China who worked through the holidays to make this filing possible. We believe this strategic path holds money benefits for AXT as well as our shareholders, our customers and our employees. For AXT, the additional capital will allow us to further strengthen our financial structure, add capacity if needed and enhance our overall positioning in Tier 1 customer opportunities. Now for our shareholders, gaining access to China's capital market give AXT an attractive balance sheet and favorable displays and leverage our consumable assets in China. When we first announced this plan several investors described it as unlocking a hidden asset, and we agree. For shareholders, this is a great opportunity to attempt to achieve substantial benefit to our market value with minimal dilution. For our customers, the additional capital can provide greater confidence in our ability to support at scale to the strong expected demand for our strategic compound semiconductor material. Indeed, it confirms our commitment to these projects and signals our confidence in winning their business and delivering on their requirements. The IPO enhances our business in the view of existing customers and potential customers. And now for our employees, it creates excitement, pride and financial opportunity through applications, participations in a stock purchasing plan and stock option plan. This participation will strengthen retention, motivation, and the commitment to excellence. As we look ahead, the likely timing of the 2022 listing couldn't be better. Then we will talk more about the listing process and time line in a moment. But with our new expanded manufacturing capability, access to China's capital markets later this year, we were aligning perfectly with significant customer interest in our substrates and major technology trends, such as 5G, data center, telecom modernization, health care monitoring, micro LED and laser-based sensing for the metaverse. Many of these trends and customer wins are already beginning to show in our performance. With the increase in our Q4 2021 guidance that we announced today we are expecting revenue growth for 2021 of more than 42% over the previous year. At the same time, our customer concentration in the last several quarters has been at an all-time low level, signaling a broad-based and sustainable demand for our products. As we enter 2022, this trend will continue. Our customer and market momentum remains strong, and we expect to see new applications ramp to volume production this year. Some of you have asked about the possibility of power outages or air quality shutdowns. We continue to monitor any possibility, short-term impact from these issues. But in the meantime, we're seeing clear signs of increasing customer demand for both new and established applications. This coupled with our ability to increase capacity as the market expands put us in a very strong position to continue our healthy growth in 2022. Our STAR Market listing offers the potential to accelerate our success. If completed, the IPO will provide proceeds that will be invested in Tongmei to enable us to expand capacity to capture high volume opportunities across our portfolio and to develop new products to drive incremental growth and value. We believe the next several years will be exciting for our company and our shareholders. As the ground work we have laid allows us to maximize our business potential. I want to thank our customers and our shareholders for their ongoing support as we mark this important moment in our growth and development. With that, I will turn the call back to Gary to discuss IPO timing and highlight some important aspects about filing. Gary?

Thank you, Morris. As Morris mentioned, we announced our intention to pursue this strategic path in November of 2020. Since then, we have completed a number of significant steps in the process to reach this point including a successful $49 million private equity round of financing, the conversion of our Beijing company into a stock issuing company and the merging of 2 of our materials companies, Jin Mei and BoYu into Tongmei. In addition to these major steps, we assembled significant documentation of our business operations, markets and other information related to our leadership and our Board of Directors. All of this resulted in the 500-plus page filing we submitted in the 8-K this morning. Including this main document, we prepared and submitted a total of 67 documents. This was truly a company-wide effort, and I'm so proud of the work that was done by the entire team. And throughout the process, we retained a strong focus on operating our business. One evidence of that is the quarterly growth in revenue we achieved. We also maintained and enhanced our relationships with the local governments, particularly at the new sites of Kazuo and Dingxing. Before I talk about next steps, I do want to highlight for our investors a few items in the 8-K filing that will be new information for you. Probably the most interesting is quantifying substrate revenue by wafer type. As you know, for competitive reasons, we prefer not to be too specific on the revenue breakdown in the last several years. However, the Tongmei filing required that we disclose additional details. Therefore, we're going to resume reporting revenue by substrate types starting today. Please note that our Q4 2021 numbers are not finalized yet, but we have taken Q1, 2 and 3 actual revenue plus the midpoint of our increased guidance for Q4, which is $36.5 million. to provide you a reasonably accurate estimated breakdown of the wafer substrate revenue. We'll report the finalized numbers on February 16, 2022, at our Q4 and year-end earnings conference. For the year 2021, we estimate that indium phosphide will be the largest revenue generator and will be approximately $47.1 million in revenue. Gallium arsenide revenue will be approximately $41.0 million and germanium revenue will be approximately $13.8 million. Total substrate product revenue will be approximately $101.9 million, which is the sum of these 3 wafer types in the substrate product line family. Raw materials will be approximately $34.3 million and total consolidated revenue will therefore be approximately $136.2 million. The Tongmei prospectus stops after Q2 2021 in terms of these breakdowns because Ernst & Young in China needed time to audit what goes into the prospectus. And the numbers can be a little confusing because according to China GAAP, Tongmei's numbers include their sales to AXT, Inc. at the technical intercompany transfer price, which is not the actual ASP to the end customer that we sold the substrate to. Another thing in the prospectus is that typical customers are listed to enable the investors to have a better understanding of the business model. In a few instances, the actual customer name is not disclosed instead it reads as customer A and so on. This is the result of strict confidentiality requirements. As you know, it is difficult for us to specifically know the total available market or TAM for our substrate product line. Sumitomo and Japan Energy do not report on their specific material divisions that we compete with, and Freiberger is a privately owned company. For a third-party opinion, Tongmei utilize market research by Yole, spelled Y-O-L-E, that does a fair amount of market research in this area. There are, therefore, market size estimates and compound annual growth rate projections in the prospectus. Lastly, I want to mention that the prospectus was filed in the Chinese language. Tongmei hired a third-party translation company to produce the English language version that we filed this morning under the 8-K. We think the translation is good. But you may notice that in some instances [indiscernible] written in native English. With the filing now submitted and then accepted, we move into the next phase of the process. Particularly, the China SEC takes a minimum of 6 months to review IPO applications. During that time or at the end of it, we expect to receive a digital request for clarification or expansion. This may require multiple rounds of questions and answers, and for any of which are publicly disclosed in China, we will file an 8-K for transparency here for our U.S. investors. This is likely to be an iterative process, and we hope it is successfully completed. Once the China Stock Exchange authorities complete their review, if we are successful with them, then the application passes to the China SEC, which is called the China Securities Regulatory Commission, known as CSRC. In terms of our ownership, AXT today owns approximately 85.5% of Tongmei after the private equity investment, minority interest ownership and employee ownership. Tongmei is required to sell an additional 10% in the IPO. Our ownership would then be 90% of what it currently is. In addition, Tongmei plans to implement an employee stock option program totaling about [ one half of a percent ]. As such, AXT's expected ownership of Tongmei after the IPO will be approximately 77%. We believe that the IPO will allow us to unlock significant value in our business. In China, semiconductors, materials, and manufacturing businesses are respected and favored and we check all 3 boxes. Investors in China also see meaningful value in our raw material companies, many of which were established more than 20 years ago. And similar to our investors here, investors in China well understand our end markets, and there is considerable excitement and perhaps even greater certainty in China regarding micro LED applications and other high-volume opportunities. In total, we are excited for the strategic opportunity this IPO holds, and we look forward to sharing our progress. Okay. This concludes our prepared comments. Morris and I will be glad to answer any of your questions now. Operator, Norma?

[Operator Instructions] Our first question comes from the line of Hamed Khorsand with BWS Financial.

Just wanted to ask about this revenue guidance that you're providing, was this from new customers? Was this order from test trials that are now becoming commercial runs? Could you just provide a little bit more insight as to what developed in the quarter that caused this revenue to increase from what you first projected?

Sure, Hamed. Yes, I think the order comes in -- especially in the last 1.5 months, I think it was pretty strong. So in a way, we didn't get the signal at the time we made our Q4 projection in last October. But as far as where are these customers coming from. I think it's all over. I mean, indium phosphide is obviously very strong, but it comes from both data center as well as potential new customers. I think they are trying to -- we think they are trying to preempt a trial run for the beginning of next year. And the gallium arsenide it's pretty strong as well. And lastly, even germanium, we have a very busy quarter as we think there's a lot of satellite launches happening right now.

Was any of the order flow you saw [indiscernible] where you were at risk of seeing some downflow in '22?

Well, we think the order seems to be strong and will continue into 2022. Yes, we did say that. However, we put a little bit question mark as we go through the rest of the winter season, as you know, winter usually is a taxing environment for weather in Beijing area as far as electricity supply. But our customer demand certainly seems to be very strong in terms of asking for us to deliver products. And one phenomenon, Hamed, as we always say, that in the past, we normally don't have a very good early visibility for our next quarter or even for next year. And as we come along I think in the last few quarters, we have increasing visibility for our businesses. So we do see 2022 should be a strong growth year for AXT.

Okay. And lastly, Gary, I remember you talked about capital expansion needs to keep up with demand. How does that look with this IPO proceeds? Are you going to use the cash to rebalance the company because you got to be spending before the proceeds arrive? Or how do you -- what is the plan with that cash?

Well, the plan for the IPO cash is definitely as Morris described, which is for future growth. And in the meantime, we are feeling in the marketplace, we're hearing from our customers that there is capacity constraints with our competitors. And that may be one reason why our own revenue was a bit higher. But we're also feeling some capacity constraints. So we won't wait for the IPO money, but we will be engaging in some capacity expansion and things like that starting in Q1.

Yes. No, so what I was saying was, are you going to lending Tongmei money for the CapEx expansion now, so then you receive the proceeds later? How does the balance sheet look like given that you're doing this IPO, but then you're spending before the proceeds arrive?

That's a good question. We have several alternatives, and we're putting together our financial plan. Frankly, we've been quite busy on the topic that we're addressing today. So normally by now, we would have put together an operating plan for 2022, but it's still in draft version, and there's a number of alternatives that include lending money to Tongmei or providing collateral security for a loan that Tongmei gets from a bank, there should be cash generated from the income statement because we're expecting to be profitable. So it's a mixture. And that's about as precise as I can be right now because it's still in a fluid form.

Yes. If I may add some more comment is, I think we are seeing in the marketplace, I mean, everybody knows that the market demand is strong. I think compound semiconductor, it flows into, for instance, [indiscernible], there is a strain in the supply chain. Gallium fortunately, is still quite a bit of supply, but the price is up, has risen up considerably compared to last year. And germanium price is up, but there's no constraint yet. But phosphorus is other constrained material. So it's almost everywhere we see the supply chain seems to be strained and there's a lot of demand from the end customers.

[Operator Instructions] Our next question comes from Richard Shannon with Craig-Hallum.

Congratulations on both of your announcements today. Maybe I'll ask the first question on the STAR Exchange listing process here you talked about, Gary, I think you mentioned at least 6 months before reply and then some back and forth after that. What advice have your advisers given you about the kind of the rounds? How long the rounds after the initial comments come back? And how long that could take? And if they've given you any advice as to whether there's a difference between the experience of China companies doing this and then U.S. NASDAQ-listed companies going through the process?

I'm not aware that there's going to be any difference in that regard. Morris may have some insight and he can comment. We're not in the same room, so I can't point to him and say what do you think, but the -- I don't -- we don't expect it to be that we just wait for 6 months and then get a long list of questions and comments. We expect to get comments on questions sooner than that, and it would be cyclical and iterative. But how soon, we don't know.

Yes. I guess in a way, if I may want to give color, I think perhaps is that I've gone through IPO process in United States that we did our secondary offering, we usually lock into a room and we ready our prospectus. And we review it and we do it 2 or 3 times and then we finally come up with the document, we submit it. And usually, that's it. But in China, I think every 1 of these number needs to be challenged. In other words, if you have a certain product, if you have better margin then they want to ask why, can you defend that? If you have worse margin, they want to understand why you're doing that? Are you just stuffing the channel and then make the revenue instead of trying to make a profit. And they worry about other things like they look at my last 2 years bank account statements from 7, 8 banks that I use and they question about where do I spend the money? And is there any fraudulent scheme that I may want to pay my customers to fortify some revenue. I mean I'm just taking this as an example, so that you can see the process of examining this detailed level is very, very detailed. And so although we already done it for the last 9, 10 months, and we have spent a lot of time at making sure the documents are all okay, including whether we fulfill all the regulatory requirements. It's our -- or our facilities, do they own it? Do they rent it? And what's the revenue is like? And so they scrub everything down. So -- but you never know even if they spend so much time to scrub it down, they could develop a question that then they want answers. And that could be we need to spend time with them and our lawyers in China as well as the bankers in China will help us to develop proper answers. And hopefully, most of the answers we can get it through quickly. But some of the examples we may have is that there are companies ahead of us which went public and took them about -- well, they have a special case, but it took them almost a year to get through the examination period from the Shanghai Stock Exchange.

Yes. So Richard, what Morris just said is a good illustration of that I don't think we're treated differently because the parent company is a U.S. company. Tongmei is basically a China company, and it's viewed as a China company that was formed in 1998. It has over 1,350 employees. It has a broad product line and many, many customers. So -- but the process in China, as Morris just described, is much more cautious. In some ways, we're asked questions for us that were like, look, we've been a public company in the United States for -- since 1998. So transparency is part of the requirement in the United States. And so we get asked questions that we think is -- this is kind of a big use of our time for something that really isn't very relevant for us. But nevertheless, we do it. And so I think the answer is we're being treated just like all the other companies, which is that they drill down a lot and pay a lot of attention to the details that probably don't matter in our opinion.

Okay. Fair enough. My last question here is on the go forward here. As you look into [ 2020 ], on your last conference call, you talked about the expectation to be able to grow, and I believe the numbers you threw out were 15% to 20% this year. Obviously, with your pre-announcement in the fourth quarter here that base from which to grow would be higher, is that still a range that you think is very achievable this year?

Although this is [ not ], I would think so, although I haven't gone to it to review it. I mean -- but the order patterns seemed to be fairly strong towards the end of the year, and we think this is going to continue. So I think we should be able to grow that for 2022. What do you think, Gary?

Yes. I mean those are conservative numbers in our view. We don't want to overstate, but there's enough activity and heat out there that I think those numbers could be viewed as conservative. But you know us, we'd rather show you and do it then just talk about it. So we have to stand by and see how things mature.

The other thing is we usually don't have very good forward visibility. The normal advice we give our shareholders is that we don't know what our next quarter look like until our conference call, not to mention for the rest of the year. But recently, we have much, much better visibility. I think because the market we address are larger market. And also if you take indium phosphide for instance, in the past, we only have data center and PONs market, right? Or even before that, was only PON and telecom market. But now you add that to the silicon photonics and plus the wearables and health care. And the latest excitement, I mean, we still need to investigate a little bit further is we hear that metaverse needs indium phosphide to track high movement. So we think this is a multi-facet growth engine behind some of the product we're offering to the market. And in gallium arsenide, it's about the same thing. I think although we are sort of disappointed about VCSEL didn't turn out to be a big market for us, well, and because demand didn't really materialize. But the high-power laser is a very surprise market growth for us. And most recently, is the power amplified market. I mean we hear our customers are just they demand a much higher volume from us, but we're still contemplating to see how we're going to increase our capacity quickly for that market. And lastly, micro LED, don't forget, I mean we've been talking about it for about a year now. We're starting to ship sample volumes. And before you know it, it's become really volume drivers.

And I'm currently showing no further questions at this time. I'd like to hand the conference back over to Dr. Morris Young for any closing comments.

Thank you for participating in our conference call. As always, please feel free to contact me, Gary Fischer or Leslie Green directly if you would like to set up a call. I look forward to speaking with you in the near term in the future.

This concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day.