Leslie Green - IR Gary Fischer - CFO Morris Young - CEO.

Jorge Rivas - Craig-Hallum Capital Group.

Good afternoon everyone and welcome to AXT's First Quarter 2015 Financial Conference Call. Leading the call today is Dr. Morris Young, Chief Executive Officer and Gary Fischer, Chief Financial Officer. My name is Viki and I will be your coordinator today. Today's call is being recorded.

I would now like to turn the call over to Leslie Green, Investor Relations for AXT. Please go ahead..

Thank you, Viki.

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 and our ability to control costs and improve efficiency, increase orders in succeeding quarters, improve our competitive position as the market improves, as well as the other market conditions and trends.

We wish to caution you that such statements deal with future events and 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 market in which the company competes, global financial conditions and uncertainties, market acceptance and demand for the company's products, and the impact of delays by our customers on the timing of sales and products.

In addition to factors that may be discussed in this call, we refer you to the company's periodic reports filed with the Securities and Exchange Commission and available online by link from our website for 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 April 30, 2016. Also before we begin, I want to note that shortly following the close of market today, we issued a press release reporting financial results for the first quarter of 2015. The 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 Fischer for a review of the first quarter results.

Gary?.

Thank you, Leslie, and good afternoon. Revenue for the first quarter of 2015 was $20.1 million compared with $19.6 million in the fourth quarter of 2014. In the first quarter of 2015, revenue from North America was 17%, Asia Pacific was 58% and Europe was about 25% of total revenue.

No customer generated more than 10% of revenue during the first quarter and the top five customers generated approximately 35% of total revenue. As a side note, last year in Q1 2014, the top five customers generated approximately 39% of total revenue.

So our trend line regarding customer concentration illustrates success in diversity of both products and customers. Gross margin in the first quarter was 23.7% compared with 25.4% of revenue for the fourth quarter of 2014. Total operating expenses in the first quarter were $6.5 million compared with $5.6 million in the prior quarter.

Of our total operating expenses, SG&A expenses were $5.3 million compared with $4.3 million for the fourth quarter of 2014. As we had guided to you in our last earnings call, we incurred approximately $1.2 million in additional legal and professional expenses in Q1 as a result of the audit committee review, which was completed in February.

In Q4, we had $600,000 of the same legal and professional expenses for this matter. This matter has been closed and we do not expect any further expenses relating to it in future quarters. Total stock compensation expense was $274,000 for the first quarter 2015, of which $5,000 was included in cost of sales, $225,000 in SG&A and, $44,000 in R&D.

Operating loss for the first quarter of 2015 was $1.7 million compared with $592,000 loss in the fourth quarter of 2014. If you factor out the $1.2 million for legal and professional expenses, our operating loss in this recent quarter would be above $400,000.

Similarly our Q4 operating loss included $600,000 for legal and professional expenses, and without it we would have been at breakeven. The $400,000 spread is basically a somewhat reduced gross margin in the recent quarter. Net interest and other for the first quarter was a gain of $930,000.

This net number consists of five categories, and let me read them of to you; number one, foreign exchange gain of $180,000; number two, sales of IntelliEpi stock for a gain $368,000; number three, net interest earnings on our $47 million in the bank of $97,000; number four, equity earnings from our unconsolidated joint ventures, a gain of $200,000; and number five, other income of $85,000.

Net loss in the first quarter of 2015 was $1.2 million or $0.03 per diluted share compared with $311,000 or $0.01 per diluted share in the fourth quarter of 2014.

Cash and cash equivalents with maturities of less than three months, short-term investments and other investments in high grade debt securities with maturities of less than two years, was $47.5 million as of March 31, 2015. Accounts receivable net of reserves were $18.8 million at March 31, compared with $17.9 million at December 31.

Net inventory was $39.5 million compared with $38.6 million as of December 31. Of this, approximately 50% is raw materials, 43% is work in progress and only 7% is finished goods. Inventory is up $900,000, but finished goods in down $500,000. So it means raw materials and WIP are up and this is intentional on our part.

Depreciation and amortization in the first quarter was $1.4 million and CapEx was $773,000. We also used cash in Q1 to repurchase our stock, and the cash used was $617,000. So, this concludes our financial overview. I will now turn it over to Dr. Morris Young for a review of our business..

Thank you, Gary. As a result of major changes in our business over the last two years, the revenue composition of AXT looks very different today than they did three years ago.

Now more equally spread among our five product groups, including semi-insulating and semi-conducting gallium arsenide substrates, indium phosphide substrates, germanium substrates and our raw material joint ventures.

Each diversity has helped AXT mitigate some of the challenges we have experienced and provides exciting opportunities in a number of emerging applications for our products. And this is especially evident in indium phosphide.

For the first time in AXT’s history, indium phosphide sales in Q1 now outpaced semi-insulating and semi-conducting gallium arsenide and germanium substrates, showing healthy growth from the prior quarter. As many of you are aware, we have been investing in indium phosphide substrate for some time.

During 2014, we began to see real world in both new and existing applications, including fiber optic lasers, detectors, solar applications and data center connectivity.

For example, fiber-to-home network requirement actively occurring across the Asia-Pacific region, Singapore and Taiwan and nearly in completion of nationwide fiber networks, while network deployment is in the earlier stage in countries such as Australia, New Zealand and China.

In China alone, plan is to have 200 million homes connected by the end of 2015. Compared to gallium arsenide, indium phosphide has greater barrier to entry limiting the competitive landscape, notably indium phosphide must be manufactured and at high pressure conditions and is a more difficult compound for crucible.

Further, it is the usual property that enables unique performance characteristics; also create challenges in terms of meeting the stringent requirement for the application in which it is used.

We at AXT, have worked collaboratively with our customers to overcome these challenges and have developed a robust proprietary manufacturing processes over time. During Q1, semi-insulating gallium arsenide was our second largest subsidiary contributor.

Mobile phones continue to use this material in their power amplifier function as do a number of applications outside of mobile, such as radar, defense and WiFi. We continue to apply resources to gain market share in all of these areas and hope to drive renewed growth this year. Now turning to semi-conducting gallium arsenide.

The fierce competitive landscape changes and general weakness in certain geographic markets continue to be a headwind for us. We are a key player at high-end of the market for applications such as backlighting, signage and automotive, where the application specifications are more stringent.

However, we are consciously stepping away in many cases with highly competitive low-end opportunities, where pricing pressure would damage our corporate gross margin performance and devalue our product at high end. As such, we’re taking a conservative view of the semi-conducting gallium arsenide market in the near future.

With regard to germanium substrates, over the last few quarters, the stalling of the CPV market caused a drop in our sales of this product. However, the satellite solar market has been very consistent and we are expecting to see modest improved in CPV demand this year.

Looking a little bit further out, SpaceX has reportedly recently received $1 billion in funding from Google and Fidelity Investments to support this plan to deliver 100s of micro satellites into a low orbit around the globe for wireless Internet access. This is likely to drive increased demand for germanium substrates over the next several years.

Finally, we had a strong quarter in Q1 for our raw material joint ventures. Despite the fact that pricing remains slow, we do not expect any major changes in the pricing environment in the near term but demand is certainly growing.

Further, it is worthwhile to note that we established our first joint venture in 1999, and since then, have built our portfolio up to ten suppliers of critical materials. Throughout that time, these joint ventures have provided us with profitable revenue and additional benefits to our vertically integrated business model.

As demand continues to grow; our joint ventures will ensure that we have adequate supply for the business opportunity we pursue. In closing, our goal is to take advantage of developing market conditions in our business. Gallium arsenide has stabilized and addresses a market with numerous applications and dynamic opportunities.

Indium phosphate is growing and while its growth may be somewhat lumpy quarter-by-quarter, we think we are out in front with this material. We are currently investing in ways to capitalize on the expected demand.

And finally, we have lowered our cost structure, which should enable us to be competitive in the market, while maintaining healthy business model. The combined effect of all these is that we are excited about opportunities ahead and have a renewed optimism about our directions and prospects. This concludes my comments on the business.

I will now turn the call back to Gary, for our second quarter guidance.

Gary?.

Thank you Morris. Looking to the second quarter, we are expecting revenues to trend up, and our range is $20.5 million to $21.5 million. We are expecting the bottom line to be in the range of breakeven to a loss of $0.01, using 32.5 million diluted common shares outstanding.

This concludes our prepared comments, but Morris and I would be glad to answer any questions that you might have.

Operator?.

Thank you. [Operator Instructions] Our first question from Edwin Mok with Needham & Company..

Hi guys, this is Arthur [ph] filling in for Edwin.

I had a quick question about your cost structure, I know you said you had the lowered the cost structure, could you provide some more color on sort of the margins going forward, if we can expect this cost structure to stay steady or maybe you continue to have improvements?.

Well, Arthur, I think we -- near term, we're a bit conservative, I think the margins will be in the maybe you know low 20s. As the volume grows that helps our margin and other variable is the product mix. We get a higher profit margin, for example, on indium phosphide than we do on germanium.

So, there is enough variables that we’re not sure we can confidently give guidance pass Q2. We feel like there is some positive developments and tailwinds. So, we’re encouraged, but it’s too soon to be specific..

Okay, that’s helpful..

Yeah. I think I can chime in although I am not a financial guy, but I think we did heavily – we had our forced reduction in Q1 of last year. I think we’ll lower our costs quite a bit and we are also making our efficiency higher -- yield higher.

So, I don’t know if you recall, last year, our breakeven point we said was $23 million of revenue and around 25% gross margin, okay. Now, I think if you look at our operating model, I think we probably can breakeven somewhere around $21 million to $21.5 million revenue and so that I think is an efficiency improvement and cost reduction effort..

Excellent, great to know. So then, my second question is also about kind of your gross margins. I know you have alluded to the fact that it was 24.7% last quarter and now it’s dropped to 23.6% [ph].

Can you try some more color on maybe some guidance or some sort of trend you see in the near quarters?.

Probably can’t say much more than we just did. We think it’s going to be in the low 20s again in the -- in Q2. We think there are some market developments that could give us tailwind in the second half but it’s too soon to be sure. We’re continuing to work on cost efficiencies, yield efficiencies, productivity tools.

So, there is actions being taken, but we don’t want to get your expectations up prematurely. So, we have to work at it and do our jobs..

All right, thank you. And then my next question is about sort of the different lines of business that you have.

Obviously, the SI Gas and the SC Gas, can you give some more information on sort of the directional change that you might expect going forward? I know you mentioned that gases are going to stay steady but and do a bit more about the raw materials and also the germanium substrates?.

I think specifically for the next quarter, Gary, we do expect from our booking or we do expect germanium to be trending up next quarter..

Modestly, yes..

Modestly. I think it’s going to trend up modestly..

LED, which is the semiconducting, that’s just a tough market. We tend to try and play on the high end of the market and we haven’t sort of put on the boxing gloves that do get out in the low end and we do think -- I mean, that’s about the raw materials. The raw material business is still good.

We’ve got a good network of companies and they sell some to us and some to the open market, but the open market demand is okay, it’s good..

It is good. However, there is no sign of price increase as of yet. So, although our revenue is growing, so, you can say the capacity -- we’re selling out everything we can make, but because of the pricing pressure, our revenues are just as it is..

Thanks. And my last question is about indium phosphide.

Could you help me kind of understand some of the drivers behind the growth that you’ve experienced in this segment?.

Well, first of all, our customer usually don’t tell us what they’re using it for. Some of them they do talk to us, for instance, [indiscernible]. They do talk to us about it and we do get a lot of market research. For instance, we know the fiber-to-the-home is a big project for China, seven year, seven and a half year development.

So, we think that’s a big driver and data center is definitely hot, but I think it’s still early its development. So, I think that the usual indium phosphide are the lasers, the detectors..

Okay, thanks. That’s very helpful. Operator [Operator Instructions] We’ll go next to Jorge Rivas with Craig-Hallum Capital Group..

Hello, guys, this is Jorge sitting in for Richard. Thanks for taking my question. So, I’ll start with indium phosphide first. So, it seems like maybe now for indium phosphide in the optical industry, it could be a significant driver for your business, given that there are more and more data centers coming through for underworld.

So, I’m wondering if you can share some of the dynamics in the market. I believe you have said it in the past that you’re one of only three players. So, I’m wondering if you can share with us what’s your -- just a general sense of market share and also about customer concentration. A - Morris Young Yeah, that’s a good question.

Indium phosphide is a -- first of all, I want to say, I always believe the indium phosphide. I mean, it’s a wonderful material although it’s very difficult to work with.

I don’t want to get too technical about it because it is a difficult material to work with, but there is really no market study -- believable market study, which shows how big the market size is and who is the major player. I know who the major competitors are.

I mean, there are two Japanese competitors other than us, no more and how big they are, because I think we’re growing so fast, it’s really difficult to say where we are.

We are certainly -- I believe we’re growing faster than the market and we certainly hear a lot of good things from our customer comments our good quality as well as -- now remember, we come back to the VGF advantage again. In gallium arsenide, we saw a loss at advantage because everybody reverted back to VGF.

So we don't have product differentiation anymore later in the marketplace, but indium phosphide we still do. And so I think we are cautiously optimistic. We are doing the best we can.

We also had, by the way, a very good development team who work with our customers and their very stringent specification requirement should win the final customer applications. So I think we are very excited about this business opportunity..

Jorge, this is Gary. I think we hope to see some market studies. I think because it's a market that's somewhat in its infancy, there is just not a lot of hard data about market size. If we have it, we'd be glad to share.

So we can only share anecdotally and talk about our customer experience and the feedback we get, but it isn't -- the compound that Morris has been fascinated by for a long time and he has always believed that there is a future in it and we are seeing some evidence of that now..

Yeah, it's definitely a great market and you guys seem to be very well positioned for that but how about customer concentration? How would you characterize your customer base? Would you say you have 1,000 customers and then is there any type of concentration risk there?.

Well, we are sitting here with large customers, absolutely. But also the diversification of customer base is fairly sizable too. I mean, how would you estimate the number of customers we have in indium phosphide? Including universities, it could be in the 50s..

Yes.

You mean indium phosphide or do you mean the total customers for the products?.

For indium phosphide..

But what is he asking about?.

He ask it for indium phosphide..

Yeah, indium phosphide..

I think we have a few very large customers, but we also have many, many diverse customer base, that's for sure. But also because these – again, this market is developing very fast. So we have quite a few irons in the fire which we hope to win later on this year that can further diversify our customer base.

And the large customer I think is going to poise to grow us well..

Yeah. One of the trends is that, if you go back in time, a lot of the customers were universities and then material was being used for research. So now there are more companies in commercial production is the material, which would be -- that's a good sign. .

Thank you. That's very helpful. And then we frequently ask this question, it's about gallium arsenide pricing. Wondering if you can give us a general sense of the pricing environment. I read your press release, you stated that gallium arsenide is stabilizing.

So I wonder if this is more of a factor of demand or is it a supply basis, it's also kind of being more balanced now and seeing some improvement there.

Wondering if you can share your view on that and also what you think it’s – what rate of improvements in the near future and I think a challenging area for you in the past couple of years, but it would be a driver of your business, I am sure. .

First of all, let me clarify.

I think you mean the wireless arena, right?.

No, actually on the gallium arsenide raw material..

Gallium raw material..

I'm sorry, gallium pricing. Yeah..

Gallium pricing, yeah, last year -- right now it's close to $200 a kilogram. I mean I think beginning of the year it was still I believe around $240. So it dropped down a clip [ph], but again I keep on saying, it's probably dropped to the bottom now. But I think the demand surprisingly is fairly strong.

We cover some on the margin side, because I think we are -- our joint venture partner, they are improving their efficiency. So I think it's a good equilibrium. There is a lot of demand for gallium. Their estimated annual usage for gallium now is more than 500 tons. And I remember --.

Per year..

Per year. And I remember about four or five years ago with only 200 tons a year. So you can see, there is a lot of diverse applications for gallium, include gallium arsenide, gallium nitride, solar cell as well as strong magnet and petroleum refining catalysts et cetera, et cetera.

So I think gallium is a rising material, but the pricing is low, hopefully steady..

Okay. And then one last question and I’m sorry if I missed this on your prepared remarks. But did you say that indium phosphide was your largest segment this quarter..

In the substrate business, yes..

Okay, in substrate. Okay, alright, that's all from me guys. Thanks a lot..

Thank you..

It appears there are no further questions at this time. Dr. Morris Young, I would like to turn the conference back to you for any additional or closing remarks..

Thank you for participating in our conference call. This quarter we will be presenting at the DA Davidson Conference in New York on May 27. As always, feel free to contact us, Gary Fischer and Leslie Green directly if you would like to meet with us. We look forward to speaking with you in the near future..

That does conclude today's conference. We thank you for your participation..