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

Arthur Su - Needham and Company Richard Shannon - Craig Hallum Tom Sepenzis - Northland.

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

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

Thank you, Derrick, 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 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 results or events 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 of 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 and available online via 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 October 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 third quarter of 2015.

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 Fischer for a review of the third quarter results.

Gary?.

Thank you, Leslie. Good afternoon. Revenue for the third quarter of 2015 was $18.4 million compared with $21.0 million in the second quarter of 2015. This is below our expectation of $19.5 million to $20.5 million and the shortfall was largely in our raw materials business which dropped from Q2 by over $1.3 million.

As Morris will describe in a moment, our gross margins were stronger than Q2 and the shortfall did not ripple to the bottom line. In the third quarter of 2015, revenue from North America was 10%, Asia Pacific 66% and Europe 24%.

In the third quarter we had two customers that generated more than 10% of revenue and the top five customers generated about 45% of total revenue, reflecting again our diversification of both products and customers. Gross margin in the third quarter increased to 25.1% from 20.9% for the second quarter of 2015 as a result of favorable product mix.

Total operating expenses in the third quarter were $5.3 million compared with $5.2 million in the prior quarter. Total stock comp expense was $311,000 of which $5,000 was included in cost of revenues, $260,000 in SG&A, and $46,000 in R&D.

The operating loss for the third quarter of 2015 was $711,000 compared with $780,000 operating loss in the previous quarter. Other income for the third quarter was $753,000.

This net number consist of four categories; foreign exchange gain of $359,000, equity earnings of our unconsolidated joint ventures of 167,000 gain, net interest earnings on our $45 million in the bank of 102,000, and other items that add up to about $125,000.

For Q3 of 2015, we are pleased to show a profit of $42,000 which compares with a net loss of Q2 of $3,000. Accounts receivable net of reserves were $17.1 million at September 30, 2015, compared with $19.3 million at June 30, 2015. Net inventory decreased in the quarter and ended at $38.1 million compared with $38.9 million at June 30.

Ending inventory consisted of approximately 53% in raw materials, 40% in work in progress, and 7% in finished goods. This is very close to the spread in Q2 as well. Depreciation and amortization in the third quarter was $1.4 million, and CapEx was coincidently also $1.4 million.

We also used cash in Q3 to repurchase our stock, and this amount of cash used was $733,000. Through the end of Q3 we have now spent approximately $2.3 million this and have repurchased a total of 891,000 shares.

Cash and cash equivalents with maturities of less than three months, short-term investments and other investments in high grade debt securities was $45.4 million as of September 30, 2015 compared with $46.3 million at the end of June 30, 2015. This concludes the financial review, I will now turn it over to Dr.

Morris Young for a review of our business..

Thank you, Gary. This is an interesting time for AXT. As many of you know, our business has undergone tremendous transformation over the last several years, a direct reflection of the transformation in our industry. This has been particularly true in the wireless segment.

Today, our revenue composition is vastly different than it was three years ago and it continuously evolved with the rise of new technologies, new applications for compound semiconductor substrates and more stringent customer requirements.

In fact, over the last four quarters, our total revenue has appeared relatively flat, but these results [indiscernible] a growing shift within our base towards indium phosphide which has surpassed both semi-insulating and semiconducting gallium arsenide substrates as the single largest segment of substrates in our sales.

Our year-over-year revenue growth rate for the last two years in indium phosphide has been more than 50% per year. This shift is significant because indium phosphide is a specialized material used in strenuous environments and requires tight specifications. The competitive landscape is limited with the number of meaningful barriers to entry.

As a result, it commands a premium value and a stable pricing environment. Its growth as a percentage of revenue has a disproportionally favorable impact on our results. This was evident in Q3. As softness in other parts of our business caused us to fall short of our revenue guidance, but we outperformed our bottom line guidance to achieve breakeven.

In the last two years the primary driver in the demand for indium phosphide has been optoelectronic devices for fiber optic communications and passive optical networks. More recently, data center connectivity is gaining momentum as the strong driver for indium phosphide demand.

With dramatic transformation occurring in the data center to accommodate the growing requirements of cloud, mobility, big data and Internet of Things. Silicon photonics is rapidly emerging as a key enabler for high-speed, high-performance connectivity within server racks, between rows and across the data center.

Intel, Cisco, HP and IBM are all actively investing in the technology and its ecosystems and making significant progress in bringing it to market. We also see a driver for six-inch indium phosphide substrate in the next generation of wireless communications.

The 5G networks which the industry believes could come as soon as year 2020 promise speeds of up to 40 times faster than 4G to enable among other things the ultrahigh definition video on mobile devices. It is also likely to offer greater network intelligence to manage the emerging complexity of Internet of Things.

As such, we expect to see frequencies up to 28 GHz, which will be challenging for silicon or even gallium arsenide nitride support. Indium phosphide is a natural choice because it has the properties to enable the increasing requirements of 5G and its lower in cost and power consumption than gallium nitrate.

Over the last three years, we have invested in both our technical capabilities and our in-house expertise in order to expand our competitive differentiation, provide cost benefits and help our customers to optimize the benefit of indium phosphide.

In addition, with our acquisition of Crystacomm, we are the only company in the industry to offer both VGF and LEC crystal growth technologies, which is giving us the flexibility to serve customers with varying technical requirements.

The Crystacomm equipment is being installed in our Fremont, California facility and we're currently in the process of bringing up, the crystal growth and poly-synthesis processes.

With quality products and deep expertise, we continue to growth our indium phosphide customer base amongst a number of customers who have recently had the major wins in Taiwan and we're ramping up shipments with some of the largest indium phosphide happy [ph] customers in Europe.

We’re also in qualification with a major customer in Japan and we are just completed qualification with a large client in United States. We expect to see revenue wavering on over the coming months from these customers and many of whom are expanding their own capacity in anticipation of growing demand and new applications.

In total, our indium phosphide pipeline is robust and we're confident in our ability to continue to drive healthy revenue growth. Tuning to the gallium arsenide.

We’re pleased to announce today that they we acquired production equipment for gallium arsenide wafer polythene and processing and handling equipment from Hitachi Metals, which exited its compound semiconductor substrate business in April.

The deal also includes a license of Hitachi Metals’ proprietary wafer processing technology that we will leverage to further enhance our product quality and consistency. So for semi-insulating gallium arsenide, we continue to focus on developing our presence in both mobile and mobile applications.

We believe that the market is relatively stable around its current levels having made a major transition in the past several years, now we are conservative in ways that will forecast this area of our business, we’re making strategic investments such as Hitachi Metals equipment purchase that we believe will position AXT to benefit from new opportunities and new applications for our products.

Now for semiconducting gallium arsenide, the market remains challenging. We continue to pursue higher end applications such as backlighting, signage and automotive. However, we have made a conscious decision not to pursue certain lower end applications as a result of serious competitive landscape in corresponding pricing environment.

As a result, we are planning for continuous softness in this area in Q4. Similarly, as Gary noted, our raw material business was down meaningfully in Q3 as a result of both price and volume decline.

As we look forward into Q4, we expect to see other meaningful decline; this is a reflection of general weakness worldwide in commodities such as copper and oil. Though revenue from our joint ventures have come down this year, they continue to provide us with profitable revenue and additional benefit to our vertically integrated business model.

In closing, AXT has undergone a very important transformation which is a reflection of the evolution of our industry. We have been able to adapt to a changing environment as a result of our diversified product portfolio as well as our ability to scale our products as demand requires.

We are actively investing in our future through focused R&D, technology M&A, the upgrade of our manufacturing infrastructure, and the continued build out of our leadership team. Dr. Hong Hou how joined us at the beginning of Q3, I'm very pleased to see a significant contribution that he has made in the short time as being with AXT.

He and Gary has added tremendous staff and experience to AXT's management team. I believe that exciting business opportunity ahead has allowed us to attract top talent like this and we are just beginning to leverage the full benefit of their expertise.

As we move forward, investors can track our progress in key areas that will ebb and flow over the any given quarter but in total will illustrate our progress towards our strategic direction. Those include total revenue growth, continued growth in indium phosphide, margin expansion and new customer qualifications.

We believe we are making the right investment in our technology, operations and management team to maximize our business opportunity and drive increased value for our shareholders. And this concludes my prepared comments. I will now turn the call back over to Gary for our fourth quarter guidance.

Gary?.

Thank you Morris. As we look ahead to Q4, we expect to see continued weakness in certain areas of our business in keeping with the near-term trends that Morris just discussed. As such, we believe that revenues will be in the range of $17 million to $18 million.

We’re expecting the bottom line to be in the range of a loss of $0.01 to loss of $0.03 per share based on 32 million common shares outstanding. However, the longer-term shift in our business towards indium phosphide coupled with potential new opportunities across our portfolio gives us confidence in our renewed growth in the coming year.

This concludes our prepared comments, Morris and I will be glad to answer your questions now.

Operator?.

[Operator Instructions] Our first question comes from Edwin Mok with Needham and Company..

Hi, Guys. This is Arthur filling in for Edwin. Sorry, he couldn't make it. First question is about your indium phosphide, it sounds like you guys are getting a lot of traction here with some major wins in Taiwan and shipments in Europe. And then last year, you provided service target of half-over-half growth of 50%.

Wondering if there was, if you had sort of a different trajectory or kind of view on the growth going out with all your success in indium phosphide?.

Well, overall, we’re very confident in our growth trajectory, but obviously we don't want to throw a number out there, but as we announced in our script that we have in the last two years, our growth rate has been more than 50% year-over-year for the last two years.

So now, the base is larger and with number of customer wins coming on and we see the environment is really robust..

Great. Sounds good.

So then following up on your press release for your acquisition of the automated processing equipment from Hitachi Materials, is there any way you can help us kind of quantify the financial impact of it, I saw there is a licensing agreement and potentially a manufacturing benefit?.

Well, we generally guided that in this calendar year, we will spend between 4 million and 6 million in CapEx. And so we still think that's about the window that we're coming in, that includes some construction in Beijing, because we're adding a square footage for indium phosphide as well as other kinds of equipment.

So this fits in into the normal kind of capital expenditure for equipment. It's very good equipment, it's going to really add a lot of automated capability for us, it should increase the cycle time, speed it up and we were very fortunate to be selected by Hitachi Metals as the company that they wish to sell this to.

They wanted to be able to make sure that the equipment went to a company that could use it in production and use it to produce wafers for people that they use to provide wafers for..

Yeah. Very good point, Gary. Let me also add on to it is that Hitachi Metals, although they have exited the substrate business, but they want to remain in the gallium arsenide epi business.

So they want to ensure that they have good technology, although they're not doing that part, they want to give it to somebody or sell it to somebody like AXT who is a competent substrate survivor in this business, who will then become their supplier for substrate for their epi business..

Great.

And my last question is regarding your gross margins, great gross margins this quarter, I saw it increased a lot relative to the last quarter, is there a way you can help us kind of think about how gross margins may possibly trend in the coming quarters, if this manufacturing equipment could probably give you a little bit of a boost, also on maybe I thought OpEx is normalizing a little bit, so should we expect it to kind of trend in that manner going forward?.

Well, we do believe that as indium phosphide becomes a greater percentage of total revenue that the gross margin will move upward into the right. But any specific quarter can be impacted by product mix.

So what you're really trying to understand is what to do in your models and what I'm doing on my financial models here at the company is keeping it relatively conservative. I want to see some more quarters go by before I feel confident that it's trending upward into the right. So in the mid-term to long-term, definitely, we expect it will expand.

In the near term, because of some of the other issues in the business such as the raw materials business, we need to be a little bit more conservative..

Great. That's all I have. Thanks..

Good questions. Thanks..

Our next question comes from Richard Shannon with Craig Hallum..

Hi, guys. Thank you for taking my questions here. Maybe a couple of quick questions on the September and December quarters here.

I guess just to help trying to model the revenue segments here, I know you're not giving out specific number like you did in the past, but indium phosphide, did that grow sequentially in the quarter?.

You mean from Q2 to Q3?.

Correct..

Yes..

It did. Okay.

Was it a meaningful number or just trying to get a sense of the modelling here, is it a meaningful number or kind of just a buzz around?.

As we said, last year, in four quarters in a row, it was more than 50% and compared to two years ago, it was yet another 50% growth, but quarter to quarter, because when the business is growing very fast, you cannot just track on one quarter alone, because sometimes the customer will over order and then the next quarter they will slow down.

And then if I were to tell you, how meaningful the growth of last quarter was and you're going to make a trajectory that is going to even have more meaningful growth in Q4, then that's a wrong projection that we won't give you..

Okay. That's fair enough. On the gross margins, obviously you've talked for many, many quarters about indium phosphide being good gross margins, but I think historically raw materials have been and that was obviously down substantially and your gross margins went up.

Have the prices come down and specifically I guess in gallium to the extent to which raw materials is no longer accretive to gross margins?.

Well, raw material, gallium itself is very hard. The gallium price, I don't know if you're checking on, yeah, it's coming down very significantly..

But in aggregate, these companies are still contributing, so you're saying are they accretive, the answer is yes. And to add a little more color about the indium phosphide growth, it was a meaningful growth and I would say it was meaningful enough that even though total revenue was off, we still achieved breakeven..

That's great result. So congratulations on it by the way. Let's see, a couple of more questions. Morris, if you could talk a little bit more about some of the initiatives and engagements you have going on with indium phosphide.

I'm sure I missed some of the detail in your prepared remarks and also can you tell us whether you expect these initiatives to help you gain some share at all in the market that would be great to know..

Sure. I think we've been saying that all along, I mean I think we have invested very heavily in indium phosphide both in terms of recruiting the right people, we have built a fairly sizable technology team in the indium phosphide, which will enable us to do the right technical sales.

We have invested very heavily in terms of our sales network, also that's why it's landing us to the big wins and customer wins. And also I think the overall environment of indium phosphide business, I would say just robust, from what we see, not only we are growing, but also our customers are really having very optimistic future outlooks.

Of course, that’s sort of in certain way, it's very difficult to get numbers around it, because you say we're gaining market share, because the published number of indium phosphide market is really lacking, we don't really know where the overall market is. I believe we're one of the leading indium phosphide producers.

And I think if I may add, now we have the LED technology, although it’s not contributing to our bottom line yet, but we are really a very complete service provider for all indium phosphide requirement for whatever the customer wants..

It’s a little difficult for us to know the TAM, because we are part of the TAM, so competitors won’t necessarily reveal much to us. Anecdotally, we do have a lot of evidence of wins, awards, designing, the qualifications. So we know the TAM is growing and we are growing with it.

We may be gaining market share, but what we really need is something you guys do in the analyst field to get out there and figure this out, because we can’t do it by ourselves. But I think now, it might be a good time for people to look at it..

Absolutely. You know, I think indium phosphide field, we are growing very, very handsomely, but I think, again, we have advantage in VGF, I mean, that gives advantage of the low EPD and better quality and it’s the déjà vu on gallium arsenide again. Remember, we only have three major players in this field and we have a better look at it..

Okay, appreciate those guys. Maybe one last question for me. You mentioned having two 10% customers.

Curious whether either of those are new 10% customers to you and whether either of them is your long-time 10% customers from year's past?.

We don’t know at this point. Again, we should find out, maybe we will find that out..

[indiscernible] were in the past, that’s why I can’t answer that part..

IQE?.

Well, IQE used to be, but - they are one of the large indium phosphide customer, but I don’t know whether they have get into the 10% customer this year..

Okay. Great, I think that’s all the questions for me. I’ll jump out of line guys. Thank you..

Thanks..

[Operator Instructions] We’ll take our next question from Tom Sepenzis with Northland..

Hey, guys, thanks for taking my question.

I think you mentioned just at the tail-end of the call that you expect to return to growth next year, so is that something that would start in March and would it be linear throughout the year? How you think next year in terms of overall growth?.

Well, I think it’s going to accelerate towards the second half of the year. The way I would view this you know, indium phosphide, we have been saying for years, I mean that business was growing, growing, but the pace was small.

Now, it has built the base, but if you give - let’s say, if we achieve - not promising, if we achieve the other 50% growth for indium phosphide, that’s a very meaningful growth. But it would take time..

And did you say that had grown 50% a quarter for the last year?.

Year-on-year, not quarter-on-quarter..

Year-on-year, not quarter-to-quarter, no, nobody can grow that fast..

Right.

But each quarter was up 50% - so basically grew 50% over the last year?.

Over the year, yes..

Okay.

So Gary, Morris, and I must have then falling off a cliff, I guess is the fair way to look at that?.

Yes..

Because it was the vast majority of your revenue a couple of years ago, so -.

Yeah, you’re touching on a key theme there, that’s part of what we are trying describe today was the transformation that’s going on within the product mix, so even though the numbers for the last few years had been relatively flat, what Morris has tried to describe is the change within the numbers and dominated by the indium phosphide progress..

At what point this Gary, Morris and I get the base as small, but it’s no longer a factor?.

Yeah, I think that would take time..

We don’t have any sense that’s going to get that small term. We are still investing in Hitachi Metals equipment, so that we can improve the cost structure..

So on the other hand I must say, hey, indium phosphide by far, we are excited about it. So you know, you can do this if you want to do a model, let’s say you take a 40 and 35 and 15 as your mix of revenue of gallium arsenide - indium phosphide versus gallium arsenide and metals and what not.

You assume this 40% is going to grow 50% next year and this - you have 35% revenue is going to grow, let’s say 5% or say flat, then you can see at the end of the next five years, it’s going to be.

So I am saying it, but it was peak time, but that 35% is still meaningful revenue, which would come in plus the investment we made, not matter what, I think we now dropped that business after we had invested so heavily and we certainly made very strong commitment to continue our gallium arsenide business..

Yeah, I can give you a couple of facts. We got a facility in say outside of Beijing that has 300,000 square feet, we have about 675 employees there now. So we have a lot of room to keep running the gallium arsenide business standard. It’s not like we are out of space or out of capacity. So we welcome to continue to be in gallium arsenide business.

I mean, as Morris said, not so much on the LED side, but on the wireless side, there is a future there, we are proud of that and we are excited about it..

Well, I guess that takes the question, why invest that heavily and have 675 employees in a 300,000 square foot facility when your revenue is going down so significantly every quarter? What gives you confidence that that business is going to find the floor at all at this point?.

Well, if not going away as the TAM, so we can be competitive in it. There are - we know, Hitachi Metals decided to step away from it, but that actually became an opportunity for us, both on the equipment side and the market side. So yes, I think you also need to look at this in perspective.

As we grow our indium phosphide revenue, some of its equipment, some of its training - we training - polishing gallium arsenide, and cleaning gallium arsenide, can be transferring to indium phosphide processing. Okay, but you can see our number of employees in China actually has decreased significantly.

I would say last year or two, that’s almost like 20%, 25% decrease. So as we transform further, we will make further adjustment. And so also let me clarify, the Hitachi Metal line that we bought is not - I mean, it’s a very good investment, but in terms of dollar amount, it’s not a big amount.

But we are leveraging the know-how and getting all the automated equipment and to be able sustain at this position in the gallium arsenide substrate supply, but it’s not a major investment in terms of dollar amount..

Okay, great. Thank you..

We have no additional questions at this time. I would like to turn the call back over to Dr. Morris Young, Chief Executive Officer for any additional or closing remarks..

Thank you for participating in our conference call. As always, please feel free to contact me, Gary Fischer or Leslie Green directly, if you like to meet with us. We look forward to speaking with you in the near future..

That does conclude today’s conference. Thank you for your participation..