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 Fischer, Chief Financial Officer. My name is Catherine and I will be your coordinator today. [Operator Instructions] 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 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 the 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 maybe 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 Fischer 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 will 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 5 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 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 JinMei, one of our consolidated joint ventures.

JinMei has been selling materials at a preset price to several customers under long-term contracts. The recent rise in gallium pricing eroded the gross margin on those sales. The overall impact to the consolidated gross margins 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 FY ‘22. 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 $518,000 is non-recurring. For comparison, total GAAP operating expense was $8.3 million in Q2 of 2021 and $6.6 million 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 phosphide 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 $960,000 in Q3.

In addition, we continue to be very well regarded in Kazuo 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 the tax credit or grants. As such, we expect our EPS in Q4 to come down from Q3. Our Q3 results included approximately $338,000 in tariffs as a result of the 25% tariff charged 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 JinMei. 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 30. 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 on the NASDAQ, the number of small details is greater. We hope to submit our application in Q4. That is a credible goal, but it’s 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 will 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 5 to 7 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 who was awaken, at the office at his 3 am and has been waiting for the call today, so Morris take it over..

Thank you, Gary and good afternoon everybody. Our third quarter and year-to-date revenue results continue to underscore and gathering momentum in our business. After years of preparation, we are now seeing sustainable, increasing demand from the technology mega trends that our substrates help to enable.

Trends such as 5G telecommunications, data center upgrade, health monitoring, the Internet of Things and the proliferation of LED lighting and display. Year-to-date, we increased our revenue by 46% over the same period in 2020, including a 36% increase in gallium arsenide and a 46% increase in indium phosphide substrates.

With our new expanded manufacturing facilities, were able to capture market share and new opportunities while meeting the stringent technical requirements of Tier 1 customers. As such, 2021 is unfolding to be a pivotal year for our business. We expect to post growth of approximately 40% this year, with substantial gains in all profitability.

And when looking ahead we believe that we can achieve double-digit revenue growth again in 2022 of between 15% to 20% with multiple existing growth drivers and the new ones being later on to the current demand. Now, in indium phosphide, Q3 marked the highest quarterly revenue in AXT’s history and once again, it was our top contributing material.

Market demand was strong across the board as capacity in our industry is now tight.

Customer who hasn’t worked with us for many quarters are now returning and several existing customers are forecasting increasing demand and our ability to expand capacity to meet customer demand is beginning to open up new avenues of opportunities in multiple applications.

Of our peers, we believe that we are in the best position to be able to respond. In Q3, indium phosphide sequential growth were driven by 4G and 5G telecommunication obligations as well as continued healthcare healthy demand for datacenter connectivity.

We believe that these applications are closely related and its potential growth in business necessity boasts the infrastructure to move it as well as the capability to efficiently handle and store it.

From a substrate perspective, any modernization of telecom and datacenter infrastructure that utilizes indium phosphide is positive for our business, whether that’s PONs, front-haul or backhaul infrastructure or silicon photonics built out within the datacenter.

While there will be continued to be quarter-to-quarter fluctuations, we believe that we have reached a tipping point in which the application that will require indium phosphide have become essential part of this nation of telecommunication business.

In addition to these major applications, we believe there are significant new applications for indium phosphide now visible on the horizon in healthcare monitoring, automotive sensors and more. Among AXT’s competitive advantage in indium phosphide is our ability to scale manufacturing volume quickly and efficiently to meet rising demand.

In addition, we have been told by multiple customers that our VGF raw material uniformity as well as consistently provide the industry lowest EPD level, which are essentially requirements for high performance applications and Tier 1 specifications. Now, turning to gallium arsenide, in Q3, we posted our highest quarterly revenue in more than 4 years.

In semiconductor gallium arsenide, we have continued to see strong demand for high-end LED applications, including automotive and lighting and display. We are also seeing rapid growth in high power lasers, particularly in China. On the wireless side, IoT continues to be strong.

In addition, with 6-inch capacity tightening up in our industry, we are beginning to see demand from customers from renewed customer demand interest in our gallium arsenide or HPT devices and our ability to expand capacity. This has not been a strong application for us for many – more than 10 years.

And our facilities give us the opportunity to be competitive once more. As we look ahead to the evolution of gallium arsenide in high-tech applications, we believe microLED in particular holds great promises for our industry.

Major customer device manufacturers are behind the development of the technology for a variety of applications, including televisions, AR/VR headsets, and portable devices and others. MircroLEDs, which should not be confused with miniLEDs uses gallium arsenide to make red for the red, blue, green LED modules that can provide almost any color.

MicroLED devices are expected to consume less power, provide sharper contrast and produce brilliant lighting and colors. We are seeing reports that the potential microLED market for smaller consumer devices like wearables and phones could be larger than an entire current market for gallium arsenide substrate today.

Regardless of the specific numbers, this is exciting space and could add significantly new value to the LED market in 2024 and beyond. Now, turning to R&D, we will continue to progress on the development of 8-inch gallium arsenide wafers.

Among the many benefits to our customers, 8-inch gallium arsenide will help to enable us to scale and cost effectively, which is required for very high volume applications.

As you may know, every step up in diameter size comes with a major increase in the technical challenges of producing it, but we have successfully delivered sample quantities to interested customers and we are working with them to meet the requirement of their emerging projects.

Moving out to the germanium substrates, revenue decreased modestly in Q3 from the prior quarter. However, the satellite solar industry market remains healthy and we are well on track for 2021 to be a growth year.

Now, moving to raw materials, as you may recall, we currently consolidate 2 joint ventures BoYu, which manufactures high temperature pBN crucibles and pBN-based tools for OLED and our other joint venture, JinMei, which is a diversified industrial high-purity material supplier. Demand continues to be strong.

We are on track to achieve significant roles in this area of our business over the prior year. In 2020, most company relocated to our campuses in Kazuo, enabling them to expand capacity in response to market demand. This coupled with a recovery in pricing of raw materials such as raw gallium has contributed to their growth this year.

As Gary mentioned, while the increase in raw material price has negatively impacted our gross margin, our 10 supply chain companies provide enormous benefit in terms of our overall profitability as well as our supply. We are highly focused on driving renewed improvement in gross margin in 2022.

We believe that our expanded growth in revenue, favorable product mix and continued improvement in our manufacturing efficiency in our new facilities will allow us to return to or exceed our prior performance. In closing, this is an exciting and transformative time for AXT.

Our strong growth highlights the market expansion we are experiencing in our key product categories across a diverse set of applications. Customers are forecasting rising demand and a positive sentiment for the coming year.

Gary and I have been around for a while and we sense that even with for us, this is a golden convergence of market and emerging technologies. For this reason, we are making important investment in our business, including larger diameter substrates, capacity expansion, and our IPO in China.

While these investments bring us to a higher level operating expenses, they gave us significant competitive advantages in our ability to scale our business and meet the need of Tier 1 customers and emerging high volume applications. We believe we have laid a strong foundation for business transformation and opportunity in 2021.

As such, we are setting the stage for other year, meaningful growth in 2022. I will now turn the call back to Gary for our fourth quarter guidance.

Gary?.

Thank you, Morris. As Morris discussed, the demand environment remains strong in Q4 with some seasonality expected in certain applications like PON and gallium arsenide for wireless devices and continued strength in several indium phosphide applications. Reflecting this, we expect to see revenue in Q4 between $34 million to $36 million.

In accordance with our commentary on Q4 gross margin and taking into consideration the expected absence of China-based tax credits or grants, we believe that our non-GAAP net profit will be in the range of $0.06 to $0.08 and our GAAP net profit will be in the range of $0.04 to $0.06. Share count will be approximately 42.8 million shares.

To put this in perspective, let’s look at our expected results for the total fiscal year of 2021, including our Q4 guidance, revenue growth is more than 40% and reflects an increase in annual profitability of more than 300% as compared to 2020.

This growth is a result of years of cultivating customer relationships, investment in our operations, and the convergence of technology trends that are likely to drive our growth for years to come. Okay, this concludes our prepared comments. Morris and I would be glad to answer your questions.

Operator?.

Thank you. [Operator Instructions] And we have a question from Richard Shannon. Your line is open..

Excellent, guys. Thanks for taking my questions here. Maybe I’ll touch on a couple of elements of the guidance here. First of all, on the revenues, my line was a little spotty. I am traveling, so I might have missed some of the drivers here that help you get to your revenue guidance.

And I guess implicit in that question here is that the range of revenue guidance here $34 million to $36 million is a million wider double, double the width that you normally have in your revenue guidance.

So, I am wondering if you can give us a sense of what’s your thinking there and what are the drivers up and down?.

Go ahead, Morris..

Yes, let me try that. I think raw material is going to be down slightly. On indium phosphide, we project to go up slightly, gallium arsenide, we project it to go up slightly, and germanium is approximately flat. As far as the widening range of the substrate revenue, first of all, I want to remind everybody, Q4 usually is a down quarter for us.

Given that we have the first 10 days of national holiday in China as well as the back-end of the Christmas holiday seasons. So, we are guiding actually sort of flat for the quarter, but we just went in the range a bit to give us potential cushions.

As you know that with the potential power shortages in China, although we do see that customer demand out there, but we just want to make sure that we have all the capacity to deliver and to our customers..

Okay, that is helpful. My second question here is on the bottom line guidance for the fourth quarter and had time to run through those numbers here, but – and obviously your OpEx has been moving modestly higher over the last few quarters or so and you typically don’t guide on gross margins.

But certainly, the EPS number here is a bit lower than what we had and I think what was in consensus? So, I guess I want to make – I want to get a sense of the drivers here anyway you can quantify or at least help us understand the magnitude of the changes both in OpEX and gross margins and other points that help us get there? And then to the degree to which the pricing things related to the gallium raw material contracts and how they bake into that would be great as well?.

Okay, so I will go first. One of the drags for Q4 is the situation with JinMei, one of the companies that we consolidate. That’s a temporary problem. But they have made some commitments for deliveries that have long trajectory. And as a result, the change in cost of raw gallium, which they have to buy, went up. So, that’s a key factor there.

And when we go down to the bottom line, OpEx this quarter in Q3, the GAAP OpEx was $9.1 million. That included about $500,000 of one-time charges related to stock compensation. So in Q4, it will come in below $9 million for sure, we hope, we think so. And – but you are right, OpEX does take back some of the gross profit dollars.

And then we think based on the changes that we see from Q3 to Q4 that it’s going to come out about what we guided a few minutes ago, so….

Okay. Maybe to follow-up on the – I am sorry, go ahead, Morris..

No, go ahead.

I want to hear what’s your thought?.

I guess a follow-up question is you quantified it Gary in your prepared remarks about the gross margin impact, I think 220 basis points in the third quarter, is the impact here similar or higher or lower in the fourth quarter?.

It’s similar, but slightly lower..

Okay, okay.

And then do we see those things abate after the fourth quarter too?.

Go ahead, Morris.

What are you going to say?.

Yes, I think so – let me go back to the – I think obviously, the EPS drop is sort of lower than Q3 for our guidance in Q4.

So, if you look at what benefit us Q3’s EPS, one part of it is that we have a tax reversal in China, which we don’t expect it to repeat in Q4 and the other is the JinMei has lower gross margin of this particular contract, they signed with the customers, which will not continue, but it will drag down for a little bit, I think, as we establish new contracts with new customers that is going to recover.

And yet the other is the government award that we received in Q3, which is now going to repeat itself in Q4. So overall, I will say, the SG&A has increased mainly because several things we are spending quite a bit of money in R&D in 6-inch indium phosphide as well as in 8-inch gallium arsenide.

And other big part of the increase that we’re spending is build up our infrastructure for the proposed IPO in China. And as you know, that proposed IPO in China give us great valuation so we can dilute very – much smaller proportion to get the fund necessary for us to grow in our business in the future. So that’s beneficial for AXT.

But in the meantime, some of these necessary costs, which is attaching to the IPO process is burdening our pricing structure. However, I would also remind you that now we have grown 40% year-over-year.

We expect our revenue to grow again next year, which I think will take care of some of the added expense that we incurred, and we’re building a much larger and stronger foundation for future growth, which will hopefully give us better profitability next year as well as more profits drop down to the bottom line..

Yes. I would just underline one important thought, which is that I view and we view as a company, Morris and me and his leadership team, we do – we want OpEx to flatten out, but we view it as an investment. It’s clear there’s something happening in our markets.

We think we’re uniquely positioned, having completed the relocation to take advantage of these things. We think we can move faster than our competitors, and we’re investing in that. And then on the same – in the same note, some of the expenses are resulting from driving for the IPO. So they’re also an investment.

So – and we think we’re going to get a return on our investment, starting next year..

Okay. Per Morris’ comments on growth, I did want to have my last question to your comments about the 15% to 20% growth next year. I wonder if you can characterize in a few different ways by the revenue segments here even within substrates.

And then also, to what degree are some new customers, particularly some of these Tier 1 customers have been recently qualified, how much they’re adding to that overall growth profile next year..

Go ahead, Morris..

Yes, I think we do expect our revenue projection. We do see – we’re talking to multiple customers in indium phosphide, and they have very exciting new applications for indium phosphide, and we do expect indium phosphide to continue to grow in our projection actually it will grow more than 30% next year.

So we’ll have a higher percentage growth for us for next year. Gallium arsenide, we are also seeing renewed interest – well, first of all, what we already see is the high-power laser in gallium arsenide, especially in China, is giving us a very high expectation for growth next year. We’re already engaged with customers.

But they are telling us that for next year, the expected volume ramp in high-power laser demand. And we’re also seeing a very exciting new interest in HBT market for us. As you know, that HBT has been sort of flat for many, many years and because our strength in providing PON substrate for the cell phone market.

So we have been absent on that HBT market for a long, long time. But now the industry expert are telling us in the next 2 years, they are seeing the HBT market actually demand to grow between almost 40% to 50% in the next 2 years as you know that this market capacity is kind of tight.

So they are talking to us, and we’re excited about returning to that market in the near future. And so that’s the two big growth driver.

I think raw material, we believe that we are poised to grow, mainly because our two joint ventures have moved to a much larger and expensive new manufacturing facility that will allow us to grow as well as the demand is very strong. In PPM, both in terms of providing crucibles for crucibles as well as for LED market. And so they are poised to grow.

And our high-purity material business, which is JinMei, although they have been flat this quarter because of the low margin, they caused the overall company, but that business is a very healthy business. And there’s increasing demand. We have the right technology and capacity to serve our customers. So we expect that to grow as well.

Germanium by the way, it’s sort of a flat projection for next year..

Okay. Great, that’s great details for me and all questions. Thank you..

Thank you. Our next question comes from Gus Richard with Northland. Your line is open..

Yes. Thanks for taking my question. I just want to make sure I get my housekeeping right. Gary, I think you mentioned you’re going to try to get OpEx for the coming quarter at around $9 million.

Was that GAAP or non-GAAP?.

That’s GAAP. I think it will be – we currently predict it will be south of $9 million, a little bit, so….

Got it. And then on the STAR listing, your SG&A rose, modeling it up about $5 million this year.

How much of that spend is for the STAR listing?.

Well, we have hired a number of people to help us on the project. There has also been a lot of administrative and permit kinds of issues that are driving these things. Things that we can’t – slip into the balance sheet into the equity section. So, I don’t know if I can give you a solid answer. I haven’t carved that out enough.

We have observed the phenomenon, but I don’t know specifically how to answer the question, so..

Yes. So, maybe let me help out a little bit. I think – look, we are probably the second NASDAQ-listed company going – trying to go public this STAR market, okay. So, perhaps the Wall Street expert doesn’t have a whole lot of experience. But I can tell you firsthand, there is a lot of required conformity that we need to follow and give you one example.

In some of our employee compensation section in China, we have – because we are going to propose to go public in China. The requirement to be a public in China requires that we pay certain, they call it housing allowances for employees. And our compensation to our employees was nice, minimum, to say for sure.

But because of the new requirement is sort of elevated to a new level. And we have to sort of lump it in. And so that’s an expanded expense. Although it’s not large, but there is a lot of these small things piling up. And they are just required conformity that we need to follow as a proposed nest, I mean in China listed company, public company.

But as you know, the other side of the equation is that once we go public, the valuation of this new company in China that we propose to go IPO is going to be much higher valuation than we could ever get.

And so as a result, we will be able to get ourselves much lower costs, much less dilution for the growth fund that we need to answer some of the capacity expansion of new business opportunity we are going to capture. So, that’s the two sides of it..

I understand it.

So, Gary just looking for a ballpark, is it a couple of $3 million a year, is it – do you have any ballpark whatsoever?.

No, I don’t. I’m sorry. I should turn on that, yes..

Yes. And let’s move on.

And then in terms of R&D, in the past when you guys have started to ramp up your efforts in 6-inch and 8-inch, 6-inch indium phosphide, 8-inch gallium arsenide, some of it had slowed through the gross margin, the pressure in the quarter, was that just from the raw materials company, or was there some incremental pressure from that R&D activity?.

You are knowledgeable about this. I think that’s good. There is some in cost of goods sold. Its way that because it’s just we manufacture and it’s a – there is many process steps in our process technology. So, it’s difficult to capture everything that’s development based.

There is not a lot of R in cost of goods sold, but there is D in terms of research versus development. And so yes, there is some there and it probably contributes some to the shortfall of the gross margin..

But the major factor was just the rising price of the raw gallium that was impacting the raw materials and not so much the R&D....

Yes. The standout, most notable driver is the 2.2% and gross margin percent that we would normally be getting from JinMei and we didn’t. So, that’s the biggest single element. And then I would say, there is still some settling in. As I look at it from a business standpoint and I do have an operating background as well.

So, it’s new facilities, it’s new equipment, and it’s new people. So, I think there is some, what I would call low-hanging fruit there, that as we mature in those areas of facilities, equipment and people that the – let’s say call manufacturing efficiencies will help the gross margin.

And I might as well just to speak to it now to – well, we have lots of listeners that, we are a little bit disappointed in Q3, Q4 gross margin, but we are very confident about bringing that number back up and for sure to 35%. But our goal is to be greater than 35%. And we think that it’s an achievable goal.

There are some situations in business where you need a miracle for something to happen. This is not one of those. We know we see exactly what’s going on in manufacturing. We know what’s going on in the marketplace. We have pretty good visibility right now from our customers, but I would say better than any time in the 7.5 years I have been at AXT.

So, we will look at that and I would encourage our shareholders to view the – not just quarter-to-quarter, but year-on-year, which is significant. And I think next year will be another very positive comparison year-on-year..

Just on gross margins, Gary what would you expect it to get through to look like? I mean – I think Q4 looks like it’s going to be the bottom based on your guidance.

Is there a steady ramp back to 35%, or is it more stair-step depending on how those long-term contracts will get on from purified gallium go?.

Yes. We have to get out of the weeds with JinMei. And a lot of that’s already happening there. But there is still some more happening in Q4. And it may dribble in Q1, we are not sure yet. So, but I don’t think it’s – I think it’s not going to be like, we won’t get to 35% until 2023, it’s going to be next year.

And maybe not Q1, but definitely Q2 is very possible. I haven’t done a ground up yet with the team. But intuitively, based on the things I just previously said about our visibility and understanding of the business, I think it’s very achievable to get there in Q2 and stay there and then go to go on pass that, so..

Got it. Alright. Thank you..

Well, let me try and lean in for a little. Hi Gus, let me repeat what I think in our prepared comments. First of all, we believe that indium phosphide is going to grow and actually grow faster than our product mix next year. And that is going to help us.

On top of the 40% growth this year, we put – we think we are going to going to grow our revenue again. That is also going to help us our gross margin. And thirdly, as Gary mentioned, we are going through some kind of a – some sort of a growing pain. Although the pain is not much, I mean, hopefully it’s – most of it is overweight.

And then with our added capacity and with more manufacturing that we are going to do and the more attractive product we are offering we have. And with also the market rising, the market demand rising, I think is very important.

And I think, the part of the gross margin drag, also I want to remind you is we are seeing gallium price going up and germanium prices go up, okay. And they are good component of our cost of goods sold, okay. But – so, I would expect every competitor or every substrate provider in our business, having this gross margin squeeze.

However, with our supply strategy, that we have joint ventures aiming making the raw gallium and in making the other raw material for us. So, we are partially mitigating the gross margin hit. In other words, we got the margin hit on the top, but below the line, our joint venture is providing us the better return.

And yes, also as you know the inflation pressure is coming. And if the capacity becomes tighter, who knows there may be a – it could be a point that maybe the price is going to go up.

But as you know, in our industry, it’s difficult to raise prices, but there are different ways to improve our margins such as there are a better product offering that we can do, such as high power laser, which require low EPD and the brand new market for us to get into and that will give us better opportunity to improve our margin that way..

Got it. Very helpful. Thank you so much..

Thanks, Gus..

Thank you. Our next question comes from Hamed Khorsand with BWS Financial. Your line is open..

Hi, I just want to understand your working capital needs here as you continue to burn cash and build inventory.

Is there a particular customer or customers that are requiring you to build this kind of inventory is a supply chain issue, because you are also – your cash has also been declining since the beginning of the year as well?.

There are so customers that require us to build inventory, including customers that want the inventory consigned to their site, but remains on our balance sheet. And one in particular, is growing and so that is a contributor.

But the another comment I can make about working capital that’s maybe insightful for this time period is that September was our – of the three months in the quarter, September was the largest revenue month. And when that happens, I don’t like it because it tends to float up AR. AR went up $3 million in Q2, maybe $3.1 million I think.

And AP went down $4 million, which means that was cash out. So – but in general, working capital, I think we are managing it okay. I don’t – we need to have inventory to keep growing the revenue. And we were comfortable with our cash position, so yes, I hope that’s helpful.

I know working capital moved quite – it moved around a lot from June 30th to September 30th, but I think it’s okay..

Okay, that was it for me. Thank you..

Thanks, Hamed. Good afternoon to you..

Thank you. Our next question comes from John-Michael Gilbert with Octavian Capital. I am sorry, he just removed. We have a question from Richard Shannon with Craig-Hallum..

Well, great. Thanks for taking a couple of more questions for me guys. Let’s see here. Morris, on the opportunity with HBTs, I have covered you and AXT for I think over a decade. And I haven’t heard you talk much about this. I guess I would love to understand the underlying reasons for this.

Is this basically a capacity issue on the behalf of your competitors that’s opening this opportunity up, or are there other drivers for this?.

I think it’s the former. I think HBT market is very mature. But from what we hear from our customers, the demand to see forecast seems to be very strong. We are still engaging our customers. And there is, when the market prior to these, this market is really mature, and it doesn’t go a whole lot.

But we are seeing from our first line customers I think over, and they are buying quite a bit a number of MOCVD reactors. And they are the one who told us that this market demand is going to grow between 40% to 50%. Of course, we are looking at this very cautiously, because this although the demand is there.

But the price pressure is there, because it’s a very large market. And but does give us the opportunity to get into something which we actually did almost like 10 years ago..

Okay.

So, we shouldn’t actually be baking anything, any contributions into say, next year’s revenue stream? Is that what you are telling me?.

In our projection we do. We are putting in something. But we were cautiously – but we are putting let me see our projection. I think we are putting about $4 million worth. So, overall scheme of things is starting to be large. But definitely, we think the opportunity is here, yes..

Okay, that’s helpful. My second and last question is on microLED. And I think I asked a version of this question last quarter. And that is, obviously, you have been talking about a revenue ramp, starting may be kind of middle of calendar ‘24, and some big opportunities, big customers in a big ecosystem.

What has to happen between now and then, like when do you determine when you have got a customer, when do you have to start building – start building capacity for this? Do you anticipate having sort of take or pay kind of situations here? Because this is clearly would ask you to build a lot of CapEx that I am sure you don’t want to strand in any way.

So, how should we think about the timeframes between now and then in your microLED business?.

Sure. That’s a very good question, Richard. Yes, we are – we are very cautiously optimistic. I mean this is a great opportunity. And the demand is there. We are talking to our customers, multiple customers actually. And we want assurances that the order is there, the demand is there.

But although we have been saying in that, the big demand is going to come in 2024. But the pilot production and sampling is actually starting now. And something like, I would say, between 500 wafers to 1000 wafers a year, next year. And we are going to need to work with our customers to see what kind of spec they need.

And we will – we are going to have a very good feeling of what’s going on. And as we speak now, we are engaging with our customer. We gave them our projected capacity expansion and they are giving us the forecast of where they will be.

But as far as take or pay, as far as signed contract is concerned, yes, we are contemplating that and it is – but on the other hand, if you sign and take a pay that we have to take – we have to deliver, don’t we. So, there are mutual requirements for each other. But this is a great opportunity.

I think we are spending the necessary front end development costs to ensure that we can capture this opportunity down the road..

Okay, that’s a good characterization. Thanks for that detail Morris..

Thank you. And I am showing no further questions in the queue. I would like to turn the call back to Dr. Morris Young for any closing remarks..

Alright. And thank you, everybody for participating in our conference call. In November, we will be participating in the Craig-Hallum Alpha Select Conference. I think we hope to see many of you there. As always, please feel free to contact me, Gary Fischer or Leslie Green directly if you would like to set up a call with us.

We look forward to speaking with you in the near future..

This concludes today’s conference calls. Thank you for participating. You may now disconnect..