AXT Q1 2024 Earnings Call Transcript

Quartr
Provided by Quartr
May 2, 2024

There are 9 speakers on the call.

Operator

afternoon, everyone, and welcome to AXT's First Quarter 2024 Earnings Call. Leading the call today is Doctor. Maurice Young, Chief Executive Officer and Gary Fisher, Chief Financial Officer. My name is John, and I will be your coordinator for today. All lines have been placed on mute to prevent any background noise.

Operator

After the speakers' remarks, there will be a question and answer session. Thank you. I would now like to turn the call over to Ms. Leslie Green, Head of Investor Relations for AXT.

Speaker 1

Thank you, John, 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 results or events 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-nineteen and other outbreaks of contagious disease, potential tariffs and trade restrictions, increased environmental regulations in China, the financial performance of our partially owned supply chain companies and the impact of delays by our customers on the timing of sales and their products.

Speaker 1

In addition to these factors that may be discussed on this call, we refer you to the company's periodic reports filed with the Securities and Exchange Commission. These are available online via 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 ataxt.com through May 2, 2025. 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 Q1 of 2024. This information is available on the Investor Relations portion of our website ataxt.com.

Speaker 1

I would now like to turn the call over to Gary Fischer for

Speaker 2

a review of our first quarter 2024 results. Gary? Thank you, Leslie, and good afternoon to everyone. Revenue for the Q1 of 2024 was $22,700,000 that's up from $20,400,000 in the Q4 of 2023 and up from $19,400,000 in the Q1 of 20 23. To break down our Q1, twenty twenty four revenue for you by product category, indium phosphide increased sequentially to 8,100,000 dollars That's reflecting strong growth from data center applications including AI and continued improvement in passive optical networks.

Speaker 2

Gallium arsenide also grew to $7,500,000 with broad based improvement across a number of applications. Germanium substrates were $1,400,000 up from the prior quarter with renewed strength in demand for satellite solar cells. Finally, as expected, revenue from our consolidated raw material joint venture companies in Q1 was $5,800,000 down from Q4 as we consumed a greater portion of their output for our growing substrate demand. In the Q1 of 2024, revenue from Asia Pacific was 79%, Europe was 16% and North America was 5%. The top 5 customers generated approximately 33% of total revenue and one customer was over the 10% level.

Speaker 2

Non GAAP gross margin in the Q1 was 27.3% compared with 23.2% in Q4 and 26.9% in Q1 of 2023. For those who prefer to track results on a GAAP basis, gross margin in the Q1 was 26.9% compared with 22.6% in Q4 26.3% in Q1. Beyond the near term, we remain confident that we can get back to the mid-thirty percent range as the environment strengthens through higher overall volume, favorable product mix and the benefits of our recycling programs along with continued efficiency improvements throughout our business. Moving to operating expense. Total non GAAP operating expense in Q1 was $8,700,000 compared with $7,500,000 in Q4 of 2023 and $8,700,000 in Q1 of 2023.

Speaker 2

On a GAAP basis, total operating expense in Q1 was $9,400,000 compared with $8,200,000 in Q4 and down from $9,500,000 in Q1 of 2023. As you've seen from our quarterly run rate in 2023, we had put in a number of constraints in place for OpEx to align with market conditions. As things are beginning to trend up, we're loosening up some of these constraints, which has brought OpEx up from the previous run rates. We do expect to hold it at approximately this level throughout the rest of this year. Our non GAAP operating loss for the Q1 of 2024 was $2,500,000 compared with a non GAAP operating loss in Q4 2023 of $2,700,000 and a non GAAP operating loss of $3,500,000 in Q1 of 2023.

Speaker 2

For reference, our GAAP operating line for the Q1 of 2024 was a loss of $3,300,000 compared with an operating loss of $3,600,000 in Q4 and an operating loss of $4,400,000 in Q1. Non operating other income and expense and other items below the operating line for the Q1 in 2024 was a net gain of $1,300,000 The details can be seen in the P and L included in our press release today. For Q1 twenty 24, we had a non GAAP net loss of $1,300,000 or $0.03 per share compared with non GAAP net loss of $2,800,000 or $0.07 per share in the 4th quarter and non GAAP net loss in Q1 of 2022 was $2,400,000 or 0 point 0 $6 per share. On a GAAP basis, net loss in Q1 was 2,100,000 dollars or $0.05 per share. By comparison, net loss was $3,600,000 or $0.09 per share in the 4th quarter and GAAP net loss in Q1 of 2023 was $3,300,000 or 0 point 0 $8 $8 per share.

Speaker 2

The weighted average basic shares outstanding in Q1 of 2024 was 43,000,000 shares. Cash and cash equivalents and investments were $41,300,000 as of March 31. By comparison at December 31, it was $52,300,000 Cash is down for two main reasons. First, our revenue billings tended to be back end loaded in the Q1 as most of China shuts down for Chinese New Year's. As a result, in Q1 accounts receivable increased by $6,100,000 This is simply a timing issue as most of that cash can be collected in Q2.

Speaker 2

The second reason for the decline in cash in Q1 was CapEx spending of $5,700,000 This is not new commitments to facilities. This was work done in 2023 for which payment was due in Q1. As we look to the balance of the year, we expect CapEx to be in the $2,000,000 to $3,000,000 range quarter per quarter, most of which goes towards facilities work, which was done in 2023. One more note on cash. From time to time, we have had outside parties approach us with an interest to invest in our supply chain companies.

Speaker 2

Currently interest in China is growing perhaps related to the change in the economic circumstances in China. We believe that there's real value in these assets to be unlocked and may consider monetizing a portion of them this year. As a reminder, we now have over 10 companies in our supply chain where we have partial ownership shared with industry partners. Depreciation and amortization in the Q1 was $2,200,000 Total stock comp was 800 ks. Net inventory was down $600,000 in the Q1.

Speaker 2

This includes inventory added through our recycling program. 33% of the inventory is raw materials and WIP was 63%, finished goods makes up approximately 4%. The increase in WIP is primarily the result of increased crystal growth in anticipation of higher demand in Q2. With improving demand, we hope to bring our total inventory down by approximately $10,000,000 over the year. Okay.

Speaker 2

This concludes our discussion of our quarterly financial results. Turning to our plan to list our subsidiary Tongmei in China on the STAR market in Shanghai. We now believe that we have had some significant developments on the issue that the CSRC previously raised and we believe the likely next step is that the CSRC can resume consideration of our application. As we said, this is a lengthy process, but we continue to believe that Tong Mei is an excellent candidate for listing. With that, I'll now turn the call over to Doctor.

Speaker 2

Morris Young for a review of our business end markets.

Speaker 3

Thank you, Gary. We believe our business is on a firm path to recovery, as evidenced by the continued growth in our business and solid execution, which allowed us to exceed our Q1 revenue and profitability guidance. In the Q1, we achieved 11% sequential growth in our revenues and 29% sequential improvement in our non GAAP net income. While certain parts of the demand environment remain somewhat soft, all three of our substrate product lines showed improvement including a 48% growth in indium phosphide revenue from Q4. Looking individually at these product lines, indium phosphide once again became our biggest selling material in Q1.

Speaker 3

Sales was driven by continued recovery in the palm market and a meaningful increase in demand related to AI. We review AI as an exciting catalyst for indium phosphide in the years to come. As AI requires high speed lasers and detectors for rapid data transfer with increased bandwidth, low attenuation and low distortion. Today, AI applications are primarily using gallium arsenide pixels, which require a relatively small amount of substrate material. But as the industry moves to 800 gig and then 1.6 terabyte speed, we expect that there will be a necessary transition to indium phosphide.

Speaker 3

We are already seeing development work happening today with next generation silicon photonics devices, electro absorption modulated lasers or EMLs for high speed data center transceivers. Revenue from these applications contributed to our strong indium phosphide growth in Q1 and will help drive our expected growth in 2024. Our gallium arsenide revenue grew 24% sequentially in Q1, reflecting increased demand across a broad base of applications, including power amplifiers, HPT applications for wireless switches, high power lasers and LEDs. We believe much of the excess inventory in the supply chain has been defeated and we are benefiting from a desire among our customers to diversify their supply base as the market recovers. For example, today our share of the HBT market is relatively small, but we believe we have a great opportunity to increase our market share over time and are pleased with early customer traction.

Speaker 3

In addition, our 8 inches Gallium Oxide development efforts have led to a groundbreaking advancements in both of our defect densities and yields. We believe this innovation can be applied to our 6 inches lead Gallium Oxide products, allowing us to further enhance our competitiveness across all of our market research. In germanium substrate, demand for satellite solar cells were down substantially throughout 2023 and is now beginning to recover. Sales increased 25% in Q1 over the prior quarter with renewed strength in Europe and Asia. And finally, coming off 3 quarters of strong sales in our raw material business as well as contribution from our recycling efforts, sales from our raw material business declined as we expected in Q1.

Speaker 3

This decline was primarily the results of our consuming a greater portion of the output from our consolidated joint venture as our substrate business has strengthened. In total, our portfolio of joint venture companies continues to be a strategic value to our business, providing money of the critical material we use to make our products and allowing us to benefit from the cost and efficiency advantages. Now in closing, we're optimistic about the coming year and the growth and expansion of our business. We are seeing tangible signs of recovery across all of our product lines with new catalyst such as AI providing strong incremental opportunity. We've worked hard over the last 2 years to pave the way for exciting future by providing world class products for a highly dynamic technology landscape, elevating our own business practices to meet the requirements of Tier 1 customers, delivering breakthrough innovations in the development of large diameter Gallium arsenide and indium phosphide substrates and executing our recycling program that both advances our ESG commitments and improves our cost structure.

Speaker 3

We remain steadfast focused on business efficiency and accelerating our return to profitability. With that, I will turn the call back to Gary for our Q2 guidance. Gary?

Speaker 2

Thank you, Morris. In keeping with our comments today, we expect Q2 revenue to be between $25,500,000 $27,500,000 We expect our non GAAP net loss will be in the range of $0.03 to $0.05 and GAAP net loss will be in the range of $0.05 to $0.07 Share count will be approximately 43,000,000 shares. Okay. Well, this concludes our prepared comments. Morris and I will be glad to answer your questions now.

Speaker 2

John, can you take it back?

Operator

Thank you. The first question comes from the line of Charles Hsieh from Needham. Please go ahead.

Speaker 4

Hi, Maurice, Gary. Congrats on the good Q1 results and very upbeat Q2 guidance. I want to start with the AI related question. The indium phosphide, I think last time when we speak, when we spoke about this, you were talking about semi insulating indium phosphide wafers potentially being used for some of the high speed detectors application. But in your prepared remarks, it sounds like you are getting a little bit more upbeat about the high speed laser type of applications for 800 gig, 1.6 terahertz, those kind of applications for the next generation, YAMAO, etcetera.

Speaker 4

So can you provide us a little bit update, new engagement on these AI applications so far? Do you when do you see the laser application will start to contribute some meaningful revenues for the indium phosphide business? Thanks.

Speaker 3

Charles, first of all, the order we received, one customer specifically told us is for AI and that was from semi ethylated indium phosphide. And the fact that we're guessing it was for detectors, it was a guess, okay? Because usually indium phosphide, good, semi insulating are either for electronic applications or for high speed detectors. However, recently in the industry, we also heard some of the EMLs require semi isolating substrates. So this whether it's for lasers or for detectors, we all know from what we are making, the customer demand for our product is sort of a slight change from silicon doped I mean sulfur doped semiconducting substrates, usually good for lasers and now it's for semi insulating iron, the indium phosphide.

Speaker 3

But whether it's for detectors or lasers, it's a guesstimate. We don't really know, sorry. But we do hear from our customer, it's for a pretty large AI customer.

Speaker 4

Got it. Thanks. Well, Maurice, thanks for the color you provide. I guess, yes, it's something we will continue to chat and obviously we don't want to dig more if there's something about your customer you don't want to share. So maybe a second question, maybe for Gary.

Speaker 4

I think in your prepared remarks, you talked a little bit more about the Star listing. It sounds like you are making some progress on that front. Can you kind of provide a little bit more color in terms of what kind of a progress exactly and give us a little bit better sense about why you think it's moving forward a little bit more this time? Thanks.

Speaker 3

So the process of communication with Shanghai Stock Exchange, CSRC is such that once we send in our applications, they will continue to ask questions. They want us to clarify a few things. And there are things which they expressed they have concerns with and we provide them with answers. And we think we made some good progress. The questions they have.

Speaker 3

So now we think we are ready to go through the next step, which is go through their review process again and they will then look at our whole application and either continue to ask questions

Speaker 2

or approve.

Speaker 4

All right. Thanks for the update. Okay. That's all from me for now. Thanks so much and congrats again on the results and guide.

Speaker 4

Yes.

Operator

The next question comes from the line of Richard Shannon from Craig Hallum. Please go ahead.

Speaker 5

Hi, guys. Thanks for taking my question as well. Congratulations on a really nice guide here. Great to see. To that point here on the guidance here, wondering if you could elaborate on a couple of items here.

Speaker 5

First of all, just trying to understand the relative growth dynamics of each of your 4 revenue buckets here. I would assume that you classified is probably your best growth driver, but wondering if you can kind of rank those and whether you expect them all to be growing sequentially. And then second of all, trying to get a sense of what's implied here for gross margins, given that you said that OpEx could generally be the same in the 2nd quarter as a first. I'm kind of getting a number that's slightly higher than the Q1, maybe as high as 30%. But just wondering if I'm doing the right math on that one.

Speaker 3

Yes. So let me first try on the business conditions. Actually, the strongest growth we think next quarter is going to come from gallium arsenide and also germanium. Germanium seems to be very strong and raw material is very strong as well. Inine phosphide actually at this point of the timing that we are projecting flat.

Speaker 3

And one other thing which is interesting about this business environment right now is that wherever the customer wants something, it's the short the lead time is extremely short. I mean, we usually ask the customer to give us at least 4 weeks lead time because we need to process the wafers and sometimes we even have to grow the crystal. So the lead time usually is long. We don't have a standard product for offering. But nowadays, I mean, customer just want 2 weeks lead time, which is great.

Speaker 3

However, it sort of prevent us from having better visibility. But we can see that gallium arsenide is extremely busy. And indium phosphide right now as we see now is a flat quarter. But things can change because we still got almost 2 months to go. Giving 2 weeks lead time, we have 6 weeks to take orders and deliver.

Speaker 3

And down the margin, Gary?

Speaker 2

Maybe we can do this on a follow-up call, Richard, because it gets kind of complicated. And I didn't understand exactly what your model is telling you, but we can work on it with you.

Speaker 5

Okay. Fair enough. Morris, I didn't want to follow-up on your comment regarding gallium arsenide being your highest growth driver here. To what degree is this maybe some inventory fill in some product areas that were driven down so hard in the last year and a half? And then I think you also mentioned some pickup in the wirelessHBT market.

Speaker 5

So I'm wondering to what degree that's contributing in this quarter?

Speaker 3

Well, first of all, I would say gallium arsenide was the 1st product coming down in terms of revenue, right? I mean, I remember it was the 2nd quarter of 2022, Johnny Asai start to come down. So it takes usually 6 weeks before all the inventory got depleted. So now it's coming back. So because indium phosphide takes, I think, 3 longer weeks before it start to come down.

Speaker 3

Quarters. Yes, 3 quarters too. So I expect indium phosphide perhaps not to recover as quickly as gallium arsenide. Although the pickup of indium phosphide last quarter, I attribute that to the new business on AI. And because I see palm business is doing okay, but not really robust.

Speaker 3

The telecom business is not great. And data center from what I see, they are still inventory out there. So I think the AI part of the data center, I think is pulling the demand for us and increase our revenue by what 40 some odd percent? 48, yes. Yes, 48% from Q4 to Q1.

Speaker 2

So yes.

Speaker 5

I didn't mean to interrupt, Morriss. Please continue.

Speaker 3

No. Actually, I forgot what my trend. So what was your other part

Speaker 5

of the question?

Speaker 2

Sorry about that.

Speaker 3

Yes.

Speaker 5

Yes, I think so. But there is an interesting follow-up to those comments here, which is, like how much of your indium phosphide is AI today? It seems like, given these kind of growth rates, it's got to be a pretty substantial part now. Can you quantify that in any way?

Speaker 3

Well, I think last quarter was significant. I would say could be as much as 20%. Although it's a little bit difficult for us to really nail it because some customer would tell us and some customer don't, okay? But as I said, indium phosphide business is very interesting. I want to encourage analysts to help us to do that analysis.

Speaker 3

There are 2 parts of indium phosphide, 1 is semi insulating and the other is semiconducting. The semi insulating is usually made for detectors and electronic applications. And the sulfur doped semiconducting are usually low EPD and good for lasers and they are the dominant demand for indium phosphide for many, many years. It's almost like 8 to 1 in favor of semiconducting wafers, okay? But the last 2 or 3 quarters, the trend is reversed.

Speaker 3

There's so much more demand on semi insulating ion doped wafers. So it's as if the laser just didn't grow or maybe they still got too much inventory. And this new demand of iron doped making either some kind of laser or more likely high speed detector is growing very strong. So what I'm hoping for is that the sulfur dome material will recover as inventory get consumed, they will come back again. But this iron node actually is a new application will continue its own trajectory of growth.

Speaker 5

Okay. Very interesting dynamics there. I'm going to ponder that while I ask a couple other questions here. I guess just a quick one here. You had a 10% customer in the quarter.

Speaker 5

Can you identify that or at least the sector and whether that they've been a 10% customer in the past?

Speaker 2

It was an Epi house, Richard. And It's actually related to the AI customer, right? So, yes. Yes. Okay.

Speaker 2

Yes. It's a historically long term customer for us that does epi. And we don't know for sure where that was going. But actually we do know, but we can't say. So I'm not going

Operator

to lie to you. Okay.

Speaker 5

Fair enough, Gary. Maybe just a couple of last questions here. And I'll ask both of you to put on your long term lenses here or I guess we'll call it medium term lens here, but just kind of one of your conjecture on the opportunity for getting back to breakeven level by the end of this year or early next year? And maybe just as a reminder, what that model looks like in terms of revenues and gross margins?

Speaker 2

Well, we certainly think that it's a reasonable target and goal to do that maybe this year. So we're not giving up on it.

Speaker 3

I would say it's this year.

Speaker 2

Yes. So It could be this year. Yes. It's probably somewhere between $28,000,000 $30,000,000 a quarter. And we would need to get the gross margins to go up and maybe close to 28% and keep the OpEx somewhere around 9.3, 9.4.

Speaker 2

That's GAAP OpEx by the way. Yes.

Speaker 3

And I think we do need some help from indium phosphide. I mean right now indium phosphide is only 50% of what we used to do at the peak.

Speaker 2

Yes. Yes. I mean, that's probably the wildcard. And it's I would say that the indium phosphide surge, especially since it's centered in the artificial intelligence area, it's happening sooner than we expected. We thought it would we believed early on it was going to happen, but it's happening sooner.

Speaker 2

So the question is, what's going to happen in the next 2 or 3 quarters? But it's a tremendous opportunity and there's 1,000,000,000 and 1,000,000,000 of dollars that are being invested in the hardware side of AI and the software side. So and of course, we play in the hardware side.

Operator

So

Speaker 2

it's pretty amazing what's on the horizon.

Speaker 3

Okay.

Speaker 5

One last question, I'll jump out of line here guys. The short report that came out on your stock early last month, I think we've established pretty well as a bunch of malarkey for the part, but does bring up an interesting topic that I think it would be very interesting for you to address. And I guess the risk that a lot of investors bring up with me and that is related to the STAR listing and the investment by private equity investors. And if there's any rejection of the application for whatever reason here, what's the risk and how do you get around the risk of having to repay that money and then find other ways to finance the company?

Speaker 2

Well, as long as we're in the process, they have no right for redemption. And equally important, they don't want to be redeemed. I mean, the last thing they want is their money back. And so they're very willing to be patient and work with us. And it's everyone's disappointed that it's taken longer than we all expected.

Speaker 3

But so let me try to help out a little bit here, Gary. Look, I think, I mean, hard assets and doing manufacturing semiconductor or materials job industry is hot in demand in China. And that is showing up in the fact that we have other investors interested in acquiring a minority share of our other joint ventures. So although the IPO takes longer than we thought it is, but I think our assets in China are highly valuable. I think the psychology or the thinking from a Chinese investor point of view, their money no longer can go into real estate to invest and doing materials and doing manufacturing and the real fundamental business manufacturing is highly desirable.

Speaker 3

So if we don't, for whatever reason, we don't go IPO. I would say one possibility is inviting other customers I mean, investors invest into our joint ventures. And we have several of them which are highly valuable. I mean, of course, the most valuable is Tongmei manufacturing substrates where we have the world ranking leadership in those field, although they are small, but nevertheless, it's highly desirable. But because we're going public in China, so we cannot separate them and then invite investor into the main body of the investment Tongmei.

Speaker 3

But for our joint ventures, we can certainly get other investors investing in those joint ventures.

Speaker 2

Yes. And let me give you we have talked about this internally. So we're not worried about it. But as I said, the PE companies want us to go public. They don't want to pull out.

Speaker 2

So these equity private equity investors are all large and premier institutions, each with an investment of just under $5,000,000 which represents a relatively small part of their respective portfolios. And so far, since they have to be patient no matter what, they're being patient. And another thing that's probably interesting to note is that they don't have any recourse or their investment is not collateralized. So that's why they need us to succeed. And we made some significant progress and some developments that we really can't give any details.

Speaker 2

But some very good steps were taken in the recent quarter, which continues to sustain our hope regarding the IPO.

Speaker 5

Well, great. I appreciate all that detail. I think a lot of investors wanted to hear that and I think that's a great response. So appreciate the time guys. That's all for me.

Operator

The next question comes from the line of Tim Savageaux from Northland Securities. Please go ahead.

Speaker 6

Hi, good afternoon and congrats on both the results and the outlook and especially the growth in indium phosphide. And I think there was a mention of kind of peak levels that you had achieved in indium phosphide. I think that's getting up toward $20,000,000 a quarter, maybe 18. Dollars But at that point, you also had some additional consumer business. And I guess my question is, as you look at it now, the market opportunity you're seeing, do you think this AI kind of optical data center opportunity can move you back toward peak indium phosphide levels by itself?

Speaker 6

And I have a follow-up.

Speaker 3

That's a good question. I the customer who use our product for consumer product at the time I mean, they still have 1 product using it for consumer product by the way. They didn't go out completely and we are, I believe, a big dominant supplier for that product. And we are also in negotiation and in qualification for yet other product, although I don't know what's the launch time and whatnot. And the other thing is that talking to their engineers, at one time, they told us they have 11 projects centered around using indium phosphide in their consumer product devices.

Speaker 3

So I don't think I'm giving that up, but indium phosphide just has so many different characteristics, such as far infrared and using as a detector, etcetera, etcetera. So it's unique in its place to be used as a technology device. Whereas AI application, I think it's an extension of what people use it for data center. If you want high bandwidth, high speed data transfer, low attenuation, I mean, that's the perfect choice. And if you have AI, that means you've got to access data much in 100 times, a 1000 times, even 10,000 times and you have so many more data center, you want to exchange information, what's the best way to transfer that information, it's no brainer.

Speaker 3

It has to be some kind of optical device to transfer that data. So I think it's difficult for me to say when it's going to be so strong and so how big, but whether it's going to rival the consumer product, but I think both of them do need indium phosphide. Yes.

Speaker 2

When Moore says optical, that means it's got to have the indium phosphide because the wavelengths can be read by indium phosphide. So but yes, we believe we will get back to those levels, Tim. As Mor says, we're not sure on the timing. And it very well could get back to that level sooner than we thought because of AI. 6 months ago, we didn't have this kind of expectation.

Speaker 2

I don't know for the people listening of it. I think last week there was really amazing article in the New York Times about the amount of money invested in AI in Q1 of this year and it was I think $32,000,000,000 And that's not just software, that's hardware too. So it's data center stuff. So I mean, we've all been around a long time and so we've seen stuff. But I was very amazed by that and I sent it to Morris and Leslie, I sent it to our Board of Directors because that's going to we know we're at the bottom of the food chain or the end of the train, but that's going to benefit indium phosphide substrates.

Speaker 2

And so the dream or the hope is that the consumer comes back and it competes against AI for who's going to be the biggest contributor to indium phosphide revenue. And we don't need a miracle for that to happen. I think it's very reasonable goal.

Speaker 6

Got it. And I want to ask a little bit more about the improvement or the pretty dramatic growth that you saw in Q1 in indium phosphide. And you've already talked to you have a unique perspective kind of in the ecosystem. And maybe I'm going to ask you to guess a little bit more here. But I guess my question is around the breadth and how we could characterize that strength.

Speaker 6

Obviously, you can sell to a lot of different folks in this arena, whether it's epi wafer suppliers or vertically integrated laser manufacturers or module manufacturers. And I think you've done business with all of those types of guys. And so whether it's looking at the type of customers and or looking at wafer sizes, what does that tell you about the breadth of demand that you see? Is there historically, you've had a couple of major customers on the data center side or can you see if the extent new customers are showing up or are there a couple of customers really moving the needle for you when you see this extraordinary growth in Q1?

Speaker 3

The Q1 customer actually is new. I mean, they are a customer on other product, but for that application, for

Speaker 2

AI was new.

Speaker 3

And they're telling us they're

Speaker 2

a customer, but I can't repeat it. It's a big, big customer. Well, there's a we know the players, right? There's Meta, there's Google, there's Microsoft. All of those data centers are going to where indium phosphide is going to have a play is rack to rack, rack to the aggregation point within the data center and then the aggregation point to a different data center.

Speaker 2

All of that needs high speed. If you think of the data that's computed in AI, then you've got to transfer it and move it around in order to get an end result. And so within the rack, we don't think they'll go to AI, to indium phosphide. But rack to rack and beyond, that's where indium phosphide has a definite application.

Speaker 3

Of course, Gary, you're not saying anything different. Why is it AI data center already doing this?

Operator

Yes. Okay.

Speaker 3

But it's just that data center has to get so busy talking to each other and exchange information a 1000 times or 10000 times that requires higher speed, higher weight. That is where you need phosphide coming.

Speaker 2

The other thing that one of our marketing guys taught me is that some of the large data centers are now having a shortage of power, electricity to run the thing. So they're downsizing in the future architecture to smaller more data centers that are smaller, but are spread around. And that's going to benefit us.

Speaker 6

Got it. Well, okay, it sounds like there was sort of a big customer helping to drive that growth in Q1. And sort of the rest of the color I was looking for, I know there's only so much you can say, but clearly, you're at the substrate level, you've got an epi wafer supplier who may be selling into a module manufacturer. I mean, I imagine that you're maybe not all the way up to the cloud provider level, but you have customer touch points all along that ecosystem. And I was just looking for as you see the pieces move around, what you're seeing in terms of opportunity at any of those levels, right, whether it's going directly to a chip supplier, obviously used to do a lot of business with Intel and their module assets are over at Jabil now.

Speaker 6

Are you seeing sort of different customers kind of show up at different parts of the food chain, I guess, in driving this AI growth?

Speaker 3

No, not yet. In fact, I think if I I mean, we have some China customer, which is showing up taking a lot of wafer as well, but they're not telling us anything. I mean, I think the customer base seems to be shifting somewhat. Before these things all happen, it's a consumer product that sort of went away. And then there was a data center that you were talking about, which was taking a lot of wafer.

Speaker 3

They are not prime customer at the table right now. There is a new Chinese customer coming, but we don't know where they're coming from. And this new customer taking this semi insulating in the fast way and we know they're telling us it's going to AI. But I wish I can see there's a second one or third one coming that would be great.

Speaker 2

Okay, thanks. We think we understand the architectural needs well enough that there's little doubt in our mind. There's no doubt frankly that we're going to end up benefiting and getting into multiple data centers along the big names that I just ran off.

Speaker 6

Got it. Thanks very much.

Speaker 2

Thanks, Tim. Next question?

Operator

The next question comes from the line of Dave Kang from B. Riley Securities. Please go ahead.

Speaker 7

Good afternoon. My first question is actually on gallium arsenide. So you're expecting that to be the main driver from Q1 to Q2. Just wondering, if there are any applications or customers kind of driving this strong growth?

Speaker 3

LED is strong for automobile. Lasers is strong, but not as high as at the peak. I would say it's about 50% of the peak level. Automobile is probably 70%, 80% of the peak. And HPT is a new, I believe, opportunity for us.

Speaker 3

And we're trying very hard to getting ourselves back into it. And if we are successful, we can expect more revenue growth for HPT as well. And the China market seems to be fairly strong in Gallium Oxide.

Operator

Got it.

Speaker 7

And just wondering how sustainable your expectation is on gallium arsenide? Are we talking just few quarters or kind of a multiyear cycle?

Speaker 3

I cannot guarantee multiyear. I would say we have probably good visibility at least to Q3. I mean demand is strong. But as you know that I do worry about the world economy. I mean I think but then people are saying there's a recession, but it never come, right?

Speaker 6

It's Yes.

Operator

I mean, I'll just comment, David. Yes.

Speaker 2

Most of our cycles are more than 1 quarter. So Gallium arsenide is more robust than we expected it to be. But we're not thinking like, oh, then it's going to drop back down in July.

Operator

Got it. And then just on

Speaker 7

indium phosphide for AI applications. Is there any data on market share, how big that is and the market share between you versus the 2 competitors?

Speaker 3

No, we don't know.

Speaker 2

There is some public projections on markets that Coherent shared publicly in one of their presentations. If you haven't seen that, you might want to take a look because there's some stuff in there that might give you some information.

Speaker 7

But just on the market share, I mean, you think should we expect maybe 1 third each for you and your competitors or somebody has a dominant market share just for on the AI? Any color on that?

Speaker 3

Yes. The customer we have, I think they are giving us order order, but I don't know whether our competitor is taking order from a different customer. Okay. In other words, the order we got, we know we got 100% of that order from that customer and they told us it's for AI, but I don't know whether our competitor are serving yet on the channel.

Speaker 6

Got it. All right. Thank you. Thanks, Dave.

Operator

The next question comes from the line of Matt Berson from Wedbush Securities. Please go ahead.

Speaker 8

Hey, thanks for taking my questions. On the HPT side of things, if you're successful in getting traction, any idea of what the size of that opportunity might be?

Speaker 3

Say it again. I didn't hear it quite here. The expected value, how

Speaker 2

big is the HBT market?

Speaker 8

No, on the HBT market, what could that look like on a quarterly or annual revenue run rate assuming you're successful in getting traction in that market?

Speaker 3

Okay. I would say close to $20,000,000 a year.

Speaker 8

Got it. So that's a nice big round number. Similarly, or slightly different question. I think a lot of the focus on any new phosphide has been around the AI opportunity. But do you have any sense of how close to the point where inventory is normalized we are?

Speaker 8

Like is that 2, 3 quarters out? Is it a year out? And then any idea in terms of how much revenue you think you're losing because there's inventory out there right now? Or what might your revenue look like if that inventory didn't exist? Any thoughts?

Speaker 3

Yes. I think right now it's very difficult for me to estimate because I don't even know whether they are in full production or not, although the amount of substrate they're buying doesn't look like it's pilot. I think they're making something. But we haven't seen I mean, the first thing I'd like to see is, I mean, the last order was for 3 months. If they give us other 6 months order, if they're increasing, then I can estimate.

Speaker 3

And better yet is, if there's a second customer solar coming in wants the same thing, and that's even better. At this point

Speaker 8

And sorry to interrupt, Maury. So I'm actually I'm asking on kind of that traditional indium phosphide business like where you know you have inventory kicking around in supply chain, if you have any idea. So not so much the AI side, but that traditional business, if you have any idea like how what the impact on your revenue is today? How much it's holding it off? And then any thoughts on when that inventory might get worked out and you might resume a normal revenue run rate on that older business?

Speaker 3

I think that's because the business is right now at just beginning, it's hard for me to tell. But I mean, I think we have the capacity. We can definitely make 3 or 5 times what they are ordering now or even 10 times if giving us a little bit time to increase our facility. So I think the volume is no problem and I think our product quality really fits well with what they wanted. So at this point, I think I don't know whether I'm answering question or not.

Speaker 3

I think I'm excited about it and we're trying to get as much information as we can. And we know the customer, end customer, which is large. I don't think they're fooling around. So hopefully, they're coming back with increased order or somebody else is going to come in following their lead. So I think that's the best I can.

Speaker 2

Yes. I've had some of these conversations with our marketing guys and I think they expect that we're going to continue to work through the inventory into the second half of this year.

Speaker 3

But that's not AI.

Speaker 2

No, no, it's not AI. It's just in general.

Speaker 3

Data center.

Speaker 2

Data center, yes. Yes.

Speaker 3

Which has the inventory.

Speaker 2

Yes. So that's what I was referring to. So there's still some out there. There's still some out there. But yes.

Speaker 8

But getting cleared out and then restoring normal levels that's probably a 20 in early 2025 type phenomenon as you're thinking right now?

Speaker 2

Yes, maybe Q4 this year, but definitely in 2025. So it's going to happen. So we can't wait. We're so excited about it. Yes.

Speaker 8

I guess last one for me, Gary. I completely understand that customers don't want to hold inventory. And so they're putting in rush orders, which makes it hard on year end to clear out your inventory because you don't want to turn down business. But I guess given that environment, how confident are you can take down inventory by $10,000,000 or what are the dynamics involved in that where you're not effectively having a turn down business because you can't meet those rush orders?

Speaker 2

Well, I wanted to take it down $10,000,000 last year. It came down last year, but not as much as our target. However, I have a couple of reasons that I think it's a realistic target. One is if you look back at our historical inventory the inventory was in the $60,000,000 level range, dollars 65,000,000 level range. So the difference is we have more inventory in the consolidated joint ventures now because they have different added product lines and things like that.

Speaker 2

And our recycling program, which is good, it helps us on gross margin and helps us with ESG, but you're converting what I would call scraps of materials or slurry, which has a little or no book value and then you bring it in at standard cost. So your inventory goes up. So it's counterintuitive. But even so, I'm absolutely convinced we can take money out of the inventory. Is it going to be $10,000,000 That's my target.

Speaker 2

And if revenue grows for us, then it makes it a little easier to take the inventory down. So yes, I don't need a miracle to have that happen. I just need some good business decisions. And it was easier frankly when I could go to China because I would hold inventory review meetings. And I haven't been there for a while because of the COVID thing, but I'm going to go this year.

Speaker 2

So we're getting back in that cycle. But it's a good question. So thanks.

Speaker 8

Awesome. Thanks for taking my question.

Operator

As there are no further questions at the queue this time, this concludes our Q and A session. I would like to turn the call over back to Doctor. Maurice Young for closing remarks.

Speaker 3

Thank you for participating in our conference call. This is a quarter we will participate in the Northland Security Growth Conference on June 25. I hope to see you there. As always, please feel free to contact me, Gary Fisher or Leslie Ring, if you would like to set up a call with us. We look forward to speaking with you in the near future.

Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.

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Earnings Conference Call
AXT Q1 2024
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