Leslie Green; IR; AXT, Inc
Gary Fischer; VP & CFO; AXT, Inc
Morris Young; CEO; AXT,Inc
Richard Shannon; Analyst; Craig-Hallum Capital Group LLC
Good afternoon, everyone, and welcome to AXT's third quarter 2023 financial conference call. Leading the call today is Dr. Morris Young, Chief Executive Officer; and Gary Fischer, Chief Financial Officer. My name is Christina, and I'll be your coordinator today. (Operator Instructions) Thank you. I would now like to turn the call over to Leslie Green, Investor Relations for AXT.
Thank you, Christina, 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 move manufacturing yields and efficiency, and 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 the financial performance of our partially owned supply chain company and the impact of delays by our customers on the timing of sales and their product.
In addition to the 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 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 November 2, 2024.
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 2023. 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. Garry?
Thank you, Leslie, and good afternoon to everyone. Our revenue for the third quarter of 2023 was $17.4 million, down from $18.6 million in the second quarter of 2023 and down from $35.2 million in the third quarter of 2022. To break down our Q3 '23 revenue for you by product line, indium phosphide came in at $4.9 million, reflecting a stabilizing market with modest improvement in data center applications. Gallium arsenide was $4.2 million.
We were pleased to obtain our first permits to ship gallium arsenide substrates during the quarter and continue to work through that process on behalf of a growing number of our gallium arsenide customers. Germanium substrates were $1.2 million up from the prior quarter, also reflecting our progress in obtaining permits on behalf of our customers.
Finally, revenue from our two consolidated raw material joint venture companies in Q3 was $7.0 million. In the third quarter of 2023, revenue from Asia Pacific was 82%, Europe was 14% and North America was 4%. The top five customers generated approximately 31% of total revenue and new customers over the 10% level.
Non-GAAP gross margin in the third quarter was 11.3% compared with 9.8% in Q2 and 42.2% in Q3 of 2022. For those who prefer to track results on a GAAP basis, gross margin in the third quarter was 10.7% compared with 9.2% in Q2 and 42.0% in Q3 of 2022.
The primary drivers affecting our corporate gross margin in Q3 were volume, product mix and an improvement in our raw material business gross margin. Beyond the near term, we remain confident that we can get back to the mid 30% range as the environment strengthens through higher overall volume, more favorable product mix and the benefits of our recycling programs, along with continued efficiency improvements throughout our business.
Moving to our operating expenses, with the reduction in overall revenue, we have maintained spending discipline in our operating expenses to align with the current environment.
Total non-GAAP operating expense in Q3 was $7.8 million, consistent with our results in Q2 2023, and down from $9.2 million in Q3 of 2022. On a GAAP basis, total operating expenses in Q3 was $8.6 million, consistent with our results in Q2 of 2023 and down from $10.2 million in Q3 of 2022. Our non-GAAP operating income for the third quarter of 2023 was a loss of $5.8 million compared with the non-GAAP operating loss in Q2 of 2023 of $5.9 million and the non-GAAP operating profit of $5.6 million in Q3 of 2022.
For reference, our GAAP operating line for the third quarter of 2023 was a loss of $6.7 million compared with an operating loss of $6.8 million in Q2 and an operating profit of $4.6 million in Q3 of 2022.
Non-operating other income and expense and other items below the operating line for the third quarter of 2023 was a net gain of $0.9 million. The details can be seen in the P&L included in our press release today.
For Q3, 2023, we had a non-GAAP net loss of $4.9 million or $0.12 per share, compared with a non-GAAP net loss of $4.2 million or $0.10 per share in the second quarter of 2023. Non-GAAP net income in Q3, 2022 was $6.8 million or $0.16 per share. On a GAAP basis, net loss in Q3 was $5.8 million or $0.14 per share. By comparison, net loss was $5.1 million or $0.12 per share in the second quarter of 2023.
GAAP net income in Q3 2022 was $5.8 million or $0.13 per share. The weighted average basic shares outstanding in Q3 was $42.6 million. Cash, cash equivalents and investments were $43.6 million as of September 30, by comparison at June 30, was $49.6 million. The reduction in cash was primarily due to net cash generated by operating activities. Although last quarter that was positive in Q3, it was negative this quarter.
Depreciation and amortization in the third quarter was $2.2 million and CapEx was about $4 million. Total stock comp was $0.9 million. As I mentioned, net inventory came down by $700K to $86.4 million at September 30. 41% of the inventory is raw materials and WIP is 55%. Finished goods makes up only approximately 4%.
Okay, this concludes the report on our quarter financial results. Turning to our plan to list our subsidiary, Tongmei in China on the STAR Market in Shanghai, we do need to resolve a one open item. Morris is in China as we speak and is working on this matter. Although it is moving slower than we expected, we are making progress and we're confident that Tongmei remains an excellent candidate for listing and will be approved to proceed.
With that, I'll now turn the call over to Dr. Morris Young for a review of our business and markets. Morris, welcome from China.
Thank you, Gary, and good morning, everybody. Well this is in China here in Mali. The demand environment include three main table and we were pleased to see some encouraging early signs of improvement in the data center market, resulting in modest higher indium phosphide revenues. We still believe that our inventory position across our markets will continue through the end of the year. Only in some cases, may persist into 2024.
But we believe the worst of the declines are behind us, and we're looking forward to the new year with optimism. We have worked diligently throughout 2023 to advance our innovation in large diameter substrates and to support future emerging opportunities across our portfolio in a fast time. As the data center market prepares to move to 800 Gbps data rates. We are seeing increased development around next-generation silicon photonics devices, electro-absorption modulation laser or EMLs for high-speed data center transceivers.
The growing adoption of AI technology is providing a strong catalyst for the industry transition to higher speed, and we are excited to be engaging with customers for new opportunities as the market expands. Our proven performance in optical devices for the data center, coupled with our success in developing six-inch indium phosphide substrates is putting us in a solid position for both current and future generation of data center optical devices. We're also seeing positive development activities in both consumer and healthcare applications for indium phosphide. This further reinforces our conviction that we are very, very early stage in our adoption of this material across a multiple multitude of emerging applications.
Our early success not only validates indium phosphide as the material of strategic importance, it validates AXT, as a world-class supplier to Tier one companies. We believe that the next two years we'll see the further expansion into these and other areas.
Now in gallium arsenide we're pleased to announce in September that Tongmei, our subsidiary in China received these initial export activities and was able to resume shipping gallium arsenide substrates and germanium substrates in the second half of September to a number of our customers. We made good progress in filling customer orders and minimizing disruptions.
We're very proud of the way our team has responded quickly and effectively, and we're grateful for the partnership of our customers in working with us through this process lagging the cost line. The market for gallium arsenide remains weak but stable. We see inventory should likely to continue into 2024. That said, we are actively preparing for a new wave of innovation in our markets.
We're pleased by the progress we're making in our eight-inch gallium arsenide for customers. And this consumer high end display and automotive applications for micro-LEDs, we today our customers' workflow applications specifications for micro-LEDs, expotentially more stringent than they were when our eight-inch development began. And yet we have been able to meet these requirements delivering outstanding TSR densities results in volume.
We feel very confident in our ability to serve this emerging market. We believe that there will be a growing number of use cases in development. Our expectation is that product development from multiple customer is slightly to ramp throughout 2024, with the first micro LED products come into market in 2025 and beyond.
In Q3, we saw a modest increase in our germanium substrate revenue, so may receive the first export permits for germanium substrate customers during the quarter and was able to ship accordingly. Overall solar cell satellite markets is navigating similar cyclical headwinds as the other markets. But we are confident that this area of our business will recover as the market strengthens.
Finally, sales from our raw material business trended down slightly in the quarter, the gross margin improved from Q2. Overall, the pricing environment remains relatively stable. We don't expect any major changes in Q4.
In closing, we're looking forward to the new year pathways with renewed optimism. While inventory rationalization may persist into the new year, we are pleased to be seeing the early signs that I can make a positive change for 2024.
We believe, that the trend that have been driven our revenue and customer expansion and remain very much intact. Further, we have executed well in our development of large diameter substrates that will pave the way for our opportunities in next-generation devices, spending from data center, consumer, and other markets. As we navigate the natural environment, we continue to prioritize our cost savings and efficiency, and we are focused accelerating our return to profitability.
I would like now to turn the call back to Gary for our fourth quarter guidance. Gary?
Thank you, Morris. In keeping with our comments today, we expect Q4 revenue to be between $16 million and $19 million. We expect our non-GAAP net loss will be in the range of $0.13 to $0.15, and GAAP net loss will be in the range of $0.15 to $0.17. Share count will be approximately 42.6 million shares.
Okay, this concludes our prepared comments. Morris and I would be glad to answer your questions now.
Question and Answer Session
Richard Shannon, Craig-Hallum.
Well, hi, Morris and Gary, thanks for taking my questions and Morris, thanks for getting up early in China this morning.
Let's hear -- let's ask question on the guidance here for the quarter, just to kind of get the assumptions built in here. Obviously, the midpoint here is roughly flat with the third quarter mix, which makes sense, given your comments about stabilization, are there any unusual trends within the substrate buckets as well as raw materials to get to that point? Are they all roughly similar to flat sequentially?
I don't think there's much ripples or nuances. It's kind of business as usual, frankly. So you know, yeah, I don't have a lot of other other color to add.
Yeah, the only thing I may add is Gary and I, we're still working through how many permits can we get. So I mean, the more the permits we can get and perhaps we can increase that slightly, but it's not a very significant increase.
Okay. And then I guess specifically, I wanted to ask on indium phosphide given the importance of that revenue stream here. You're talking about the strength in data center, but hadn't mentioned anything about consumer telecom or some of the other markets here. So you're going to kind of delineated by the submarkets that are driving that? Is the fourth quarter you still expecting data center to grow? And I guess specifically I wanted to touch on the fact that I think your large customer in that area has transferred that transceiver business to another buyer. And so want to get a sense the degree to which that business will sustain.
Gary, you want to take that or, (multiple speakers)-- ?
Sure, I can start and you can join if you want. So data center is a strong sector for indium phosphide. Our business development guy, Tim Bettles is it kind of upbeat about it, frankly. So that's a positive. The Jabil transaction we talked about this with Tim today, and he actually feels it's a good decision.
So basically, it will allow Intel to hit in his view, okay, to focus on their core strengths and it shouldn't it shouldn't detract at all from our revenue stream to Intel and if they grow and improve, it will increase. So Jbil becomes basically a systems integrator or that's what they do is assemble stuff. So on and on, Tim thinks it's a good shift in the business model. But of course, it's our opinion from AXT, clearly, it's Intel's decision so that we don't see it as a negative at all, we see that as a positive sign.
Okay, fair enough. Maybe just the last topic on indium phosphide here. Just wanted to get a sense of continued traction with the consumer electronics applications, whether it's your big historical customer, any new ones coming in here, just some thoughts on how they-- how you expect that to go over the next few quarters?
Yeah, we continue to work with our customers, although this is still early but we have sent samples to at least two customers who potentially is going to decide how much the ramp and what's the timing for ramping. But we are in the early stage of qualification. But that application I understand, is one consumer applications and is scheduled to launch if it is successful in Q3 of 2024. So I think you know that activity is still, I believe, is still I mean, given the market is so dire, I think, is accurate and people are planning for next-generation application for indium phosphide.
Okay, fair enough. Two more questions from me, I'll jump out of line. First one, just following up on the comments and micro LED, I may have missed something in there with the spotty line here. But I guess my general question here is how is the environment here and the importance of this to your certain customers out there relative to last quarters? Are things holding in there in terms of time frame and size? Are there is there more uncertainty here in as the macros certainly seemed to get worse over the last 90 days?
Well, I think the intention for customer to proceed is it's firming up. I do believe they're coming. I think the only question I have is, what's the volume is going to be and how fast it's going to ramp up to the next phase, et cetera? I mean, we're were given the initial ramp up volume production I think is somewhere around mid-2025. And of course, it's going to ramp gradually from around next year onwards and into the first stage of production is 2025, I think. But I think that timing, although it's slipped from early predictions, but nevertheless, I think the customer is committed to go ahead with it.
Okay, and last question for Gary, is on cash flow. I think last quarter you're talking about and trying to generate some positive working capital here. And I see I think inventories are down slightly, but perhaps you're expecting or hoping for a little bit more, what's your general thought here as we look on operating cash flow and working capital benefits this quarter and into the near future?
Well, first of all, in terms of inventory, and I've gone back with my coworkers sort of looked at some historic inventory levels when maybe we were doing $25 million a quarter, $30 million a quarter. So it illustrates to me that, we should be able to take inventory down. So I'm still targeting to do that. I think at a minimum, we should shrink it by at least $10 million.
It's reciprocally, it's easy to do that if our run rates are high and it's harder to do that when our run rates are so frankly, modest right now. So I feel confident that we can do it and that we will do it. So it's a in terms of -- if you look at our overall -- like I was looking at the cash generated from operating activities in our internal cash flow thing, its negative 280,000 for the first nine months of this year.
So because you know you're adding back depreciation, you're adding back stock comp and there are some low hanging fruit items on the balance sheet inventory is one, our accounts receivable is one. Specially in China we have pretty long day sales outstanding, so I'd like to bring that in. So yes, I think it's okay.
I will, of course, be delighted to bank the IPO money. But in the meantime, I think we're say --
That's all from me guys, I will jump out of line.
Christina, any more questions?
Yeah, so there are no further questions at this time. So I --
Thank you for your participation on this call. We will be presenting at the Needham Growth Conference in January. And looking forward to seeing many of you there, as always, 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.
Thanks, Morris. Thank you all.
Thank you. And this conclude today's conference call. You may now disconnect.