Q3 2021 AXT Inc Earnings Call

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 book Accordingly, I will be your coordinator today at this time all participants are in a listen only mode. After the speaker's presentation there'll be a question and answer session to ask a question. During the session you will need to press.

Star one on your telephone please.

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 X T. 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 substrate our product mix, our ability to increase orders in succeeding quarters to control costs and expenses to improve manufacturing.

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 managed.

<unk> current expectations and are subject to risks and uncertainties that could cause actual events or results to differ materially these uncertainties.

But are not limited to overall conditions in the markets in which the company competes global financial conditions and uncertainties over 19, and other outbreaks of can take these potential tariffs and trade restrictions increased environmental regulations.

Market acceptance and 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.

Additionally, the factors that may be discussed in this call. We refer you to the company's periodic reports filed with the Securities and Exchange Commission. 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.

<unk> on our website at <unk> Dot com through October 2022.

Also before we begin I want to note that shortly 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 <unk> Dot Com I would now like to turn the call over to Gary Fischer for a review of our third quarter results.

Gary.

Leslie good afternoon to everyone.

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 stock based compensation.

Yes.

All of my commentary I'll 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.

From $33 7 million in the second quarter of 2021 and up 36% from the $25 5 million in the third quarter of 'twenty 'twenty.

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 $23 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 $25 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 five customers generated approximately 25% of total revenue our.

Our continued revenue revenue diversity.

Illustrates 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%.

Paired with 36, 4% in Q2 of 2021 and 34, 8% in Q3 of 2020.

For those who prefer to track the results on a GAAP basis gross margin in the third quarter was 33, 3%.

Compared with $36 three in Q2 of 2021 and 34.6 in Q3 of 2020.

The sequential decline decline in gross margin was primarily driven by low margin sales at Jimmy one of our consolidated joint ventures generally 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 impact to the consolidated gross margin in Q3 was approximately 220 basis points.

At least one of those contracts expired in Q3, but we accept 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 as a unique and important aspect of our supply chain strategy.

As we look ahead, we believe that our increasing volume.

Proving product mix and continued improvement in manufacturing efficiency will allow us to drive continued gross margin improvement as we progress through FY 'twenty. Two 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 K as nonrecurring.

For comparison total GAAP operating expense was $8 3 million in Q2 of 2021 and $6 six 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 six inch indium phosphide and the development of eight 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 H P.

<unk> 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 at $4 9 million.

$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 or 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's supply chain accounted for under the equity method.

It also included a tax credit in China's totaling approximately 960 K in Q3.

In addition, we continue to be very well regarded and causal 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 four facilities investment in the region.

As we look ahead to Q4, we do not expect our results to the benefit from either a tax credit for grants.

Such we expect our EPS in Q4 to come down from Q3.

Our Q3 results included approximately 330 8-K in tariffs as a result of the 25% tariff charge 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, a $5 4 million or <unk> 13 per share compared with $5 4 million or 12 cents per share in the second quarter of 2021.

And with 1.0 million or four cents per share for the third quarter of 2020.

On a GAAP basis, net income was $3 8 million or nine cents per share.

So it's a bit lower than we forecasted as a result of the lower gross margin contribution from Jin me by comparison net income was $4 4 million or 10 cents per share in the second quarter of 2021.

And 1.0 a million or two says here 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 30th 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 in 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 plans to list our company in China on the star market in Shanghai.

We are working closely with our China investment banker at 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 has incredible goal, but it is by no means easily accomplished our teams had been responsive and working hard on all topics and we continue to make good progress.

So in conclusion, we we know.

We have now had three consecutive quarters of revenue over $30 million level.

And we see continued opportunity on horizon.

I'll 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 five to seven months. So last year, he and I were both in China.

For this call and I can tell you. It's it's it's hard to get up in the middle of the night. So Morris was awake at the office at his three a M.

And has been waiting for this call today, so at Morris to take it over.

Thank you Gary and good afternoon everybody.

Our third quarter and you just need revenue results continue to underscore the gathering momentum in our business.

After years of preparation we are now seeing sustainable increasing demand from the technology Mega trends that our substrate helped too.

Trends such as hygiene telecommunications.

<unk> health monitoring the internet of things.

The proliferation of OLED lighting and display.

Year to date, we've 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 substrate.

We thought when you expanded manufacturing facility, we're able to capture market share.

And new opportunities, while meeting the stringent technical requirement of tier one customers.

As such.

One is the only one is unfolding to be a pivotal year for our business.

We expect to post growth approximately 40% this year with substantial gay eight hold profitability.

And we're looking ahead, we believe that we can achieve double digit revenue growth again in 2022, Oh between 15% to 20%.

Multiple existing growth drivers.

And the new ones being later.

To the current demand.

Now in the bottom line too.

Q3 marked the highest quarterly revenue in <unk>.

History.

It was again.

It was our top contributing materially.

Market demand was strong across the board there's capacity in our industry, it's an outright.

Customer who has worked with us for many quarters I read now returned.

It's simple existing customers our book at the increasing demand.

Our ability to expand capacity to meet customer demand is beginning to open up new avenues of opportunity in multiple applications.

In Q3, indium phosphide sequential growth were driven by a 45 G telecommunication obligations.

Well continue how scared healthy demand with data center connectivity.

We believe that these applications are closely related and the potential growth in Vegas.

Jesse.

The infrastructure to move it as well.

It's the capability to efficiently handle and store it.

From a subsea perspective.

Any mother monetization.

And data center infrastructure that utilizes indium phosphide is positive for our business.

Whether that's palms rental back.

Infrastructure.

Or silicon photonics build out within the datacenter.

Well, 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.

Has become a central part of one of these days.

Oh telecommunication business.

In addition to these major applications. We believe there are significant new applications for indium phosphide now visible on the horizon healthcare monitoring other motive sensors and more.

All exe's comparative advantage of 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. They had all of VEGF grow material unifoliate uniformity as well as consistently provide the industry's lowest EQT level, which is essentially requirement for high performance applications and tier.

When specifications.

Now turning to gallium arsenide.

In Q3, we posted our highest quarterly revenue in more than four years.

Semi conducting gallium arsenide, we continue to see strong demand for high end, OLED applications, including automotive and lighting and display.

We're also seeing rapid growth in high power lasers, particularly in China.

On the wireless side.

O T continues to be strong.

In addition, with six inch capacity tightening up in our industry would be we're beginning to see demand come.

Customers.

From the new customer demand and interest in our gallium arsenide for HPT devices, and our ability to expand capacity.

This not being a strong application for us who money more than 10 years.

And our facilities give us the opportunity to be competitive wentzville.

As we look ahead to the evolution of gallium arsenide high Tech applications, we believe micro OLED in particular holds great promises who all of the industry.

Major consumer device manufacturers are behind the development of the technology for a variety of applications, including talent.

Elevations.

We are.

Portable devices and others.

That's the only DS, which should not be confused with mini Leds uses gallium arsenide to make red blood is that blue Green led the modules.

That can provide almost any color.

Micro OLED devices.

Practice to consume less power provides sharper contrast, and produce really in line.

And Carlos.

We're seeing reports that the potential micro OLED market for smaller consumer devices, like wearables and phones could be larger than entire current market for gallium arsenide substrates debate.

Regardless of the specific numbers this is an exciting space.

At significantly new value to the OLED market in 2024 and beyond.

Now turning to R&D.

We continue to progress.

The development of eight inch gallium arsenide wafers among.

Among the many benefits to our customers eight inch gallium arsenide would 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 come through as the major increase in the technical challenges of producing it.

But we have successfully delivered sample quantities to interested customers and we're working with them to meet the requirements of their emerging projects.

Moving now to 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.

Finally to raw materials.

You May recall, we currently consider consolidated two joint ventures.

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Which manufacturers high temperature P D inclusive.

PBF based tools for OLED.

And on the joint venture Gene Mi, which is who has a diversified industrial IPO immature supply.

Demand continues to be strong we are on track to achieve significant growth in this area of our business over the prior year.

In 2020, most company relocated to our campus in casual.

Enabling them to expand capacity in response to market demand.

This coupled with a recovery in pricing of raw materials, such as raw gallium that's contributed.

Contributing to their growth this year.

As mentioned as Gary mentioned, while the increase your raw material price.

Negatively impacting our gross margin.

Our 10 supply chain companies provide enormous benefit in terms of our overall profitability as well as all the supply.

We're highly focused on driving renewed improvement in gross margin in 2022.

We believe that.

Our expanded growth in revenue.

Well product mix.

Continued improvement in our manufacturing efficiency and our new facilities.

Allow us to return to.

Exceed our prior performance.

In closing.

This is an exciting and twice when they hit time for <unk>.

Our strong growth highlights the market expansion.

But are you seeing in all key product categories.

Across a diverse set of applications customers are forecasting rising demand.

The positive sentiment for the coming year.

Gary and I would be.

Around for a while.

We sense that even with this is it go the convergence of market and emerging technologies.

For this reason, we're making important investments in our business.

Including larger diameter substrates.

Our city expansion and our IPO in China.

While these investments bring us to a higher level of operating expenses. They gave us a significant competitive advantages in our ability to scale our business.

And meet the need of tier one customers emerging high volume applications.

We believe we have laid a strong foundation for business transformation.

Community in 2021.

As such we're setting the stage for either you or meaningful growth.

In 2022.

I'll now call 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 season 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 of 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 for grants, we believe that our non-GAAP net profit will be in the range of six to eight and our GAAP net profit will be in the range of four to six sets 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 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 as a reminder to ask a question you will need to press star one on your telephone.

To withdraw your question press the pound key.

Again, if you would like to ask a question. Please press star one on your telephone please standby, what we call up compile the Q&A roster.

Again to ask a question Thats Star one.

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. Your first of all on the revenues.

My line was a little spotty I'm traveling so I might've 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. Your 34 to 36 is a million wider double double the width that you'd normally have in your revenue guidance. So I wonder if you can give us a sense of what youre thinking there and what are the.

Drivers up and down.

Yeah.

Go ahead Morris.

Let me try that.

I think raw material is going to be down slightly.

Indium phosphide, we project to go up slightly.

Gallium arsenide.

Checked 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.

Given that we have the first 10 days of National holiday in China as well as the back end of the Christmas holiday season.

So we are guiding actually sort of flat for the quarter, but we just widening the range a bit to give us potential pushes.

As you know that with you.

You know the potential.

Power shortages in China.

Although we do see that customer demand out there, but we just wanted to make sure that we have or 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 I haven't had time to run through those numbers here, but.

And obviously your Opex has been moving modestly higher over the last few a few quarters or so.

And you typically don't guide on gross margins, but certainly the the end EPS number here is a bit lower than what we had and I think it was what was in consensus. So I guess I want to make sure. We don't want to get a sense of the drivers here any way you can quantify or at least help us understand the magnitude of the changes both in Opex and gross margins in the 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 baked into that would be great as well.

Okay. So I'll go first.

Oh.

One of them one of the drags for Q4 is the situation with Genmab.

One of the companies that we consolidate.

That's a temporary problem.

But.

They have they have made some commitments for deliveries that are have long trajectory.

And as a result of the change the change in cost of raw gallium, which they have to buy a.

Went up so so that's a key factor there.

And.

When we go down to the bottom line.

Yeah Opex opex.

Opex this quarter in Q3, the GAAP Opex was.

Uh huh.

$9 1 million.

That included about $500000 of one time charges.

Related to stock compensation.

So so in Q4.

It will come in below 9 million for sure. We hope we think so.

And but you're right Opex does take back some of the gross profit dollars.

And then we.

<unk>.

We think based on the changes that we see from Q3 to Q4 that.

It's going to come out about what we guided to a few minutes ago. So.

Okay, maybe to follow up on the.

No.

I'm sorry go ahead Morris.

No go ahead.

What's your.

I get I guess, a follow up question is and you quantified it during your prepared remarks about the gross margin impact I think 220 basis points.

In the third quarter, as the impact your simpler or or or higher or lower in the fourth quarter.

It's it's it's similar but slightly lower.

Okay.

Okay.

And then do we see those.

Those things abate after the fourth quarter too.

Go ahead Morris what are we going to say.

Yeah.

I think so.

Let me go back to the I think obviously the.

The EPS drop is.

Sort of.

Lower than Q3 for our guidance in Q4 so.

If you look at that.

What benefit does Q3s.

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 GMA has lower gross margin of this particular contract is signed with the customers, which will not continue but it will drag down a little bit I think you know us.

We establish new contract it was new customers that is going to recover and yet the other than the other is the government.

Award that we received in Q3, which is now going to repeat itself in Q4, So overall I would say.

SG&A has increased mainly because several things we are spending quite a bit of money in R&D is six inch indium phosphide as well yeah.

Each gallium arsenide.

Other big part of the increase that we're spending is.

<unk> built up our infrastructure for the put for the output.

The IPO in China.

And as you know the proposed IPO in China gives us great valuation. So we can value very much smaller proportion to get did fund necessary for us to grow.

In the future so that's beneficial for <unk>, but in the meantime, some of these necessary cost which is attaching to the IPO process is is burdening our water.

President structure.

However, I would also remind you that you know now we have grown 40% year over year.

But our revenue to grow again next year, which I think are.

Take care of some of the.

Added expense that we could and we're building a much.

Larger and stronger foundation for future growth.

Each will hopefully give us better profitability next year.

As well.

More profits dropped down to the bottom line.

Yeah, just underline one and one important thought which is that.

I view and we view it as a company Morris and me and his leadership team what we do.

We want Opex, just flattened 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 can move faster than our competitors and.

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 there are also an investment so.

And we think we're going to get a return on our investment.

Starting next year.

Okay.

Okay.

Per Morris as our comments on growth I didn't want to have my last question here for your comments about the 15% to 20% growth next year I Wonder if you can characterize in a few different ways you know by the revenue segments here, even within substrates and then also to what degree are some new customers you know, particularly some of these tier one customers have been read.

Has it been qualified how much they are adding to that overall growth profile next year.

Go ahead Morris.

Yeah, I think we do expect.

Our revenue protection, we do see where 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.

<unk> actually.

It will grow more than 30% next year. So it will have a higher percentage grows.

For next year.

Gallium arsenide.

So seeing reuse interest well first of all what we already see is the high power laser in gallium arsenide, especially China is giving us very high.

I expect they should will gross like tier we 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 HPT market was.

As you know the D a.

It has been sort of flat or many many years and because of our strength in providing P. M.

Sub grades.

The cell phone market. So we have been acting on that.

The market for a long long time, but now the industry experts are telling us in the next two years. They are seeing you know the HDD market actually demand to grow between almost.

The 40% to 50% in the next two years as you know that this pocket capacity is kind of tight so they are talking to us and we're excited about returning to that market in the near future.

So that's the two big growth driver I think raw materials, we believe that we're poised to grow.

Mainly because our two joint ventures are moved to a much larger and expensive.

Got you.

Capacity manufacturing facility that will allow us to grow as well as the demand is very strong and P. P. M. Both enjoys all providing crucible for crystal lows as walls.

Oh for LCD market.

So they they are poised to grow and how high purity.

Materials business would you still may although they are being flat this quarter because of the low margin because the overall company, but that business is a very healthy business and and.

This increasing demand.

Have the right technology and capacity to serve our customers. So we expect that to grow as well do you mean by the way is sort of a flat production for next year.

Okay, Great. That's a great detail for me and all my questions. Thank you.

Yeah.

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

Yes, thanks for taking the questions.

I just want to make sure I get my housekeeping right.

Gary I think you mentioned youre going to try to get Opex in coming quarter.

Around $9 million was that GAAP or non-GAAP.

That's GAAP.

I think it'll be okay. We currently predict it will be south of $9 million little bit. So yeah got it and then on the sorry on lifting.

SG&A rose I'm modeling it up about $5 million this year, how much of that spend is.

Starting with Spain.

Well.

We've hired a number of people to help us on the project.

There's also been a lot of it.

Administrative and permit kinds of issues that are driving these things.

Yeah.

So slip into the balance sheet as it entered the equity section so.

Ah.

I don't know if I can give you a.

A solid answer I I haven't carved that out enough.

Observe the phenomenon, but I don't have I don't know specifically how to answer the question Joe.

Yeah, So maybe let me help relative a little bit I think.

Look we are probably just second Nasdaq listing.

The company is.

Trying to go public.

This star market, Okay. So perhaps the wall Street expert it doesn't have a whole another experience, but I can tell you firsthand that.

A lot of required conformity that we need to follow I give you. One example.

Yeah.

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 property getting China requires that we pay surgeon they call it housing allowances for employees.

And our compensation to our employees was not you know minimum.

To say for sure, but because of the new requirement is saw the elevated to a new level and we have to sort of lumpy bidding and so that just expanded.

Although it's not a lot, but there's a lot of these small things piling up and they are just required conformity that we need to follow I'd say proposed and that's I mean, China, let's say comfort public company.

As you know the other side Oh.

The question is that once we go public the valuation of this new company in China that we proposed to IPO is going to be much higher valuation than new week with camera cat and so as a result, we will be able to you know.

Get ourselves.

Much lower.

Costs are much less dilution with a growth fund that we need to answer some of the capacity expansion new business opportunity. We can capture so that's the two side of it.

I understand it so Gary I was just looking for a ballpark is it you know couple of $3 million a year is it.

Do you have any ballpark whatsoever.

No I don't I am sorry.

Yeah, Yeah, let's move on and then in terms of R&D.

You know in the past when you guys are starting to ramp up your efforts in six and eight inch six inch indium phosphide damage gallium arsenide some of it had flowed through.

Gross margin 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.

Because I said you know what.

Manufacturer.

There's many process steps.

In our process technology.

So.

It's difficult to capture everything that's development base, there's not a lot of them are in cost of goods sold but there is D. In terms of research versus development.

And.

Yes.

So yes, there is some there.

It probably contribute some to the shortfall of the gross margin.

But the major.

There was just the rising quite so the raw gallium that was impacting the raw materials and not so much the yarn R&D.

Yes.

Daryl.

The standout.

Most notable driver is the two 2% and gross margin percent.

Would normally be getting from Jin Mei.

And we didn't.

So that's that's the biggest single element.

And then I would say.

There's still some settling in.

No.

As I look at it from a business standpoint that you know I do have an operating background as well so.

You know, it's it's new facilities, new equipment and as new people.

So I think theres, some some what I would call low hanging fruit there.

As we mature in those areas of facilities equipment and people.

That the Uh huh.

What's it called manufacturing efficiencies will will help the gross margin.

And I might as well just to speak to it now as to why we have lots of listeners.

We're a little bit disappointed in Q.

Q3, Q4 gross margin, but we're very confident about bringing that number back up.

And.

For sure at a 35%, but our goal is to be greater than 35%.

And we think that it's an achievable goal, there's 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.

Pretty good visibility right now.

From our customers that I would say better than.

Anytime in the seven and a half years I've been at H T.

So we.

We will get there and you know what.

I'd encourage you know.

Our shareholders should stay.

We use or not.

Not just quarter to quarter, but year on year, which is significant and I think next year. It will be another very positive comparison year on year.

Okay.

On gross margins or would you.

You expect that trajectory to look like I mean.

I think Q4 looks like it's going to be the bottom based on your guidance.

Your city ramp back to 35%.

Or is it more stair step depending on how those long term contracts.

Purified gallium go yeah, we have to get out of the weeds with Jin Mei.

A lot of that's already happened, but there's still some more happening in Q4 and it may dribble into Q Q1, we're not sure yet so but I don't think it's I think it's not going to be.

We won't get to 35% until 2023, it's going to be next year.

And.

Maybe not Q1, but.

Definitely Q2s very possible I haven't done a grounds up yet with the team.

But intuitively.

Just 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 going to go on Paas that so.

Got it alright.

I mean, we're a little bit.

Hi.

Gus.

Let me repeat what I I didn't hear all prepared comments.

First of all we believe that indium phosphide is going to grow.

Actually grow faster than our product mix next year.

That could help us and on top of the 40% growth. This year, we put we think we're going to grow our revenue again.

That is also going to help us our gross.

Gross margin and thirdly, as Gary mentioned, you know we are going through some kind of.

Some sort of a growing pain.

Although the opinions that much I mean, hopefully its most of it is overweight and then with our added capacity at least more manufacturing that we're going to do on the you know the more attractive product offering we have and with also the market.

The market demand rising I think is very very important and you know I think you know the.

Part of the gross margin.

Drag also I want to remind you is we're seeing gallium price going up.

And germanium private school.

Okay and they are.

Good component.

Cost of goods sold.

Okay, but.

So I would expect every competitor or every substrate provider in all business, having these gross margin squeeze. However, we saw a supply strategy that we have joint ventures in making them raw gallium and either in making the other raw.

Materials was so we are partially mitigating that.

Gross margin in Hollywood words.

<unk> got the margin hit on the top but below the line our joint venture is providing us the better.

Return.

And yet 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 you know as you know in our industry is difficult to raise prices but.

Different ways to improve our margins such as you know there are better product offering that we can't do.

Such as high power laser, which require low E. P D and a 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, guys.

Thank you. Our next question comes from Hamad course, and with BW as financial your line is open.

Hi, I just wanted to understand your working capital needs here as it continues to burn cash and build inventory.

Is there a particular customer or customers that are requiring you to build this kind of inventory as a supply chain issue.

Cause your also your cash has also been declining since the beginning of year as well.

There are some customers that require us to build inventory.

Including customers.

What the inventory consigned to their site, but it remains on our balance sheet.

And one in particular.

Growing.

And so that that is a contributor.

Uh huh.

But the.

You know.

Another another comment I can make about working capital.

Maybe insightful for for this time period is that September was our of the three months in the quarter September was the largest revenue month.

When that happens I don't like it because.

It tends to load up.

Went up like $3 million Q2, maybe three one I think.

And it went down $4 million, which means that was cash out so.

But in general.

Working capital I think.

We're managing it okay.

We need to have inventory.

To keep growing the revenue.

And.

Yeah.

We were comfortable with our cash position.

So yeah I hope that's helpful.

I know working capital moved quite it moved around a lot.

June 30 to September 30th.

But I think it's it's okay.

Okay.

Was it for me. Thank you. Thanks.

Thanks, Amit.

Good afternoon to you.

Okay.

Thank you. Our next question comes from John Michael Go better with Octavian capital.

I'm sorry, he just removed that we have a question from Richard Shannon with Craig Hallum.

Well great. Thanks for taking a couple more questions for me guys, let's see here Morris on the opportunity with each be teach you know I've covered you in an XD for I think over a decade and I haven't heard you talk much about this.

I'd love to understand the underlying reasons for this is this basically a capacity issue on the back of your competitors. That's opening this opportunity or are there other drivers for this.

I think there's some form of Ah I think.

<unk> market is very mature.

But from what we're hearing from our customers the demand forecast seems to be very strong.

We are still engaging our customers and they are.

When the market prior to these market is fairly mature I mean does it go a whole lot, but we've seen you know Paul.

Our first line consumers that'd be grower and theyre buying quite a bit a number of mo's CBD reactors and.

They are the ones, who told us that the market demand is going to grow between 40% to 50% of of course, we are looking at this very cautiously because this although the demand is there but.

The price pressure is there because it is a.

Very large market.

And but it does give us the opportunity to getting to something which we exited almost like 10 years ago.

Okay.

Okay. So we shouldn't necessarily be baking anything any contributions into say next year's revenue stream is that what you're telling me.

In our projections, we do we are putting something.

But we are cautiously.

We're putting let me see I'll protection I think we're putting about $4 million worse.

So overall scheme of things is that going to be large, but definitely we think the opportunities here yes.

Okay. That's helpful. My second and last question is on micro Idiot I think asked a version of this question last quarter and that is.

Obviously, you've been talking about a revenue ramp starting maybe kind of middle of calendar 'twenty, four and some big opportunities big customers and a big ecosystem what has to happen between now and then like when do you determine.

When you've 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 it's clearly what would ask you to build a lot of capex that I'm sure you don't want to strand in any way. So how should we think about the timeframe between now and then in your micro OLED 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 and we want assurances that.

The order is there the demand is there.

But.

We've been saying that the big demand is going to come in 2020 a tour.

But the pilot production and assembly is actually starting now and you know something like that.

I would say between 500 to 1000 wafer a year next year.

And we're going to need to work with our customers to see what kind of expect they need and we're gonna have a very good feeling of what's going on and as we.

We speak now we are engaging with our customer we get them.

Our projected capacity expansion and they are giving us the forecasts are aware.

It will be but as far as take or pay is bottomed.

Track is concerned.

Yes, we are contemplating that ended this.

But on the other hand, they do sign it take or pay that we have to we have to deliver.

So they are new to requirement for each other but this is a great opportunity.

We are spending the necessary.

<unk> development cost to ensure that we can capture this opportunity down the road.

Yeah.

Okay. That's a good characterization thanks for that detail Morris that's all for me.

Yeah.

Thank you and I'm showing no further questions in the queue I'd 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.

And I think the.

And we hope to see many of you there.

Always please feel free to contact me, Gary Fischer or Leslie Green directly if you would like to set up a call with us.

And we look forward to speaking with you in the near future.

This concludes today's conference call. Thank you for participating you may now disconnect.

Okay.

[music].

[music].

[music].

Good afternoon, everyone and welcome to Axt's third quarter 2021 financial conference call.

The call today is Dr. Morris Young Chief Executive Officer, and Gary Fischer, Chief Financial Officer, My name is Catherine and I book Accordingly.

I'll be your coordinator today at this time all participants are in a listen only mode. After the speaker's presentation there'll be a question and answer session to ask a question. During the session you will need to press star one on your telephone. 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 X T. 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 substrate our product mix, our ability to increase orders in succeeding quarters to control costs and expenses to improve manufacturing yield.

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 managed.

<unk> current expectations and are subject to risks and uncertainties that could cause actual events or results to differ materially these uncertainties.

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 can take these potential tariffs and trade restrictions increased environmental regulations, either market acceptance and demand for the company's products the financial performance of <unk>.

Our partially owned supply chain companies and the impact of delays by our customers on the timing of sales of their products.

Dish into the factors that may be discussed in this call. We refer you to the company's periodic reports filed with the Securities and Exchange Commission. 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 <unk> Dot com through October 2022.

Also before we begin I want to note that shortly 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 <unk> Dot Com I would now like to turn the call over to Gary Fischer for a review of our third quarter results.

Gary.

Leslie and 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 stock based compensation.

Okay.

Yes.

All of my commentary I'll 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 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 upfront.

$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 five customers generated approximately 25% of total revenue our continued revenue 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%.

Paired 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 the third quarter was 33, 3% compared with $36. Three in Q2 of 2021 and 34 six in Q3 of 2020.

The sequential decline decline in gross margin was primarily driven by low margin sales at Jimmy one of our consolidated joint ventures.

<unk> 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 margin in Q3 was approximately 220 basis points.

At least one of those contracts expired in Q3, but we accept 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 as a unique and important aspect of our supply chain strategy.

As we look ahead, we believe that our increasing volume.

Moving product mix and continued improvement in manufacturing efficiency will allow us to drive continued gross margin improvement as we progress through FY 'twenty two.

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, so of which 518 K as nonrecurring.

For comparison total GAAP operating expense was $8 3 million in Q2 of 2021 and $6 six 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 six inch indium phosphide and the development of eight 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 <unk>.

<unk> and our shareholders.

Non-GAAP operating profit for the third quarter of 2021 was 4.0 million cars.

Paired with non-GAAP operating profit in Q2 of 2021 at $4 9 million.

$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 XD supply chain accounted for under the equity method.

It also included a tax credit in China totaling approximately 960 K in Q3.

In addition, we continue to be very well regarded in cargo 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 the benefit from either a tax credit or grants as such we expect our EPS in Q4 to come down from Q3.

Our Q3 results included approximately 330 8-K in tariffs as a result of the 25% tariff charge 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 <unk> 13 per share compared with $5 4 million or 12 cents per share in the second quarter of 2021.

And with 1.0 million or four cents per share for the third quarter of 2020.

On a GAAP basis, net income was $3 8 million or <unk> <unk> per share.

So it's a bit lower than we forecasted as the lower gross margin contribution from Jin Mei by comparison net income was $4 4 million or 10 cents per share in the second quarter of 2021.

And 1.0 a million or two here 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 30th 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 in 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 plans 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 has incredible goal, but it is by no means easily accomplished our teams had been responsive and working hard on all topics and we'll continue to make good progress.

So in conclusion, we we know.

We have now had three consecutive quarters of revenue over $30 million level.

We see continued opportunity on horizon.

I'll now turn the call over to Dr. Morris Young for.

For a review of our business and markets Morris has been in China Since July and will remain there for five to seven months. So last year, he and I were both in China for.

For this call and I can tell you. It's it's it's hard to get up in the middle of the night. So Morris was awake at the office at his three a M.

And has been waiting for this call today, so at Morris take it over.

Thank you Gary and good afternoon everybody.

Our third quarter and year to date revenue results continue to underscore the gathering momentum in our business.

After years of preparation.

We're now seeing sustainable increasing demand from the technology Mega trends that our substrate helped you.

Trends such as <unk> telecommunications.

Health monitoring the internet of things.

The proliferation of OLED lighting and display.

Year to date, we have 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 substrate.

We thought when you expanded manufacturing facility, we're able to capture market share.

New opportunities while meeting the stringent requirement of tier one customers.

As such.

There is only one is imploding to be a pivotal year for our business.

We expect to post growth approximately 40% this year with substantial gay a whole profitability.

And we're looking ahead, we believe that we can achieve double digit revenue growth again in 2022, Oh between 15% to 20%.

With multiple existing growth drivers and the new ones being later on to the current demand.

Now in the bottom line Q.

Q3 marked the highest quarterly revenue in <unk>.

<unk> history.

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 has worked with us for many quarters I read now returned.

Several existing customers are broke at the increasingly advantage.

Our ability to expand capacity to meet customer demand is beginning to open up new avenues of opportunity you see multiple applications.

With 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 <unk> telecommunication obligations as well as continued how scared healthy demand with datacenter.

Activity.

We believe that these applications are closely related and the potential growth in Vegas.

Jesse.

The infrastructure to move it.

It's the capability to efficiently handle and story.

From a sub 6% respectively.

Any mother monetization.

Welcome and data center infrastructure that utilize the indium phosphide is positive well business.

Whether that's ponds rental.

More infrastructure.

Or silicon Photonics buildout 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.

Central PA.

Oh telecommunication business.

In addition to these major applications. We believe there are significant new applications for indium phosphide now visible on the horizon inhouse care monitoring other motive sensors and more.

Among <unk> comparative advantage of 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 VEGF grow material uniformly uniformity as well, it's consistently provide the industry's lowest EQT level, which I essentially requirement for high performance applications and Geo.

<unk> specifications.

Now turning to gallium arsenide.

In Q3, we posted our highest quarterly revenue in more than four years.

Semi conducting gallium arsenide, we continue to see strong demand for high end, OLED applications, including automotive and lighting and display.

We're also seeing rapid growth in <unk>.

Our lasers, particularly in China.

On the violence.

Iot continues to be strong.

In addition, with six inch capacity tightening up in our industry, where we're beginning to see demand from.

<unk> customers.

From the new customer demand and interest.

Well HPT devices.

Our ability to expand capacity.

This has not being a strong application for us who have money more than 10 years.

Our facilities give us the opportunity to be competitive wentzville.

As we look ahead to the evolution of gallium arsenide high Tech applications, we believe micro OLED in particular hold great promise for our industry.

Major consumer device manufacturers.

And the development of the technology for a variety of applications, including talent televisions.

Our VR headsets.

Portable devices and others.

Currently these who should not be confused with mini Leds uses gallium arsenide, you'll make Greg Gordon.

Blue Green OLED modules.

Micro OLED devices are expected to consume less power provides sharper contrast, and produce really in light.

And Carlos.

We're seeing reports that the potential micro OLED market for smaller consumer devices, like wearables and phones could be larger than entire current market for gallium arsenide substrates debate.

Regardless of the specific numbers this is an exciting space.

At significantly new value to the OLED market in 2024 and beyond.

Now turning to R&D.

We will continue.

Progress on the development of eight inch gallium arsenide wafers.

Among the many benefits to our customers eight inch gallium arsenide would 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 the major increase in the technical challenges of producing it.

We have successfully delivered sample quantities to interested customers and we're working with them to meet the requirement of their emerging projects.

Moving now to germanium substrates.

Revenue decreased modestly in Q3 from the prior quarter.

However, the satellite solar industry.

It remains healthy.

Oh, well on track for 2021 to be a growth year.

Finally to raw materials.

As you May recall, we currently consider consolidated two joint ventures.

<unk>, which manufactures high temperature TVN crucibles.

<unk> based tools for OLED.

And on the joint venture Jean Marie <unk>.

Who has a diversified industrial IPO imager supplier.

Demand continued to be strong we are on track to achieve significant growth in this area of our business over the prior year.

In 2020, most company relocated to our campus in casual.

Cable and then to expand capacity in response to market demand.

This coupled with a recovery in pricing of raw materials, such as raw gallium.

You alluded to their growth this year.

As mentioned as Gary mentioned, while the increase your raw material price is.

<unk> impacted our gross margin.

Our 10 supply.

Companies provide enormous benefit in terms of the whole overall profitability.

As well as our supply.

We are highly focused on driving renew the improvement in gross margin in 2022.

We believe that.

Our expanded growth in revenue.

Favorable product mix.

Continued improvement in our manufacturing efficiency and our new facilities.

Allow us to return to.

See our prior performance.

In closing.

This is an exciting and tourists will may take time for <unk>.

Our strong growth highlights the market expansion.

It is being our key product categories.

Across a diverse set of applications customers are forecasting rising demand.

The positive sentiment.

The coming year.

Gary and I would be.

Around for a while.

We said that even with flat. This is a go then convergence of market and emerging technologies.

For this reason, we're making important investments in our business.

Including larger diameter substrates.

<unk> expansion and our IPO in China.

While these investments bring us to a higher level of operating expenses. They gave us a significant competitive advantages in our ability to scale our business.

And meet the need of tier one customers emerging high volume applications.

We believe we have laid a strong foundation for business transformation.

Opportunity in 2021.

As such we're setting the stage for either you or meaningful growth.

In 2022.

I'll now call 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 seasonal 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 of 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 six to eight.

And our GAAP net profit will be in the range of four to six.

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 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 the 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 will be glad to answer your questions operator.

Thank you as a reminder to ask a question you will need to press star one on your telephone.

To withdraw your question press the pound key.

Again, if you would like to ask a question. Please press star one on your telephone please standby, while we called compile the Q&A roster.

Again to ask a question Thats Star one.

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. Your first of all on the revenues.

My line was a little spotty I'm traveling so I might've 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 to 36 1 million wider double the all the words that you would normally have in your revenue guidance. So I wonder if you can give us a sense of whats your thinking there and what are the.

Drivers up and down.

Go ahead Morris.

Let me try that.

I think raw material is going to be down slightly.

Indium phosphide, we project to go up slightly.

Awesome.

Projected to go up slightly.

<unk> 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.

Given that we have the first 10 days of National holiday in China, as well as the backend of the Christmas holiday seasons.

So we're guiding actually sort of flat for the quarter, but we just widening the range a bit to give us potential pushes.

As you know that with.

You know the potential.

Power shortages in China.

Although we do see that customer demand out there, but we just wanted to make sure that we have or 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 I haven't had time to run through those numbers here, but.

And obviously your Opex is moving modestly higher over the last few a few quarters or so.

And you typically don't guide on gross margins, but certainly the thee and EPS number here is a bit lower than what we had and I think it was what was in consensus. So I guess I wanted to make sure I wanted to get a sense of the drivers here any way you can quantify or at least help us understand the magnitude of the changes both in Opex and gross margins in the 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 baked into that would be great as well.

Okay. So I'll go first.

Oh.

One of the one of the drags for Q4 is the situation with Ginnie Mae.

One of the companies that we consolidate.

That's a temporary problem.

But.

They have they have made some commitments for deliveries that had long.

Trajectory.

And as a result of the changes.

The change in cost of raw gallium, which they have to buy.

Went up so so that's a key factor there.

And.

When we go down to the bottom line.

Yeah.

Yeah, Opex Opex this quarter in Q3, the GAAP Opex was.

$9 1 million.

That included about $500000 of one time charges.

Related to stock compensation.

So so in Q4.

It will come in below $9 million for sure. We hope we think so.

And but you're right Opex does take back some of the gross profit dollars.

And then we.

<unk>.

We think based on the changes that we see from Q3 to Q4.

It's going to come out about what we guided in a few minutes ago. So.

Okay, maybe to follow up on the.

Yeah.

I'm sorry go ahead Morris.

No go ahead.

One of the year and what jeweler.

Sure.

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

It's it's it's similar but slightly lower.

Okay.

Okay.

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

Go ahead Morris what are we going to say.

Yeah.

I think so.

Let me go back to the I think obviously the EPS dropped.

Sort of.

Lower than Q3 for our guidance in Q4, So you know.

If you look at the 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.

The other is.

The GMA has lower gross margin of this particular contract is signed with the customers, which will not continue but it will drag down a little bit I think you know us.

We established new contract with new customers that is going to recover and yet the other than the other is the government.

The award that we received in Q3, which is now going to repeat itself in Q4, So overall I would say.

The SG&A has increased.

Mainly because several things were spending quite a bit of money in R&D is 16, Genie frostbite as well yeah.

Each gallium arsenide.

Other big part of the increase that we're spending is.

Build up our infrastructure for the put for the proposed IPO in China.

And as you know not proposed IPO in China gives us great valuation. So we can dilute very a much smaller proportion to get the funds necessary for us to grow.

In the future so that's beneficial for <unk>, but in the meantime, as some of these necessary cost, which is attaching to the IPO process.

<unk> is burdening our water.

This 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.

Take care of some of the added expense that we could and we're building a much larger and stronger foundation for future growth.

Each will hopefully give us better.

The ability next year.

As well.

More profits dropped down to the bottom line.

Yeah, I would just underline one and one important thought which is that.

I view and we view it as a company Morris and me and his leadership team we do.

We want Opex, just flattened out, but we view it as an investment.

It's clear there is something happening in our markets.

We think we're uniquely positioned having completed the relocation to take advantage of these things.

We can move faster than our competitors.

And we're investing in that.

Then on the same in the same note some of the expenses are.

Resulting from driving for the IPO.

So theyre also an investment so.

And we think we're going to get a return on our investment.

Starting next year.

Okay.

Okay.

Morris as our comments on growth I didn't want to have my last question here for your comments about the 15% to 20% growth next year I Wonder if you can characterize in a few different ways.

The revenue segments here, even within substrates and then also to what degree are some new customers you know, particularly some of these tier one customers have been recently been qualified how much they are adding to that overall growth profile next year.

Go ahead Morris.

Yeah, I think we do expect.

Our revenue projections, we do see where 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.

<unk> actually.

It will grow more than 30% next year, so well have a higher percentage grows for us for next year.

So seeing renewed interest well first of all what were already see is the high power laser in gallium arsenide, especially China is giving us very high.

Expectation for growth next year, we're already engaged with customers.

But.

But they are telling us that for next year.

Expected volume that a high power laser demand.

And we're also seeing a very exciting.

New interesting HPT market was.

As you know the H D D.

It has been sort of flat or many many years and because of our strength in <unk>.

Providing P M.

Sub grades.

For the cell phone market. So we have been absent from HPT market for a long long time, but now the industry experts are telling us in the next two years they are seeing.

HPT market actually demand to grow between almost.

The 40% to 50% in the next two years as you know that this pocket 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're poised to grow.

Mainly because our two joint ventures are moved to a much larger and expensive.

New.

Capacity manufacturing facility that will allow us to grow as well as the demand is very strong in ppm boasting choice, all providing crucible for crystals as walls.

Oh Boy OLED market.

And so they are poised to grow and how high purity.

Material business, which is in may although they are being flat this quarter because of the low margin because the overall company, but that business is a very healthy business and and.

There is increasing demand and we have the right technology and capacity to serve our customers. So we expect that to grow as well do you mean by the way, it's sort of a flat projection for next year.

Okay, Great. That's a great detail for me and all my questions. Thank you.

Yeah.

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

Yeah, Thanks for taking the questions.

I just wanted to make sure I get my housekeeping right Gary.

Gary I think you mentioned youre going to try to get Opex coming quarter.

Around $9 million was that GAAP or non-GAAP.

That's gas in it.

I think it'll be okay. We currently predict it will be south of $9 million little bit got it and then on the sorry on lifting.

SG&A rose I'm modeling it up about $5 million this year, how much of that spend is.

Fourth starting with Spain.

Well.

We've hired a number of people to help us on the project.

<unk>.

There's also been a lot of it.

It is.

Administrative and permit kinds of issues that are driving these things.

Things that we can't.

No.

So slip into the balance sheet as it entered the equity section so.

Hi.

I don't know if I can give you.

A solid answer I I haven't carved that out enough what we've observed the phenomenon, but I don't have I don't know specifically how to answer the question Joe.

Yeah, So maybe let me help relative a little bit I think.

Look we are probably the second NASDAQ list.

Listed company.

He tried to go public.

This star market, Okay, So perhaps the wall Street.

It doesn't have a whole lot of experience, but I can tell you firsthand that has a lot of required conformity that we need to follow I give you. One example.

In some of our employee compensations section in China.

We have now.

Because we are going to propose to go public in China, and the requirement to be a property in China. It requires that we pay surgeon they call it housing allowances for employees.

Our compensation to our employees was not you know minimum.

For sure, but because of the new requirement is saw the elevated to a new level and we have to sort of lumpy bidding and so that just expanded it.

Expense, although it is not a lot, but there's a lot of these small things piling up.

And they are just required conformity that we need to follow as a.

Post and that's I mean, China listed public company, but.

As you know the other side of the question is that once we go public the valuation of this new company in China that we proposed to IPO is going to be much higher valuation than new weekly camera cat and so as a result, we will be able to.

Get ourselves.

The much lower cost.

Much less dilution for the growth fund that we need to answer some of the capacity expansion new business opportunity they were going to capture so that's the two side of it.

Okay.

Understand so Gary I was just looking for a ballpark is it.

A couple of $3 million a year is it.

Do you have any ballpark whatsoever.

No I'm sorry.

I should note.

Yes, yes.

Move on and then in terms of R&D.

You know in the past when you guys are starting to ramp up your efforts in six eight inch six inch indium phosphide and gallium arsenide.

A lot of it had flowed through.

The gross margin 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.

Because as you.

We manufacture in Italy.

Theres many process steps in there.

Process technology.

So it.

It's difficult to capture everything that's development base, there's not a lot of them are in cost of goods sold but there is D. In terms of research versus development.

And.

So yes, there is some there.

It probably contribute some to the shortfall of the gross margin.

But the major <unk>.

There was just the rising price of the raw gallium that was impacting the raw materials and not so much the yarn R&D.

Yes.

Daryl.

The standout.

Most notable driver is the two 2%.

Gross margin percent.

Would normally be getting from Jin Mei.

And we didn't.

So that's that's the biggest single element.

And then I would say.

There is still some settling in.

No.

As I look at it from a business standpoint, I do have an operating background as well so.

You know, it's it's new facilities, new equipment and as new people.

So I think there is some some what I would call low hanging fruit there that as we mature in those areas of facilities equipment and people.

At the.

So, let's say cost manufacturing efficiencies will will help the gross margin.

And I might as well just.

Just to speak to it now.

Lots of listeners.

We're a little bit disappointed in Q.

Q3, Q4 gross margin, but we're 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 is an achievable goal and then 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.

Pretty good visibility right now.

From our customers that I would say better than any.

Anytime in the seven and a half years I've been at H T.

So.

We'll get there.

Yeah.

I would encourage you know.

Our shareholders.

To view the <unk>.

Not just quarter to quarter, but year on year, which is significant and I think next year. It will be another very positive comparison year on year.

Just on gross margins.

Would you expect that trajectory to look like I mean.

I think Q4 looks like it's going to be the bottom based on your guidance.

Here, a city ramp back to 35% or is it more stair step depending on how those long term contracts.

For purified gallium go yeah, we have to get out of the weeds with Jin Mei.

A lot of that's already happened, but there's still some more happening in Q4 and it may dribble into Q Q1, we're not sure yet so but I don't think it's I think it's not going to be.

We won't get to 35% until 2023, it's going to be next year.

And.

Maybe not Q1, but.

Definitely Q2s very possible I haven't done a grounds up yet with the team.

But intuitively.

Intuitively just 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 Paas that so.

Yes.

Got it alright, thank you.

I mean, a little bit.

Hi.

Gus.

Let me repeat what I I didn't hear all prepared comments.

First of all we believe that indium phosphide is going to grow.

Actually grow faster than our product mix next year and that could help us.

On top of all the 40% growth this year.

We think we're going to grow our revenue again.

That is also going to help us out.

Gross margin and <unk>.

Thirdly, as Gary mentioned, we.

We are going through some kind of a.

Some sort of a growing pain.

Although the opinions that much I mean hopefully.

Most of it is overweight and then with our added capacity at least more manufacturing that we're going to do on the.

More attractive product offering we have and with also the market the.

The market demand rising I think is very very important and you know I think.

Part of the gross margin.

Drag also I want to remind you is we're seeing gallium price going up.

And germanium price okay.

Okay and they are.

Good component.

Cost of goods sold.

Okay, but.

So I would expect every competitor well every substrate provider in all business, having this gross margin squeeze. However, we saw a supply strategy that we have joint ventures in making them raw gallium and aimed at being maintained.

You know other raw material was so we are partially mitigating the the <unk>.

Gross margin no Hollywood words, we got the margin hit on the top but below the line our joint venture is providing us the better.

Return.

And yet also as you know the inflation pressure is coming and if the capacity becomes tighter who knows that may.

It could be a point that maybe the price is going to go up but you know as you know in our industry is difficult to raise prices, but there are different ways to improve our margins such as better product offering that we can do.

Such as high power laser, which require low E. P D and a brand new market for us to get into and that will give us better opportunity to <unk>.

Improve our margin that way.

Got it very helpful. Thank you so much.

Thanks, guys.

Thank you. Our next question comes from humid core Sandwich BW as financial your line is open.

Hi, I just wanted to understand your working capital needs here, you're continues burn cash and build inventory.

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

There are some customers that require us to build inventory.

<unk> customers.

What the inventory consigned to their site, but remains on our balance sheet.

And one in particular is growing.

And so that that is a contributor so.

Yeah.

But the.

You know.

Another another comment I can make about working capital this.

Maybe insightful for for this time period is that September was our three months in the quarter September was the largest revenue month.

And when that happens I don't like it because it.

It tends to load up.

Ah went up $3 million Q2, maybe three one I think.

And it went down $4 million, which means that was cash out so.

In general.

Yeah.

Working capital I think.

We're managing it okay I don't.

We need to have inventory.

To keep growing the revenue.

And.

We.

We're comfortable with our cash position.

So yeah I hope that's helpful.

I know working capital move it moved around a lot.

June 30 to September 30th.

But I think it's okay.

Okay.

Was it for me. Thank you. Thanks.

Thanks, Amit.

Good afternoon.

Okay.

Thank you. Our next question comes from John Michael Go better with our JV in the capital.

I'm sorry, he just removed that we have a question from Richard Shannon with Craig Hallum.

Well great. Thanks for taking a couple more questions for me guys, let's see here Morris on the opportunity with HB teach you know I've covered you in an XD for I think over a decade and I haven't heard you talk much about this.

I'd 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 he is the former.

Thank you.

HPT market is very mature.

But from what we're hearing from our customers the demand forecast seems to be very strong.

We are still engaging our customers and there is.

Wyndham.

When the market prior to these this market is fairly mature I mean does it go a whole lot, but we're seeing.

Our first line consumers that'd be grower and theyre buying quite a bit a number of mo's CBD reactors and.

They are the ones, 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 is a.

Very large market.

And but it does give us the opportunity to getting to something which we exited almost like 10 years ago.

Okay. So we shouldn't necessarily be baking in anything any contributions into say next year's revenue stream is that what you're telling me.

In our projections, we do we are putting something.

But we're cautiously look but.

We're putting let me see our projection I think were putting about $4 million.

So I don't know.

Our scheme of things is staggeringly large, but definitely we think the opportunities here yes.

Okay. That's helpful. My second and last question is on micro Leds I think asked a version of this question last quarter and that is.

Obviously, you've been talking about a revenue ramp starting maybe kind of middle of calendar 'twenty, four and some big opportunities big customers and a big ecosystem.

What has to happen between now and then like when do you determine.

You know when you've got a customer when do you have to start building start building capacity for this do you anticipate having sort of a.

Take or pay kind of situations here because this is clearly what would ask you to build a lot of capex that I'm sure you don't want a strand in any way. So how should we think about the timeframe between now and then in your micro OLED 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 orders there the demand is there.

But although we've been saying that the big demand is going to come in 2024.

But the pilot production and assembly is actually starting now and you know something like.

I would say between 500 to 1000 wafer a year next year.

And we're going to need to work with our customers to see what kind of spread they need and we're gonna have a very good feeling of what's going on and as we speak now we are engaging with our customer we gave them you know our projected.

Capacity expansion, and they're giving us beforehand, so where there will be but as far as take or pay is bottomed.

Track is concerned.

Yes, we are contemplating that ended this.

But on the other hand me do cite take or pay that we have to we have to deliver Dolby. So they are new to requirement for each other but this is a great opportunity.

We are spending the necessary.

And then development cost to ensure that we can capture this opportunity down the road.

Yeah.

Okay. That's a good characterization thanks for that detail Morris that's all for me.

Sure.

Thank you and I'm showing no further questions in the queue I'd like to turn the call back to Dr. Morris Young for any closing remarks.

Alright.

Thank you everybody for participating in our conference call in November we will be participating in the Craig Hallum.

Alpha select conference.

And I think the.

We hope to see many of you there.

Please feel free to contact me, Gary Fischer or Leslie Green directly if you would like to set up a call with us and we look forward to speaking with you in the near future.

This concludes today's conference call. Thank you for participating you may now disconnect.