Good afternoon, everyone, and welcome to AXT's Second Quarter 2024 Financial Conference Call. Leading the call today is Dr. Morris Young, Chief Executive Officer, and Gary Fisher, Chief Financial Officer. My name is Christina and I'll be your coordinator today. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [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, emerging applications using chips or devices fabricated on our substrates, our product mix, global economic and political conditions including trade tariffs and import and export restrictions, our ability to increase orders in succeeding quarters, to control costs and expenses, to improve manufacturing yields and efficiencies, or to utilize our manufacturing capacity. 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. In addition to the matters just listed, these uncertainties and risks include but are not limited to, the financial performance of our partially owned supply chain companies, increased environmental regulation in China, and COVID-19 and other outbreaks of a contagious disease. In addition to the factors just mentioned or 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 call will be available on our website at axt.com through August 1, 2025. I also want to note that shortly following the close of market today, we issued a press release reporting financial results for the second quarter of 2024. This information is also 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 second quarter 2024 results.

Thank you, Leslie, and good afternoon to everyone. Revenue for the second quarter of 2024 was $27.9 million, up 23% from $22.7 million in the first quarter of 2024, and up 50% from $18.6 million in the second quarter of 2023. To break down our Q2 2024 revenue for you by product category, Indium phosphide was $7.7 million, reflecting continued demand from data center applications, including AI, as well as passive optical networks. Gallium arsenide also grew to $9.1 million, with broad-based improvement across a number of applications. Germanium substrates were $2.9 million, up from the prior quarter, with renewed strength and demand for satellite solar cells. Finally, revenue from our consolidated raw material joint venture companies in Q2 was $8.2 million, up substantially from Q1 on growing demand. In the second quarter of 2024, revenue from Asia Pacific was 78%, Europe was 17%, and North America was 5%. The Top 5 customers generated approximately 31.8% of total revenue, and no customer was over the 10% level. Non-GAAP gross margin in the first quarter was 27.6% compared with 27.3% in Q1 and 9.8% in Q2 of 2023. For those who prefer to track results on a GAAP basis, gross margin in the second quarter was 27.4% compared with 26.9% in Q1 and 9.2% in Q2 of 2023. Moving to OpEx, total non-GAAP operating expense in Q2 was $8.9 million compared with $8.7 million in Q1 of 2024 and $7.8 million in Q2 of last year. On a GAAP basis, total OpEx in Q2 2024 was $9.5 million compared with $9.4 million in Q1 of 2024 and $8.6 million in Q2 of 2023. We expect OpEx to hold at approximately this level throughout the balance of 2024. Our non-GAAP operating loss for the second quarter of 2024 is $1.2 million compared…

Thank you, Gary. Q2 was another solid quarter of growth with our revenue up 23% sequentially and more than 50% year-over-year. In addition our non-GAAP net loss was smaller than our earlier guidance. We saw good performance in indium phosphide substrates and healthy growth in gallium arsenide and germanium substrates. Our raw material business was also up substantially over Q1. Overall, we're encouraged by the science of addition adoption in new applications such as AI as well as ongoing broader based market recovery. The magnitude of the revenue improvement is good news, we are encouraged. We're expecting the recovery to be somewhat lumpy quarter-to-quarter as the various segments work their way back to more normalized seasonality. As we come into the second half of this year, we're feeling very good about our progress as a company and our ability to support exciting new growth, new high-value applications. Looking individually at our product lines, indium phosphide grew 67% in Q2 over the same quarter a year ago. That growth has been a function of continued recovery in the power market and a meaningful increase in demand related to high-speed optical connectivity and AI. Today, AI applications are primarily using gallium arsenide VCSEL for shorter-range transmissions, which require a relatively small amount of substrate material. But as the industry moves to 800 gig for medium to long distance transmission beginning in 2025, and then to 1.6 terabit speed, we expect that indium phosphide will be a necessary material. We're already seeing development work happening today with next generation silicon photonics devices and electro-absorption modulated lasers or EMLs for high-speed data center receivers. Those technologies use significantly more material than a gallium arsenide VCSEL. We have strong contribution in Q1 and Q2 from these applications. And while we always caution investors that the…

Thank you, Morris. In keeping with our comments today, we expect Q3 revenue to be between $25.0 million and $27.0 million. We expect our non-GAAP net loss will be in the range of $0.06 to $0.08 and GAAP net loss will be in the range of $0.07 to $0.09. We expect share count will be approximately 43.1 million shares. Okay, this concludes our prepared comments. Morris and I would be glad to answer your questions now. Christina, operator, you can take over now.

[Operator Instructions] Your first question comes from Charles Shi of Needham. Your line is open.

Hey, good afternoon. Maybe the first question, I want to get a little bit more color on the Q3 guidance. Looks like $26 million at the midpoint, slightly down from the Q2 level. I think in the preparing marks, you already mentioned maybe some degree of moderation in gallium arsenide. Maybe even you talk about some of that in germanium as well. But wonder, is indium phosphide a raw material, is -- the other two product categories holding up or what's the general sense right now?

Sure, Charles. I think raw material is probably going to hold up. I think it's probably going to be the same level as Q2. Indium phosphide, my feeling is, the order we got from AI for Q1 and Q2, we're not counting on it to continue as of yet. But because it's a sort of a startup business, so order can come in anytime. If that were to come in, then we can probably sort of maintain our same level as Q2. But at this point, we’re not -- we're discounting that. So with that, say negative, indium phosphide [standard] (ph) will provide the growth. And as you know, telecom and datacom -- regular datacom business, there are still some inventory to be digested in Q3. So that's not going to provide growth. So as I said, I think we had a very good strong growth provided by AI applications in Q1 and Q2. And Q3, we are not counting on that at this point.

Yeah, what I would add too is that the orders are a bit, jumping around some. Some of the stuff that we thought was going to come in Q3 came in in Q2. But I think the key thing for us is we are getting the orders. We're not losing market share and we're in very close communication with our customers and there's lots of transparency on both sides. So I think we're in a good spot.

Yeah, Thanks. Morris, I think there are some new languages around your AI opportunity this quarter. I thought we went through this exercise for a few quarters. And I think you and I were thinking maybe the indium phosphide opportunity you were seeing in the prior quarters are more for like photo detectors, some really advanced photo detector. But this quarter sounds like you're gaining some confidence that the indium phosphide substrates are actually going into the optical transceivers. Wonder if there's any new data points that lead to this slight change in how you think about the end application of the indium phosphide?

Well, I'm not so sure. I've got the, I mean, we have the confidence it’s going into AI, but I'm not sure what specific application it is. It is a -- I think it is a transceiver. But I think what we are -- we're not seeing a continued order from our customer as of now yet. We're seeing maybe there are some market adoption for the time being. And it will come, hopefully, later this quarter and definitely to the second part of this year.

And I'm not sure we're intelligent in terms of knowledge level to know precisely where the indium phosphide is going into AI. There may be more than one application within AI. So…

Yeah, as we discussed with you, I think we know that our end customer definitely told us it's for AI. Our second level, in other words, epi customers are telling us it's for AI and they're also telling us who they are selling to. And end customer application, I don't want to name them now, I discovered this, but I think it's well known. But it's what specific application is used for, we don't know yet.

Absolute knowledge, yeah. When you find out, Charles, let us know though, okay?

Okay. So maybe the last question I still want to ask about this indium phosphide. I think over the past three months, we did hear from some of the optical transceiver companies basing the North America, talking about the potential indium phosphide shortage over the next five years, as well things like you mentioned the 800 gig plus transceivers ramps up in higher volume We know you're important player, but you do have a competition. So, want to get your thoughts on whether you see a shortage, could be an issue or not, and whether that particular end customer talking about shortage, are they talking about any specific supplier in mind or they're giving a broad market comment which could mean something quite positive for AXT going into the next few years as AI ramps up.

Yeah, I would definitely think in our end as far as substrate is concerned, Charles, we're confident we have the best technology in terms of EPD, in terms of commercial availability, and ability to expand our expansion, because we have a very good supply chain, supplier through our joint ventures. And as you know that our indium phosphide revenue at this point is only half of what we -- the peak level was. So definitely we can we can grow to that level. And as you also recall on that upcycle we grew our indium phosphide revenue 50% year-over-year for two years in a row. Okay. So we definitely don't feel any difficulties of expanding our capability to provide more substrate. As far as technology is concerned, we are developing 6-inch indium phosphide capability And our 4-inch is growing very good. On technology front, we also applied two very good technology development over the last six months or so. So that enables us to have much better yield and so we can have better quality material and controlling our costs. So if you know anybody who feel there’s a potential shortage of indium phosphide, go talk to them and we can sign long-term deals. We will guarantee supplies.

I'm not sure that's my business but thanks for the answers. Thanks, Morris. Thanks, Gary. That's all for me.

Good questions, Charles.

Your next question comes from the line of Richard Shannon from Craig-Hallum Capital Group. Your line is open.

Hi, Morris and Gary. Thanks for taking my questions as well. I guess someone to take a point of view past this third quarter you just guided to where your body language sounds fairly positive across most of your business here and maybe kind of push you to give us some sense of what you're seeing not only for the fourth quarter qualitatively. Are you seeing any improvement or possibility of improvement across any of these segments? And then maybe more broadly and higher level, how or what kind of -- what your conversation with customers give you about confidence going into 2025?

Sure, Richard. I think -- from my perspective, I think obviously, we cover a lot of market segment, okay? So if I were to pick one of my favorite, which is indium phosphide, I think the excitement of using it in AI, it definitely excites me. We are in talk with customers about potentially running in commercial applications, although I don't know the exact timing of it, but I think our customers are increasing their trial order from 100 wafers to 200 wafer per month and whether they start coming the fourth quarter or first quarter of next year, that's questionable. And as far as the PONs market and telecom market is concerned, I mean, we hear there are data center business is still sort of lagging and telecom market is not doing very well. But I think things this will start to digest its inventory and hopefully, that we can have some recovery for the PONs market as well as the regular data center market, right? So as far as gallium arsenide is concerned, we are seeing good growth in terms of HPTs because our customers are sort of worried about diversifying their supply chain for wireless HPTs. So we hope that HPT would continue to grow -- as far as industrial applications, we are seeing some softness in the LEDs where customers are telling us that they are seeing the third quarter slowing down a bit. But I don't know whether it's going to continue in Q4 or not, that I don't know. As far as industrial laser for gallium arsenide is concerned, again, it's softer for Q3 than Q2, but I don't have much visibility into Q4 yet. As far as satellite communication is concerned, I think Q2 was a very strong quarter and Q3 slowed down a bit. But if you hear that the low orbit satellite, which is going to fill in the gap for 5G Plus telecom network, then I think Elon Musk is talking about launching another 40,000 satellite and China has a plan to launch another 15,000. So that market can grow rapidly, although I think I'm worried about that market a bit is because germanium material is a fairly sensitive part of our cost of goods sold. So although the market potential to grow is very, very big, but we will need to see what's the cost of goods sold or raw material is going to be. And our raw material is shaping up to be a very good supply chain supply line. You can see that we have almost 40% growth last quarter. And I think Q3 is going to hold up on the same supply, and we have more supply chain joint ventures to join us in the coming quarters. So I think our supply chain joint venture is giving us good growth opportunity as well.

Yeah. I want to add a perspective that I think is useful and it sort of differentiates us from the traditional sort of chip companies in the semiconductor industry, which is that we have a record where our products and product segments have a very long positive trajectory. So we all know that if you're making chips, you've really got to rotate one out and a new one in, maybe every 18 months. But we first got traction in indium phosphide with passive optical networks back in 2013 and '14, but it's still a market that exists. And so almost all the markets that we touch, while they may go up and down some, but the long five to 15-year path is generally upward and to the right. So we think we're well positioned for growth across a number of markets and gives us the ability to deliver strong results going into 2025. The strong second quarter that we just had puts our first half run rate just over $50 million. So we're now targeting to be in triple digits once again. So that just gives a little color, I think so. Next question.

Thanks for all that. Maybe I'll dig in a little bit on the indium phosphide and AI angle here. Maybe you can give us a perspective of the customer base here and really kind of digging not just into your direct customer but the end customer, which you seem to have visibility in certain cases. To what degree are these transceiver and ultimately end users, which I assume are to a large degree, hyperscalers, to what degree are those Chinese or Western world customers?

I think at this point, we understand it's definitely Western world customers. So the way I understand, Richard, this is, okay, I mean, if I look at it from 25,000 feet up, what is AI? You need competition, you need data source, and lastly, you need to transfer this data very rapidly and a massive amount, okay? I think the first one to go is a short distance, which is VCSEL using the optical cable. And as the short distance communication speeds up, then you're looking at sort of medium range and long range. I think that's where I think indium phosphide will start to shine. And so you're talking about whether it's going to be an EML or silicon photonics, okay? And as the speed goes up, as the data transfer needs to get more and more, definitely that we're confident it's going to grow, okay? And it doesn't need a whole lot of market growth to move our needle, as you know. And I think the other thing is, I think if you look at indium phosphide now, it looks like it's sort of waiting for its next growth opportunity,. But look at it, I mean, when the consumer products started to grow two years ago, our revenue on indium phosphide zoomed almost 50% year-over-year for two years in a row. And so that shows that we have the capability to make the supply chain satisfied. I mean, customers are very happy with us. I mean the fact that they didn't adopt in the next-generation form is not because of us. And I know there are other customers and other applications potentially that are using indium phosphide such as following eyeball or glucose monitoring…

Consumer applications.

Yeah, consumer applications. It's poised to grow because it's a special ability to work in the far infrared range. So it's not because of us. It's material characteristics. It will just shine in certain applications. I think it will come.

Fair enough. Kind of a two-part question. It's probably mostly for Gary, kind of more on the financial side here. But last quarter, you talked about driving inventory down $10 million. This quarter, you just said downwards is $10 million still possible there. And then also on the last conference call, you talked about the potential for hitting breakeven in the fourth quarter. Just curious whether you still think that's possible. Thanks.

Breakeven, I think, is still possible. Again, as we've said before, it's going to depend on volume, of course, and mix. So it's definitely something that we would strive to achieve. So, bringing inventory down remains a priority for us. What clouds the picture a bit is that we've had great success in our recycling program. So, you don't see the full effect of our inventory reduction efforts in the numbers. Our largest target is indium phosphide for inventory reduction. And as our revenue grows, we expect to be in a good position to bring the inventory down. But it's -- I have to say openly to the community that it's taking longer than I thought. But we understand why, and we're working it. So, we haven't taken our eye off the ball. It just hasn't happened as quickly as I hoped.

Yeah. Richard, I think Gary is definitely right about indium phosphide inventory and because the demand all of a sudden drops in Q3 -- I mean, 2023, that sort of forced us to have -- as you know, you need to build inventory to supply into the customers and all of a sudden, they put a stop to it, that's why the buildup was. But I think the good part of it is that those indium phosphide would never be written off or written down because they are as good as gold. I mean, if anything, the value will go up rather than go down.

Okay. Fair enough. Thanks, guys.

Thanks, Richard.

Your next question comes from the line of Tim Savageaux from Northland Capital Markets. Your line is open.

Hi, good afternoon. I wanted to go back to the kind of capacity/shortage question. You mentioned, Morris, I think, talking about indium phosphide trial orders for customers going from 100 to 200 wafers. And I'm getting the sense that a lot of what's occurred to date has been that kind of development sort of activity. But I guess my question -- my first question is, are you getting a sense as we kind of move forward in the year here, what production volumes might look like in the future relative to the trial volumes that you just discussed? And I'll follow up from there.

Yeah, I think, first of all, most of our customers, they gave us forward guidance, okay? I mean, one specific data center customer, silicon photonics, I mean, they gave us forward guidance. So that is production, but they can change. For instance, that customer when the market was really slow, they told us they had inventory, they went as low as, let's say, 400 wafer a month and they told us it's going to grow to 900 a month in the fourth quarter. We cannot hold them to it, but usually, they do deliver. Okay? That's one example of what customer will give us forecast. And on the pilot production customer is concerned 100 to 200 trial order, I think we're hopeful, but they don't tell us when it's going to start in production. They do give us a volume forecast. That's how we negotiate sort of a forward-looking total price package. But I don't know whether I can hold them to that or not, but they're talking about thousands of wafers, okay? So you can say, if they go to 100 to 200, definitely the minimum level is 1,000 before we're going to give them a big discount, okay? But whether they go to 1,500 or 2,000, it's -- I mean, last time when consumer products start to boom it was in the 5,000s.

Yeah, Tim, what I would say is that we have very strong convictions about these markets for indium phosphide. We don't have quite as much clarity on quarter-to-quarter. But we definitely see that these things are coming. And I've mentioned this, I think, in the past, but I want to remind you that in the last five years, we have significantly upgraded our facility in Beijing, where we manufacture the indium phosphide. Customers have toured it and have been very impressed, and we've added capacity. So I don't think -- we're not losing sleep about total capacity capabilities. So -- and we will have enough advanced knowledge and awareness when it's time to add more equipment, but that's going to be the issue. It's not -- it's probably not going to be facilities now, which is good. It will be equipment. And we're set up to be able to do that relatively quickly for a manufacturing company. So I think we're really in a great spot. And when it comes, it's going to be a lot of fun.

All right. Looking forward to that. And along those lines, and you mentioned you're, I guess, a little bit below half your previous peak in terms of indium phosphide revenue, but my question kind of goes to what you were just saying, Gary, which is you're talking some examples here of some of these pilot volumes going up by a factor of 10 or 5 or 10 or something like that. But what is your -- could you estimate for us your maximum kind of quarterly revenue capacity in indium phosphide right now without adding any new gear or space?

I'll let Morris give the forward look, but let's just look -- I'm just quickly looking back to confirm my memory in real life, we got as high in terms of indium phosphide revenue as $17.7 million, okay? So -- and we haven't subtracted capacity. So I think it's pretty easy to say for me it's just a mere accounting thing. Well, we could at least get to $17.7 million. But I know Morris will say we could do more than that.

Yeah, there are two factors. One is that we have substantially upped our yield. Don't tell our customers that. So that will enable us to increase our capability to deliver more wafers. But on the downside, and also will shave off our costs. But on the downside, as you know, every cycle brings the piranhas, the customer when they have the order in hand, they want lower price. So we are sharpening up our pencils and if a customer gives us bigger orders, we are willing to work with them. But I think what we have on savings in terms of better yields and better supply chain supply. Indium phosphide, we upped our yield. We have increased our recycling capability. And so -- and we're going to have other supply chain supplement to help us to reduce the cost, all in favor of reducing our cost to help our customers to deliver better products for the common good of all consumers.

Okay, great. And just one question on gross margins. You performed pretty strongly there in the quarter, I guess, talking about recycling being one of the contributors. But I think you had expected gross margins to come down given product mix, which looks like it's a little bit of upside, but it looks like it came in as expected. So I wonder what the kind of moving parts were for the gross margin strength in the quarter. And likewise, on the guide, you look to be guiding gross margins back down a bit. I wonder what are the factors driving that.

Yeah. You're following the trail pretty accurately. I think for the upside surprise, which we were pleased with, one contributor was a good performance on the gallium arsenide recycling program. And that's gotten more traction during the Q2 time period. We were actually starting that program back in 2023, but I think it's really getting into -- it's making a difference. So what that means is that's done through one of our subsidiaries called JinMei and actually through one of their subsidiaries, so we're the grandparent, I guess. But they're doing well. And JinMei's contribution to gross margin on the consolidated basis was above their normal average in Q2. So that was one thing. And we also did better on manufacturing efficiencies just in general. So each little -- it's never one -- in this kind of business, it's never -- it's rarely ever one big thing. It's usually two or three or four medium-sized things. But efficiencies is one. The recycling program is another. So -- and we're hopefully being a little bit conservative for the implied guidance on gross margin. But that's kind of our style, I think, is to be a little bit more cautious because we're not always sure.

Great. Thanks very much.

You’re welcome, Tim. Good questions.

Your next question comes from the line of Dave Kang from B. Riley. Your line is open.

Thank you, good afternoon. First question is on indium phosphide. Just wondering if you have the data on the mix between high-speed optics for AI versus the rest?

Well, actually, at this point, AI is still relatively small. If I were to estimate, it's probably 10% to 12% of indium phosphide. Yeah.

Okay. Got it. And then second question is on any -- well, any market share data. So I'm assuming most of your -- your competitors have most of the AI market share at this point. Is that a fair assumption or like Sumitomo?

I would tend to think we -- I mean, unless we are wrong, but of course, we don't have what our competitors are doing. We don't have their financial numbers. But from what I understand from our customers, they are buying everything from us.

The reason for that is that our quality on the number of measurements, including EPD, is hands over our competitors. So keep in mind, the only serious competitor is Sumitomo and we're just better than -- on this particular product, we are viewed as orders of magnitude better. So for companies where yield counts and they don't -- where reliability counts, they're going to AXT. And we don't think that's going to change. We've got a really long head start, shall we say.

Got it. And just quickly on the Tongmei listing situation. You mentioned zero companies got dropped. I mean, what are the odds that you guys are getting dropped?

Well, I think the environment for going public in China or the requirement for going to be listed on the Shanghai Stock Exchange or Shenzhen Stock Exchange or even Beijing Stock Exchange, there are three of them now there in China. But I think the regulations to allow company to be listed has changed very dramatically this year. I mean, two years ago, there are up to about 500 or 600 companies going public on the STAR Market. And this year, I think there are probably -- I think you can count with your fingers, less than 10. And there were 300 companies asked to be not on the queue for application to be listed on STAR Market. And we just updated our application for six months results. So that's a good sign for us. As we also -- Gary said, we have worked one of the very important issue that Shanghai Stock Exchange was looking at. So, hopefully, we can resolve that. And with our six months results, hopefully, we have better deals to report in the next three to six months.

Yeah. Just a little bit more on that, which is that you have to refresh your application. And a number of companies, more than several hundreds of companies were asked not to bother, don't refresh because you're not ready for prime time. They had companies going in early 2020 that had no revenue. So they've raised the bar over the time period, but never to us in terms of saying go away. So they -- on the contrary, they have actually told our investor bankers that this is an attractive offering. You guys have a lot of good stuff that we're in favor of. So we can't guarantee that they wouldn't change their mind, but they've had plenty of time to say something negative like this, and they have not. So we're -- that's why we remain optimistic and we're just staying in the game to go for it.

Okay. Thank you.

You’re welcome.

And with no further questions, I'll turn the floor back over to Dr. Morris Young.

Thank you for participating in our conference call. This quarter, we will participate in the Needham Virtual SemiCap Growth Conference, the Jefferies Technology Summit and Evercore ISI Semiconductor, IT Hardware & Networking Conference. We hope to see you there. As always, feel free to contact me, Gary Fischer or Leslie Green if you would like to set up a call. We look forward to speaking with you in the near future.

Thank you. And this does conclude today's conference call. You may now disconnect. Have a great day.