Executive Summary / Key Takeaways

• AXT, Inc. is a materials science company specializing in high-performance compound and single-element semiconductor substrates (InP, GaAs, Ge) and integral raw materials, leveraging a vertically integrated manufacturing model primarily based in China.
• The company possesses differentiated technology, particularly in achieving extremely low defect densities (EPD) in InP and GaAs substrates, which is critical for high-performance applications like high-speed optical interconnects (AI data centers) and wireless HPTs, providing a competitive edge over rivals.
• Recent financial performance in Q1 2025 was significantly impacted by geopolitical trade restrictions, specifically new China export controls on InP, and operational challenges including yield issues in GaAs, resulting in a negative gross margin and sequential revenue decline.
• Management forecasts sequential revenue growth in Q2 2025, driven by opportunities within China (AI data centers, lidar, wireless HPTs), even while excluding outside-China InP shipments pending export permits, and anticipates gross margin recovery starting in Q2 as yield issues are addressed.
• Key factors for investors to monitor include the timing and success of obtaining InP export permits, the execution of yield improvements in GaAs production, the progress of the Tongmei STAR Market IPO (and associated redemption risk), and the company's ability to capitalize on emerging high-value applications amidst a volatile geopolitical and economic backdrop.

Setting the Scene: A Foundational Role in Advanced Semiconductors

AXT, Inc. occupies a critical, albeit often behind-the-scenes, position in the semiconductor ecosystem. As a materials science company, it specializes in the design, development, manufacture, and distribution of high-performance compound and single-element semiconductor substrates, commonly known as wafers. Unlike the ubiquitous silicon wafers that form the backbone of most electronics, AXT's substrates are crafted from materials like indium phosphide (InP), gallium arsenide (GaAs), and germanium (Ge). These materials are essential for applications where silicon falls short, such as those requiring high speed, specific wavelengths of light, or superior thermal management.

The company's strategic foundation was laid with the establishment of its PRC subsidiary, Beijing Tongmei Xtal Technology Co., Ltd. (Tongmei), in 1998. This move anchored AXT's manufacturing operations in China, leveraging cost advantages that remain central to its business model. Over the years, AXT has cultivated a vertically integrated supply chain through partial ownership of raw material joint ventures in China. This structure provides a degree of control over critical inputs like high-purity gallium and pBN crucibles, aiming for competitive pricing, reliable supply, and valuable market visibility.

AXT's technological differentiation is rooted in its crystal growth and wafer processing expertise. While specific details of its proprietary process technology, such as the Vertical Gradient Freeze (VGF) method, are not extensively quantified in terms of direct comparative metrics, the company repeatedly highlights its ability to achieve extremely low defect densities (EPD) in its substrates. This low EPD is a critical performance metric, particularly for demanding applications like high-speed optical interconnects and certain wireless components, where material quality directly impacts device reliability and yield for downstream manufacturers. Management asserts that AXT leads the industry in low EPD ion diode InP material, a key differentiator for next-generation EML lasers and silicon photonics. Similarly, breakthroughs in low EPD GaAs are cited as valuable for HPT devices and emerging lidar applications. The company's R&D efforts are focused on advancing these capabilities, including the development of 6-inch InP and leveraging 8-inch GaAs learning for 6-inch production, with stated goals of improving yield, reducing cost, and meeting stringent customer specifications.

The competitive landscape for AXT is populated by both larger, diversified players and niche specialists. Direct competitors in substrates include companies like Sumitomo (SEKEY), JX, Freiberger, Umicore (UMICY), Vital, and CCTC. More broadly, companies like AIXTRON (AIXTY), IQE (IQEPF), and Wolfspeed (WOLF) operate in related compound semiconductor spaces, sometimes offering alternative materials or integrated solutions. AXT positions itself by emphasizing its cost efficiency, enabled by its China manufacturing base, and its specific technological edge in low EPD substrates. While competitors may possess greater scale, broader product portfolios, or more extensive financial resources, AXT aims to compete effectively by delivering specialized, high-quality materials at a competitive price point, particularly leveraging its vertical integration. However, this China-centric model also exposes AXT to unique geopolitical and regulatory risks, a factor that has become increasingly prominent.

Performance Under Pressure: Geopolitics and Operational Headwinds

The first quarter of 2025 painted a challenging picture for AXT, heavily influenced by external pressures and internal operational adjustments. Revenue for Q1 2025 came in at $19.4 million, a notable decrease from $22.7 million in Q1 2024 and $25.1 million in Q4 2024. This decline was primarily attributed to lower demand across several substrate categories, including GaAs (broad applications), InP (data center, PON), and Ge (China market).

Compounding the revenue challenge, gross profit plummeted to a loss of $1.2 million in Q1 2025, resulting in a negative gross margin of 6.4%, a significant drop from 26.9% in Q1 2024 and 17.6% in Q4 2024. Management identified three primary factors for this margin erosion: significant unfavorable yields in semi-insulating GaAs production, an unfavorable product mix heavily weighted towards lower-margin raw materials due to reduced substrate sales, and increased unabsorbed manufacturing overhead resulting from lower substrate volumes. The yield issue in GaAs was specifically linked to an aggressive attempt to scale output quickly for a wireless opportunity, highlighting the delicate balance between speed and efficiency in complex manufacturing processes.

The impact of geopolitical tensions was acutely felt in Q1 2025. Following earlier China export controls on gallium and germanium (effective Aug 2023), China added indium phosphide substrates to its export control list on February 4, 2025. This necessitated a new export permit process for InP shipments outside of China. While AXT believes its InP sales are not for military applications and expects permits to be granted, the portal for applications only opened in April 2025, creating immediate delays and impacting Q1 revenue by an estimated $4 million to $5 million. The uncertainty surrounding permit timing remains a significant factor influencing near-term revenue recognition for outside-China InP sales.

Despite the headwinds in substrates, the raw materials segment showed resilience, with sales increasing significantly to $8.3 million in Q1 2025, up 43% year-over-year. This growth was driven by stronger market demand for refined gallium and pBN crucibles, along with contributions from the recycling program.

Operating expenses were relatively controlled, totaling $9.0 million in Q1 2025, slightly down from $9.4 million in Q1 2024 and $10.6 million in Q4 2024. The decrease was mainly due to lower compensation costs, partially offset by higher legal and professional fees (potentially related to ongoing legal proceedings, including a shareholder class action and derivative lawsuit). R&D expenses remained relatively stable, reflecting continued investment in technology development, particularly for crystal ingot processing and advanced substrate capabilities.

The net result was a GAAP net loss attributable to AXT, Inc. of $8.8 million, or $0.20 per share, in Q1 2025, compared to a net loss of $2.1 million, or $0.05 per share, in Q1 2024.

Liquidity remains a key area of focus. As of March 31, 2025, cash and restricted cash totaled $38.2 million, an increase of $4.4 million from December 31, 2024. This increase was primarily driven by net cash provided by financing activities ($6.9 million), including proceeds from short-term and long-term loans, and favorable exchange rate changes, which offset net cash used in operating activities ($3.3 million) and investing activities ($0.8 million). Inventory levels remain elevated at $80.4 million, although down sequentially, and reducing inventory continues to be a priority for management. The company holds approximately $2.7 million available under its stock repurchase program but has no current plans for repurchases.

The potential redemption obligation of approximately $49 million related to the Tongmei IPO private equity investment remains a material consideration should the IPO not be completed.

Strategic Responses and Outlook: Targeting Recovery and High-Value Growth

Facing these challenges, AXT's strategy centers on leveraging its core strengths to capitalize on emerging opportunities while diligently addressing operational and geopolitical hurdles. The outlook for Q2 2025 reflects this dynamic. Management guided for Q2 revenue in the range of $20.0 million to $22.0 million. Crucially, this guidance excludes any revenue contribution from indium phosphide shipments to customers outside of China, pending the export permit process. The expectation for sequential growth, even without this significant revenue stream, is based on optimizing opportunities within China.

Within China, AXT is seeing increasing demand for InP in cloud and data center connectivity, driven by efforts to develop domestic sources for EML and silicon photonics-based lasers. While the China data center market is currently a smaller portion of the global InP opportunity, it is expected to see significant growth. AXT's sales of InP within China are increasing, and management anticipates healthy double-digit sequential growth in revenue from China data center applications in Q2 2025.

In gallium arsenide, the company is seeing recovery in China and Taiwan across applications like industrial lasers, wireless routers, and Wi-Fi. Despite the yield setback in Q1 related to the wireless HPT market, AXT still views this as a sizable opportunity. Management is taking a more measured approach to scaling production for HPTs and is laser-focused on resolving the yield issues, which they believe are within their control. They expect to see improvement beginning in Q2 and continuing throughout 2025, contributing to revenue growth in this segment. Design activity and qualification for GaAs-based lidar in the autonomous vehicle market in China also present an exciting emerging opportunity, where AXT's low-EPD material is demonstrating value.

The raw materials business is expected to remain healthy, contributing to the sequential growth in Q2. Germanium revenue is expected to remain low in Q2, following the strategic decision to exit low-margin business impacted by high raw material costs, but the long-term market for low orbit satellites is seen as promising once pricing stabilizes.

Gross margin is a key focus for recovery. Management expects gross margin to improve to around 10% in Q2 2025, driven by manufacturing improvements aimed at addressing the Q1 yield issues. Further gross margin recovery is anticipated in the second half of 2025, contingent on production volume growth and continued yield improvements, as well as a more favorable product mix if InP export permits are obtained.

The timing of InP export permits remains a critical variable. Applications were submitted in April 2025, and while initial responses typically take around 45 business days, the timing is uncertain. Management does not expect to ship InP to customers outside China before mid-June at the earliest, suggesting that any realization of the "several million dollars" of InP backlog would likely impact Q3 2025 revenue. Customers are reportedly waiting patiently and continuing to place orders, indicating that AXT's position as a major InP supplier with differentiated low-EPD technology provides a degree of stickiness, as competitors reportedly cannot easily match AXT's capacity or quality for these demanding applications. The market dynamics for InP are still seen as supporting approximately 20% growth, which AXT aims to capture in the second half of 2025 and fully in 2026, assuming permit approvals.

The Tongmei STAR Market IPO process continues, albeit slowly. While many other applicants have been removed from the queue, Tongmei remains in the "in-process" category, which management views as a positive sign given the more selective environment. The IPO is subject to review and approval by Chinese authorities, and its completion would provide access to China's capital markets, while its failure could trigger the $49 million redemption right for private equity investors.

Conclusion

AXT, Inc. is navigating a complex period marked by significant geopolitical headwinds and operational adjustments, as evidenced by the challenging financial results in Q1 2025. The imposition of new export controls on indium phosphide and the impact of yield issues in gallium arsenide production have created near-term revenue delays and margin pressures. However, the company possesses fundamental strengths in its vertically integrated model, its China manufacturing base, and crucially, its differentiated technology in producing low-EPD substrates essential for high-performance applications.

The investment thesis hinges on AXT's ability to successfully navigate the export permit process for InP, resolve its manufacturing yield challenges, and capitalize on the growing demand in high-value markets like AI data centers, wireless HPTs, and lidar, particularly within China where domestic sourcing is gaining traction. Management's Q2 2025 guidance signals an expected sequential rebound driven by these opportunities, coupled with anticipated gross margin recovery. While risks related to geopolitical volatility, regulatory uncertainty, and the outcome of the Tongmei IPO remain pertinent, AXT's strategic focus on technological leadership and operational execution in targeted growth areas positions it to potentially return to profitability and unlock value as market conditions and trade dynamics evolve. Investors should closely monitor progress on InP export permits, yield improvements, and the trajectory of demand in key end markets.