AXT, Inc. (AXTI) Q3 2017 Earnings Report, Transcript and Summary

Good afternoon everyone and welcome to AXT's Third Quarter 2017 Financial Conference Call. Leading the call today is Dr. Morris Young, Chief Executive Officer and Gary Fischer, Chief Financial Officer. My name is Glenda and I'll be your coordinator today. At this time, all participants are in a listen-only mode. Later, we will conduct the question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would like to turn the call over to Leslie Green, Investor Relations for AXT.

Thank you, Glenda and good afternoon everyone. Before we begin, as usual, 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 and our ability to control costs and improve efficiencies, increase orders in succeeding quarters, increase our competitive position in the market, our ability to meet market demands for our products, as well as other market conditions and trends, including expected growth in the markets we serve. We wish to caution you that such statements deal with future events, are based on management's current expectations and are subject to risks and uncertainties that could cause actual events or results to differ materially. These uncertainties and risks include, but are not limited to, overall conditions in the markets in which the Company competes, global financial conditions and uncertainties, market acceptance and demand for the Company's products and the impact of delays by our customers on the timing of sales of products. In addition to 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, and available online by link from our website for 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 Web site at axt.com through October 26, 2018. Also, before we begin, I want to note that shortly following the close of market today, we issued a press release reporting financial results for the third quarter of 2017. This information is available on the Investor Relations portion of our Web site at axt.com. I would now like to turn the call over to Gary Fischer for a review of our third quarter results. Gary?

Thank you, Leslie and good afternoon everyone. I'll begin by saying total revenue for the third quarter of 2017 was 28.2 million, compared with 23.6 million for the second quarter of 2017. Of our total revenue, substrates sales increased to 22.4 million, compared with 19.1 million in the prior quarter. Revenue from our raw material joint ventures was 5.8 million in Q3, compared with 4.5 million in Q2. In the third quarter of 2017, revenue from North America was 8%, Asia Pacific 68% and Europe 24%. Two customers generated more than 10% of revenue in Q3 and the top five customers generated approximately 39% of total revenue, reflecting again our diversification of those products and customers. Gross margin in the third quarter was 39.5%, compared with 30.8% in the prior quarter. Of course we're very pleased to see the gross margin improve, while no single factor accounted for the majority improvement, the following factors contributed. Number one was favorable product mix. Indium phosphide in Q3 was at a record high for revenue and germanium was also better than expected. Number two, higher volumes across the AXT substrate universe meant that overhead was spread over more units and that helps gross margin. Number three is a convergence of significant manufacturing efficiencies, including improvement in overall inner [ph] yields and crystal growth, consistently high product quality and good raw material cost. Number four is, to a lesser extent, we also had the benefit of a few other factors related to the three partially companies that we consolidate as raw materials, so gross margin improved to 39.5 from 30.8. Total operating expenses were 5.9 million in the third quarter, compared with 5.0 million in the second quarter. Total operating expenses in Q3, included onetime expenses of approximately $500,000, consisting of 250,000 in special R&D expenses for indium phosphide development program as well as a set of fees related to our new facility. We expect total operating expenses in Q4 to remain at this level, including approximately $500,000 in onetime items related to personnel and the end of the year employee bonuses in Q4. In Q1 2018, we expect to return to more normalized and sustainable operating expense level of 5.2 million to 5.3 million. Total stock compensation expense for the quarter was $339,000. Operating profit for the third quarter of 2017 was 5.2 million, compared with 2.3 million in the previous quarter. Interest and other income for the third quarter was a net charge of $820,000. This net number consists of four categories, number one, net interest earned of 122,000; number two, equity accounting for our unconsolidated joint venture companies, a loss of 266,000; number three, other items that add up to about $150,000; number four, foreign exchange loss of 339,000. Exchange loss is higher than usual and is largely due to the fact that we transferred funds to our Beijing Company in order to purchase the new site and during the process of that transfer, the Chinese Renminbi appreciated in value. As a result we incurred a foreign exchange loss in the conversion. The tax provision for the third quarter is 181K, compared with 321K in Q2. For Q3 of 2017, we had a net profit of $4.4 million or $0.11 per share. By comparison, we had a net profit of 1.9 million or $0.05 per share in the second quarter of 2017. In Q3, the diluted share count was 40.1 million shares. Cash and cash equivalents and investments closed at 78.3 million as of September 30. During the third quarter, net cash generated from operations was positive at 4.3 million, so that's a good number. This was offset by the purchase of the new facility. As a result, cash, cash equivalents and investments at September 30 were down from the previous quarter by 9.2 million. Depreciation and amortization in third quarter was 1.1 million and CapEx was 15 million and then includes the new facility. Accounts receivables net of reserves were 20.9 million at September 30, compared with 18.3 million at June 30. Net inventory at September 30 was 40.8 million, compared with 40.6 million in inventory at June 30, ending inventory which is pretty consistent with approximately 52% in raw materials, 42% in WIP and 6% in finished goods. So the financial review is completed. I'd like to turn the call over now to Dr. Morris Young for a review of our business. Morris?

Thank you, Gary, and good afternoon everybody. Q3 was another solid quarter, contributing to what is expected to be a year of strong growth for AXT. Once again, we posted revenue growth in all of our product categories, including record revenue in indium phosphide. We continue to see resurgence in new applications for complex semiconductor substrates and we're pleased that our growth is coming from a diverse set of drivers with additional opportunities like 3D sensing still on the horizon. Along with solid revenue growth we also achieved positive gross margin improvement and outperformed our profitability expectations for the quarter. The key to these results is that our products are well positioned in strategic growing markets. In addition, we're seeing the benefits of the operational efficiencies and the improvements that we began successfully implementing more than a year ago. One of the most exciting area of growth for AXT in recent years has been indium phosphide. This is a highly specialized material in which AXT has made considerable improvements, investments, both in R&D, for achieving strength in technical properties as well as in customer support to access our customers in overcoming the technical hurdles in the development of indium phosphide based products. This investment has allowed AXT to establish itself as a leader in the space in which technical barriers to entry are very high. Further, the long term increasing demand for higher bandwidth and faster speed for networking and communications lead us to believe that indium phosphide will have a decade long type of life cycle in which we adjust at early stages. One of the fastest growing applications currently is data center connectivity, driven by indium phosphide based silicon photonics. This technology uses light of photon to move data at a very high speed over the thin optical fibers, which is filled directly into a semiconductor devise. Today, silicon photonics products are being deployed to connect switches within the large data centers. In the future, its bandwidth to the servers increases. Silicon photonics will be used to collect service. Leading global companies such as Intel, HP, Cisco, IDN, Broadcom, Infinera, Mellanox and many others are driving this adoption. As the exponential grows in data traffic convergence at the data center, hybrid scale clouds providers such as Microsoft Azure, have publicly stated that they're deploying silicon photonics in order to drive scale with data rates of 100 gigabits per second and beyond. In the relatively short period of time, we're seeing the data center connectivity applications becoming the largest contributor to our indium phosphide revenues. In addition to data center connectivity, silicon photonics is also being leveraged in a wide variety of applications in telecommunications, [indiscernible], metrology, consumer electronics and display, healthcare, sensing, autonomous cars, security and others. While demand from these applications today is small, the opportunity collectively represent for the future businesses is encouraging. In addition to silicon photonics, the passive optical network market is the other contributor to our indium phosphide revenues. As has been always well publicized, this market particularly in China has been weak in recent quarters, largely as a result of our inventory rebalancing. We continue to take appropriate choice cum conservative view, but believe that its eventual recovery will provide additional growth opportunity for our indium phosphide business. AXT supplies into a number of regions and customers worldwide and it was well positioned as the market improves. And finally, a third area of focus for indium phosphide is telecommunications. With the current infrastructure upgrade cycle and preparation for 5G are providing opportunities in shorthorn, longhorn and mach up [ph] deployments. We believe that this application would be a market driver and contributor to our revenue growth for years to come. In total, we're pleased with the continued growth of our indium phosphide business and what we review as encouraging signals that our customers that demand will continue to be positive in 2018. As a result, we're currently increasing our indium phophide capacity at our Beijing facility in a meaningful way. We have always mentioned that a certain amount lumpiness in our revenue is to be expected, as we are selling into many emerging applications that are working towards wall and protection. And also we are in the early stages of it, so that it could see lumpiness. However, we're seeing customers more proactively planning for future demand and working with us to ensure that their need can be met. For example, during this quarter, we received our first multimillion dollar long term order for indium phosphide substrates. While this order is not a guarantee of revenue, it does demonstrate that customers are viewing our product as a strategic part of their planning and an important part of their growth. Now turning to gallium arsenide, while the applications driving growth in gallium arsenide has changed meaningfully in the last several years. The potential missed opportunity from this substrate is once again sizable. This is a result of the unique properties of the material that makes this suitable for a host of interesting new applications. For example, ingots gallium arsenide is highly effective for use in solar panel and is also transparent enough that can be used under the glass and other mobile solutions. Audi and BMW are using solar panels on certain new models to provide power to the vehicle's climate control system fan without ruining the battery, even when the vehicle is turned off. In addition, Audi and Alta Devices recently announced that they partnership to integrate solar cells into panoramic glass roofs of Audi models to generate solar energy that increases the range of Audi electric vehicles. The first prototype is expected to be developed by the end of 2017. Ingots gallium arsenide is also being used in solar cells like sands of lifetime [ph] with certain journal applications, as the material is lightweight and provide efficient solar cover. In addition, as we mentioned last quarter gallium arsenide governs a spectrum of light that isn't seen by the human eye making it a making it ideally suited for application that call for infrared light. We're currently experiencing growing customer demand for a variety of other high-end applications for infrared light in which in EPD requirements, limit the number of competitors that can meet the stringent specifications. These applications include virtual and augmented reality, retinal recognition and automotive sensing, among others. 3D sensing is the other application garnering as much attention as a result of its use for facial recognition in Apple iPhone X announced in Q3. While AXT is not participating in initial customer commercialization of 3D sensing technology, we view this as an opportunity for high-end substrate manufacturers because the strict technical requirement of 3D sensing provide a strong barrier to entry to new or low end players. Today, only three competitors, including AXT, are able to provide low EPD substrates in sufficient volume for production ramp. We understand that our substrate meets the technical qualification for these applications and believe that we could see incremental opportunity in 2018, once we have demonstrated good progress in moving our gallium arsenide production line to the new site and can submit substrate for qualification. We are on track to have the first 3D sensing substrate for customer qualification in Q1 from our new site. Turning to germanium substrates, this segment of our business grew again sequentially in Q3 and as the satellite industry continues its positive trend. The satellite industry association recently reported in its annual report that as more satellite are used for observing conditions on earth are the fastest growing segment of the market. We typically see a fairly consistent demand for germanium substrate used in satellite solar cells. But we're seeing growth in demand throughout 2017. We believe that positive market conditions are likely to continue to provide opportunities over the coming quarters. Finally, with regard to our partially owned raw material companies in China, revenue increased in the third quarter, as many of the markets into which they supply are improving. In addition, the three that would consolidate into our financial statement collectively made a positive contribution. All ten companies remain an important part of our supplies chain strategy and we believe that as the demand for compound semiconductor substrate continues to increase, our holdings will provide important leverage for our operations as well as opportunity for positive contribution to our overall financial ladder. Now, before I close, I want to give you an update on the relocation of our gallium arsenide manufacturing to our new facility in the city of Dingxing, China. We are on schedule with our place and pleased with our progress today. As you may know, Dingxing is approximately 90 mile drive south of our current Beijing location. The site has approximately 140,000 square feet of existing manufacturing space and 50,000 square feet designated for offices and dormitories. And it also has plenty of acreage available for expansion. Under the direct supervision of our general manager, we're actively preparing the new facility for the requirements of gallium arsenide manufacturing. And we're also in the process of installing and testing those new relocated equipment. In addition, we're working to complete our initial staffing and training requirement. I'm very pleased to report that the result of all these is that within only six months of acquiring the facility, we already have our first single crystal ingots grown. And extensive testing has been shown that they have a consistent quality level as those products are produced at our Beijing facility. As we have discussed, we're planning for a staged relocation of gallium arsenide throughout 2018, which means that we will produce substrates from both our current location at Beijing and the new Dingxing site for a period of time. And then gradually increase production volume at the new site and continue to expect have an initial qualification substrate late this quarter and we're working with customers to set a qualification beginning in Q1. We are not required to move indium phosphide and germanium substrate production line this time. Those substrates will continue to be manufactured in our Beijing facility for the foreseeable future and overtime we believe we will evaluate our plan for a possible relocation. In closing, this is an exciting time for our business. We see great upside potential from the applications across our product portfolio that we are already qualified into as supply. In addition, new opportunities for incremental obligations like 3D sensing promises for 2018 and beyond. In essence, the basis for our optimism about our business is that the applications that we sell into have multiyear cycles. It's in the view that is shared by many expert analysts, we're early being and we're well positioned for growth in these markets for many years to come. Further, we believe that the relocation of our gallium arsenide manufacturing will allow us to expand our ability to support the increasing customer demand for our substrates. And we're pleased that our operational discipline is enabling us to drive improved profitability and cash generation. This concludes my prepared comments. I'll turn the call back to Gary for our fourth quarter guidance. Gary?

Thank you, Morris. As we discussed, we're excited to see upside potential across our portfolio and believe we're well positioned in many applications that will drive our business growth in 2018 and beyond. Coming off of a very strong quarter in Q3 and heading into a typically seasonally weak Q4, we expect to see revenue of between 26.0 million to 27.0 million in Q4. If we take the midpoint of our Q4 guidance, we're therefore expecting 2017 revenue to be approximately $99 million, which represents annual growth of 22% over the prior year 2016. Given the expected Q4 OpEx levels that I discussed earlier, we believe our profit per share in Q4 would be in the range of $0.07 to $0.09 per share, based on 40.1million diluted common shares outstanding. Using the midpoint of this range, we're expecting an increase in the annual earnings per share in 2017 over 2016, an increase of 47% on EPS. This concludes our prepared comments and Morris and I would be glad to answer your questions now at this time.

Thank you. [Operator Instructions] And our first question comes from the line of Edwin Mok from Needham & Company. Your line is now open. Edwin Mok, your line is now open.

Hey guys, sorry about that. Congratulations for a great quarter. So first I have a question on the GaAs market. Morris thanks for providing some color regarding the different opportunities and beyond the traditional GaAs market. But just I wonder now maybe is there a way to think about the size of these opportunities. There is a number of different applications for GaAs and I think you mentioned higher for example and obviously Vixel. Any interesting thought you think about know how big are these opportunity, is it top going to be as big as the traditional RF market or they smaller and anywhere you can kind of give us some color on them.

That's a very big question because gallium arsenide of course covers a lot of applications. Let's take the easiest question first perhaps is RF market, I mean RF market was decimated by the SOI and now we are not afraid to mention it and so the PM business was totally lost. But on the other hand as we move into 4.5G or 5G, gallium arsenide fall into the 5 - excuse me, I mean it is very much in transit application for wireless handsets. And so for LEDs we mentioned in our last quarter conference call, we see a strong demand from high end customers who take our gallium arsenide to make red LEDs as well as infrared LEDs. Although the application of those market and we are still in the process of collecting all the datas and we even hear some horticulture indoor farming could potentially be a big market driver, but all these applications very diverse and takes a lot of time to collect all these data. But I can tell you one thing I share with you is one of our major customers using gallium arsenide semiconducting wafers is telling us they are building capacity bit time. So if they are building, we should prepare also to build their back capacity to support them. We also talk about this strong and automobile application you know I think it's really early in this stage although we have been working on this project for almost 7 years, but it went finally start to show some real applications which could drive volume. So we are excited about, but how big it could be. I really don't know because it really depends on how many people wants to install in their fancy electric cars or to keep their car cool during - parked under the sun So, but it's a very large European car manufacturer wants to put it into their car within this potential it could be a very large market. And then obviously the ultimate 3D sensing, we are very excited about 3D sensing. Although it may have a sort of slow starts as we were projecting and all this could be a huge starts, but I think all the analyst or the market study says that maybe has a slower start, but I think the future for these application is just great I mean I have seen many, many people telling me they are waiting to buy the next generation phone because they want to have this application feature in there. So we have been also wondering how big opportunity for the substrates is.

Okay.

So I spend some calculation and I hope you can correct to see whether I am right or wrong. I see you know the final device been is - it's a bit aggressive market is $100 however substrates adjustable market is between 4% to 5%. So if they are $ 100 million, we are $4 million to $5 million. If they are $1 billion we are $40 million to $50 million. That's for the substrates. So is that a reasonable answer, sir.

Yeah, that is actually that's extremely helpful. Thanks, thanks very much. Just one clarification, you talked about Vixel, you mentioned that you have a customer qualifying your substrates in the first quarter. Is that substrate being filled in your Beijing facility, I think you kind of repeat that, I'm sorry, I missed your commentary on that.

Well, in our commentary we said we don't - we are not playing in the 3D sensing market now. We don't have a purchase order in hand. But we are in contact with our customers from their feedback we have these customers. They are pleased with our position which is for prepare ourselves for very large volume production. They are also telling us our quality of our product is great however some customers have an issue is as they want to qualify substrates twice. So they say well why don't you supply good material that you can produce on the new side and we will start to qualify that and so we said our estimated new product coming from Beijing the new site should be at the end of Q1 of next year. That's why I am saying we should be able to submit a qualification wafers in Q1 of 2018. However, we do have enough inventory in our Beijing site of this low EPD the good quality material fit for this 3D sensing application. So if the customer are willing to take that own site manufacturing to qualifying to their product, that could perfectly be fit for their requirements.

Okay, great. That actually that's extremely a good clarification. Second one I have is on InP. I think last quarter you guys talked about roughly around half with anti-demand come from the plant market you had been roughly on the order comes from silicon photonics and a quarter from other applications. Is there a way you can update us with that number, is that still roughly on the same mix?

No, I think some of silicon photonics all I mean in pounds, especially pounds market is having this problem right now, so the inventory or the way I view it is pound market is probably if you look at if there is no inventory on the hand, it should be a very large size market, but the growth rate is relatively small. My estimation is may be 10% to 15%. However, silicon photonics coming from a smaller base it has seen much greater growth potential. So, so far as far as we can see we said two to three years ago silicon photonics mix revenue was almost zero. Now it's the biggest contributor however it's difficult for us to really put a numbers on because lot of times we don't really know what exactly what they are using it for, but if we only call it that when we are sure about is silicon photonics we only count of once we want to assure is pounds market, silicon photonics definitely is a bigger in position and now it shows bigger potential for growth too.

Okay, great actually that's helpful. Last question I have is on gross margin, Gary. If I did the math correctly in the fourth quarter, you said gross margin is moderate, this 39.5% you framed on the third quarter. Is that correct? That's the first part. Second part is as you ramp the new site, do you expect to have like some additional fixed cost exception and the fore put some pressure on gross margin? If so anywhere you can kind of quantify that?

Okay. In regards to Q4, we haven't really said the specific number for margin, but I don't think that we want to say that it's going to be equal to Q3. Q3 was very strong, very good, the sun and the moon lined up and that was a very, very positive, but I am glad to get those from time to time, but I don't think it's prudent to have people that run models to be modeling at that high level. I think somewhere in the mid-thirties in a plus or minus is reasonable and Morris and I feel that we should be striving internally for something more, but it may not be achieved so we should help all of us understand Q3 is very good, but

I always want of put the pressure on the CFO to deliver better margins.

Yeah. In regards to your second question, in theory I think there will be some duplication of cost. It's going to be hard to not have that however, I am not sure it will be sub centered, so let's take the assets first. So the actual facility the useful life depreciation cycle is 27.5 years. So that - if you speaking I mean it's the extra facility cost of won't hit the income statement in any harsh way. Furthermore, as we do move out of the Beijing facility at some point then you will stop depreciating the facility because that's no longer in use. Not the entire plant, but maybe for example a building. So when you no longer depreciate it then you are just depreciating at one site again, So maybe there is a short period of cross over, but then what you do move from whole of listening audience, that particular building if it is not depreciated, then it's subject to the impairment test which will basically be is your book value greater than the market value. But given the reason for relocation which is the municipal government of Beijing is basically occupying Tongzhou the region that we are in. The real estate market already is responding to that and will continue to respond we believe recently upward. So we don't think that it will subject to an impairment lie down. So that covers the plant kind of things, 27.5 years. Maybe some quarters of cross over, that it's a relatively small number. Then let's talk about equipment, so in theory there would be zero equipment increase, because we have enough equipment that we can use it pretty quickly. We proved that when we have the on the - mentioned it the fire back in Q1. So our guys will within days moving equipment part of that building into another building and refitting it and retuning it. And they did a marvellous job, so however there will be some increased equipment depreciation because the volume expectations have enlarged. So we will take advantage of all the equipment. But we will also purchase new equipment not because we are relocating but because we need more equipment because the volume is higher. So as we are already feeling pressure in indium phosphide this past a few quarters we saw pressure in Germanium. We had some slight pressures in Gallium Arsenide, but we expect that to become a little harder going forward and that's before even 3D sensing. So we are remaining confident we will be playing with 3D sensing and that's part of the reason we are planning to buy more equipments. So to summarize the building stuff, I think would be or there is going to be some double charges of depreciation, but I think it will be for 1 or 2 or 3 quarters and will be very noticeable and on an equipment, in theory there would be no more equipment except there will be because of adding capacity because we are already ahead of what we thought we - if you go back to 2017, back in December and January, we have exceeded what we expected. So that's going to put pressure on this equipment. But I will advantage to give you a sort of a commercial about what we think about ourselves as entrepreneurs and business people. We are very good at adding capacity. We have proven that in a fast slide we gain market share well beyond what the market has allowed because we can move faster than our competitors. And so we are still doing that again for Indium Phosphide now and we expect do that with Gallium Arsenide.

So let me add a few more comments on the increased expenses. You know now we are going to operate in two sites and we obviously we need the people to travel on the new site for instance you know that our facility managers. We have our all facility needs trained and those new facility needs to hire new people, so, there will be adding to expenses. I mean, we may need to hire new people to as operate at new site and we need to train them at the whole site. So that could be some of the tendency, but those increase costs are minimum, okay and but what can come out of it is that we will be then very low prepared if the market plays out to be what we expect it to be a huge opportunity coming in 2018, '19 and '20. And we are the best prepared company. We have a new facility, we have the increased capacity and we have now more trained operators to help us to produce all these great products we have been making.

And I know most of the listeners are aware they expect we need to talk about additional human resources, the price for that is significantly lower than you would imagine it would be additional trained operators in United States. So yeah, we are going to need to hire new operators and train them and everybody begins to do that, but the actual dollars spend are real, but they are relatively small.

That's great so far, thank you guys.

Thank you. And our next question comes from the line of [indiscernible] from BWF Financial. Your line is now open.

Hi, just what I ask you here is just given the commentary you are talking about, all the seasonal weakness you're seeing right now coming from Indium Phosphide.

Say that question again please.

Your commentary outlines a lot of strength in Gallium Arsenide and Germanium. So I am trying to figure out and understand that the seasonal weakness here talking about for Q4 which has been natural on the pass. Is that all just coming Indium Phosphide this time or just spread out?

I think in our budget Indium Phosphide will come down a bit Germanium I think we're remain strong although we have one customer taking a little bit of less material because of Christmas. I feel Gallium Arsenide surprisingly it will be rather strong in Q3 and arsenic while maybe they are taking too much of the inventory for Q3 and then they have taken it either. Yeah, so Indium Phosphide will be down. Gallium will be down, Germanium will be flat and raw materials are not sure about. It's hard for those guys to project this far in advance, so.

Okay and just trying to figure out lead times Q1 has also been seasonally soft quarter for you guys as well. So are you guys seeing extended lead times or you seeing extending the lead time or are you seeing good enough demand or do you think that it comes back in Q1 could be abnormally strong.

No, on Q1 I don't think we are normally soft. I think Q1 is your bounce back. You know Q4, I still mean is one is the holiday season towards the end of the year and we also have a national holiday for our factory. We are closed on for ten days.

In China?

In China, so the lead time wise I tell you it's also depending customer in specific products. For instance, well, the Gallium Arsenide six inch product. The lead time is very long I mean we have to almost and they are they are talking all those to ask for more material to be delivered and, but then in Q4 they do tell us hey, we got that inventory so done a bit, so you have to worry about in a comparing to a very strong Q3 in Q4 you took a slack and that if you tick that number compared to Q2 or Q1 is still a great increase that's the way I will describe it.

Okay, and last question is how long before your crystals gets qualified from your new facility.

How long the crystal will be qualified? What?

For a new customer for crystal qualify in the new site, how long will they take?

Well, it all depends. I mean some customers well one of the customer, a Japanese customer by the way they tell us they will take 12 months. We had a other customer, a European customer told us two months.

So the smaller customers will do with what I will call paper call. We will provide substantial characterization data from wafers from both sites and presumably we believe they will be looking same and our customer will sure check the box and say okay we are done, we qualify, it could be a day. And then the customers are actually touch and feel and examine new substrates and compare to the old substrates. It will depend on how compelling their interest is to qualify us. If they are fan of the AXT, if they want to be in the AXT universe they are going to be motivated people quickly. If they are the all present that spectrum then it might take longer time. So it's going to be different for each customer.

I would agree, but Gary I think you also have the take into consideration and we believe their market is really very hot, and there is another hold you can't buy Gallium Arsenide like candies. If you take time to qualify AXT substrates I mean that's also to your determent do you worry about the pipe -

You take too long.

Yeah, you take too long. But some of them they do have their quality standard. So they are in communication with each one of them and asking them what's your requirement so that we can plan ahead. You know some of the customers tell us they will take 12 months. So then we make extra effort to make sure that we have inventory build for them so that will be qualified. So I think what we are seeing to is that it's far true to us and nothing to our making that we cost, but this qualification process is going to be taking place in their market that is relatively strong and that's going to provide compelling motivation from the customer base to do with more quickly than they might have.

Yeah, let's say there are only three suppliers in the world.

Great, thank you.

Look one of the reason I told them that you should qualify us quickly is that if you want to switch to the other supplier and you need to take that much longer time to qualify them too.

Okay, having anything else.

No, thank you.

All right, operator next question please.

Thank you and our next question comes from the line of John Sepenzis from Northland. Your line is now open.

Hey, guys, thanks for taking my question and congratulations on another great quarter. I am wondering if you could just give me any kind of update on end gap and 5G if you are testing that at all or a lot of people pulling in for these 5G cellular phones are they have networks up in late '18 and early '19 so I wonder if you have been talking anybody about potentially using in Indium Phosphide as an alternative to Gallium Arsenide in cellular.

Yeah, I mean that's a very good question. Actually maybe two quarters ago we were very gentle and proposing perhaps that the next generation cell phone will need the Indium Phosphide to operate at a 28 gigahertz of high speed, but now our enthusiasm sort of cool off a bit and mainly because one of the large cell phone device maker said well it's probably longer the launce until 2022. And the reason why they said is not going to happen sooner and they will happen later is because they say what the first generation cell 5G is going to exercise on the high speed receiving end. In other words the mobile phone all they need to do is receiving the 28 gigahertz speed frequency signal on the mobile phone. So if it is only on receiving end perhaps you can find a better solution other than indium phosphide because indium phosphide is a great advantages that it not only can to deliver where high power, high frequency that only metrology power signal to the base station and also needs to operate at a very low voltage because cell phone and all operating at 1.5 volt, but if the only need for it to receive then the urgent need for Indium Phosphide solar diminishes. Okay, so we hear a lot of demand for that is in micro cells, but those micro cells because they are powered by AC, the house current. So they can operate those high frequency devices with silicon carbide, Gallium android based devices. However, although and so - I think the Indium Phosphide opportunity probably will be pushed out for a year to two okay, and so that sort of the last opportunity. However I will say the other great opportunity for 5G to come I really tying up all these microcell together. See if you have a lot of this microcells, then microcells could be hundred times the number of base stations like what we have for cell phone tower today and you need to connect all these cells together and then feeding to the central station as well seeing to data center and so for Indium Phosphide, if you are going to use so much more data and so much sometimes described almost a hundred times or a thousand times the data rate, then you need Indium Phosphide on the fiber side to get all these cells connected together and also the connecting back to the - the data center as well as taking the data and feed it back into individual self [ph] cell. So I think our play into the 5G is more than just a mobile cell phone market. Although that market is delayed for a little bit, but we are going to be kept very busy if these 5G starts to launch.

Great, thank you for that. And then it sounded like from your commentary that the Chinese pawn market the kind of get a little bit softer in the quarter and as looking a little bit softer than you thought maybe directionally you saw it in the Q2 was starting to improve, so did I hear that correctly?

No. Actually I think the way we described was that in 2015 let's say the pounds market as when we saw it was let's say a hundred. In 2016 it dropped down to something like 20, in 2017 we believe that was steady, it recovered to around 50 to 55 and that market if you see that's around their level. It's not improving, it's not going down, but I also saw a run report saying that is all because of the inventory correction and people bill too much inventory though they want to adjust the inventory. So it depends on what you think 2018 is going to be. So as far as I am concerned, I don't believe this market can be down forever because China wants to launch 5G as well. And they are going to build a lot of data centers which every time you connect a data on fiber to some kind of device, you need it on.

Okay, great. And then in terms of the new facility, is that all gas right now and are you going to add silicon Germanium or Indium Phosphide at any time in the near term, is that something that you do like a year from now once you got the gas transferred?

Yeah, I think three years from now I probably would consider moving a lot of things more there but I think in the first phase of time is Gallium Arsenide certainly.

That's it, thank you very much.

Trying to keep it as a single focus, Gallium Arsenide is the focus.

Got it. Thank you.

Next question.

Thank you and our next question comes from the line of John Fisher from Dougherty & Company. Your line is now open.

Thank you good afternoon, two questions. One when you gone into 2018, given the strength of the business because it did this year in a broad based strength. Is there anything any end markets or specific product lines that you would expect or you are concerned about potentially slowing from a growth stand point in 2018 that may be a strong contributor here in '17? Again thinking in terms of risks just - everything is going really well right now and just kind of trying to think in terms of the other side of the point, any potential risks or concerns that we might want to keep at the front of our mind.

You know we can give you a product line by project line for instance Germanium satellite launches are lined up.

Already schedules there.

All ready schedule. So I don't think it's going to slow down. Gallium Arsenide at least from the LED side and our customers are showing as they are expanding their capacity so I expect to give a date to buy it more from us but on the other hand I also worry about I will going to lose market share to our competitors. I don't think so, but that's one potential worry and Indium Phosphide, we have got a large order so we are prepared for that and I think the question is pound markets and China markets is now recovered and that should lay you on to what these already into the big order we already received. And Gallium Arsenide wireless you know leaving that a potential negative, I mean because Gallium Arsenide device make our actually need that they are very, very busy. So some of them not telling me that they are dropping on the low end. It's less profitable they don't want to do anymore. Since we're selling real estate, if they don't do it, it will impact our business, but on the other hand you value you could say full of 5 or 6 of them they are all growing and so one of them is not doing so well, so be it. In 3D sensing, I really think this is really big judgment. I am hoping for the home run, but maybe it's going to be later than somewhere because the technology is so attractive that entry to barrier is so high and we shouldn't be looking for a short term gratitude or and we think this is going to be a long play. If we prepare ourselves for it, it should be a long growing market and I think the time for it to explosive grows maybe 2019.

Okay. So without expecting any contribution from 3D sensing when you look out to 2018, you're going to grow -

We do expect something.

Okay. Well I think most people when they model their - taking into consider they haven't put anything in their models yet for 3D sensing. You are going to grow the business from a top line stand point about 20% this year of low 20s. Is that a comparable growth rate for '18 that you think you can hit or do you think there will be much of a deceleration from the low 20% revenue growth, '18 versus '17?

We are going to talk to our sales voice for our next year budget, but somewhere around 20 is what we are trying to drive.

Okay.

But obviously we need to build that - the model from the bottom up, which will share customers.

And then the final question, I don't know how sensitive the order is, but any extra detail you can provide on the multimillion dollar order that you received in Indium Phosphide end market, any description or any details or nuggets that you can put around that order?

Yeah, first of all we are very excited of having that order. Essentially make it we always say that we will lift quarter by quarter. We have the opportunity to cancel it anytime and if they say stop to and cannot deliver, but this is a good indication that a customer we are claiming for their peak volume increase. They worry about their supply lot. So they talk to our customer, they - then our customers are made to tell us hey, be very, very some prepared and there is a peak order come. So I think this is - I mean although that customer we do negotiate the annual capacity updates as well as price negotiation every year anyway, but this is an usual driver.

Yeah, and it's more formal and firm than just giving projections.

No, no. I mean year-to-day.

Yeah.

But this is - it's formal, but it's nothing extra.

So I think what the way we view John, is it's an interesting data point which could be suggesting that the customer base is becoming more sensitive to supply and to measure their got it line up which would mean that there is - they are on demand and the customers demand is driving that so, we hopeful right, we think we are and we have to wait and see. Yeah.

Yeah.

Yeah, I mean so that the question is how do we build it into our budget, also how do we plan for our capacity expansion. So we usually do conservative way in terms of budget in our sales revenue production, but we do aggressively for capacity expansion because we want to be prepared for and we believe that we have the entrepreneur spiriting ourselves so we can capture all of these upside. So we are on the consideration I think is I mean I hope on proving to be right in that China market cannot be done forever. Sometime it's got to come up. And there is not a whole lot of substitute supplier in the world.

So and so any hint or clue on the addreseable end market that is order is would be categorized under.

No, no hint or clue.

Okay, thanks.

Thank you. And our next question comes from the line of Richard Shannon from Craig-Hallum. Your line is now open.

Hi, guys thanks for taking my questions. Well I just have a couple of quick ones here. First one on the Indium Phosphide, what's your customer base in terms of breadth looks like for silicon photonics. Is there still kind of single customer driving that or you have you seen breadth here recently and or do you expect some to come next year?

We always had multiple customers, we always have. I mean we are also developing new silicon photonics customers, but I think it - I think what's interesting is some of the silicon photonics users more substrates to achieve the same thing versus dollars. So but because we sell just the substrates, so it's very difficult for us to tell in who well we think we know who is winning that's part of our concern. And we also developing to relationship with others and we also serving to the market and so we think silicon photonics is a great opportunity for Indium Phosphide.

Second probably last question here on gross margins, Gary gave us some moving pieces on the third quarter number and you mentioned some favourable drivers in raw materials. Is that a onetime impact or how does that translate going forward and specifically any comments about the pricing environment for Gallium as in terms of how you see that trending going forward?

Well the raw materials have been trending down, but now it will begin to see back up so we have a hedging model built into the business which is our own gross margins will determine if raw material prices go up. However, our partially in companies in China that are in the raw materials business, will benefit from that and so hopefully there is some offset but yeah, I think Morris can give some more colour of it basically raw materials generally are tipping up.

Yeah.

Yeah, our JVs are doing very well. We have a JV which is servicing to the LED market I mean they are seeing big orders although compare AXT as a whole they are much smaller.

Alright. Okay that's fair enough. I think that's all the questions for me guys.

Thank you and our next question comes from the line of Dave Kang from B. Riley. Your line is now open.

Thank you, good afternoon. The first question is just a clarification, what is the stock composition?

339,000.

And then for fourth quarter, how should we model CapEx, is it going to be down quite a bit or -

Well, we don't have a new facility to buy yet, but we'll -

We don't have anything that's going to be as large in this quarter, but there will be capacity growth in indium phosphides since there's going to furnaces for that equipment, but probably it will be down because we're not going to spend $15 million on furnace system.

More of the strategy that I've been also telling investors is that we're buying extra 30% mini equipment in proposal for the move. So what we want to do is buy the new equipment and have it set up in the new facility and have the quantify them. Once they're running, we can start moving on the 20%, 30% flow off the new furnaces and new equipment - old equipment from Beijing site to the new site. So I think in the next year I think the CapEx should increase. I mean either than buying the facility.

Okay and then just four questions on the indium phosphide, so is the indium phosphide better than GaAs right now?

Well, compared to individual, yes, it is by far the largest.

No, combined?

No, combined gallium arsenide is still big. But also you got give credit to gallium arsenide, they grow very well too.

And then on that multimillion dollar order, what about in terms of shipment timeframe, can you give us some color on that?

What they're telling us is between 10 to 12 months delivery.

Got it and then my last question, in terms of customer concentration for indium phosphide, so what will be the top customer in terms of percentage of indium phosphide revenue? Would they be like 50% or any color on that?

Yeah, we have many customers. In fact - and it also depends upon timeline, if some of the customers where we got them to big - so I don't think we can say who is the largest and who will propose for long time.

Well, what I'm trying to understand is whether silicon photonics is really driven by one customer or multiple customers.

We don't give that detail David, but the answer it's numerous customers. There's not huge concentration that's - there are certainly customers larger than others, but as we said two quarters we ago, we have a sort of new bucket that we talk about with indium phosphide, which is other small orders because so many companies are jumping on the optical band wagging and doing optical development of products. So they're all buying indium phosphide.

Got it. Thank you.

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

Thank you for participating in our conference call. As always please free to contact me, Garry Fischer, Leslie Green directly. If you would like to meet with us, we look forward to speaking with you in the near future.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program and you may now disconnect. Everyone have a great day.