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AXT (NASDAQ:AXTI)
Q3 2018 Earnings Conference Call
Oct. 31, 2018 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon, everyone, and welcome to AXT's third-quarter 2018 financial conference call. Leading the call today is Dr. Morris Young, chief executive officer; and Gary Fischer, chief financial officer. My name is Lauren, and I will be your coordinator today.

[Operator instructions] As a reminder, this conference call is being recorded. I would now like to turn the call over to Leslie Green, investor relations for AXT. Ms. Green, you may begin.

Leslie Green -- Investor Relations

Thank you, Lauren, 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 and our ability to control costs, improve efficiency, increase orders in succeeding quarters, improve our competitive position in the market, our schedule and timeliness regarding our relocation plan, our thoughts on air pollution in Beijing, global, economic and political conditions, including trade tariffs and restrictions, 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 results or events 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, potential tariffs and trade restrictions, increased environmental regulations in China, 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 website at axt.com through July 25, 2019. 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. This information is available on the Investor Relations portion of our website at axt.com.

I would now like to turn the call over to Gary Fischer for a review of our third-quarter results. Gary?

Gary Fischer -- Vice President and Chief Financial Officer

Thank you, Leslie, and good afternoon. Total revenue for the third quarter of 2018 was $28.6 million. This compares with $27.1 million in the second quarter of 2018 and $28.2 million for the third quarter of 2017. This represents year-to-date growth of approximately 9% over the same period in 2017.

Of our total revenue, substrate sales were $22.8 million, compared with $21.6 million in the prior quarter. Revenue from our raw material joint ventures was $5.8 million in Q3, compared with $5.5 million in Q2. In the third quarter of 2018, revenue from North America was 11%, Asia Pacific was 72% and Europe was 17%. In the third quarter, one customer reached 10% of revenue and the top-five customers generated approximately 39% of total revenue.

Gross margin in the third quarter was 37.1%, compared with 40.6% in the prior quarter. Our substrate products held their own in terms of gross margin but our three consolidated raw material companies each had a quarter-to-quarter decline. That plus the fact that Q2 had an about a 1% incremental upside from the sale of material previously written off account for the change from Q2 to Q3. Total operating expenses in Q3 were $6.3 million compared with $6.5 million in Q2.

Operating expenses continue to be in line with our run-rate expectations for the year. Total stock compensation expense for the third quarter was $461,000. Operating profit for the third quarter of 2018 was $4.3 million compared with $4.5 million in the previous quarter and $5.2 million for Q3 of 2017. Interest and other income for the third quarter was a net gain of $200,000.

This number consists of three categories: one, net interest, which we earned $100,000 in; two, equity accounting on our unconsolidated joint venture companies, which broke even; and three, a foreign-exchange gain of $100,000. The tax provision in the third quarter was $410,000 compared to $367,000 in Q2. I do want to take a moment to talk about the U.S. tariffs with China.

In the tariff list that was released by the United States government on September 24, 2018, it included wafer substrates that we manufacture and import to the United States. Therefore, our Q4 2018 forecast will include approximately $150,000 for tariffs of 10% charged on the import in wafers into the United States from China. It has been said that President Trump might raise the rate to 25% in 2019. These amounts are not what we would consider to be dramatic hits.

Nevertheless, they are real and will have an impact going forward unless the two countries can sort out and resolve the trade-war issues. For Q3 2018, we had a net profit of $3.9 million or $0.10 per share. By comparison, we had a net profit of $3.9 million or $0.10 per share in the second quarter of 2018 and $4.4 million or $0.11 per share in Q3 2017. The diluted share count in Q3 was 40, 331,000 shares.

Cash and cash equivalent investments closed at $42 million as of September 30. By comparison, at June 30, it was $54 million. The primary reason for the decline was the new facility and equipment. Depreciation and amortization in the third quarter was $1.2 million and capital expenditures were $12.7 million.

Accounts receivables net of reserves were $23.3 million as of September 30, compared with $22.4 million as of June 30. Net inventory at September 30 was $58.7 million compared with $57.0 million in inventory at June 30. Ending inventory consisted of approximately 51% in raw materials, 44% in work in process and only 5% in finished goods. OK, this concludes the financial comments.  I'll turn the call now over to Dr.

Morris Young for a review of our business. Morris?

Morris Young -- Chief Executive Officer

Thank you, Gary, and good afternoon, everybody. We continue to execute solidly in Q3. Our revenue and profitability came in at the high end of our expectations, highlighting demand for our products across a diverse set of applications and our ongoing effort to drive efficiencies in our business. Many of the key applications into which we sell appear to be in the early stages of a long and promising life cycle.

We're also encouraged to see new emerging applications that are likely to contribute to our growth for years to come. As such, the relocation of our gallium arsenide germanium manufacturing lines is providing us the opportunity to plan for growth in our industry and to prepare our business to meet increasing customer demand. Now, turning to our markets. We achieved another record quarter in indium phosphide revenue in Q3, with relative strength in all of its primary applications.

In particular, demand for silicon photonics based applications such as datacenter connectivity grew from the prior quarter. This is coming as a result of a substantial increase in the volume of global network and datacenter traffic that is driving the need for a more cost-effective, energy-efficient, and high-bandwidth solution. We believe that the continued adoption of silicon photonics technology in hybrid center, hybrid scale and enterprise datacenters as well as the transition over time to 100g and 400g technologies will fuel the need for indium phosphide for years to come. In addition to datacenter connectivity, the current infrastructure-upgrade cycle in preparation for 5G in telecommunication applications are providing opportunities in short-haul, long-haul and metro deployments.

As the other data point for the expected growth in this application, Intel announced in Q3 that it has begun assembling a new portfolio of 100 gigabit per second silicon photonics transceivers that are optimized to meet the bandwidth requirement and the front-haul environment conditions of 5G communication infrastructure. The industry move to 5G, along with a ramp in existing network traffic for services, such as video streaming is likely to strain the existing communication infrastructure. As a result, it will be -- it will need to support an expanded spectrum range over time, driving demand for more efficient solutions. Beyond silicon photonics, power applications contributed meaningfully to our record Q3 indium phosphide revenue.  As expected, PON sales were down from Q2, following a very strong first half and this is likely to continue through Q4.

This market trend tends to be somewhat lumpy quarter over quarter. The power applications should provide significant opportunities for our indium phosphide product over many years. Driving the demand is the ongoing need for faster broadband networks and increasing fiber to the home requirements. In a report published in August, Dell'Oro indicated that it believed the global PONs market to be on track to grow at a five-year compounded annual growth rate of nearly 40% from 2017 to 2022, driven by the adoption of next-generation PON technology such as 10 gigabit per second EPON and AXT is now well-positioned in this market and supplies virtually all the major customers.

Q3 was also a growth quarter overall for our gallium arsenide business, driven by increased revenue by semi-insulating substrates. While wireless application streaming remained remarkable, we saw contribution from the emerging use of thin-film gallium arsenide-based solar cells. The reduced weight and ongoing progress in energy efficiency making these solar cells effective for extending the flight time of drones and other types of unmanned aerial vehicles. This technology is similar to what we have seen used in certain automobiles to expand battery life.

Our experience with the emerging solar cell application is that this demand is lumpy but the expansion of its use in multiple industries, such as that its adoption will likely to grow over time. Growth in the semiconducting gallium arsenide substrates are offset somewhat in Q3 by weaker demand conditions in LEDs. Based on the discussion with customers in this space, we expect a softness in our traditional lighting, signage and display applications to persist in Q4. It's worth noting that we are beginning to see more meaningful contribution from Android-based 3D sensing.

To date, this year, our revenue have reached nearly $1 million from 3D-sensing programs in Asia, though the commercialization of the technology in the Android ecosystem is still in its early stages. We expect that revenue will ramp slowly over the course of 2019 and into 2020 as new devices come to market. In addition, with the technology performance of our wafer and the solid progress we are making in relocating our gallium arsenide production line, we're positioning ourselves to expand beyond Android in the coming years. Given the many applications of 3D-sensing technology, we believe that it will represent a great opportunity for all high-end substrate manufacturers for years to come.

Broadly speaking, gallium arsenide is continuing to experience a period of renewed innovation, with a number of new applications being developed to take advantage of its unique opportunities. Applications such as augmented and virtual reality, 5G wireless, LiDAR for other autonomous cars, retinal recognition and many others are emerging and will require the performance characteristics and adaptability that gallium arsenide offers. Most recently, we have seen rising demand for gallium arsenide in high-powered fiber lasers that supplement traditional cutting, welding and drilling tools for industries, micro fabrication, aerospace, and defense applications. The stringent technical specifications for these high-end applications continue to serve -- to severely limit the number of companies that can provide substrates in enough volume to meet global demand.

And importantly, as demand for these applications increases, AXT will be uniquely positioned through our current capacity expansion to accommodate the growing requirement of our customers. As an update on our relocation, I'm proud of the work our team is doing to execute this significant undertaking efficiently, while ensuring that the need of our current customers remain the forefront of our focus. Every quarter we put behind us, diminishes our execution risks and moves us closer to the supporting the next leg of industry growth with new, modern facilities and plenty of room for expansion. As we have said, our ongoing strategy is to complete the move in a measured and incremental way in order to provide a seamless transition for our customers, while ramping up to meet the increasing demand.

For the end of this year, we expect to have relocated approximately 6% -- 60% of our wafer production and expect to be close to completion by the middle of 2019. We are now well under way with customer qualifications, including all of our major customers. Further, our internal qualification results to date demonstrate consistent specification across of our sites, which gives us the confidence that those remaining customers who require qualification will find quality levels that are on-par with substrates from our -- made from our current facility. Turning to germanium substrates.

As expected, this area of our business was a bit down in Q3, coming off several strong quarters. Overall, the satellite industry is expected to continue its positive trend, providing us with upside opportunities in the quarters to come. And finally, raw material revenue increased modestly in Q3, with raw prices holding relatively stable. The continued relative health of our partially owned raw material companies allow us to be breakeven with the seven that we account for using the equity method.

The additional three that will consolidated contribute to our profitability in Q3. It is important to note that the benefit to rising raw material prices for our joint ventures is offset somewhat on the substrate side of our business by higher cost of our cost of goods sold. But on balance, this unique vertical integration provided tremendous value in managing the market dynamics for the materials that are critical to our manufacturing and offers certain volume and cost advantage that will aid in our competitiveness. Now, in closing, 2018 has been a critical year of execution for AXT.

Our success to date in driving growth and profitability in our business, while undertaking the construction of two new facilities and the relocation of our gallium arsenide and germanium production lines demonstrates the talent and dedication of the AXT team. And though our work is still under way, we look forward to the coming quarters for measured optimism and a firm belief that we are positioning ourselves to benefit from the numerous opportunities that are taking shape in front of us. This concludes my prepared comments I will now turn the call back to Gary for our fourth-quarter guidance. Gary?

Gary Fischer -- Vice President and Chief Financial Officer

Thank you, Morris. We expect to see revenue in Q4 of between $26.5 million to $27.5 million. We remain confident in a gross margin going forward of around 37.5%. However, in this Q4, we believe we will be lower than that as a result of a drag from the three raw material companies that we consolidate as well as some year-end inventory adjustments.  As a result, we believe our profit per share in Q4 will be in the range of $0.05 to $0.07, based on 40.431 million diluted common shares outstanding.  OK, this concludes our prepared comments.

Morris and I will be glad to answer your questions now. Lauren, the operator?

Questions and Answers:

Operator

Thank you [Operator instructions] And our first question comes from Richard Shannon with Craig-Hallum. Your line is now open.

Richard Shannon -- Craig-Hallum Capital Group -- Analyst

Hi, Morris and Gary. Thanks for taking my questions. Maybe I'll ask a question on the fourth-quarter sales guidance here, a little bit down sequentially. I wonder, if maybe at a high level, Gary, can you help us understand the moving parts here by the three major substrates as well as raw materials?

Gary Fischer -- Vice President and Chief Financial Officer

Yeah, the substrate guys -- I mean, the raw material guys will probably be flat plus or minus, a little bit, no big change there in the revenue side. On the wafer substrate side, Morris can chime in here to help out but the -- generally, as you know, Richard, Q4 is typically a bit down from Q3 and we were hoping that this year might be different. But it's not going to be. So it is a general softness, on the LED side.

We've seen some softness and generally, we're just -- we think that the revenue for no big specific reasons, but it's going to be less in Q4 -- less in Q3.

Morris Young -- Chief Executive Officer

Yeah, just a volatile category, I think, in substrates are down slightly. Indium phosphide, we were hoping for it to continue to grow but then we had a very good quarter in Q3 and so we're a bit cautious on its continued growth. And in semi-insulating, I think, things are bit soft as well. And Gary just said about semiconducting so just about every category.

I mean, other than the JV business, I think, it's going to be sort of flat. Otherwise, everybody is down slightly.

Richard Shannon -- Craig-Hallum Capital Group -- Analyst

OK. Would you attribute this to similar reasons we've seen a lot of other quarters reporting so far this season about general macro weakness? Or Gary, I  think, you said you're not seeing any specific customers. I just want to make clear that there's no specific customers and/or geographies that you are seeing some of this weakness from.

Gary Fischer -- Vice President and Chief Financial Officer

Right, I think, that's accurate. It's a general softness and you could say, at least, part of it is macroeconomic. But part of it is cyclical and seasonal for AXT, because we generally don't have a strong Q4 revenue number.

Morris Young -- Chief Executive Officer

Yeah and I think the other thing is this. We do have our own way of coming up to this guidance number. I mean, they do change is -- we collected data from our sales people and as they start to see some industry softness, they tend to be slightly lower in their forecast. That's, everything, if it is down 5% then that's what contributes to the softness in the overall.

Richard Shannon -- Craig-Hallum Capital Group -- Analyst

OK. Let me ask a question on gross margins.  Gary, I heard your comments about the confidence in 37.5% overall here, but this quarter you got dragged down here. I didn't have enough time to try to run this through my model real quickly. So wonder if you can give us a sense of how much lower you're expecting that, and then how much of it are you expecting from the tariffs that you mentioned earlier in your comments?

Gary Fischer -- Vice President and Chief Financial Officer

OK, so...

Richard Shannon -- Craig-Hallum Capital Group -- Analyst

Hello, Gary, are you still there?

Morris Young -- Chief Executive Officer

Are we cut off?

Richard Shannon -- Craig-Hallum Capital Group -- Analyst

Guys, can you hear me? This is Richard.

Gary Fischer -- Vice President and Chief Financial Officer

Yeah, we can hear you. Can you hear us?

Richard Shannon -- Craig-Hallum Capital Group -- Analyst

OK, you went blank for about 25 seconds. I didn't hear a thing after my question.

Gary Fischer -- Vice President and Chief Financial Officer

Can you hear me now, Richard?

Richard Shannon -- Craig-Hallum Capital Group -- Analyst

I can hear you now, Gary.

Gary Fischer -- Vice President and Chief Financial Officer

OK, so let me repeat. Something -- there's nothing -- we didn't touch anything in this room so it must be the gremlins for Halloween out there playing tricks on people. So for gross margin, we're saying for this quarter it's...

Richard Shannon -- Craig-Hallum Capital Group -- Analyst

Guys, I don't know if you can hear me. The gremlins are active, to say the least. Oh you just came back in again.

Gary Fischer -- Vice President and Chief Financial Officer

How about now?

Richard Shannon -- Craig-Hallum Capital Group -- Analyst

I can hear you now but as soon as you started to answer my question, it went out for 10 seconds.

Morris Young -- Chief Executive Officer

OK, go head.

Gary Fischer -- Vice President and Chief Financial Officer

It must be my voice is haunting the ghost. OK so about Q4 gross margin and about Q4 tariffs. Gross margin will be around 35% on my model plus or minus something. And then on the tariffs, I'm using $150,000 each quarter if it's 10%.

We don't know what the President will do in 2019, but it's reported that he has said he's considering to raise it to 25%. So neither of those numbers...[Technical difficulty]

Operator

And pardon me, this is the operator. We are experiencing some technical difficulties. Please stand by. Your conference will begin momentarily.

Once again, we are experiencing technical difficulties. Please stand by. And pardon me, speakers, are you able to hear and speak now?

Gary Fischer -- Vice President and Chief Financial Officer

I can hear you fine. Can you hear me?

Operator

Yes, I can hear you, as well.

Richard Shannon -- Craig-Hallum Capital Group -- Analyst

And Gary, I can hear you too.

Gary Fischer -- Vice President and Chief Financial Officer

OK. Morris, you wanted to say the test? Test one...

Morris Young -- Chief Executive Officer

OK. Test one, two, three, Morris.

Gary Fischer -- Vice President and Chief Financial Officer

Well, Lauren, can you hear him OK?

Operator

Yes.

Richard Shannon -- Craig-Hallum Capital Group -- Analyst

I can hear you, Morris. Thanks.

Operator

Yes, I can hear everyone OK, as well. And Richard, you are still in the queue. Can you still hear us all as well?

Richard Shannon -- Craig-Hallum Capital Group -- Analyst

I can hear you as well, operator. Thanks.

Operator

OK, perfect.

Gary Fischer -- Vice President and Chief Financial Officer

All right. So I think, I covered gross margins, but let me just repeat on the tariffs. At 10%, we estimate it will cost us $150,000 a quarter. That will be charged to cost of goods sold.  And it's been said that the President will possibly increase the tariffs to 25% so that's a wildcard.

And of course, it's out of our control. Neither number, 10% or 25%, is a killer issue but they are real numbers and it's detrimental to us. So we can complain or bang our head against the wall, or whatever, but that's the way it is so -- OK, next question?

Richard Shannon -- Craig-Hallum Capital Group -- Analyst

I think, I'll jump out of the line and maybe jump in later but thanks a lot for the time, guys.

Gary Fischer -- Vice President and Chief Financial Officer

All right, Richard. Thanks. Operator, next question?

Operator

Thank you. [Operator instructions] And our next question comes from Hamed Khorsand. Your line is now open.

Hamed Khorsand -- BWS Financial -- Analyst

What happened in Q3 with indium phosphide that all of a sudden you saw a positive traction but now you're seeing -- you're saying that, that's not happening again in Q4. You were trying to be conservative. What was that one-time event that caused indium phosphide to increase in Q3?

Gary Fischer -- Vice President and Chief Financial Officer

There wasn't any one-time event. It was just strong demand and the demand has kind of leveled off for Q4. So instead of growing, it's relatively flat.

Hamed Khorsand -- BWS Financial -- Analyst

OK.

Gary Fischer -- Vice President and Chief Financial Officer

But it wasn't a one-off or anything. It was just generally, the silicon photonics part was strong, the PON was still OK but wasn't as strong as Q2. And we think that PON will remain soft in Q4, and then we don't have a prediction yet about what happens to PON in Q1.

Hamed Khorsand -- BWS Financial -- Analyst

OK and do you have any insight if this is more inventory related at your customers or you don't have that kind of a visibility?

Morris Young -- Chief Executive Officer

Well, Hamed, I think, the way we run our projection, is such that, again, this early stage of the quarter. We obviously take our customers' advice of how strong they think the growth is. But on the other hand, when we give guidance, we have to take what's in the dialogue and what our customer is telling us that they expect to order from us. And those how the number come

Gary Fischer -- Vice President and Chief Financial Officer

Yeah.

Morris Young -- Chief Executive Officer

And as Gary said, it's not going to be drastically down but we don't think it's going to grow significantly next quarter. But it's still holding its own.

Gary Fischer -- Vice President and Chief Financial Officer

Yeah and Hamed, I want to say that we're attributing -- there have been times when we've had some inventory corrections for indium phosphide in the food chain. I'm not so sure that our guys have told us that specifically this time.  They're just forecasting relatively flat Q to Q for indium phosphide. But it's probably based on the customers end-market demand as opposed to the customer having too much inventory, because that hasn't been said, so...

Morris Young -- Chief Executive Officer

Yeah but the other thing is that our customer in indium phosphide probably has two levels of inventory. One is our epi grower customer and the end customer also has a potential inventory if they were to grow. So if they were to build inventory then they'd probably pull very strongly. And if they think that they have enough inventory, they may stay flat or if they want to consume some inventory then they may be down.

But I think overall, the trend is we're confident it will continue to grow, but quarter to quarter, that's what we see.

Hamed Khorsand -- BWS Financial -- Analyst

OK. And then just from an inside standpoint on the solar cell commentary, do you know where that -- your product is ending up on the wafer side? Is it ending up in solar? Or is it ending up in being used for car batteries?

Morris Young -- Chief Executive Officer

We think, it's mostly for the solar cells.

Gary Fischer -- Vice President and Chief Financial Officer

The drones.

Morris Young -- Chief Executive Officer

The drones.

Hamed Khorsand -- BWS Financial -- Analyst

OK, all right. Thank you.

Gary Fischer -- Vice President and Chief Financial Officer

Thanks, Hamed. Next question?

Operator

Thank you. And our next question comes from Gus Richard with Northland. Your line is now open.

Gus Richard -- Northland Capital Markets -- Analyst

Yes, thanks for taking my question. In terms of OPEX, do you feel like that is peaking in terms of the cost of moving facilities and going to start to level out and come down?

Gary Fischer -- Vice President and Chief Financial Officer

That's a very good question, Gus. And we've been looking at it.  We have some people in the -- our corporate controller actually is over in Beijing this week and one of my requests was for her to drill down on that looking forward. We're pretty much at what our expectations were for the run rate right now and we have a track record historically of having long -- multiple having quarters where it stays pretty stable. I don't really think it's going to go back down.

I think, it's going to stay up. So I don't -- I would caution you to not take it down below $6 million and we haven't put the numbers together yet for next year. But I would -- I think, it's going to be somewhere in the mid 6s when we finish putting it together.

Gus Richard -- Northland Capital Markets -- Analyst

Got it, very helpful. And then Morris, I think, you mentioned you'd done about $1 million worth of substrates for VCSELs at this point. Is that pre-production volume? Can you give a little more color on that?

Morris Young -- Chief Executive Officer

Yes, from what we know it's mostly pre-production volume. I mean, customers are buying some 100s and some 50s for sampling and for development work and nobody has given us any consistent volume -- production volume yet at this point. But we do have multiple customers taking volume samples from us.

Gary Fischer -- Vice President and Chief Financial Officer

Yeah, in aggregate, it's close to $1 million.  We don't view it as production yet but we view it as planting seeds and as the Android community begins to ramp in production, which we all know that's not quite yet, but it's on the horizon, then we would expect some of those seeds are going to grow and become volume production. But we're not baking it into our numbers at this point.

Gus Richard -- Northland Capital Markets -- Analyst

Got it. And then on the LED weakness, is that broad-based, one customer? Any color there?

Morris Young -- Chief Executive Officer

Yeah, it's generally broad-based. Our customers are telling us the whole future looks bright but then they do see softness going forward and in the last quarter as well.

Gus Richard -- Northland Capital Markets -- Analyst

Got it. OK, I'll jump in line. Thanks.

Gary Fischer -- Vice President and Chief Financial Officer

Thanks, Gus.

Operator

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

Richard Shannon -- Craig-Hallum Capital Group -- Analyst

Well, I came back quite fast. Just a few questions, guys. Maybe I'll follow up on 3D sensing. I guess, the first question is the customers that you're doing pre-production volumes with so far for Android, are those also customers that are currently supplying the one main guy that's out in the market with 3D sensing today?

Morris Young -- Chief Executive Officer

I think, the answer is no.

Richard Shannon -- Craig-Hallum Capital Group -- Analyst

OK. And is this with 4-inch or 6-inch or what size wafer are you supplying there?

Morris Young -- Chief Executive Officer

We -- the sample that we supply mainly are 6-inch but when we comp in the $3 million -- $1 million  VCSEL revenue, I know, there are some which is 3-inch. But there is -- those are the timer flight VCSELs.

Richard Shannon -- Craig-Hallum Capital Group -- Analyst

OK. A couple other questions on a different topic here. JV profitability. I think, you're viewing this a little less favorably in the fourth quarter.

Can you give us a sense of what that is? Is that gallium pricing, lower volumes in certain product areas? Or can you help us out understanding that, please?

Morris Young -- Chief Executive Officer

Yeah, let me try on the pricing first. I don't think there's any particularly pricing pressure we experience. Although, and you know, Richard, every year with major customers, we do negotiate new pricing. But we don't see any particular pressure on pricing.  I think, we have, as Gary commented, I think, one big item was our JVs.

Three of our JVs are having the environmental issues with China government and they have some orders from the local government. They have to shut down for a short period of time during Q4 to reorganize themselves, to requalify for production again. That's why they have a one-time cost issue. I mean, they're going to lose money in the fourth quarter.

And what was the second part, Gary?

Gary Fischer -- Vice President and Chief Financial Officer

Well, I think, that the raw material companies that Morris is describing, there's government-mandated improvements that they have to install for safety and environmental reasons. And so their efficiency and productivity rate is going to be down or zero for part of the quarter.

Richard Shannon -- Craig-Hallum Capital Group -- Analyst

OK.

Morris Young -- Chief Executive Officer

Yeah, And the second -- there was a second part in the gross margin decrease in your prepared comment. I forgot what it was.

Gary Fischer -- Vice President and Chief Financial Officer

The comment about Q3 was that it was entirely, because of the three raw material companies that would consolidate and we expect them to continue to be a drag in Q4. So...

Richard Shannon -- Craig-Hallum Capital Group -- Analyst

OK. And to follow up on that last comment, Gary. Is there an inflection point or a reversal that you expect ending some of these one-time situations that JV, both the consolidated and the equity ones can return to profitability?

Morris Young -- Chief Executive Officer

I think, that as far as JV is concerned, I think, I can answer definitely, it's going to be one-time issue. But once they get -- they comply to this pollution and safety issues then they will come back in production and they will reverse back to the normal pattern.

Richard Shannon -- Craig-Hallum Capital Group -- Analyst

OK, fair enough. I'll let in one last question and I'll jump out of the line again. Can you give us your thought process on CAPEX, going forward? I think, you mentioned $12 plus million spending in the third quarter. I know, you've got a little bit more elevated spending.

If you can give us a sense of what your expectations are for fourth quarter and then when do we get back down to the more historical level you've shown prior to the FAB move.

Gary Fischer -- Vice President and Chief Financial Officer

Yeah, I think, Q4 is going to be somewhere between $10 million and $20 million depending on when certain things are executed and the triggers are pulled. I think, Q1 will have a little bit more CAPEX for the facility and then the rest of next year, I think, will be just modest amounts for equipment. We have bought some extra equipment in this process sort of above and beyond what we normally would be buying for both growth and upgrades. And that's basically to be able to facilitate the relocation more easily.

So we bought ahead and that means depreciation is going to -- we're charging ourselves a little bit sooner than we would have. But I think we probably will end up with a little bit less in Qs 2, 3, and 4 next year because of that. We -- again, we haven't worked all the numbers out with our team yet for the 2019 budget but that's what we've sort of discussed in meetings and stuff. We could have a little bit lighter acquisition of equipment.

Morris Young -- Chief Executive Officer

I think, overall, if you count the amount of money that we spent so far, we expect to spend about between $30 million to $35 million to complete our new construction as well as equipment...

Gary Fischer -- Vice President and Chief Financial Officer

The new equipment, yeah.

Morris Young -- Chief Executive Officer

New equipment we need to buy. And beyond that, then, we have our two brand new factory as well as increased equipment for more production.

Gary Fischer -- Vice President and Chief Financial Officer

And we were just over there, Morris and I were, and in fact, Leslie would -- joined us. And so we toured the new sites and it was very encouraging. Looks very good. So...

Richard Shannon -- Craig-Hallum Capital Group -- Analyst

OK, excellent. I guess, all my questions. Thanks, guys.

Morris Young -- Chief Executive Officer

OK.

Operator

Thank you. And I am not showing any further questions at this time. I would now like to turn the call back over to Dr. Morris Young for any closing remarks.

Morris Young -- Chief Executive Officer

Thank you for participating in our conference call. During Q4, we'll be participating in the Craig-Hallum Alpha Select Conference on November 15 in New York City. We look forward to seeing many of you there. As always, please feel free to contact me, Gary Fischer, or Leslie Green directly if you would like to meet with us.

We look forward to speaking with you in the near future.

Gary Fischer -- Vice President and Chief Financial Officer

Happy Halloween.

Operator

[Operator signoff]

Duration: 43 minutes

Call Participants:

Leslie Green -- Investor Relations

Gary Fischer -- Vice President and Chief Financial Officer

Morris Young -- Chief Executive Officer

Richard Shannon -- Craig-Hallum Capital Group -- Analyst

Hamed Khorsand -- BWS Financial -- Analyst

Gus Richard -- Northland Capital Markets -- Analyst

More AXTI analysis

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