AXT Inc (AXTI) 2018 Q4 法說會逐字稿

Good afternoon, everyone, and welcome to the AXT Fourth Quarter and Fiscal Year 2018 Financial Conference Call. With me on the call today is Dr. Morris Young, Chief Executive Officer; and Gary Fischer, Chief Financial Officer. My name is Catherine, and I'll be your coordinator today. (Operator Instructions) As a reminder, this call will be recorded. I would now like to turn the call over to Leslie Green, Investor Relations for AXT.

Thank you, Catherine, and good afternoon, everyone. Before we begin, I would like to remind you that during the course of this conference call, including comments made in response to your questions, we will provide projections or make other forward-looking statements regarding, among other things, the future financial performance of the company 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 events or results to differ materially. These uncertainties and risks include, but are not limited to, overall conditions in the market in which the company competes, global financial conditions and uncertainties, potential trade and tariffs restrictions, increased environmental regulations in China, market acceptance and demand for the products -- for the company's products and the impact and delays by our customers on the timing of sales and products. In addition to the factors that may be discussed in this call, we refer you to the company's periodic report 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 expectations.

This conference call will be available on our website at axt.com through February 20, 2020. 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 fourth quarter and fiscal year of 2018. 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 fourth quarter and fiscal year results. Gary?

Thank you, Leslie, and good afternoon, everyone. Total revenue for the fourth quarter of 2018 was $22.2 million. This compares with $28.6 million in the third quarter of 2018 and $26.3 million for the fourth quarter of 2017. Of our total revenue, substrate sales were $17.2 million compared with $22.8 million in the prior quarter. Revenue from our raw material joint ventures was $5.0 million in Q4 compared with $5.8 million in Q3. In the fourth quarter of 2018, revenue from North America was 10%, Asia Pacific was 69% and Europe was 21%. In the fourth quarter, one customer reached 10% of revenue, and the top 5 customers generated approximately 35% of total revenue. Gross margin in the fourth quarter was 26.3% compared with 37.1% in the prior quarter.

This decline was the result of 3 factors. First, the drop in revenue meant that our overhead costs were spread out over fewer units produced and sold so each unit carried a greater share of the overhead. With higher revenue, we can spread the overhead cost more favorably, and that delivers a higher gross margin as we saw in the earlier 3 quarters of 2018.

Lower revenue is a key factor in understanding the lower gross margin. A second factor is that the manufacturing overhead numbers have increased as we have hired and trained new employees and incurred other costs resulting from the relocation of gallium arsenide and germanium. And the third factor is the cost of raw materials. Especially in germanium, we saw a sharp increase, but in general, material costs moved up and peaked in late Q3 and Q4. We are seeing things move back down now, but they were a contributor to a reduced gross margin in Q4.

As we look forward, we certainly believe we can go back in the previous ranges. The timing will depend on the recovery in the markets we serve as an increase in revenue will be a primary driver for the improvement. In addition, we are also implementing programs to improve yields and stabilize and optimize the efficiencies of multiple manufacturing sites. These are expected to contribute to an improvement over the next couple of quarters.

Moving on, total operating expenses in Q4 were $6.5 million compared with $6.3 million in Q3. Total stock compensation expense in the fourth quarter was $534,000. Operating loss for the fourth quarter of 2018 was $638,000 compared with operating profit of $4.3 million in the previous quarter and $3.7 million for Q4 2017.

Interest and other income for the fourth quarter was a net loss of 414k. This number consists of 3 main categories: number one, net interest earned of 256k; number two, foreign exchange gain of 390k; and number three, equity accounting on our unconsolidated joint venture companies, which was a loss of $1.1 million. This loss was primarily the result of a $1.1 million charge incurred by one of our partially owned supply chain companies, which was required to temporarily shut down during the fourth quarter to install manufacturing improvements mandated by a regional environmental agency. It has since resumed production and operations.

Income tax for the fourth quarter was a benefit of $173,000 compared with the provision of $410,000 in Q3. As expected, our Q4 results included approximately 150k in tariffs as a result of the 10% tariff charge on importing wafers into the United States from China.

For Q4 2018, we have a net loss of $1.1 million or a loss of $0.03 per share. By comparison, we had a net profit of $3.9 million or $0.10 per share in the third quarter of 2018 and a profit of $3.1 million or $0.08 per share in Q4 2017. The share count in Q4 was 39.2 million shares.

Cash, cash equivalents and investments closed at $39 million as of December 31. By comparison, at September 30, it was $42 million. The primary reasons for the decline were the new facility and equipment. Depreciation and amortization in the fourth quarter was $1.4 million, and capital expenditures were $11 million.

Accounts receivables net of reserves were $19.5 million at December 31 compared with $23.3 million at September 30, 2018. Net inventory at December 31 was $58.6 million compared with $58.7 million in inventory at September 30. Ending inventory consisted of approximately 46% of raw materials, 48% in work in progress and only 6% in finished goods.

Let me give you a little bit more color about inventory and specifically about our focus to now start trending it down. We did let inventory grow on the front end of the relocation program, and then we slowed that down last spring and inventory has been relatively flat since June 30, 2018. We began efforts to reduce inventory in Q3 of last year and believe that we will begin to see more meaningful results over the coming quarters. With the programs we have in place, we would expect to be able to drive it below $50 million and perhaps a bit more over the coming year.

We have made the reduction in inventory a focus for our team in China, and in my last few trips, I have conducted an all-hands meeting with the team to keep us all focused. Morris also attends as we want the team to understand that this is important. I'm going back to China in March and will continue to focus on this topic.

Before we move on to the fiscal year results, I want to say one more thing about the use of cash in 2019. Our primary expenditure will be focused on the completion of the facility for which we expect to spend approximately $21 million over the course of 2019. Some of this cost will be offset in our cash balance by a reduction in inventory, as I've discussed, as well as our expectation of returning to positive operating cash flow in the second half of 2019.

Also, as a reminder, the current facility in Beijing has considerable value that we will be able to monetize in the future.

Okay. This concludes the discussion of our quarterly financial results. Let me now briefly highlight the fiscal year.

For fiscal year 2018, revenue was $102.4 million, up from $98.7 million in fiscal year 2017. Gross margin for 2018 was 36.2% of revenue compared with 34.9% for 2017. Net income for the fiscal year of 2018 was $9.7 million or $0.24 per share compared with $10.1 million or $0.26 per share for fiscal year 2017.

Okay. This concludes our financial review. I will now turn the call over to Dr. Morris Young for a review of our business. Morris?

Thank you, Gary, and good afternoon, everybody. Coming off of a strong Q3, we enter Q4 with the understanding that our customers across our portfolio were cautious regarding our -- their Q4 requirements. As we discussed in October, the reasons behind this were both market-related and customer-specific. In fact, our revised guidance in January underscored that Q4 turned out to be a significantly more disappointing than we had originally estimated. This drop for us was a combination of trade tension; weakness in the LED market, particularly in China, and for applications such as automotive, slowdown in growth in data center market as well as inventory rebalancing at several of our large customers; and the natural lumpiness of revenue from emerging applications for our gallium arsenide product.

In total, it felt like a perfect storm. As we move into Q1, 2 things appear to be true. First, the markets and geographies that were weak in Q4 will remain so throughout Q1. And second, the inventory correction of certain customers will also continue through Q1.

Having said that, in our current discussion with customers, sentiment is improving for 2019 demand in all of our key applications that drive our business. For indium phosphide, demand for data center connectivity, PON and telecommunications is expected to strengthen during the year. Though Q1 is remaining sluggish, customers are expressing optimism about the continued adoption of silicon photonics technology in cloud and large enterprise data centers as well as transition over time to 100G and 400G technologies. In addition, preparation for 5G communication infrastructure in the second half of 2019 and throughout 2020 are expected to provide opportunity in short-haul, long-haul, metro and even front-haul deployment. The PON market is relatively stable in Q1 at this current reduced rate, but early discussions with customers suggest that we could see improvements in the market in a quarter or 2 out, though visibility remains limited.

We're also seeing some interest in indium phosphide research and development activities and new customers that could add incrementally to our growth opportunity in 2019. Similarly, while the LED market has been -- has seen a setback in recent quarters, customer sentiment indicates that demand for high-end application in second half is likely to show some recovery. Further, AXT is well positioned across a variety of new applications for gallium arsenide when they start to ramp.

3D sensing for Android could provide us our first entry point this year as we ship nearly $1 million to preproduction programs in 2018. Semiconducting gallium arsenide for solid-state applications, such as drones and airplanes and automotive solar panels, were lumpy in 2018. However, these program are quite active, and AXT supplies substrates with -- for them with unique properties that further expand our competitive depreciations. We expect that they will again contribute positively to our 2019 revenue.

For our germanium substrates, which did grew in 2018 over 2017, appear poised for a positive year in 2019 as a result of continuing demand in satellite solar cells. As such, the many drivers for our business remains intact. The trend that we have always believed will propel AXT in the years to come continue to take shape in a very intangible way. Despite a quarter-to-quarter fluctuation, these are major transformation trends that are not going away, data center expansion, 5G laser-based sensing, LED proliferation, fiberoptic communications and others. AXT's product are fundamental to all of them. What's more, we are actively preparing our business for these opportunities.

The relocation of our manufacturing facility is progressing on schedule, and we expect to have at least 90% of our gallium arsenide germanium production capability established by the end of Q2. These position us well for new and recovering gallium arsenide business opportunities. In addition, we are now well underway with current customer qualifications, including all our major customers.

Given all these dynamics, our priorities for the coming years are as follows. First, we will drive improvement in our gross margin. Increasing revenue will help margin recovery, but we also believe that we can improve our manufacturing efficiency and the yields to achieve better results. We're implementing programs in Q1 to help address this issue. Second, we continue to be disciplined in our use of cash. These include efforts now underway to reduce inventory, as Gary mentioned, as well as taking opportunity to delay or eliminate unnecessary expenditures and align our capacity expansion with market conditions. Third, we'll continue to improve the important work of assisting and supporting our customers through the qualification of our new facilities. We believe the new location offer great benefits to them, and we are committed to helping them making a seamless transition.

And finally, we'll continue to focus on innovation. Across our portfolio, customers are actively developing new applications for our products and seeking our assistance and expertise in helping to make their vision a reality. Often, this involves our material scientists helping them overcome technical challenges within their particular process. In other cases, they require more stringent wafer specifications or specialized doping, and our team applies decades of expertise to make these possible.

In 2018, we've made a significant improvement in the performance of our germanium substrate that is meaningful to our customers. As such, we entered 2019 with an enhanced competitive position in the solar cell satellite market. And finally, we continue to set the space in our industry for low EPD characteristics in both gallium arsenide and indium phosphide material. Our innovation in this area is unmatched by our competitors, and we believe it will become a key differentiator for AXT across a variety of application in 2019.

In closing, 2018 was a mixed year. Global economic conditions were made more difficult by the uncertainties of trade tensions and spending in certain end markets. They took a pause, impacting our expected growth and profitability for the year. Despite these challenges, indium phosphide revenues set another record in 2018, and silicon photonics passed the tipping point of broader market adoption. We also saw growth in a host of new gallium arsenide applications that further suggest this material is entering its next period of expansion.

In addition, AXT made a significant progress in 2018 in relocation of our gallium arsenide and germanium product lines, meeting every major milestone we established. Neither the relocation nor its timing was of our choosing, but we believe strongly that it will improve out to be beneficial to our business. The new facility gives us long-term capacity and a new level of substratication in our manufacturing to accommodate the major trend that are likely to drive demand for our product in the years ahead. Further, every bit of progress we make diminishes the risk of our business and position us for the future we envision. As we look to the years ahead, we are encouraged that the tones of our customer discussion include an expectation for market recoveries this year. We believe our competitive position remains strong, and this will enable us to return growth when the market recovers.

In the meantime, we intend to continue our relocation, strengthen our business and drive greater efficiency in our model. This concludes my prepared comments. I will now turn the call back to Gary for our first quarter guidance. Gary?

Thank you, Morris. And as we discussed, we do not expect business conditions to improve meaningfully in the first quarter. As such, we expect to see revenue in Q1 of between $20.0 million to $21.0 million. We believe our loss per share in Q1 will be in the range of $0.04 to $0.06 based on 39.2 million basic shares outstanding.

Okay. This concludes our prepared comments, and Morris and I would be glad to answer your questions now. Catherine? Operator?

(Operator Instructions) And our first question comes from Richard Shannon with Craig-Hallum.

Maybe a couple of questions on the guidance here. I just want to understand if there is any difference in growth rates of your major product categories, indium phosphide, gallium arsenide and germanium, the raw materials relative to each other that gets you to your guidance for the first quarter.

I think there is no major differentiation. Although, I think we are relatively optimistic about the future of indium phosphide. I think we'll probably start to see some indication that is going to come on strong and continue to be strong in Q2 as well. The VCSEL market, right now, we don't have much visibility at all. Germanium, although, it could be sort of flattish in Q1, but we did see a major inquiry on germanium that gives us an optimism that, potentially, it can come on, on Q2 and beyond.

Yes. This is Gary. I think that's accurate. I don't think there's any special meaning, that one product application or one substrate material is changed from Q4 to Q1. As Morris says, we do see some light at the end of some of these tunnels, we think, for Q2. But it's really pretty much what Q4 was, is more of the same in Q1.

Okay. Second question also from a financial point of view is I didn't have an chance to run the numbers, given the guidance that came just for the Q&A, but what's implied for gross margins here typically? Revenues have a factor in gross margins since it's down. I would imagine you wouldn't expect it up much here, if at all. But just wondering, Gary, if you can give us any more color on how you expect gross margins in the first quarter.

Yes, well, as -- yes, I'm happy to comment. As I said, the robust gross margins that we enjoyed in the first 3 quarters of 2018, the first 3 quarters of 2018, a key contributor to that was solid revenue. So it goes -- it's pretty much obvious, if we have revenue this low for Q1, there's not going to be much change in the gross margins. So yes...

Okay. And maybe if you can comment a little bit further, and I realize that this just ask you to have visibility that you clearly don't have a lot of right now, but how should we think about the gross margin progression throughout the year? I mean, should -- if we hit revenue numbers similar to what you may have hit in 2018, should we expect similar gross margins? Or are there other impacts, negative or positive, that we should think about?

No. I think, internally, we think if we can reach those numbers, that we should be back in that range. So...

Yes, of course. Given our product proportionality and to some of our products are more profitable...

In the product mix, right.

Yes. And so if they recover strongly, then that will give us benefit. And germanium pricing, I mean, definitely hit a high of late Q3 of last year, and now it is starting to decline. And so we shall see whether it declines any further because customer price is very difficult to move. We can hold onto the pricing that we get off of them, but you cannot, usually cannot maybe raise a price with customers.

Yes, yes. To put it another way, if -- since we can't raise prices, but we also don't see a lot of price degradation. So if the order rate returns and the revenue returns, we should have high goals and we should shoot to be back in those ranges.

Okay. Fair enough. One last question for me and I'll jump on the line. In indium phosphide, I think you had some relatively more positive comments about data center demand there, it didn't sound like you were expecting much pickup this quarter. But I wonder if you can talk about what should we expect there. Could we possibly see a record or near-record quarter overall for indium phosphide this year? And do you have any view or line of sight into adding more sizable customers other than your -- kind of your lead one in the silicon photonics space?

Yes. Richard, although it's still in early stages, but the last time we were still in discussion with a major customer, we're trying to -- and it looks like it could provide us some upside for Q2. And if we win that contract, that will be a great opportunity for us. Although, I think there is an inventory correction at this point from some of our major data center customers, and I do expect that correction to be over by Q2 or Q3, so that should provide us some recovery. As well as the 5G front-haul, I mean, again, according to our customer and customer's customer, they all commented that they do expect that product to start to ramp by Q4 of this year, and that should layer on to the growth. And we also said we saw some research activities of using indium phosphide for glucose monitoring, which could provide us some potential for -- but not -- perhaps not production volume by next year, even maybe 2020, but nevertheless, it could be a major opportunity. And we also are working with yet another Japanese customer, and that should develop into a major growth opportunity for 2020. So there are multiple layers of customers and opportunities as we look ahead on indium phosphide. It becomes clear that I think it should provide us with opportunities to grow. So we are actively preparing, given such a downtime, we're cautiously preparing for capacity expansion on indium phosphide.

Yes, and just let me add a -- sort of a summary cap, which is that nothing has changed in a negative way about indium phosphide. So as the economy returns to sort of a normal run rate, we saw record-setting quarters several times in 2018. And it's almost common sense that we'll see that again in 2019 if indeed things come back like we are advised that they will.

Our next question comes with Quinn Bolton with Needham & Company.

Obviously, sort of a tough near-term outlook, but it seems like you're starting to, as you say, see some light at the end of the tunnel. I'm kind of wondering as you have these customer discussions, are folks starting to place orders on the books for deliveries in the second quarter that give you some confidence that Q1 may be the trough? Or are we -- does visibility in purchase order coverage not yet really give you good insight into Q2?

We normally say we don't have long-term visibility. I mean, most of our customers, especially now, give us very short orders. When they want it, they want it in the next 2 weeks. But with it, as I commented earlier, I was on the phone with a major, major customer, and they are -- we're talking about potentially big orders, but still in discussion stage. But I think I'm getting excited because there's not a whole lot of suppliers in the world, and we have the best product, we believe. So we should be able to get it, but nevertheless, again, it's Q2. So we've got to get some Q1 first, which is another 40 days away.

Yes, Quinn, a lot of our main customers do give us rolling forecasts, and we do now build a forecast. A couple of years back, we tried not to do that. But just like it happened in the Q4 numbers, they gave us a forecast, but they didn't come through with it. So we're seeing some positive notes, but we don't normally have much visibility anyway, and it's probably premature to say Q1 is absolutely, definitely, the trough, although I think probably we think it is. But that's more intuition than the fact that we can go look at the backlog and say, "Oh, look at the backlog, it's this." Yes.

And the other thing that I want to comment is that you know our business. I mean, we don't have -- although we do have a large inventory, but we don't have a whole lot of finished goods inventory, right? So if somebody were to place a major order with us, it's at least 6 weeks away. So we have to enter the book now to sort of give them the delivery before the end of Q1.

Yes, it would be almost too late to move the needle for Q1, but it can for Q2. So -- but yes, it's a very fair question. And I guess our answer is we're getting indications that Q1 is the trough, but if you compared -- if you went and studied our backlog, it wouldn't necessarily lead a skeptic to the same conclusion.

Right. Okay, okay. And on the indium phosphide side, it sounds certainly like you're seeing headwinds that I think many of the data center markets are seeing with inventory digestion. Just a question about the mix between datacom and telecom applications right now. Is your business mostly skewed to datacom and sort of the 5G telco brings a mix perhaps more to balance between datacom and telecom? Or just some comments around telco versus datacom in the indium phosphide business.

Yes. I'm not so sure we can tell the difference because we don't serve that into that market. We only deal -- we mostly deal with happy growers, happy customers. And happy customers, they serve a variety of customers. And when they -- but I think most of them are data center, and that's probably datacom business. Telecom business, I mean -- but then they also buy substrates and they can make plays for telecom applications, but it's hard for us to tell the major difference.

I think 5G, they will do that for the front lines. Right? Front-haul?

Yes. 5G, they will do the front-haul. But that's also why we read -- our customer's customers are telling that their laser can be used for front-haul 5G telecom applications. So...

And then, Gary, just obviously a big step-down in the gross margin in Q4 and Q1, and you kind of went through the 3 factors that led to that. Am I right to sort of think that the under-absorption of fixed cost is probably the biggest of those 3 factors? And that as we come into the first half of the year, the germanium prices have already started to correct. I think you said your fixed costs, due to the gas and germanium move, probably started to come down after the middle part of the year. So are those that -- those 2 factors are smaller factors, and the biggest factor is just really overall level of revenue as we're thinking about modeling that gross margin recovery.

Yes. I think that's fair assessment. We do see a definite favorable trend in downward pricing of raw materials. So we're not really focusing on that as something to try and go change or move, whereas we, of course, are focusing on revenue and costs.

Yes. And for our raw material, if price change, it takes a quarter or 2 because of our inventory. It has to go through our inventory before we realize the benefit.

Okay. Okay. And then lastly, Morris, I think you mentioned a $1 million sort of preproduction order around the VCSEL. Just as you look into the second half of the year and the recovery, what sort of assumptions are you planning for on that VCSEL opportunity? Are you kind of leading it out of your kind of mainline forecast and leaving it as upside if it hits? Or are you starting to build in some expectations for that Android opportunity?

Yes. We have 3 or 4 happy customers who tell us that they are qualifying to somewhere around 4 to 6 developed programs of Android phones. And those customers, I think, we hear that they're delivering to Android phones. But then none of them have told us specifically they are ready for production order at this point. So we're anxiously waiting, but nobody has told us that you're qualified, now you can start to have the order. And so I think our expectation is that we have worked on it, and we've worked with our customers to satisfy most of their requirements, such as EPDs, such as -- you name it. Certainly, the pixel market seems to be a very tight specification market. And we've passed most of the requirements so far, so we do expect it to start to ramp. But none of them -- we haven't got a major order that told us if we're qualified, we're ready to go.

And our next question comes from Catharine Trebnick with Dougherty.

One, just on -- thinking about the modeling. So it looks like even though we might have the trough, we might not have the trough, I understand we're not all clairvoyants on this. But I would expect that the OpEx, we should keep the OpEx going forth, similar to what was in Q4 and you're not going through any staff reductions, that you do see opportunity, you are preparing for opportunity and not to really slice and dice into the OpEx.

Right. And I would add that we also don't expect it to go up. So I think flat is, in that range, is a safe way to model.

Okay. Perfect. And then the other question is, you did talk about 5G. Do you have any 5G customers in hand right now for orders?

Well, we -- I went to the OFC conference in San Francisco, and we definitely had discussion with our customers. And one of the gallium arsenide customers are telling us that for 5G, it looks like there's opportunity for the pHEMT, gallium arsenide pHEMT market to come back. And they actually told us fairly robust predictions on how much it will come back, but they haven't placed an order. So I'm guardedly optimistic. And the second area of the 5G is really our customers' customers are gearing up for the front-haul for the 5G data center connections.

The short answer is, yes, we do have customers using our product for 5G. But it's development stage. So -- but that's what it is right now. It's not a high-volume production yet so...

Our next question comes from Hamed Khorsand with BWS Financial.

So first question I have, how much of this inventory, it's raw or work in progress, is that the new facility versus your existing facility?

Yes. I think it's difficult to differentiate, but of course, the major reason for the inventory build was because of the relocation issue. I mean, some of our customers are very sticky about why you make the transition, why don't you deliver from the old facility, you want to make sure that you deliver from that new facility before I qualify your new facility, so that we built a fairly sizable inventory. Even given that, we've lost some business opportunity because they say, "Well, you cannot supply me, guarantee that you can supply from an old facility." So we do have that issue. I think now it's gradually coming off. I mean, because as the customers qualify the new facility, that means we can deliver from both facilities. We don't have to maintain both facilities' inventory. And so that should relieve that. But for us to differentiate how much we have in the old facility and new facility, it's all difficult.

So when should we expect these qualifications to happen? I mean, you guys were first thinking like it would happen around when you were 50% of the move, and now we're now talking about 90% movement. So how far away are you?

Well, okay, so there are 2 layers. I mean, one is that we have build our facility and we said our facility should be ready by the end of June. In other words, our facility is fully capable and we have delivered, of course, samples to our customers for qualification long before that. And that's almost -- some of them are a year ago. And we start to deliver samples to them, they start to looking at it. They start to apply their rigorous method of qualification. And the good news is that these -- quite a few major customers have passed. They say, you're qualified, but nevertheless, some of them are still telling us, "Well, I want you to ramp in controlled way." One specific customer are telling us you can deliver 20% of the product on the new facility. They want us to watch the quality of it and the performance of it and before they start to increase it to 50%, 75%, and hopefully, 100%. So our expectation is that we're fully ready to take orders from our new facility by June 30 and hopefully, given a 6-month transition, every customer will start to -- well, at least 70%, 80% of them will start to take all products, both the new as well as old facility.

Okay. And then with this kind of inventory on hand, does it play a role as far as how much you can control your gross margins right now? Or is there going to be -- your gross margin is going to be hit right now because of the higher input costs and so forth? You're really running it low, inefficiently.

No, the inventory doesn't impact the gross margin. So yes, it doesn't impact it. So...

Yes, the inventory we just have behind.

Yes. Put it in a different way, to use debits and credits, but the inventory stays on the balance sheet and the gross margin is on the income statement. And so -- but it doesn't transfer to income statement at some punitive rate because it's so high. It transfers at the normal standard cost. So yes. Any more questions, Hamed?

And our next question comes from Gus Richard with Northland.

Actually, let me try it this way. As you transfer more production to the new facility, can you walk us through, until your steady-state, what that impact is going to be on the gross margin line? You've got to fill 2 facilities at this point and absorb them. As you move more material to the new facility, what happens to the gross margin line? And over what time?

Yes. The facilities will be -- will go into depreciation on a stage basis depending on the utilization rate. So that's -- that depreciation useful life will be 27.5 years. So our -- the equipment that we depreciate is 5 years, but the facility stuff is 27.5 years.

However, there is not a whole lot of new equipment added, right, to our new facility. So we don't expect to see a great increase in depreciation rate. However, I think it will be a bit higher depreciation rate as we move into the new facility. That's one of the penalties we would need to pay. However, I mean, there's other things that we need to manage, is when do we decommission the old facility of Beijing. If once we don't use them, then we stop depreciation of the old facility. So those are the 2 things that we knew we'd have to manage.

Yes, that's well said.

But it's not going to be...

When do you expect to decommission that facility in Beijing?

Well, it won't be a digital phenomenon. It will be an analog phenomenon. So we will probably decommission at least part of a building this calendar year. It's already under analysis and discussion. We haven't looked past that yet, but probably late this year or next year, and there could be more on one side of the street that we can decommission. The side of the street that we use for indium phosphide, which is also used for wafer processing and for sort of China headquarter stuff, that will not get decommissioned anytime soon unless somebody comes in with some very generous purchase offer and we decide it's time to pull that trigger sooner than we thought. So...

So one of the things I think it is, is that depreciation base for our Beijing facility is somewhere around $22 million, $23 million. Right? And the equivalent part of it is actually very low, mostly it's facilities and land, and those, the value of which is definitely 3x or 4x of that. And so once we moved our production out of it, it really doesn't make any sense to continue to depreciate those parts. Okay? So yes, I think the depreciation with the new factory definitely will be higher, but I think, Gary, you made the analysis, it's not going to be phenomenally higher. I forgot how much it was, about -- I think something like $1 million per quarter for depreciation for the new facility.

Maybe a little bit -- that's not low, that's for sure. I mean, it's -- I don't think it's going to be much more than that. So Gus, in terms of the timing, I don't have an exact time line yet. So -- but I can say that the facility depreciation will go up throughout 2019. Even when we start to decommission, maybe there might be 1 quarter when they're equal, it's breakeven or something, one offsets the other. And then it will play out in 2020. So we still need to get a time line to understand a little bit more of the details that conform to GAAP and the stuff like that. In the meantime, we remain confident that if the market comes back and our products get used in the applications that we think they're going to be used in, then we can grow the revenue base to do the absorption. So yes, it's a business factor and it's a good question. It's probably not -- we think it's a manageable problem. So...

Okay. Got it. And then just in '18, you ramped up SG&A for training and whatnot and the facility's move. My expectation was it was going to peak in Q2, and it looks like it's popped up again in December. I'm just wondering what's forcing it back up and your expectation for it to remain at that level going forward.

Well, it's more than one thing. A fair amount of it is facility-related and the relocation. Some of it involves like building consultants, facility consultants as we do the construction. So we don't capitalize that, we expense it. I don't think you should trend it down until I can get my arms around it more. I think that would be too positive or too aggressive of a step. So for now, I think you should trend it to be flat, plus or minus 100k, and it's something that we want to drill down on more and we haven't done that yet. So...

So let me go from the $25,000 and higher, okay? We have not hired. I mean, you and I or -- we carry on SG&A. We haven't hired new people. My salary, and definitely, I didn't have that kind of an increase, so the step-up is related to our new factory. Okay? So if you drill down, there could be a new facility contract with -- that we need to review on the new environment, design work, et cetera. But then now, instead of one facility, now we have 3 facilities, but they are China-related, HR people, et cetera...

And G&A people.

And G&A people. So -- but they cannot be that high. Okay? So I didn't -- once we make the move, definitely, it will be a little bit higher, but it's not going to be enormously high. I think it will come down to some reasonable level, I think. So AXT didn't transform into an expensive AXT.

And there are no further questions in the queue. I'd like to turn the call back to Dr. Morris Young for any closing remarks.

Thank you for participating in our conference call. 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.

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.