UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC. 20549

FORM 10-Q

(Mark One)

x                              Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

for the quarterly period ended September 30, 2006

or

o                                 Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

for the transition period from            to            

Commission File Number 000-24085

AXT, INC.
(Exact name of registrant as specified in its charter)

 

4281 Technology Drive, Fremont, California 94538
(Address of principal executive offices) (Zip code)

(510) 683-5900
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x   No o

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Act. (Check one):

Large accelerated filer o         Accelerated filer o         Non-accelerated filer x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o   No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

 

AXT, INC.
FORM 10-Q
TABLE OF CONTENTS

		Page
PART I. FINANCIAL INFORMATION		3
Item 1. Financial Statements (unaudited)		3
Condensed Consolidated Balance Sheets as of September 30, 2006 and December 31, 2005		3
Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2006 and 2005		4
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2006 and 2005		5
Notes to Condensed Consolidated Financial Statements		6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		17
Item 3. Quantitative and Qualitative Disclosures About Market Risk		31
Item 4. Controls and Procedures		31
PART II. OTHER INFORMATION		32
Item 1. Legal Proceedings		32
Item 1A. Risk Factors		32
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		45
Item 3. Defaults Upon Senior Securities		45
Item 4. Submission of Matters to a Vote of Security Holders		45
Item 5. Other Information		45
Item 6. Exhibits		46
Signatures		47

 

2

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

AXT, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands, except per share data)

		September 30,			December 31,
		2006			2005
Assets:
Current assets:
Cash and cash equivalents		$	10,587		$	17,472
Short-term investments		5,357			5,555
Accounts receivable, net of allowances of $202 and $609 as of September 30, 2006 and December 31, 2005, respectively		8,800			5,226
Inventories, net		17,359			16,156
Prepaid expenses and other current assets		4,079			1,801
Assets held for sale		4,659			—
Total current assets		50,841			46,210
Property, plant and equipment, net		10,772			17,306
Restricted deposits		7,150			7,450
Other assets		3,806			3,832
Total assets		$	72,569		$	74,798
Liabilities and stockholders’ equity:
Current liabilities:
Accounts payable		$	4,078		$	3,070
Accrued liabilities		3,225			3,533
Accrued restructuring		—			465
Current portion of long-term debt		450			300
Income taxes payable		1,182			2,495
Total current liabilities		8,935			9,863
Long-term debt, net of current portion		6,803			7,420
Other long-term liabilities		2,237			1,897
Total liabilities		17,975			19,180
Commitments and contingencies (Note 11)
Stockholders’ equity:
Preferred stock, $0.001 par value per share; 2,000 shares authorized; 883 shares issued and outstanding as of September 30, 2006 and December 21, 2005.		3,532			3,532
Common stock, $0.001 par value per share; 70,000 shares authorized; 23,247 and 22,977 shares issued and outstanding as of September 30, 2006 and December 31, 2005, respectively		23			23
Additional paid-in capital		156,618			155,441
Accumulated deficit		(107,216		)	(104,776		)
Accumulated other comprehensive income		1,637			1,398
Total stockholders’ equity		54,594			55,618
Total liabilities and stockholders’ equity		$	72,569		$	74,798

 

See accompanying notes to condensed consolidated financial statements.

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AXT, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited, in thousands, except per share data)

		Three Months Ended September 30,						Nine Months Ended September 30,
		2006			2005			2006			2005
Revenue		$	12,547		$	6,153		$	31,373		$	18,819
Cost of revenue		9,068			5,008			23,625			17,268
Gross profit		3,479			1,145			7,748			1,551
Operating expenses:
Selling, general and administrative		2,641			2,898			9,724			9,866
Research and development		392			472			1,497			1,257
Impairment charge		1,417			—			1,417			—
Restructuring charge (benefit)		—			14			(2		)	376
Total operating expenses		4,450			3,384			12,636			11,499
Loss from continuing operations		(971		)	(2,239		)	(4,888		)	(9,948		)
Interest income, net		103			136			342			386
Other income (expense), net		641			(193		)	1,693			(494		)
Loss from continuing operations before provision (benefit) for income taxes		(227		)	(2,296		)	(2,853		)	(10,056		)
Provision (benefit)for income taxes		(862		)	45			(406		)	98
Income (loss) from continuing operations		635			(2,341		)	(2,447		)	(10,154		)
Discontinued operations:
Gain from discontinued operations, net of tax		4			9			7			67
Gain from disposal, net of tax		—			250			—			603
Net income (loss)		$	639		$	(2,082	)	$	(2,440	)	$	(9,484	)
Basic income (loss) per share:
Income (loss) from continuing operations		$	0.03		$	(0.10	)	$	(0.11	)	$	(0.45	)
Gain from discontinued operations, net of tax		—			0.01			—			0.03
Net income (loss)		$	0.03		$	(0.09	)	$	(0.11	)	$	(0.42	)
Shares used in computing basic net income (loss) per share		23,158			22,994			23,066			23,073
Diluted income (loss) per share:
Income (loss) from continuing operations		$	0.02		$	(0.10	)	$	(0.11	)	$	(0.45	)
Gain from discontinued operations, net of tax		—			0.01			—			0.03
Net income (loss)		$	0.02		$	(0.09	)	$	(0.11	)	$	(0.42	)
Shares used in computing diluted net income (loss) per share		24,378			22,994			23,066			23,073

 

See accompanying notes to condensed consolidated financial statements.

4

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AXT, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)

		Nine Months Ended September 30,
		2006			2005
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss		$	(2,440	)	$	(9,484	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation		2,365			2,874
Amortization of investments premium/discount		(55		)	188
Non-cash restructuring charge		—			376
Loss on disposal of property, plant and equipment		89			291
Stock-based compensation		649			2
Realized gain on sale of investments		(2,032		)	—
Gain on disposal of discontinued operations		—			(53		)
Impairment of property, plant and equipment		1,417			—
Changes in assets and liabilities:
Accounts receivable, net		(3,574		)	(855		)
Inventories, net		(1,203		)	862
Prepaid expenses and other current assets		(2,278		)	567
Other assets		26			74
Accounts payable		1,008			421
Accrued liabilities and restructuring		(773		)	(1,620		)
Income taxes payable		(1,313		)	131
Other long-term liabilities		340			147
Net cash used in operating activities		(7,774		)	(6,079		)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment		(2,157		)	(1,711		)
Proceeds from sales of property, plant and equipment		161			31
Purchases of investments		(7,924		)	(7,783		)
Proceeds from sale of investments		10,174			16,958
Decrease in restricted cash		300			615
Proceeds from sale of assets held for sale, net		—			1,303
Net cash provided by investing activities		554			9,413
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from (payments of):
Issuance of common stock		528			60
Repurchase of common stock		—			(246		)
Long-term debt payments		(467		)	(450		)
Net cash provided by (used in) financing activities		61			(636		)
Effect of exchange rate changes		274			(230		)
Net increase (decrease) in cash and cash equivalents		(6,885		)	2,468
Cash and cash equivalents at the beginning of the period		17,472			12,117
Cash and cash equivalents at the end of the period		$	10,587		$	14,585

 

See accompanying notes to condensed consolidated financial statements.

5

 

AXT, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Basis of Presentation

The accompanying condensed consolidated financial statements of AXT, Inc. (“AXT,” “Company,” “we,” “us” and “our” refer to AXT, Inc. and all of its consolidated subsidiaries) are unaudited, and have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, the year-end condensed consolidated balance sheet was derived from the Company’s audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, considered necessary to present fairly the financial position, results of operations and cash flows of AXT and its subsidiaries for all periods presented.

Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ materially from those estimates.

The results of operations are not necessarily indicative of the results to be expected in the future or for the full fiscal year. It is recommended that these condensed consolidated financial statements be read in conjunction with our consolidated financial statements and the notes thereto included in our 2005 Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 30, 2006 and our Quarterly Reports on Form 10-Q for the quarterly periods ended March 31, 2006 and June 30, 2006 filed with the Securities and Exchange Commission on May 12, 2006 and August 11, 2006, respectively.

Certain reclassifications have been made to the prior year’s condensed consolidated financial statements to conform to current period presentation.

Note 2. Discontinued Operations and Related Assets Held for Sale

In June 2003, we announced the discontinuation of our opto-electronics division, which we had established as part of our acquisition of Lyte Optronics, Inc. in May 1999. The discontinued opto-electronics division manufactured blue, cyan and green high-brightness light emitting diodes (HBLEDs) for the illumination markets, including full-color displays, wireless handset backlighting and traffic signals, and also manufactured vertical cavity surface emitting lasers (VCSELs) and laser diodes for fiber optic communications and storage area networks. Because of this discontinuation, the results of operations of the opto-electronics division have been segregated from continuing operations and are reported separately as discontinued operations in our condensed consolidated statements of operations for all periods presented.

In September 2003, we completed the sale of substantially all of the assets of our opto-electronics business to Lumei Optoelectronics Corp. (Lumei) and Dalian Luming Science and Technology Group, Co., Ltd. for the Chinese Renminbi (RMB) equivalent of $9.6 million.

Our condensed consolidated financial statements have been presented to reflect the opto-electronics business as a discontinued operation for all periods presented. Operating results of the discontinued operation are as follows (in thousands):

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		Three Months Ended September 30,						Nine Months Ended September 30,
		2006			2005			2006			2005
Revenue		$	—		$	—		$	—		$	—
Cost of revenue		—			—			—			—
Gross profit		—			—			—
Operating expenses:
Selling, general and administrative		(4		)	(9		)	(7		)	(67		)
Research and development		—			—			—			—
Impairment costs					—			—
Total operating expenses		(4		)	(9		)	(7		)	(67		)
Gain from discontinued operations, net of tax		4			9			7			67
Gain from disposal, net of tax		—			250			—			603
Net income		$	4		$	259		$	7		$	670

 

The carrying value of the assets and liabilities of the discontinued opto-electronics business included in the condensed consolidated balance sheets are as follows (in thousands):

 

Note 3. Accounting for Stock-Based Compensation

Effective January 1, 2006, we adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”). SFAS 123(R) establishes accounting for stock-based awards exchanged for employee services. Accordingly, stock-based compensation cost is measured at each grant date, based on the fair value of the award, and is recognized as expense over the employee’s requisite service period. All of the Company’s stock compensation is accounted for as an equity instrument. The Company previously applied Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations and provided the required pro forma disclosures of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”).

We have elected the modified prospective application transition method for adopting SFAS 123(R). Under this method, the provisions of SFAS 123(R) apply to all awards granted or modified after the date of adoption. The unrecognized expense of awards not yet vested at the date of adoption will be recognized in net income (loss) in the periods after the date of adoption using the same Black-Scholes valuation method and assumptions determined under the original provisions of SFAS 123, as disclosed in our previous quarterly and annual reports.

Prior to the Adoption of SFAS 123(R)

Prior to the adoption of SFAS 123(R), we provided the disclosures required under SFAS 123, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosures.” SFAS 123(R) requires us to present pro forma information for the comparative period prior to adoption as if we had accounted for all our employee stock options under the fair value method of the original SFAS 123. The following table illustrates the effect on net loss and net loss per share if we had applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation to the prior-year periods (in thousands, except per share data):

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Impact of the Adoption of SFAS No. 123 (R)

We elected to adopt the modified prospective application transition method as provided by SFAS 123(R), and we recorded $206,000 and $649,000 of stock compensation expense in our unaudited condensed consolidated statements of operations for the three and nine months ended September 30, 2006. We elected not to capitalize any stock-based compensation to inventory as of January 1, 2006 when the provisions of SFAS 123(R) were initially adopted. We utilized the Black-Scholes valuation model for estimating the fair value of the stock compensation granted both before and after the adoption of SFAS 123(R). In accordance with the modified prospective application transition method, our condensed consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). The following table summarizes compensation costs related to our stock-based compensation plan (in thousands, except per share data):

 

As of September 30, 2006, the total compensation cost related to unvested stock-based awards granted to employees under our stock option plan but not yet recognized was approximately $856,000, net of estimated forfeitures of $20,000. This cost will be amortized on a straight-line basis over a weighted-average period of approximately 1.27 years and will be adjusted for subsequent changes in estimated forfeitures. We elected not to capitalize any stock-based compensation to inventory as of September 30, 2006, due to the immateriality of the amount.

The amortization of stock compensation under SFAS 123(R) for the period after our January 1, 2006 adoption is based on the single-option approach.

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We estimate the fair value of stock options using a Black-Scholes valuation model, consistent with the provisions of SFAS 123(R), Securities and Exchange Commission Staff Accounting Bulletin No. 107 and our prior period pro forma disclosures of net loss, including stock-based compensation (determined under a fair value method as prescribed by SFAS No. 123). The fair value of our stock options granted to employees for the three and nine months ended September 30, 2006 and 2005 was estimated using the following weighted-average assumptions:

 

The following table summarizes the stock option transactions during the nine months ended September 30, 2006 (in thousands, except per share data):

		Shares		Weighted- average Exercise Price			Weighted- average Remaining Contractual Life		Aggregate Intrinsic Value
							(in years)
Options outstanding as of December 31, 2005		2,917		$	2.30
Granted		26		2.78
Exercised		(269	)	1.96
Canceled		(85	)	1.50
Options outstanding as of September 30, 2006		2,589		$	2.37		6.62		$	6,037
Options vested and expected to vest as of September 30, 2006		2,573		$	2.37		6.60		$	5,993
Options exercisable as of September 30, 2006		1,768		$	2.80		5.77		$	3,712

 

The options outstanding and exercisable as of September 30, 2006 were in the following exercise price ranges:

Options Outstanding as of September 30, 2006									Options Vested and Exercisable as of September 30, 2006
Range of Exercise Price		Shares		Weighted-average Exercise Price			Weighted-average Remaining Contractual Life		Shares		Weighted-Average Exercise Price
$1.17 - $ 1.38		1,484,795		$	1.29		7.37		790,693		$	1.31
$1.39 - $ 1.44		11,500		$	1.41		8.64		2,813		$	1.40
$1.45 - $ 2.24		620,363		$	2.17		5.99		527,241		$	2.18
$2.25 - $ 5.00		354,433		$	3.63		5.73		331,315		$	3.64
$5.01 - $41.50		117,500		$	13.41		3.02		116,250		$	13.45
		2,588,591		$	2.37		6.62		1,768,312		$	2.80

 

The total intrinsic value of options exercised for the three and nine months ended September 30, 2006 was $0.2 million and $0.4 million. Cash received from option exercises for the three and nine months ended September 30, 2006 was $0.2 million and $0.5 million, respectively. The total fair value of options vested for the three and nine months ended September 30, 2006 was $0.8 million and $1.6 million, respectively.

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Note 4. Cash, Cash Equivalents and Investments

Our cash, cash equivalents and investments are classified as follows (in thousands):

		September 30, 2006												December 31, 2005
		Amortized Cost			Gross Unrealized Gain			Gross Unrealized (Loss)			Fair Value			Amortized Cost			Gross Unrealized Gain			Gross Unrealized (Loss)			Fair Value
Classified as:
Cash		$	6,591		$	—		$	—		$	6,591		$	12,803		$	—		$	—		$	12,803
Cash equivalents:
Money market funds		2,341			—			—			2,341			1,729			—			—			1,729
U.S. Treasury and agency securities		1,055			—			—			1,055			—			—			—
Commercial paper		600			—			—			600			2,940			—						2,940
Total cash equivalents		3,996			—			—			3,996			4,669			—			—			4,669
Total cash and cash equivalents		10,587			—			—			10,587			17,472			—			—			17,472
Investments:
U.S. Treasury and agency securities		5,627			—			(9		)	5,618			4,460						(12		)	4,448
Asset-backed securities		1,092			—			(3		)	1,089			3,285			—			(11		)	3,274
Commercial paper		900			—						900			—									—
Corporate bonds		3,183			—			(3		)	3,180			2,504			—			(13		)	2,491
Corporate equity securities		452			1,268			—			1,720			1,468			1,324			—			2,792
Total investments		11,254			1,268			(15		)	12,507			11,717			1,324			(36		)	13,005
Total cash, cash equivalents and investments		$	21,841		$	1,268		$	(15	)	$	23,094		$	29,189		$	1,324		$	(36	)	$	30,477
Contractual maturities on investments:
Due within 1 year		$	8,117								$	9,375		$	8,384								$	9,682
Due after 1 through 5 years		3,137									3,132			3,333									3,323
		$	11,254								$	12,507		$	11,717								$	13,005

 

The investments include $7.2 million and $7.5 million, respectively, recorded as restricted deposits on the condensed consolidated balance sheets as of September 30, 2006 and December 31, 2005.

We manage our investments as a single portfolio of highly marketable securities that is intended to be available to meet our current cash requirements. For the three months ended September 30, 2006, we had $0.7 million of gross realized gains on sales of our available-for-sale securities. For the three months ended September 30, 2005, we had no gross realized gains or losses on sales of our available-for-sale securities. For the nine months ended September 30, 2006, we had $2.0 million of gross realized gains on sales of our available-for-sale securities. For the nine months ended September 30, 2005, we had no gross realized gains or losses on sales of our available-for-sale securities.

The gross unrealized losses related to our portfolio of available-for-sale securities were primarily due to a decrease in the fair value of debt securities as a result of an increase in interest rates during 2005 and the first nine months of 2006. We have determined that the gross unrealized losses on our available-for-sale securities as of September 30, 2006 are temporary in nature. We reviewed our investment portfolio to identify and evaluate investments that have indications of possible impairment. Factors considered in determining whether a loss is temporary include the magnitude of the decline in market value, the length of time the market value has been below cost (or adjusted cost), credit quality, and our ability and intent to hold the securities for a period of time sufficient to allow for any anticipated recovery in market value. The following table provides a breakdown of our available-for-sale securities with unrealized losses as of September 30, 2006 (in thousands):

		In Loss Position < 12 months						In Loss Position > 12 months						Total In Loss Position
		Fair Value			Gross Unrealized (Loss)			Fair Value			Gross Unrealized (Loss)			Fair Value			Gross Unrealized (Loss)
Short-term investments:
U.S. Treasury and agency securities		$	5,618		$	(9	)	$	—		$	—		$	5,618		$	(9	)
Asset-backed securities		—			—			1,089			(3		)	1,089			(3		)
Corporate bonds		3,180			(3		)	—			—			3,180			(3		)
Total in loss position		$	8,798		$	(12	)	$	1,089		$	(3	)	$	9,887		$	(15	)

 

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Note 5. Inventories, Net

The components of inventories are summarized below (in thousands):

 

Note 6. Restructuring Charges

Our restructuring accrual is as follows (in thousands):

For the nine months ended September 30, 2006		Restructuring Accrual as of December 31, 2005			Additions/Reversals			Payments			Restructuring Accrual as of September 30, 2006
Future lease payments related to abandoned facilities		$	250		$	—		$	(250	)	$	—
Workforce reduction		215			(2		)	(213		)	—
Total		$	465		$	(2	)	$	(463	)	$	—

 

In December 2005, as part of our ongoing effort to reduce our Fremont, California facility headcount, we reduced the workforce at the facility by 15 full-time equivalent positions that we no longer required to support production and operations, or approximately 29% of the workforce based at this facility. Accordingly, we recorded a restructuring charge of approximately $273,000 related to the reduction in force for severance-related expenses, of which $215,000 remained on the consolidated balance sheet as of December 31, 2005. We completed the reduction in force by the end of the first quarter of 2006.

In the three months ended September 30, 2006, we had incurred no restructuring charges. As of September 30, 2006, we have a zero balance for the restructuring accrual for workforce reduction and for future lease payments related to abandoned U.S. facilities located in California that are no longer required to support production, as these have all been paid.

Note 7. Net Income (Loss) Per Share

Basic net income (loss) per share is calculated by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share includes the dilutive effect of common stock equivalents outstanding during the period calculated using the treasury stock method. Common stock equivalents consist of the shares issuable upon the exercise of stock options.

A reconciliation of the numerators and denominators of the basic and diluted net income or loss per share calculations is as follows (in thousands, except per share data):

		Three Months Ended September 30,						Nine Months Ended September 30,
		2006			2005			2006			2005
Numerator:
Net income (loss)		$	639		$	(2,082	)	$	(2,440	)	$	(9,484	)
Less: Preferred stock dividends		(44		)	(44		)	(132		)	(132		)
Net income (loss) available to common stockholders		$	595		$	(2,126	)	$	(2,572	)	$	(9,616	)
Denominator:
Denominator for basic net income (loss) per share - weighted average common shares		23,158			22,994			23,066			23,073
Effect of dilutive securities:
Common stock options		1,220			—			—			—
Denominator for dilutive net income (loss) per common share		24,378			22,994			23,066			23,073
Basic net income (loss) per share		$	0.03		$	(0.09	)	$	(0.11	)	$	(0.42	)
Diluted net income (loss) per share		$	0.02		$	(0.09	)	$	(0.11	)	$	(0.42	)
Options excluded from diluted net loss per share as the impact is anti-dilutive		120			2,956			2,589			2,956

 

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Note 8. Comprehensive Income (Loss)

The components of comprehensive income (loss) are as follows (in thousands):

		Three Months Ended September 30,						Nine Months Ended September 30,
		2006			2005			2006			2005
Net income (loss)		$	639		$	(2,082	)	$	(2,440	)	$	(9,484	)
Foreign currency translation gain (loss)		196			(12		)	274			(230		)
Unrealized gain (loss) on available-for-sale investments		151			377			1,997			(1,044		)
Less: reclassification adjustment for realized gain included in net income (loss)		(650		)	—			(2,032		)	—
Comprehensive income (loss)		$	336		$	(1,717	)	$	(2,201	)	$	(10,758	)

 

Note 9. Segment Information and Foreign Operations

Segment Information

We operate in one segment for the design, development, manufacture and distribution of high-performance compound semiconductor substrates and sale of raw materials. In accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“SFAS No. 131”), our chief operating decision-maker has been identified as our Chief Executive Officer, who reviews operating results to make decisions about allocating resources and assessing performance for the Company. All material operating units qualify for aggregation under SFAS No. 131 due to their identical customer base and similarities in economic characteristics, nature of products and services, and procurement, manufacturing and distribution processes. Since we operate in one segment, all financial segment and product line information required by SFAS No. 131 can be found in the condensed consolidated financial statements.

Geographical Information

The following table represents revenue amounts (in thousands) reported for products shipped to customers in the corresponding geographic region:

*                    Primarily the United States

Long-lived assets consist of property, plant and equipment, and are attributed to the geographic location in which they are located. Long-lived assets by geographic region were as follows (in thousands):

 

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Significant Customers

One customer represented 18.4% of our revenue for the three months ended September 30, 2006 and two customers represented 11.5% and 10.7%, respectively, of our revenue for the three months ended September 30, 2005. One customer represented 15.0% and 11.5% of our revenue for the nine months ended September 30, 2006 and 2005, respectively. Our top five customers represented 44.1% and 45.4% of our revenue for the three months ended September 30, 2006 and 2005, respectively. Our top five customers represented 40.3% and 35.6% of our revenue for the nine months ended September 30, 2006 and 2005, respectively.

Note 10. Investments in Privately-held Companies

We have made strategic investments in private companies located in China in order to gain access at a competitive cost to raw materials that are critical to our substrate business. Our investments in these privately-held companies are summarized below (in thousands):

		Investment Balance as of
Company		September 30, 2006			December 31, 2005			Accounting Method		Ownership Percentage
Beijing Ji Ya Semiconductor Material Co., Ltd		$	996		$	996		Consolidated		46	%
Nanjing Jin Mei Gallium Co., Ltd		592			592			Consolidated		83
Beijing BoYu Manufacturing Co., Ltd		410			410			Consolidated		70
Xilingol Tongli Ge Co. Ltd		925			864			Equity		25
Emeishan Jia Mei High Pure Metals Co., Ltd		673			596			Equity		25

 

The investment balances for the two companies accounted for under the equity method are included in other assets in the condensed consolidated balance sheets. We own 25% of the ownership interests in each of these companies. These two companies are not considered variable interest entities because:

·                       both companies have sustainable businesses of their own;

·                       our voting power is proportionate to our ownership interests;

·                       we only recognize our respective share of the losses and/or residual returns generated by the companies if they occur; and

·                       we do not have a controlling financial interest in, do not maintain operational or management control of, do not control the board of directors of, and are not required to provide additional investment or financial support to either company.

Undistributed retained earnings relating to our investments were $3.9 million and $2.2 million as of September 30, 2006 and 2005, respectively. Net income recorded from our investments was $609,000 and $416,000 for the three months ended September 30, 2006 and 2005, respectively. Net income recorded from our investments was $1,333,000 and $747,000 for the nine months ended September 30, 2006 and 2005, respectively.

The minority interest for those investments that are consolidated is included within “Other long-term liabilities” in the condensed consolidated balance sheets and within Other income (expense), net on the condensed consolidated statements of operations.

Note 11. Commitments and Contingencies

Legal Matters

On October 15, 2004, a purported securities class action lawsuit was filed in the United States Court for the Northern District of California, City of Harper Woods Employees Retirement System v. AXT, Inc. et al., No. C 04 4362 MJJ. The Court consolidated the case with a subsequent related case and appointed a lead plaintiff. On April 5, 2005, the lead plaintiff filed a consolidated complaint, captioned as Morgan v. AXT, Inc. et al., No. C 04 4362 MJJ. The lawsuit complaint names AXT, Inc. and our chief technology officer as defendants, and is brought on behalf of a class of all purchasers of our securities from February 6, 2001 through April 27, 2004. The complaint alleges that we announced financial results during this period that were false and misleading. No specific amount of damages is claimed. We believe that there are meritorious defenses against this litigation and intend to vigorously defend it. On September 23, 2005, the Court granted our motion to dismiss the complaint, with leave to amend. The lead plaintiff filed an amended complaint, which we have moved to dismiss. Due to the inherent uncertainties of litigation, we cannot accurately predict the ultimate outcome of the litigation. Any unfavorable outcome of the litigation could have an adverse impact on our business, financial condition and results of operations.

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On June 1, 2005, a lawsuit was filed in the Superior Court of California, County of Alameda, Zhao et al. v. American Xtal Technology, et al., No. R 605215713. The lawsuit complaint names as defendants AXT, Inc., our chief technology officer and one of our suppliers. The lawsuit is brought on behalf of two former employees and their minor child. The complaint alleges personal injury, general negligence, intentional tort, wage loss and other damages, including punitive damages, as a result of exposure to the child while in utero to high levels of gallium arsenide and methanol used in the production of gallium arsenide wafers. We believe that there are meritorious defenses against this litigation and intend to vigorously defend it. Our commercial general liability insurance carrier has agreed to fund our defense of the case, but has reserved the right to deny coverage, in whole or in part, in the future under selected policy provisions and applicable law. The plaintiffs have made an initial settlement demand within our insurance limits. Due to the inherent uncertainties of litigation, we cannot accurately predict the ultimate outcome of the litigation. Any unfavorable outcome of the litigation could have an adverse impact on our business, financial condition and results of operations.

Indemnification Agreements

We enter into standard indemnification arrangements in the ordinary course of business. Pursuant to these arrangements, we indemnify, hold harmless, and agree to reimburse the indemnified parties, generally their business partners or customers, for losses suffered or incurred by the indemnified party in connection with any U.S. patent, or any copyright or other intellectual property infringement claim by any third party with respect to our products. The term of these indemnification agreements is generally perpetual after the execution of the agreement. The maximum potential amount of future payments we could be required to make under these agreements is unlimited. We have never incurred costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, we believe the estimated fair value of these agreements is minimal.

We have entered into indemnification agreements with our directors and officers that may require us to indemnify our directors and officers against liabilities that may arise by reason of their status or service as directors or officers, other than liabilities arising from willful misconduct of a culpable nature; to advance their expenses incurred as a result of any proceeding against them as to which they could be indemnified; and to obtain directors’ and officers’ insurance if available on reasonable terms, which we currently have in place.

Product Warranty

We warrant our products against material defects for a specific period of time, generally twelve months. We provide for the estimated future costs of warranty obligations in cost of revenue when the related revenue is recognized. The accrued warranty costs represent the best estimate at the time of sale of the total costs that we expect to incur to repair or replace products that fail while still under warranty. The amount of accrued estimated warranty costs is primarily based on historical experience as to product failures as well as current information on repair costs. On a quarterly basis, we review the accrued balance and update this based on historical warranty cost trends. The following table reflects the change in our warranty accrual, which is included in “Accrued liabilities” on the condensed consolidated balance sheets, during the three and nine months ended September 30, 2006 and 2005 (in thousands):

		Three Months Ended September 30,						Nine Months Ended September 30,
		2006			2005			2006			2005
Beginning accrued warranty and related costs		$	204		$	82		$	120		$	135
Charged to cost of revenue		553			(60		)	699			(113		)
Actual warranty expenditures		(186		)	—			(248		)	—
Ending accrued warranty and related costs		$	571		$	22		$	571		$	22

 

Sales Returns

In March 2004, we increased our reserve for repair and replacement costs by $745,000. As of September 30, 2006, this reserve balance was zero since approximately $487,000 had been utilized and approximately $258,000 had been reversed to revenue as we favorably resolved an outstanding matter with a customer.

Note 12. Foreign Exchange Transaction Gains/Losses

We incurred foreign currency transaction exchange losses of $59,000 and $61,000 for the three months ended September 30, 2006 and 2005, respectively. We incurred foreign currency transaction exchange losses of $48,000 and of $110,000 for the nine months ended September 30, 2006 and 2005, respectively. These amounts are included in “Other income (expense), net” on the condensed consolidated statements of operations.

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Note 13. Recent Accounting Pronouncements

In February 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 155, “Accounting for Certain Hybrid Instruments — an amendment of FASB Statements No. 133 and 140” (“SFAS 155”). SFAS 155 amends SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”) and SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS 140”). SFAS 155 allows entities the option of applying fair value accounting to certain hybrid financial instruments in their entirety if they contain embedded derivatives that would otherwise require bifurcation under SFAS 133. SFAS 155 will be effective for us as of January 1, 2007. We are currently assessing the impact that SFAS 155 may have on our consolidated financial position, results of operations or cash flows.

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting For Uncertain Tax Positions — An Interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes”. It prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after Decemeber 15, 2006. We are currently assessing the impact of the adoption that FIN 48 may have on our consolidated financial position, results of operations or cash flows.

In June 2006, the FASB ratified the consensus reached by the EITF on Issue No. 06-3, How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation) (“ EITF 06-3”). EITF 06-3 includes any tax assessed by a governmental authority that is directly imposed on a revenue-producing transaction between a seller and a customer and may include, but is not limited to, sales, use, value added, and some excise taxes. EITF 06-3 concludes that the presentation of taxes on either a gross (included in revenues and costs) or a net (excluded from revenues) basis is an accounting policy decision that should be disclosed. In addition, for any such taxes that are reported on a gross basis, a company should disclose the amounts of those taxes in interim and annual financial statements for each period for which an income statement is presented if those amounts are significant. The provisions of EITF 06-3 should be applied to financial reports for interim and annual reporting periods beginning after December 15, 2006, with earlier adoption permitted. We are currently assessing the impact of the adoption that EITF 06-3 may have on our consolidated financial position, results of operations or cash flows.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 provides a new single authoritative definition of fair value and provides enhanced guidance for measuring the fair value of assets and liabilities and requires additional disclosures related to the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. SFAS 157 is effective for us as of January 1, 2008. We are currently assessing the impact, if any, of SFAS 157 on our consolidated financial position, results of operations or cash flows.

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — an amendment of FASB Statements No. 87, 88, 106, and 132(R)” (“SFAS 158”). SFAS 158 requires balance sheet recognition of the overfunded or underfunded status of pension and postretirement benefit plans. Under SFAS 158, actuarial gains and losses, prior service costs or credits, and any remaining transition assets or obligations that have not been recognized under previous accounting standards must be recognized as a component of accumulated other comprehensive income (loss) within stockholders’ equity, net of tax effects, until they are amortized as a component of net periodic benefit cost. In addition, the measurement date and the date at which plan assets and the benefit obligation are measured, are required to be the company’s fiscal year-end. SFAS 158 is effective for us as of December 31, 2007, except for the measurement date provisions, which are effective December 31, 2009. The adoption of SFAS 158 is not expected to have a material impact on our consolidated financial position, results of operations or cash flows.

 In September 2006, the SEC released Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 provides interpretative guidance on how public companies quantify financial statement misstatements. There have been two common approaches used to quantify such errors. Under an income statement approach, the “roll-over” method, the error is quantified as the amount by which the current year income statement is misstated. Alternatively, under a balance sheet approach, the “iron curtain” method, the error is quantified as the cumulative amount by which the current year balance sheet is misstated. In SAB 108, the SEC established an approach that requires quantification of financial statement misstatements based on the effects of the misstatements on each of the company’s financial statements and the related financial statement disclosures. This model is commonly referred to as a “dual approach” because it requires quantification of errors under both the roll-over and iron curtain methods. SAB 108 is effective for us as of January 1, 2007. The adoption of SAB 108 is not expected to have a material impact on our consolidated financial position, results of operations or cash flows.

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Note 14. Subsequent Events

In September 2006, tax authorities in the People’s Republic of China (“PRC”) announced their intention to impose customs duties on, and to reduce or eliminate refunds of value-added taxes that companies pay when they purchase, certain raw materials, including gallium and arsenic.  The combination of these actions could significantly increase our costs.  Implementing regulations are not expected to be published before late November 2006, and it is possible that these regulations will not be adopted or that changes will be made in their outline before adoption.  Lobbying efforts are being made to remove gallium and arsenic from the list of affected materials, but there is no way to know if these efforts will have any impact on the final form of the regulations.  There appears to be a possibility that the value-added tax refund on gallium will not be completely eliminated, but merely reduced.  If the regulations are adopted as currently proposed, they would not have a material impact on our fourth quarter results because they would only be in effect for a portion of the quarter. They may potentially, however, have a significant adverse impact on our gross margins and net income (loss) in 2007, although we do not have the facts necessary to estimate its magnitude at this time.  We are also exploring alternatives for restructuring our operations in the PRC in order to mitigate the impact of these regulations if and when they are adopted.   We will not know the exact impact of any restructuring or the amount of time that it might take to accomplish until toward the end of this year.

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