UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 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, 2014

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)

DELAWARE
 
94-3031310
(State or other jurisdiction of Incorporation or organization)
 
(I.R.S. Employer Identification No.)

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 check mark whether the registrant has submitted electronically and posted on its Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o
 
Accelerated filer x
     
Non-accelerated filer o
 
Smaller reporting company o
(Do not check if a smaller reporting company)
   

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.

Class
 
Outstanding at November 3, 2014
Common Stock, $0.001 par value
 
32,837,252
 


AXT, INC.
FORM 10-Q
TABLE OF CONTENTS

 
Page
3
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50

2

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (unaudited)

AXT, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited, in thousands, except per share data)

   
September 30,
   
December 31,
 
   
2014
   
2013*
 
ASSETS
       
Current assets:
       
Cash and cash equivalents
 
$
25,793
   
$
24,961
 
Short-term investments
   
15,366
     
12,499
 
Accounts receivable, net of allowances of $987 and $1,054 as of September 30, 2014 and December 31, 2013, respectively
   
21,079
     
14,943
 
Inventories
   
36,648
     
39,127
 
Prepaid expenses and other current assets
   
5,914
     
8,010
 
Total current assets
   
104,800
     
99,540
 
Long-term investments
   
7,332
     
10,145
 
Property, plant and equipment, net
   
34,663
     
37,621
 
Related party notes receivable – long-term
   
1,874
     
1,715
 
Other assets
   
15,216
     
14,801
 
Total assets
 
$
163,885
   
$
163,822
 
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
Accounts payable
 
$
9,480
   
$
8,140
 
Accrued liabilities
   
6,790
     
7,286
 
Total current liabilities
   
16,270
     
15,426
 
Long-term portion of royalty payments
   
1,925
     
2,525
 
Other long-term liabilities
   
323
     
325
 
Total liabilities
   
18,518
     
18,276
 
Commitments and contingencies (Note 11)
               
Stockholders’ equity:
               
Preferred stock, $0.001 par value; 2,000 shares authorized; 883 shares issued and outstanding as of September 30, 2014 and December 31, 2013  (Liquidation preference of $6.2 million and $6.1 million as of September 30, 2014 and December 31, 2013, respectively)
   
3,532
     
3,532
 
Common stock, $0.001 par value per share; 70,000 shares authorized; 32,771 and 32,605 shares issued and outstanding as of September 30, 2014 and December 31, 2013, respectively
   
32
     
32
 
Additional paid-in capital
   
195,151
     
194,156
 
Accumulated deficit
   
(68,082
)
   
(67,005
)
Accumulated other comprehensive income
   
8,333
     
8,953
 
Total AXT, Inc. stockholders’ equity
   
138,966
     
139,668
 
Noncontrolling interests
   
6,401
     
5,878
 
Total stockholders’ equity
   
145,367
     
145,546
 
Total liabilities and stockholders’ equity
 
$
163,885
   
$
163,822
 

*Derived from the audited consolidated financial statements included in the Annual Report on Form 10-K filed with the SEC for the year ended December 31, 2013.

See accompanying notes to condensed consolidated financial statements.
3

AXT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands, except per share data)

   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2014
   
2013
   
2014
   
2013
 
                 
Revenue
 
$
23,138
   
$
20,521
   
$
63,932
   
$
66,732
 
Cost of revenue
   
17,820
     
18,075
     
51,736
     
57,717
 
Gross profit
   
5,318
     
2,446
     
12,196
     
9,015
 
                                 
Operating expenses:
                               
Selling, general and administrative
   
3,505
     
4,303
     
10,629
     
12,435
 
Research and development
   
1,160
     
766
     
2,922
     
2,627
 
Restructuring charge
   
     
     
907
     
 
Total operating expenses
   
4,665
     
5,069
     
14,458
     
15,062
 
Income (loss) from operations
   
653
     
(2,623
)
   
(2,262
)
   
(6,047
)
Interest income, net
   
106
     
55
     
360
     
136
 
Equity in earnings of unconsolidated joint ventures
   
390
     
346
     
1,502
     
1,099
 
Other income (expense), net
   
(236
)
   
(47
)
   
250
     
(491
)
                                 
Income (loss) before provision for income taxes
   
913
     
(2,269
)
   
(150
)
   
(5,303
)
Provision for (benefit from) income taxes
   
43
     
(204
)
   
254
     
322
 
Net income (loss)
   
870
     
(2,065
)
   
(404
)
   
(5,625
)
Less: Net income attributable to noncontrolling interest
   
(226
)
   
(230
)
   
(673
)
   
(1,105
)
Net income (loss) attributable to AXT, Inc.
 
$
644
   
$
(2,295
)
 
$
(1,077
)
 
$
(6,730
)
                                 
Net income (loss) attributable to AXT, Inc. per common share:
                               
Basic
 
$
0.02
   
$
(0.07
)
 
$
(0.04
)
 
$
(0.21
)
Diluted
 
$
0.02
   
$
(0.07
)
 
$
(0.04
)
 
$
(0.21
)
                                 
Weighted average number of common shares outstanding:
                               
Basic
   
32,504
     
32,366
     
32,416
     
32,407
 
Diluted
   
32,738
     
32,366
     
32,416
     
32,407
 

See accompanying notes to condensed consolidated financial statements.
4

AXT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited, in thousands)

   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2014
   
2013
   
2014
   
2013
 
                 
Net income (loss)
 
$
870
   
$
(2,065
)
 
$
(404
)
 
$
(5,625
)
Other comprehensive income (loss), net of tax:
                               
Change in foreign currency translation gain (loss), net of tax
   
32
     
307
     
(408
)
   
1,177
 
Change in unrealized gain (loss) on available-for-sale investments, net of tax
   
(418
)
   
73
     
(279
)
   
26
 
Total other comprehensive income (loss), net of tax
   
(386
)
   
380
     
(687
)
   
1,203
 
Comprehensive income (loss)
   
484
     
(1,685
)
   
(1,091
)
   
(4,422
 
Less: Comprehensive income attributable to noncontrolling interest
   
(229
)
   
(272
)
   
(606
)
   
(1,353
)
Comprehensive income (loss) attributable to AXT, Inc.
 
$
255
   
$
(1,957
)
 
$
(1,697
)
 
$
(5,775
)

See accompanying notes to condensed consolidated financial statements
5

AXT, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)

   
Nine Months Ended
September 30,
 
   
2014
   
2013
 
Cash flows from operating activities:
       
Net loss
 
$
(404
)
 
$
(5,625
)
                 
Adjustments to reconcile net loss to net cash provided by operating activities:
               
Depreciation and amortization
   
4,219
     
4,075
 
Amortization of marketable securities premium
   
352
     
394
 
Stock-based compensation
   
861
     
1,004
 
Provision for doubtful accounts
   
9
     
627
 
Gain on sale of investments
   
(626
)
   
(811
)
Gain on disposal of property, plant and equipment, net
   
(10
)
   
(7
)
Changes in assets and liabilities:
               
Accounts receivable, net
   
(6,182
)
   
1,083
 
Inventories
   
2,400
     
2,147
 
Prepaid expenses and other current assets
   
2,076
     
(1,730
)
Other assets
   
(655
)
   
(77
)
Accounts payable
   
1,372
     
2,647
 
Accrued liabilities
   
(187
)
   
774
 
Other long-term liabilities
   
(648
)
   
(494
)
Net cash provided by operating activities
   
2,577
     
4,007
 
                 
Cash flows from investing activities:
               
Purchases of property, plant and equipment
   
(1,374
)
   
(3,919
)
Proceeds from sale of property, plant and equipment
   
10
     
9
 
Purchases of available for sale securities
   
(11,346
)
   
(14,091
)
Proceeds from sales and maturities of available for sale securities
   
10,998
     
12,486
 
Net cash used in investing activities
   
(1,712
)
   
(5,515
)
                 
Cash flows from financing activities:
               
Proceeds from common stock options exercised
   
134
     
278
 
Repurchase of the Company’s common stock, including commission
   
     
(287
)
Dividends paid by joint ventures
   
(83
)
   
(1,730
)
Net cash provided by (used in) in financing activities
   
51
     
(1,739
)
Effect of exchange rate changes on cash and cash equivalents
   
(84
)
   
336
 
Net increase (decrease) in cash and cash equivalents
   
832
     
(2,911
)
Cash and cash equivalents at the beginning of the period
   
24,961
     
30,634
 
Cash and cash equivalents at the end of the period
 
$
25,793
   
$
27,723
 

See accompanying notes to condensed consolidated financial statements.
6

AXT, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1. Basis of Presentation

The accompanying condensed consolidated financial statements of AXT, Inc. (“AXT,” the “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 data was derived from our audited consolidated financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. In the opinion of our 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 our consolidated subsidiaries for all periods presented.

Our management 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 2013 Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”) on March 14, 2014 and our Quarterly Reports on Form 10-Q for the three months ended March 31, 2014 and June 30, 2014 filed with the SEC on May 9, 2014 and August 8, 2014, respectively.

The consolidated financial statements include the accounts of AXT, our wholly-owned subsidiary, Beijing Tongmei Xtal Technology Co., Ltd., and our majority-owned subsidiaries, Beijing JiYa Semiconductor Material Co., Ltd., Nanjing Jin Mei Gallium Co., Ltd. and Beijing BoYu Semiconductor Vessel Craftwork Technology Co., Ltd. All significant inter‑company accounts and transactions have been eliminated. Investments in business entities in which we do not have control, but have the ability to exercise significant influence over operating and financial policies (generally 20-50% ownership), are accounted for by the equity method. For majority-owned subsidiaries, we reflect the noncontrolling interest of the portion we do not own on our condensed consolidated balance sheets in stockholders’ equity and in our condensed consolidated statements of operations.

7

Note 2. Investments and Fair Value Measurements

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

   
September 30, 2014
   
December 31, 2013
 
       
Gross
   
Gross
           
Gross
   
Gross
     
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
   
Cost
   
Gain
   
(Loss)
   
Value
   
Cost
   
Gain
   
(Loss)
   
Value
 
Classified as:
                               
Cash
 
$
25,769
   
$
   
$
   
$
25,769
   
$
24,852
   
$
   
$
   
$
24,852
 
Cash equivalents:
                                                               
Money market fund
   
24
     
     
     
24
     
109
     
     
     
109
 
Total cash and cash equivalents
   
25,793
     
     
     
25,793
     
24,961
     
     
     
24,961
 
                                                                 
Investments (available for sale):
                                                               
Certificates of deposit
   
9,713
     
2
     
(16
)
   
9,699
     
6,320
     
2
     
(4
)
   
6,318
 
Corporate bonds
   
11,543
     
2
     
(26
)
   
11,519
     
14,276
     
8
     
(6
)
   
14,278
 
Corporate equity security
   
88
     
1,392
     
     
1,480
     
125
     
1,923
     
     
2,048
 
Total investments
   
21,344
     
1,396
     
(42
)
   
22,698
     
20,721
     
1,933
     
(10
)
   
22,644
 
Total cash, cash equivalents and investments
 
$
47,137
   
$
1,396
   
$
(42
)
 
$
48,491
   
$
45,682
   
$
1,933
   
$
(10
)
 
$
47,605
 
Contractual maturities on investments:
                                                               
Due within 1 year
 
$
13,972
                   
$
15,366
   
$
10,569
                   
$
12,499
 
Due after 1 through 5 years
   
7,372
                     
7,332
     
10,152
                     
10,145
 
   
$
21,344
                   
$
22,698
   
$
20,721
                   
$
22,644
 

We manage our investments as a single portfolio of highly marketable securities that is intended to be available to meet our current cash requirements. We have no investments in auction rate securities. Proceeds from sales of available-for-sale investments during the three months and nine months ended September 30, 2014 were $319,000 and $665,000, respectively. Gross realized gains from sales of available-for-sale investments during the three months and nine months ended September 30, 2014 were $302,000 and $626,000, respectively. There were no sales of available-for-sales securities and no realized gains and losses for the three and nine months ended September 30, 2013.
 
Also included in short-term investments at September 30, 2014 is our investment in the common stock of Intelligent Epitaxy Technology, Inc. (IntelliEPI), a Taiwan publicly-traded company. We began classifying this asset as an available-for- sale security upon its initial public offering (IPO) in 2013. Prior to the IPO in 2013, during the third and fourth quarter of 2013, we sold some of our stock in IntelliEPI and realized a gain of approximately $800,000. During the nine months ended September 30, 2014 we sold additional IntelliEpi stock and realized a gain of approximately $626,000. An unrealized gain of $1.4 million net of tax remains as of September 30, 2014 for IntelliEpi stock still held. These securities are valued at fair market value at September 30, 2014. There is no assurance that the Company will realize this value when the securities are sold in the future.
 
The gross unrealized losses related to our portfolio of available-for-sale securities were primarily due to changes in interest rates and market and credit conditions of the underlying securities. We have determined that the gross unrealized losses on some of our available-for-sale securities as of September 30, 2014 are temporary in nature. We periodically review 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 summarizes the fair value and gross unrealized losses related to available-for-sale securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of September 30, 2014 (in thousands):

   
In Loss Position
< 12 months
   
In Loss Position
> 12 months
   
Total In
Loss Position
 
       
Gross
       
Gross
       
Gross
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
   
Value
   
(Losses)
   
Value
   
(Losses)
   
Value
   
(Losses)
 
Investments:
                       
Certificates of deposit
 
$
4,009
   
$
(16
)
 
$
   
$
   
$
4,009
   
$
(16
)
Corporate bonds
   
3,802
     
(25
)
   
4,583
     
(1
)
   
8,385
     
(26
)
Total in loss position
 
$
7,811
   
$
(41
)
 
$
4,583
   
$
(1
)
 
$
12,394
   
$
(42
)

8

The following table summarizes the fair value and gross unrealized losses related to available-for-sale securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of December 31, 2013 (in thousands):

   
In Loss Position
< 12 months
   
In Loss Position
> 12 months
   
Total In
Loss Position
 
       
Gross
       
Gross
       
Gross
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
   
Value
   
(Loss)
   
Value
   
(Loss)
   
Value
   
(Loss)
 
Investments:
                       
Certificates of deposit
 
$
3,425
   
$
(4
)
 
$
720
   
$
(0
)
 
$
4,145
   
$
(4
)
Corporate bonds
   
4,473
     
(5
)
   
3,711
     
(1
)
   
8,184
     
(6
)
Total in loss position
 
$
7,898
   
$
(9
)
 
$
4,431
   
$
(1
)
 
$
12,329
   
$
(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 (see Note 6). The investment balances for all of these companies, including minority investments indirectly in privately-held companies made by our consolidated joint ventures, accounted for under the equity method are included in “other assets” in the consolidated balance sheets and totaled $12.1 million and $10.9 million as of September 30, 2014 and December 31, 2013, respectively.
 
We also maintain minority investments in one company which is accounted for under the cost method as we do not have the ability to exercise significant influence over their operations. Our investments under the cost method are reviewed for other than temporary declines in value on a quarterly basis. We monitor our investments for impairment and record reductions in carrying value when events or changes in circumstances indicate that the carrying value may not be recoverable. As of September 30, 2014 and December 31, 2013, our investments in this unconsolidated company had a carrying value of $200,000 and were also included in “other assets” in the condensed consolidated balance sheets.

Fair Value Measurements

ASC topic 820, Fair value measurement (“ASC 820”) establishes three levels of inputs that may be used to measure fair value. Level 1 instrument valuations are obtained from real-time quotes for transactions in active exchange markets involving identical assets. Level 2 instrument valuations are obtained from readily-available pricing sources for comparable instruments. Level 3 instrument valuations are obtained from unobservable inputs in which there is little or no market data, which require us to develop our own assumptions. As of September 30, 2014, we did not have any Level 3 assets or liabilities. On a recurring basis, we measure certain financial assets and liabilities at fair value, primarily consisting of our short-term and long-term investments.
 
The type of instrument valued based on quoted market prices in active markets include our money market funds, which are generally classified within Level 1 of the fair value hierarchy. Other than corporate equity securities which are based on quoted market prices and classified as Level 1, we classify our available-for-sale securities including certificates of deposit, corporate bonds as having Level 2 inputs. The valuation techniques used to measure the fair value of these financial instruments having Level 2 inputs were derived from quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency. There were no changes in valuation techniques or related inputs in the three months and nine months ended September 30, 2014. There have been no transfers between fair value measurement levels during the three months and nine months ended September 30, 2014.
9

The following table summarizes our financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2014 (in thousands):

   
Balance as of
September 30, 2014
   
Quoted Prices in
Active Markets of
Identical Assets
(Level 1)
   
Significant Other
Observable Inputs
(Level 2)
 
Assets:
           
Cash equivalents and investments:
           
Money market fund
 
$
24
   
$
24
   
$
 
Corporate equity securities
   
1,480
     
1,480
     
 
Certificates of deposit
   
9,699
     
     
9,699
 
Corporate bonds
   
11,519
     
     
11,519
 
Total
 
$
22,722
   
$
1,504
   
$
21,218
 
Liabilities
 
$
   
$
   
$
 
 
The following table summarizes our financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2013 (in thousands):
 
   
Balance as of
December 31, 2013
   
Quoted Prices in
Active Markets of
Identical Assets
(Level 1)
   
Significant Other
Observable Inputs
(Level 2)
 
Assets:
           
Cash equivalents and investments:
           
Money market fund
 
$
109
   
$
109
   
$
 
Corporate equity securities
   
2,048
     
2,048
     
 
Certificates of deposit
   
6,318
     
     
6,318
 
Corporate bonds
   
14,278
     
     
14,278
 
Total
 
$
22,753
   
$
2,157
   
$
20,596
 
Liabilities
 
$
   
$
   
$
 

Items Measured at Fair Value on a Nonrecurring Basis

Certain assets that are subject to nonrecurring fair value measurements are not included in the table above. These assets include investments in companies accounted for by equity and cost methods (See Note 6). We did not record any other-than-temporary impairment charges for any of these investments during the three and nine months ended September 30, 2014 and 2013.

Note 3. Inventories

The components of inventories are summarized below (in thousands):
 
   
September 30,
   
December 31,
 
   
2014
   
2013
 
Inventories:
       
Raw materials
 
$
19,249
   
$
21,063
 
Work in process
   
14,372
     
14,027
 
Finished goods
   
3,027
     
4,037
 
   
$
36,648
   
$
39,127
 

As of September 30, 2014 and December 31, 2013, carrying values of inventories were net of inventory reserve of $11.9 million and $11.0 million, respectively, for excess and obsolete inventory.

10

Note 4. Accrued Liabilities
 
The components of accrued liabilities are summarized below (in thousands):
 
   
September 30,
   
December 31,
 
   
2014
   
2013
 
Accrued compensation and related charges
 
$
1,823
   
$
1,762
 
Accrued product warranty
   
904
     
1,048
 
Current portion of royalty payments
   
800
     
800
 
Dividends payable by consolidated joint ventures
   
647
     
649
 
Accrued professional services
   
528
     
543
 
Accrued income taxes
   
244
     
125
 
Other accrued liabilities
   
1,844
     
2,359
 
   
$
6,790
   
$
7,286
 

Note 5. Related Party Transactions

In August 2011, our consolidated joint venture, Beijing JiYa Semiconductor Material Co., Ltd. (JiYa), entered into a non-interest bearing note agreement in the amount of $1.7 million with one of its equity investment entities. The original term of the loan was for two years and ten months with 3 periodic principal payments required. After various amendments to the terms of the note, in December 2013 the parties agreed to delay all principal repayment until December 2016. As of September 30, 2014, and December 31, 2013, we included $1.7 million in “Related party notes receivable – long term” in our consolidated balance sheets.
 
Beginning in 2012, JiYa is contractually obligated under an agency sales agreement to sell raw material on behalf of one of its equity investment entities. JiYa bills the customers and remits the receipts, net of its portions of sales commission, to this equity investment entity. For the three months ended September 30, 2014 and 2013, JiYa has recorded $0 of income from agency sales. For the nine months ended September 30, 2014 and 2013, JiYa has recorded $0 and $20,000 of income from agency sales respectively, which was included in “other expense, net” in our condensed consolidated statements of operations. As of September 30, 2014 and December 31, 2013, there were no amounts payable to this equity investment entity.
 
JiYa also purchases raw materials from one of its equity investment entities for production in the ordinary course of business. As of September 30, 2014 and December 31, 2013, amounts payable of $1.85 million and $1.5 million, respectively, were included in “accounts payable” in our condensed consolidated balance sheets.
 
Beginning in 2012, our consolidated joint venture, Nanjing Jin Mei Gallium Co., Ltd. (Jin Mei), is contractually obligated under an agency sales agreement to sell raw material on behalf of its equity investment entity. Jin Mei bills the customers and remits the receipts, net of its portions of sales commission, to this equity investment entity. For the three months ended September 30, 2014 and 2013, Jin Mei has recorded $1,000 and $29,000 income from agency sales, respectively, which were included in “other income (expense), net” in the consolidated statements of operations. For the nine months ended September 30, 2014 and 2013, $17,000 and $123,000 of income from agency sales was recorded in “other expense, net” respectively, in our condensed consolidated statements of operations.
 
In March 2012, our wholly-owned subsidiary, Beijing Tongmei Xtal Technology Co., Ltd. (Tongmei), entered into an operating lease for the land it owns with our consolidated joint venture Beijing BoYu Semiconductor Vessel Craftwork Technology Co., Ltd. The lease agreement for the land of approximately 22,081 square feet commenced on January 1, 2012 for a term of 10 years with annual lease payments of $24,000 subject to a 5% increase at each third year anniversary. The annual lease payment is due by January 31 of each year.
 
Tongmei has paid $120,000 on behalf of Donghai County Dongfang High Purity Electronic Materials Co., Ltd., its equity investment entity, to purchase materials. In 2014, an agreement was signed between Tongmei and Donghai to set the date of repayment on December 31, 2015. As of September 30, 2014, this balance was included in “Related party notes receivable – long term” in our consolidated balance sheets.
 
In April 2014, Tongmei loaned an additional of $49,000 to Dongfang. The loan bears interest at 6.15% per annum and the principal and interest is due on December 31, 2015. As of September 30, 2014, this balance was included in “Related party notes receivable – long term” in our consolidated balance sheets.
 
Our Related Party Transactions Policy seeks to prohibit all conflicts of interest in transactions between related parties and us, unless they have been approved by our Board of Directors. This policy applies to all of our employees and directors, our subsidiaries and our joint ventures. Our executive officers retain board seats on the Board of Directors of the companies in which we have invested in our China joint ventures. See Note 6 for further details.
11

Note 6. Investments in Companies

We have made strategic investments in private companies located in China in order to gain access to raw materials at a competitive cost that are critical to our substrate business.

The investments are summarized below (in thousands):

   
Original Investment as of
       
   
September 30,
   
December 31,
 
Accounting
 
Ownership
 
Company
 
2014
   
2013
 
Method
 
Percentage
 
Beijing JiYa Semiconductor Material Co., Ltd.
 
$
3,331
   
$
3,331
 
Consolidated
   
46
%
Nanjing Jin Mei Gallium Co., Ltd.
   
592
     
592
 
Consolidated
   
83
%
Beijing BoYu Semiconductor Vessel Craftwork Technology Co., Ltd.
   
1,346
     
1,346
 
Consolidated
   
70
%
   
$
5,269
   
$
5,269
           
 
   
Investment Balance as of
           
   
September 30,
   
December 31,
 
Accounting
 
Ownership
 
Company
  2014     2013  
Method
 
Percentage
 
Donghai County Dongfang High Purity Electronic Materials Co., Ltd.
 
$
1,761
   
$
1,900
 
Equity
   
46
%
Xilingol Tongli Germanium Co. Ltd.
   
5,355
     
4,692
 
Equity
   
25
%
Emeishan Jia Mei High Purity Metals Co., Ltd.
   
988
     
945
 
Equity
   
25
%
   
$
8,104
   
$
7,537
           

Our ownership of Beijing JiYa Semiconductor Material Co., Ltd. (JiYa) is 46%. We continue to consolidate JiYa as we have significant influence in management and have majority control of the board. Our Chief Executive Officer is chairman of the JiYa board, while our president of China operations and our vice president of China administration and our vice president of wafer production are also members of the board.
 
Our ownership of Nanjing Jin Mei Gallium Co., Ltd. (Jin Mei) is 83%. We continue to consolidate Jin Mei as we have significant influence in management and have majority control of the board. Our Chief Executive Officer is chairman of the Jin Mei board, while our president of China operations and our vice president of China administration are also members of the board.
 
Our ownership of Beijing BoYu Semiconductor Vessel Craftwork Technology Co., Ltd (BoYu) is 70%. We continue to consolidate BoYu as we have a significant influence in management and have majority control of the board. Our Chief Executive Officer is chairman of the BoYu board, while our president of China operations and our vice president of China administration are also members of the board.
 
Although we have representation on the boards of directors of each of these companies, the daily operations of each of these companies are managed by local management and not by us. Decisions concerning their respective short term strategy and operations, any capacity expansion and annual capital expenditures, and decisions concerning sales of finished product, are made by local management with some inputs from us.
 
During the three months ended September 30, 2014 and 2013, the three consolidated joint ventures generated $1.1 million and $565,000 of income, respectively, of which $226,000 and $230,000, respectively, were allocated to minority interests, resulting in $837,000 and $335,000 of income, respectively, included in our net income (loss). During the nine months ended September 30, 2014 and 2013, the three consolidated joint ventures generated $2.9 million and $3.3 million of income, respectively, of which $673,000 and $1.1 million, respectively, was allocated to minority interests, resulting in $2.2 million and $2.2 million of income, respectively, included in our net income (loss).
 
For the three minority investment entities that are not consolidated, the investment balances are included in “other assets” in our condensed consolidated balance sheets and totaled $8.1 million and $7.5 million as of September 30, 2014 and December 31, 2013. We own 46% of the ownership interests in one of these companies and 25% in each of the other two companies.  These three companies are not considered variable interest entities because:

· all three companies have sustainable businesses of their own;
12

· 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 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, any of these companies.

We also maintain minority investments in privately-held companies made indirectly through our consolidated joint ventures.  These minority investments are accounted for under the equity method in the books of our consolidated joint ventures. As of September 30, 2014 and December 31, 2013, our consolidated joint ventures included these minority investments in “other assets” in the condensed consolidated balance sheets with a carrying value of $4.0 million and $3.4 million, respectively.

All of the minority investment entities that are not consolidated and are accounted for under the equity method had the following summarized income information (in thousands) for the three and nine months ended September 30, 2014 and 2013.

 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
2014
 
2013
 
2014
 
2013
 
         
Net revenue
 
$
11,487
   
$
11,024
   
$
38,433
   
$
29,938
 
Gross profit
 
$
5,371
   
$
3,628
   
$
17,458
   
$
10,516
 
Operating income
 
$
2,289
   
$
2,393
   
$
8,377
   
$
6,566
 
Net income
 
$
1,759
   
$
1,631
   
$
6,485
   
$
4,960
 

Our percentage of the entity earnings from all the minority investment entities that are not consolidated and are accounted for under the equity method were $390,000 and $346,000 for the three months ended September 30, 2014 and 2013, respectively, and $1.5 million and $1.1 million for the nine months ended September 30, 2014 and 2013, respectively.
 
We also maintain minority investments directly in one privately-held company accounted for under the cost method and we do not have the ability to exercise significant influence over their operations. As of September 30, 2014 and December 31, 2013, our investments in this unconsolidated privately-held company had a carrying value of $200,000 and are included in “other assets” in the condensed consolidated balance sheets.

Note 7. Stockholders’ Equity

Consolidated Statement of Changes in Equity
(in thousands)

   
Preferred
Stock
   
Common
Stock
   
Additional
Paid In Capital
   
Accumulated
Deficit
   
Other
Comprehensive
Income/(loss)
   
AXT, Inc.
stockholders’
equity
   
Noncontrolling
interests
   
Total
stockholders’
equity
 
Balance as of December 31, 2013
 
$
3,532
   
$
32
   
$
194,156
   
$
(67,005
)
 
$
8,953
   
$
139,668
   
$
5,878
   
$
145,546
 
Common stock options exercised
                   
134
                     
134
             
134
 
Stock-based compensation
                   
861
                     
861
             
861
 
Net (loss) income
                           
(1,077
)
           
(1,077
)
   
673
     
(404
)
Dividends declared by joint ventures
                                                   
(83
)
   
(83
)
Change in unrealized (loss) gain on marketable securities
                                   
(279
)
   
(279
)
           
(279
)
Currency translation adjustment
                                   
(341
)
   
(341
)
   
(67
)
   
(408
)
Balance as of September 30, 2014
 
$
3,532
   
$
32
   
$
195,151
   
$
(68,082
)
 
$
8,333
   
$
138,966
   
$
6,401
   
$
145,367
 

There were no reclassification adjustments from accumulated other comprehensive income for the nine months ended September 30, 2014 and 2013.
 
Stock Repurchase Program

On February 21, 2013, our Board of Directors approved a stock repurchase program pursuant to which we may repurchase up to $6.0 million of our outstanding common stock through February 27, 2014. These purchases can be made from time to time in the open market and are funded from our existing cash balances and cash generated from operations. During 2013, we repurchased approximately 285,000 shares at an average price of $2.51 per share for a total purchase price of $716,000 under the stock repurchase program.

As of December 31, 2013, approximately $5.3 million remained available for future repurchases under this program. No shares were repurchased in 2014 under this program and the plan expired on February 27, 2014.
 
On October 27, 2014, our Board of Directors approved a stock repurchase program pursuant to which we may repurchase up to $5.0 million of our outstanding common stock. These purchases can be made from time to time in the open market and are funded from our existing cash balances and cash generated from operations.  See Note 16 for further details.

13

Note 8. Stock-Based Compensation

We account for stock-based compensation in accordance with the provisions of FASB Accounting Standards Codification (“ASC”) topic 718, Compensation-Stock Compensation (“ASC 718”), which established accounting for stock-based awards exchanged for employee services. 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 of the award. All of our stock-based compensation is accounted for as an equity instrument.

The following table summarizes compensation costs related to our stock-based awards (in thousands):

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2014
   
2013
   
2014
   
2013
 
                 
Cost of revenue
 
$
4
   
$
6
   
$
14
   
$
17
 
Selling, general and administrative
   
227
     
285
     
716
     
860
 
Research and development
   
41
     
43
     
131
     
127
 
Total stock-based compensation
   
272
     
334
     
861
     
1,004
 
Tax effect on stock-based compensation
   
     
     
     
 
Net effect on net income (loss)
 
$
272
   
$
334
   
$
861
   
$
1,004
 

As of September 30, 2014, the unamortized compensation costs related to unvested stock options granted to employees under our stock option plan was approximately $1.3 million, net of estimated forfeitures of $46,000. These costs will be amortized on a straight-line basis over a weighted-average period of approximately 2.6 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, 2014 due to the immateriality of the amount.
 
We estimate the fair value of stock options using the Black-Scholes valuation model. There were 200,000 and 60,000 stock options granted with weighted average grant date fair values of $1.08 and $1.21 in the three months ended September 30, 2014 and 2013, respectively. There were 252,000 and 60,000 stock options granted with weighted average grant date fair values of $1.09 and $1.21 in the nine months ended September 30, 2014 and 2013, respectively. The fair value of our stock options granted to employees for the three and nine months ended September 30, 2014 was estimated using the following weighted-average assumptions:

   
Three Months Ended
   
Nine Months Ended
 
   
September 30, 2014
   
September 30, 2014
 
         
Expected term (in years)
   
4.4
     
4.3
 
Volatility
   
62.26
%
   
63.10
%
Expected dividend
   
0
%
   
0
%
Risk-free interest rate
   
1.86
%
   
1.88
%

14

The following table summarizes the stock option transactions during the nine months ended September 30, 2014 (in thousands, except per share data):

Stock Options
 
Shares
   
Weighted-
average
Exercise
Price
   
Weighted-
average
Remaining
Contractual
Life
(in years)
   
Aggregate
Intrinsic
Value
 
                 
Balance as of January 1, 2014
   
2,671
   
$
3.29
     
6.71
   
$
893
 
Granted
   
252
     
2.26
                 
Exercised
   
(112
)
   
1.21
                 
Canceled and expired
   
(73
)
   
5.18
                 
Balance as of September 30, 2014
   
2,738
   
$
3.23
     
6.72
   
$
585
 
                                 
Options vested and expected to vest as of September 30, 2014
   
2,738
   
$
3.23
     
6.72
   
$
585
 
                                 
Options exercisable as of September 30, 2014
   
1,688
   
$
3.52
     
5.44
   
$
505
 

The aggregate intrinsic value in the table above represents the total pretax intrinsic value, based on our closing price of $2.44 on September 30, 2014, which would have been received by the option holder had all option holders exercised their options on that date.

Restricted stock awards

A summary of activity related to restricted stock awards for the nine months ended September 30, 2014 is presented below:

Stock Awards
 
Shares
   
Weighted-Average
Grant Date Fair Value
 
Non-vested as of January 1, 2014
   
241,232
   
$
3.44
 
Granted
   
55,044
   
$
2.18
 
Vested
   
(48,420
)
 
$
4.66
 
Non-vested as of September 30, 2014
   
247,856
   
$
2.92
 

As of September 30, 2014, the unamortized compensation costs related to unvested restricted stock awards was approximately $514,000, which is to be amortized on a straight-line basis over a weighted average period of approximately 1.2 years.

15

Note 9. Net Income (loss) Per Share

Basic net income (loss) per share is computed using the weighted-average number of common shares outstanding during the periods less shares of common stock subject to repurchase and non-vested stock awards. Diluted net income (loss) per share is computed using the weighted-average number of common shares outstanding and potentially dilutive common shares outstanding during the periods. The dilutive effect of outstanding stock options and restricted stock awards is reflected in diluted earnings per share by application of the treasury stock method. Potentially dilutive common shares consist of common shares issuable upon the exercise of stock options. Potentially dilutive common shares are excluded in net loss periods, as their effect would be anti-dilutive.
 
A reconciliation of the numerators and denominators of the basic and diluted net income (loss) per share calculations is as follows (in thousands, except per share data):

   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2014
   
2013
   
2014
   
2013
 
Numerator:
               
Net income (loss) attributable to AXT, Inc.
 
$
644
   
$
(2,295
)
 
$
(1,077
)
 
$
(6,730
)
Less: Preferred stock dividends
   
(44
)
   
(44
)
   
(132
)
   
(132
)
                                 
Net income (loss) available to common stockholders
 
$
600
   
$
(2,339
)
 
$
(1,209
)
 
$
(6,862
)
Denominator:
                               
Weighted average common shares (basic)
   
32,504
     
32,366
     
32,416
     
32,407
 
Effect of dilutive securities:
                               
Common stock options
   
201
     
     
     
 
Restricted stock awards
   
33
     
     
     
 
Weighted average common shares (dilutive)
   
32,738
     
32,366
     
32,416
     
32,407
 
Net income (loss) attributable to AXT, Inc. per common share:
                               
Basic
 
$
0.02
   
$
(0.07
)
 
$
(0.04
)
 
$
(0.21
)
Diluted
 
$
0.02
   
$
(0.07
)
 
$
(0.04
)
 
$
(0.21
)
Options excluded from diluted net income (loss)  per share as the impact is anti-dilutive
   
2,000
     
2,524
     
2,684
     
2,563
 
Restricted stock excluded from diluted net income (loss) per share as the impact is anti-dilutive
   
77
     
243
     
250
     
242
 

The 883,000 shares of $0.001 par value Series A preferred stock issued and outstanding as of September 30, 2014 and December 31, 2013, valued at $3,532,000, are non-voting and non-convertible preferred stock with a 5.0% cumulative annual dividend rate payable when declared by the board of directors and a $4 per share liquidation preference over common stock, which must be paid before any distribution is made to common stockholders. These preferred shares were issued to Lyte Optronics, Inc. stockholders in connection with the completion of our acquisition of Lyte Optronics, Inc. on May 28, 1999.

Note 10. 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 materials. In accordance with ASC topic 280, Segment Reporting, 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. Since we operate in one segment, all financial segment and product line information can be found in the condensed consolidated financial statements.
16

The following table represents revenue amounts (in thousands):

   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2014
   
2013
   
2014
   
2013
 
Revenue
 
$
23,138
   
$
20,521
   
$
63,932
   
$
66,732
 

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

   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30
 
   
2014
   
2013
   
2014
   
2013
 
Geographical region:
               
Europe (primarily Germany)
 
$
5,429
   
$
5,732
   
$
16,980
   
$
16,043
 
China
   
4,298
     
6,611
     
13,423
     
20,344
 
Taiwan
   
3,835
     
1,536
     
8,735
     
8,474
 
Japan
   
3,511
     
1,931
     
9,281
     
7,233
 
Asia Pacific (excluding China, Taiwan and Japan)
   
3,537
     
2,413
     
8,376
     
6,828
 
North America (primarily the United States)
   
2,528
     
2,298
     
7,137
     
7,810
 
Total
 
$
23,138
   
$
20,521
   
$
63,932
   
$
66,732
 

 Long-lived assets consist primarily 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):

   
As of
 
   
September 30,
   
December 31,
 
   
2014
   
2013
 
         
North America
 
$
255
   
$
204
 
China
   
34,408
     
37,417
 
   
$
34,663
   
$
37,621
 

Significant Customers

No customer represented more than 10% of our revenue for the three months ended September 30, 2014 and 2013. No customer represented more than 10% of our revenue for the nine months ended September 30, 2014 and 2013. Our top five customers, although not the same five customers for each period, represented 35% and 37% of our revenue for the three months ended September 30, 2014 and 2013, respectively. Our top five customers, although not the same five customers for each period, represented 35% and 31% of our revenue for the nine months ended September 30, 2014 and 2013, respectively.

We perform ongoing credit evaluations of our customers’ financial condition, and limit the amount of credit extended when deemed necessary, but generally do not require collateral. One customer accounted for over 10% of our trade accounts receivable balance as of September 30, 2014 while one customer accounted for 20% of our trade accounts receivable balance as of December 31, 2013.
17

Note 11. Commitments and Contingencies

Indemnification Agreements

We have entered into indemnification agreements with our directors and officers that require us to (i) 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, (ii) advance their expenses incurred as a result of any proceeding against them as to which they could be indemnified and (iii) obtain directors’ and officers’ insurance if available on reasonable terms, which we currently have in place.
 
Product Warranty

We provide warranties for our products for a specific period of time, generally twelve months, against material defects. We provide for the estimated future costs of warranty obligations in cost of sales 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 product parts that fail while still under warranty. The amount of accrued estimated warranty costs are 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 balances and update these based on the 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, 2014 and 2013 (in thousands):

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2014
   
2013
   
2014
   
2013
 
                 
Beginning accrued warranty and related costs
 
$
980
   
$
804
   
$
1,048
   
$
588
 
Accruals for warranties issued
   
243
     
183
     
820
     
588
 
Adjustments related to pre-existing warranties including expirations and changes in estimates
   
(55
)
   
14
     
(357
)
   
351
 
Cost of warranty repair
   
(264
)
   
(106
)
   
(607
)
   
(602
)
Ending accrued warranty and related costs
 
$
904
   
$
895
   
$
904
   
$
895
 

Contractual Obligations

We lease certain office space, manufacturing facilities and equipment under long-term operating leases expiring at various dates through February 2023. The majority of our lease obligations relates to our lease agreement for the facility at Fremont, California with approximately 27,760 square feet, which commenced on December 1, 2008 for a term of seven years, with an option by us to cancel the lease after five years, upon forfeiture of the security deposit and payment of one-half of the fifth year’s rent. On June 28, 2013, we sent a notice to terminate the lease effective November 30, 2013 with an early termination penalty of $142,000 which was recorded as an expense in the third quarter of 2013. On August 2, 2013, we signed a new lease agreement for the current facility with reduced footage of 20,767 square feet, which commenced on December 1, 2013 for a term of two years. The reduced square footage, the reduced rate per square foot, and the expected reduced operating costs, would save us approximately total $382,000 during 2014 and 2015. In September 2014, we signed an amendment to the current lease to further reduce square footage to 19,467 square feet and to extend the term of the lease two more years.

We entered into a royalty agreement with a vendor effective December 3, 2010 with a term of eight years, terminating December 31, 2018.  We and our related companies are granted a worldwide, nonexclusive, royalty bearing, irrevocable license to certain patents for the term of the agreement. We shall pay a total of $7.0 million royalty payment over eight years beginning in 2011 based on future royalty bearing sales. This agreement contains a clause that allows us to make a claim for credit, starting in 2013, in the event that the royalty bearing sales for the year is lower than a pre-determined amount set forth in this agreement.

Outstanding contractual obligations as of September 30, 2014 are summarized as follows (in thousands):

   
Payments due by period
 
Contractual Obligations
 
Total
   
Less than 1 year
   
1-3
years
   
4-5
years
   
More than
5 years
 
Operating leases
 
$
689
   
$
260
   
$
330
   
$
53
   
$
46
 
Royalty agreement
   
2,725
     
800
     
1,206
     
719
     
 
Total
 
$
3,414
   
$
1,060
   
$
1,536
   
$
772
   
$
46
 

18

Purchase Obligations

In the normal course of business, we purchase or place orders for the necessary materials for our products from various suppliers and we commit to purchase products where we may incur a penalty if the agreement was canceled. As of September 30, 2014, we did not have any outstanding material purchase obligations.

Legal Proceedings

From time to time we may be involved in judicial or administrative proceedings concerning matters arising in the ordinary course of business. We do not expect that any of these matters, individually or in the aggregate, will have a material adverse effect on our business, financial condition, cash flows or results of operations.

Note 12. Foreign Exchange Transaction Gains/Losses

We incurred foreign currency transaction exchange losses of $556,000 and $67,000 for the three months ended September 30, 2014 and 2013, respectively. We incurred foreign currency transaction exchange losses of $381,000 and $964,000 for the nine months ended September 30, 2014 and 2013, respectively. These amounts are included in “other income (expense), net” on our condensed consolidated statements of operations.

Note 13. Income Taxes

We account for income taxes in accordance with ASC topic 740, Income Taxes (“ASC 740”) which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. ASC 740 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that a portion of the deferred tax asset will not be realized.
 
In accordance with Section 382 of the Internal Revenue Code, the amounts of and benefits from net operating loss and tax credit carryforwards may be impaired or limited in certain circumstances. Events which cause limitations in the amount of net operating losses or credits that we may utilize in any one year include, but are not limited to, a cumulative ownership change of more than 50% as defined, over a three year period. As a result of the implementation of Interpretation 48, we recognized $16.4 million of liability for unrecognized tax benefits. Of this amount, none was accounted for as a reduction to balance of retained earnings. The amount decreased tax loss carryforwards in the U.S., which are fully offset by a valuation allowance.
 
We recognize interest and penalties related to uncertain tax positions in income tax expense. Income tax expense for the three months ended September 30, 2014 includes no interest and penalties. As of September 30, 2014, we have no accrued interest and penalties related to uncertain tax positions. We file income tax returns in the U.S. federal, various states and foreign jurisdictions. We have substantially concluded all U.S. federal and state income tax matters through December 31, 2012.
 
Provision for income taxes for three and nine months ended September 30, 2014 and 2013 was mostly related to our China subsidiary and our China joint venture operations. We have made a tax election in China whereby certain minimum foreign withholding taxes are treated as an expense and not a tax credit. Besides the state taxes liabilities, no federal income tax benefit or expense has been provided for the three and nine months ended September 30, 2014 and 2013 due to our net loss, our valuation allowance being utilized and uncertainty of future profits in the U.S.

Note 14. Restructuring Charges

On February 25, 2014, we announced a restructuring plan with respect to our wholly-owned subsidiary, Beijing Tongmei Xtal Technology Co, Ltd. (“Tongmei”) in order to better align manufacturing capacity with demand.  Under the restructuring plan, Tongmei implemented certain workforce reductions with respect to its manufacturing facility in China. We also announced that the restructuring plan would be completed by March 31, 2014, depending on local legal requirements.

In the first quarter of 2014, we reduced the workforce at Tongmei by approximately 93 positions that are no longer required to support production and operations, or approximately 11 percent of the workforce. Accordingly, we recorded a restructuring charge of approximately $907,000 related to the reduction in force for severance-related expenses. As of March 31, 2014, we have completed this restructuring plan and the reduction in force. During the three month period ended September 30, 2014, we incurred no additional restructuring charges.
19

Note 15. Recent Accounting Pronouncements
 
In May 2014, as part of its ongoing efforts to assist in the convergence of U.S. GAAP and International Financial Reporting Standards (“IFRS”), FASB issued ASU 2014-09, “Revenue from Contracts with Customers.” The new guidance sets forth a new five-step revenue recognition model which replaces the prior revenue recognition guidance in its entirety and is intended to eliminate numerous industry-specific pieces of revenue recognition guidance that have historically existed in U.S. GAAP. The underlying principle of the new standard is that a business or other organization will recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects what it expects in exchange for the goods or services. The standard also requires more detailed disclosures and provides additional guidance for transactions that were not addressed completely in the prior accounting guidance. The ASU provides alternative methods of initial adoption and is effective for annual and interim periods beginning after December 15, 2016. We are currently evaluating the impact that this standard will have on our consolidated financial statements.
 
Note 16. Subsequent Events

On October 27, 2014, our Board of Directors approved a stock repurchase program pursuant to which we may repurchase up to $5.0 million of our outstanding common stock. These purchases can be made from time to time in the open market and are funded from our existing cash balances and cash generated from operations.

20

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This quarterly report on Form 10-Q, including the following sections, contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, particularly statements relating to our expectations regarding results of operations, outlook, customer demand, our ability to expand our markets and increase sales, industry trends, customer qualifications of our products, gross margins, the impact of the adoption of certain accounting pronouncements, our investments in capital projects, and our belief that we have adequate cash and investments to meet our needs over the next 12 months. These forward-looking statements are based upon management’s current views with respect to future events and financial performance, and are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results or those anticipated in such forward-looking statements. Such risks and uncertainties include those set forth under the section entitled “Risk Factors” below, which identify important factors that could cause actual results to differ materially from those predicted in any such forward-looking statements. We caution investors that actual results may differ materially from those projected in the forward-looking statements as a result of certain risk factors identified in this Form 10-Q and other filings we have made with the Securities and Exchange Commission. Forward-looking statements may be identified by the use of terms such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” and similar expressions. Statements concerning our future or expected financial results and condition, business strategy and plans or objectives for future operations are forward-looking statements.

These forward-looking statements are not guarantees of future performance. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We undertake no obligation to revise or update any forward‑looking statements in order to reflect any event or circumstance that may arise after the date of this report. Readers are urged to carefully review and consider the various disclosures made in this report, which attempt to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations and prospects. This discussion should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2013 and the condensed consolidated financial statements included elsewhere in this report.

Overview

We are a leading worldwide developer and producer of high-performance compound and single element semiconductor substrates including substrates made from gallium arsenide (GaAs), indium phosphide (InP) and germanium (Ge). We currently sell the following substrate products in the sizes and for the applications indicated:

Product
   
Substrates
 
Diameter
 
Applications
GaAs (semi-insulating)
 
2”, 3”, 4”, 5”, 6”
 
·  Power amplifiers and radio frequency integrated circuits for wireless handsets (cell phones)
       
·  Direct broadcast television
       
·  High-performance transistors
       
·  Satellite communications
         
GaAs (semi-conducting)
 
2”, 3”, 4”, 6”
 
·  High brightness light emitting diodes
       
·  Lasers
       
·  Optical couplers
         
InP
 
2”, 3”, 4”
 
·  Broadband and fiber optic communications
         
Ge
 
2”, 4”, 6”
 
·  Satellite and terrestrial solar cells
       
·  Optical applications

We manufacture all of our semiconductor substrates using our proprietary vertical gradient freeze (VGF) technology. Most of our revenue is from sales of GaAs substrates. We manufacture all of our products in the People’s Republic of China (PRC or China), which generally has favorable costs for facilities and labor compared to comparable facilities in the United States, Europe or Japan. We also have joint ventures in China, which provide us with pricing advantages, reliable supply and enhanced sourcing lead-times for key raw materials that are central to our final manufactured products. These joint ventures produce products including 99.99% pure gallium (4N Ga), high purity gallium, arsenic, germanium, germanium dioxide, pyrolytic boron nitride (pBN) crucibles and boron oxide (B2O3). Our ownership interest in these entities ranges from 20% to 83%. We consolidate, for accounting purposes, the joint ventures in which we have majority or controlling financial interest and significant influence on management, and employ equity accounting for the joint ventures in which we have a smaller ownership interest. We purchase portions of the materials produced by these joint ventures for our own use and the joint ventures sell the remainder of their production to third parties. We use our direct sales force in the United States and China and independent sales representatives in Europe and other parts of Asia to market and sell our substrates.
21

On August 11, 2014, we announced the appointment of Mr. Gary L. Fischer as the Company’s Vice President, Chief Financial Officer and Corporate Secretary, effective as of August 11, 2014. Dr. Morris S. Young, Chief Executive Officer of the Company relinquished his role as Interim Chief Financial Officer and Corporate Secretary of the Company, effective as of August 11, 2014.

Restructuring Charges

On February 25, 2014, we announced a restructuring plan with respect to our wholly-owned subsidiary, Beijing Tongmei Xtal Technology Co, Ltd. (“Tongmei”) in order to better align manufacturing capacity with demand. Under the restructuring plan, Tongmei implemented certain workforce reductions with respect to its manufacturing facility in China.  We also announced that the restructuring plan would be completed by March 31, 2014, depending on local legal requirements.

In the first quarter of 2014, we reduced the workforce at Tongmei by approximately 93 positions that are no longer required to support production and operations, or approximately 11 percent of the workforce. Accordingly, we recorded a restructuring charge of approximately $907,000 related to the reduction in force for severance-related expenses. As of March 31, 2014, we have completed this restructuring plan and reduction in force. During the three month period ended September 30, 2014, we incurred no additional restructuring charges.

Critical Accounting Policies and Estimates

We prepared our condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America. As such, we make estimates, assumptions and judgments that affect the amounts reported on our financial statements. These estimates, assumptions and judgments about future events and their effects on our results cannot be determined with certainty, and are made based upon our historical experience and on other assumptions that are believed to be reasonable under the circumstances. These estimates may change as new events occur or additional information is obtained, and we may periodically be faced with uncertainties, the outcomes of which are not within our control and may not be known for a prolonged period of time. The discussion and analysis of our results of operations and financial condition are based upon these condensed consolidated financial statements.

We have identified the policies below as critical to our business operations and understanding of our financial condition and results of operations. A critical accounting policy is one that is both material to the presentation of our financial statements and requires us to make difficult, subjective or complex judgments that could have a material effect on our financial condition and results of operations. They may require us to make assumptions about matters that are highly uncertain at the time of the estimate, and different estimates that we could have used, or changes in the estimate that are reasonably likely to occur, may have a material impact on our financial condition or results of operations.

Revenue Recognition

We manufacture and sell high-performance compound semiconductor substrates and sell certain raw materials including gallium, germanium dioxide, and pBN crucibles. After we ship our products, there are no remaining obligations or customer acceptance requirements that would preclude revenue recognition. Our products are typically sold pursuant to a purchase order placed by our customers, and our terms and conditions of sale do not require customer acceptance. We recognize revenue upon shipment and transfer of title of products to our customers, which is either upon shipment from our dock, receipt at the customer’s dock, or removal from consignment inventory at the customer’s location, provided that we have received a signed purchase order, the price is fixed or determinable, title and risk of ownership have transferred, collection of resulting receivables is probable, and product returns are reasonably estimable. We do not provide training, installation or commissioning services.

We provide allowance for future returns based on historical experience, current economic trends and changes in customer demand at the time revenue is recognized.

22

Accounts Receivable and Allowance for Doubtful Accounts

We periodically review the likelihood of collection on our accounts receivable balances and provide an allowance for doubtful accounts receivable primarily based upon the age of these accounts. We evaluate receivables from U.S. customers with an emphasis on balances in excess of 90 days and for receivables from customers located outside the U.S. with an emphasis on balances in excess of 120 days and reserve allowance on the receivable balances if needed. The reason for the difference in the evaluation of receivables between foreign and U.S. customers is that U.S. customers have historically made payments in a shorter period of time than foreign customers. Foreign business practices generally require us to allow customer payment terms that are longer than those accepted in the United States. We assess the probability of collection based on a number of factors, including the length of time a receivable balance has been outstanding, our past history with the customer and their creditworthiness.
 
As of September 30, 2014 and December 31, 2013, our accounts receivable, net, balance was $21.1 million and $14.9 million, respectively, which was net of an allowance for doubtful accounts of $430,000 and $869,000, respectively. If actual uncollectible accounts differ substantially from our estimates, revisions to the estimated allowance for doubtful accounts would be required, which could have a material impact on our financial results for the future periods.
 
The allowance for sales returns is also deducted from gross accounts receivable. As of September 30, 2014 and December 31, 2013, our allowance for sales returns was $557,000 and $186,000, respectively.

Warranty Reserve

We maintain a warranty reserve based upon our claims experience during the prior twelve months. Warranty costs are accrued at the time revenue is recognized. As of September 30, 2014 and December 31, 2013, accrued product warranties totaled approximately $0.9 million and $1.0 million, respectively. If actual warranty costs differ substantially from our estimates, revisions to the estimated warranty liability would be required, which could have a material impact on our financial condition and results of operations for future periods.

Inventory Valuation

Inventories are stated at the lower of cost or market. Cost is determined using the weighted-average cost method. Our inventory consists of raw materials as well as finished goods and work-in-process that include material, labor and manufacturing overhead costs. Given the nature of our substrate products, and the materials used in the manufacturing process, the wafers and ingots comprising work-in-process may be held in inventory for up to two years and three years, respectively, as the risk of obsolescence for these materials is low. We routinely evaluate the levels of our inventory in light of current market conditions in order to identify excess and obsolete inventory, and we provide a valuation allowance for certain inventories based upon the age and quality of the product and the projections for sale of the completed products. As of September 30, 2014 and December 31, 2013, we had an inventory reserve of $11.9 million and $11.0 million, respectively, for excess and obsolete inventory. If actual demand for our products were to be substantially lower than estimated, additional inventory adjustments for excess or obsolete inventory might be required, which could have a material impact on our business, financial condition and results of operations.

Impairment of Investments

We classify our investments in debt and equity securities as available-for-sale securities in accordance with ASC topic 320, Investments - Debt and Equity Securities (“ASC 320”). All available-for-sale securities with a quoted market value below cost (or adjusted cost) are reviewed in order to determine whether the decline is other-than-temporary. 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.

We invest in equity instruments of privately-held companies in China for business and strategic purposes. These investments are classified as other assets and are accounted for under the cost method as we do not have the ability to exercise significant influence over their operations. We monitor our investments for impairment and record reductions in carrying value when events or changes in circumstances indicate that the carrying value may not be recoverable. Determination of impairment is highly subjective and is based on a number of factors, including an assessment of the strength of investee’s management, the length of time and extent to which the fair value has been less than our cost basis, the financial condition and near-term prospects of the investee, fundamental changes to the business prospects of the investee, share prices of subsequent offerings, and our intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in our carrying value. We had no write‑downs for the three or nine months ended September 30, 2014 or 2013.
23

Fair Value of Investments

ASC 820, Fair Value Measurement (“ASC 820”) establishes three levels of inputs that may be used to measure fair value.

Level 1 instruments represent quoted prices in active markets. Therefore, determining fair value for Level 1 instruments does not require significant management judgment, and the estimation is not difficult.

Level 2 instruments include observable inputs other than Level 1 prices, such as quoted prices for identical instruments in markets with insufficient volume or infrequent transactions (less active markets), issuer credit ratings, non-binding market consensus prices that can be corroborated with observable market data, model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated with observable market data for substantially the full term of the assets or liabilities, or quoted prices for similar assets or liabilities. These Level 2 instruments require more management judgment and subjectivity compared to Level 1 instruments, including:

· Determining which instruments are most similar to the instrument being priced requires management to identify a sample of similar securities based on the coupon rates, maturity, issuer, credit rating, and instrument type, and subjectively select an individual security or multiple securities that are deemed most similar to the security being priced.

· Determining which model-derived valuations to use in determining fair value requires management judgment. When observable market prices for identical securities or similar securities are not available, we price our marketable debt instruments using non-binding market consensus prices that are corroborated with observable market data or pricing models, such as discounted cash flow models, with all significant inputs derived from or corroborated with observable market data.

Level 3 instruments include unobservable inputs to the valuation methodology that are significant to the measurement of fair value of assets or liabilities. The determination of fair value for Level 3 instruments requires the most management judgment and subjectivity. As of September 30, 2014, we did not have any assets or liabilities without observable market values that would require a high level of judgment to determine fair value (Level 3 assets). There have been no transfers between fair value measurement levels during the three and nine months ended September 30, 2014.

Impairment of Long-Lived Assets

We evaluate the recoverability of property, equipment and intangible assets in accordance with ASC topic 360, Property, Plant and Equipment (“ASC 360”). When events and circumstances indicate that long-lived assets may be impaired, we compare the carrying value of the long-lived assets to the projection of future undiscounted cash flows attributable to these assets. In the event that the carrying value exceeds the future undiscounted cash flows, we record an impairment charge against income equal to the excess of the carrying value over the assets’ fair value. Fair values are determined based on quoted market values, discounted cash flows or internal and external appraisals, as applicable. We had no “Assets held for sale” on the condensed consolidated balance sheet as of September 30, 2014 or December 31, 2013.

Stock-based Compensation

We account for stock-based compensation in accordance with ASC topic 718, Stock-based Compensation (“ASC 718”), using the modified prospective method. Share-based awards granted include stock options and restricted stock awards. We utilize the Black‑Scholes option pricing model to estimate the grant date fair value of stock options, which requires the input of highly subjective assumptions, including expected volatility and expected term. Historical volatility was used while the expected term for our options was estimated based on historical option exercise behavior and post-vesting forfeitures of options, and the contractual term, the vesting period and the expected term of the outstanding options. Further, we apply an expected forfeiture rate in determining the amount of share-based compensation. We use historical forfeitures to estimate the forfeitures for stock compensation awards that are not expected to vest. Changes in these inputs and assumptions can materially affect the measure of estimated fair value of our stock compensation. The cost of restricted stock awards is determined using the fair value of our common stock on the date of grant.
 
We recognize the compensation costs net of an estimated forfeiture rate over the requisite service period of the options award, which is generally the vesting term of four years. Compensation expense for restricted stock awards is recognized over the vesting period, which is generally three years or four years. Stock-based compensation expense is recorded in cost of revenue, research and development, and selling, general and administrative expenses.
24

Income Taxes

We account for income taxes in accordance with ASC topic 740, Income Taxes (“ASC 740”) which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. ASC 740 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that a portion of the deferred tax asset will not be realized.
 
We provide for income taxes based upon the geographic composition of worldwide earnings and tax regulations governing each region, particularly China. The calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of complex tax laws, particularly in foreign countries such as China.
 
See Note 13—“Income Taxes” in the notes to condensed financial statements for additional information.

25

Results of Operations

Revenue

   
Three Months Ended
         
   
September 30,
   
Increase
     
   
2014
   
2013
   
(Decrease)
   
% Change
 
   
($ in thousands)
         
Revenue
 
$
23,138
   
$
20,521
   
$
2,617
     
12.8
%

Revenue increased $2.6 million, or 12.8%, to $23.1 million for the three months ended September 30, 2014 from $20.5 million for the three months ended September, 2013.  In aggregate, revenue increased for our substrate materials products as a result of general increased demand, favorable product mix and more stabilization in demand from our customers in the wireless devices market. In addition, a wafer substrate manufacturer elected to purchase raw wafers in the open market and awarded orders to us. Similarly, our raw materials revenue increased as a result of stronger demand and our ability to respond quickly to short lead time requirements.


   
Nine Months Ended
         
   
September 30,
   
Increase
     
   
2014
   
2013
   
(Decrease)
   
% Change
 
   
($ in thousands)
         
Revenue
 
$
63,932
   
$
66,732
   
$
(2,800
)
   
(4.2
%)

Revenue decreased $2.8 million, or 4.2%, to $63.9 million for the nine months ended September 30, 2014 from $66.7 million for the nine months ended September, 2013. The revenue decrease resulted from decreased demand for our substrate materials, particularly in the wireless devices market. This decrease was partially offset when a wafer substrate manufacturer elected to purchase raw wafers in the open market and awarded orders to us. In addition, the decreases were partially offset by increases in our raw materials revenue.

Revenue by Geographic Region

 
Three Months Ended
         
   
September 30,
   
Increase
     
   
2014
   
2013
   
(Decrease)
   
% Change
 
   
($ in thousands)
         
Europe (primarily Germany)
 
$
5,429
   
$
5,732
     
(303
)
   
(5.3
%)
% of total revenue
   
23.4
%
   
27.9
%
               
China
   
4,298
     
6,611
     
(2,313
)
   
(35.0
%)
% of total revenue
   
18.6
%
   
32.2
%
               
Taiwan
   
3,835
     
1,536
     
2,299
     
149.7
%
% of total revenue
   
16.6
%
   
7.5
%
               
Japan
   
3,511
     
1,931
     
1,580
     
81.8
%
% of total revenue
   
15.2
%
   
9.4
%
               
Asia Pacific (excluding China, Taiwan and Japan)
   
3,537
     
2,413
     
1,124
     
46.6
%
% of total revenue
   
15.3
%
   
11.8
%
               
North America (primarily the United States)
   
2,528
     
2,298
     
230
     
10.0
%
% of total revenue
   
10.9
%
   
11.2
%
               
Total revenue
 
$
23,138
   
$
20,521
   
$
2,617
     
12.8
%

Revenue by geographic region shows strong expansion in both Taiwan and Japan which resulted from a strategic focus of our selling and business development efforts in these two countries initiated late in 2013.  This strategic focus delivered modest benefits earlier in 2014 and more substantial benefits in Q3 2014.  Further, we assigned additional resources for technical support to assist our customers in characterizing the products we delivered. Revenue from customers in China decreased primarily due to decreased substrate revenue and raw materials revenue.
26

 
Nine Months Ended
         
   
September 30,
   
Increase
     
   
2014
   
2013
   
(Decrease)
   
% Change
 
   
($ in thousands)
         
Europe (primarily Germany)
 
$
16,980
   
$
16,043
   
$
937
     
5.8
%
% of total revenue
   
26.5
%
   
24.1
%
               
China
   
13,423
     
20,344
     
(6,921
)
   
(34.0
%)
% of total revenue
   
21.0
%
   
30.5
%
               
Taiwan
   
8,735
     
8,474
     
261
     
3.1
%
% of total revenue
   
13.7
%
   
12.7
%
               
Japan
   
9,281
     
7,233
     
2,048
     
28.3
%
% of total revenue
   
14.5
%
   
10.8
%
               
Asia Pacific (excluding China, Taiwan and Japan)
   
8,376
     
6,828
     
1,548
     
22.7
%
% of total revenue
   
13.1
%
   
10.2
%
               
North America (primarily the United States)
   
7,137
     
7,810
     
(673
)
   
(8.6
%)
% of total revenue
   
11.2
%
   
11.7
%
               
Total revenue
 
$
63,932
   
$
66,732
   
$
(2,800
)
   
(4.2
%)

Revenue by geographic region shows expansion particularly in Japan and also in Asia Pacific.  Increases in Japan resulted from a strategic focus of our selling and business development efforts initiated late in 2013.  Increases in Asia Pacific resulted from generally a more active market for our products with existing customers.  Further, we assigned additional resources for technical support to assist our customers in characterizing the products we delivered. Revenue from customers in China decreased primarily due to decreased substrate revenue and raw materials revenue.

Gross Margin
 
   
Three Months Ended
September 30,
   
Increase
     
   
2014
   
2013
   
(Decrease)
   
% Change
 
   
($ in thousands)
         
Gross profit
 
$
5,318
   
$
2,446
   
$
2,872
     
117.4
%
Gross Margin %
   
23.0
%
   
11.9
%
               

Gross margin increased primarily due to product mix, cost saving and increase volume.

   
Nine Months Ended
September 30,
   
Increase
     
   
2014
   
2013
   
(Decrease)
   
% Change
 
   
($ in thousands)
         
Gross profit
 
$
12,196
   
$
9,015
   
$
3,181
     
35.3
%
Gross Margin %
   
19.1
%
   
13.5
%
               

Gross margin increased primarily due to product mix and implementation of cost-saving activities.

Selling, General and Administrative Expenses

   
Three Months Ended
September 30,
   
Increase
     
   
2014
   
2013
   
(Decrease)
   
% Change
 
   
($ in thousands)
         
Selling, general and administrative expenses
 
$
3,505
   
$
4,303
   
$
(798
)
   
(18.5
)%
% of total revenue
   
15.1
%
   
21.0
%
               

Selling, general and administrative expenses decreased primarily due to a decrease in bad debt expense, lower facility rent and implementation of cost-saving activities.
27

   
Nine Months Ended
September 30,
   
Increase
     
   
2014
   
2013
   
(Decrease)
   
% Change
 
   
($ in thousands)
         
Selling, general and administrative expenses
 
$
10,629
   
$
12,435
   
$
(1,806
)
   
(14.5
)%
% of total revenue
   
16.6
%
   
18.6
%
               

Selling, general and administrative expenses decreased primarily due to a decrease in bad debt expense and the companywide cost saving efforts implemented in 2014 including lower personnel related costs, lower facility rent in Fremont and lower stock-based compensation expenses.

Research and Development

   
Three Months Ended
September 30,
   
Increase
     
   
2014
   
2013
   
(Decrease)
   
% Change
 
   
($ in thousands)
         
Research and development
 
$
1,160
   
$
766
   
$
394
     
51.4
%
% of total revenue
   
5.0
%
   
3.7
%
               

Research and development expenses increased primarily due to the higher usage of materials for product testing from our joint ventures in China and higher personnel related costs.

   
Nine Months Ended
September 30,
   
Increase
     
   
2014
   
2013
   
(Decrease)
   
% Change
 
   
($ in thousands)
         
Research and development
 
$
2,922
   
$
2,627
   
$
295
     
11.2
%
% of total revenue
   
4.6
%
   
3.9
%
               

Research and development expenses increased primarily due to the higher usage of materials for product testing from our joint ventures in China and higher personnel related costs associated with research and development, partially offset by lower consulting expenses accrued for product testing.

Restructuring Charges

In the first quarter of 2014, we reduced the workforce at Tongmei by approximately 93 positions that are no longer required to support production and operations, or approximately 11 percent of the workforce. Accordingly, we recorded a restructuring charge of approximately $907,000 related to the reduction in force for severance-related expenses. As of March 31, 2014 we have completed this restructuring plan and the reduction in force. During the three month period ended September 30, 2014, we incurred no restructuring charges.

Interest Income, Net
 
   
Three Months Ended
September 30,
   
Increase
     
   
2014
   
2013
   
(Decrease)
   
% Change
 
   
($ in thousands)
         
Interest income, net
 
$
106
   
$
55
   
$
51
     
92.7
%
% of total revenue
   
0.5
%
   
0.3
%
               

Interest income, net increased primarily due to higher returns from the mix of investment securities.


   
Nine Months Ended
September 30,
   
Increase
     
   
2014
   
2013
   
(Decrease)
   
% Change
 
   
($ in thousands)
         
Interest income, net
 
$
360
   
$
136
   
$
224
     
164.7
%
% of total revenue
   
0.6
%
   
0.2
%
               

Interest income, net increased primarily due to higher returns from the mix of investment securities.
28

Equity in Earnings of Unconsolidated Joint Ventures

   
Three Months Ended
September 30,
   
Increase
     
   
2014
   
2013
   
(Decrease)
   
% Change
 
   
($ in thousands)
         
Equity in earnings of unconsolidated joint ventures
 
$
390
   
$
346
   
$
44
     
12.7
%
% of total revenue
   
1.7
%
   
1.7
%
               

Equity in earnings of unconsolidated joint ventures remained relatively unchanged compared to the prior year same period.

   
Nine Months Ended
September 30,
   
Increase
     
   
2014
   
2013
   
(Decrease)
   
% Change
 
   
($ in thousands)
         
Equity in earnings of unconsolidated joint ventures
 
$
1,502
   
$
1,099
   
$
403
     
36.7
%
% of total revenue
   
2.3
%
   
1.6
%
               

Equity in earnings of unconsolidated joint ventures increased on a year to date basis compared to the same period last year primarily due to higher net income from improved performance of our minority-owned joint ventures that are not consolidated.
 
Other Income (Expense), Net
 
   
Three Months Ended
September 30,
   
Increase
     
   
2014
   
2013
   
(Decrease)
   
% Change
 
   
($ in thousands)
         
Other income (expense), net
 
$
(236
)
 
$
(47
)
 
$
(189
)
   
402.1
%
% of total revenue
   
(1.0
)%
   
(0.2
)%