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 June 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)

 

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 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.

 

Class

 

Outstanding at August 6, 2006

Common Stock, $0.001 par value

 

23,125,428

 

 



 

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 June 30, 2006 and December 31, 2005

3

Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2006 and 2005

4

Condensed Consolidated Statements of Cash Flows for the six months ended June 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

 

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



 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

AXT, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands, except per share data)

 

 

 

June 30,

 

December 31,

 

 

 

2006

 

2005

 

Assets:

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

11,053

 

$

17,472

 

Investments

 

6,199

 

5,555

 

Accounts receivable, net of allowances of $631 and $619 as of June 30, 2006 and December 31, 2005, respectively

 

7,429

 

5,226

 

Inventories, net

 

16,192

 

16,156

 

Prepaid expenses and other current assets

 

3,602

 

1,801

 

Total current assets

 

44,475

 

46,210

 

Property, plant and equipment, net

 

16,648

 

17,306

 

Restricted deposits

 

7,300

 

7,450

 

Other assets

 

3,743

 

3,832

 

Total assets

 

$

72,166

 

$

74,798

 

 

 

 

 

 

 

Liabilities and stockholders’ equity:

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

3,453

 

$

3,070

 

Accrued liabilities

 

3,023

 

3,533

 

Accrued restructuring

 

 

465

 

Current portion of long-term debt

 

450

 

300

 

Income taxes payable

 

2,508

 

2,495

 

Total current liabilities

 

9,434

 

9,863

 

Long-term debt, net of current portion

 

6,952

 

7,420

 

Other long-term liabilities

 

1,958

 

1,897

 

Total liabilities

 

18,344

 

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 June 30, 2006 and December 21, 2005, respectively.

 

3,532

 

3,532

 

Common stock, $0.001 par value per share; 70,000 shares authorized; 23,121 and 22,977 shares issued and outstanding as of June 30, 2006 and December 31, 2005, respectively

 

23

 

23

 

Additional paid-in capital

 

156,182

 

155,441

 

Accumulated deficit

 

(107,855

)

(104,776

)

Accumulated other comprehensive income

 

1,940

 

1,398

 

Total stockholders’ equity

 

53,822

 

55,618

 

Total liabilities and stockholders’ equity

 

$

72,166

 

$

74,798

 

 

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

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

10,355

 

$

6,032

 

$

18,826

 

$

12,666

 

Cost of revenue

 

7,596

 

5,905

 

14,557

 

12,260

 

Gross profit

 

2,759

 

127

 

4,269

 

406

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

3,853

 

2,716

 

7,083

 

6,968

 

Research and development

 

571

 

423

 

1,105

 

785

 

Restructuring

 

 

237

 

(2

)

362

 

Total operating expenses

 

4,424

 

3,376

 

8,186

 

8,115

 

Loss from operations

 

(1,665

)

(3,249

)

(3,917

)

(7,709

)

Interest income, net

 

111

 

131

 

239

 

250

 

Other income (expense), net

 

814

 

(196

)

1,052

 

(301

)

Loss before provision for income taxes

 

(740

)

(3,314

)

(2,626

)

(7,760

)

Provision for income taxes

 

138

 

18

 

456

 

53

 

Loss from continuing operations

 

(878

)

(3,332

)

(3,082

)

(7,813

)

Discontinued operations:

 

 

 

 

 

 

 

 

 

Gain from discontinued operations, net of tax

 

2

 

 

3

 

58

 

Gain from disposal, net of tax

 

 

53

 

 

353

 

Net loss

 

$

(876

)

$

(3,279

)

$

(3,079

)

$

(7,402

)

 

 

 

 

 

 

 

 

 

 

Basic and diluted loss per share:

 

 

 

 

 

 

 

 

 

Loss from continuing operations

 

$

(0.04

)

$

(0.14

)

$

(0.14

)

$

(0.34

)

Gain from discontinued operations, net of tax

 

0.00

 

0.00

 

0.00

 

0.02

 

Net loss

 

$

(0.04

)

$

(0.14

)

$

(0.14

)

$

(0.32

)

 

 

 

 

 

 

 

 

 

 

Shares used in computing basic and diluted net loss per share

 

23,052

 

23,079

 

23,019

 

23,113

 

 

See accompanying notes to condensed consolidated financial statements.

 

4



 

AXT, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)

 

 

 

Six Months Ended

 

 

 

June 30,

 

 

 

2006

 

2005

 

 

 

 

 

 

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net loss

 

$

(3,079

)

$

(7,402

)

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

Depreciation

 

1,761

 

2,068

 

Amortization of marketable securities premium/discount

 

(30

)

152

 

Non-cash restructuring charge

 

 

362

 

Loss on disposal of property, plant and equipment

 

67

 

217

 

Stock-based compensation

 

443

 

(2

)

Realized gain on sale of investments

 

(1,438

)

 

Gain on disposal of discontinued operations

 

 

(53

)

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable, net

 

(2,203

)

(921

)

Inventories, net

 

(36

)

1,126

 

Prepaid expenses and other current assets

 

(1,801

)

85

 

Other assets

 

89

 

43

 

Accounts payable

 

383

 

(79

)

Accrued liabilities and restructuring

 

(975

)

(1,181

)

Income taxes payable

 

13

 

90

 

Other long-term liabilities

 

61

 

26

 

Net cash used in operating activities

 

(6,745

)

(5,469

)

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Purchases of property, plant and equipment

 

(1,331

)

(827

)

Proceeds from sales of property, plant and equipment

 

161

 

31

 

Purchases of marketable securities

 

(4,697

)

(5,380

)

Proceeds from sale of marketable securities

 

5,985

 

13,988

 

Decrease in restricted cash

 

150

 

 

Proceeds from assets held for sale, net

 

 

1,303

 

Net cash provided by investing activities

 

268

 

9,115

 

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Proceeds from (payments of):

 

 

 

 

 

Issuance of common stock

 

298

 

60

 

Repurchase of common stock

 

 

(193

)

Long-term debt payments

 

(318

)

(300

)

Net cash used in financing activities

 

(20

)

(433

)

Effect of exchange rate changes

 

78

 

(218

)

Net increase (decrease) in cash and cash equivalents

 

(6,419

)

2,995

 

Cash and cash equivalents at the beginning of the period

 

17,472

 

12,117

 

Cash and cash equivalents at the end of the period

 

$

11,053

 

$

15,112

 

 

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 balance sheet data were derived from audited financial statements, but do 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 Report on Form 10-Q for the quarterly period ended March 31, 2006 filed with the Securities and Exchange Commission on May 12, 2006.

 

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.

 

In June 2005, we completed the sale of a building located in Monterey Park, California. This asset had been classified as “assets held for sale” in the amount of $1.25 million on the consolidated balance sheet as of December 31, 2004. We received net proceeds on the sale of the property of approximately $1.3 million and accordingly recorded a gain on disposal of $53,000.

 

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):

 

6



 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

 

$

 

$

 

$

 

Cost of revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

(2

)

 

(3

)

(58

)

Research and development

 

 

 

 

 

Impairment costs

 

 

 

 

 

Total operating expenses

 

(2

 

(3

(58

)

Gain from discontinued operations, net of tax

 

2

 

 

3

 

58

 

Gain from disposal, net of tax

 

 

53

 

 

353

 

Net income

 

$

2

 

$

53

 

$

3

 

$

411

 

 

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):

 

 

 

June 30,
2006

 

December 31,
2005

 

Current assets:

 

 

 

 

 

Cash

 

$

428

 

$

472

 

Total current assets

 

428

 

472

 

Total assets

 

$

428

 

$

472

 

Current liabilities:

 

 

 

 

 

Accrued liabilities

 

$

47

 

$

95

 

Total liabilities

 

47

 

95

 

Net assets

 

381

 

377

 

Total liabilities and net assets

 

$

428

 

$

472

 

 

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(R)”).

 

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, “ Accounting for Stock-Based Compensation,” 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):

 

7



 

 

 

Three Months

 

Six Months

 

 

 

Ended

 

Ended

 

 

 

June 30,

 

June 30,

 

 

 

2005

 

2005

 

Net loss:

 

 

 

 

 

As reported

 

$

 (3,279

)

$

 (7,402

)

Add: Stock-based employee
compensation expense (income)
included in net loss as reported

 

2

 

(3

)

Less: Stock-based compensation expense
using the fair value based method, net
of related tax

 

(232

)

(467

)

Pro forma net loss

 

$

(3,509

)

$

(7,872

)

Basic and diluted net loss per common share

 

 

 

 

 

As reported

 

$

(0.14

)

$

(0.32

)

Proforma

 

$

(0.15

)

$

(0.34

)

Shares used in computing basic and diluted
net loss per share

 

23,079

 

23,113

 

 

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 $186,000 and $443,000 of stock compensation expense in our unaudited condensed consolidated statements of operations for the three and six months ended June 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):

 

 

 

Three Months

 

Six Months

 

 

 

Ended

 

Ended

 

 

 

June 30,

 

June 30,

 

 

 

2006

 

2006

 

Stock-based compensation in the form of employee stock options, included in:

 

 

 

 

 

 

 

 

 

 

 

Cost of revenue

 

$

32

 

$

60

 

Selling, general and administrative

 

91

 

264

 

Research and development

 

63

 

119

 

 

 

 

 

 

 

Total stock-based compensation

 

$

186

 

$

443

 

Tax effect on stock-based compensation

 

 

 

 

 

 

 

 

 

Net effect on net loss

 

$

186

 

$

443

 

 

 

 

 

 

 

Effect on basic and diluted net loss per share

 

$

(0.01

)

$

(0.02

)

 

As of June 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 $1.0 million, net of estimated forfeitures of $44,000. This cost will be amortized on a straight-line basis over a weighted-average period of approximately 1.23 years and will be adjusted for subsequent changes in estimated forfeitures. We elected not to capitalize any stock-based compensation to inventory as of June 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.

 

8



 

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 months and six months ended June 30, 2006 was estimated using the following weighted-average assumptions:

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

Expected term (in years)

 

5.0

 

5.0

 

5.0

 

5.0

 

 

 

 

 

 

 

 

 

 

 

Volatility

 

83.95

%

NA

 

85.91

%

93.2

%

 

 

 

 

 

 

 

 

 

 

Expected dividend

 

0

%

0

%

0

%

0

%

 

 

 

 

 

 

 

 

 

 

Risk-free interest rate

 

5.10

%

NA

 

4.86

%

3.72

%

 

 

 

 

 

 

 

 

 

 

Estimated forfeitures

 

2.90

%

0

%

9.59

%

0

%

 

 

 

 

 

 

 

 

 

 

Weighted-average fair value

 

$

2.67

 

$

NA

 

$

1.68

 

$

0.86

 

 

The following table summarizes the stock option transactions during the six months ended June 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 at December 31, 2005

 

2,917

 

$

2.30

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Granted

 

19

 

2.54

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Exercised

 

(144

)

2.08

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Canceled

 

(70

)

1.53

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Options outstanding at June 30, 2006

 

2,722

 

$

2.34

 

6.89

 

$

3,826

 

 

 

 

 

 

 

 

 

 

 

 

 

Options vested and expected to vest at June 30, 2006

 

2,685

 

$

2.34

 

6.87

 

$

3,757

 

 

 

 

 

 

 

 

 

 

 

 

 

Options exercisable at June 30, 2006

 

1,673

 

$

2.89

 

5.78

 

$

1,920

 

 

The options outstanding and exercisable at June 30, 2006 were in the following exercise price ranges:

 

Options Outstanding at June 30, 2006

 

Options Vested and Exercisable
at June 30, 2006

 

 

 

 

 

 

 

Weighted-Average

 

 

 

 

 

 

 

 

 

Weighted-Average

 

Remaining

 

 

 

Weighted-Average

 

Range of Exercise Price

 

Shares

 

Exercise Price

 

Contractual Life

 

Shares

 

Exercise Price

 

$

1.17

 

$

1.38

 

 

1,584,545

 

$

1.29

 

7.62

 

701,304

 

$

1.32

 

$

1.39

 

$

1.41

 

 

11,500

 

$

1.41

 

8.89

 

2,344

 

$

1.40

 

$

1.45

 

$

2.21

 

 

634,894

 

$

2.17

 

6.24

 

505,524

 

$

2.18

 

$

2.25

 

$

5.00

 

 

373,370

 

$

3.59

 

6.01

 

349,326

 

$

3.61

 

$

5.01

 

$

41.50

 

 

117,500

 

$

13.41

 

3.27

 

115,000

 

$

13.49

 

 

 

 

 

 

 

2,721,809

 

$

2.34

 

6.89

 

1,673,498

 

$

2.89

 

 

The total intrinsic value of options exercised for the three and six months ended June 30, 2006 was $167,000 and $233,000. Cash received from option exercises for the three and six months ended June 30, 2006 was $232,000 and $298,000. The total fair value of options vested for the three months and six months ended June 30, 2006 was $291,000, and $800,000, respectively.

 

9



 

Note 4. Cash, Cash Equivalents and Investments

 

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

 

 

 

June 30, 2006

 

December 31, 2005

 

 

 

 

 

Gross

 

Gross

 

 

 

 

 

Gross

 

Gross

 

 

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

Fair

 

Amortized

 

Unrealized

 

Unrealized

 

Fair

 

 

 

Cost

 

Gain

 

(Loss)

 

Value

 

Cost

 

Gain

 

(Loss)

 

Value

 

Classified as:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash

 

$

7,584

 

$

 

$

 

$

7,584

 

$

12,803

 

$

 

$

 

$

12,803

 

Cash equivalents:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

2,771

 

 

 

2,771

 

1,729

 

 

 

1,729

 

Commercial paper

 

698

 

 

 

698

 

2,940

 

 

 

2,940

 

Total cash equivalents

 

3,469

 

 

 

3,469

 

4,669

 

 

 

4,669

 

Total cash and cash equivalents

 

11,053

 

 

 

11,053

 

17,472

 

 

 

17,472

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury and agency securities

 

4,488

 

 

(21

)

4,467

 

4,460

 

 

(12

)

4,448

 

Asset-backed securities

 

1,649

 

 

(6

)

1,643

 

3,285

 

 

(11

)

3,274

 

Commercial paper

 

888

 

 

(1

)

887

 

 

 

 

 

Corporate bonds

 

3,635

 

 

(14

)

3,621

 

2,504

 

 

(13

)

2,491

 

Corporate equity securities

 

1,087

 

1,794

 

 

2,881

 

1,468

 

1,324

 

 

2,792

 

Total investments

 

11,747

 

1,794

 

(42

)

13,499

 

11,717

 

1,324

 

(36

)

13,005

 

Total cash, cash equivalents and investments

 

$

22,800

 

$

1,794

 

$

(42

)

$

24,552

 

$

29,189

 

$

1,324

 

$

(36

)

$

30,477

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Contractual maturities on investments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Due within 1 year

 

$

8,410

 

 

 

 

 

$

10,182

 

$

8,384

 

 

 

 

 

$

9,682

 

Due after 1 through 5 years

 

3,337

 

 

 

 

 

3,317

 

3,333

 

 

 

 

 

3,323

 

 

 

$

11,747

 

 

 

 

 

$

13,499

 

$

11,717

 

 

 

 

 

$

13,005

 

 

The investments include $7.3 million and $7.5 million, respectively, recorded as restricted deposits on the condensed consolidated balance sheets as of June 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 June 30, 2006, we had $1.1 million of gross realized gains on sales of our available-for-sale securities. For the three months ended June 30, 2005, we had no gross realized gains or losses on sales of our available-for-sale securities. For the six months ended June 30, 2006, we had $1.4 million of gross realized gains on sales of our available-for-sale securities. For the six months ended June 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 and equity securities as a result of an increase in interest rates during 2005 and the first six months of 2006. We have determined that the gross unrealized losses on our available-for-sale securities as of June 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

 

10



 

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 June 30, 2006 (in thousands):

 

 

 

In Loss Position

 

In Loss Position

 

Total In

 

 

 

< 12 months

 

> 12 months

 

Loss Position

 

 

 

 

 

Gross

 

 

 

Gross

 

 

 

Gross

 

 

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

Unrealized

 

 

 

Value

 

(Loss)

 

Value

 

(Loss)

 

Value

 

(Loss)

 

Short-term investments:

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury and agency securities

 

$

3,078

 

$

(13

)

$

1,389

 

$

(8

)

$

4,467

 

$

(21

)

Asset-backed securities

 

203

 

 

1,440

 

(6

)

1,643

 

(6

)

Commercial paper

 

887

 

(1

)

 

 

887

 

(1

)

Corporate bonds

 

2,633

 

(10

)

488

 

(4

)

3,121

 

(14

)

Total in loss position

 

$

6,801

 

$

(24

)

$

3,317

 

$

(18

)

$

10,118

 

$

(42

)

 

Note 5. Inventories, Net

 

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

 

 

 

June 30,

 

December 31,

 

 

 

2006

 

2005

 

Inventories, net:

 

 

 

 

 

Raw materials

 

$

6,815

 

$

6,667

 

Work in process

 

8,878

 

9,141

 

Finished goods

 

499

 

348

 

 

 

$

16,192

 

$

16,156

 

 

Note 6. Restructuring Charges

 

Our restructuring accrual is as follows (in thousands):

 

For the three months ended June 30, 2006

 

Restructuring Accrual
as of March 31, 2006

 

Additions/
Reversals

 

Payments

 

Restructuring
Accrual as of June
30, 2006

 

Future lease payments related to abandoned facilities

 

$

128

 

$

 

$

(128

)

$

 

Workforce reduction

 

 

 

 

 

Total

 

$

128

 

$

 

$

(128

)

$

 

 

For the six months ended June 30, 2006

 

Restructuring Accrual
as of December 31,
2005

 

Additions/
Reversals

 

Payments

 

Restructuring
Accrual as of June
30, 2006

 

Future lease payments related to abandoned facilities

 

$

250

 

$

 

$

(250

)

$

 

Workforce reduction

 

215

 

(2

)

(213

)

 

Total

 

$

465

 

$

(2

)

$

(463

)

$

 

 

In December 2005, we reduced the workforce at our Fremont, California facility by approximately 15 positions that we no longer required to support production and operations, or approximately 29%. This measure was taken as part of our ongoing effort to reduce our Fremont, California facility headcount. 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.

 

11



 

As of June 30, 2006, we have a zero balance for the restructuring accrual 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 out. This was included on the accompanying condensed consolidated balance sheet as accrued restructuring.

 

Note 7. Net Loss Per Share

 

Basic net loss per share is calculated by dividing net loss available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted net 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 loss per share calculations is as follows (in thousands, except per share data):

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

Numerator:

 

 

 

 

 

 

 

 

 

Net loss

 

$

(876

)

$

(3,279

)

$

(3,079

)

$

(7,402

)

Less: Preferred stock dividends

 

(44

)

(44

)

(88

)

(88

)

Net loss available to common stockholders

 

$

(920

)

$

(3,323

)

$

(3,167

)

$

(7,490

)

Denominator:

 

 

 

 

 

 

 

 

 

Denominator for basic net loss per share - weighted average common shares

 

23,052

 

23,079

 

23,019

 

23,113

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

Common stock options

 

 

 

 

 

Denominator for dilutive net loss per common share

 

23,052

 

23,079

 

23,019

 

23,113

 

Basic and diluted net loss per share

 

$

(0.04

)

$

(0.14

)

$

(0.14

)

$

(0.32

)

Options excluded from diluted net loss per share as the impact is anti-dilutive

 

2,722

 

2,492

 

2,722

 

2,492

 

 

Note 8. Comprehensive Loss

 

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

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(876

)

$

(3,279

)

$

(3,079

)

$

(7,402

)

Foreign currency translation loss

 

207

 

(74

)

78

 

(218

)

Unrealized gain (loss) on available-for-sale investments

 

(1,409

)

(200

)

1,902

 

(1,421

)

Less: reclassification adjustment for realized gain included in net loss

 

(1,062

)

 

(1,438

)

 

Comprehensive loss

 

$

(3,140

)

$

(3,553

)

$

(2,537

)

$

(9,041

)

 

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 the Chief Executive Officer, who reviews operating results to make decisions about allocating resources and

 

12



 

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:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

Revenues:

 

 

 

 

 

 

 

 

 

North America*

 

$

2,703

 

$

1,310

 

$

4,662

 

$

2,282

 

Europe

 

2,258

 

1,802

 

3,664

 

3,584

 

Japan

 

1,130

 

559

 

1,796

 

799

 

Taiwan

 

1,415

 

402

 

2,929

 

2,058

 

Asia Pacific

 

2,849

 

1,959

 

5,775

 

3,943

 

Consolidated

 

$

10,355

 

$

6,032

 

$

18,826

 

$

12,666

 

 


*                    Primarily the United States

 

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

 

 

 

June 30,

 

December 31,

 

 

 

2006

 

2005

 

Long-lived assets:

 

 

 

 

 

North America

 

$

6,388

 

$

6,547

 

Asia Pacific

 

10,260

 

10,759

 

 

 

$

16,648

 

$

17,306

 

 

Significant Customers

 

One customer represented 11.4% and 14.6% of revenue for the three months ended June 30, 2006 and 2005, respectively. One customer represented 12.7% and 12.2% of revenue for the six months ended June 30, 2006 and 2005, respectively. Our top five customers represented 40.6% and 38.7% of revenue for the three months ended June 30, 2006, and 2005, respectively. Our top five customers represented 38.5% and 39.8% of revenue for the six months ended June 30, 2006, and 2005, respectively.

 

Note 10. Corporate Affiliates

 

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

 

 

 

 

 

 

 

June 30,

 

December 31,

 

Accounting

 

Ownership

 

Affiliate

 

2006

 

2005

 

Method

 

Percentage

 

Beijing Ji Ya Semiconductor Material Co., Ltd

 

$

996

 

$

1,071

 

Consolidated

 

46

%

Nanjing Jin Mei Gallium Co., Ltd

 

592

 

616

 

Consolidated

 

83

 

Beijing BoYu Manufacturing Co., Ltd

 

410

 

409

 

Consolidated

 

70

 

Xilingol Tongli Ge Co. Ltd

 

878

 

847

 

Equity

 

25

 

Emeishan Jia Mei High Pure Metals Co., Ltd

 

639

 

584

 

Equity

 

25

 

 

13



 

The investment balances for the two affiliates 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 affiliates. These two affiliates are not considered variable interest entities because:

 

                       both affiliates 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 affiliates if they occur, or both; and

 

                       we do not have a controlling financial interest, 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 affiliate.

 

Undistributed retained earnings relating to our corporate affiliates were $3.3 million and $1.8 million as of June 30, 2006 and 2005, respectively. Net income recorded from our corporate affiliates was $455,000 and $243,000 for the three months ended June 30, 2006 and 2005, respectively. Net income recorded from our corporate affiliates was $724,000 and $332,000 for the six months ended June 30, 2006 and 2005, respectively.

 

The minority interest for those affiliates 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.

 

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, its chief technology officer, its former interim chief executive officer, a former safety department employee and a supplier to AXT. 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. AXT’s commercial general liability insurance carrier has agreed to fund AXT’s 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. There is $21 million in available limits under the policies in question. 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

 

14



 

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 during the three months and six months ended June 30, 2006 and 2005 (in thousands):

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

 

 

 

 

 

 

 

 

Beginning accrued warranty and related costs

 

$

184

 

$

135

 

$

120

 

$

135

 

Charged to cost of revenue

 

41

 

(53

)

146

 

(53

)

Actual warranty expenditures

 

(21

)

 

(62

)

 

Ending accrued warranty and related costs

 

$

204

 

$

82

 

$

204

 

$

82

 

 

Sales Returns

 

In March 2004, we increased our reserve for repair and replacement costs by $745,000. As of June 30, 2006, this reserve 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 gains of $47,000 and losses of $29,000 for the three months ended June 30, 2006, and 2005, respectively. We incurred foreign currency transaction exchange gains of $11,000 and losses of $49,000 for the six months ended June 30, 2006, and 2005, respectively. These amounts are included in other income (expense), net on the condensed consolidated statements of operations.

 

15



 

Note 13. Recent Accounting Pronouncements

 

In February 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 155 (“SFAS 155”), “Accounting for Certain Hybrid Instruments – an amendment of FASB Statements No. 133 and 140”. 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 gives 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 uncertainly 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.

 

Note 14. Subsequent Event

 

In June 2006, the Company filed a Form S-3 shelf registration with the Securities and Exchange Commission, which was declared effective by the SEC on August 2006. Under the shelf registration process, we may offer shares of our common stock with a total value of up to $25.0 million.

 

16



 

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

 

This Management’s Discussion and Analysis of Financial Condition and Results of Operations includes a number of forward-looking statements made pursuant to the provisions of Section 21E of the Securities Exchange Act of 1934. 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. These risks and uncertainties include those set forth under “Risks Related to our Business” below. Forward-looking statements may be identified by the use of terms such as “anticipates”, “believes”, “estimates”, “expects” and “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. 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, 2005 and the condensed consolidated financial statements included elsewhere in this report.

 

Overview

 

We design, develop, manufacture and distribute high-performance compound and single element semiconductor substrates comprising gallium arsenide (GaAs), indium phosphide (InP) and germanium (Ge). Our substrate products are used primarily in lighting display applications, wireless communications and fiber optic communications. We believe our vertical gradient freeze, or VGF, technique for manufacturing semiconductor substrates provides significant benefits over other methods and has enabled us to become a leading manufacturer of such substrates. We pioneered the commercial use of VGF technology to manufacture GaAs substrates and subsequently used VGF technology to manufacture substrates from InP and Ge.

 

We also manufacture and sell raw materials related to our substrate business through five joint ventures located in China. These joint ventures produce products including 99.99% pure gallium (4N Ga), high purity gallium, arsenic, germanium, germanium dioxide, paralytic boron nitride (pBN) crucibles and boron oxide. AXT’s ownership interest in these entities ranges from 25% to 83%. We consolidate the three ventures in which we own a majority or controlling financial interest and employ equity accounting for the two joint ventures in which we have a 25% interest. We purchase portions of the materials produced by these ventures for our own use and the joint ventures sell the remainder of their production to third parties.

 

Revenue from continuing operations increased $6.2 million, or 48.6%, to $18.8 million for the six months ended June 30, 2006 from $12.7 million for the same period of 2005 primarily due to our improved product quality and higher customer demands for six-inch diameter wafers. As of June 30, 2006, we had available cash, cash equivalents and short-term investments of $17.3 million, excluding restricted deposits.

 

Discontinued Opto-Electronics Business

 

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. See Note 2 to our condensed consolidated financial statements for details regarding the accounting for discontinued operations.

 

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.

 

In June 2005, we completed the sale of a building located in Monterey Park, California. This asset had been classified as “assets held for sale” in the amount of $1.25 million on the consolidated balance sheet as of December 31, 2004. We received net proceeds on the sale of the property of approximately $1.3 million and accordingly recorded a gain on disposal of $53,000.

 

17



 

Restructuring Charges

 

In December 2005, we further reduced the work force at our Fremont, California facility by approximately 15 positions that we no longer required to support production and operations, or approximately 29%. This measure was taken as part of our ongoing effort to reduce our Fremont, California facility headcount, and we expect to save $0.9 million annually in payroll and related expenses. Accordingly, we recorded a restructuring charge of approximately $273,000 related to the reduction in force for severance-related expenses, of which $215,000 was the balance as of December 31, 2005. We completed the reduction in force in the first quarter of 2006.

 

As of June 30, 2006, the remaining restructuring accrual for future lease payments related to abandoned U.S. facilities located in California that are no longer required to support production was zero, as these have all been paid out. This was included on the accompanying condensed consolidated balance sheet as accrued restructuring.

 

Critical Accounting Policies and Estimates

 

We have prepared our condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America. As such, we have had to 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.

 

We believe that the following are our critical accounting policies:

 

Revenue Recognition

 

We manufacture and sell high-performance compound and single element 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 recognition of the revenue earned on the sale. 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 ordinarily 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. Additionally, we do not provide discounts or other incentives to customers except for one customer with which we agreed in the fourth quarter of 2004 to provide a certain amount of cumulative discounts on future product purchases from us. We will recognize these discounts in future periods as a reduction in revenue as products are sold to this customer.

 

We provide for future returns based on historical experience, current economic trends and changes in customer demand at the time revenue is recognized. In the first quarter of 2004, we recorded a specific reserve for sales returns of $745,000 related to our failure to follow certain testing requirements and provide testing data and information to certain customers. This reserve was based on discussions with some of the affected customers and review of specific shipments. As of June 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.

 

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 provide a 100% allowance for U.S. receivables in excess of 90 days and for foreign receivables in excess of 120 days. 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 June 30, 2006 and December 31, 2005, our accounts receivable balance was $7.4 million and $5.2 million,

 

18



 

respectively, which was net of an allowance for doubtful accounts of $0.6 million and $0.6 million, 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 period.

 

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 June 30, 2006 and December 31, 2005, accrued product warranties totaled $204,000 and $120,000, 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.

 

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 June 30, 2006 and December 31, 2005, we had an inventory reserve of $17.7 million and $16.9 million for excess and obsolete inventory, respectively. The majority of this inventory has not been scrapped. 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 as prescribed by Statement of Financial Accounting Standards (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” 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 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 the 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.

 

Impairment of Long-Lived Assets

 

We evaluate the recoverability of property, equipment and intangible assets in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” 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.

 

Employee Stock Options

 

We grant options to substantially all management employees and believe that this program helps us to attract, motivate and retain high quality employees, to the ultimate benefit of our stockholders. Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”), using the modified prospective application transition method. Under this transition method, stock-based compensation cost was recognized in the condensed consolidated financial statements for all share-based payments after January 1, 2006. Compensation cost recognized includes the estimated expense for the portion of the vesting period after January 1, 2006 for share-based payments prior to, but not vested as of January 1, 2006, based on the grant date fair

 

19



 

value estimated in accordance with the original provisions of SFAS 123 “Accounting for Stock-Based Compensation”. Results for prior periods have not been restated, as provided for under the modified prospective application transition method. See Note 3 to our condensed consolidated financial statements.

 

Income Taxes

 

We account for income taxes in accordance with SFAS No. 109 “Accounting for Income Taxes” (“SFAS 109”), 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. SFAS 109 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.

 

Results of Operations

 

Revenue

 

 

 

Three Months Ended

 

 

 

 

 

 

 

June 30,

 

Increase

 

 

 

 

 

2006

 

2005

 

(Decrease)

 

% Change

 

 

 

($ in thousands)

 

 

 

 

 

GaAs

 

$

8,125

 

$

4,487

 

$

3,638

 

81.1

%

InP

 

613

 

280

 

333

 

118.9

%

Ge

 

169

 

25

 

144

 

576.0

%

Raw materials

 

1,448

 

1,231

 

217

 

17.6

%

Other

 

 

9

 

(9

)

(100

)%

Total revenue

 

$

10,355

 

$

6,032

 

$

4,323

 

71.7

%

 

Revenue increased $4.3 million, or 71.7%, to $10.4 million for the three months ended June 30, 2006 from $6.0 million for the three months ended June 30, 2005. Total GaAs substrate revenue increased $3.6 million, or 81.1%, to $8.1 million for the three months ended June 30, 2006 from $4.5 million for the three months ended June 30, 2005.

 

Sales of 5 inch and 6 inch diameter GaAs substrates were $3.3 million for the three months ended June 30, 2006 compared with $0.5 million for the three months ended June 30, 2005. The increase in larger diameter substrate revenue was due to the fact that, while the GaAs device market grew in strength for both cellular and the WLAN (Wide Local Area Network) markets, the compound semiconductor industry has been experiencing capacity constraints; with our excess capacity we were able to benefit from the overflow business from our competition.

 

 Sales of 2 inch, 3 inch and 4 inch diameter GaAs substrates were $4.9 million for the three months ended June 30, 2006 compared with $4.0 million for the three months ended June 30, 2005. The increase in smaller diameter substrate revenue was due to the continued growth of LED laser diodes and commercial epitaxy.

 

InP substrate revenue increased $333,000, or 118.9%, to $613,000 for the three months ended June 30, 2006 from $280,000 for the three months ended June 30, 2005. The increase in InP substrate revenue was due to one particular large customer order as a result of a government contract which is not expected to repeat for the remainder of 2006.

 

Ge substrate revenue increased $144,000, or 576.0%, to $169,000 for the three months ended June 30, 2006 from $25,000 for the three months ended June 30, 2005. The increase in Ge substrate revenue was due to more customer qualifications in China where demand for photovoltaic applications is high.

 

Raw materials revenue increased $217,000, or 17.6%, to $1.4 million for the three months ended June 30, 2006 from $1.2 million for the three months ended June 30, 2005. The increase in raw materials revenue was due to sales of germanium dioxide to a new customer.

 

20



 

Revenue

 

 

 

Six Months Ended

 

 

 

 

 

 

 

June 30,

 

Increase

 

 

 

 

 

2006

 

2005

 

(Decrease)

 

% Change

 

 

 

($ in thousands)

 

 

 

 

 

GaAs

 

$

14,880

 

$

9,680

 

$

5,200

 

53.7

%

InP

 

909

 

417

 

492

 

118.0

%

Ge

 

205

 

30

 

175

 

583.3

%

Raw materials

 

2,832

 

2,522

 

310

 

12.3

%

Other

 

 

17

 

(17

)

(100

)%

Total revenue

 

$

18,826

 

$

12,666

 

$

6,160

 

48.6

%

 

Revenue increased $6.1 million, or 48.6%, to $18.8 million for the six months ended June 30, 2006 from $12.7 million for the six months ended June 30, 2005. Total GaAs substrate revenue increased $5.2 million, or 53.7%, to $14.9 million for the six months ended June 30, 2006 from $9.7 million for the six months ended June 30, 2005.

 

Sales of 5 inch and 6 inch diameter GaAs substrates were $6.0 million for the six months ended June 30, 2006 compared with $1.0 million for the six months ended June 30, 2005. The increase in larger diameter substrate revenue was due to the fact that, while the GaAs device market grew in strength for both cellular and the WLAN (Wide Local Area Network) markets, the compound semiconductor industry has been experiencing capacity constraints; with our excess capacity we were able to benefit from the overflow business from our competition.

 

Sales of 2 inch, 3 inch and 4 inch diameter GaAs substrates were $8.7 million for the six months ended June 30, 2006 compared with $8.7 million for the six months ended June 30, 2005. We have sold a larger quantity of smaller diameter wafers in 2006 compared to 2005, but generated the same dollar revenue due to the continuing pricing pressures causing average sales prices to decline. The reason for the increase in sales volume was due to the continued growth of LED laser diodes and commercial epitaxy.

 

InP substrate revenue increased $0.5 million, or 118.0%, to $0.9 million for the six months ended June 30, 2006 from $417,000 for the six months ended June 30, 2005. The increase in InP substrate revenue was due to the receipt of one large customer order for a government contract that is not expected to repeat for the remainder of 2006.

 

Ge substrate revenue increased $0.2 million, or 583.3%, to $0.2 million for the six months ended June 30, 2006 from $30,000 for the six months ended June 30, 2005. The increase in Ge substrate revenue was due to more customer qualifications in China where demand for photovoltaic applications is high.

 

Raw materials revenue increased $310,000, or 12.3%, to $2.8 million for the six months ended June 30, 2006 from $2.5 million for the six months ended June 30, 2005. The increase in raw materials revenue was mainly due to sales of germanium dioxide to a new customer.

 

21



 

Revenue by Geographic Region

 

 

 

Three Months Ended

 

 

 

 

 

 

 

June 30,

 

Increase

 

 

 

 

 

2006

 

2005

 

(Decrease)

 

% Change

 

 

 

($ in thousands)

 

 

 

 

 

North America *

 

$

2,703

 

$

1,310

 

$

1,393

 

106.3

%

% of total revenue

 

26

%

22

%

 

 

 

 

Europe

 

2,258

 

1,802

 

456

 

25.3

%

% of total revenue

 

22

%

30

%

 

 

 

 

Japan

 

1,130

 

559

 

571

 

102.1

%

% of total revenue

 

11

%

9

%

 

 

 

 

Taiwan

 

1,415

 

402

 

1,013

 

252.0

%

% of total revenue

 

14

%

7

%

 

 

 

 

Asia Pacific (excluding Japan and Taiwan)

 

2,849

 

1,959

 

890

 

45.4

%

% of total revenue

 

27

%

32

%

 

 

 

 

Total revenue

 

$

10,355

 

$

6,032

 

$

4,323

 

71.7

%

 


*                 Primarily the United States

 

The North America revenue increased by $1.4 million, or 106.3%, to $2.7 million for the three months ended June 30, 2006 from $1.3 million for the three months ended June 30, 2005. We believe our quality has improved as shown by customers that have qualified our China-grown products as sales to existing customers increased by $1.1 million, while we gained $0.3 million in sales to new customers.

 

The Europe revenue increased by $0.5 million, or 25.3%, to $2.3 million for the three months ended June 30, 2006 from $1.8 million for the three months ended June 30, 2005. This increase came from increased substrate sales to customers in France, partially offset by decreases in sales to customers in Germany and the United Kingdom.

 

The Japan revenue increased by $0.6 million, or 102.1%, to $1.1 million for the three months ended June 30, 2006 from $0.6 million for the three months ended June 30, 2005. The increase came from substrate sales to existing customers mainly in larger diameter wafers.

 

The Taiwan revenue increased by $1.0 million, or 252.0%, to $1.4 million for the three months ended June 30, 2006 from $0.4 million for the three months ended June 30, 2005. The increase was due to sales to existing customers of $0.9 million mainly in larger diameter wafers, while we gained $0.1 million in sales to new customers mainly in smaller diameter wafers.

 

The Asia Pacific (excluding Japan and Taiwan) revenue increased by $0.9 million, or 45.4% to $2.8 million for the three months ended June 30, 2006 from $2.0 million for the three months ended June 30, 2005. Of this increase, sales to customers in China accounted for $0.5 million of the increase in substrate sales and $0.1 million of the increase in raw material sales. Revenue from sales to customers in Malaysia and Singapore accounted for $0.2 million of the increase in substrate sales.

 

22



 

 

 

Six Months Ended

 

 

 

 

 

 

 

June 30,

 

Increase

 

 

 

 

 

2006

 

2005

 

(Decrease)

 

% Change

 

 

 

($ in thousands)

 

 

 

 

 

North America *

 

$

4,662

 

$

2,282

 

$

2,380

 

104.3

%

% of total revenue

 

25

%

18

%

 

 

 

 

Europe

 

3,664

 

3,584

 

80

 

2.2

%

% of total revenue

 

19

%

28

%

 

 

 

 

Japan

 

1,796

 

799

 

997

 

124.8

%

% of total revenue

 

10

%

7

%

 

 

 

 

Taiwan

 

2,929

 

2,058

 

871

 

42.3

%

% of total revenue

 

16

%

16

%

 

 

 

 

Asia Pacific (excluding Japan and Taiwan)

 

5,775

 

3,943

 

1,832

 

46.5

%

% of total revenue

 

30

%

31

%

 

 

 

 

Total revenue

 

$

18,826

 

$

12,666

 

$

6,160

 

48.6

%

 


*                 Primarily the United States

 

The North America revenue increased by $2.4 million, or 104.3%, to $4.7 million for the six months ended June 30, 2006 from $2.3 million for the six months ended June 30, 2005. We believe our quality has improved as shown by customers that have qualified our China-grown products as sales to existing customers increased by $1.8 million, while we gained $0.6 million in sales to new customers.

 

The Europe revenue increased by $80,000, or 2.2%, to $3.7 million for the six months ended June 30, 2006 from $3.6 million for the six months ended June 30, 2005. This increase came from increased substrate sales to customers in France, partially offset by decreases in sales to customers in the United Kingdom. In the United Kingdom we lost one customer in the second half of 2005 due to quality problems with our product. We are beginning to regain sales to this customer as it began placing orders with us again in the first half of 2006.

 

The Japan revenue increased by $997,000, or 124.8%, to $1.8 million for the six months ended June 30, 2006 from $799,000 for the six months ended June 30, 2005. Raw material sales to a new customer accounted for $0.3 million of this increase, while $0.3 million was from substrate sales to new customers that have qualified our China-grown products, and by $0.4 million of increased sales to existing customers, mainly for larger diameter wafers.

 

The Taiwan revenue increased by $871,000, or 42.3%, to $2.9 million for the six months ended June 30, 2006 from $2.1 million for the six months ended June 30, 2005. The increase was due to sales to existing customers of $0.7 million mainly in large diameter wafers, while we gained $0.2 million in sales to new customers mainly in smaller diameter wafers.

 

The Asia Pacific (excluding Japan and Taiwan) revenue increased by $1.8 million, or 46.5% to $5.8 million for the six months ended June 30, 2006 from $3.9 million for the six months ended June 30, 2005. Of this increase, sales to customers in Malaysia and Singapore accounted for $1.3 million of the increase, mainly in larger diameter wafers, while sales to customers in China increased by $0.3 million, and Korea increased by $0.2 million.

 

23



 

Gross Margin

 

 

 

Three Months Ended

 

 

 

 

 

 

 

June 30,

 

Increase

 

 

 

 

 

2006

 

2005

 

(Decrease)

 

% Change

 

 

 

($ in thousands)

 

 

 

 

 

Gross profit

 

$

2,759

 

$

127

 

$

2,632

 

2,072.4

%

Gross Margin %

 

26.6

%

2.1

%

 

 

 

 

 

Gross margin. Gross margin increased to 26.6% of total revenue for the three months ended June 30, 2006 compared with 2.1% of total revenue for the three months ended June 30, 2005. Gross margin in the three months ended June 30, 2006 was positively impacted by sales of approximately $802,000 of gallium arsenide (GaAs) wafers which were previously fully reserved. Product mix also contributed to higher gross margins as we sold a greater amount of InP substrates, as well as larger diameter GaAs wafers, both of which contributed larger gross profits. In December 2005, we reduced the workforce at our Fremont, California facility that we no longer required to support production. This workforce reduction accounted for approximately 2% of the increase in gross margin in the three months ended June 30, 2006. Gross margin in the three months ended June 30, 2005 was negatively impacted by a $765,000 charge to cost of revenues as a result of an inventory valuation adjustment. This charge negatively impacted gross margin by 12.7%. Gross margin in the three months ended June 30, 2005 was positively impacted by sales of approximately $651,000 of GaAs wafers which were previously fully reserved.

 

 

 

Six Months Ended

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