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AXTI > SEC Filings for AXTI > Form 10-Q on 10-May-2013All Recent SEC Filings

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Form 10-Q for AXT INC


10-May-2013

Quarterly Report


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, 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. 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, 2012 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",   ? Power amplifiers and radio frequency integrated
                           4", 5",     circuits for wireless handsets (cell phones)
                                6"
                                     ? Direct broadcast television
                                     ? High-performance transistors
                                     ? Satellite communications

GaAs (semi-conducting)     2", 3",   ? High brightness light emitting diodes
                                4"
                                     ? Lasers
                                     ? Optical couplers

InP                        2", 3",   ? Broadband and fiber optic communications
                                4"

Ge                         2", 4",   ? Satellite and terrestrial solar cells
                                6"
                                     ? 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 pricing advantages, reliable supply and enhanced sourcing lead-times for key raw materials which 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 employ equity accounting for the joint ventures in which we have a smaller ownership interest and significant influence on management. 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. 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.


Table of Contents

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.

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 in excess of 90 days and for receivables from customers located outside the U.S. in excess of 120 days and reserve allowance on the receivable balances if needed. 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 March 31, 2013 and December 31, 2012, our accounts receivable, net, balance was $17.0 million and $17.9 million, respectively, with no allowance for doubtful accounts. 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 affected period.

The allowance for sales returns is also deducted from gross accounts receivable. As of March 31, 2013 and December 31, 2012, our allowance for sales returns was $270,000 and $245,000, 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 March 31, 2013 and December 31, 2012, accrued product warranties totaled $749,000 and $588,000, 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 for future periods.


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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 March 31, 2013 and December 31, 2012, we had an inventory reserve of $9.7 million and $10.1 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 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 months ended March 31, 2013 or 2012.

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 March 31, 2013, 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 months ended March 31, 2013.


Table of Contents

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 March 31, 2013 or December 31, 2012.

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 for stock options 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.

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.


Table of Contents

Results of Operations

Revenue
                  Three Months Ended
                       March 31,              Increase
                   2013          2012        (Decrease)       % Change
                   ($ in thousands)
GaAs            $   11,723     $ 12,231     $       (508 )         (4.2 )%
InP                  1,849        1,451              398           27.4 %
Ge                   2,551        2,630              (79 )         (3.0 )%
Raw materials        6,257        7,174             (917 )        (12.8 ) %
Total revenue   $   22,380     $ 23,486     $     (1,106 )         (4.7 ) %

Revenue decreased $1.1 million, or 4.7%, to $22.4 million for the three months ended March 31, 2013 from $23.5 million for the three months ended March 31, 2012. Total GaAs substrate revenue decreased $508,000, or 4.2%, to $11.7 million for the three months ended March 31, 2013 from $12.2 million for the three months ended March 31, 2012. The decrease in GaAs substrate revenue was primarily due to the softer demand environment from our current customer base in both wireless devices market and the light emitting diode (LED) market.

Sales of 2 inch, 3 inch and 4 inch diameter GaAs substrates, which are mainly semi-conducting substrates used in LED applications, decreased $515,000 to $7.5 million for the three months ended March 31, 2013 from $8.0 million for the three months ended March 31, 2012. The decrease in revenue from smaller diameter substrates was primarily due to weaker demand from our current customers in the LED market.

Sales of 5 inch and 6 inch diameter GaAs substrates, which are mainly semi-insulting substrates used in wireless devices, increased slightly by $6,000 to $4.2 million for the three months ended March 31, 2013 from $4.2 million for the three months ended March 31, 2012. The increase in revenue from larger diameter substrates was primarily due to fluctuation in demand for 5 inch semi-insulating GaAs substrate.

InP substrate revenue increased $398,000, or 27.4%, to $1.8 million for the three months ended March 31, 2013 from $1.5 million for the three months ended March 31, 2012 as demand from customers in the optical networking industry increased. We continued to see renewed demand for these substrates as investment in high-speed optical communications increased worldwide.

Ge substrate revenue decreased slightly by $79,000, or 3.0%, to $2.6 million for the three months ended March 31, 2013 from $2.6 million for the three months ended March 31, 2012 due to fluctuation in demand from our customers for satellite applications and for concentrated photovoltaic solar applications.

Raw materials revenue decreased $917,000, or 12.8%, to $6.3 million for the three months ended March 31, 2013 from $7.2 million for the three months ended March 31, 2012 primarily due to decreased selling prices which was partially offset by increased tonnage sold.

                           Revenue by Geographic Region


                                              Three Months Ended
                                                  March 31,               Increase
                                              2013          2012         (Decrease)       % Change
                                               ($ in thousands)
China                                      $    6,029     $   5,774     $        255            4.4 %
% of total revenue                                 27 %          25 %
Europe (primarily Germany)                      4,689         4,565              124            2.7 %
% of total revenue                                 21 %          19 %
Taiwan                                          3,779         2,046            1,733           84.7 %
% of total revenue                                 17 %           9 %
North America (primarily the United
States)                                         3,469         5,167           (1,698 )        (32.9 )%
% of total revenue                                 16 %          22 %
Japan                                           2,282         2,189               93            4.2 %
% of total revenue                                 10 %           9 %
Asia Pacific (excluding China, Taiwan
and Japan)                                      2,132         3,745           (1,613 )        (43.1 ) %
% of total revenue                                  9 %          16 %
Total revenue                              $   22,380     $  23,486     $     (1,106 )         (4.7 ) %


Table of Contents

Revenue from customers in China increased by $255,000, or 4.4%, to $6.0 million for the three months ended March 31, 2013 from $5.8 million for the three months ended March 31, 2012 primarily due to increased GaAs substrate revenue and Ge substrate revenue partially offset by decreased raw materials revenue.

Revenue from customers in Europe increased by $124,000, or 2.7%, to $4.7 million for the three months ended March 31, 2013 from $4.6 million for the three months ended March 31, 2012 primarily due to increased GaAs substrate revenue and raw materials revenue partially offset by decreased Ge substrate revenue.

Revenue from customers in Taiwan increased by $1.7 million, or 84.7%, to $3.8 million for the three months ended March 31, 2013 from $2.0 million for the three months ended March 31, 2012 primarily due to increased semi-insulating GaAs substrate revenue and InP substrate revenue.

Revenue from customers in North America decreased by $1.7 million, or 32.9%, to $3.5 million for the three months ended March 31, 2013 from $5.2 million for the three months ended March 31, 2012 primarily due to decreased raw materials revenue resulting from decreased selling prices of 4N raw gallium and decreased orders from our customers for semi-insulating GaAs substrates.

Revenue from customers in Japan increased by $93,000, or 4.2%, to $2.3 million for the three months ended March 31, 2013 from $2.2 million for the three months ended March 31, 2012 primarily due to increased raw materials revenue partially offset by decreased GaAs substrate revenue.

Revenue from customers in Asia Pacific (excluding China, Taiwan and Japan) decreased by $1.6 million, or 43.1%, to $2.1 million for the three months ended March 31, 2013 from $3.7 million for the three months ended March 31, 2012 primarily due to decreased semi-insulating GaAs substrate revenue from customers in Singapore.

Gross Margin

                   Three Months Ended
                        March 31,              Increase
                    2013          2012        (Decrease)       % Change
                    ($ in thousands)
Gross profit     $    3,484      $ 8,194     $     (4,710 )        (57.5 )%
Gross Margin %         15.6 %       34.9 %

Gross margin decreased to 15.6% of total revenue for the three months ended March 31, 2013 from 34.9% of total revenue for the three months ended March 31, 2012. Higher priced raw material in our inventory and overall lower average selling prices negatively impacted the gross margins for all substrates. Gross margins for raw material sales also decreased due to decreased selling prices of 4N raw gallium.

Selling, General and Administrative Expenses

                                                  Three Months Ended
                                                       March 31,               Increase
                                                  2013           2012         (Decrease)       % Change
                                                   ($ in thousands)
Selling, general and administrative expenses   $    3,925      $   3,785     $        140            3.7 %
% of total revenue                                   17.5 %         16.1 %

Selling, general and administrative expenses increased $140,000, or 3.7% to $3.9 million for the three months ended March 31, 2013 from $3.8 million for the three months ended March 31, 2012. The increase was primarily due to higher personnel related costs, higher health insurance from our joint ventures in China and higher stock-based compensation expenses resulting from the options and stock awards granted in 2012 which were expensed over the vesting schedule, offset by lower freight charges.

Research and Development

                              Three Months Ended
                                   March 31,               Increase
                             2013            2012         (Decrease)       % Change
                               ($ in thousands)
. . .
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