More annual reports from AXT:
2023 ReportPeers and competitors of AXT:
Amtech Systems 1 - --------------------------------------------------------------------------------- -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K ------------------------ (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 OR [ ] 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: 0-24085 AMERICAN XTAL TECHNOLOGY, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 94-3031310 (STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 4311 SOLAR WAY, FREMONT, CALIFORNIA 94538 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (510) 683-5900 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, $.001 PAR VALUE Indicate by checkmark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15 (d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes [X] No [ ] Indicate by checkmark if disclosure of delinquent filers pursuant to Item405 of Regulation S-K is not contained herein, and will not be contained, to thebest of registrant's knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or any amendment to thisForm 10-K. [ ] The aggregate market value of the voting stock held by non-affiliates ofthe registrant, based upon the closing sale price of the common stock onDecember 31, 1998 as reported on the Nasdaq National Market, was approximately$115,515,000. Shares of common stock held by each officer, director and by eachperson who owns 5% or more of the outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This determination ofaffiliate status is not a conclusive determination for other purposes. As of December 31, 1998, 16,116,675 shares, $.001 par value, of theregistrant's common stock was outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the definitive proxy statement for the registrant's 1999 annualmeeting of stockholders to be filed with the Commission pursuant to Regulation14A not later than 120 days after the end of the fiscal year covered by thisform are incorporated by reference into Part III of this Form 10-K report. - --------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 2 PART I This report includes forward-looking statements which reflect our currentviews with respect to future events and our potential financial performance.These forward-looking statements are subject to certain risks and uncertainties,including those discussed in "Business", "Management's Discussion and Analysisof Financial Condition and Results of Operations", and elsewhere in this report,that could cause actual results to differ materially from historical results orthose anticipated. In this report, the words "anticipates," "believes,""expects," "intends," "future" and similar expressions identify forward-lookingstatements. Readers are cautioned not to place undue reliance on theseforward-looking statements, which speak only as of the date of this report. ITEM 1. BUSINESS GENERAL We use a proprietary vertical gradient freeze, commonly referred to as"VGF," technique to produce high-performance compound semiconductor substrateswhich are used in a variety of electronic and opto-electronic applications suchas wireless and fiber optic telecommunications, lasers, LEDs, satellite solarcells and consumer electronics. We primarily manufacture and sell galliumarsenide, called GaAs, substrates. Sales of GaAs substrates accounted forapproximately 81.8% of our product revenues in 1998. We also manufacture andsell indium phosphide, or InP, and germanium, or Ge, substrates and arecurrently developing other high-performance compound substrates includinggallium phosphide, or GaP, and gallium nitride, or GaN. Our customers include: - EMCORE, - Hewlett Packard, - Motorola, - NEC, - Nortel, - Siemens, - Sony, - Spectrolab, and - TRW. BACKGROUND Recent advances in communications and information technologies have createda growing need for power efficient, high-performance electronic systems that operate at very high frequencies, have increased computational and displaycapabilities, and can be produced cost-effectively in commercial volumes. In thepast, electronic systems manufacturers have relied on advances in siliconsemiconductor technology to meet many of these demands. Silicon-basedsemiconductor devices, however, have performance limitations in power efficient,high-performance electronic applications. In addition, silicon-basedsemiconductor devices currently do not possess the electrical propertiesnecessary to be used effectively in most opto-electronic applications such asLEDs and lasers. As a result of the limitations of silicon, semiconductor devicemanufacturers are increasingly utilizing alternative substrates to improve theperformance of semiconductor devices or to enable new applications. Thesealternative substrates may be composed of a single element, such as Ge, ormultiple elements which may include: - gallium, - aluminum, - indium, 1 3 - arsenic, - phosphorus, and - nitrogen. Substrates that consist of more than one element are commonly referred toas "compound substrates" and include GaAs, InP, GaP and GaN. GaAs is currentlythe most widely used compound substrate. In comparison to silicon, compoundsubstrates have electrical properties that allow semiconductor devices tooperate at much higher speeds or at the same speed with lower power consumption.For example, electrons move up to five times faster in GaAs than in silicon.Compound substrates also have better opto-electronic characteristics thansilicon which allow them to convert energy into light and lasers, or to detectlight and convert light into electrical energy. The GaAs substrate market isdivided into two segments, semi-insulating and semi-conducting. Semi-insulating GaAs substrates. The market for semi-insulating GaAssubstrates is the fastest growing segment of the GaAs market. According toprojections by Dataquest, IDC and Strategies Unlimited, the market forsemi-insulating GaAs substrates was estimated at $125 million in 1998 and isexpected to grow to approximately $400 million by the year 2002. This growth isbeing driven by increasing demand for semi-insulating GaAs substrates in avariety of power-efficient, high-performance applications, including cellularphones, radars, satellite communication systems and direct broadcast systems. Manufacturers integrate semi-insulating GaAs substrates into devices usingeither an ion implantation or epitaxial process. Ion implantation is the processof implanting ions directly into the semi-insulating GaAs substrate to modifythe electrical parameters of the substrate so that it can be used to manufacturemany of today's high-performance electronic devices. This process requires theelectrical parameters of the substrate to be as uniform as possible. Epitaxy, amore recently developed process, involves the growth of layers of othermaterials onto the semi-insulating GaAs substrate. While generally moreexpensive than the ion implantation process, the epitaxial process enablesdevices to achieve even greater performance advantages. The epitaxial processrequires that the GaAs substrate have an extremely smooth surface, few physicalimperfections, uniform electrical properties and low dislocation density, whichis a measurement of the crystalline perfection of the substrate material. Traditionally, crystals for semi-insulating GaAs substrates for the ionimplantation and epitaxy markets have been grown using the liquid-encapsulated czochralski, or LEC technique. The LEC technique requires a high temperaturegradient in the manufacturing process. Because the temperature gradient in theLEC technique is high, the resulting crystals have a relatively high dislocationdensity which weakens a crystal's physical structure and increases the risk ofbreakage of the GaAs substrate during device manufacturing. In addition, assemi-insulating GaAs substrates continue to grow in size to support increasinglycomplex devices, the manufacturing challenges facing the LEC technique increase. Semi-conducting GaAs substrates. We believe that the market forsemi-conducting GaAs substrates, based on 1998 market data and annual growthrates projected by Dataquest, IDC and Strategies Unlimited, was approximately$90 million in 1998 and we expect that the market will continue to grow. Themarket for semi-conducting GaAs substrates is being driven by increasing demandfor a number of opto-electronic applications such as LEDs and lasers, which areincorporated into a variety of products including: - traffic lights, - digital versatile discs, more commonly known as DVD players, - CD players, - CD-ROMs, - laser printers, - automobile lights and - electronic displays. 2 4 In contrast to semi-insulating GaAs substrates which undergo either an ionimplantation or epitaxial process, semi-conducting GaAs substrates only undergoan epitaxial process. As with semi-insulating GaAs substrates, semi-conductingGaAs substrates that undergo the epitaxial process must have a smooth surface,few physical imperfections, uniform electrical properties and a low dislocationdensity. The traditional method of growing crystals for producingsemi-conducting GaAs substrates is the Horizontal Bridgeman, or HB, technique.With the HB technique, the crystal is grown in a semi-cylindrical containerwhich results in a semi-circular, or D-shaped, substrate. In order to produce around semi-conducting GaAs substrate, the HB technique requires that theD-shaped substrate be cut into a circle, resulting in a large amount ofdiscarded substrate. In addition, crystals grown using the HB techniquegenerally have a relatively high dislocation density and less uniform electricalproperties. These and other inherent technical difficulties limit the ability ofthe HB technique to be used to cost-effectively produce high-quality substratesgreater than three inches in diameter. Other high-performance substrates. We believe there are significant growthopportunities in manufacturing other high-performance substrates. For example,we believe that the markets for InP and GaP substrates, based on 1997 marketdata and annual growth rates projected by Dataquest, IDC and StrategiesUnlimited, were an aggregate of approximately $150 million in 1998 and we expectthat these markets will continue to grow. Semi-insulating InP substrates areused in power-efficient, high-performance electronic applications such aswireless and high-bandwidth communications and semi-conducting InP substratesare used in such applications as fiber optic communications and lasers. GaPsubstrates are used by manufacturers of LEDs. The traditional method for growingcrystals for InP and GaP substrates has been the LEC, technique. In addition tocompound substrates, the market for the element Ge is developing in response tothe growing demand for solar cells in satellite communications. We believe thatthe market for Ge substrates used to manufacture solar cells was approximately$60 million in 1998 and we expect that the market will continue to grow. Thisapplication requires the use of Ge substrates which must be manufactured withfew defects and minimal breakage. We believe the further development of thesemarkets depends on the ability of suppliers to cost-effectively manufacture power-efficient, high-performance compound and single-element substrates. THE AXT SOLUTION We use a proprietary VGF technique to produce high-performance GaAs andother substrates for use in a variety of electronic and opto-electronicapplications. We believe that our VGF technique, which we have developed overthe past 12 years, provides certain significant advantages over traditionalmanufacturing methods for growing crystals used in the production ofsemi-insulating and semi-conducting GaAs substrates. We believe that we arecurrently the only high-volume supplier of GaAs substrates manufactured by usingthe VGF technique and are positioned to become a leading manufacturer andsupplier of other compound and Ge substrates. In the GaAs substrate market, crystals grown using our proprietary VGFtechnique have a dislocation density that is significantly lower than crystalsgrown using either the LEC or HB technique. As a result, we believe our GaAssubstrates have greater mechanical strength which often results in reducedbreakage during the ion implantation and epitaxial growth processes.Furthermore, we believe the low dislocation density of our semi-insulating andsemi-conducting GaAs substrates translates into fewer defects in the materialslayered onto the substrate during the epitaxy process. In addition,semi-insulating GaAs substrates produced using our VGF technique have moreuniform electrical properties than LEC-produced GaAs substrates, which isimportant for the ion implantation process. In the semi-conducting GaAssubstrate market, VGF-grown crystals, unlike those grown using the traditionalHB technique, can be processed into round substrates with minimal wastedmaterial. Using our VGF technique, we have been able to produce GaAs substratesas large as six inches in diameter. In addition to the GaAs substrate market, we believe we can leverage ourexpertise in the VGF technique to manufacture and produce commercial volumes ofother compound and single-element substrates. For example, in 1998, we shippedGe and InP substrates to customers and qualified our wafers with many morepotential customers. 3 5 STRATEGY Our strategy is to be the leading developer and supplier ofhigh-performance GaAs substrates for both the semi-insulating andsemi-conducting markets, and to continue to expand into the development andsupply of other substrates. The key elements of our strategy include: Advance VGF technology leadership. We pioneered the commercial use of theVGF technique and have continued to develop and enhance our technology over thecourse of 12 years through substantial investments in research and development.Our efforts have led to significant improvements in the dislocation density,mechanical strength and uniformity of the electrical properties of GaAssubstrates. We believe that our experience and expertise in VGF technologyprovides us with a competitive advantage over more recent market entrants whoare utilizing variations of the VGF technology. We intend to continue to advanceour VGF technology through continued investment in research and development andparticipation in certain government sponsored research programs. Extend leadership in GaAs market. We are currently one of the largestsuppliers of GaAs substrates worldwide. Historically, we have been a leadingsupplier of GaAs substrates in the epitaxy segment of the semi-insulating marketand in the semi-conducting market for GaAs substrates for lasers. We intend toincrease our share of these markets by continuing to provide high-quality,price-competitive substrates. In addition, in the semi-insulating GaAs substratemarket, we intend to leverage our demonstrated success in the epitaxy segment tofurther penetrate the ion implantation segment. In the semi-conducting GaAssubstrate market, we also intend to capitalize on our leadership to furtherpenetrate the high-volume, cost-sensitive LED market. Leverage VGF technology to manufacture additional substrates. We believeour VGF technology is a platform which we can leverage to rapidly develop andcost-effectively manufacture additional high-quality compound substrates foremerging applications in markets such as wireless and fiber opticcommunications. For example, we recently began shipping InP and Ge substratesdeveloped using our VGF technique to customers. Unlike the more traditionalmethods of growing crystals, we can use our VGF technology to grow the crystalsfor these other substrates without having to make a significant investment innew capital equipment. Increase manufacturing capacity to target high-volume markets. We increasedour manufacturing capacity by approximately 30,000 square feet in the fourthquarter of 1998. In addition, in June 1998, we have purchased an additional58,000 square foot facility in Fremont, California. In January 1999, weannounced we had received a business license for operations in Beijing, Chinaand had purchased a 30,000 square foot facility in a major tax-free industrialpark in Beijing. These new facilities provide us with additional manufacturingcapacity. We believe that this increased manufacturing capacity will enable usto further lower unit production costs and provide our high-performancesubstrates at competitive prices for high-volume markets such as LEDs. Leverage existing customer relationships. We currently sell our GaAssubstrates to over 200 customers, including: - EMCORE, - Hewlett Packard, - Motorola, - NEC, - Nortel, - Siemens, - Sony, - Spectrolab, and - TRW. 4 6 We believe our past success in providing high-quality GaAs substrates tothese customers will provide us with a competitive advantage in supplying themadditional substrates as their needs develop. For example, we recently beganshipments of InP substrates to TRW, which currently purchases a significantportion of its GaAs substrates from us. In addition, we intend to establishalliances and joint development arrangements with customers to develop newproducts, increase manufacturing efficiencies and more effectively serve ourcustomers' needs. CUSTOMERS We sold our products to over 200 customers during 1998. Each of thecustomers listed below purchased substrates in excess of $500,000 during 1998: Alpha Industries Picogiga Alpha Photonics Quantum Epitaxial Designs Electronics & Materials, Inc. RF Micro Devices Epitaxial Products International SDL, Inc. EMCORE Co. Siemens Hewlett Packard Sony Motorola Spectrolab Nortel Sumitomo Chemical Opto Power TRW Space & Defense We have historically entered into significant contracts with a number ofgovernment agencies and customers for the development of certain products. Formore information regarding our development efforts, see " Research andDevelopment." In the twelve months ended December 31, 1998, one customer accounted for13.7% of our total revenues. No customer accounted for more than 10.0% of ourtotal revenues in 1996 and 1997. In 1996, 1997 and 1998, our five largestcustomers accounted for 35.5%, 34.9% and 39.5%, respectively, of our totalrevenues. Generally, we do not have long-term or other non-cancelablecommitments from our customers and usually sell products pursuant to customerpurchase orders. The loss of any major customer could have a material adverseeffect on our business and operating results. TECHNOLOGY AXT's VGF technique. Our proprietary VGF technique produces high-qualitycrystals from which we produce high-performance compound and single-elementsubstrates for use in a variety of electronic and opto-electronic applications. Our VGF technique is designed to control the crystal-growth process withminimal temperature variation. Unlike traditional techniques, our VGF techniqueplaces the hot GaAs melt above the cool crystal, thereby reducing the turbulenceof the GaAs melt which results when the melt and crystal are inverted. Thetemperature gradient between the melt and the crystal in the VGF technique issignificantly lower than in traditional techniques. These aspects of the VGFtechnique enable us to grow crystals that have a relatively low dislocationdensity and high uniformity. One of the benefits of these characteristics isthat the crystal, and the substrate into which the crystal is manufactured, aremechanically strong. The mechanical strength often results in substrates withlower breakage rates during a customer's manufacturing process. Under the VGF technique, the GaAs melt and growing crystal are contained ina closed chamber. A number of benefits result from the use of this closedsystem. Because the VGF system is sealed and the crystal growth is isolated,both semi-insulating and semi-conducting crystals can be grown in the samesystem without the time consuming and expensive process of completelyreconfiguring the system. The closed system isolates the crystal from theoutside environment during growth and significantly reduces potentialcontamination of the crystal by impurities. The closed system also allows formore precise control of the gallium-to-arsenic ratio which results in betterconsistency and uniformity of the crystals. Therefore, crystals grown using theVGF technique are consistently of a high quality. In addition, the use ofcylindrical crucibles, which are sized to 5 7 meet a customer's requirements, enables us to produce circular substrates with aminimum amount of discarded material. The VGF technique is highly automated and the temperature gradient iscontrolled electronically rather than by physically moving the crystal orfurnace. As a result, there is no physical movement to disturb the sensitivecrystal. The entire crystal growth process is run under computer control withminimal operator intervention. A single operator can supervise the control ofmany VGF furnaces which results in significant cost savings. We believe the VGF technology is a platform which we can leverage torapidly develop and cost-effectively manufacture additional high-quality substrates. Unlike the more traditional methods of growing crystals, we can usethe VGF technology to grow crystals from these other substrates without havingto make a significant investment in new capital equipment. For example, we usethe proprietary VGF technique to manufacture InP and Ge substrates. VGF compared to traditional techniques for producing GaAs substrates. Webelieve our proprietary VGF technique provides significant advantages over thetraditional crystal growth techniques. The LEC technique is the traditionalmethod for producing semi-insulating GaAs substrates. Unlike the VGF technique,the LEC technique is designed so that the hotter GaAs melt is located beneaththe cooler crystal, which results in greater turbulence in the melt. The LECtechnique requires a temperature gradient between the GaAs melt and the coolcrystal which is approximately 50 to 200 times higher than the temperaturegradient of the VGF technique. The turbulence and the high temperature gradientcause LEC-grown crystals to have a higher dislocation density than VGF-growncrystals. This characteristic results in a higher rate of breakage of theLEC-developed substrate during the device manufacturing process. In addition,the LEC technique is essentially an open process whereby the melt and growingcrystal are exposed to the environment for the entire duration of the crystalgrowth process. This exposure results in greater propensity for impuritycontamination as well as difficulty in controlling the ratio of gallium toarsenic. Because the crystal is not contained in a crucible, fluctuations intemperature cause the diameter of the crystal to vary. Thus, to ensure propersize with the LEC technique, the crystal must be grown significantly larger thanthe desired size of the resulting substrate. During the LEC process, the crystalis grown by dipping a seed crystal through molten boric oxide into a melt andslowly pulling the seed up into the cool zone above the boric oxide where thecrystal hardens. As the GaAs melt is consumed, the crucible containing theremaining liquid must be raised in coordination with the pulling of the crystal.These moving parts and the relative complexity of the system result in highermaintenance costs. Unlike the VGF technique, the LEC technique uses large,complex electro-mechanical systems that are expensive to acquire and requirehighly skilled personnel to operate. The HB technique is the traditional method for producing semi-conductingGaAs substrates. The HB technique holds the GaAs melt in a semi-cylindrical"boat." Because of the semi-cylindrical shape of the boat, semi-conducting GaAscrystals grown using the HB technique have a semi-circular cross-section. As aresult of this semi-circular shape, more crystal material must be discarded tocut the crystal ingot into a cylindrical shape from which round substrates canbe produced. Furthermore, crystals grown using the HB technique have a higherdislocation density than VGF-grown crystals. These and other inherent technicaldifficulties limit the ability of the HB technique to be used tocost-effectively produce high-quality substrates greater than three inches indiameter. Since the HB technique uses a quartz crucible during the growthprocess which can contaminate the GaAs melt with silicon impurities, the HBtechnique is also unsuitable for making semi-insulating GaAs substrates. PRODUCTS We currently sell the compound substrates GaAs and InP, and thesingle-element substrate Ge. We supply various sizes of substrates in 2, 3, 4,and 6 square inches according to our customers' specifications and work closelywith our customers to ensure that we manufacture substrates to each customer'sparticular specifications. 6 8 The table below sets forth our products, their available sizes and selectedapplications: SUBSTRATE MATERIAL DIAMETER (IN INCHES) APPLICATIONS ------------------ -------------------- ------------ GaAs semi-insulating 2,3,4,6 - Cellular phones - Direct broadcast television - High-performance transistors - Satellite communicationsGaAs semi-conducting 2,3,4 - LEDs - Lasers - Optical couplers - DisplaysInP semi-insulating 2,3 - Fiber optic communications - Satellite communications - High-performance transistors - Automotive collision avoidance radarsInP semi-conducting 2 - Fiber optic communications - LasersGe 4 - Satellite solar cells MANUFACTURING Our manufacturing operations, which include crystal growth, slicing,testing, edge grinding, polishing, inspecting and packaging the substrates forshipment, are located at our headquarters in Fremont, California. Our Fremontfacilities are ISO 9002 certified. Many of our manufacturing operations arecomputer monitored or controlled, enhancing reliability and yield. We depend on a single or limited number of suppliers for certain criticalmaterials, including gallium, for use in the production of substrates. Wegenerally purchase these materials through standard purchase orders and notpursuant to long-term supply contracts. We seek to maintain sufficient levels ofinventory for certain materials to guard against interruptions in supply and tomeet our near term needs. To date, we have been able to obtain sufficientsupplies of materials in a timely manner. However, a stoppage or delay insupply, receipt of defective or contaminated materials, or increases in thepricing of such raw materials could materially adversely affect our operatingresults. In the third quarter of 1998, we completed the expansion of ourapproximately 50,000 square feet facility located in Fremont, California byapproximately 30,000 square feet to meet anticipated production needs through1999. Because we currently perform all steps in our manufacturing process at ourFremont facility, any interruption resulting from earthquake, fire, equipmentfailures or other causes would have a material adverse effect on our results ofoperations. For more information regarding the risks relating to ourmanufacturing process and our new facility, see "Factors Affecting FutureResults -- If we do not achieve acceptable yields of crystals and the successfuland timely production of substrates, the shipment of our products would bedelayed and our business adversely affected." and "Factors Affecting FutureResults -- We are subject to additional risks as a result of the recentcompletion of a new manufacturing facility," respectively. Additionally, in connection with further expanding our manufacturingcapacity, we purchased an additional 58,000 square foot facility in Fremont,California and a 30,000 square foot facility in Beijing, China in 1998. SALES AND MARKETING We sell our products worldwide through our direct sales force as well asthrough independent international sales representatives. Our direct sales forceconsists of highly trained, technically sophisticated sales engineers who areknowledgeable in the manufacturing and use of compound and single-elementsubstrates. Our direct sales force operates out of our corporate office inFremont, California and our Japanese subsidiary. Our sales engineers work withcustomers during all stages of the substrate manufacturing process, fromdeveloping the precise composition of the substrate through manufacturing andprocessing the substrate 7 9 to the customer's exact specifications. We believe that maintaining a closerelationship with customers and providing customers with ongoing technicalsupport improves customer satisfaction and will provide us with a competitiveadvantage in selling other substrates to our customers. International sales, excluding Canada, as a percentage of total revenues in1996, 1997 and 1998 were 35.0%, 34.1% and 28.8%, respectively. In addition toour direct sales force in Japan, we have independent sales representatives inFrance, Japan, South Korea, Taiwan and the United Kingdom. Except for sales byour Japanese subsidiary, which are denominated in yen, we receive all paymentsfor products in U.S. dollars. In order to raise market awareness of our products, we advertise in tradepublications, distribute promotional materials, publish technical articles,conduct marketing programs and participate in industry trade shows andconferences. For more information regarding the risks relating to ourinternational operations, see "Factors Affecting Future Results -- We derive asignificant portion of our revenues from international sales and our ability tosustain and increase our international sales involve significant risks". RESEARCH AND DEVELOPMENT Our research and development efforts are focused on developing newsubstrates, improving the performance of existing products and processes, andreducing costs in the manufacturing process. We have assembled amulti-disciplinary team of highly skilled scientists, engineers and techniciansto meet our research and development objectives. Among other projects, we haveresearch and development projects involving the development of GaN and highpurity GaAs epitaxy substrates. Our research and development expenses in 1996, 1997 and 1998 were $592,000,$1.3 million and $2.5 million, respectively. In addition to internally fundedresearch and development, we have also funded a significant portion of ourresearch and development efforts through contracts with the U.S. government andcustomer funded research projects. In 1996, 1997 and 1998, we received $2.0million, $2.3 million and $1.8 million, respectively, from U.S. governmentagencies and customer funded research contracts. Under our contracts, we retainrights to the VGF and wafer fabrication technology which we develop. The U.S.government retains rights to utilize the technologies we develop for governmentpurposes only. Our total research and development costs, including both contract fundedand internally funded research and development expenses, for 1996, 1997 and 1998totaled $1.4 million, $2.8 million and $3.3 million, respectively. We expect tocontinue to expend substantial resources on research and development. Thedevelopment of compound and single-element substrates is highly complex. Therecan be no assurance that we will successfully develop and introduce new productsin a timely and cost-effective manner or that our development efforts willsuccessfully permit our products to meet changing market demands. For moreinformation regarding the risks relating to our research and developmentefforts, see "Factors Affecting Future Results -- We must effectively respond torapid technological changes by continually introducing new products that achievebroad market acceptance." COMPETITION The markets for GaAs substrates are intensely competitive. Our principalcompetitors in the market for semi-insulating GaAs substrates currently include: - Freiberger; - Hitachi Cable; - Litton Airtron; and - Sumitomo Electric. In the semi-conducting GaAs substrate market, our principal competitorscurrently are Sumitomo Electric and Hitachi Cable. We also face competition frommanufacturers that produce GaAs substrates for their own use. In addition, weface competition from companies, such as IBM, that are actively developingalternative materials to GaAs. As we enter new markets, such as the Ge and InPsubstrate markets, we expect 8 10 to face competitive risks similar to those for its GaAs substrates. Many of ourcompetitors and potential competitors have been in the business longer than usand have greater manufacturing experience, more established technologies thanour VGF technique, broader name recognition and significantly greater financial,technical and marketing resources than us. We cannot assure you that we willcompete successfully against these competitors in the future or that ourcompetitors or potential competitors will not develop enhancements to the LEC,HB or VGF techniques that will offer price and performance features that aresuperior to ours. Increased competitive pressure could also lead to intensifiedprice-based competition, resulting in lower prices and margins, which wouldmaterially adversely affect our business, financial condition and results ofoperations. We believe that the primary competitive factors in the markets in which ourproducts compete are: - quality, - price, - performance, - customer support and satisfaction, and - customer commitment to competing technologies. Our ability to compete in target markets also depends on factors such as: - the timing and success of the development and introduction of new products by us and our competitors, - the availability of adequate sources of raw materials, and - protection of our products by effective utilization of intellectual property laws and general economic conditions. In order to remain competitive, we believe we must invest significantresources in developing new substrates and in maintaining customer satisfactionworldwide. There can be no assurance that our products will continue to competefavorably or that we will be successful in the face of competition from existingcompetitors or new companies entering our target markets. If we fail to competesuccessfully, our financial condition and results of operation would bematerially adversely affected. PROTECTION OF OUR INTELLECTUAL PROPERTY Our success and competitive position for our VGF technique dependsmaterially on our ability to maintain trade secrets, patents and otherintellectual property protections. To protect our trade secrets, we take certainmeasures to ensure their secrecy, such as executing non-disclosure agreementswith our employees, customers and suppliers. Despite our efforts, we cannotassure you that others will not gain access to our trade secrets, or that we canmeaningfully protect our intellectual property. In addition, effective tradesecret protection may be unavailable or limited in certain foreign countries.Although we intend to protect our rights vigorously, these measures may not besuccessful. We rely primarily on the technical and creative ability of our personnel,rather than on patents, to maintain our competitive position. To date, we havebeen issued one U.S. patent, which relates to our VGF technique, and have twopatent applications, one of which relates to our VGF technique, pending. We haveone pending application for a Japanese patent but no issued foreign patents.There can be no assurance that our pending applications or any future U.S. orforeign patent applications will be approved, that any issued patents willprotect our intellectual property or will not be challenged by third parties, orthat the patents of others will not have an adverse effect on our ability to dobusiness. Moreover, the laws of certain foreign countries may not protect ourintellectual property rights to the same extent as the laws of the UnitedStates. We believe that, due to the rapid pace of technological innovation inthe GaAs and other substrate markets, our ability to establish and maintain aposition of technology leadership in the industry depends more on the skills ofour development personnel than upon the legal protections afforded our existingtechnologies. 9 11 Although there are currently no pending material lawsuits against us orunresolved notices that we are infringing intellectual property rights ofothers, we may be notified in the future that we are infringing the patentand/or other intellectual property rights of others. Litigation may be necessaryin the future to enforce our patents and other intellectual property rights, toprotect our trade secrets, to determine the validity and scope of theproprietary rights of others, or to defend against claims of infringement orinvalidity. We cannot assure you that we would prevail in any future litigation.Any litigation, whether or not determined in our favor or settled by us, wouldbe costly and would divert the efforts and attention of our management andtechnical personnel from normal business operations, which would have a materialadverse effect on our business, and results of operations. Adversedeterminations in litigation could result in the loss of our proprietary rights,subject us to significant liabilities, require us to seek licenses from thirdparties or prevent us from licensing our technology, any of which could have amaterial adverse effect on our business and results of operations. ENVIRONMENTAL REGULATIONS We are subject to federal, state and local laws and regulations concerningthe use, storage, handling, generation, treatment, emission, release, dischargeand disposal of certain materials used in our research and development andproduction operations, as well as laws and regulations concerning environmentalremediation and employee health and safety. The growing of crystals and theproduction of substrates involve the use of certain hazardous raw materials,including, but not limited to, arsenic. We cannot guarantee that our controlsystems will be successful in preventing a release of these materials or otheradverse environmental conditions. Any release or other failure to comply withpresent or future environmental laws and regulations could result in theimposition of significant fines against us, the suspension of production or acessation of operations. In addition, there can be no assurance that existing orfuture changes in laws or regulations will not require expenditures orliabilities to be incurred by us, or in restrictions on our operations. AtDecember 31, 1998, we believe we were in substantial compliance with allapplicable environmental regulations. BACKLOG We include in backlog only those customer orders which have been acceptedby us and which shipment is generally expected within 12 months. As of December31, 1998, our backlog was approximately $8.7 million. Backlog can fluctuategreatly based upon, among other matters, the timing of orders. In addition,purchase orders in our backlog are subject to changes in delivery schedules orto reduction in size or cancellation at the option of the purchaser withoutsignificant penalty. We have experienced, and may continue to experience,cancellation, reduction and rescheduled delivery of orders in our backlog. Our backlog may vary significantly from time to time depending upon the level ofcapacity available to satisfy unfilled orders. Accordingly, although useful forscheduling production, backlog as of any particular date may not be a reliableindicator of sales for any future period. EMPLOYEES As of December 31, 1998, we had 314 full-time employees, of whom 263 wereprincipally engaged in manufacturing, 32 in sales, general and administrationand 19 in research and development. Our success is in part dependent on ourability to attract and retain highly skilled workers, who are in high demand inthe Silicon Valley area. None of our employees is represented by a union and wehave never experienced a work stoppage. Management considers its relations withits employees to be good. 10 12 EXECUTIVE OFFICERS As of December 31, 1998, our executive officers and directors were asfollows: NAME AGE POSITION ---- --- -------- Morris S. Young, Ph.D. ... 53 Chairman of the Board of Directors, President and Chief Executive OfficerTheodore S. Young, 58 Senior Vice President, Marketing and Director Ph.D. ..................Davis Zhang............... 42 Senior Vice President, ProductionGary S. Young............. 55 Vice President, SalesGuy D. Atwood............. 56 Vice President and Chief Financial Officer, Treasurer and SecretaryXiao Gordon Liu........... 34 Vice President, Engineering and DevelopmentJesse Chen(1)(2).......... 40 DirectorB.J. Moore(1)(2).......... 62 DirectorDonald L. Tatzin(1)(2).... 46 Director - ------------------------(1) Member of the compensation committee.(2) Member of the audit committee. Morris S. Young, Ph.D. co-founded AXT in 1986 and has served as ourChairman of the Board of Directors since February 1998 and President and ChiefExecutive Officer, as well as a director since 1989. Dr. Young holds a B.S. inMetallurgical Engineering from Chengkung University, Taiwan, an M.S. inMetallurgy from Syracuse University and a Ph.D. in Metallurgy from PolytechnicUniversity. Theodore S. Young, Ph.D. co-founded AXT in 1986 and has served as ourSenior Vice President, Marketing since 1989 and served as President from 1987 to1989. He has also acted as a director since our inception, including as theChairman of the Board of Directors from January 1987 to January 1998. Dr. Youngholds a B.S. in Physics from National Taiwan University, an M.S. in Geophysicsfrom the University of Alaska and a Ph.D. in Plasma Physics from theMassachusetts Institute of Technology. Davis Zhang co-founded AXT in 1986 and has served as our Senior VicePresident, Production since January 1994. From 1987 to 1993, Mr. Zhang served asour Senior Production Manager. Mr. Zhang holds a B.S. in Mechanical Engineeringfrom Northern Communication University, Beijing, China. Gary S. Young joined us in 1991 and has served as our Vice President, Salessince July 1993. From 1991 to 1993, Mr. Young served as our Sales andAdministrative Manager. From 1973 to 1991, Mr. Young worked in various capacities with several companies, including as a Systems Engineer for IBM andas a software engineer for Boole & Babbage, Inc., an independent softwarevendor. Mr. Young holds a B.S. in Mathematics from National Taiwan NormalUniversity, an M.A. in Mathematics from Northeast Missouri State University andan M.S. in Operations Research from Purdue University. Guy D. Atwood joined us in August 1997 as our Vice President and ChiefFinancial Officer and has served as our Treasurer and Secretary since February1998. From 1991 to August 1997, Mr. Atwood served at various times as ChiefFinancial Officer for several private companies, most recently the alumniassociation for the University of California at Berkeley and AvenuSoftware, afilm and video software company, of which he was also its President. Mr. Atwoodwas self-employed as a financial consultant from 1994 to 1995, and also providedservices in such capacity to the Company from June to September 1995. Mr. Atwoodholds a B.S. in Accounting from the University of California at Berkeley. Xiao Gordon Liu joined us in 1995 as Senior Engineer and was promoted toVice President, Engineering and Development in November 1998. Prior to joiningus, Mr. Liu was a postdoctoral fellow and associate specialist at University ofCalifornia at Berkeley and a research associate at the University of Lund,Sweden. Mr. Liu holds a Ph.D. in Physics from the University of Lund, Sweden andhas published more than 30 scientific papers. 11 13 Jesse Chen has served as a director of AXT since February 1998. Since May1997, Mr. Chen has served as a Managing Director of Maton Venture, an investmentcompany. Prior to that, Mr. Chen co-founded BusLogic, Inc., a computerperipherals company and served as its Chief Executive Officer from 1990 to 1996.Mr. Chen serves on the Board of Directors of several private companies. Mr. Chenhas a B.S. degree in Aeronautical Engineering from Chenkung University, Taiwanand an M.S. in Electrical Engineering from Loyola Marymount University. B.J. Moore has served as a director of AXT since February 1998. Since 1991,Mr. Moore has been self-employed as a consultant and has served as a director toseveral technology-based companies. Mr. Moore currently serves on the Board ofDirectors for Adaptec, Inc., a computer peripherals company and DionexCorporation, an ion chromatography systems company, as well as several privatecompanies. From 1986 to 1991, Mr. Moore served as President and Chief ExecutiveOfficer of Outlook Technology, an electronics test equipment company. Mr. Mooreholds a B.S. and an M.S. degree in Electrical Engineering from the University ofTennessee. Donald L. Tatzin has served as a director of AXT since February 1998. Since1993, Mr. Tatzin has served as Executive Vice President of Showboat, Inc., agaming company. In addition, Mr. Tatzin served as a director for Sydney HarbourCasino, an Australian gaming company from 1995 to 1996 and as its ChiefExecutive Officer from April to October 1996. Prior to that, Mr. Tatzin was adirector and consultant with Arthur D. Little, Inc., from 1976 to 1993. Mr.Tatzin holds an S.B. in Economics and an S.B. and masters degrees in CityPlanning from the Massachusetts Institute of Technology and an M.S. in Economicsfrom Australian National University. ITEM 2. PROPERTIES In the third quarter of 1998, we completed the expansion of ourapproximately 50,000 square foot facility located in Fremont, California byapproximately 30,000 square feet to meet anticipated production needs through1999. Additionally, in connection with further expanding our manufacturingcapacity, we purchased an additional 58,000 square foot facility in Fremont,California and a 30,000 square foot facility in Beijing, China in 1998. ITEM 3. LEGAL PROCEEDINGS In October 1998, a vendor submitted a claim against us to the ArbitrationCommission in Shenzhen, China, alleging that we failed to honor our obligation to take delivery of the full quantity of Ge under a purchase contract with thevendor. We believe that this action is without merit and will continue tovigorously defend our position. We expect the cost of defending this matter willnot materially adversely affect our operating results through fiscal 1999.However, there can be no assurance that our defense of this matter will besuccessful. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 12 14 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AXT common stock has been trading publicly on the Nasdaq National Marketunder the symbol "AXTI" since May 20, 1998, the date we consummated our initialpublic offering. The following table sets forth, for the periods indicated, therange of quarterly high and low closing sales prices for AXT's common stock onthe Nasdaq National Market. HIGH LOW ------- ------- FISCAL 1998January 1, 1998 through May 19, 1998..................... Not ApplicableMay 20, 1998 through June 30, 1998....................... $15.000 $10.125Third Quarter ended September 30, 1998................... 15.500 7.000Fourth Quarter ended December 31, 1998................... 10.813 6.000 As of December 31, 1998, there were 181 holders of record of our commonstock. Because many shares of AXT's common stock are held by brokers and otherinstitutions on behalf of stockholders, we are unable to estimate the totalnumber of stockholders represented by these record holders. We have never paid or declared any cash dividends on our common stock anddo not anticipate paying cash dividends in the foreseeable future. ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA YEARS ENDED DECEMBER 31, ---------------------------------------------- 1994 1995 1996 1997 1998 ------ ------- ------- ------- ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENT OF OPERATIONS DATA:Revenues: Product revenues................................ $5,666 $11,520 $14,222 $23,014 $41,493 Contract revenues............................... 1,791 2,958 2,005 2,321 1,797 ------ ------- ------- ------- ------- Total revenues.......................... 7,457 14,478 16,227 25,335 43,290Cost of revenues: Cost of product revenues........................ 3,091 6,030 9,270 13,674 24,550 Cost of contract revenues....................... 1,422 2,234 795 1,553 804 ------ ------- ------- ------- ------- Total cost of revenues.................. 4,513 8,264 10,065 15,227 25,354 ------ ------- ------- ------- -------Gross profit...................................... 2,944 6,214 6,162 10,108 17,936Operating expenses:Selling, general and administrative............... 921 1,716 2,033 2,959 5,016Research and development.......................... 149 448 592 1,289 2,504 ------ ------- ------- ------- ------- Total operating expenses................ 1,070 2,164 2,625 4,248 7,520 ------ ------- ------- ------- -------Income from operations............................ 1,874 4,050 3,537 5,860 10,416Interest expense.................................. (3) (12) (170) (570) (781)Interest and other income (expense)............... 65 282 (72) (34) 568 ------ ------- ------- ------- -------Income before provision for income taxes.......... 1,936 4,320 3,295 5,256 10,203Provision for income taxes........................ 775 1,581 1,249 1,998 3,877 ------ ------- ------- ------- -------Net income........................................ $1,161 $ 2,739 $ 2,046 $ 3,258 $ 6,326 ====== ======= ======= ======= =======Basic net income per share........................ $ 0.44 $ 0.97 $ 0.71 $ 1.11 $ 0.42 ====== ======= ======= ======= =======Diluted net income per share...................... $ 0.10 $ 0.23 $ 0.17 $ 0.25 $ 0.42 ====== ======= ======= ======= =======Shares used in basic net income per share calculations.................................... 2,634 2,821 2,882 2,938 14,928Shares used in diluted net income per share calculations.......... 11,676 11,813 11,811 12,839 15,177 13 15 DECEMBER 31, ---------------------------------------------- 1994 1995 1996 1997 1998 ------ ------- ------- ------- ------- (IN THOUSANDS) BALANCE SHEET DATA:Cash, cash equivalents and short-term investments..................................... $1,446 $ 835 $ 756 $ 3,054 $16,122Working capital................................... 2,859 3,760 5,542 14,209 41,068Total assets...................................... 5,757 11,316 17,384 30,613 75,023Long-term debt, net of current portion............ -- 2,350 5,582 7,728 16,347Stockholders' equity.............................. 4,213 7,005 8,999 18,591 51,168 14 16 ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Management's Discussion and Analysis of Financial Condition andResults of Operations includes a number of forward-looking statements whichreflect current views with respect to future events and financial performance.These forward-looking statements are subject to certain risks and uncertainties,including those discussed in the "Factors Affecting Future Results" andelsewhere in this report that could cause actual results to differ materiallyfrom historical results or those anticipated. In this report, the words"anticipates," "believes," "expects," "future," "intends," and similarexpressions identify forward-looking statements. Readers are cautioned not toplace undue reliance on these forward-looking statements, which speak only as ofthe date hereof. RESULTS OF OPERATIONS Overview We use a proprietary VGF technique to produce high-performance compoundsemiconductor substrates for use in a variety of electronic and opto-electronicapplications. We were founded in 1986 and commenced product sales in 1990. Wecurrently sell GaAs, InP and GaN substrates to manufacturers of semiconductordevices for use in applications such as wireless and fiber optictelecommunications, lasers, LEDs, and consumer electronics. We also sell Gesubstrates for use in satellite solar cells. We have been profitable on an annual basis since 1990 and our totalrevenues were $16.2 million, $25.3 million and $43.3 million for the years ended December 31, 1996, 1997 and 1998, respectively. Total revenues consist ofproduct revenues and contract revenues. Our product revenues were $14.2 million,$23.0 million and $41.5 million for the years ended December 31, 1996, 1997 and1998, respectively. Product revenues are generally recognized upon shipment ofproducts to customers. Historically, virtually all of our product revenues havebeen derived from sales of GaAs substrates, which, in the years ended December31, 1997 and 1998, accounted for 95.0% and 81.8%, respectively, of the ourproduct revenues. We began selling InP and Ge substrates to our customers inlate 1997 and GaN substrates in late 1998. Our contract revenues were $2.0 million, $2.3 million and $1.8 million forthe years ended December 31, 1996, 1997 and 1998, respectively. Contractrevenues are recognized under the percentage of completion method and relatedresearch costs are included in cost of contract revenues. Contract revenuesconsist of research and development contracts with U.S. government agencies andcustomer-funded research projects. The largest of the government contracts was afour-year U.S. Department of Defense Title III Program for development of GaAssubstrates (the "Title III GaAs contract"), which was awarded to us in March1994 and under which we were paid an aggregate of $6.1 million. The Title IIIGaAs contract was completed in 1998. We retain rights to the VGF and waferfabrication technology developed under these government and customer-fundedresearch contracts and are therefore able to leverage these programs to continueto broaden our product and technology offerings. In 1995, we established a wholly-owned subsidiary in Japan to distributeour products. This subsidiary serves primarily as a direct sales and supportoffice for our customers in Japan. We also utilize independent salesrepresentatives in France, Japan, South Korea, Taiwan and the United Kingdom.Domestic sales are generated by our direct sales force. International sales,excluding Canada, accounted for 35.0%, 34.1% and 28.8% of total revenues for theyears ended December 31, 1996, 1997 and 1998, respectively. Except for sales inJapan, which are denominated in yen, we denominate and collect our internationalsales in U.S. dollars. Doing business in Japan subjects us to fluctuations inexchange rates between the U.S. dollar and the Japanese yen. We incurred foreignexchange losses of $114,000, $186,000 and $24,000 for the years ended December31, 1996, 1997 and 1998, respectively. During the year ended December 31, 1998,we bought foreign exchange contracts to hedge against certain trade accountsreceivable in Japanese yen. The outstanding commitments with respect to suchforeign exchange contracts had a total value of approximately $1.6 million as ofDecember 31, 1998. Since July 1996, we have conducted all of our operations in a 50,000 squarefoot office and production facility located in Fremont, California. Prior totransitioning our manufacturing operations to this facility, we 15 17 leased a 20,000 square foot manufacturing facility in Dublin, California. Inlate 1998, we expanded the size of our current manufacturing facility byapproximately 30,000 square feet to meet our anticipated future production needsthrough 1999. In June 1998, we purchased an additional 58,000 square footfacility in Fremont, California directly across the street from our existingmanufacturing facility and moved marketing, sales, engineering andadministrative personnel into a portion of the building. We believe that thisnew facility will not be used for production of substrates prior to the end of1999. In January 1999, we announced we had received a business license foroperations in Beijing, China and had purchased a 30,000 square foot facility ina major tax-free industrial park in Beijing. This facility is expected to beoperational during the second quarter of 1999. We expect that our proprietaryVGF crystal growth operations will continue to be housed in Fremont, California,and our other manufacturing operations will be conducted in both Fremont andBeijing. In connection with the granting of stock options, we recorded aggregatedeferred compensation of $322,000 and $203,000, representing the differencebetween the deemed fair value of the Common Stock for accounting purposes and the option exercise price at the date of grant for the years ended December 31,1997 and 1998, respectively. This deferred compensation will be amortized overthe vesting period of the applicable options of which $102,000 and $96,000 wasamortized during the years ended December 31, 1997 and 1998, respectively. RESULTS OF OPERATIONS The following table sets forth certain operating data as a percentage oftotal revenues for the periods indicated. YEARS ENDED DECEMBER 31, -------------------------- 1996 1997 1998 ------ ------ ------ Revenues: Product revenues.......................................... 87.6% 90.8% 95.8% Contract revenues......................................... 12.4 9.2 4.2 ----- ----- ----- Total revenues.................................... 100.0 100.0 100.0Cost of revenues: Cost of product revenues.................................. 57.1 54.0 56.7 Cost of contract revenues................................. 4.9 6.1 1.9 ----- ----- ----- Total cost of revenues............................ 62.0 60.1 58.6 ----- ----- -----Gross margin................................................ 38.0 39.9 41.4Operating expenses: Selling, general and administrative....................... 12.5 11.7 11.5 Research and development.................................. 3.6 5.1 5.8 ----- ----- ----- Total operating expenses.......................... 16.1 16.8 17.3 ----- ----- -----Income from operations...................................... 21.9 23.1 24.1Interest expense............................................ (1.0) (2.2) (1.8)Interest and other income (expense)......................... (0.5) (0.1) 1.3 ----- ----- -----Income before provision for income taxes.................... 20.4 20.8 23.6Provision for income taxes.................................. 7.7 7.9 9.0 ----- ----- -----Net income.................................................. 12.7% 12.9% 14.6% ===== ===== ===== 16 18 The following table sets forth product and contract gross profits and grossmargins for the periods indicated. YEARS ENDED DECEMBER 31, --------------------------- 1996 1997 1998 ------ ------ ------- (DOLLARS IN THOUSANDS) Product gross profit.................................... $4,952 $9,340 $16,943Product gross margin.................................... 34.8% 40.6% 40.8%Contract gross profit................................... $1,210 $ 768 $ 993Contract gross margin................................... 60.3% 33.1% 55.3% YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1998 Revenues. Total revenues increased 70.9% from $25.3 million for the yearended December 31, 1997 to $43.3 million for year ended December 31, 1998.Product revenues increased 80.3% from $23.0 million for the year ended December31, 1997 to $41.5 million for the year ended December 31, 1998. The increase in product revenues reflected an increase in the volume of sales of GaAs and InPsubstrates to existing domestic and international customers, the addition of newcustomers and the introduction of Ge substrates in the fourth quarter of 1997.Ge substrates totaled 15.6% of product revenues for the year ended December 31,1998 compared to only 3.6% in 1997. International revenues, excluding Canada, decreased from 34.1% of totalrevenues for the year ended December 31, 1997 to 28.8% of total revenues for theyear ended December 31, 1998, primarily reflecting the introduction of Gesubstrates in late 1997, which are currently sold only to domestic customers. Webelieve that Ge substrates will be sold only to U.S. customers for theforeseeable future, which is expected to cause our international revenues todecline as a percentage of total revenues. Contract revenues decreased 22.6% from $2.3 million for the year endedDecember 31, 1997 to $1.8 million for the year ended December 31, 1998. Contractrevenues in 1997 were higher than in 1998 primarily because we recognizedsignificant revenue from a $1.2 million customer-funded Ge substrates researchcontract that was completed in June 1997. Contract revenues declined from 9.2%of total revenues for the year ended December 31, 1997 to 4.2% for the yearended December 31, 1998 as a result of product revenue growth combined with adecline in contract revenues. In future periods, we expect contract revenues tocontinue to decline as a percentage of total revenues. Gross margin. Gross margin increased from 39.9% for the year ended December31, 1997 to 41.4% for the year ended December 31, 1998. Product gross marginincreased slightly from 40.6% for the year ended December 31, 1997 to 40.8% forthe year ended December 31,1998, reflecting the higher yields achieved in GaAsand InP production, partially offset by lower margins from Ge substrates. Contract gross margins increased from 33.1% for the year ended December31,1997 to 55.3% for the year ended December 31, 1998. This increase was due toa shift in contract revenue mix from a lower margin customer-funded contract forGe substrates research completed in June 1997 to higher margin governmentcontracts. Selling, general and administrative expenses. Selling, general andadministrative expenses increased 69.5% from $3.0 million for the year endedDecember 31, 1997 to $5.0 million for the year ended December 31, 1998. Thisincrease resulted primarily from increased personnel and administrative expensesrequired to support additional sales volume. Selling, general and administrativeexpenses as a percentage of total revenues decreased slightly from 11.7% for theyear ended December 31,1997 to 11.5% for the year ended December 31, 1998. Research and development expenses. Research and development expensesincreased 94.3% from $1.3 million for the year ended December 31, 1997 to $2.5million for the year ended December 31, 1998. This increase resulted primarilyfrom the hiring of additional engineers and the purchase of materials to developnew products and to enhance existing products. In addition to our fundedresearch and development, we incurred research and development expenses relatingto government and customer-funded research contracts, which are included in thecost of contract revenues. For the year ended December 31, 1998, total researchand 17 19 development costs, including both contract funded and internally funded researchand development expenses, totaled $3.3 million, or 7.6% of total revenues. Interest expense. Interest expense increased from $570,000 for the yearended December 31, 1997 to $781,000 for the year ended December 31, 1998. Thisincrease was primarily the result of additional borrowings in 1998 we incurredto finance the purchase of the our new building and to finance expansion ofproduction facilities and related equipment purchases. Interest and other income (expense). Interest and other income (expense) increased from $34,000 of expense for the year ended December 31, 1997 to$568,000 of income for the year ended December 31, 1998. This increase wasprimarily the result of interest income earned on the $25.8 million in netproceeds raised from our initial public offering in May 1998. Provision for Income Taxes. Income tax expense remained at 38.0% of incomebefore provision for income taxes for the years ended December 31, 1997 and1998. YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1997 Revenues. Total revenues increased 56.1% from $16.2 million for the yearended December 31, 1996 to $25.3 million for the year ended December 31, 1997.Product revenues increased 61.8% from $14.2 million for the year ended December31, 1996 to $23.0 million for the year ended December 31, 1997. The increase inproduct revenues reflected an increase in the volume of sales of GaAs substratesto existing domestic and international customers, sales to new customers and theintroduction of Ge substrates in the fourth quarter of 1997. International revenues, excluding Canada, decreased from 35.0% of totalrevenues for the year ended December 31, 1996 to 34.1% of total revenues for theyear ended December 31, 1997, primarily reflecting the introduction of Gesubstrates in late 1997, which were sold only to U.S. customers. Contract revenues increased 15.8% from $2.0 million for the year endedDecember 31, 1996 to $2.3 million for the year ended December 31, 1997. Thisincrease was primarily due to revenues recognized from a $1.2 millioncustomer-funded Ge substrates research contract that was completed in 1997. Thisincrease was partially offset by a reduction in government contract revenues.Contract revenues declined from 12.4% of total revenues for the year endedDecember 31, 1996 to 9.2% for the year ended December 31, 1997 as a result ofproduct revenue growth exceeding contract revenue growth. Gross margin. Gross margin increased from 38.0% for the year ended December31, 1996 to 39.9% for the year ended December 31, 1997. Product gross marginincreased from 34.8% for the year ended December 31, 1996 to 40.6% for the yearended December 31, 1997. The lower product gross margin in 1996 resultedprimarily from duplicate expenses of approximately $500,000 due to simultaneousoperations of two facilities and manufacturing inefficiencies relating to thetransition to our new production facility. Contract gross margin declined from 60.3% for the year ended December 31,1996 to 33.1% for the year ended December 31, 1997. This decrease was due to ashift in contract revenue mix from higher margin government research contractsin 1996 to a lower margin customer-funded contract for Ge substrates research.In addition, in 1996 gross margin was favorably impacted by large incentiveawards which we were paid upon completion of certain milestones of the Title IIIGaAs contract. Selling, general and administrative expenses Selling, general andadministrative expenses increased 45.5% from $2.0 million for the year endedDecember 31, 1996 to $3.0 million for the year ended December 31, 1997. Thisincrease resulted primarily from increased domestic and international salespersonnel and administrative expenses required to support increased salesvolume. Research and development expenses. Research and development expensesincreased 117.7% from $592,000 for the year ended December 31, 1996 to $1.3million for the year ended December 31, 1997. This increase resulted primarilyfrom the hiring of additional engineers to develop new products and to enhanceexisting products. For the year ended December 31, 1997, total research anddevelopment costs, including 18 20 both contract funded and internally funded research and development expenses, totaled $2.8 million, or 11.2% of total revenues. Interest expense. Interest expense increased from $170,000 for the yearended December 31, 1996 to $570,000 for the year ended December 31, 1997. Thisincrease resulted primarily from additional borrowings incurred in 1996 tofinance our new manufacturing facility, the expansion of production facilitiesin 1997 and related equipment purchases. Interest and other income (expense). Interest and other income (expense)decreased from $72,000 of expense for the year ended December 31, 1996 to$34,000 of expense for the year ended December 31, 1997. This decrease was dueto higher interest income generated on investments from the proceeds of a $5.9million private equity financing completed in March 1997, partially offset byforeign currency transaction losses incurred due to the increase in the value ofthe U.S. dollar compared to the Japanese yen. Provision for income taxes. Income tax expense was virtually unchanged from37.9% of income before provision for income taxes for the year ended December31, 1996 to 38.0% of income before provision for income taxes for the year endedDecember 31, 1997. SELECTED QUARTERLY RESULTS OF OPERATIONS The following table sets forth unaudited quarterly results in dollars forthe eight quarters ended December 31, 1998. We believe that all necessaryadjustments, consisting only of normal recurring adjustments, have been includedin the amounts stated below to present fairly such quarterly information. Theoperating results for any quarter are not necessarily indicative of results forany subsequent period. QUARTERS ENDED --------------------------------------------------------------------------------------- MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, 1997 1997 1997 1997 1998 1998 1998 1998 -------- -------- --------- -------- -------- -------- --------- -------- (IN THOUSANDS) Revenues: Product revenues.............. $4,494 $5,360 $6,060 $7,100 $9,238 $10,293 $10,887 $11,074 Contract revenues............. 600 842 447 432 492 497 508 301 ------ ------ ------ ------ ------ ------- ------- ------- Total revenues......... 5,094 6,202 6,507 7,532 9,730 10,790 11,395 11,375Cost of revenues: Cost of product revenues...... 2,805 3,167 3,604 4,098 5,460 6,139 6,684 6,267 Cost of contract revenues..... 498 654 210 191 265 218 157 164 ------ ------ ------ ------ ------ ------- ------- ------- Total cost of 3,303 3,821 3,814 4,289 5,725 6,357 6,841 6,431 revenues............. ------ ------ ------ ------ ------ ------- ------- -------Gross profit.................... 1,791 2,381 2,693 3,243 4,005 4,433 4,554 4,944Operating expenses: Selling, general and 642 674 703 940 966 1,119 1,110 1,821 administrative.............. Research and development...... 222 296 306 465 640 669 736 459 ------ ------ ------ ------ ------ ------- ------- ------- Total operating 864 970 1,009 1,405 1,606 1,788 1,846 2,280 expenses............. ------ ------ ------ ------ ------ ------- ------- -------Income from operations.......... 927 1,411 1,684 1,838 2,399 2,645 2,708 2,664Interest expense................ (115) (151) (158) (146) (181) (157) (169) (273)Interest and other income (91) 77 (8) (12) 21 (25) 206 365 (expense)..................... ------ ------ ------ ------ ------ ------- ------- -------Income before provision for 721 1,337 1,518 1,680 2,239 2,463 2,745 2,756 income taxes..................Provision for income taxes...... 274 508 577 639 854 943 1,037 1,043 ------ ------ ------ ------ ------ ------- ------- -------Net income...................... $ 447 $ 829 $ 941 $1,041 $1,385 $ 1,520 $ 1,708 $ 1,713 ====== ====== ====== ====== ====== ======= ======= ======= 19 21 The following table sets forth selected consolidated financial informationas a percentage of total revenues for each of our last eight quarters. QUARTERS ENDED --------------------------------------------------------------------------------------- MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, 1997 1997 1997 1997 1998 1998 1998 1998 -------- -------- --------- -------- -------- -------- --------- -------- Revenues: Product revenues.............. 88.2% 86.4% 93.1% 94.3% 94.9% 95.2% 95.5% 97.4% Contract revenues............. 11.8 13.6 6.9 5.7 5.1 4.8 4.5 2.6 ------ ------ ------ ------ ------ ------- ------- ------- Total revenues......... 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0Cost of revenues: Cost of product revenues...... 55.0 51.1 55.4 54.4 56.1 56.9 58.6 55.1 Cost of contract revenues..... 9.8 10.5 3.2 2.5 2.7 2.0 1.4 1.4 ------ ------ ------ ------ ------ ------- ------- ------- Total cost of 64.8 61.6 58.6 56.9 58.8 58.9 60.0 56.5 revenues............. ------ ------ ------ ------ ------ ------- ------- -------Gross margin.................... 35.2 38.4 41.4 43.1 41.2 41.1 40.0 43.5Operating expenses: Selling, general and 12.6 10.8 10.8 12.5 9.9 10.4 9.7 16.0 administrative.............. Research and development...... 4.4 4.8 4.7 6.2 6.6 6.2 6.5 4.0 ------ ------ ------ ------ ------ ------- ------- ------- Total operating 17.0 15.6 15.5 18.7 16.5 16.6 16.2 20.0 expenses............. ------ ------ ------ ------ ------ ------- ------- -------Income from operations.......... 18.2 22.8 25.9 24.4 24.7 24.5 23.8 23.5Interest expense................ (2.3) (2.4) (2.4) (1.9) (1.9) (1.5) (1.5) (2.4)Interest and other income (1.7) 1.2 (0.2) (0.2) 0.2 (0.2) 1.8 3.2 (expense)..................... ------ ------ ------ ------ ------ ------- ------- -------Income before provision for 14.2 21.6 23.3 22.3 23.0 22.8 24.1 24.3 income taxes..................Provision for income taxes...... 5.4 8.2 8.9 8.5 8.8 8.7 9.1 9.2 ------ ------ ------ ------ ------ ------- ------- -------Net income...................... 8.8% 13.4% 14.4% 13.8% 14.2% 14.1% 15.0% 15.1% ====== ====== ====== ====== ====== ======= ======= ======= The following table sets forth product and contract gross profits and grossmargins for the eight quarters ended December 31, 1998. MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, 1997 1997 1997 1997 1998 1998 1998 1998 -------- -------- --------- -------- -------- -------- --------- -------- (DOLLARS IN THOUSANDS) Product gross profit............ $1,689 $2,193 $2,456 $3,002 $3,778 $ 4,154 $ 4,203 $ 4,807Product gross margin............ 37.6% 40.9% 40.5% 42.3% 40.9% 40.4% 38.6% 43.4%Contract gross profit........... $ 102 $ 188 $ 237 $ 241 $ 227 $ 279 $ 351 $ 137Contract gross margin........... 17.0% 22.3% 53.0% 55.8% 46.1% 56.1% 69.1% 45.5% Our total revenues have increased in each of the eight quarters endedDecember 31, 1998, except for the quarter ended December 31, 1998, which wascomparable to the prior quarter. These quarterly increases reflect increasedproduct shipments to both the semi-insulating and semi-conducting GaAs and InPmarkets and the introduction of Ge substrates in the quarter ended December 31,1997. In the quarter ended December 31, 1998, revenues from the sales of Gesubstrates declined by $1.2 million from the prior quarter as a result of amajor customer having excess inventory and deferring shipments. This decline inrevenues was offset by a $1.2 million increase in GaAs shipments due primarilyto increased orders from Southeast Asia for semi-conducting substrates. Contractrevenues increased in the quarters ended March 31 and June 30, 1997 primarily asa result of revenues recognized from a $1.2 million customer-funded Gesubstrates research contract. Contract revenues decreased in the quarter endedDecember 31, 1998 due primarily to the temporary reduction in the level of workperformed on contracts in progress. We experienced higher product gross margins in the four quarters of 1997primarily as a result of better product yields achieved from the new productionfacility completed in 1996 and improved manufacturing efficiencies from largerproduction volumes. In addition, due to a recycling program implemented in thequarter ended December 31, 1997, we were able to recycle scrapped inventory thathad accumulated over prior quarters. This recycling program had a significantpositive impact on the product gross margin for the quarter ended December 31,1997. While we will continue the recycling program, we expect the program tohave a less significant impact on product gross margins in the future asevidenced by the decline in product gross 20 22 margins for March 31, 1998. The increase in the overall product gross margin inthe quarter ended December 31, 1997 was partially offset by lower product grossmargins from sales of Ge substrates, which have lower gross margins than GaAsand InP substrates. The decrease in the overall product gross margins for thefirst three quarters of 1998 was primarily due to an increase in sales of Gesubstrates. We experienced significantly lower contract gross margins for thequarters ended March 31, 1997 and June 30, 1997 due to a shift in contractrevenue mix from higher margin government research contracts in prior quartersto a lower margin customer-funded contract for Ge substrates research. Thedecrease in contract gross margin from the quarter ended December 31, 1997 tothe quarter ended March 31, 1998 was due to a shift in contract revenue mix fromhigher margin government research contracts in prior quarters to a lower margincost sharing contract for InP substrates research. Contract gross margin in thequarter ended September 30, 1998 was favorably impacted by the recognition ofcertain performance incentives under the Title III GaAs contract. The lowercontract gross margin in the quarter ended December 31, 1998 was primarily dueto the lower margin on the cost sharing contract for InP substrates research. Selling, general and administrative expenses for the quarter ended December31, 1997 were higher than the quarters ended June 30 and September 30, 1997, aswe built our management infrastructure to support its increased sales volume.Selling, General and administrative expenses for the quarter ended December 31,1998 were significantly higher than the previous three quarters due primarily toincreases in our bad debt allowance to cover exposure from increasedinternational sales and for legal expenses in connection with an arbitrationcase. Research and development expenses for the four quarters ended September 30,1998 significantly increased over the prior three quarters ended September 30,1997, primarily due to increased new product research and materials purchasedfor research on InP substrates. Research and development expenses for thequarter ended December 31, 1998 decreased primarily due to lower materialpurchases for three research projects. We believe that our quarterly and annual revenues, expenses and operatingresults could vary significantly in the future and that period-to-periodcomparisons should not be relied upon as indications of future performance.There can be no assurance that our revenues will grow in future periods or thatit will sustain its level of total revenues or its rate of revenue growth on aquarterly or annual basis. We may, in some future quarter, have operatingresults that will be below the expectations of stock market analysts andinvestors. In such event, the price of the our common stock could be materiallyadversely affected. LIQUIDITY AND CAPITAL RESOURCES During the past five years, we have funded our operations primarily fromcash provided by operations, short-term and long-term borrowings and a privatefinancing of $5.9 million for preferred stock completed in March 1997. Wecompleted our initial public offering in May 1998, and raised net proceeds ofapproximately $25.8 million. As of December 31, 1998, we had working capital of$40.8 million, including cash and cash equivalents of $16.1 million, compared toworking capital at December 31, 1997 of $14.2 million, including cash of $3.1million, and compared to working capital at December 31, 1996 of $5.5 million,including cash of $756,000. During the year ended December 31, 1996, net cash provided by operations of$474,000 was due primarily to net income of $2.0 million, depreciation of$867,000 and an increase in accounts payable and accrued liabilities of$629,000, offset in part by increases in inventory of $2.3 million, and accountsreceivable and other assets of $727,000. The increase in inventory was primarilydue to increases in raw material and work-in-process inventory to provide anadequate supply of material in anticipation of large orders for the upcomingyear. These inventory increases resulted in a decrease in the inventory turnoverratio from 4.5 turns per year at December 31, 1995 to 3.3 turns per year atDecember 31, 1996. The increase in accounts receivable was primarily a result of increased sales in Japan, which generally have longer payment cycles. Theincrease in sales to Japan also adversely impacted days sales outstanding, whichincreased from 49 days at December 31, 1995 to 60 days at December 31, 1996. 21 23 During the year ended December 31, 1997, net cash used in operations of$1.2 million was primarily due to increases in inventory of $4.4 million andaccounts receivable of $3.0 million, offset in part by net income of $3.3million, depreciation of $1.2 million and increases in accounts payable andaccrued liabilities of $1.6 million. The increase in inventory during thisperiod included additional Ge inventory, which primarily resulted in a decreasein the inventory turnover ratio from 3.3 turns per year at December 31, 1996 to2.2 turns per year at December 31, 1997. The increases in accounts payable andaccrued liabilities, accounts receivable and inventory were primarily the resultof a 56.1% increase in revenues from the prior year. In addition, accountsreceivable increased due to the increase in international revenues, whichhistorically have longer payment cycles. This increase in payment cyclesresulted in an increase in days sales outstanding from 60 days at December 31,1996 to 64 days at December 31, 1997. During the year ended December 31, 1998, net cash used in operations of$6.3 million was primarily due to increases in inventory of $12.2 million,accounts receivable of $2.9 million and prepaid and other assets of $1.6million, offset in part by net income of $6.3 million, depreciation of $2.0million, and increases in accounts payable of $1.7 million and accruedliabilities of $496,000. The increases in accounts receivable, inventory andaccounts payable were primarily the result of the 70.9% increase in totalrevenues from the prior year. In addition, inventory increased due to ourdecision to maintain the Ge substrates production line during the fourth quarterof 1998 in anticipation of future large orders, although shipments to a largecustomer had been deferred. Accordingly, the inventory turnover ratio declinedfrom 2.2 turns per year at December 31, 1997 to 1.7 turns per year at December31, 1998. The increase in prepaid and other assets was due primarily to depositson manufacturing equipment and materials for our new Beijing, China facility andU.S. operations and for increases in prepaid insurance, taxable bond fees andbank fees. The increase in accrued liabilities was the result of an increase inlegal expenses in connection with an arbitration case, and higher vacation andpayroll expenses due to the increased number of personnel. Days salesoutstanding decreased from 64 days at December 31, 1997 to 62 days at December31, 1998, reflecting improved collection efforts. Net cash used in investing activities was $3.9 million, $4.9 million, and$16.4 million for the years ended December 31, 1996, 1997 and 1998,respectively, which amounts were attributed in each period to the purchase ofproperty, plant and equipment. For the year ended December 31, 1998, theproperty acquired included our new 58,000 square foot building at a cost of $9.0million and the 30,000 square foot addition for $2.0 million. Net cash provided by financing activities was $3.5 million, $8.4 millionand $35.5 million for the years ended December 31, 1996, 1997 and 1998,respectively. For the year ended December 31, 1996, net cash provided byfinancing activities resulted primarily from long-term borrowings of $3.5million to complete our manufacturing facility. For the year ended December 31,1997, net cash provided by financing activities resulted primarily from theissuance of $5.9 million of preferred stock and $2.7 million for long-term bankborrowings, partially offset by the repayment of $300,000 of short-termborrowings. For the year ended December 31, 1998, net cash provided by financingactivities consisted primarily of net proceeds of $25.8 million from our initialpublic offering and long-term net borrowings of $9.6 million. Long-term netborrowings reflected the issuance of $11.6 million in taxable variable raterevenue bonds in November 1998 and equipment loans in the amount of $2.3 millionless repayment of existing long-term debts in the amount of $4.3 million.Long-term borrowings were used for the purchase of the new 58,000 square footfacility, for construction of the additional 30,000 square foot manufacturingspace and related equipment. We have generally financed our equipment purchases through securedequipment loans over five-year terms at interest rates ranging from 6.0% to 9.0%per annum. Our manufacturing facilities have been financed by long-termborrowings, which were repaid by the taxable variable rate revenue bonds in1998, except for a $1.0 million SBA loan. The SBA loan has an interest rate of7.3% per annum, matures in 2016 and is subordinated to the taxable variable raterevenue bonds. The taxable variable rate revenue bonds have a term of 25 yearsand mature in 2023 with an interest rate at 200 basis points below the primerate and are traded in the public market. Repayment of principal and interestunder the bonds is secured by a letter of credit from our bank and is paid on aquarterly basis. We have the option to redeem in whole or in part the bondsduring their term. At December 31, 1998, $11.6 million was outstanding under thetaxable variable rate revenue bonds. 22 24 We currently have a $15.0 million line of credit with a commercial bank atan interest rate equal to the prime rate plus one-half percent. This line ofcredit is secured by all business assets, less equipment, and expires in May1999. This line of credit is subject to certain financial covenants regardingcurrent financial ratios and cash flow requirements, which were met as ofDecember 31, 1998. We must obtain the lender's approval to obtain additionalborrowings or to further pledge our assets, except for borrowings secured by thepledge of equipment or obtained in the normal course of business. At December31, 1998, no amount was outstanding under the $15.0 million line of credit. We anticipate that the combination of existing working capital and theborrowings available under current credit agreements will be sufficient to fundworking capital and capital expenditure requirements for the next 12 months. Ourfuture capital requirements will depend on many factors, including the rate ofrevenue growth, our profitability, the timing and extent of spending to supportresearch and development programs, the expansion of selling and marketing andadministrative activities, and market acceptance of our products. We expect thatwe may need to raise additional equity or debt financing in the future, althoughwe are not currently negotiating for additional financing nor do we have anyplans to obtain additional financing at this time. There can be no assurancethat additional equity or debt financing, if required, will be available on theacceptable terms or at all. If we are unable to obtain such additional capital,if needed, we may be required to reduce the scope of our planned productdevelopment and selling and marketing activities, which would have a materialadverse effect on our business, financial condition and results of operations.In the event that we do raise additional equity financing, further dilution toour investors will result. YEAR 2000 READINESS Some computers, software, and other equipment include computer code inwhich calendar year data is abbreviated to only two digits. As a result of thisdesign decision, some of these systems could fail to operate or fail to producecorrect results if "00" is interpreted to mean 1900, rather than 2000. Theseproblems are widely expected to increase in frequency and severity as the year2000 approaches, and are commonly referred to as the "year 2000 problem." Assessment. The year 2000 problem affects the computers, software and otherequipment that we use, operate or maintain for our operations. Accordingly, wehave organized a program team responsible for monitoring the assessment andremediation status of our year 2000 projects and reporting such status to ourboard of directors. This project team is currently assessing the potentialeffect and costs of remediating the year 2000 problem for our internal systems.To date, we have obtained verification or validation from our significantequipment and system vendors that the software programs and applications andrelated hardware that we use, operate or maintain for our operations arecompliant with the year 2000. Internal infrastructure. We believe that we have identified and evaluatedall of the major computers, software applications and related equipment used in connection with our internal operations to determine if they must be modified,upgraded or replaced to minimize the possibility of a material disruption to ourbusiness. We are in the process of modifying, upgrading, and replacing majorsystems that have been assessed as adversely affected, and expect to completethis process before the end of fiscal 1999. As of December 31, 1998, we haveincurred approximately $300,000 in this process. Systems other than information technology systems. In addition to computersand related systems, the operation of office and facilities equipment, such asfax machines, telephone switches, security systems, and other common devices maybe affected by the year 2000 problem. We are currently assessing the potentialeffect and costs of remediating the year 2000 problem on our office equipment atour facilities in Fremont, California. We estimate the total cost to us ofcompleting any required modifications, upgrades or replacements of our internalsystems will not exceed $100,000, almost all of which we believe will beincurred during 1999. This estimate is being monitored and we will revise it asadditional information becomes available. Based on the activities described above, we do not believe that the year2000 problem will have a material adverse effect on our business or operatingresults. 23 25 Suppliers. We are in the process of contacting third-party suppliers ofcomponents used in the manufacture of our products to identify and, to theextent possible, resolve issues involving the year 2000 problem. However, wehave limited or no control over the actions of these third-party suppliers.Thus, while we expect that we will be able to resolve any significant year 2000problems with these third parties, there can be no assurance that thesesuppliers will resolve any or all year 2000 problems before the occurrence of amaterial disruption to the operation of our business. Any failure of these thirdparties to timely resolve year 2000 problems with their systems could have amaterial adverse effect on our business, operating results and financialcondition. Most likely consequences of year 2000 problems. We expect to identify andresolve all year 2000 problems that could materially adversely affect ourbusiness operations. However, we believe that it is not possible to determinewith complete certainty that all year 2000 problems affecting us have beenidentified or corrected. The number of devices that could be affected and theinteractions among these devices are simply too numerous. In addition, no onecan accurately predict how many year 2000 problem-related failures will occur orthe severity, duration, or financial consequences of these perhaps inevitablefailures. As a result, we believe that the following consequences are possible: - a significant number of operational inconveniences and inefficiencies for us, our contract manufacturers and our customers that will divert management's time and attention and financial and human resources from ordinary business activities; - business disputes and claims for pricing adjustments or penalties due to year 2000 problems by our customers, which we believe will be resolved in the ordinary course of business; and - business disputes alleging that we failed to comply with the terms of contracts or industry standards of performance, some of which could result in litigation or contract termination. Contingency plans. We are currently developing contingency plans to beimplemented if our efforts to identify and correct year 2000 problems affectingour internal systems are not effective. We expect to complete our contingencyplans by the end of August 1999. Depending on the systems affected, these planscould include: - accelerated replacement of affected equipment or software; short- to medium-term use of backup equipment and software; increased work hours for our personnel; and use of contract personnel to correct on an accelerated schedule any year 2000 problems that arise or to provide manual workarounds for information systems. Our implementation of any of these contingency plans could have a materialadverse effect on our business, operating results and financial condition. Disclaimer. The discussion of our efforts and expectations relating to year2000 compliance are forward-looking statements. Our ability to achieve year 2000compliance and the level of incremental costs associated therewith, could beadversely affected by, among other things, the availability and cost ofprogramming and testing resources, third party suppliers' ability to modifyproprietary software, and unanticipated problems identified in the ongoingcompliance review. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board issued Statement ofFinancial Accounting Standard No. 133, "Accounting for Derivative Instrumentsand Hedging Activities" ("SFAS 133"). SFAS 133 established a new model foraccounting for derivatives and hedging activities and supersede and amend anumber of existing accounting standards. SFAS 133 requires that all derivativebe recognized in the balance sheet at their fair market value. In addition,corresponding derivative gains and losses should be either reported in thestatement of operations or stockholders' equity, depending on the type ofhedging relationship that exists with respect to such derivatives. Adopting theprovisions of SFAS 133, which will be effective in fiscal year 2000, is notexpected to have a material effect on the Company's consolidated financialstatements. 24 26 FACTORS AFFECTING FUTURE RESULTS In addition to the other information in this report, the following factorsshould be considered carefully in evaluating our business before purchasingshares of our stock. A number of factors could cause our quarterly financial results to be worsethan expected, resulting in a decline in our stock price. Although we have beenprofitable on an annualized basis since 1990, due to the foregoing factors, webelieve that period-to-period comparisons of our operating results cannot berelied upon as an indicator of our future performance. It is likely that in somefuture quarter, our operating results may be below the expectations of publicmarket analysts or investors. If this occurs, the price of our common stockwould likely decrease. For more information regarding our results, see"Management's Discussion and Analysis of Financial Condition and Results ofOperations". Our quarterly and annual revenues and operating results have variedsignificantly in the past and may vary significantly in the future due to anumber of factors, including: - fluctuations in demand for our substrates due to reduction in the value of Asian currencies and the turmoil in the Asian financial markets; - our expense levels and expected research and development requirements; - our ability to develop and bring to market new products on a timely basis; - the volume and timing of orders from our customers; - the availability of raw materials; - fluctuations in manufacturing yields; - our manufacturing expansion in Beijing, China; - changes in the unit of products sold; - introduction of products and technologies by our competitors; and - costs relating to possible acquisitions and integration of technologies or businesses. For more information regarding our results, see "Management's Discussionand Analysis of Financial Condition and Results of Operations." VGF is a new technique for producing substrates which must achievewidespread acceptance if we are to succeed. We believe that our competitorsprincipally utilize the traditional LEC or HB crystal growing processes forproducing semi-insulating and semi-conducting GaAs substrates. We furtherbelieve that we are the only high-volume supplier of semi-insulating andsemi-conducting GaAs substrates which utilize the VGF technique, a newertechnology than either the LEC or HB techniques. We cannot assure you that ourcurrent customers will continue to use our VGF-produced substrates or thatadditional companies will purchase our products manufactured from the VGFtechnique. Failure to gain increased market acceptance of our VGF technique byeither current or prospective customers could materially adversely affect ouroperating results. A significant portion of our prospective customers are wirelesscommunications manufacturers, fiber optic communications manufacturers andmanufacturers of other high-speed semiconductor devices that use GaAs substratesproduced using either the LEC or HB techniques. To establish the VGF techniqueas a preferred process for producing substrates for prospective customers, wemust offer products with superior prices and performance on a timely basis andin sufficient volumes. We must also overcome the reluctance of these customersto purchase our GaAs substrates due to possible perceptions of risks relating toconcerns about the quality and cost-effectiveness of our GaAs substrates whencompared to substrates produced by the traditional LEC or HB techniques. Inaddition, potential GaAs substrate customers may be reluctant to rely on arelatively small company for critical materials used to manufacture theirsemiconductor devices. If we do not achieve acceptable yields of crystals and the successful andtimely production of substrates, the shipment of our products would be delayedand our business adversely affected. The highly complex 25 27 processes of growing crystals as well as other steps involved in manufacturingsubstrates which we engage in can be adversely affected by a number of factors,including the following: - chemical or physical defects in the crystals; - contamination of the manufacturing environment; - substrate breakage; - equipment failure; and - performance of personnel involved in the manufacturing process. We have been adversely affected in the past due to the occurrence of acombination of these factors which resulted in product shipment delays andadversely affected our business. A significant portion of our manufacturing costs are fixed. As a result, we must increase the production volume of substrates and improve yields in order toreduce unit costs, increase margins and maintain and improve our results ofoperations. Such decreases in production volume and yields could materiallyadversely affect our business, financial condition and results of operations. In the past, we have sometimes manufactured substrates which have not metcertain customers' manufacturing process requirements. We have fixed suchoccurrences through minor changes to the substrates or the manufacturingprocess. Recurrence of such problems and our inability to solve them maymaterially hurt our performance. We have begun producing and shipping Ge and InP substrates in commercialvolume. We also understand that we must achieve the same manufacturingcapability for six inch GaAs wafers. We cannot assure you that we will be ableto manufacture the Ge and InP substrate or the larger GaAs substrates incommercial volumes with acceptable yields. Our business, financial condition andresults of operations would be materially adversely affected if we experiencelow yields of these substrates. Because substantially all of our revenue is derived from sales of our GaAssubstrates, we are dependent on widespread market acceptance of theseproducts. We currently derive substantially all of our revenues from sales ofour GaAs substrates. We expect that revenue from GaAs substrates will accountfor a significant majority of our revenues for the next several years. GaAssubstrates are primarily used in electronic applications such as wirelesscommunications, fiber optic communications and other high-speed semiconductordevices, as well as in opto-electronic applications such as lasers and LEDs. Ifthere is a decrease in demand for GaAs substrates by semiconductor devicemanufacturers or if new substrates for these electronic and opto-electronicapplications are developed and successfully introduced by competitors, ourrevenues may decline and our business will be materially adversely affected. Further, other companies, including IBM, are actively involved indeveloping other devices which could provide the same high-performance, lowpower capabilities as GaAs-based devices at competitive prices, such assilicon-germanium based devices for use in certain wireless applications. Ifthese silicon-germanium based devices are successfully developed and are adoptedby semiconductor device manufacturers, demand for GaAs substrates coulddecrease. This development could cause our revenues to fall, which couldadversely affect our business, financial condition and results of operations. In order to be successful, we must develop and introduce in a timely mannernew substrates and continue to improve our current substrates to addresscustomer requirements and compete effectively on the basis of price andperformance. Recently, we have begun commercial shipments of Ge and InPsubstrates and are currently developing other substrates, including galliumphosphide and gallium nitride. Factors that may affect the success of productimprovements and product introductions include the development of markets forsuch improvements and substrates, achievement of acceptable yields, price andmarket acceptance. Many of these factors are beyond our control. We cannotassure you that our product development efforts will be successful or that ournew products will achieve market acceptance. To the extent that productimprovements and new product introductions do not achieve market acceptance, ourbusiness, financial condition and results of operations would be materiallyadversely affected. 26 28 Our limited ability to protect our intellectual property may adverselyaffect our ability to compete. We rely on a combination of patents, copyrights,trademarks and trade secret laws and contractual restrictions on employees,consultants and third parties from disclosure to protect our intellectualproperty rights. Despite our efforts to protect our proprietary rights,unauthorized parties may attempt to copy or otherwise obtain and use ourproducts or technology. Policing unauthorized use of our products is difficult,and we cannot be certain that the steps we have taken will preventmisappropriation of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States. Webelieve that, due to the rapid pace of technological innovation in the GaAs andother substrate markets, our ability to establish and maintain a position oftechnology leadership in the industry depends more on the skills of ourdevelopment personnel than upon the legal protections afforded our existingtechnologies. To date, we have been issued one U.S. patent, which relates to the VGFtechnique, and have two U.S. patent applications pending, one which relates tothe VGF technique. Additionally, we have one pending application for a Japanesepatent but no issued foreign patents. We cannot assure you that: - the pending or any future U.S. or foreign patent applications will be approved; - any issued patents will protect our intellectual property; - third parties will not challenge the ownership rights of the patents or the validity of the patent applications; - the patents owned by others will not have an adverse effect on our ability to do business; or - others will not independently develop similar or competing technology or design around any patents issued to us. Moreover, the laws of certain foreign countries may not lend protection toour patents to the same extent as the laws of the United States. See"Business-Intellectual property" for more information regarding risks relatingto protecting our intellectual property rights. If we infringe the proprietary rights of others, we may be forced to entercostly royalty or licensing agreements. We could in the future receive a claimthat we are infringing the patent, trademark, copyright or other proprietaryrights of other third parties. If any claims were asserted against us forviolation of patent, trademark, copyright or other similar laws as a result ofthe use by us, our customers or other third parties of our products, thoseclaims would be costly and time-consuming to defend, would divert ourmanagement's attention and could cause product delays. In addition, if wediscovered we violated other third party rights, we could be required to enterinto costly royalty or licensing agreements as a result of such claims. Theseroyalty or licensing agreements may adversely affect our operating results. If we fail to comply with stringent environmental regulations, we may besubject to significant fines or the cessation of our operations. We are subjectto federal, state and local environmental laws and regulations. Any failure tocomply with present or future environmental laws and regulations could result inthe imposition of significant fines on us, the suspension of production or acessation of operations. In addition, existing or future changes in laws orregulations may require us to incur further significant expenditures orliabilities, or additional restriction in our operations. For more informationregarding environmental regulations that affect our operations, see"Business -- Environmental regulations." We purchase critical raw materials required to grow crystals from single orlimited sources, and could lose sales if these sources fail to fill ourneeds. We do not have any long-term supply contracts with any of our suppliers,and we currently purchase raw materials required to grow crystals from single ora limited number of suppliers. For example, we purchase a majority of thegallium we use from Rhone-Poulenc. Due to our reliance on a limited group of suppliers, we are exposed toseveral risks such as the potential inability to obtain adequate supply ofmaterials, reduced control over pricing of our products and meeting customerdelivery schedules. We have experienced delays receiving orders of certain materials due toshortages. We may continue to experience these delays due to shortages of materials and as a result be subject to higher costs. Although we 27 29 attempt to preempt supply interruptions by maintaining adequate levels ofinventory of critical materials and attempts to obtain additional suppliers,shortages or price increases caused by suppliers may nevertheless recur. If we are unable to receive adequate and timely deliveries of critical rawmaterials, relationships with current and future customers could be harmed,which could materially adversely affect our business, financial condition andresults of operations. We are subject to additional risks as a result of the recent completion ofa new manufacturing facility. In connection with further expanding ourmanufacturing capacity, we purchased an additional 58,000 square foot facilityin Fremont, California and a 30,000 square foot facility in Beijing, China. in1998. The improvements to the new facility subject us to significant risks,including: - unavailability or late delivery of process equipment; - unforeseen engineering problems; - work stoppages; - unanticipated cost increases; and - unexpected changes or concessions required by local, state or federal regulatory agencies with respect to necessary licenses, land use permits and building permits. If any of the above occur, it could materially adversely affect operationsunder the new facility which in turn would materially adversely affect ourbusiness, financial condition and results of operations. Finally, the operation of the new facility, together with the recentexpansion of our current facility by approximately 30,000 square feet, will alsoexpose us to additional risks. For example, the additional fixed operatingexpenses associated with the new facility may only be offset by sufficientincreases in product revenues. We cannot assure you that the demand for ourproducts will grow as we currently expect, and if this does not occur, we wouldnot be able to offset the costs of operating the new facility, which maymaterially adversely affect our results of operations. We must effectively respond to rapid technological changes by continuallyintroducing new products that achieve broad market acceptance. We and ourcustomers compete in a market that is characterized by rapid technologicalchanges and continuous improvements in substrates. Accordingly, our futuresuccess depends upon whether we can apply our proprietary VGF technique todevelop new substrates that meet the needs of customers and compete effectivelyon the basis of quality, price and performance. If we are unable to timelydevelop new, economically viable products that meet market demands, our revenueswill decline, which could adversely affect our results of operation and causethe price of our stock to fall. It is difficult to predict accurately the time required and the costsinvolved in researching, developing and engineering new products. Thus, ouractual development costs could exceed budgeted amounts and our productdevelopment schedules could require extension. We have experienced productdevelopment delays in the past and may experience similar delays in the futurewhich could materially adversely affect our business. For example, ourintroduction of InP substrates was delayed approximately six months as a resultof delays in the finalization of the manufacturing process for these substrates.In addition, if we are unable to introduce reliable quality products, we couldsuffer from reduced orders, higher manufacturing costs, product returns andadditional service expenses, all of which could result in lower revenues. The sales cycle for our GaAs substrates is long and we may incursubstantial, non-recoverable expenses or devote significant resources to salesthat do not occur as anticipated. We have experienced and continue to experiencedelays in obtaining purchase orders for GaAs substrates while customers evaluateour substrates. A customer's decision to purchase our GaAs substrates is basedupon whether the customer prefers substrates developed using our proprietary VGFtechnique or substrates developed using the more traditional LEC and HBtechniques. The amount of time it takes for a customer to evaluate our GaAssubstrates typically ranges from three months to a year or more, depending onthe amount of time required to test and qualify substrates from new vendors.Since our substrates are generally incorporated into a customer's products atthe design 28 30 stage, the customer's decision to use our substrates often precedes volumesales, if any, by a significant period. If a customer decides at the designstage not to incorporate our substrates into its products, we may not haveanother opportunity to sell substrates for those products for many months oreven years. Thus, our GaAs substrates typically have a lengthy sales cycle,during which we may expend substantial funds and sales, marketing and managementefforts to attract the potential customer. However, there is a risk that theseexpenditures may not result in sales. Consequently, if sales forecasted from aspecific customer for a particular quarter are not delivered in that quarter, wemay be unable to compensate for the shortfall, which could materially adverselyaffect our operating results. We anticipate that sales of any future products under development will havesimilar lengthy sales cycles and will, therefore, be subject to riskssubstantially similar to those inherent in the lengthy sales cycle of our GaAssubstrates. The loss of one or more of our key customers would significantly hurt ouroperating results. A small number of customers have historically accounted for asubstantial portion of our revenues. We expect that a significant portion of ourfuture sales will be due to a limited number of customers. Our top fivecustomers accounted for approximately 35.5%, 34.9% and 39.5% of our revenues in1996, 1997 and 1998, respectively. Our customers are not obligated to purchaseany specified quantity of products or to provide us with binding forecasts ofproduct purchases. In addition, our customers may reduce, delay or cancel ordersat any time without any significant penalty. Our substrates are typically one of many components used in semiconductordevices produced by our customers. Demand for our products is therefore subjectto many factors beyond our control, including: - demand for our customers' products; - competition faced by our customers in their particular industries; - the technical, sales and marketing and management capabilities of our customers; and - the financial and other resources of our customers. In the past, we have experienced reductions, cancellations and delays incustomer orders. If any one of our major customers reduces, cancels or delaysorders in the future, our business, financial condition and results of operationcould be materially adversely affected. Intense competition in the market for GaAs substrates could prevent us fromincreasing revenue and sustaining profitability. The market for GaAs substratesis intensely competitive. In the semi-insulating GaAs substrates market, ourprincipal competitors currently include: - Freiberger Compound Materials; - Hitachi Cable; - Litton Airtron; and - Sumitomo Electric Industries. We also compete with manufacturers that produce GaAs substrates for theirown use. In addition, we compete with companies, such as IBM, that are activelydeveloping alternative materials to GaAs. As we enter new markets, such as theGe and InP substrate markets, we expect to face competitive risks similar tothose for our GaAs substrates. Many of our competitors and potential competitors have a number ofsignificant advantages over us, including: - having been in the business longer than we have; - more manufacturing experience; - more established technologies than our VGF technique; 29 31 - broader name recognition; and - significantly greater financial, technical and marketing resources. Our competitors could develop enhancements to the LEC, HB or VGF techniquesthat are superior to ours in terms of price and performance. Our competitorsalso could intensify price-based competition, resulting in lower prices andmargins. For more information regarding the risks we face from our competitors,see "Business -- Competition." We derive a significant portion of our revenues from international salesand our ability to sustain and increase our international sales involvesignificant risks. Our ability to grow will depend in part on the expansion ofinternational sales and operations which have and are expected to constitute asignificant portion of our revenues. International sales, excluding Canada,represented 34.1% and 28.8% of our total revenues in 1997 and 1998,respectively. Sales to customers located in Japan and other Asian countriesrepresented 23.5% and 18.7% of our total revenues in 1997 and 1998. Sales tocustomers in Japan, in particular, accounted for 17.1% and 11.5% of our totalrevenues in 1997 and 1998, respectively. We expect that sales to customersoutside the United States, including device manufacturers located in Japan andother Asian countries who sell their products worldwide, will continue torepresent a significant portion of our revenues. Our dependence on international sales involves a number of risks,including: - import restrictions and other trade barriers; - unexpected changes in regulatory requirements; - longer periods to collect accounts receivable; - export license requirements; - political and economic instability (in particular, the current instability of the economies of Japan and other Asian countries); and - unexpected changes in diplomatic and trade relationships. Our sales, except for sales by our Japanese subsidiary, are denominated inU.S. dollars. Thus, increases in the value of the dollar could increase the price of our products in non-U.S. markets and make our products more expensivethan competitors' products in such markets. For example, doing business in Japansubjects us to fluctuations in the exchange rates between the U.S. dollar andthe Japanese yen. In 1996, 1997 and 1998, we incurred foreign exchange losses of$114,000, $186,000 and $24,000, respectively. If we do not effectively managethe risks associated with international sales, our business, financial conditionand results of operations could be materially adversely affected. In order tominimize our foreign exchange risk, we have bought foreign exchange contracts tohedge against certain trade accounts receivable in Japanese yen. Because wecurrently denominate sales in U.S. dollars except in Japan, we do not anticipatethat the adoption of the Euro as a functional legal currency of certain Europeancountries will materially affect our business. If we lose certain key personnel or are unable to hire additional qualifiedpersonnel as necessary, we may not be able to successfully manage our businessor achieve our objectives. Our success depends to a significant degree upon thecontinued service of Morris S. Young, Ph.D., AXT's President and Chief ExecutiveOfficer, as well as other key management and technical personnel. We neitherhave long-term employment contracts with, nor key person life insurance on, anyof our key personnel. In addition, our management team has limited experience asexecutive officers of a public company. We believe our future success will also depend in large part upon ourability to attract and retain highly skilled managerial, engineering, sales andmarketing, finance and manufacturing personnel. The competition for theseemployees is intense, especially in Silicon Valley, and there can be noassurance that we will be successful in attracting and retaining new personnel.The loss of the services of any of our key personnel, the inability to attractor retain qualified personnel in the future or delays in hiring requiredpersonnel, particularly engineers, could make it difficult for us to manage ourbusiness and meet key objectives, such as product introduction, on time. 30 32 Continued rapid growth may strain our operations. We have recentlyexperienced a period of rapid growth and expansion which has placed, andcontinues to place, a significant strain on our operations. To accommodate thisanticipated growth, we will be required to: - improve existing and implement new operational and financial systems, procedures and controls; - hire, train and manage additional qualified personnel; - effectively manage multiple relationships with our customers, suppliers and other third parties; and - maintain effective cost controls. We may not be able to install adequate control systems in an efficient andtimely manner, and our current or planned personnel systems, procedures andcontrols may not be adequate to support our future operations. We are in theprocess of installing a new management information system; however, thefunctionality of this new system has not been fully implemented. Thedifficulties associated with installing and implementing these new systems,procedures and controls may place a significant burden on our management and ourinternal resources. In addition, international growth will require expansion ofour worldwide operations and enhance our communications infrastructure. Anydelay in the implementation of such new or enhanced systems, products andcontrols, or any disruption in the transition to such new or enhanced systems,products and controls, could adversely affect our ability to accurately forecastsales demand, manage manufacturing, purchasing and inventory levels, and recordand report financial and management information on a timely and accurate basis.Our inability to manage growth effectively could affect our revenues andadversely impact our profitability. Our failure and the failure of our key suppliers and customers to be year2000 compliant could negatively impact our business. The year 2000 computerissue creates a risk for us. If systems do not correctly recognize dateinformation when the year changes to 2000, there could be an adverse impact onour operations. The risk exists in four areas: - potential warranty or other claims from our customers; - systems we used to run our business; - systems used by our suppliers; and - the potential reduced spending by other companies on networking solutions as a result of significant information systems spending on year 2000 remediation. We are currently evaluating our exposure in all of these areas. We are in the process of conducting a comprehensive inventory andevaluation of the information systems used to run our business. We have a numberof projects underway to replace older systems that are known to be year 2000non-compliant. Other systems, which are identified as non-compliant, will beupgraded or replaced. For the year 2000 non-compliance issues identified todate, the cost of remediation is not expected to be material to our operatingresults. However, if implementation of replacement systems is delayed, or ifsignificant new non-compliance issues are identified, our operating results orfinancial condition could be materially adversely affected. We have contacted more than thirty key suppliers to determine if theiroperations and the products and services they provide are year 2000 compliant.Where practicable, we will attempt to mitigate our risks with respect to thefailure of suppliers to be year 2000 ready. However, such failures remain apossibility and could have an adverse impact on our operating results orfinancial condition. We believe our current products are year 2000 compliant; however, since allcustomer situations cannot be anticipated, we may see an increase in warrantyand other claims as a result of the year 2000 transition. In addition,litigation regarding year 2000 compliance issues is expected to escalate. Forthese reasons, the impact of customer claims could have a material adverseimpact on our operating results or financial condition. 31 33 Year 2000 compliance is an issue for virtually all businesses whosecomputer systems and applications may require significant hardware and softwareupgrades or modifications. Companies owning and operating such systems may planto devote a substantial portion of their information systems' spending to fundsuch upgrades and modifications and divert spending away from networkingsolutions. Such changes in customers' spending patterns could have a materialadverse impact on our business, operating results or financial condition. We may engage in future acquisitions that we must successfully integrateinto our business and that may dilute our stockholders and cause us to assumecontingent liabilities. As part of our business strategy, we may in the futurereview acquisition prospects that would complement our current productofferings, augment our market coverage or enhance our technical capabilities, orthat may otherwise offer growth opportunities. In the event of any futureacquisitions, we could: - issue equity securities which would dilute current stockholders' percentage ownership; - incur substantial debt; or - assume contingent liabilities. Such actions by us could materially adversely affect our operating resultsand/or the price of our common stock. Any future acquisitions creates risks for us, including: - difficulties in the assimilation of acquired personnel, operations, technologies or products; - unanticipated costs associated with the acquisition could materially adversely affect our operating results; - diversion of management's attention from other business concerns; - adverse effects on existing business relationships with suppliers and customers; - risks of entering markets where we have no or limited prior experience; - potential loss of key employees of acquired organizations; and - loss of customers that, through product acquisition, now become competitors. These risks and difficulties could disrupt our ongoing business, distractour management and employees and increase our expenses. We may not be able tosuccessfully integrate any businesses, products, technologies or personnel thatwe might acquire in the future, and our failure to do so could have a materialadverse effect on our business, operating results and financial condition. We may need additional capital to fund our future operations which may notbe available. We believe that our cash balances and cash available from creditfacilities and future operations will enable us to meet our working capitalrequirements for at least the next 12 months. We do not currently anticipate theneed for additional capital but if cash from future operations is insufficient,or if cash is used for acquisitions or other currently unanticipated uses, wemay need additional capital. To the extent that we raise additional capitalthrough the sale of equity or convertible debt securities, the issuance of suchsecurities could result in dilution to existing stockholders. On December 1, 1998, we raised approximately $11.6 million by issuingvariable rate taxable demand revenue bonds series 1998 for: - the purchase of a commercial building and to finance tenant improvements at 4281 Technology Drive, Fremont, California; - to refinance an existing loan and to finance tenant improvements on our principal offices; and - the permanent financing for an existing bank construction loan. 32 34 These debt securities have rights, preferences and privileges that aresenior to holders of common stock, as other debt securities which we may issuein the future would be, and the term of any debt could impose restrictions onour operations. We cannot assure you that if we required additional capital, itwill be available on acceptable terms, or at all. If we are unable to obtainadditional capital, we may be required to reduce the scope of our plannedproduct development and marketing efforts, which would materially adverselyaffect our business, financial condition and operating results. See"Management's Discussion and Analysis of Financial Condition and Results ofOperations." Our executive officers and directors control 21% of our common stock andare able to significantly influence matters requiring stockholder approval. Executive officers, directors and entities affiliated with them, inthe aggregate, currently beneficially own approximately 21% of our outstandingcommon stock. These stockholders, if acting together, are able to significantlyinfluence all matters requiring our stockholder approval, including the electionof directors and the approval of mergers or other business combinationtransactions. This concentration of ownership could delay or prevent a change ofcontrol of AXT and could reduce the likelihood of an acquisition of AXT at apremium price. Provisions in our charter or agreements may delay or prevent a change ofcontrol. Provisions in our amended and restated certificate of incorporation andbylaws may have the effect of delaying or preventing a merger or acquisition ora change of control or changes in our management. These provisions include,among others: - the division of the board of directors into three separate classes of three year terms; - the right of the board to elect the director to fill a space created by the expansion of the board; - the ability of the board to alter our bylaws; - authorizing the issuance of up to 2,000,000 shares of "blank check" preferred stock; and - the requirement that at least 10% of the outstanding shares are needed to call a special meeting of stockholders. Furthermore, because we are incorporated in Delaware, we are subject to theprovisions of section 203 of the Delaware General Corporation Law. Theseprovisions prohibit certain large stockholders, in particular those owning 15%or more of the outstanding voting stock, from consummating a merger orcombination with a corporation unless: - 66 2/3% of the shares of voting stock not owned by this large stockholder approve the merger or combination, or - the board of directors approves the merger or combination or the transaction which resulted in the large stockholder owning 15% or more of our outstanding voting stock. Our stock price has been and may continue to be volatile and is dependenton external and internal factors. Our stock has fluctuate significantly since webegan trading on the Nasdaq national market. In 1998, our stock price closed aslow as $6.00 and as high as $15.50. Various factors could cause the price of ourcommon stock to continue to fluctuate substantially, including: - actual or anticipated fluctuations in our quarterly or annual operating results; - changes in expectations as to our future financial performance or changes in financial estimates of securities analysts; - announcements of technological innovations by us or our competitors; - new product introduction by us or our competitors; - large customer orders or order cancellations; and - the operating and stock price performance of other comparable companies. 33 35 In addition, the stock market in general has experienced extreme volatilitythat often has been unrelated to the operating performance of particular companies. These broad market and industry fluctuations may adversely affect thetrading price of our common stock, regardless of our actual operatingperformance. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Since many of our Japanese invoices are denominated in yen, we have boughtforeign exchange contracts to hedge against certain trade accounts receivable inJapanese yen. As of December 31, 1998, our outstanding commitments with respectto the foreign exchange contracts had a total value of approximately $1.6million equivalent. Many of the contracts were entered six months prior to thedue date and the dates coincide with the receivable terms we have on theinvoices. By matching the receivable collection date and contract due date, weattempt to minimize the impact of foreign exchange fluctuation. ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Consolidated Financial Statements and Supplementary Data required bythis item are set forth at the pages indicated at Item 14(a). ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING ANDFINANCIAL DISCLOSURES None. 34 36 PART III The SEC allows us include information required in this report by referringto other documents or reports we have already or will soon be filing. This iscalled "Incorporation by Reference." We intend to file your definitive proxystatement pursuant to Regulation 14A not later than 120 days after the end ofthe fiscal year covered by this report, and certain information therein isincorporated in this report by reference. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The information required by this Item is incorporated by reference toinformation set forth in our definitive proxy statement under the heading"Proposal No. 1 -- Election of Directors" and in Part I of this report under theheading "Executive Officers of the Registrant." The information required by this Item with respect to compliance withSection 16(a) of the Securities Exchange Act of 1934 is incorporated byreference to information set forth in the definitive Proxy Statement under theheading "Executive Compensation and Other matters." ITEM 11. EXECUTIVE COMPENSATION. The information required by this Item is incorporated by reference toinformation set forth in our definitive proxy statement under the heading"Executive Compensation and Other matters." ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information required by this Item is incorporated by reference toinformation set forth in our definitive proxy statement under the heading "StockOwnership of Certain Beneficial Owners and Management." ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information required by this Item is incorporated by reference toinformation set forth in our definitive proxy statement under the heading"Certain Relationships and Related Transactions." 35 37 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this report: (1) Financial Statements: INDEX TO CONSOLIDATED FINANCIAL STATEMENTS PAGE ---- Report of Independent Accountants........................... 37 Consolidated Balance Sheets as of December 31, 1997 and 1998........................................................ 38 Consolidated Statements of Operations for the Years Ended December 31, 1996, 1997, and 1998........................... 39 Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 1996, 1997 and 1998................ 40 Consolidated Statements of Cash Flows for the Years Ended December 31, 1996, 1997, and 1998........................... 41 Notes to Consolidated Financial Statements.................. 42 (2) Financial Statement Schedules All schedules have been omitted because the required information is not present or not present in amounts sufficient to require submission of the schedules or because the information required is included in the Consolidated Financial Statements or Notes thereto. (3) Exhibits See Index to Exhibits on page 54 hereof. The exhibits listed in the accompanying Index to Exhibits are filed as part of this report. (b) Reports on form 8-K None 36 38 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of American Xtal Technology, Inc. In our opinion, the accompanying consolidated balance sheets and therelated consolidated statements of operations, stockholders' equity and cashflows present fairly, in all material respects, the financial position ofAmerican Xtal Technology, Inc. and its subsidiaries at December 31, 1997 and1998, and the results of their operations and their cash flows for each of thethree years in the period ended December 31, 1998, in conformity with generallyaccepted accounting principles. These financial statements are theresponsibility of the Company's management; our responsibility is to express anopinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditingstandards which require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements, assessing theaccounting principles used and significant estimates made by management, andevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for the opinion expressed above. PRICEWATERHOUSECOOPERS LLP San Jose, CaliforniaJanuary 28, 1999 37 39 AMERICAN XTAL TECHNOLOGY, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA) ASSETS DECEMBER 31, ------------------ 1997 1998 ------- ------- Current assets: Cash and cash equivalents................................. $ 3,054 $16,122 Accounts receivable, less allowance for doubtful accounts of $100 and $550....................................... 6,005 8,902 Inventories............................................... 8,361 20,579 Prepaid expenses and other current assets................. 858 2,507 Deferred income taxes..................................... 225 466 ------- ------- Total current assets.............................. 18,503 48,576Property, plant and equipment............................... 12,110 26,447 ------- ------- Total assets...................................... $30,613 $75,023 ======= ======= LIABILITIES AND STOCKHOLDERS' EQUITYCurrent liabilities: Accounts payable.......................................... $ 1,722 $ 3,455 Accrued liabilities....................................... 1,827 2,323 Current portion of long-term debt......................... 745 1,730 ------- ------- Total current liabilities......................... 4,294 7,508Long-term debt, net of current portion...................... 7,728 16,347 ------- ------- Total liabilities................................. 12,022 23,855 ------- -------Contingencies (Note 12)Stockholders' equity: Convertible preferred stock, no par value, 25,000,000 shares authorized, 10,128,737 and 0 shares issued and outstanding............................................ 8,553 -- Common stock, no par value, 100,000,000 shares authorized, 3,041,531 shares with no par value and 16,116,675 shares with $0.001 par value issued and outstanding.... 867 16 Additional paid in capital................................ -- 35,537 Deferred compensation..................................... (220) (327) Retained earnings......................................... 9,584 15,910 Accumulated other comprehensive income -- cumulative translation adjustments................................ (193) 32 ------- ------- Total stockholders' equity........................ 18,591 51,168 ------- ------- Total liabilities and stockholders' equity........ $30,613 $75,023 ======= ======= The accompanying notes are an integral part of these consolidated financial statements. 38 40 AMERICAN XTAL TECHNOLOGY, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA) YEARS ENDED DECEMBER 31, ----------------------------- 1996 1997 1998 ------- ------- ------- Revenues: Product revenues.......................................... $14,222 $23,014 $41,493 Contract revenues......................................... 2,005 2,321 1,797 ------- ------- ------- Total revenues.................................... 16,227 25,335 43,290Cost of revenues: Cost of product revenues.................................. 9,270 13,674 24,550 Cost of contract revenues................................. 795 1,553 804 ------- ------- ------- Total cost of revenues............................ 10,065 15,227 25,354 ------- ------- -------Gross profit................................................ 6,162 10,108 17,936Operating expenses: Selling, general and administrative....................... 2,033 2,959 5,016 Research and development.................................. 592 1,289 2,504 ------- ------- ------- Total operating expenses.......................... 2,625 4,248 7,520 ------- ------- -------Income from operations...................................... 3,537 5,860 10,416Interest expense............................................ (170) (570) (781)Interest and other income (expense)......................... (72) (34) 568 ------- ------- -------Income before provision for income taxes.................... 3,295 5,256 10,203Provision for income taxes.................................. 1,249 1,998 3,877 ------- ------- -------Net income.................................................. $ 2,046 $ 3,258 $ 6,326 ======= ======= =======Net income per share: Basic..................................................... $ 0.71 $ 1.11 $ 0.42 ======= ======= ======= Diluted................................................... $ 0.17 $ 0.25 $ 0.42 ======= ======= =======Shares used in net income per share calculations: Basic..................................................... 2,882 2,938 14,928 ======= ======= ======= Diluted................................................... 11,811 12,839 15,177 ======= ======= ======= The accompanying notes are an integral part of these consolidated financial statements. 39 41 AMERICAN XTAL TECHNOLOGY, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARE DATA) ACCUMULATED OTHER COMPREHENSIVE CONVERTIBLE INCOME -- PREFERRED STOCK COMMON STOCK ADDITIONAL CUMULATIVE --------------------- ------------------- PAID IN DEFERRED RETAINED TRANSLATION SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION EARNINGS ADJUSTMENTS ----------- ------- ---------- ------ ---------- ------------ -------- ------------- Balance at January 1, 1996..................... 8,928,737 $ 2,618 2,848,956 $ 107 $ -- $ -- $ 4,280 $ --Common stock options exercised................ -- -- 40,750 52 -- -- -- --Comprehensive income Net income............... -- -- -- -- -- -- 2,046 -- Other comprehensive income Currency translation adjustment........... -- -- -- -- -- -- -- (104)Comprehensive income....... -- -- -- -- -- -- -- -- ----------- ------- ---------- ------ ------- ----- ------- -----Balance at December 31, 1996..................... 8,928,737 2,618 2,889,706 159 -- -- 6,326 (104)Issuance of series C convertible preferred stock in March 1997 at $5.00 per share, net of issuance costs........... 1,200,000 5,935 -- -- -- -- ----Common stock options exercised................ -- -- 151,825 386 -- -- -- --Deferred compensation...... -- -- -- 322 -- (322) -- --Amortization of deferred compensation............. -- -- -- -- -- 102 -- --Comprehensive income Net income............... -- -- -- -- -- -- 3,258 -- Other comprehensive income Currency translation adjustment........... -- -- -- -- -- -- -- (89)Comprehensive income....... -- -- -- -- -- -- -- -- ----------- ------- ---------- ------ ------- ----- ------- -----Balance at December 31, 1997..................... 10,128,737 8,553 3,041,531 867 -- (220) 9,584 (193)Common stock with no par value converted to common stock of $0.001 par value.................... -- -- -- (864) 864 -- -- --Conversion of preferred stock to common stock.... (10,128,737) (8,553) 10,128,737 10 8,543 -- -- --Common stock options exercised................ -- -- 71,407 -- 138 -- -- --Issuance of common stock upon initial public offering, net of issuance costs.................... -- -- 2,875,000 3 25,789 -- -- --Deferred compensation...... -- -- -- -- 203 (203) -- --Amortization of deferred compensation............. -- -- -- -- -- 96 -- --Comprehensive income Net income............... -- -- -- -- -- -- 6,326 -- Other comprehensive income Currency translation adjustment........... -- -- -- -- -- -- -- 225Comprehensive income....... -- -- -- -- -- -- -- -- ----------- ------- ---------- ------ ------- ----- ------- -----Balance at December 31, 1998..................... -- $ -- 16,116,675 $ 16 $35,537 $(327) $15,910 $ 32 =========== ======= ========== ====== ======= ===== ======= ===== COMPREHENSIVE TOTAL INCOME ------- ------------- Balance at January 1, 1996..................... $ 7,005 $ --Common stock options exercised................ 52 --Comprehensive income Net income............... 2,046 2,046 Other comprehensive income Currency translation adjustment........... (104) (104) -------Comprehensive income....... -- $ 1,942 ------- =======Balance at December 31, 1996..................... 8,999Issuance of series C convertible preferred stock in March 1997 at $5.00 per share, net of issuance costs........... 5,935 --Common stock options exercised................ 386 --Deferred compensation...... -- --Amortization of deferred compensation............. 102 --Comprehensive income Net income............... 3,258 3,258 Other comprehensive income Currency translation adjustment........... (89) (89) -------Comprehensive income....... -- $ 3,169 ------- =======Balance at December 31, 1997..................... 18,591Common stock with no par value converted to common stock of $0.001 par value.................... -- --Conversion of preferred stock to common stock.... --Common stock options exercised................ 138 --Issuance of common stock upon initial public offering, net of issuance costs.................... 25,792 --Deferred compensation...... -- --Amortization of deferred compensation............. 96 --Comprehensive income Net income............... 6,326 6,326 Other comprehensive income Currency translation adjustment........... 225 225 -------Comprehensive income....... -- $ 6,551 ------- =======Balance at December 31, 1998..................... $51,168 ======= The accompanying notes are an integral part of these consolidated financial statements. 40 42 AMERICAN XTAL TECHNOLOGY, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) YEARS ENDED DECEMBER 31, ------------------------------ 1996 1997 1998 ------- ------- -------- Cash flows from operating activities: Net income................................................ $ 2,046 $ 3,258 $ 6,326 Adjustments to reconcile net income to cash provided by (used in) operations: Depreciation and amortization............................. 867 1,164 2,048 Deferred income taxes..................................... (43) 264 (241) Stock compensation........................................ -- 102 96 Changes in assets and liabilities: Accounts receivable.................................... (578) (3,013) (2,897) Inventories............................................ (2,298) (4,406) (12,218) Prepaid expenses and other current assets.............. (149) (84) (1,649) Accounts payable....................................... 247 894 1,733 Accrued liabilities.................................... 382 665 496 ------- ------- -------- Net cash provided by (used in) operating activities...................................... 474 (1,156) (6,306) ------- ------- --------Cash flows from investing activities: Purchases of property, plant and equipment................ (3,946) (4,856) (16,385) ------- ------- -------- Net cash used in investing activities............. (3,946) (4,856) (16,385) ------- ------- --------Cash flows from financing activities: Proceeds from the issuance of common stock, net........... 52 386 25,930 Proceeds from the issuance of convertible preferred stock.................................................. -- 5,935 -- Payments of short-term bank borrowings.................... (300) (300) -- Proceeds from long-term debt borrowings................... 3,469 2,654 13,942 Payments of long-term debt borrowings..................... -- -- (4,338) Proceeds from (payments of) notes payable to related parties................................................ 276 (276) -- ------- ------- -------- Net cash provided by financing activities......... 3,497 8,399 35,534 ------- ------- --------Effect of exchange rate changes............................. (104) (89) 225 ------- ------- --------Net increase (decrease) in cash and cash equivalents........ (79) 2,298 13,068Cash and cash equivalents at beginning of year.............. 835 756 3,054 Cash and cash equivalents at beginning of year.............. 835 756 3,054 ------- ------- --------Cash and cash equivalents at end of year.................... $ 756 $ 3,054 $ 16,122 ======= ======= ========Supplemental disclosures: Interest paid............................................. $ 203 $ 579 $ 781 ======= ======= ======== Income taxes paid......................................... $ 794 $ 1,814 $ 4,378 ======= ======= ======== The accompanying notes are an integral part of these consolidated financial statements. 41 43 AMERICAN XTAL TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES American Xtal Technology, Inc. (the "Company") was incorporated inCalifornia in December 1986 and reincorporated in Delaware in 1998. The Companyuses a proprietary vertical gradient freeze ("VGF") technique to producehigh-performance compound semiconductor base materials, or substrates, for usein a variety of electronic and opto-electronic applications. The Companymanufactures and sells gallium arsenide ("GaAs"), indium phosphide ("InP") andgermanium ("Ge") substrates. The Company also has research and developmentcontracts with the U.S. Department of Defense ("DOD") and other third partiesfor developing GaAs and other substrates. In May 1998, the Company completed its initial public offering ("IPO") andissued 2,875,000 shares of its common stock at $10.00 per share, including theshares from an over-allotment option. The Company received cash of approximately$25,792,000 net of underwriting discounts, commissions and IPO expenses. Uponthe closing of the IPO, all outstanding shares of the Company's then convertiblepreferred stock were automatically converted into shares of common stock. Use of Estimates The preparation of financial statements in conformity with generallyaccepted accounting principles requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. Actual results could differ from these estimates. Principles of Consolidation The consolidated financial statements include the accounts of the Companyand its wholly-owned subsidiaries. All material intercompany accounts andtransactions have been eliminated. Foreign Currency Translation The functional currencies of the Company's Japanese and Chinesesubsidiaries are the local currencies. Transaction gains and losses resultingfrom transactions denominated in currencies other than the US dollar for theCompany or in the local currencies for the subsidiaries are included in theresults of operations for the year. The assets and liabilities of the subsidiaries are translated at the ratesof exchange on the balance sheet date. Income and expense items are translatedat the average rate of exchange for the period. Gains and losses from foreigncurrency translation are included as a separate component of stockholders'equity. Revenue Recognition Product revenues are generally recognized upon shipment. The Companyprovides an allowance for estimated returns at the time revenue is recognized.Contract revenues are recognized under the percentage of completion method basedon costs incurred relative to total contract costs. Costs associated withcontract revenues are included in cost of contract revenues. All costs ofcontract revenues are research and development expenses which are funded by thecontract. Concentration of Credit Risk The Company manufactures and distributes GaAs, InP and Ge substrates andperforms services under research and development contracts. Financialinstruments which potentially subject the Company to concentration of creditrisk consist primarily of trade accounts receivable. The Company investsprimarily in 42 44 AMERICAN XTAL TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) money market accounts and commercial paper instruments. Cash equivalents aremaintained with high quality institutions and their composition and maturitiesare regularly monitored by management. The Company performs ongoing credit evaluations of its customers' financialcondition and limits the amount of credit extended when deemed necessary, butgenerally does not require collateral. No customer represented greater than10.0% of product revenues in fiscal years 1996 and 1997, and one customer in1998, represented 14.2% of product revenues. For fiscal 1996, one governmententity represented 91.3% of contract revenues. For fiscal 1997, one governmententity and a third party represented 47.4% and 52.6%, respectively, of contractrevenues. For fiscal 1998, one government entity represented 100% of contractrevenues. No customer accounted for 10% or more of the trade accounts receivablebalance as of December 31, 1997, and 1998. Cash Equivalents The Company considers all highly liquid debt instruments purchased with anoriginal maturity of three months or less to be cash equivalents. Inventory Inventory is stated at the lower of cost or market, cost being determinedusing the weighted average method. Property, Plant and Equipment Property, plant and equipment are stated at cost less accumulateddepreciation computed using the straight-line method over the estimated economiclives of the assets, generally five years. Leasehold improvements are amortizedover the shorter of the estimated useful life or the term of the lease. Impairment of Long-Lived Assets Pursuant to Statement of Financial Accounting Standard No. 121, "Accountingfor the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposedof" ("SFAS 121"), the Company reviews long-lived assets based upon a gross cashflow basis and will reserve for impairment whenever events or changes incircumstances indicate the carrying amount of the assets may not be fullyrecoverable. Based on its most recent analysis, the Company believes that therewas no impairment of its property, plant and equipment as of December 31, 1998. Stock-Based Compensation The Company accounts for stock-based employee compensation arrangementsusing the intrinsic value method as prescribed in Accounting Principles BoardOpinion No. 25, "Accounting for Stock Issued to Employees" and relatedInterpretations thereof. Accordingly, compensation costs for stock options ismeasured as the excess, if any, of the market price of the Company's stock atthe date of grant over the stock option exercise price. In addition, the Companycomplies with the disclosure provisions of Statement of Financial AccountingStandard No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). Income Taxes The Company accounts for deferred income taxes using the liability method,under which the expected future tax consequences of timing differences betweenthe book and tax basis of assets and liabilities are recognized as deferred taxassets and liabilities. 43 45 AMERICAN XTAL TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Comprehensive Income In 1998, the Company adopted Statement of Financial Accounting Standard No.130 "Reporting Comprehensive Income" ("SFAS 130"). Comprehensive income isdefined as the change in equity of a company during a period from transactionsand other events and circumstances excluding transactions resulting frominvestment by owners and distribution to owners. The difference between netincome and comprehensive income for the Company relates to foreign currencytranslation adjustments. Comprehensive income for the years ended December 31,1996, 1997 and 1998 is disclosed in the Statement of Stockholders' Equity. Segment Reporting In 1998, the Company adopted Statement of Financial Accounting Standard No.131, "Disclosures about Segments of an Enterprise and Related Information"("SFAS 131"). SFAS 131 requires that companies report separately, in thefinancial statements, certain financial and descriptive information aboutoperating segment profit or loss, certain specific revenue and expense items,and segment assets. Additionally, companies are required to report informationabout the revenues derived from their products and service groups, aboutgeographic areas in which the Company earns revenues and holds assets, and aboutmajor customers. (See Note 11 for these disclosures). Recent Accounting Pronouncements In June 1998, the Financial Accounting Standards Board issued Statement ofFinancial Accounting Standard No. 133, "Accounting for Derivative Instrumentsand Hedging Activities" ("SFAS 133"). SFAS 133 established a new model foraccounting for derivatives and hedging activities and supersedes and amends anumber of existing accounting standards. SFAS 133 requires that all derivativesbe recognized in the balance sheet at their fair market value. In addition,corresponding derivative gains and losses should be either reported in thestatement of operations or stockholders' equity, depending on the type ofhedging relationship that exists with respect to such derivatives. Adopting theprovisions of SFAS 133, which will be effective in fiscal year 2000, is notexpected to have a material effect on the Company's consolidated financialstatements. 44 46 AMERICAN XTAL TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 2. BALANCE SHEET DETAIL DECEMBER 31, ------------------ 1997 1998 ------- ------- (IN THOUSANDS) Inventories: Raw materials.......................................... $ 2,224 $ 7,687 Work in process........................................ 5,623 12,059 Finished goods......................................... 514 833 ------- ------- $ 8,361 $20,579 ======= =======Property, plant and equipment: Land................................................... $ 1,120 $ 1,120 Building............................................... 4,731 14,191 Machinery and equipment................................ 8,130 13,668 Leasehold improvements................................. 240 256 Construction in progress............................... 1,773 3,144 ------- ------- 15,994 32,379 Less: Accumulated depreciation and amortization........ 3,884 5,932 ------- ------- $12,110 $26,447 ======= =======Accrued liabilities: Accrued compensation................................... $ 690 $ 934 Accrued income tax..................................... 282 -- Customer advances...................................... 260 -- Allowance for sales returns............................ 247 336 Other.................................................. 348 1,053 ------- ------- $ 1,827 $ 2,323 ======= ======= NOTE 3. DEBT On September 11, 1995, the Company obtained a bank loan of up to $4.5million to finance the construction of a new commercial building in Fremont,California. The loan, which was due on September 11, 1996, was refinanced withtwo new loans: (1) On October 1, 1996, the Company obtained a loan for $3.5 million from a commercial bank. The loan has an interest rate of 8.3% per annum, matures in 2006 and is secured by the land and building. The loan was fully repaid as of December 31, 1998. (2) On August 15, 1996, the Company obtained a $1.0 million debenture loan from the Bay Area Employment Development Company guaranteed by the U.S. Small Business Administration. The loan has an interest rate of 7.3% per annum, matures in 2016 and is subordinate to the $3.5 million bank loan. As of December 31, 1997 and 1998, $1.0 million and $0.9 million was outstanding under this debenture loan, respectively. The Company obtained equipment loans from several different banks throughfinancing companies to finance the purchase of new manufacturing equipment forthe Company's Fremont, California facility. These loans have a maturity of fiveyears with interest rates ranging from 6.0% to 9.0% per annum. These loans aresecured by the machinery and equipment purchased with the loans. As of December31, 1997 and 1998, $3.2 million and $5.5 million was outstanding under theseloans, respectively. 45 47 AMERICAN XTAL TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) In November 1996, the Company obtained a $3.0 million line of credit("LOC") with a bank which expired in April 1998. In March 1998, the Companyobtained a $15.0 million LOC which expires in May 1999 to replace the $3.0million LOC. The $15.0 million LOC is secured by the Company's business assets,excluding equipment. Borrowings under the $15.0 million LOC bear interest at thebank's prime interest rate plus one-half percent. The $15.0 million LOC issubject to certain financial covenants regarding current financial ratios andcash flow requirements which have all been met as of December 31, 1998. AtDecember 31, 1997 and 1998, no amount was outstanding under the LOC. In May 1997, the Company obtained a bank loan for $1.4 million under the$3.0 million LOC. The loan was to finance construction of manufacturingfacility. The loan consisted of two parts: (i) a loan for $750,000 which bearsinterest at the bank's prime rate plus one percent and is secured by propertyand (ii) a loan for $690,000 which bears interest at the bank's prime rate plusone-half percent and is secured by the Company's business assets, excludingequipment, which was assumed under the LOC. At the time of building completion,the $750,000 loan is convertible into a new term loan with a maturity of tenyears and an interest rate fixed at the nine-year U.S. Treasury Bond yield plus2.3% and will be secured by the land and building. At December 31, 1997,$106,000 was outstanding at an interest rate of 8.3% per annum. During the yearended December 31, 1998, this construction loan was fully prepaid. In December 1998, the Company completed the sale of $11.6 million bonds.The bonds, which are secured by a letter of credit from a bank, have a term of25 years, bear interest at 200 basis points below prime (5.6% at December 31,1998). Repayment of principal and interest under the bonds is by installmentpayments on a quarterly basis. The Company has an option to redeem in whole orin part of the bonds during the term of the bonds. The aggregate future repayments of long-term debt outstanding at December31, 1998 are $2.8 million in 1999, $2.9 million in 2000, $2.9 million in 2001,$2.6 million in 2002, $1.7 million in 2003 and $10.6 million thereafter. A totalinterest amount of $5.4 million is included in these aggregate futurerepayments. NOTE 4. RESEARCH AND DEVELOPMENT CONTRACTS In March 1994, the Company was awarded a four-year, $6.1 million contractunder the DOD Title III program for the development of GaAs substrates. TheTitle III contract is comprised of three different contract components: Acost-plus-fixed-fee component totaling $1.2 million, a firm-fixed-price ("FFP")component totaling $4.4 million and a $500,000 component consisting of a bonusaward. The bonus award may be earned upon reaching specific contract milestones.Under the FFP component, 10.0% of the cost reimbursement is withheld by the DODuntil the completion of the project in May 1998. The amounts relating to this10.0% withholding were $625,000, $319,000, and $325,000 at December 31, 1996,1997 and 1998, respectively. For the years ended December 31, 1996, 1997 and 1998, the Companyrecognized contract revenues of $1.5 million, $364,000 and $416,000,respectively, under the Title III contract. For the years ended December 31,1996, 1997 and 1998, the Company incurred costs of $468,000, $211,000 and$87,000, respectively, under the Title III contract. As of December 31, 1998,the Title III contract was completed and the total contract revenue of $6.1million had been completely recognized. Certain products were manufactured under the Title III contract and thecosts were charged to such contracts. As permitted under the contract, theproducts were sold to third parties, generating product revenues of $95,000, $0and $0 for the years ended December 31, 1996, 1997 and 1998, respectively. In January 1997, the Company was awarded a $1.2 million contract from athird party. The contract was an FFP contract under which the Company producedGe substrates. The contract was completed in July 1997. For the year endedDecember 31, 1997, the Company recognized contract revenues of $1.2 million andincurred contract costs of $1.1 million under the contract. 46 48 AMERICAN XTAL TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) In May 1997, the Company was awarded a $2.5 million, 30-month contractunder the DOD Title III program. In August 1998, the contract was amended suchthat the work scope was extended and the total contract amount was increased to$3.1 million. The contract is a cost-sharing agreement for the development ofInP substrates. Contract revenues are recognized under the percentage ofcompletion method based on total estimated revenue and the proportion of costsincurred relative to total contract costs. For the years ended December 31, 1997and 1998, the Company recognized contract revenues of $661,000 and $1,238,000,respectively and incurred contract costs of $252,000 and $628,000, respectivelyunder this contract. The Company has no additional obligations with regards to any of the aboveresearch and development contracts. NOTE 5. FOREIGN EXCHANGE CONTRACTS AND TRANSACTION LOSSES The Company uses short-term forward exchange contracts for hedging purposesto reduce the effects of adverse foreign exchange rate movements. During theyear ended December 31, 1998, the Company bought foreign exchange contracts tohedge against certain trade accounts receivable in Japanese yen. These contractsare accounted for using hedge accounting, under which the change in the fairvalue of the forward contracts is recognized as part of the related foreigncurrency transactions as they occur. As of December 31, 1998, the Company'soutstanding commitments with respect to the foreign exchange contracts, whichwere commitments to sell Japanese yen, had a total value of approximately $1.6million. During the years ended December 31, 1996, 1997 and 1998, the Companyincurred foreign transaction exchange losses of $114,000, $186,000 and $24,000,respectively. NOTE 6. INCOME TAXES The components of the provision for income taxes were as follows: YEARS ENDED DECEMBER 31, -------------------------- 1996 1997 1998 ------ ------ ------ (IN THOUSANDS) Current: Federal........................................ $1,116 $1,571 $3,627 State.......................................... 178 79 441 Foreign........................................ -- 84 50 ------ ------ ------ Total current.......................... 1,294 1,734 4,118 ------ ------ ------Deferred: Federal........................................ (36) 235 (228) State.......................................... (9) 29 (13) ------ ------ ------ Total deferred......................... (45) 264 (241) ------ ------ ------ Total provision........................ $1,249 $1,998 $3,877 ====== ====== ====== 47 49 AMERICAN XTAL TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The following is a reconciliation of the effective income tax rates and theU.S. statutory federal income tax rate: YEARS ENDED DECEMBER 31, ------------------------- 1996 1997 1998 ----- ----- ----- Statutory federal income tax rate.................... 34.0% 34.0% 34.0%State income taxes, net of federal tax benefits...... 4.7 4.1 2.7Foreign sales corporation benefit.................... (2.4) (1.7) (1.7)Foreign income taxed at higher rate.................. -- 1.6 0.2Other................................................ 1.6 0.0 2.8 ---- ---- ----Effective tax rate................................... 37.9% 38.0% 38.0% ==== ==== ==== Deferred tax assets (liabilities) are summarized as follows: DECEMBER 31, -------------- 1997 1998 ---- ------ (IN THOUSANDS) Deferred tax assets: Bad debt and inventory reserves........................... $497 $ 816 Vacation accrual.......................................... 67 75 State taxes............................................... 13 137 Other..................................................... -- 181 ---- ------ Deferred tax assets....................................... 577 1,209Deferred tax liabilities: Depreciation.............................................. (352) (743) ---- ------ Net deferred tax asset............................ $225 $ 466 ==== ====== NOTE 7. RETIREMENT SAVINGS PLAN The Company has a 401(k) Savings Plan (the "Savings Plan") which qualifiesas a thrift plan under Section 401(k) of the Internal Revenue Code. Allfull-time U.S. employees are eligible to participate in the Savings Plan afterone year from the date of hire. Participants may contribute up to 6.0% of theirearnings to the Savings Plan with a discretionary matching amount provided bythe Company. The Company's contributions to the Savings Plan for the years endedDecember 31, 1996, 1997 and 1998 were $69,000, $87,000 and $101,000,respectively. NOTE 8. STOCK OPTION AND EMPLOYEE STOCK PURCHASE PLANS Stock Option Plans In 1993, the Company adopted the 1993 Stock Option Plan ("1993 Plan") whichprovides for granting of incentive and non-qualified stock options to employees,consultants, and directors of the Company. Under the 1993 Plan, 880,000 sharesof common stock have been reserved for issuance as of December 31, 1998. Optionsgranted under the 1993 Plan are generally for periods not to exceed ten yearsand are granted at the fair market value of the stock at the date of grant asdetermined by the board of directors. Options granted under the 1993 Plangenerally vest 25.0% upon grant and 25.0% each year thereafter, with fullvesting occurring on the third anniversary of the grant date. In May 1997, the Company adopted the 1997 Stock Option Plan ("1997 Plan")which provides for granting of incentive and non-qualified stock options toemployees, consultants and directors of the Company. Under the 1997 Plan,2,800,000 shares of common stock have been reserved for issuance as of December31, 48 50 AMERICAN XTAL TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1998. Options granted under the 1997 Plan are generally for periods not toexceed ten years (five years if the option is granted to a 10.0% stockholder)and are granted at the fair market value of the stock at the date of grant asdetermined by the board of directors. Options granted under the 1997 Plangenerally vest 25.0% at the end of one year and 2.1% each month thereafter, withfull vesting after four years. The following summarizes the Company's stock option activity under the 1993Plan and the 1997 Plan and related weighted average exercise price within eachcategory for each of the years ended December 31, 1996, 1997 and 1998: SHARES OPTIONS WEIGHTED AVERAGE AVAILABLE OUTSTANDING OPTION PRICE ---------- ----------- ---------------- Balance at December 31, 1995............ 322,594 244,900 $1.53 Granted............................... -- -- -- Exercised............................. -- (40,750) 1.26 Canceled.............................. -- -- -- ---------- ---------Balance at December 31, 1996............ 322,594 204,150 1.58 Additional shares authorized.......... 1,367,000 -- -- Granted............................... (1,315,100) 1,315,100 4.95 Exercised............................. -- (151,825) 2.54 Canceled.............................. 24,475 (24,475) 3.38 ---------- ---------Balance at December 31, 1997............ 398,969 1,342,950 4.77 Additional shares authorized.......... 1,500,000 -- -- Granted............................... (246,000) 246,000 7.10 Exercised............................. -- (71,407) 1.94 Canceled.............................. 100,968 (100,968) 5.39 ---------- ---------Balance at December 31, 1998............ 1,753,937 1,416,575 5.25 ========== ========= At December 31, 1996, 1997 and 1998, options for 107,450, 76,725 and956,827 shares, respectively, were vested. During the years ended December 31, 1997 and 1998, the Company grantedoptions for the purchase of 1,315,100 shares and 246,000 shares, respectively, of common stock to employees at a weighted average exercise price of $4.95 pershare and $7.10 per share, respectively. Management calculated deferredcompensation of $322,000 and $203,000 related to options granted during theyears ended December 31, 1997 and 1998, respectively. Such deferred compensationis amortized over the vesting period relating to these options of whichapproximately $102,000 and $96,000 was amortized during the years ended December31, 1997 and 1998, respectively. Information relating to stock options outstanding under the 1993 Plan andthe 1997 Plan at December 31, 1998 is as follows: OPTIONS OUTSTANDING ----------------------------------------------- WEIGHTED AVERAGE WEIGHTED NUMBER REMAINING AVERAGE OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE ----------- ---------------- -------------- Range of exercise prices: $1.20 - $1.90......................... 43,675 6.6 years $1.56 $5.00 - $5.50......................... 1,152,900 8.2 years 5.00 $7.00 - $8.25......................... 220,000 9.6 years 7.29 --------- $1.20 - $8.25......................... 1,416,575 8.4 years 5.25 ========= 49 51 AMERICAN XTAL TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) OPTIONS VESTED ------------------------ WEIGHTED NUMBER AVERAGE VESTED EXERCISE PRICE ------- -------------- Range of exercise prices: $1.20 - $7.00........................................ 956,827 $2.61 Certain Pro Forma Disclosures In October 1995, SFAS 123 established a fair value based method ofaccounting for employee stock options. The weighted average grant-date fairvalue of options granted during the years ended December 31, 1997 and 1998 (nooptions were granted during the year ended December 31, 1996) was $0.06 and$0.98, respectively. Had compensation cost for the Company's options beendetermined based on the fair value at the grant dates, as prescribed in SFAS123, the Company's pro forma net income and net income per share would have beenas follows: YEARS ENDED DECEMBER 31, -------------------------- 1996 1997 1998 ------ ------ ------ (IN THOUSANDS, EXCEPT PER SHARE DATA) Net income: As reported.................................... $2,046 $3,258 $6,326 Pro forma net income........................... 2,032 3,111 6,131Net income per share: As reported: Basic....................................... $ 0.71 $ 1.11 $ 0.42 Diluted..................................... 0.17 0.25 0.42 Pro forma net income: Basic....................................... $ 0.71 $ 1.06 $ 0.41 Diluted..................................... 0.17 0.24 0.40 The fair value of each option grant is estimated on the date of grant usingthe Black-Scholes option pricing model with the following weighted-averageassumptions used for grants during the years ended December 31, 1997 and 1998(no options were granted during the year ended December 31, 1996); dividendyield of 0.0% for both periods; risk-free interest rates of 6.1% and 5.2% foroptions granted during the years ended December 31, 1997 and 1998, respectively;and expected lives of 4.5 and 5.0 years for options granted during the yearsended December 31, 1997 and 1998, respectively; and volatility of 0.0% and 75%for the years ended December 31, 1997 and 1998. Because additional option grants are expected to be made each year, theabove pro forma disclosures are not representative of pro forma effects onreported net income for future years. 50 52 AMERICAN XTAL TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Employee Stock Purchase Plan In May 1997, the Company's board of directors approved an Employee StockPurchase Plan (the "1997 Purchase Plan"). Under this plan, employees of theCompany were allowed to purchase a certain number of shares of Common Stock byDecember 31, 1997. A total of 67,000 shares were purchased as of December 31,1997. In February 1998, the Company's board of directors approved a 1998 EmployeeStock Purchase Plan (the "1998 Purchase Plan") and reserved a total of 250,000shares of the Company's common stock for issuance thereunder. The Company'sshareholders approved the 1998 Purchase Plan in March 1998. The 1998 PurchasePlan permits eligible employees to acquire shares of the Company's common stockthrough payroll deductions. The common stock purchase price is determined as 85%of the lower of the market price of the common stock at the purchase date or thedate of offer to the employee. NOTE 9. NET INCOME PER SHARE Statement of Financial Accounting Standard No. 128 "Earnings per Share"requires a reconciliation of the numerators and denominators of the basic anddiluted net income per share calculations as follows: YEARS ENDED DECEMBER 31, ------------------------------------------------------------------------------ 1996 1997 1998 ------------------------ ------------------------ ------------------------ PER PER PER SHARE SHARE SHARE INCOME SHARES AMOUNT INCOME SHARES AMOUNT INCOME SHARES AMOUNT ------ ------ ------ ------ ------ ------ ------ ------ ------ (IN THOUSANDS, EXCEPT PER SHARE DATA) Basic EPS calculation............ $2,046 2,882 $0.71 $3,258 2,938 $1.11 $6,326 14,928 $0.42Effect of dilutive securities Common stock options........... -- -- -- -- 72 -- -- 249 -- Convertible preferred stock.... -- 8,929 -- -- 9,829 -- -- -- --Diluted EPS calculation.......... $2,046 11,811 $0.17 $3,258 12,839 $0.25 $6,326 15,177 $0.42 NOTE 10. RELATED PARTY TRANSACTIONS During the years ended December 31, 1996, 1997 and 1998, the Companypurchased $760,000, $1,540,000 and $ 3,681,000, respectively, of raw materialsand manufactured quartz from a supplier which is owned by a family member of anofficer. 51 53 AMERICAN XTAL TECHNOLOGY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) NOTE 11. SEGMENT AND FOREIGN OPERATIONS INFORMATION The Company has two reportable segments: semiconductor substratesmanufacturing and research and development contracting. In the semiconductorsubstrates manufacturing segment, the Company manufactures and sellshigh-performance compound semiconductor substrates for use in electronic andopto-electronic applications. In the research and development contractingsegment, the Company contracts with the U.S. Department of Defense and otherparties for developing semiconductor substrates. The research and developmentcontracting segment did not meet the requirements for separate disclosure of areportable segment as defined in SFAS 131. The Company sells its substrates in the United States and in other parts ofthe world. The Company has operations in Japan and China. Revenues by geographiclocation based on the country of the customer, and income from operations andidentifiable assets based on country in which the Company operates, were asfollows: YEARS ENDED DECEMBER 31, ----------------------------- 1996 1997 1998 ------- ------- ------- (IN THOUSANDS) Net revenues: United States............................... $10,028 $15,653 $29,449 Europe...................................... 2,216 2,497 3,960 Canada...................................... 522 1,034 1,356 Japan....................................... 2,653 4,323 4,997 Asia Pacific and other...................... 808 1,828 3,528 ------- ------- ------- Consolidated................................ $16,227 $25,335 $43,290 ======= ======= =======Income from operations: United States............................... $ 3,529 $ 5,662 $10,334 Japan....................................... 8 198 82 ------- ------- ------- Consolidated................................ $ 3,537 $ 5,860 $10,416 ======= ======= =======Identifiable assets at end of year: United States............................... $16,467 $28,967 $71,019 Japan....................................... 917 1,056 2,728 China....................................... -- -- 1,276 ------- ------- ------- Consolidated................................ $17,384 $30,613 $75,023 ======= ======= ======= NOTE 12. CONTINGENT LIABILITIES From time to time the Company is involved in litigation in the normalcourse of business. Management believes that the outcome of matters to date willnot have a material adverse effect on the Company's financial position orresults of operations. 52 54 SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signed onits behalf by the undersigned, thereunto duly authorized. AMERICAN XTAL TECHNOLOGY, INC. By: /s/ MORRIS S. YOUNG ------------------------------------ Morris S. Young President and Chief Executive Officer (Principal Executive Officer) Date: March 30, 1999 POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signatureappears below hereby constitutes and appoints Morris S Young and Guy D. Atwood,and each of them, his true and lawful attorney-in-fact and agent, with fullpower of substitution, each with power to act alone, to sign and execute onbehalf of the undersigned any and all amendments to this Report on Form 10-K,and to perform any acts necessary in order to file the same, with all exhibitsthereto and other documents in connection therewith with the Securities andExchange Commission, granting unto said attorney-in-fact and agent full powerand authority to do and perform each and every act and thing requested andnecessary to be done in connection therewith, as fully to all intents andpurposes as he might or could do in person, hereby ratifying and confirming allthat said attorney-in-fact and agent, or their or his or her substitutes, shalldo or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, thisreport has been signed below by the following persons on behalf of theregistrant and in the capacities and on the date indicated. SIGNATURE TITLE DATE --------- ----- ---- /s/ MORRIS S. YOUNG President, Chief Executive March 30, 1999- -------------------------------------------------------- Officer, and Chairman of the Morris S. Young Board (Principal Executive Officer) /s/ GUY D. ATWOOD Vice President, Chief March 30, 1999- -------------------------------------------------------- Financial Officer (Principal Guy D. Atwood Financial and Accounting Officer) /s/ THEODORE S. YOUNG Senior Vice President, March 30, 1999- -------------------------------------------------------- Marketing, Director Theodore S. Young /s/ DONALD L. TATZIN Director March 30, 1999- -------------------------------------------------------- Donald L. Tatzin /s/ JESSE CHEN Director March 30, 1999 /s/ JESSE CHEN Director March 30, 1999- -------------------------------------------------------- Jesse Chen /s/ B.J. MOORE Director March 30, 1999- -------------------------------------------------------- B.J. Moore 53 55 AMERICAN XTAL TECHNOLOGY, INC. EXHIBITS TO FORM 10-K ANNUAL REPORT FOR THE YEAR ENDED DECEMBER 31, 1998 EXHIBITNUMBER DESCRIPTION- ------- ----------- 2.1* Agreement and Plan of Merger between American Xtal Technology, a California corporation, and American Xtal Technology Delaware Corporation, a Delaware corporation. 3.1 Restated Certificate of Incorporation.10.1* Form of Indemnification Agreement for directors and officers.10.2* 1993 Stock Option Plan and forms of agreements thereunder.10.3* 1997 Stock Option Plan and forms of agreements thereunder.10.4* 1997 Employee Stock Purchase Plan and forms of agreements thereunder.10.5* 1998 Employee Stock Purchase Plan and forms of agreements thereunder.10.6* Loan Agreement between U.S. Bank National Association and us dated March 4, 1998.10.7** Purchase and Sale Agreement by and between Limar Realty Corp. #23 and us dated April 1998.10.8 Loan Agreement between U.S. Bank National Association and us dated September 18, 1998.10.9 Letter of Credit and Reimbursement Agreement between U.S. Bank National Association and us dated December 1, 1998.10.10 Bond Purchase Contract between Dain Rauscher Incorporated and us dated December 1, 1998.10.11 Remarketing Agreement between Dain Rauscher Incorporated and us dated December 1, 1998.21.1* List of Subsidiaries.23.1 Consent of Independent Accountants.23.2** Consent of Counsel (included in Exhibit 5.1).24.1* Power of Attorney (see signature page).27.1 Financial Data Schedule. - ---------------* As filed with the SEC in our Registration Statement on Form S-1 on March 17, 1998. ** As filed with the SEC in our Registration Statement on Amendment No. 2 to Form S-1 on May 11, 1998. 54 1 EXHIBIT 3.1 RESTATED CERTIFICATE OF INCORPORATION OF AMERICAN XTAL TECHNOLOGY, INC. AMERICAN XTAL TECHNOLOGY, INC., a corporation organized and existing underthe laws of the State of Delaware, hereby certifies as follows: 1. The name of the corporation is American Xtal Technology, Inc. 2. The original name of the corporation was American Xtal TechnologyDelaware Corporation. 3. The date of filing of its original Certificate of Incorporation withthe Secretary of State of the State of Delaware was November 13, 1997. 4. This Restated Certificate of Incorporation was duly adopted inaccordance with the provisions of Section 245 of the Delaware GeneralCorporation Law. This Restated Certificate of Incorporation only restates andintegrates and does not further amend the provisions of the corporation'scertificate of incorporation as heretofore amended, and there is no discrepancybetween those provisions and the provisions of this Restated Certificate ofIncorporation. 5. This Restated Certificate of Incorporation restates and integrates theCertificate of Incorporation of this corporation as herein set forth in full: FIRST: The name of the corporation is American Xtal Technology, Inc. (hereinafter sometimes referred to as the "Corporation"). SECOND: The address of the registered office of the Corporation in the State of Delaware is Incorporating Services, Ltd., 15 East North Street, in the City of Dover, County of Kent. The name of the registered agent at that address is Incorporating Services, Ltd. THIRD: The purpose of the Corporation is to engage in any lawful act or activity for which a corporation may be organized under the General Corporation Law of Delaware. 1 2 FOURTH: STOCK The Corporation is authorized to issue two classes of stock to be designated, respectively, "Preferred Stock" and "Common Stock." The total number of shares of Preferred Stock the Corporation shall have authority to issue is 2,000,000, $.001 par value per share, and the total number of shares of Common Stock the Corporation shall have authority to issue is 40,000,000, $0.001 par value per share. The shares of Preferred Stock shall initially be undesignated as to series. The Board of Directors is hereby authorized, within the limitations and restrictions stated herein, to determine or alter the rights, preferences, privileges and restrictions granted to or imposed upon a wholly unissued series of Preferred Stock, and the number of shares constituting any such series and the designation thereof, or any of them; and to increase or decrease the number of shares constituting any such series and the designation thereof, or any of them; and to increase or decrease the number of shares of any series subsequent to the issue of shares of that series, but, in respect of decreases, not below the number of shares of such series then outstanding. If the number of shares of any such series of Preferred Stock shall be so decreased, the shares constituting such decrease shall be retired and shall not be reissued by the Corporation. FIFTH: The following provisions are inserted for the management of the business and the conduct of the affairs of the Corporation, and for further definition, limitation and regulation of the powers of the Corporation and of its directors and stockholders: A. The business and affairs of the Corporation shall be managed by or under the direction of the Board of Directors. In addition to the powers and authority expressly conferred upon them by statute or by this Certificate of Incorporation or the Bylaws of the Corporation, the directors are hereby empowered to exercise all such powers and do all such acts and things as may be exercised or done by the Corporation. B. The directors of the Corporation need not be elected by written ballot unless the Bylaws so provide. C. Any action required or permitted to be taken by the stockholders of the Corporation must be effected at a duly called annual or special meeting of stockholders of the Corporation and may not be effected by any consent in writing by such stockholders. 2 3 D. Special meetings of stockholders of the Corporation may be called only (1) by the Board of Directors pursuant to a resolution adopted by a majority of the total number of authorized directors (whether or not there exist any vacancies in previously authorized directorships at the time any such resolution is presented to the Board for adoption) or (2) by the holders of not less than ten percent (10%) of all of the shares entitled to cast votes at the meeting. SIXTH: A. The number of directors shall initially be set at five (5) and, thereafter, shall be fixed from time to time exclusively by the Board of Directors pursuant to a resolution adopted by a majority of the total number of authorized directors (whether or not there exist any vacancies in previously authorized directorships at the time any such resolution is presented to the Board for adoption). The directors shall be divided into three classes with the term of office of the first class (Class I) to expire at the first annual meeting of the stockholders; the term of office of the second class (Class II) to expire at the second annual meeting of stockholders; the term of office of the third class (Class III) to expire at the third annual meeting of stockholders; and thereafter for each such term to expire at each third succeeding annual meeting of stockholders after such election. Subject to the rights of the holders of any series of Preferred Stock then outstanding, a vacancy resulting from the removal of a director by the stockholders as provided in Article SIXTH, Section C below may be filled at a special meeting of the stockholders held for that purpose. All directors shall hold office until the expiration of the term for which elected, and until their respective successors are elected, except in the case of the death, resignation, or removal of any director. B. Subject to the rights of the holders of any series of Preferred Stock then outstanding, newly created directorships resulting from any increase in the authorized number of directors or any vacancies in the Board of Directors resulting from death, resignation or other cause (other than removal from office by a vote of the stockholders) may be filled only by a majority vote of the directors then in office, though less than a quorum, and directors so chosen shall hold office for a term expiring at the next annual meeting of stockholders at which the term of office of the class to which they have been elected expires, and until their respective successors are elected, except in the case of the death, resignation, or removal of any director. No decrease in the number of directors constituting the Board of Directors shall shorten the term of any incumbent director. C. Subject to the rights of the holders of any series of Preferred Stock then outstanding, any directors, or the entire Board of Directors, may be 3 4 removed from office at any time, with or without cause, but only by the affirmative vote of the holders of at least a majority of the voting power of all of the then outstanding shares of capital stock of the Corporation entitled to vote generally in the election of directors, voting together as a single class. Vacancies in the Board of Directors resulting from such removal may be filled by a majority of the directors then in office, though less than a quorum, or by the stockholders as provided in Article SIXTH, Section A above. Directors so chosen shall hold office for a term expiring at the next annual meeting of stockholders at which the term of office of the class to which they have been elected expires, and until their respective successors are elected, except in the case of the death, resignation, or removal of any director. SEVENTH: The Board of Directors is expressly empowered to adopt, amend or repeal Bylaws of the Corporation. Any adoption, amendment or repeal of Bylaws of the Corporation by the Board of Directors shall require the approval of a majority of the total number of authorized directors (whether or not there exist any vacancies in previously authorized directorships at the time any resolution providing for adoption, amendment or repeal is presented to the Board). The stockholders shall also have power to adopt, amend or repeal the Bylaws of the Corporation. Any adoption, amendment or repeal of Bylaws of the Corporation by the stockholders shall require, in addition to any vote of the holders of any class or series of stock of the Corporation required by law or by this Certificate of Incorporation, the affirmative vote of the holders of at least sixty-six and two-thirds percent (66-2/3%) of the voting power of all of the then outstanding shares of the capital stock of the Corporation entitled to vote generally in the election of directors, voting together as a single class. EIGHTH: A director of the Corporation shall not be personally liable to the Corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, except for liability (i) for any breach of the director's duty of loyalty to the Corporation or its stockholders, (ii) for acts or omissions not in good faith or which involved intentional misconduct or a knowing violation of law, (iii) under Section 174 of the Delaware General Corporation Law, or (iv) for any transaction from which the director derived an improper personal benefit. If the Delaware General Corporation Law is hereafter amended to authorize the further elimination or limitation of the liability of a director, then the liability of a director of the Corporation shall be eliminated or limited to the fullest extent permitted by the Delaware General Corporation Law, as so amended. 4 5 Any repeal or modification of the foregoing provisions of this Article EIGHTH by the stockholders of the Corporation shall not adversely affect any right or protection of a director of the Corporation existing at the time of such repeal or modification. NINTH: The Corporation reserves the right to amend or repeal any provision contained in this Certificate of Incorporation in the manner prescribed by the laws of the State of Delaware and all rights conferred upon stockholders are granted subject to this reservation; provided, however, that, notwithstanding any other provision of this Certificate of Incorporation or any provision of law which might otherwise permit a lesser vote or no vote, but in addition to any vote of the holders of any class or series of the stock of this Corporation required by law or by this Certificate of Incorporation, the affirmative vote of the holders of at least 66-2/3% of the voting power of all of the then outstanding shares of the capital stock of the Corporation entitled to vote generally in the election of directors, voting together as a single class, shall be required to amend or repeal this Article NINTH, Article FIFTH, Article SIXTH, Article SEVENTH or Article EIGHTH. [remainder of page intentionally left blank] 5 6 IN WITNESS WHEREOF, this Restated Certificate of Incorporation has beenexecuted on behalf of the Corporation by Morris S. Young, its President andChief Executive Officer and attested by Guy D. Atwood, its Secretary, this 18thday of June, 1998. AMERICAN XTAL TECHNOLOGY, INC. By: /s/ Morris S. Young -------------------------------- Morris S. Young, President and Chief Executive OfficerAttest: By: /s/ Guy D. Atwood --------------------------- Guy D. Atwood, Secretary 6 1 Exhibit 10.8 LOAN AGREEMENT- ------------------------------------------------------------------------------------------------------------------------- Principal Loan Date Maturity Loan No. Call 19 Collateral Account Officer Initials $15,000,000.00 09-18-1998 320-18 070 0215644521 JAF35- ------------------------------------------------------------------------------------------------------------------------- References in the shaded area are for Lender's use only and do not limit the applicability of this document to anyparticular loan or item.- -------------------------------------------------------------------------------------------------------------------------Borrower: AMERICAN XTAL TECHNOLOGY Lender: U.S. BANK NATIONAL ASSOCIATION 4311 SOLAR WAY Fremont Business Banking FREMONT, CA 94538 39510 Paseo Padre Pkwy Fremont, CA 94538 THIS LOAN AGREEMENT between AMERICAN XTAL TECHNOLOGY ("Borrower") and U.S.BANK NATIONAL ASSOCIATION ("Lender") is made and executed on the following termsand conditions. Borrower has received prior commercial loans from Lender or hasapplied to Lender for a commercial loan or loans and other financialaccommodations, including those which may be described on any exhibit orschedule attached to this Agreement. All such loans and financialaccommodations, together with all future loans and financial accommodations fromLender to Borrower, are referred to in this Agreement individually as the "Loan"and collectively as the "Loans." Borrower understands and agrees that: (a) ingranting, renewing, or extending any Loan, Lender is relying upon Borrower'srepresentations, warranties, and agreements, as set forth in this Agreement; (b)the granting, renewing, or extending of any Loan by Lender at all times shall besubject to Lender's sole judgment and discretion; and (c) all such Loans shallbe and shall remain subject to the following terms and conditions of thisAgreement. TERM. This Agreement shall be effective as of SEPTEMBER 18, 1998, and shallcontinue thereafter until all Indebtedness of Borrower to Lender has beenperformed in full and the parties terminate this Agreement in writing. DEFINITIONS. The following words shall have the following meanings whenused in this Agreement. Terms not otherwise defined in this Agreement shall havethe meanings attributed to such terms in the Uniform Commercial Code. Allreferences to dollar amounts shall mean amounts in lawful money of the UnitedStates of America. Agreement. The word "Agreement" means this Loan Agreement, as this LoanAgreement may be amended or modified from time to time, together with allexhibits and schedules attached to this Loan Agreement from time to time. Account. The word "Account" means a trade account, account receivable, orother right to payment for goods sold or services rendered owing to Borrower (orto a third party grantor acceptable to Lender). Account Debtor. The words "Account Debtor" mean the person or entityobligated upon an Account. 2 Advance. The word "Advance" means a disbursement of Loan funds under thisAgreement. Borrower. The word "Borrower" means AMERICAN XTAL TECHNOLOGY. The word"Borrower" also includes, as applicable, all subsidiaries and affiliates ofBorrower as provided below in the paragraph titled "Subsidiaries and Affiliates." Borrowing Base. The words "Borrowing Base" mean as determined by Lenderfrom time to time, the lesser of (a) $15,000,000.00; or (b) the sum of (i)80.000% of the aggregate amount of Eligible Accounts, plus (ii) 50.000% of theaggregate amount of eligible Inventory (not to exceed in corresponding Loanamount based on Eligible Inventory of $5,500,000.00). The Borrowing Base formulaapplies only when borrowings exceed $5,000,000.00 Business Day. The words "Business Day" mean a day on which commercial banksare open for business in the State of California. CERCLA. The word "CERCLA" means the Comprehensive Environmental Response,Compensation, and Liability Act of 1980, as amended. Cash Flow. The words "Cash Flow" mean net income after taxes, and exclusiveof extraordinary gains and income, plus depreciation and amortization. Collateral. The word "Collateral" means and includes without limitation allproperty and assets granted as collateral security for a Loan, whether real orpersonal property, whether granted directly or indirectly, whether granted nowor in the future, and whether granted in the form of a security interest,mortgage, deed of trust, assignment, pledge, chattel mortgage, chattel trust,factor's lien, equipment trust, conditional sale, trust receipt, lien, charge,lien or title retention contract, lease or consignment intended as a securitydevice, or any other security or lien interest whatsoever, whether created bylaw, contract, or otherwise. The word "Collateral" includes without limitationall collateral described below in the section titled "COLLATERAL." Debt. The word "Debt" means all of Borrower's liabilities excludingSubordinated Debt. Eligible Accounts. The words "Eligible Accounts" mean, at any time, all ofBorrower's Accounts which contain selling terms and conditions acceptable toLender. The net amount of any Eligible Account against which Borrower may borrowshall exclude all returns, discounts, credits, and offsets of any nature. Unlessotherwise agreed to by Lender in writing, Eligible Accounts do not include: (a) Accounts with respect to which the Account Debtor is an officer,an employee or agent of Borrower. -2- 3 (b) Accounts with respect to which the Account Debtor is a subsidiaryof, or affiliated with or related to Borrower or its shareholders, officers, ordirectors. (c) Accounts with respect to which goods are placed on consignment,guaranteed sale, or other terms by reason of which the payment by the AccountDebtor may be conditional. (d) Accounts with respect to which Borrower is or may become liableto the Account Debtor for goods sold or services rendered by the Account Debtorto Borrower. (e) Accounts which are subject to dispute, counterclaim, or setoff. (f) Accounts with respect to which the goods have not been shipped ordelivered, or the services have not been rendered, to the Account Debtor. (g) Accounts with respect to which Lender, in its sole discretion,deems the creditworthiness or financial condition of the Account Debtor to beunsatisfactory. (h) Accounts of any Account Debtor who has filed or has had filedagainst it a petition in bankruptcy or an application for relief under any provision of any state or federal bankruptcy, insolvency, or debtor-in-reliefacts; or who has had appointed a trustee, custodian, or receiver for the assetsof such Account Debtor; or who has made an assignment for the benefit ofcreditors or has become insolvent or fails generally to pay its debts (includingits payrolls) as such debts become due. (i) Accounts with respect to which the Account Debtor is the UnitedStates government or any department or agency of the United States. (j) Accounts which have not been paid in full within 90 DAYS from theinvoice date. The entire balance of any Account of any single Account debtorwill be ineligible whenever the portion of the Account which has not been paidwithin 90 DAYS from the invoice date is in excess of 25.000% of the total amountoutstanding on the Account. (k) That portion of the Accounts of any single Account Debtor whichexceeds 20.000% of all of Borrower's Accounts. (l) Accounts with respect to Datings, Progress Billings, Retainage,Cash Sales, Cash on Delivery, Potential Offsets and Service Charges. (m) Accounts with respect to which the Account Debtor is not aresident of the United States, except to the extent such Accounts are supportedby insurance, bonds or other assurances satisfactory to Lender. (Foreignadvances will be allowed as pre-qualified by CRD). Eligible Inventory. The words "Eligible Inventory" mean, at any time, allof Borrower's Inventory as defined below except: -3- 4 (a) Inventory which is not owned by Borrower free and clear of allsecurity interests, liens, encumbrances, and claims of third parties. (b) Inventory which Lender, in its sole discretion, deems to beobsolete, unsalable, damaged, defective, or unfit for further processing. (c) Eligible inventory for purposes of determining the Borrower'sBorrowing Base shall be defined as raw material at cost and scrap value of WIPand finished goods. ERISA. The word "ERISA" means the Employee Retirement Income Security Actof 1974, as amended. Event of Default. The words "Event of Default" mean and include withoutlimitation any of the Events of Default set forth below in the section titled"EVENTS OF DEFAULT." Expiration Date. The words "Expiration Date" mean the date of terminationof Lender's commitment to lend under this Agreement. Grantor. The word "Grantor" means and includes without limitation each andall of the persons or entities granting a Security Interest in any Collateralfor the Indebtedness, including without limitation all Borrowers granting such aSecurity Interest. Guarantor. The word "Guarantor" means and includes without limitation eachand all of the guarantors, sureties, and accommodation parties in connectionwith any indebtedness. Indebtedness. The word "Indebtedness" means and includes without limitationall Loans, together with all other obligations, debts and liabilities ofBorrower to Lender, or any one or more of them, as well as all claims by Lenderagainst Borrower, or any one or more of them; whether now or hereafter existing,voluntary or involuntary, due or not due, absolute or contingent, liquidated orunliquidated; whether Borrower may be liable individually or jointly with others; whether Borrower may be obligated as a guarantor, surety, or otherwise;whether recovery upon such indebtedness may be or hereafter may become barred byany statute of limitations; and whether such Indebtedness may be or hereaftermay become otherwise unenforceable. Inventory. The word "Inventory" means all of Borrower's raw materials, workin process, finished goods, merchandise, parts and supplies, of every kind anddescription, and goods held for sale or lease or furnished under contracts ofservice in which Borrower now has or hereafter acquires any right, whether heldby Borrower or others, and all documents of title, warehouse receipts, bills oflading, and all other documents of every type covering all or any part of theforegoing. Inventory includes inventory temporarily out of Borrower's custody orpossession and all returns on Accounts. -4- 5 Lender. The word "Lender" means U.S. BANK NATIONAL ASSOCIATION, itssuccessors and assigns. Line of Credit. The words "Line of Credit" mean the credit facilitydescribed in the Section titled "LINE OF CREDIT" below. Liquid Assets. The words "Liquid Assets" mean Borrower's cash on hand plusBorrower's readily marketable securities. Loan. The word "Loan" or "Loans" means and includes without limitation anyand all commercial loans and financial accommodations from Lender to Borrower,whether now or hereafter existing, and however evidenced, including withoutlimitation those loans and financial accommodations described herein ordescribed on any exhibit or schedule attached to this Agreement from time totime. Note. The word "Note" means and includes without limitation Borrower'spromissory note or notes, if any, evidencing Borrower's Loan obligations infavor of Lender, as well as any substitute, replacement or refinancing note ornotes therefor. Permitted Liens. The words "Permitted Liens" mean: (a) liens and securityinterests securing indebtedness owed by Borrower to Lender; (b) liens for taxes,assessments, or similar charges either not yet due or being contested in goodfaith; (c) liens of materialmen, mechanics, warehousemen, or carriers, or otherlike liens arising in the ordinary course of business and securing obligationswhich are not yet delinquent; (d) purchase money liens or purchase moneysecurity interests upon or in any property acquired or held by Borrower in theordinary course of business to secure indebtedness outstanding on the date ofthis Agreement or permitted to be incurred under the paragraph of this Agreementtitled "Indebtedness and Liens"; (e) liens and security interests which, as ofthe date of this Agreement, have been disclosed to and approved by the Lender inwriting; and (f) those liens and security interests which in the aggregateconstitute an immaterial and insignificant monetary amount with respect to thenet value of Borrower's assets. Related Documents. The words "Related Documents" mean and include withoutlimitation all promissory notes, credit agreements, loan agreements,environmental agreements, guaranties, security agreements, mortgages, deeds oftrust, and all other instruments, agreements and documents, whether now orhereafter existing, executed in connection with the Indebtedness. Security Agreement. The words "Security Agreement" mean and include withoutlimitation any agreements, promises, covenants, arrangements, understandings orother agreements, whether created by law, contract, or otherwise, evidencing,governing, representing, or creating a Security Interest. Security Interest. The words "Security Interest" mean and include withoutlimitation any type of collateral security, whether in the form of a lien,charge, mortgage, deed of trust, assignment, pledge, chattel mortgage, chattel trust, factor's lien, equipment trust, -5- 6conditional sale, trust receipt, lien or title retention contract, lease orconsignment intended as a security device, or any other security or lieninterest whatsoever, whether created by law, contract, or otherwise. SARA. The word "SARA" means the Superfund Amendments and ReauthorizationAct of 1986 as now or hereafter amended. Subordinated Debt. The words "Subordinated Debt" mean indebtedness andliabilities of Borrower which have been subordinated by written agreement toindebtedness owed by Borrower to Lender in form and substance acceptable toLender. Tangible Net Worth. The words "Tangible Net Worth" mean Borrower's totalassets excluding all intangible assets (i.e., goodwill, trademarks, patents,copyrights, organizational expenses, and similar intangible items, but includingleaseholds and leasehold improvements) less total Debt. Working Capital. The words "Working Capital" mean Borrower's currentassets, excluding prepaid expenses, less Borrower's current liabilities. LINE OF CREDIT. Lender agrees to make Advances to Borrower from time totime from the date of this Agreement to the Expiration Date, provided theaggregate amount of such Advances outstanding at any time does not exceed theBorrowing Base. Within the foregoing limits, Borrower may borrow, partially orwholly prepay, and reborrow under this Agreement as follows. Conditions Precedent to Each Advance. Lender's obligation to make anyAdvance to or for the account of Borrower under this Agreement is subject to thefollowing conditions precedent, with all documents, instruments, opinions,reports, and other items required under this Agreement to be in form andsubstance satisfactory to Lender: (a) Lender shall have received evidence that this Agreement and allRelated Documents have been duly authorized, executed, and delivered by Borrowerto Lender. (b) Lender shall have received such opinions of counsel, supplementalopinions, and documents as Lender may request. (c) The security interests in the Collateral shall have been dulyauthorized, created, and perfected with first lien priority and shall be in fullforce and effect. (d) All guaranties required by Lender for the Line of Credit shallhave been executed by each Guarantor, delivered to Lender, and be in full forceand effect. (e) Lender, at its option and for its sole benefit, shall haveconducted an audit of Borrower's Accounts, Inventory, books, records, andoperations, and Lender shall be satisfied as to their condition. -6- 7 (f) Borrower shall have paid to Lender all fees, costs, and expensesspecified in this Agreement and the Related Documents as are then due andpayable. (g) There shall not exist at the time of any Advance a conditionwhich would constitute an Event of Default under this Agreement, and Borrowershall have delivered to Lender the compliance certificate called for in the paragraph below titled "Compliance Certificate." Making Loan Advances. Advances under the credit facility, as well asdirections for payment from Borrower's accounts, may be requested orally or inwriting by authorized persons. Lender may, but need not, require that all oralrequests be confirmed in writing. Each Advance shall be conclusively deemed tohave been made at the request of and for the benefit of Borrower (a) whencredited to any deposit account of Borrower maintained with Lender or (b) whenadvanced in accordance with the instructions of an authorized person. Lender, atits option, may set a cutoff time, after which all requests for Advances will betreated as having been requested on the next succeeding Business Day. Mandatory Loan Repayments. If at any time the aggregate principal amount ofthe outstanding Advances shall exceed the applicable Borrowing Base, Borrower,immediately upon written or oral notice from Lender, shall pay to Lender anamount equal to the difference between the outstanding principal balance of theAdvances and the Borrowing Base. On the Expiration Date, Borrower shall pay toLender in full the aggregate unpaid principal amount of all Advances thenoutstanding and all accrued unpaid interest, together with all other applicablefees, costs and charges, if any, not yet paid. Loan Account. Lender shall maintain on its books a record of account inwhich Lender shall make entries for each Advance and such other debits andcredits as shall be appropriate in connection with the credit facility. Lendershall provide Borrower with periodic statements of Borrower's account, whichstatements shall be considered to be correct and conclusively binding onBorrower unless Borrower notifies Lender to the contrary within thirty (30) daysafter Borrower's receipt of any such statement which Borrower deems to beincorrect. COLLATERAL. To secure payment of the Line of Credit and performance of allother Loans, obligations and duties owed by Borrower to Lender, Borrower (andothers, if required) shall grant to Lender Security Interests in such propertyand assets as Lender may require (the "Collateral"), including withoutlimitation Borrower's present and future Accounts, general intangibles, andInventory. Lender's Security Interests in the Collateral shall be continuingliens and shall include the proceeds and products of the Collateral, includingwithout limitation the proceeds of any insurance. With respect to theCollateral, Borrower agrees and represents and warrants to Lender: Perfection of Security Interests. Borrower agrees to execute such financingstatements and to take whatever other actions are requested by Lender to perfectand continue Lender's Security Interests in the Collateral Upon request ofLender, Borrower will deliver to Lender any and all of the documents evidencingor constituting the Collateral, and Borrower will note Lender's interest uponany and all chattel paper if not delivered to Lender for -7- 8possession by Lender. Contemporaneous with the execution of this Agreement,Borrower will execute one or more UCC financing statements and any similarstatements as may be required by applicable law, and will file such financingstatements and all such similar statements in the appropriate location orlocations. Borrower hereby appoints Lender as its irrevocable attorney-in-factfor the purpose of executing any documents necessary to perfect or to continueany Security Interest. Lender may at any time, and without further authorizationfrom Borrower, file a carbon, photograph, facsimile, or other reproduction ofany financing statement for use as a financing statement. Borrower willreimburse Lender for all expenses for the perfection, termination, and thecontinuation of the perfection of Lender's security interest in the Collateral.Borrower promptly will notify Lender of any change in Borrower's name includingany change to the assumed business names of Borrower. Borrower also promptlywill notify Lender of any change in Borrower's Social Security Number orEmployer Identification Number. Borrower further agrees to notify Lender inwriting prior to any change in address or location of Borrower's principalgovernance office or should Borrower merge or consolidate with any other entity. Collateral Records. Borrower does now, and at all times hereafter shall,keep correct and accurate records of the Collateral, all of which records shallbe available to Lender or Lender's representative upon demand for inspection andcopying at any reasonable time. With respect to the Accounts, Borrower agrees tokeep and maintain such records as Lender may require, including withoutlimitation information concerning Eligible Accounts and Account balances andagings. With respect to the Inventory, Borrower agrees to keep and maintain suchrecords as Lender may require, including without limitation informationconcerning Eligible Inventory and records itemizing and describing the kind,type, quality, and quantity of Inventory, Borrower's Inventory costs and sellingprices, and the daily withdrawals and additions to Inventory. Collateral Schedules. Concurrently with the execution and delivery of thisAgreement, Borrower shall execute and deliver to Lender schedules of Accountsand Inventory and Eligible Accounts and Eligible Inventory, in form andsubstance satisfactory to the Lender. Thereafter and at such frequency as Lendershall require, Borrower shall execute and deliver to Lender such supplementalschedules of Eligible Accounts and Eligible Inventory and such other matters andinformation relating to the Accounts and Inventory as Lender may request. Representations and Warranties Concerning Accounts. With respect to theAccounts, Borrower represents and warrants to Lender: (a) Each Accountrepresented by Borrower to be an Eligible Account for purposes of this Agreementconforms to the requirements of the definition of an Eligible Account; (b) AllAccount information listed on schedules delivered to Lender will be true andcorrect, subject to immaterial variance; and (c) Lender, its assigns, or agentsshall have the right at any time and at Borrower's expense to inspect, examine,and audit Borrower's records and to confirm with Account Debtors the accuracy ofsuch Accounts. Representations and Warranties Concerning Inventory. With respect to theInventory, Borrower represents and warrants to Lender: (a) All Inventoryrepresented by -8- 9Borrower to be Eligible Inventory for purposes of this Agreement conforms to therequirements of the definition of Eligible Inventory; (b) All Inventory valueslisted on schedules delivered to Lender will be true and correct, subject toimmaterial variance; (c) The value of the Inventory will be determined on aconsistent accounting basis; (d) Except as agreed to the contrary by Lender inwriting, all Eligible Inventory is now and at all times hereafter will be inBorrower's physical possession and shall not be held by others on consignment,sale on approval, or sale or return; (e) Except as reflected in the Inventoryschedules delivered to Lender, all Eligible Inventory is now and at all timeshereafter will be of good and merchantable quality, free from defects; (f)Eligible Inventory is not now and will not at any time hereafter be stored witha bailee, warehouseman, or similar party without Lender's prior written consent,and, in such event, Borrower will concurrently at the time of bailment cause anysuch bailee, warehouseman, or similar party to issue and deliver to Lender, inform acceptable to Lender, warehouse receipts in Lender's name evidencing thestorage of Inventory; and (g) Lender, its assigns, or agents shall have theright at any time and at Borrower's expense to inspect and examine the Inventoryand to check and test the same as to quality, quantity, value, and condition. REPRESENTATIONS AND WARRANTIES. Borrower represents and warrants to Lender,as of the date of this Agreement, as of the date of each disbursement of Loanproceeds, as of the date of any renewal, extension or modification of any Loan,and at all times any Indebtedness exists: Organization. Borrower is a corporation which is duly organized, validlyexisting, and in good standing under the laws of the State of California and isvalidly existing and in good standing in all states in which Borrower is doingbusiness. Borrower has the full power and authority to own its properties and totransact the businesses in which it is presently engaged or presently proposes to engage. Borrower also is duly qualified as a foreign corporation and is ingood standing in all states in which the failure to so qualify would have amaterial adverse effect on its businesses or financial condition. Authorization. The execution, delivery, and performance of this Agreementand all Related Documents by Borrower, to the extent to be executed, deliveredor performed by Borrower, have been duly authorized by all necessary action byBorrower; do not require the consent or approval of any other person, regulatoryauthority or governmental body; and do not conflict with, result in a violationof, or constitute a default under (a) any provision of its articles ofincorporation or organization, or bylaws, or any agreement or other instrumentbinding upon Borrower or (b) any law, governmental regulation, court decree, ororder applicable to Borrower. Financial Information. Each financial statement of Borrower supplied toLender truly and completely disclosed Borrower's financial condition as of thedate of the statement, and there has been no material adverse change inBorrower's financial condition subsequent to the date of the most recentfinancial statement supplied to Lender. Borrower has no material contingentobligations except as disclosed in such financial statements. -9- 10 Legal Effect. This Agreement constitutes, and any instrument or agreementrequired hereunder to be given by Borrower when delivered will constitute,legal, valid and binding obligations of Borrower enforceable against Borrower inaccordance with their respective terms. Properties. Except for Permitted Liens, Borrower owns and has good title toall of Borrower's properties free and clear of all Security Interests, and hasnot executed any security documents or financing statements relating to suchproperties. All of Borrower's properties are titled in Borrower's legal name,and Borrower has not used, or filed a financing statement under, any other namefor at least the last (5) years. Hazardous Substances. The terms "hazardous waste," "hazardous substance,""disposal," "release," and "threatened release," as used in this Agreement,shall have the same meanings as set forth in the "CERCLA," "SARA," the HazardousMaterials Transportation Act, 49 U.S.C. Section 1801, et seq., the ResourceConservation and Recovery Act, 42 U.S.C. Section 6901, et seq., Chapters 6.5through 7.7 of Division 20 of the California Health and Safety Code, Section25100, et seq., or other applicable state or Federal laws, rules, or regulationsadopted pursuant to any of the foregoing. Except as disclosed to andacknowledged by Lender in writing, Borrower represents and warrants that: (a)During the period of Borrower's ownership of the properties, there has been nouse, generation, manufacture, storage, treatment, disposal, release orthreatened release of any hazardous waste or substance by any person on, under,about or from any of the properties. (b) Borrower has no knowledge of, or reasonto believe that there has been (i) any use, generation, manufacture, storage,treatment, disposal, release, or threatened release of any hazardous waste orsubstance on, under, about or from the properties by any prior owners oroccupants of any of the properties, or (ii) any actual or threatened litigationor claims of any kind by any person relating to such matters. (c) NeitherBorrower nor any tenant, contractor, agent or other authorized user of any ofthe properties shall use, generate, manufacture, store, treat, dispose of, orrelease any hazardous waste or substance on, under, about or from any of theproperties; and any such activity shall be conducted in compliance with allapplicable federal, state, and local laws, regulations, and ordinances,including without limitation those laws, regulations and ordinances describedabove. Borrower authorizes Lender and its agents to enter upon the properties tomake such inspections and tests as Lender may deem appropriate to determinecompliance of the properties with this section of the Agreement. Any inspectionsor tests made by Lender shall be at Borrower's expense and for Lender's purposesonly and shall not be construed to create any responsibility or liability on thepart of Lender to Borrower or to any other person. The representations andwarranties contained herein are based on Borrower's due diligence in investigating the properties for hazardous waste and hazardous substances.Borrower hereby (a) releases and waives any future claims against Lender forindemnity or contribution in the event Borrower becomes liable for cleanup orother costs under any such laws, and (b) agrees to indemnify and hold harmlessLender against any and all claims, losses, liabilities, damages, penalties, andexpenses which Lender may directly or indirectly sustain or suffer resultingfrom a breach of this section of the Agreement or as a consequence of any use,generation, manufacture, storage, disposal, release or threatened release of ahazardous waste or substance on the properties. The provisions of this sectionof the Agreement, including the obligation to -10- 11indemnify, shall survive the payment of the Indebtedness and the termination orexpiration of this Agreement and shall not be affected by Lender's acquisitionof any interest in any of the properties, whether by foreclosure or otherwise. Litigation and Claims. No litigation, claim, investigation, administrativeproceeding or similar action (including those for unpaid taxes) against Borroweris pending or threatened, and no other event has occurred which may materiallyadversely affect Borrower's financial condition or properties, other thanlitigation, claims, or other events, if any, that have been disclosed to andacknowledged by Lender in writing. Taxes. To the best of Borrower's knowledge, all tax returns and reports ofBorrower that are or were required to be filed, have been filed, and all taxes,assessments and other governmental charges have been paid in full, except thosepresently being or to be contested by Borrower in good faith in the ordinarycourse of business and for which adequate reserves have been provided. Lien Priority. Unless otherwise previously disclosed to Lender in writing,Borrower has not entered into or granted any Security Agreements, or permittedthe filing or attachment of any Security Interests on or affecting any of theCollateral directly or indirectly securing repayment of Borrower's Loan andNote, that would be prior or that may in any way be superior to Lender'sSecurity Interests and rights in and to such Collateral. Binding Effect. This Agreement, the Note, all Security Agreements directlyor indirectly securing repayment of Borrower's Loan and Note and all of theRelated Documents are binding upon Borrower as well as upon Borrower'ssuccessors, representatives and assigns, and are legally enforceable inaccordance with their respective terms. Commercial Purposes. Borrower intends to use the Loan proceeds solely forbusiness or commercial related purposes. Employee Benefit Plans. Each employee benefit plan as to which Borrower mayhave any liability complies in all material respects with all applicablerequirements of law and regulations, and (i) no Reportable Event nor ProhibitedTransaction (as defined in ERISA) has occurred with respect to any such plan,(ii) Borrower has not withdrawn from any such plan or initiated steps to do so,(iii) no steps have been taken to terminate any such plan, and (iv) there are nounfunded liabilities other than those previously disclosed to Lender in writing. Location of Borrower's Offices and Records. Borrower's place of business,or Borrower's chief executive office, if Borrower has more than one place ofbusiness, is located at 4311 SOLAR WAY, FREMONT, CA 94538. Unless Borrower hasdesignated otherwise in writing this location is also the office or officeswhere Borrower keeps its records concerning the Collateral. Information. All information heretofore or contemporaneously herewithfurnished by Borrower to Lender for the purposes of or in connection with thisAgreement or any transaction contemplated hereby is, and all informationhereafter furnished by or on behalf -11- 12of Borrower to Lender will be, true and accurate in every material respect onthe date as of which such information is dated or certified; and none of suchinformation is or will be incomplete by omitting to state any material factnecessary to make such information not misleading. Survival of Representations and Warranties. Borrower understands and agreesthat Lender, without independent investigation, is relying upon the aboverepresentations and warranties in extending Loan Advances to Borrower. Borrowerfurther agrees that the foregoing representations and warranties shall becontinuing in nature and shall remain in full force and effect until such timeas Borrower's Indebtedness shall be paid in full, or until this Agreement shallbe terminated in the manner provided above, whichever is the last to occur. AFFIRMATIVE COVENANTS. Borrower covenants and agrees with Lender that,while this Agreement is in effect, Borrower will: Litigation. Promptly inform Lender in writing of (a) all material adversechanges in Borrower's financial condition, and (b) all existing and allthreatened litigation, claims, investigations, administrative proceedings orsimilar actions affecting Borrower or any Guarantor which could materiallyaffect the financial condition of Borrower or the financial condition of anyGuarantor. Financial Records. Maintain its books and records in accordance withgenerally accepted accounting principles, applied on a consistent basis, andpermit Lender to examine and audit Borrower's books and records at allreasonable times. Financial Statements. Furnish Lender with, as soon as available, but in noevent later than ninety (90) days after the end of each fiscal year, Borrower'sbalance sheet and income statement for the year ended, audited by a certifiedpublic accountant satisfactory to Lender, and, as soon as available, but in noevent later than forty-five (45) days after the end of each fiscal quarter,Borrower's balance sheet and profit and loss statement for the period ended,prepared and certified as correct to the best knowledge and belief by Borrower'schief financial officer or other officer or person acceptable to Lender. Allfinancial reports required to be provided under this Agreement shall be preparedin accordance with generally accepted accounting principles, applied on aconsistent basis, and certified by Borrower as being true and correct. Additional Information. Furnish such additional information and statements,lists of assets and liabilities, agings of receivables and payables, inventoryschedules, budgets, forecasts, tax returns, and other reports with respect toBorrower's financial condition and business operations as Lender may requestfrom time to time. Financial Covenants and Ratios. Comply with the following covenants andratios: Net Worth Ratio. Maintain a ratio of Total Liabilities to Tangible NetWorth of less than 1.00 TO 1.00. -12- 13 Working Capital. Maintain Working Capital in excess of $30,000,00.00. Current Ratio. Maintain a ratio of Current Assets to Current Liabilities inexcess of 1.50 TO 1.00. Cash Flow Requirements. Maintain Cash Flow at not less than the followinglevel: 1.50 TO 1.00 DEFINED AS: NET PROFIT AFTER TAXES PLUS DEPRECIATION PLUSAMORTIZATION PLUS INTEREST EXPENSE MINUS DIVIDENDS MINUS WITHDRAWS MINUSINTERNALLY FUNDED FIXED ASSETS DIVIDED BY CURRENT PORTION LONG TERM DEBT PLUS INTEREST EXPENSE. (ONE TIME ALLOWANCE OF $1,760,000.00 TO BE ADDED BACK TO CASHFLOW FOR FISCAL YEAR 1998 TO COMPENSATE FOR NON-FINANCEABLE PORTION OFTECHNOLOGY DRIVE PROPERTY PURCHASE EFFECTIVE JUNE 30, 1998). Except as providedabove, all computations made to determine compliance with the requirementscontained in this paragraph shall be made in accordance with generally acceptedaccounting principles, applied on a consistent basis, and certified by Borroweras being true and correct. Insurance. Maintain fire and other risk insurance, public liabilityinsurance, and such other insurance as Lender may require with respect toBorrower's properties and operations, in form, amounts, coverages and withinsurance companies reasonably acceptable to Lender. Borrower, upon request ofLender, will deliver to Lender from time to time the policies or certificates ofinsurance in form satisfactory to Lender, including stipulations that coverageswill not be canceled or diminished without at least ten (10) days' prior writtennotice to Lender. Each insurance policy also shall include an endorsementproviding that coverage in favor of Lender will not be impaired in any way byany act, omission or default of Borrower or any other person. In connection withall policies covering assets in which Lender holds or is offered a securityinterest for the Loans, Borrower will provide Lender with such loss payable orother endorsements as Lender may require. Insurance Reports. Furnish to Lender, upon request of Lender, reports oneach existing insurance policy showing such information as Lender may reasonablyrequest, including without limitation the following: (a) the name of theinsurer; (b) the risks insured; (c) the amount of the policy; (d) the propertiesinsured; (e) the then current property values on the basis of which insurancehas been obtained, and the manner of determining those values; and (f) theexpiration date of the policy. In addition, upon request of Lender (however notmore often than annually), Borrower will have an independent appraisersatisfactory to Lender determine, as applicable, the actual cash value orreplacement cost of any Collateral. The cost of such appraisal shall be paid byBorrower. Other Agreements. Comply with all terms and conditions of all otheragreements, whether now or hereafter existing, between Borrower and any otherparty and notify Lender immediately in writing of any default in connection withany other such agreements. Loan Fees and Charges. In addition to all other agreed upon fees andcharges, pay the following: BORROWER AGREES TO PAY LENDER A NONREFUNDABLE LOANFEE (FOR LETTER OF CREDIT) IN THE AMOUNT OF $59,933.00. -13- 14 Loan Proceeds. Use all Loan proceeds solely for Borrower's businessoperations, unless specifically consented to the contrary by Lender in writing. Taxes, Charges and Liens. Pay and discharge when due all of itsindebtedness and obligations, including without limitation all assessments,taxes, governmental charges, levies and liens, of every kind and nature, imposedupon Borrower or its properties, income, or profits, prior to the date on whichpenalties would attach, and all lawful claims that, if unpaid, might become alien or charge upon any of Borrower's properties, income, or profits. Providedhowever, Borrower will not be required to pay and discharge any such assessment,tax, charge, levy, lien or claim so long as (a) the legality of the same shallbe contested in good faith by appropriate proceedings, and (b) Borrower shallhave established on its books adequate reserves with respect to such contestedassessment, tax, charge, levy, lien, or claim in accordance with generallyaccepted accounting practices. Borrower, upon demand of Lender, will furnish toLender evidence of payment of the assessments, taxes, charges, levies, liens andclaims and will authorize the appropriate governmental official to deliver toLender at any time a written statement of any assessments, taxes, charges,levies, liens and claims against Borrower's properties, income, or profits. Performance. Perform and comply with all terms, conditions, and provisions set forth in this Agreement and in the Related Documents in a timely manner, andpromptly notify Lender if Borrower learns of the occurrence of any event whichconstitutes an Event of Default under this Agreement or under any of the RelatedDocuments. Operations. Maintain executive and management personnel with substantiallythe same qualifications and experience as the present executive and managementpersonnel; provide written notice to Lender of any change in executive andmanagement personnel; conduct its business affairs in a reasonable and prudentmanner and in compliance with all applicable federal, state and municipal laws,ordinances, rules and regulations respecting its properties, charters,businesses and operations, including without limitation, compliance with theAmericans With Disabilities Act and with all minimum funding standards and otherrequirements of ERISA and other laws applicable to Borrower's employee benefitplans. Inspection. Permit employees or agents of Lender at any reasonable time toinspect any and all Collateral for the Loan or Loans and Borrower's otherproperties and to examine or audit Borrower's books, accounts, and records andto make copies and memoranda of Borrower's books, accounts, and records. IfBorrower now or at any time hereafter maintains any records (including withoutlimitation computer generated records and computer software programs for thegeneration of such records) in the possession of a third party, Borrower, uponrequest of Lender, shall notify such party to permit Lender free access to suchrecords at all reasonable times and to provide Lender with copies of any recordsit may request, all at Borrower's expense. Compliance Certificate. Unless waived in writing by Lender, provide LenderQUARTERLY (WITHIN 45 DAYS) and at the time of each disbursement of Loan proceedswith a certificate executed by Borrower's chief financial officer, or otherofficer or person acceptable -14- 15to Lender, certifying that the representations and warranties set forth in thisAgreement are true and correct as of the date of the certificate and furthercertifying that, as of the date of the certificate, no Event of Default existsunder this Agreement. Environmental Compliance and Reports. Borrower shall comply in all respectswith all environmental protection federal, state and local laws, statutes,regulations and ordinances; not cause or permit to exist, as a result of anintentional or unintentional action or omission on its part or on the part ofany third party, on property owned and/or occupied by Borrower, anyenvironmental activity where damage may result to the environment, unless suchenvironmental activity is pursuant to and in compliance with the conditions of apermit issued by the appropriate federal, state or local governmentalauthorities; shall furnish to Lender promptly and in any event within thirty(30) days after receipt thereof a copy of any notice, summons, lien, citation,directive, letter or other communication from any governmental agency orinstrumentality concerning any intentional or unintentional action or omissionon Borrower's part in connection with any environmental activity whether or notthere is damage to the environmental and/or other natural resources. Additional Assurances. Make, execute and deliver to Lender such promissorynotes, mortgages, deeds of trust, security agreements, financing statements,instruments, documents and other agreements as Lender or its attorneys mayreasonably request to evidence and secure the Loans and to perfect all SecurityInterests. RECOVERY OF ADDITIONAL COSTS. If the imposition of or any change in anylaw, rule, regulation or guideline, or the interpretation or application of anythereof by any court or administrative or governmental authority (including anyrequest or policy not having the force of law) shall impose, modify or makeapplicable any taxes (except U.S. federal, state or local income or franchisetaxes imposed on Lender), reserve requirements, capital adequacy requirements or other obligations which would (a) increase the cost to Lender for extending ormaintaining the credit facilities to which this Agreement relates, (b) reducethe amounts payable to Lender under this Agreement or the Related Documents, or(c) reduce the rate of return on Lender's capital as a consequence of Lender'sobligations with respect to the credit facilities to which this Agreementrelates, then Borrower agrees to pay Lender such additional amounts as willcompensate Lender therefore, within five (5) days after Lender's written demandfor such payment, which demand shall be accompanied by an explanation of suchimposition or charge and a calculation in reasonable detail of the additionalamounts payable by Borrower, which explanation and calculations shall beconclusive in the absence of manifest error. NEGATIVE COVENANTS. Borrower covenants and agrees with Lender that whilethis Agreement is in effect, Borrower shall not, without the prior writtenconsent of Lender: Indebtedness and Liens. (a) Except for trade debt incurred in the normalcourse of business and indebtedness to Lender contemplated by this Agreement,create, incur or assume indebtedness for borrowed money, including capitallease, (b) except as allowed as a Permitted Lien, sell, transfer, mortgage,assign, pledge, lease, grant a security interest in, or -15- 16encumber any of Borrower's assets, or (c) sell with recourse any of Borrower'saccounts, except to Lender. Continuity of Operations. (a) Engage in any business activitiessubstantially different than those in which Borrower is presently engaged, (b)cease operations, liquidate, merge, transfer, acquire or consolidate with anyother entity, change ownership, change its name, dissolve or transfer or sellCollateral out of the ordinary course of business, (c) pay any dividends onBorrower's stock (other than dividends payable in its stock), provided, howeverthat notwithstanding the foregoing, but only so long as no Event of Default hasoccurred and is continuing or would result from the payment of dividends, ifBorrower is a "Subchapter S Corporation" (as defined in the Internal RevenueCode of 1986, as amended), Borrower may pay cash dividends on its stock to itsshareholders from time to time in amounts necessary to enable the shareholdersto pay income taxes and make estimated income tax payments to satisfy theirliabilities under federal and state law which arise solely from their status asShareholders of a Subchapter S Corporation because of their ownership of sharesof stock of Borrower, or (d) purchase or retire any of Borrower's outstandingshares or alter or amend Borrower's capital structure. Loans, Acquisitions and Guaranties. (a) Loan, invest in or advance money orassets, (b) purchase, create or acquire any interest in any other enterprise orentity, or (c) incur any obligation as surety or guarantor other than in theordinary course of business. CESSATION OF ADVANCES. If Lender has made any commitment to make any Loanto Borrower, whether under this Agreement or under any other agreement, Lendershall have no obligation to make Loan Advances or to disburse Loan proceeds if:(a) Borrower or any Guarantor is in default under the terms of this Agreement orany of the Related Documents or any other agreement that Borrower or anyGuarantor has with Lender; (b) Borrower or any Guarantor becomes insolvent,files a petition in bankruptcy or similar proceedings, or is adjudged abankrupt; (c) there occurs a material adverse change in Borrower's financial,condition, in the financial condition of any Guarantor, or in the value of anyCollateral securing any Loan; or (d) any Guarantor seeks, claims or otherwiseattempts to limit, modify or revoke such Guarantor's guaranty of the Loan or anyother loan with Lender. ADDITIONAL DEFINITIONS. Current Assets. The words "Current Assets" mean Borrower's cash on hand plus Borrower's receivables plus inventory. Current Liabilities. The words "Current Liabilities" mean all Borrower'snotes payable plus Borrower's accounts payable plus Borrower's income taxespayable plus Borrower's accruals plus Borrower's current portion of long termdebt. Current Ratio. The words "Current Ratio" mean Borrower's total CurrentAssets divided by Borrower's total Current Liabilities. BORROWING BASE CERTIFICATE. Unless waived in writing by Lender, Borrower -16- 17agrees to provide Lender with a Borrower's Certificate within THIRTY (30) daysafter the end of each month (if borrowings exceeds $5,000,000.00). Each"Borrower's Certificate" shall be in a form (Lender form #63-5900) acceptable toLender, duly executed by Borrower and detailing the status of the Line of Creditas of the date thereon. AGING AND LISTING OF ACCOUNTS RECEIVABLE AND PAYABLE. Borrower covenantsand agrees with Lender that, while this Agreement is in effect, Borrower shalldeliver to Lender within THIRTY (30) DAYS after the end of each month (ifborrowings exceed $5,000,000.00), a detailed aging of Borrower's accounts andcontracts receivable and accounts payable as of the last day of that monthtogether with an explanation of any adjustments made at the end of that month,all in a form acceptable to Lender. CUSTOMER LISTING. Borrower agrees with Lender that, while this Agreement isin effect, Borrower will furnish Lender with, as soon as available after the endof each fiscal year, a listing of Account Debtors and their addresses, currentas of the year end, in form satisfactory to Lender. COLLATERAL AUDITS. Borrower covenants and agrees with Lender that, whilethis Agreement is in effect, collateral audits will be performed annually. TANGIBLE NET WORTH. Maintain a Minimum Tangible Net Worth of not less than$44,000,000.00 (step-up by 100% of any new equity). INVENTORY REPORTING. Borrower covenants and agrees with Lender that, whilethis Agreement is in effect, Borrower shall deliver to Lender after the end ofeach month, a schedule of Eligible Inventory to include raw materials at costplus scrap value of work in progress and finished goods when borrowings exceed$5,000,000.00. INVESTMENT ACQUISITIONS. Borrower covenants and agrees with Lender that,while this Agreement is in effect, Borrower shall not, without prior writtenconsent of Lender, make any Investment Acquisitions over $250,000.00 PROFITABILITY. Borrower covenants and agrees with Lender that, while thisAgreement is in effect, Borrower shall maintain semi-annual profitabilitygreater than zero. ACCESS LAWS. An exhibit, titled "ACCESS LAWS," is attached to thisAgreement and by this reference is made a part of this Agreement just as if allthe provisions, terms and conditions of the Exhibit had been fully set forth inthis Agreement. EVENTS OF DEFAULT. Each of the following shall constitute an Event ofDefault under this Agreement: Default on Indebtedness. Failure of Borrower to make any payment when dueon the Loans. -17- 18 Other Defaults. Failure of Borrower or any Grantor to comply with or toperform when due any other term, obligation, covenant or condition contained inthis Agreement or in any of the Related Documents, or failure of Borrower tocomply with or to perform any other term, obligation, covenant or conditioncontained in any other agreement between Lender and Borrower. Default in Favor of Third Parties. Should Borrower or any Grantor defaultunder any loan, extension of credit, security agreement, purchase or salesagreement, or any other agreement, in favor of any other creditor or person thatmay materially affect any of Borrower's property or Borrower's or any Grantor'sability to repay the Loans or perform their respective obligations under thisAgreement or any of the Related Documents. False Statements. Any warranty, representation or statement made orfurnished to Lender by or on behalf of Borrower or any Grantor under thisAgreement or the Related Documents is false or misleading in any materialrespect at the time made or furnished, or becomes false or misleading at anytime thereafter. Defective Collateralization. This Agreement or any of the Related Documentsceases to be in full force and effect (including failure of any SecurityAgreement to create a valid and perfected Security Interest) at any time and forany reason. Insolvency. The dissolution or termination of Borrower's existence as agoing business, the insolvency of Borrower, the appointment of a receiver forany part of Borrower's property, any assignment for the benefit of creditors,any type of creditor workout, or the commencement of any proceeding under anybankruptcy or insolvency laws by or against Borrower. Creditor or Forfeiture Proceedings. Commencement of foreclosure orforfeiture proceedings, whether by judicial proceeding, self-help, repossessionor any other method, by any creditor of Borrower, any creditor of any Grantoragainst any collateral securing the Indebtedness, or by any governmental agency.This includes a garnishment, attachment, or levy on or of any of Borrower'sdeposit accounts with Lender. Events Affecting Guarantor. Any of the preceding events occurs with respectto any Guarantor of any of the Indebtedness or any Guarantor dies or becomesincompetent, or revokes or disputes the validity of, or liability under, anyGuaranty of the Indebtedness. Change in Ownership. Any change in ownership of twenty-five percent (25%)or more of the common stock of Borrower. Adverse Change. A material adverse change occurs in Borrower's financialcondition, or Lender believes the prospect of payment or performance of theIndebtedness is impaired. EFFECT OF AN EVENT OF DEFAULT. If any Event of Default shall occur, exceptwhere otherwise provided in this Agreement or the Related Documents, allcommitments and -18- 19obligations of Lender under this Agreement or the Related Documents or any otheragreement immediately will terminate (including any obligation to make LoanAdvances or disbursements), and, at Lender's option, all Indebtednessimmediately will become due and payable, all without notice of any kind toBorrower, except that in the case of an Event of Default of the type describedin the "Insolvency" subsection above, such acceleration shall be automatic andnot optional. In addition, Lender shall have all the rights and remediesprovided in the Related Documents or available at law, in equity, or otherwise.Except as may be prohibited by applicable law, all of Lender's rights andremedies shall be cumulative and may be exercised singularly or concurrently. Election by Lender to pursue any remedy shall not exclude pursuit of any otherremedy, and an election to make expenditures or to take action to perform anobligation of Borrower or of any Grantor shall not affect Lender's right todeclare a default and to exercise its rights and remedies. MISCELLANEOUS PROVISIONS. The following miscellaneous provisions are a partof this Agreement: Amendments. This Agreement, together with any Related Documents,constitutes the entire understanding and agreement of the parties as to thematters set forth in this Agreement. No alteration of or amendment to thisAgreement shall be effective unless given in writing and signed by the party orparties sought to be charged or bound by the alteration or amendment. APPLICABLE LAW. THIS AGREEMENT HAS BEEN DELIVERED TO LENDER AND ACCEPTED BYLENDER IN THE STATE OF CALIFORNIA. IF THERE IS A LAWSUIT, BORROWER AGREES UPONLENDER'S REQUEST TO SUBMIT TO THE JURISDICTION OF THE COURTS OF SACRAMENTOCOUNTY, THE STATE OF CALIFORNIA. THIS AGREEMENT SHALL BE GOVERNED BY ANDCONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF CALIFORNIA. Caption Headings. Caption headings in this Agreement are for conveniencepurposes only and are not to be used to interpret or define the provisions ofthis Agreement. Multiple Parties; Corporate Authority. All obligations of Borrower underthis Agreement shall be joint and several, and all references to Borrower shallmean each and every Borrower. This means that each of the persons signing belowis responsible for ALL obligations in this Agreement. Consent to Loan Participation. Borrower agrees and consents to Lender'ssale or transfer, whether now or later, of one or more participation interestsin the Loans to one or more purchasers, whether related or unrelated to Lender.Lender may provide, without any limitation whatsoever, to any one or morepurchasers, or potential purchasers, any information or knowledge Lender mayhave about Borrower or about any other matter relating to the Loan, and Borrowerhereby waives any rights to privacy it may have with respect to such matters.Borrower additionally waives any and all notices of sale of participationinterests, as well as all notices of any repurchase of such participationinterests. Borrower also agrees that the purchasers of any such participationinterests will be considered as the absolute owners of such interests in theLoans and will have all the rights granted under the participation agreement or -19- 20agreements governing the sale of such participation interests. Borrower furtherwaives all rights of offset or counterclaim that it may have now or lateragainst Lender or against any purchaser of such a participation interest andunconditionally agrees that either Lender or such purchaser may enforceBorrower's obligation under the Loans irrespective of the failure or insolvencyof any holder of any interest in the Loans. Borrower further agrees that thepurchaser of any such participation interests may enforce its interestsirrespective of any personal claims or defenses that Borrower may have againstLender. Costs and Expenses. Borrower agrees to pay upon demand all of Lender'sexpenses, including without limitation attorneys' fees, incurred in connectionwith the preparation, execution, enforcement, modification and collection ofthis Agreement or in connection with the Loans made pursuant to this Agreement.Lender may pay someone else to help collect the Loans and to enforce thisAgreement, and Borrower will pay that amount. This includes, subject to anylimits under applicable law, Lender's attorneys' fees and Lender's legalexpenses, whether or not there is a lawsuit, including attorneys' fees forbankruptcy proceedings (including efforts to modify or vacate any automatic stayor injunction), appeals, and any anticipated post-judgment collection services.Borrower also will pay any court costs, in addition to all other sums providedby law. Notices. All notices required to be given under this Agreement shall begiven in writing, may be sent by telefacsimile (unless otherwise required bylaw), and shall be effective when actually delivered or when deposited with anationally recognized overnight courier or deposited in the United States mail,first class, postage prepaid, addressed to the party to whom the notice is to begiven at the address shown above. Any party may change its address for noticesunder this Agreement by giving formal written notice to the other parties,specifying that the purpose of the notice is to change the party's address. Tothe extent permitted by applicable law, if there is more than one Borrower,notice to any Borrower will constitute notice to all Borrowers. For noticepurposes, Borrower will keep Lender informed at all times of Borrower's currentaddress(es). Severability. If a court of competent jurisdiction finds any provision ofthis Agreement to be invalid or unenforceable as to any person or circumstance,such finding shall not render that provision invalid or unenforceable as to anyother persons or circumstances. If feasible, any such offending provision shallbe deemed to be modified to be within the limits of enforceability or validity;however, if the offending provision cannot be so modified, it shall be strickenand all other provisions of this Agreement in all other respects shall remainvalid and enforceable. Subsidiaries and Affiliates of Borrower. To the extent the context of anyprovisions of this Agreement makes it appropriate, including without limitationany representation, warranty or covenant, the word "Borrower" as used hereinshall include all subsidiaries and affiliates of Borrower. Notwithstanding theforegoing however, under no circumstances shall this Agreement be construed torequire Lender to make any Loan or other financial accommodation to anysubsidiary or affiliate of Borrower. -20- 21 Successors and Assigns. All covenants and agreements contained by or onbehalf of Borrower shall bind its successors and assigns and shall inure to thebenefit of Lender, its successors and assigns. Borrower shall not, however, havethe right to assign its rights under this Agreement or any interest therein,without the prior written consent of Lender. Survival. All warranties, representations, and covenants made by Borrowerin this Agreement or in any certificate or other instrument delivered byBorrower to Lender under this Agreement shall be considered to have been reliedupon by Lender and will survive the making of the Loan and delivery to Lender ofthe Related Documents, regardless of any investigation made by Lender or onLender's behalf. Time Is of the Essence. Time is of the essence in the performance of thisAgreement. Waiver. Lender shall not be deemed to have waived any rights under thisAgreement unless such waiver is given in writing and signed by Lender. No delayor omission on the part of Lender in exercising any right shall operate as awaiver of such right or any other right. A waiver by Lender of a provision inthis Agreement shall not prejudice or constitute a waiver of Lender's rightotherwise to demand strict compliance with that provisions or any otherprovision of this Agreement. No prior waiver by Lender, nor any course ofdealing between Lender and Borrower, or between Lender and any Grantor, shallconstitute a waiver of any of Lender's rights or of any obligations of Borroweror of any Grantor as to any future transactions. Whenever the consent of Lenderis required under this Agreement, the granting of such consent by Lender in anyinstance shall not constitute continuing consent in subsequent instances wheresuch consent is required, and in all cases such consent may be granted orwithheld in the sole discretion of Lender. BORROWER ACKNOWLEDGES HAVING READ ALL THE PROVISIONS OF THIS LOANAGREEMENT, AND BORROWER AGREES TO ITS TERMS. THIS AGREEMENT IS DATED AS OF SEPTEMBER 18, 1998.BORROWER:AMERICAN XTAL TECHNOLOGYBy: /s/ MORRIS S. YOUNG ------------------------------------------------- Authorized Officer (Title) -21- 22LENDER:U.S. BANK NATIONAL ASSOCIATIONBy: /s/ JASON FLOYD ------------------------------------------------- Authorized Officer -22- 1 Exhibit 10.9 LETTER OF CREDIT AND REIMBURSEMENT AGREEMENT This Letter of Credit and Reimbursement Agreement ("Agreement") is made andentered into as of December 1, 1998, by and between American Xtal Technology,Inc. (the "Borrower") and U.S. Bank National Association (the "Bank"). RECITALS A. The Borrower and Harris Trust Company of California (the "Trustee")have entered into an Indenture dated as of December 1, 1998 (the "Indenture"),pursuant to which the Borrower will issue its Variable Rate Taxable DemandRevenue Bonds Series 1998 (the "Bonds") in an aggregate principal amount of$11,615,000. B. To assure payment of the principal and interest with respect to theBonds when due, the Borrower has requested that the Bank issue an irrevocable,direct pay letter of credit in favor of the Trustee in substantially the form ofExhibit A hereto (such letter of credit and any successor letter of credit beingthe "Letter of Credit"), in the amount of $11,986,680 (the "Commitment"), ofwhich $11,615,000 shall support the payment of principal with respect to theBonds and $371,680 shall support the payment of 96 days of interest with respectto the Bonds at a rate not to exceed 12% per annum based on a 360-day year(actual days elapsed). C. As more fully set forth in this Agreement, the Borrower has agreed toreimburse the Bank for drawings under the Letter of Credit and to grant to theBank a security interest in certain Collateral (as hereafter defined) to securethe Obligations (as hereafter defined) of the Borrower under this Agreement. AGREEMENT NOW, THEREFORE, in consideration of the mutual covenants and agreementscontained herein, and for other good and valuable consideration, the receipt andadequacy of which are hereby acknowledged, the parties agree as follows: ARTICLE I DEFINITIONS SECTION 1.1 Certain Defined Terms. For purposes of this Agreement(including the Recitals hereof), the following terms shall have the respectivemeanings specified below. "Agreement" shall mean this Letter of Credit and Reimbursement Agreement,including the exhibits hereto. "Annual Letter of Credit Fee" shall have the meaning assigned to that termin Section 8.1(a) hereof. "Bank" shall mean U.S. Bank National Association. 2 "Bank Documents" shall mean the Loan Agreement, the Pledge Agreement, theDeeds of Trust, the Security Agreement, and the Third Party LienholderAgreement. "Business Day" shall mean a day of the year which is not (i) a Saturday orSunday or (ii) a day on which banks located in Sacramento, California, or bankslocated in the city in which the principal office of the Trustee or the TenderAgent (as such terms are defined in the Indenture) is located are authorized orobligated by law or executive order to close or (iii) a day on which the New York Stock Exchange is closed. "Bonds" shall have the meaning assigned to that term in Recital A hereto. "Closing Date" shall mean the date that all conditions precedent to theissuance of the Letter of Credit are satisfied in accordance with the termshereof. "Collateral" shall mean, collectively, (i) the "Collateral" as defined inthe Security Agreement and (ii) the "Property" and the "Collateral" as definedin the Deeds of Trust. "Commitment" shall have the meaning assigned to that term in Recital Bhereto. "Deeds of Trust" shall mean, collectively, each Deed of Trust, SecurityAgreement, Assignment of Leases and Rents and Fixture Filing executed anddelivered by the Borrower for the benefit of the Bank securing the Obligations(in whole or in part) and encumbering the Collateral or any portion thereof, ineach case, as the same may be amended, supplemented or otherwise modified fromtime to time in writing in accordance therewith. "Event of Default" shall have the meaning assigned to that term in Section7.1 hereof. "Fixed Interest Rate" shall mean a fixed, nonfloating interest rate withrespect to the Bonds established in accordance with the terms of Section 2.03(D)of the Indenture. "Improvements" shall have the meaning assigned to that term in the Deeds ofTrust. "Indenture" shall have the meaning assigned to that term in Recital Ahereto. "Interest Drawing" shall have the meaning assigned to that term in theLetter of Credit. "Interest Purchase Drawing" shall have the meaning assigned to that term inthe Letter of Credit. "Letter of Credit" shall have the meaning assigned to that term in RecitalB hereto. "Letter of Credit Origination Fee" shall have the meaning assigned to thatterm in Section 8.1(b) hereof. "Loan Agreement" means that certain Loan Agreement dated as of September18, 1998, by and between the Borrower and the Bank, as the same may be amended,supplemented or otherwise modified from time to time in writing in accordancetherewith. 2 3 "Obligations" shall mean all obligations of the Borrower to the Bank underthis Agreement and the Related Documents, including without limitation theobligation to reimburse the Bank for amounts paid under the Letter of Credit,the obligation to pay the fees due hereunder, and the obligation to prepayobligations on account of the Letter of Credit during the continuance of anEvent of Default. "Outstanding" with respect to the Bonds shall have the meaning assigned tothat term in the Indenture. "Pledge Agreement" means that certain Pledge Agreement and SecurityAgreement of even date herewith made by the Borrower in favor of the Bank, as the same may be amended, supplemented or otherwise modified from time to time inwriting in accordance therewith. "Potential Default" shall mean an event which, with the passage of time orthe giving of notice, or both, would constitute an Event of Default. "Principal Drawing" shall have the meaning assigned to that term in theLetter of Credit. "Principal Purchase Drawing" shall have the meaning assigned to that termin the Letter of Credit. "Property" shall have the meaning assigned to that term in the Deeds ofTrust. "Reference Rate" shall mean the fluctuating per annum rate announced fromtime to time by the Bank in Sacramento, California as its "prime rate." Theprime rate is a rate set by the Bank based upon various factors including theBank's costs and desired return and general economic conditions, and is used asa reference point for pricing some loans, which may be priced at, above, orbelow the prime rate. "Related Documents" shall mean, collectively, the Bank Documents, theLetter of Credit, the Bonds and the Indenture. "Security Agreement" shall mean that certain Security Agreement of evendate herewith by and between the Borrower, as debtor, and the Bank, as securedparty, as the same may be amended, supplemented or otherwise modified from timeto time in writing in accordance therewith. "Third Party Lienholder Agreement" means that certain Third PartyLienholder Agreement dated as of November 30, 1998, by and between the Bank andthe United States Small Business Administration, and acknowledged and consentedto by the Borrower, as the same may be amended, supplemented or otherwisemodified from time to time in writing in accordance therewith. SECTION 1.2 Accounting Terms. All accounting terms used herein and notspecifically defined herein shall be construed in accordance with generallyaccepted accounting principles, consistently applied. 3 4 ARTICLE II AMOUNT AND TERMS OF THE LETTER OF CREDIT SECTION 2.1 The Letter of Credit. The Borrower requests the Bank to issuethe Letter of Credit, and the Bank agrees, on the terms and conditionshereinafter set forth, to issue the Letter of Credit to the Trustee. TheBorrower agrees to execute and deliver such additional application materialswith respect to the Letter of Credit and such other documents as the Bank shallreasonably request in connection therewith. SECTION 2.2 Issuing the Letter of Credit. The Letter of Credit shall beissued to the Trustee on the Closing Date upon fulfillment of the conditions setforth in Article III hereof. The Borrower shall reimburse the Bank for any andall draws under the Letter of Credit in accordance with the terms and conditionsset forth below. SECTION 2.3 Reimbursement. In satisfaction of its obligation to reimbursethe Bank for any amount drawn under the Letter of Credit, the Borrower herebyagrees to (i) pay to the Bank the amount of each Interest Drawing and eachInterest Purchase Drawing on the day such drawing is honored by the Bank and(ii) to pay to the Bank the amount of each Principal Drawing and each PrincipalPurchase Drawing on the day such drawing is honored by the Bank. SECTION 2.4 Grant of Security. As security for its obligation to reimburse the Bank for any amounts paid pursuant to any drawing under the Letter of Creditand for all other obligations of the Borrower hereunder, including any interestdue pursuant to Section 2.9, the Borrower hereby pledges and assigns to theBank, and grants to the Bank a lien and security interest in, all of theBorrower's right, title, and interest in and to the Collateral. The Borroweragrees to maintain and preserve the Collateral and to take such actions as theBank shall, from time to time, reasonably request to create, establish, maintainand perfect the Bank's security interest therein. SECTION 2.5 Reimbursement and Computations. All payments made on account ofthe Obligations shall be made by the Borrower, without setoff or counterclaim,in lawful money of the United States of America in immediately available funds,free and clear of and without deduction for any taxes, fees or other charges ofany nature whatsoever imposed by any taxing authority and must be received bythe Bank by 1:00 p.m. California time on the day of payment, it being expresslyagreed and understood that if a payment is received after 1:00 p.m. Californiatime by the Bank, such payment will be considered to have been made by theBorrower on the next succeeding Business Day and interest thereon shall bepayable by the Borrower at the rate specified in Section 2.9 hereof during suchextension. All payments to the Bank hereunder shall be made at the followingaddress: U.S. Bank National Association, 980 Ninth Street, Suite 1200,Sacramento, California 95814, Attention: International Department. SECTION 2.6 Non-Business Days. Whenever any payment or reimbursement to bemade hereunder, or any bond redemption required to be made pursuant to Section5.l(f), shall be due or required on a day which is not a Business Day, suchpayment, reimbursement or redemption shall be made on the next succeedingBusiness Day, and such extension of time shall 4 5in such case be included in the computation of any such payment, reimbursementor redemption (if applicable). SECTION 2.7 Evidence of Obligation. The Bank shall maintain in accordancewith its usual practice an account or accounts evidencing the obligation of theBorrower resulting from each drawing under the Letter of Credit. In any legalaction or proceeding in respect of this Agreement, the entries made in suchaccount or accounts shall, in the absence of error in calculation, be conclusiveevidence of the existence and amounts of the obligations of the Borrower thereinrecorded. SECTION 2.8 Obligations Absolute. The payment or reimbursement obligationsof the Borrower under this Agreement shall be unconditional and irrevocable, andshall be paid strictly in accordance with and subject to the terms andconditions of this Agreement under all circumstances, including, withoutlimitation, the following circumstances: (a) any lack of validity or enforceability of any of the RelatedDocuments; (b) any amendment or waiver of or any consent to departure from allor any of the Related Documents; (c) the existence of any claim, set-off, defense, or other rightwhich the Borrower may have at any time against the Trustee or any otherbeneficiary, or any transferee, of the Letter of Credit (or any persons orentities for whom the Trustee, any such beneficiary, or any such transferee maybe acting), the Bank, or any other person or entity, whether in connection withthis Agreement, the transactions contemplated herein or in the RelatedDocuments, or any unrelated transaction; (d) any statement or any other document presented under the Letter ofCredit proving to be forged, fraudulent, or invalid in any respect or anystatement therein being untrue or inaccurate in any respect; (e) payment by the Bank under the Letter of Credit againstpresentation of a draft or certificate which does not comply with the terms ofthe Letter of Credit; or (f) any other circumstance or happening whatsoever, whether or notsimilar to any of the foregoing. SECTION 2.9 Default Interest. If an Event of Default has occurred and iscontinuing, the Obligations shall bear interest, payable on demand, at theReference Rate plus 5% per annum (such sum, the "Default Rate") until suchrequired payment plus interest thereon has been paid; provided, however, thatnothing contained in this Section 2.9 shall be construed to waive or limit anyof the rights and remedies of the Bank with respect to such nonpayment underthis Agreement or the Related Documents. 5 6 SECTION 2.10 Tranches of Debt. The obligations owing at any time by theBorrower to the Bank shall, solely for the purpose of identifying which portionsof the Obligations are secured by specific items of Collateral, be divided intothe following tranches ("Tranches"): Tranche Maximum Principal Amount of Tranche ------- ----------------------------------- A $4,900,000 B $5,440,000 C All remaining indebtedness and Obligations owing hereunder or under the Related Agreements at any timeAny payments received by the Bank hereunder shall be applied to the Obligationspayable under each of the Tranches on a pro rata basis. As the maximum amount ofthe Letter of Credit is reduced in connection with each partial redemption ofthe Bonds required under Section 5.l(f) hereof, the reduction of the maximumprincipal amount of Obligations payable under each of the Tranches shall be asset forth in Schedule I attached hereto. SECTION 2.11 Repayment of Bank Debt. The Borrower hereby agrees that,simultaneously with its issuance of the Bonds and the Bank's issuance of theLetter of Credit, a portion of the proceeds derived from the sale of the Bondsshall be paid directly to the Bank for the purpose of paying in full allindebtedness owing under (a) that certain promissory note dated as of October 1,1996, in favor of Commercial Bank of Fremont (now the Bank) in the originalprincipal amount of $3,537,355.00 (the "Fremont Note"), and (b) that certainpromissory note dated as of May 27, 1997, in favor of U.S. Bank (now the Bank)in the original principal amount of $750,000.00 (the "USB Note"). The amount ofprincipal and interest owing under (i) the Fremont Note is $3,481,838.90 ofprincipal and accrued and unpaid interest, and (ii) the USB Note is $709,117.68of principal and accrued and unpaid interest. (The amounts listed in thepreceding clauses (i) and (ii) represent principal and accrued and unpaidinterest outstanding under the Fremont Note and the USB Note, respectively, asof December 5, 1998. To the extent that the Fremont Note and the USB Note arerepaid prior to December 5, 1998, as is currently anticipated by the parties,the Bank will promptly refund to the Borrower the amount of any overpayment.) ARTICLE III CONDITIONS OF ISSUANCE SECTION 3.1 Conditions Precedent to Issuance of the Letter of Credit. Theobligation of the Bank to issue the Letter of Credit is subject to the conditionprecedent that the Bank shall have received on or before the date of the issuance of the Letter of Credit each of the following, in form and substancesatisfactory to the Bank: (a) a fully executed copy of the Indenture; (b) a fully executed copy of the Pledge Agreement; 6 7 (c) a fully executed copy of each Deed of Trust, acknowledged and inrecordable form; (d) evidence satisfactory to the Bank that all the Collateral hasbeen duly pledged to the Bank; (e) an opinion of counsel to the Borrower, opining as to such matters(including, but not limited to, the validity and enforceability of thisAgreement and the other Related Documents to which the Borrower is a party), andotherwise in such form and substance as the Bank shall reasonably require; (f) certified copies of all documents evidencing any necessary actionapproving this Agreement and each Related Document to which the Borrower is aparty and all other necessary action with respect to each such document; (g) policies of title insurance insuring, to the Bank's satisfaction,the first priority liens (or, in the case of the lien on the Solar Way propertythat is to be junior to the lien on such property held by the SBA, as specifiedin the Third Party Lienholder Agreement, such lower priority as the Bank mayaccept in its discretion) of the Deeds of Trust encumbering the land describedin Exhibit A to each Deed of Trust ("Land"), in such form, and with suchendorsements, as the Bank shall require; (h) a fully executed Third Party Lienholder Agreement in form andsubstance acceptable to the Bank; (i) a UCC-1 Financing Statement executed by the Borrower and recordedin the Office of the Secretary of State of California; and (j) such credit applications, financial statements, authorizationsand such information concerning the Borrower and its operations and condition(financial and otherwise) as the Bank may reasonably request. SECTION 3.2 Additional Conditions Precedent to Issuance of the Letter ofCredit. The obligation of the Bank to issue the Letter of Credit shall besubject to the further conditions precedent that on the date of the issuance ofthe Letter of Credit: (a) the following statements shall be true, and the Bank shall havereceived a certificate signed by the Borrower, dated the date of such issuance,stating that: (i) the representations and warranties contained in Section 4.1of this Agreement, Section 4 of each Deed of Trust and Section 4 of the SecurityAgreement are correct on and as of the date of issuance of the Letter of Creditas though made on and as of such date; and 7 8 (ii) no event has occurred and is continuing, or would resultfrom the issuance of the Letter of Credit, which constitutes an Event of Defaultor would constitute an Event of Default but for the requirement that notice begiven or time elapse or both; and (b) the Bank shall have received such other filings or recordations, approvals, opinions, or documents as the Bank may reasonably request. ARTICLE IV REPRESENTATIONS AND WARRANTIES SECTION 4.1 Representations and Warranties of the Borrower. The Borrowerrepresents and warrants as follows: (a) The Borrower is a corporation duly organized, validly existingand in good standing under the laws of the jurisdiction of its incorporation, isqualified to do business and is in good standing in each jurisdiction in whichthe failure so to qualify or be in good standing would result in a materialadverse effect on the business or condition (financial or otherwise) of theBorrower, and has all requisite power and authority to own its assets and carryon its business and to execute, deliver and perform its obligations hereunderand under the Related Documents to which it is a party. (b) The execution, delivery, and performance by the Borrower of thisAgreement and each Related Document to which it is a party (i) are within itspowers, (ii) have been duly authorized by all necessary action, (iii) do notcontravene any law or contractual restriction binding on or affecting theBorrower, and (iv) do not result in or require the creation of any lien,security interest, or other charge or encumbrance (except as provided in orcontemplated by this Agreement or any of the Related Documents) upon or withrespect to any of its properties. (c) No consent, authorization, approval, or other action by, and nonotice to or filing with, any governmental authority or regulatory body isrequired for the due execution, delivery, and performance by the Borrower ofthis Agreement and each Related Document to which it is a party other than thatwhich has been obtained or will be obtained when required. (d) This Agreement is, and each Related Document to which theBorrower is a party when delivered hereunder will be, the legal, valid, andbinding obligation of the Borrower enforceable against the Borrower inaccordance with its terms, except to the extent that such enforcement may belimited by applicable bankruptcy, insolvency, and other similar laws affectingcreditors' rights generally, and by the application of equitable principles. (e) There is no pending or threatened action, investigation, orproceeding before any court, governmental agency, or arbitrator against oraffecting the Borrower which may materially adversely affect the ability of theBorrower to perform its obligations hereunder or under any Related Document towhich it is a party. 8 9 (f) The pledge and assignment pursuant to this Agreement and theRelated Documents of the Collateral and any and all amounts on deposit from timeto time in any accounts which are part of the Collateral, create a valid bindingfirst priority security interest therein securing the Obligations purported tobe secured thereby. (g) All financial statements, copies of which have heretofore beenfurnished to the Bank, are complete and correct and present fairly in accordancewith generally accepted accounting principles, the financial condition of theBorrower, and since the date of such statements there has been no materialadverse change in the Borrower or the Collateral. ARTICLE V COVENANTS SECTION 5.1 Affirmative Covenants of the Borrower. So long as a drawing isavailable under the Letter of Credit or the Borrower shall have any obligationto pay any amount to the Bank hereunder, the Borrower will, unless the Bankshall otherwise consent in writing: (a) preserve and maintain its existence and its rights, andfranchises that Borrower reasonably deems necessary in the operation of itsbusiness, (b) comply with the requirements of the Related Documents to which itis a party, and all applicable laws, ordinances, rules, and regulations of anygovernmental authority, the non-compliance with which would have a materialadverse effect on the Borrower's operations, properties, ownership, assets,management, or condition (financial or otherwise) or which could materiallyimpair the Borrower's ability to perform its obligations under this Agreement orany Related Document; (c) promptly, upon learning thereof, give written notice to the Bankof: (1) the occurrence of any Potential Default or Event of Default; (2) any litigation or proceeding affecting the Borrower whichcould have a material adverse effect on the condition of the Borrower or theProperty; and (3) a material adverse change in the business, operations,property or financial or other condition of the Borrower; (d) comply with all agreements, conditions, covenants, restrictionsand other instruments which affect or impose a lien upon the Property or any ofthe other Collateral, except as permitted under the Bank Documents; (e) comply with all agreements, conditions, covenants andrestrictions set forth in the Loan Agreement and the other Bank Documents; and (f) cause the Bonds to be redeemed on or prior to the dates (subjectto Section 2.6) and in the minimum principal amounts set forth on Schedule 1hereto. 9 10 SECTION 1.18 Negative Covenants of the Borrower. So long as a drawing isavailable under the Letter of Credit or the Borrower shall have any obligationto pay any amount to the Bank hereunder, the Borrower will not, without thewritten consent of the Bank: (a) sell, lease, transfer, or otherwise dispose of the Collateral,except in connection with the transactions contemplated or permitted herein andin the Bank Documents; (b) create or permit to exist any lien, security interest or othercharge or encumbrance, or any other type of preferential arrangement, upon orwith respect to the Collateral, except as permitted under the Bank Documents; (c) enter into or consent to any amendment or modification of theIndenture; (d) request a conversion of interest on the Bonds to the FixedInterest Rate; or (e) issue or incur, as the case may be, any bond, note, loan, advanceor other indebtedness or obligation (including lease and installment saleobligations) having a lien senior to or on a parity with the Bank's lien on allor any portion of the Collateral, except as permitted under the Bank Documents. ARTICLE VI ADDITIONAL PROVISIONS RELATING TO COLLATERAL SECTION 6.1 Exercise of Rights with Respect to Collateral. Upon the occurrence and during the continuance of any Event of Default hereunder, theBank is authorized to (a) apply the Collateral in satisfaction of theObligations; and (b) in the name of the Bank or in the name of the Borrower, (i)exercise all other rights and remedies provided for herein, in any RelatedDocument or otherwise available to it in respect of the Collateral and toexercise all the rights and remedies of a secured party under the UniformCommercial Code and other laws in effect in the State of California, (ii)without notice, retain the Collateral or any part thereof, and (iii) dispose ofthe Collateral in any manner permitted by law; provided, however, that the Bankshall not be obligated to make any sale of Collateral or the proceeds thereofregardless of any notice of sale having been given. The Bank may adjourn anypublic or private sale from time to time by announcement at the time and placefixed therefor, and such sale may, without further notice, be made at the timeand place to which it was so adjourned. SECTION 6.2 Bank to Exercise Reasonable Care. The Bank shall be deemed tohave exercised reasonable care in the custody and preservation of any Collateralin its possession if such Collateral is accorded treatment substantially equalto that which the Bank accords its own property of similar nature, it beingunderstood that the Bank shall not have any responsibility for taking anynecessary steps to preserve rights against any parties with respect to anyCollateral. SECTION 6.3 Further Assurances. The Borrower agrees that at any time, andfrom time to time, at the expense of the Borrower, the Borrower will promptlyexecute and deliver all further instruments and documents, and take all furtheraction, that may be necessary or reasonably desirable, as the Bank may request,in order to protect any security interest granted or 10 11purported to be granted hereby or by any Related Document or to enable the Bankto exercise and enforce its rights and remedies hereunder or under any BankDocument with respect to any Collateral. ARTICLE VII EVENTS OF DEFAULT SECTION 7.1 Events of Default. The occurrence of any of the followingevents shall be an "Event of Default" hereunder: (a) the Borrower shall fail to pay any amount payable by it underthis Agreement or any Related Document when due; or (b) any representation or warranty made, or deemed made, by theBorrower under or in connection with this Agreement or any Related Documentshall prove to have been incorrect in any material respect when made, or (c) the Borrower shall fail to perform or observe its covenantcontained in Section 5.l(f) or the Bonds shall otherwise not be redeemed on orprior to the dates and in the minimum principal amounts set forth on Schedule 1hereto; or (d) the Borrower shall fail to perform or observe any other term,covenant, or agreement contained in this Agreement on its part to be performedor observed and any such failure shall remain unremedied for 30 days afterwritten notice thereof shall have been given to the Borrower by the Bank; or (e) the Borrower shall generally not pay its debts as such debtsbecome due, or shall admit in writing its inability to pay its debts generally,or shall make a general assignment for the benefit of creditors; or anyproceeding shall be instituted by or against the Borrower seeking to adjudicateit a bankrupt or insolvent or seeking liquidation, winding up, reorganization,arrangement, adjustment, protection, relief or composition of it or its debtsunder any law relating to bankruptcy, insolvency, or reorganization or relief ofdebtors, or seeking the entry of an order for relief or the appointment of a receiver, trustee, or other similar official for it or for any substantial partof its property (and, in the case of an involuntary proceeding, such proceedingshall remain undismissed or unstayed for a period of 60 days); or the Borrowershall take any action to authorize any of the actions set forth above in thissubsection (e); or (f) any provision of this Agreement or any Related Document to whichthe Borrower is a party shall at any time for any reason cease to be valid andbinding on the Borrower or shall be declared to be null and void, or thevalidity of any provision of this Agreement or any such Related Document shallbe contested by the Borrower or the enforceability of any provision of thisAgreement or any such Related Document shall be contested by the Borrower, or aproceeding shall be commenced by any governmental agency or authority havingjurisdiction over the Borrower seeking to establish the invalidity of thisAgreement or any such Related Document or the unenforceability in any respectthereof; or 11 12 (g) any event of default under any Related Document shall haveoccurred. SECTION 7.2 Upon an Event of Default. If any Event of Default shall haveoccurred and be continuing, the Bank may do any, all, or none of the following:(i) declare that all amounts available for drawing under the Letter of Creditare due and payable, (ii) give notice to the Trustee to demand the immediateprepayment of the Bonds as contemplated in Section 7.01(e) of the Indenture, and(iii) exercise in respect of the Collateral any or all rights and remedies as ifa draft representing the full amount then available under the Letter of Credithad been presented to the Bank and paid by it. ARTICLE VIII FEES AND PAYMENTS SECTION 8.1 Fees. (a) Annual Letter of Credit Fee. The Borrower shall pay to the Bankcommencing on the Closing Date, an annual fee (the "Annual Letter of CreditFee") for providing the Letter of Credit in an amount equal to one andone-quarter percent (1.25%) per annum calculated on the basis of a 360-day yearand actual days elapsed, based on the actual daily amount of the Letter ofCredit available to be drawn upon in such year. Such fee shall be due andpayable to the Bank annually in advance on the Closing Date and on eachanniversary thereof. (b) The Letter of Credit Origination Fee. The Borrower shall pay tothe Bank a fee (the "Letter of Credit Origination Fee") for providing the Letterof Credit in an amount equal to one-half of one percent (.50%) of theCommitment. Such fee shall be due and payable upon the issuance of the Letter ofCredit. ARTICLE IX MISCELLANEOUS SECTION 9.1 Amendments, Etc. No amendment or waiver of any provision ofthis Agreement, nor consent to any departure by the Borrower therefrom, shall inany event be effective unless the same shall be in writing and signed by theBank and then such waiver or consent shall be effective only in the specificinstance and for the specific purpose for which given. SECTION 9.2 Notices, Etc. All notices and other communications provided forhereunder shall be in writing and mailed by registered mail, return receiptrequested, or delivered, or shall be by facsimile transmission promptlyconfirmed in writing, addressed as follows: To the Trustee: Harris Trust Company of California 601 South Figueroa Street, 49th Floor 12 13 Los Angeles, CA 90017 Attention: Corporate Trust Department Facsimile: (213) 239-0631 To the Borrower: American Xtal Technology, Inc. 4311 Solar Way Fremont, CA 94538 Attention: Guy D. Atwood Facsimile: (510) 683-5901 To the Bank: U.S. Bank National Association Fremont Business Banking 39510 Paseo Padre Parkway Fremont, CA 94538 Attention: Jason A. Floyd Facsimile: (510) 791-1340or, as to each party, to such other person or at such other address as shall bedesignated by such party in a written notice to the other party. All suchnotices and communications shall be effective (i) if delivered by hand, whendelivered; (ii) if sent by mail, upon the earlier of the date of receipt or fiveBusiness Days after deposit in the mail, first class (or air mail, with respectto communications to be sent to or from the United States), postage prepaid; and(iii) if sent by facsimile transmission, when sent, except that notices to theBank pursuant to the provisions of Article II hereof shall not be effectiveuntil received by the Bank. SECTION 9.3 No Waiver; Remedies. No failure on the part of any party heretoto exercise, and no delay in exercising, any right hereunder shall operate as awaiver thereof, nor shall any single or partial exercise of any right hereunderpreclude any other or further exercise thereof or the exercise of any otherright. The remedies herein provided are cumulative and not exclusive of anyremedies provided by law. SECTION 9.4 Indemnification. (a) The Borrower hereby indemnifies and holds the Bank harmless fromand against any and all claims, damages, losses, liabilities, costs, or expenseswhich the Bank may incur or which may be claimed against the Bank by reason of(i) any conditions, occupancy, use, possession, conduct or management of, orwork done in or about, or from the planning, design, acquisition, installation,or construction of the Property, or any part thereof, or (ii) carrying out ofany of the transactions contemplated by this Agreement and the RelatedDocuments, including, but not limited to, any certifications or representationsmade by the Borrower in connection therewith; provided, however, that theBorrower shall not be obligated to indemnify the Bank for 13 14claims, damages, losses, liabilities, costs and expenses resulting solely fromthe Bank's gross negligence or willful misconduct. (b) Nothing in this Section 9.4 is intended to limit the Borrower'sobligations contained in Article II hereof. Without prejudice to the survival of any other obligation of the Borrower hereunder, the indemnities and obligationsof the Borrower contained in this Section 9.4 shall survive the payment in fullof amounts payable pursuant to Article II hereof and the termination of theLetter of Credit. (c) In the event that any applicable law, order, regulation, treatyor directive issued by any central bank or other governmental authority, agencyor instrumentality or any governmental or judicial interpretation or applicationthereof, or compliance by the Bank with any request or directive (whether or nothaving the force of law) issued by any central bank or other governmentalauthority, agency or instrumentality: (1) does or shall subject the Bank to any tax of any kindwhatsoever with respect to this Agreement or the Letter of Credit, or change thebasis of taxation of payments to the Bank of any reimbursement, fee, interest orany other amount payable hereunder (except for change in the rate of tax on theoverall net income of the Bank); (2) does or shall impose, modify or hold applicable any reserve,capital requirement, special deposit, compulsory loan or similar requirementsagainst assets held by, or deposits or other liabilities in or for the accountof, advances or loans by, or other credit extended by, or any other acquisitionof funds by, any office of the Bank which is not otherwise included in thedetermination of interest payable on the Obligations; or (3) does or shall impose on the Bank any other condition;and the result of any of the foregoing is to increase the cost to the Bank ofissuing, renewing or maintaining the Letter of Credit or to reduce any amountreceivable in respect thereof or the rate of return on the capital of the Bankor any corporation controlling the Bank, then, in any such case, the Borroweragrees to promptly pay to the Bank, upon its written demand, any additionalamounts necessary to compensate the Bank for such additional cost or reducedamounts receivable or rate of return as determined by the Bank with respect tothis Agreement or the Letter of Credit. If the Bank becomes entitled to claimany additional amounts pursuant to this subparagraph (c), it shall promptlynotify the Borrower of the event by reason of which it has become so entitled. Acertificate as to any additional amounts payable pursuant to the foregoingsentence containing the calculation thereof in reasonable detail submitted bythe Bank to the Borrower shall be conclusive in the absence of manifest error.The provisions hereof shall survive the termination of this Agreement andpayment of the Obligations and all other amounts payable hereunder. SECTION 9.5 Liability of the Bank. As between the Borrower and the Bank,the Borrower assumes all risks of the acts or omissions of the Trustee and anyother beneficiary or transferee of the Letter of Credit with respect to its useof the Letter of Credit. Neither the Bank nor any of its officers or directorsshall be liable or responsible for: (a) the use which may be 14 15made of the Letter of Credit or any acts or omissions of the Trustee and anyother beneficiary or transferee in connection therewith; (b) the validity,sufficiency, or genuineness of documents presented to the Bank, or of anyendorsements thereon, even if such documents should prove to be in any or allrespects invalid, insufficient, fraudulent, or forged; (c) payment by the Bankagainst presentation of documents which do not comply with the terms of theLetter of Credit, including failure of any documents to bear any reference oradequate reference to the Letter of Credit; or (d) any damage, deficiency, loss,cost, or expense arising out of any action, claim, or other circumstance of anynature whatsoever relating to the payment or failure to make payment under theLetter of Credit, except that the Borrower shall have a claim against the Bank,and the Bank shall be liable to the Borrower, to the extent of any direct, asopposed to consequential, damages suffered by the Borrower which the Borrowerproves were caused by (i) the Bank's willful misconduct or gross negligence indetermining whether documents presented under the Letter of Credit comply with the terms of the Letter of Credit or (ii) the Bank's willful failure to makelawful payment under the Letter of Credit after the presentation to it by theTrustee or a successor trustee under the Indenture of a draft and certificatestrictly complying with the terms and conditions of the Letter of Credit. Infurtherance and not in limitation of the foregoing, the Bank may acceptdocuments that appear on their face to be in order, without responsibility forfurther investigation, regardless of any notice or information to the contrary,unless acceptance of such documents after receipt of such notice constitutesgross negligence or willful misconduct. SECTION 9.6 Costs, Expenses, and Taxes. The Borrower agrees to payimmediately following demand therefor all reasonable costs and expenses inconnection with the preparation, execution, delivery, filing, and recording ofthis Agreement, the Bank Documents, and any other documents which may bedelivered in connection with this Agreement, including, without limitation, thereasonable fees and out-of-pocket expenses of counsel for the Bank with respectthereto and with respect to advising the Bank as to its rights andresponsibilities under this Agreement and the Related Documents, the costs ofsubstituting a letter of credit or other credit enhancement, and any and allother costs, expenses, fees, liabilities, and claims of any nature whatsoever(including reasonable counsel fees and expenses) arising out of or in connectionwith (i) the enforcement of this Agreement, the Related Documents and such otherdocuments as may be delivered in connection therewith, (ii) any action orproceeding relating to a court order, injunction, or other process or decreerestraining or seeking to restrain the Bank from paying any amount under theLetter of Credit and (iii) amending or supplementing this Agreement or theRelated Documents for any purpose. In addition, the Borrower shall pay any andall stamp and other taxes and fees payable or determined to be payable inconnection with the execution, delivery, filing, and recording of allinstruments required by the Bank to be filed in connection with the transactionscontemplated hereby, and, to the extent permitted by law, agrees to hold theBank harmless from and against any and all liabilities with respect to orresulting from any delay in paying or omission to pay such taxes and fees. TheBorrower shall be furnished with copies of bills relating to the foregoing uponrequest. SECTION 9.7 Participations, Etc. The Borrower acknowledges that the Bankmay elect to sell, assign and otherwise transfer to other persons (each, a"Transferee") all or portions of, and participations in, the Bank's interestshereunder and under the Related Documents from time to time and expressly agreesthat each Transferee shall be entitled to the rights of the 15 16"Bank" hereunder. For purposes of this Section 9.7, the Bank may disclose to apotential or actual Transferee any and all information supplied to the Bank byor on behalf of the Borrower. The Borrower agrees to execute and deliver to theBank such documents, instruments and agreements, including, without limitation,amendments to the Related Documents, deemed necessary or desirable by the Bankto effect such transfers. SECTION 9.8 Binding Effect. This Agreement shall become effective when itshall have been executed by the parties hereto and thereafter shall be bindingupon and inure to the benefit of the parties hereto and their respectivesuccessors and assigns (including Transferees, as described in Section 9.7hereof. SECTION 9.9 Assignments. The Borrower may not assign its rights orobligations under this Agreement without the prior written consent of the Bankin its sole discretion. Subject to the foregoing, all provisions contained inthis Agreement or any document or agreement referred to herein or relatinghereto shall inure to the benefit of the Bank, its successors and assigns, andshall be binding upon the Borrower and its successors and assigns. SECTION 9.10 Severability. Any provision of this Agreement which isprohibited, unenforceable, or not authorized in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such prohibition,unenforceability, or nonauthorization without invalidating the remainingprovisions hereof or affecting the validity, enforceability or legality of suchprovision in any other jurisdiction. SECTION 9.11 Governing Law. This Agreement shall be governed by, andconstrued in accordance with, the laws of the State of California (withoutgiving effect to principles of conflict of laws). SECTION 9.12 Headings. Section headings in this Agreement shall have nosubstantive or interpretative effect, are included herein for convenience ofreference only and shall not constitute a part of this Agreement for any otherpurpose. SECTION 9.13 Counterparts. This Agreement may be executed in severalcounterparts, each of which shall be regarded as the original and all of whichshall constitute one and the same Agreement. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to beduly executed and delivered by their respective officers thereunto dulyauthorized as of the date first above written. 16 17 AMERICAN XTAL TECHNOLOGY, INC. By: /s/ GUY ATWOOD ------------------------------------- Its: Vice President ------------------------------------ U.S. BANK NATIONAL ASSOCIATION By: /s/ GLEN V. GUGLIELIMINA ------------------------------------- Its: Senior Vice President ------------------------------------ 17 18 EXHIBIT A TO LETTER OF CREDIT AND REIMBURSEMENT AGREEMENT Irrevocable Letter of Credit U.S. Bank National Association 980 Ninth Street, Suite 1200 Sacramento, California 95814 Date: [________________] CREDIT No. [_________________]Harris Trust Company of California601 South Figueroa Street, 49th Fl.Los Angeles, CA 90077Attention: Corporate Trust Department Ladies & Gentlemen: You, as Trustee under that certain Indenture dated as of December 1, 1998(the "Indenture"), between you and American Xtal Technology, Inc. (the"Borrower"), pursuant to which the Borrower has executed and delivered U.S.$11,615,000 in aggregate principal amount of its Variable Rate Taxable DemandRevenue Bonds Series 1998 (Xtal Project) (the "Bonds"), are hereby irrevocablyauthorized to draw on this Irrevocable Letter of Credit No. [__________] issuedby U.S. Bank National Association (the "Bank"), for the account of the Borrower,available by your drafts at sight upon the terms and conditions hereinafter setforth, an aggregate amount that does not exceed the sum of the PrincipalComponent and the Interest Component as set forth below, which in no event willexceed U.S. $11,986,680 (such sum, subject to such maximum amount, being hereinreferred to as the "Stated Amount"). This Letter of Credit is effectiveimmediately and expires on the close of business at the Bank's Office (asdefined below) on December 1, 2008 (the "Expiration Date"). The amount available under Principal Drawings (as defined in paragraph (A)below) and Principal Purchase Drawings (as defined in paragraph (C) below) shallnot exceed, in the aggregate, U.S. $11,615,000, as such amount shall bedecreased as hereinafter provided (the "Principal Component"). The amountavailable under Interest Drawings (as defined in paragraph (B) below) andInterest Purchase Drawings (as defined in paragraph (D) below) shall not exceedU.S. $371,680, representing payment of up to 96 days' interest accrued on theBonds at or prior to the Expiration Date, calculated at the rate of twelvepercent (12%) per annum on the basis of a 360-day year (actual days elapsed), assuch amount may be decreased and/or increased as hereinafter provided (the"Interest Component"). At no time may the aggregate drawing outstandinghereunder exceed the Stated Amount. 1 19 Funds under this Letter of Credit are available to you against your sightdrafts drawn on us, stating on their face: "Drawn under Irrevocable Letter ofCredit No. [__________] issued by U.S. Bank National Association, 980 NinthStreet, Suite 1200, Sacramento, California 95814." (A) Subject to paragraph (C) below, if the drawing is being made withrespect to any payment of principal with respect to the Bonds (a "PrincipalDrawing"), the sight draft shall be accompanied by your written certificatepurporting to be signed by you in the form of Exhibit A attached heretoappropriately completed. (B) If the drawing is being made with respect to a payment of interestwith respect to the Bonds (an "Interest Drawing"), the sight draft shall beaccompanied by your written certificate purporting to be signed by you in theform of Exhibit B hereto appropriately completed. (C) If the drawing is being made in accordance with Section 2.04 of theIndenture with respect to payment of the portion of the purchase price of Bondsdelivered to the Trustee or the Tender Agent appointed pursuant to the Indenture(the "Tender Agent") equal to the principal amount of such Bonds (a "PrincipalPurchase Drawing"), the sight draft shall be accompanied by your writtencertificate purporting to be signed by you in the form of Exhibit C attachedhereto appropriately completed. (D) If the drawing is being made with respect to payment of the portion ofthe purchase price of Bonds referred to in paragraph (C) above equal to theamount of accrued and unpaid interest with respect to such Bonds to the date ofpurchase of such Bonds (an "Interest Purchase Drawing"), the sight draft shallbe accompanied by your written certificate purporting to be signed by you in theform of Exhibit D attached hereto appropriately completed, and such InterestPurchase Drawing shall be made simultaneously with the related PrincipalPurchase Drawing. Presentation of such draft(s) and certificate(s) shall be made at the Bank's office located at 980 Ninth Street, Suite 1200, Sacramento, California95814, Attention: International Department, Fax No. (916) 556-5763 or at anyother office in the United States that may be designated by us by written noticedelivered to you (the "Bank's Office"). We hereby agree that all drafts drawn under and in compliance with theterms of this Letter of Credit will be duly honored by us upon delivery of thecertificate(s) as specified herein if presented at such office on or before theExpiration Date. Provided that in each case the documents presented inconnection with a drawing conform to the terms and conditions hereof, thefollowing time schedule shall prevail: (A) If a drawing is made by you hereunder and received by us at or priorto 9:00 a.m. Pacific time, on a Business Day (as hereinafter defined), paymentshall be made to you or to your order of the amount specified, in immediatelyavailable funds, at or prior to 1:00 p.m. Pacific time, on the same BusinessDay. 2 20 (B) If a drawing is made by you hereunder and received by us after 9:00a.m. Pacific time, on a Business Day, payment shall be made to you or to yourorder of the amount specified, in immediately available funds, at or prior to9:30 a.m. Pacific time, on the following Business Day. If requested by you, payment under this Letter of Credit shall be made bydeposit of immediately available funds into an account designated by you. As used herein, "Business Day" shall mean a day other than (i) a Saturday,or a Sunday or (ii) a day on which banks located in Sacramento, California, orbanks located in the city in which your principal office or the principal officeof the Tender Agent is located are authorized or obligated by law or executiveorder to close or (iii) a day on which the New York Stock Exchange is closed.All payments hereunder shall be made with our own funds. Each drawing honored by the Bank under this Letter of Credit shallimmediately reduce the Principal Component or the Interest Component (as thecase may be) by the amount of such drawing, and the Stated Amount shall becorrespondingly reduced. The Principal Component shall also be decreased withoutamendment and without notice to you by the amount specified by the Trustee fromtime to time pursuant to a notice to the Bank in the form attached hereto asExhibit E, such decrease to be effective upon receipt by the Bank of suchnotice. The Principal Component and the Interest Component (and correspondingly,the Stated Amount) so reduced shall be reinstated only as follows: (A) The Interest Component (and correspondingly the Stated Amount) soreduced shall be reinstated, in the case of a reduction resulting from anInterest Drawing only, automatically as of the Bank's close of business inSacramento, California, on the day the Bank honors such Interest Drawing, to anamount equal to 96 days' interest on the Bonds Outstanding, calculated at therate of Twelve Percent (12%) per annum on the basis of a 360-day year (actualdays elapsed). (B) The Interest Component and the Principal Component (andcorrespondingly the Stated Amount) so reduced shall be reinstated, in the caseof a reduction resulting from an Interest Purchase Drawing or a PrincipalPurchase Drawing pursuant to Section 2.04 of the Indenture only, automaticallyupon and to the extent the Bank has received from you notice of thereimbursement of such payment in immediately available funds pursuant to yourcertificate in the form of Exhibit F; in such case, the Principal Componentshall be reinstated in an amount equal to the portion of such paymentattributable to reimbursement of the Principal Purchase Drawing and the InterestComponent shall be reinstated to an amount equal to 96 days' interest on theBonds Outstanding, calculated at the rate of Twelve Percent (12%) per annum onthe basis of a 360-day year (actual days elapsed). If the amount available under this Letter of Credit has been decreasedpursuant to a Principal Drawing, the Bank shall have the right to amend thisLetter of Credit or the right to require you to surrender this Letter of Creditto the Bank, and to accept a substitute Letter of Credit which has an expressPrincipal 3 21Component and Interest Component equal to the Principal Component and InterestComponent as so decreased, but otherwise in a form and having terms identical tothis Letter of Credit. Only you as Trustee may make a drawing under this Letter of Credit. Uponthe payment to you or to your order of the amount specified in a sight draftdrawn hereunder, we shall be fully discharged on our obligation under thisLetter of Credit with respect to such sight draft, and we shall not thereafterbe obligated to make any further payments under this Letter of Credit in respectof such sight draft to you or any other person who may have made to you or makesto you a demand for payment of principal of, purchase price of, or interest on,any Bond. Upon the earliest of (i) the making by you of the final drawing availableto be made hereunder, (ii) our receipt of a certificate purporting to be signedby your duly authorized officer and a duly authorized officer of the Borrowerstating that: "(a) the conditions precedent to the acceptance of an AlternateLetter of Credit set forth in the Indenture have been satisfied, (b) the Trusteehas accepted the Alternate Letter of Credit, and (c) upon receipt by U.S. BankNational Association of this certificate, Irrevocable Letter of Credit No.[__________] issued by U.S. Bank National Association, shall terminate," or(iii) the Expiration Date, this Letter of Credit shall automatically terminateand be delivered to the Bank for cancellation. This Letter of Credit is subject to the Uniform Customs and Practice forDocumentary Credits (1993 Revision), International Chamber of Commerce,Publication No. 500 (the "Uniform Customs"), excluding Article 41 thereof. Inaddition, the Bank agrees that, notwithstanding the second sentence of Article17 of the Uniform Customs, if the Expiration Date occurs on a Business Day uponwhich the Bank's Office is closed by virtue of an interruption of the naturedescribed in Article 17, the Expiration Date will be extended to the nextBusiness Day upon which the Bank's Office is open. As to matters not governed bythe Uniform Customs, this Letter of Credit shall be governed by and construed inaccordance with the laws of the State of California, without giving effect toconflicts of law principles. Communications with respect to this Letter ofCredit shall be in writing and shall be addressed to the Bank's Office,specifically referring thereon to "Irrevocable Letter of Credit No. [_________]issued by U.S. Bank National Association, 980 Ninth Street, Suite 1200,Sacramento, California 95814." This Letter of Credit may be transferred more than once, but only in theamount of the full utilized balance hereof and only after receipt from theBorrower of the Bank's then applicable transfer fee, to any single transfereewho has succeeded Harris Trust Company of California as trustee under theIndenture. Transfers may be effected only through ourselves and only uponpresentation to us of a duly executed instrument of transfer in the formattached hereto as Exhibit G. Any transfer of this Letter of Credit as aforesaidmust be endorsed by us on the reverse hereof and may not change the place ofpresentation from our Letter of Credit office in Sacramento, California. This Letter of Credit sets forth in full our undertaking, and suchundertaking shall not in any way be modified, amended, amplified or limited byreference to any document, instrument or agreement referred to herein(including, without limitation, the Bonds), except only 4 22the certificate(s) and the sight draft(s) referred to herein; and any suchreference shall not be deemed to incorporate herein by reference any document,instrument or agreement except for such certificate(s) and such sight draft(s). Very truly yours, U.S. BANK NATIONAL ASSOCIATION By: _____________________________________ Name: _______________________________ Title: ______________________________ By: _____________________________________ Name: _______________________________ Title: ______________________________ 5 23 CERTIFICATE FOR PRINCIPAL DRAWING EXHIBIT A TO IRREVOCABLE LETTER OF CREDIT NO. [_________________] CERTIFICATE FOR PRINCIPAL DRAWING The undersigned, [Insert Name of Beneficiary] (the "Trustee") herebycertifies to U.S. Bank National Association (the "Bank"), with reference toIrrevocable Letter of Credit No. [_________________] (the "Letter of Credit";any capitalized term used herein and not defined shall have its respectivemeaning as set forth in the Letter of Credit) issued by the Bank in favor of theTrustee, that: 1. The Trustee is the Trustee under the Indenture for the holders of theBonds. 2. The Trustee is making a drawing under the Letter of Credit withrespect to the payment of the principal amount with respect to all or a portionof the Bonds by reason of acceleration or prepayment pursuant to the terms ofthe Indenture or by their maturity. 3. The amount of the sight draft accompanying this Certificate does notexceed the Principal Component under the Letter of Credit. 4. The amount of the sight draft accompanying this Certificate wascomputed in accordance with the terms and conditions of the Bonds and theIndenture. IN WITNESS WHEREOF, the Trustee has executed and delivered this Certificateas of the ___________ day of _________________. Very truly yours, _________________________________________________ [Insert Name], as Trustee By: _____________________________________________ [Insert Name and Title of Authorized Officer] 6 24 CERTIFICATE FOR INTEREST DRAWING EXHIBIT B TO IRREVOCABLE LETTER OF CREDIT NO. [_________________] CERTIFICATE FOR INTEREST DRAWING The undersigned, [Insert Name of Beneficiary] (the "Trustee") herebycertifies to U.S. Bank National Association (the "Bank"), with reference toIrrevocable Letter of Credit No. [_________________] (the "Letter of Credit";any capitalized term used herein and not defined shall have its respectivemeaning as set forth in the Letter of Credit) issued by the Bank in favor of theTrustee, that: 1. The Trustee is the Trustee under the Indenture for the holders of theBonds. 2. The Trustee is making a drawing under the Letter of Credit withrespect to the payment of interest accrued with respect to the Bonds that is dueand payable and that has accrued on or before the Expiration Date. 3. The amount of the sight draft accompanying this Certificate does notexceed the Interest Component under the Letter of Credit. 4. The amount of the sight draft accompanying this Certificate wascomputed in accordance with the terms and conditions of the Bonds and theIndenture. IN WITNESS WHEREOF, the Trustee has executed and delivered this Certificateas of the ___________ day of _________________. Very truly yours, _________________________________________________ [Insert Name], as Trustee By: _____________________________________________ [Insert Name and Title of Authorized Officer] 7 25 CERTIFICATE FOR PRINCIPAL PURCHASE DRAWING EXHIBIT C TO IRREVOCABLE LETTER OF CREDIT NO. [_________________] CERTIFICATE FOR PRINCIPAL PURCHASE DRAWING The undersigned, [Insert Name of Beneficiary] (the "Trustee") herebycertifies to U.S. Bank National Association (the "Bank"), with reference toIrrevocable Letter of Credit No. [_________________] (the "Letter of Credit";any capitalized term used herein and not defined shall have its respectivemeaning as set forth in the Letter of Credit) issued by the Bank in favor of theTrustee, that: 1. The Trustee is the Trustee under the Indenture for the holders of theBonds. 2. The Trustee is making a drawing under the Letter of Credit to pay theportion of the purchase price of Bonds delivered to the Trustee or the TenderAgent, as the case may be, pursuant to Section 2.04 of the Indenture equal tothe principal amount with respect to such Bonds. 3. The principal amount with respect to the purchased Bonds for which this drawing is made is $[insert Amount], and the Trustee has not heretoforemade a drawing which has been honored under the Letter of Credit with respect tothe principal amount, or any portion thereof, of the Bonds for such purchase.The amount of the sight draft accompanying this Certificate does not exceed suchamount. 4. The amount of the sight draft accompanying this Certificate does notexceed the Principal Component under the Letter of Credit. 5. The amount of the sight draft accompanying this Certificate wascomputed in accordance with the terms and conditions of the Bonds and theIndenture. IN WITNESS WHEREOF, the Trustee has executed and delivered this Certificateas of the ___________ day of _________________. Very truly yours, _________________________________________________ [Insert Name], as Trustee By: _____________________________________________ [Insert Name and Title of Authorized Officer] 8 26 CERTIFICATE FOR INTEREST PURCHASE DRAWING EXHIBIT D TO IRREVOCABLE LETTER OF CREDIT NO. [_________________] CERTIFICATE FOR INTEREST PURCHASE DRAWING The undersigned, [Insert Name of Beneficiary] (the "Trustee") herebycertifies to U.S. Bank National Association (the "Bank"), with reference toIrrevocable Letter of Credit No. [_________________] (the "Letter of Credit";any capitalized term used herein and not defined shall have its respectivemeaning as set forth in the Letter of Credit) issued by the Bank in favor of theTrustee, that: 1. The Trustee is the Trustee under the Indenture for the holders of theBonds. 2. The Trustee is making a drawing under the Letter of Credit to pay theportion of the purchase price of Bonds delivered to the Trustee or the TenderAgent, as the case may be, pursuant to Section 2.04 of the Indenture equal tothe amount of accrued and unpaid interest with respect to such Bonds to the dateof purchase thereof. 3. The amount of accrued and unpaid interest with respect to thepurchased Bonds for which this drawing is made is $[Insert Amount], and theTrustee has not heretofore made a drawing which has been honored under thisLetter of Credit for the accrued and unpaid interest, or any portion thereof,with respect to the purchased Bonds for such purchase. The amount of the sightdraft accompanying this certificate does not exceed the amount of interestaccrued and unpaid with respect to such Bonds to the date of purchase thereof. 4. The amount of the sight draft accompanying this Certificate does notexceed the Interest Component under the Letter of Credit. 5. The amount of the sight draft accompanying this Certificate wascomputed in accordance with the terms and conditions of the Bonds and theIndenture. IN WITNESS WHEREOF, the Trustee has executed and delivered this Certificateas of the ___________ day of _________________. Very truly yours, _________________________________________________ [Insert Name], as Trustee By: _____________________________________________ [Insert Name and Title of Authorized Officer] 9 27 CERTIFICATE FOR REDUCTION OF STATED AMOUNT EXHIBIT E TO IRREVOCABLE LETTER OF CREDIT NO. [_________________]U.S. Bank National Association980 9th StreetSuite 1100Sacramento, California 95814Re: Irrevocable Letter of Credit No. [_________________] issued by U.S. Bank National AssociationLadies & Gentlemen: The undersigned (the "Trustee"), as beneficiary under the IrrevocableLetter of Credit No. [_________________] (the "Letter of Credit"; anycapitalized term used herein and not defined shall have its respective meaningas set forth in the Letter of Credit), hereby consents to a reduction of the[Principal Component to $_______________] [AND/OR] [Interest Component to$_______________]. IN WITNESS WHEREOF, the Trustee has executed and delivered this Certificateas of the ___________ day of _________________. Very truly yours, _________________________________________________ [Insert Name], as Trustee By: _____________________________________________ [Insert Name and Title of Authorized Officer] 10 28 REIMBURSEMENT CERTIFICATE EXHIBIT F TO IRREVOCABLE LETTER OF CREDIT NO. [_________________]U.S. Bank National Association980 9th StreetSuite 1100Sacramento, California 95814Re: Irrevocable Letter of Credit No. [_________________] issued by U.S. Bank National Association Ladies & Gentlemen: The undersigned, [Insert Name of Beneficiary] (the "Trustee") herebycertifies to U.S. Bank National Association (the "Bank"), with reference toIrrevocable Letter of Credit No. [_________________] (the "Letter of Credit";any capitalized term used herein and not defined shall have its respectivemeaning as set forth in the Letter of Credit) issued by the Bank in favor of theTrustee, that: 1. The Trustee is the Trustee under the Indenture for the holders of theBonds. 2. The Trustee has today paid to you by wire transfer of immediatelyavailable funds the amount of $__________, for the reimbursement to you of[$__________ of unpaid principal with respect to the Bonds in connection with aPrincipal Purchase Drawing and] $ __________ of accrued interest with respect tothe Bonds in connection with an Interest Purchase Drawing [, in each case]honored pursuant to the Trustee's draft dated __________ in the aggregate amountof $__________. IN WITNESS WHEREOF, the Trustee has executed and delivered this Certificateas of the __________ day of __________________. Very truly yours, _________________________________________________ [Insert Name], as Trustee 11 29 TRANSFER CERTIFICATE EXHIBIT G TO IRREVOCABLE LETTER OF CREDIT NO. [_________________] [Date]U.S. Bank National Association980 9th StreetSuite 1100Sacramento, California 95814Re: Irrevocable Letter of Credit No. [_________________] issued by U.S. Bank National AssociationLadies & Gentlemen: For value received, the undersigned beneficiary hereby irrevocablytransfers to: [Insert Name and Address of Transferee]all rights of the undersigned beneficiary to draw under the above Letter ofCredit in its entirety. By this transfer, all rights of the undersigned beneficiary in such Letterof Credit are transferred to the transferee, and the transferee shall have thesole rights as beneficiary thereof, including sole rights relating to anyamendments, whether increases or extensions or other amendments and whether nowexisting or hereafter made. The Letter of Credit may hereafter be amended,extended or increased without necessity of any consent of or notice to theundersigned beneficiary, and you will give notice thereof directly to thetransferee. The advice of such Letter of Credit is returned herewith, and we ask you toendorse the transfer on the reverse thereof and forward it directly to thetransferee with your customary notice of transfer.SIGNATURE AUTHENTICATED Yours very truly,__________________________________ _________________________________________(Bank) Signature of Beneficiary 12 30 SCHEDULE 1 TO LETTER OF CREDIT AND REIMBURSEMENT AGREEMENT [See attached.] 1 EXHIBIT 10.10 BOND PURCHASE CONTRACT $11,615,000 AMERICAN XTAL TECHNOLOGY, INC. VARIABLE RATE TAXABLE DEMAND REVENUE BONDS SERIES 1998 (XTAL PROJECT) dated December 1, 1998 among AMERICAN XTAL TECHNOLOGY, INC., Issuer and DAIN RAUSCHER INCORPORATED, Underwriter 2 BOND PURCHASE CONTRACT $11,615,000 AMERICAN XTAL TECHNOLOGY, INC. VARIABLE RATE TAXABLE DEMAND REVENUE BONDS SERIES 1998 (XTAL PROJECT) December 1, 1998American Xtal Technology, IncAttn: Mr. Guy D. Atwood4311 Solar WayFremont, California 94538Dear Mr. Atwood: Dain Rauscher Incorporated (the "Underwriter") hereby offers to enter intothis Bond Purchase Contract (the "Purchase Contract") with American XtalTechnology, Inc. (the "Issuer"). The offer is hereby made subject to acceptanceby the Issuer (by the execution and delivery of this Purchase Contract to theUnderwriter) on or before 8:00 a.m., Pacific Standard Time, on December 1, 1998and upon such acceptance, this Purchase Contract shall be in full force andeffect in accordance with its terms and shall be binding upon the Issuer and theUnderwriter. Capitalized terms used herein and not otherwise defined have themeaning set forth in the Official Statement hereinafter defined. The Issuer is entering into this Purchase Contract in order to induce theUnderwriter to enter into this Purchase Contract and to purchase the $11,615,000aggregate principal amount of American Xtal Technology, Inc. Variable RateTaxable Demand Revenue Bonds Series 1998 (Xtal Project) (the "Bonds") on theterms set forth herein. The Issuer, by its acceptance of the offer made herein, requests the Underwriter to purchase the Bonds. The Bonds are issued pursuant to an Indenture, dated as of December 1,1998 (the "Indenture"), by and between the Issuer and Harris Trust Company ofCalifornia, as trustee (the "Trustee"), in the form heretofore delivered to usauthorizing the Bonds. The Issuer will enter into a Letter of Credit and Reimbursement Agreementdated December 1, 1998 (the "Reimbursement Agreement") with U.S. Bank NationalAssociation (the "Bank"), pursuant to which the Bank will issue on or before theDate of Delivery of the Bonds (the "Bond Issuance Date") to the Trustee for theaccount of the Issuer, an irrevocable direct-pay letter of credit (the "Letterof Credit"), which will permit the Trustee to draw an amount equal to theprincipal and up to 96 days' interest on the Bonds at a maximum rate of twelvepercent (12%) per annum. The Reimbursement Agreement will provide forreimbursement by the Issuer to the Bank in the event of drawings under theLetter of Credit. The Indenture, this Purchase Contract and the ReimbursementAgreement are herein referred to as the "Program Documents." References in thisPurchase Contract to the authorization, execution and delivery of andperformance under the Program Documents by a person or an entity shall be deemedto refer only to those Program Documents to which such person or entity is aparty. The Issuer's obligation under the Reimbursement Agreement will be securedby a first lien and third lien Deed of Trust, Security Agreement, Assignment ofLeases and Rents and Fixture Filing, a Security Agreement and other security asset forth in the Reimbursement Agreement. SECTION 1. PURCHASE AND PURCHASE PRICE. Under the terms and conditions andin reliance upon the representations, warranties and agreements set forthherein, the Issuer agrees to execute and deliver $11,615,000 aggregate principalamount of the Bonds and the Underwriter agrees to purchase all (but not lessthan all) of said Bonds at an aggregate Purchase Price of par. 1 3 The Bonds will bear interest as provided in the Indenture. SECTION 2. OFFICIAL STATEMENT. The Issuer shall deliver or cause to bedelivered to the Underwriter, promptly after acceptance hereof and prior to theClosing, copies of the Official Statement dated November 23, 1998, relating tothe Bonds and approved for distribution by the Issuer (which Official Statement,including the cover page and all appendices, exhibits, reports and statementsincluded therein or attached thereto being herein called the "OfficialStatement"), signed on behalf of the Issuer by a duly authorized officer of theIssuer. The Issuer hereby ratifies, approves and authorizes the use by theUnderwriter, prior to the date hereof, in connection with the offer and sale ofthe Bonds, of the Program Documents, the Letter of Credit and all informationcontained herein and therein of all other documents, certificates or statementsfurnished by the Issuer to the Underwriter in connection with the transactionscontemplated by this Purchase Contract. The Underwriter agrees that it will notconfirm the sale of any Bonds unless the settlement of such sale is accompaniedby or preceded by the delivery of a copy of the final Official Statement. In the event that the Bonds, or the remarketing of the Bonds, shouldbecome subject to the continuing disclosure requirements of Rule 15c2-12 underthe Securities Exchange Act of 1934 (the "Rule"), the Issuer will furnish to theUnderwriter all information reasonably required by the Underwriter to complywith the Rule. To the extent necessary to comply with the Rule, if applicable,the Issuer will notify the Underwriter if it becomes aware of any fact or eventwhich might or would cause the Official Statement, as then supplemented oramended, to contain any untrue statement of a material fact or to omit to statea material fact required to be stated therein or necessary to make thestatements therein not misleading, and the Issuer will cooperate with the Underwriter by furnishing such information as is reasonably required to amend orsupplement the Official Statement, and prepare or file any other papers, incompliance with the Rule. SECTION 3. CLOSING; BONDS. At 8:00 a.m., Pacific Standard Time, December1, 1998, or at such other time or on such earlier or later date as theUnderwriter and the Issuer mutually agree upon, the Issuer will deliver or causeto be delivered to the Underwriter the Bonds in definitive form, duly executed,and authenticated together with the other documents hereinabove mentioned, andthe Underwriter will accept such delivery and pay the Purchase Price of theBonds set forth in Section 1 hereof in federal funds payable to the order of theTrustee for the account of the Issuer. Delivery and payment shall besimultaneously, as aforesaid, made at such place in New York, New York as theUnderwriter shall designate or in such other city as the Underwriter and theIssuer mutually agree upon. This payment and delivery shall be called the"Closing." The Bonds shall be in fully registered form, registered in such namesas the Underwriter shall submit to the Trustee prior to the Closing and shall bein denominations of One Hundred Thousand Dollars ($100,000) or any integralmultiple of $5,000 above such amount, except as otherwise provided in theIndenture. The Bonds shall be made available to the Underwriter for checking atleast one (1) Business Day prior to the Closing. Notwithstanding the foregoingand any other references in this Purchase Contract to delivery of Bonds, orsimilar statements, the Bonds are registered in the name of Cede & Co. asnominee of the Depository Trust Company ("DTC") and DTC procedures will befollowed and take precedence over any conflicting procedures or provisions. SECTION 4. REPRESENTATIONS, WARRANTIES AND COVENANTS OF THE ISSUER. TheIssuer represents warrants and covenants to the Underwriter that: (a) The Issuer is a Delaware corporation and is duly qualified totransact business in California. The Issuer has full power and authority to ownits property (including, without limitation, the Project), to carry on itsbusiness as presently being conducted and as contemplated to be conducted by theProgram Documents and to execute, deliver and perform its obligations under theProgram Documents. (b) Both at the date of the Official Statement and at the date ofClosing, the statements and information in the Official Statement (as the samemay be supplemented or amended with the written approval of the Underwriter), tothe extent they relate or pertain to the Issuer, do not contain any untruestatement of material fact or omit to state any fact required to be statedtherein or necessary to make the statements therein, in the light of thecircumstances under which such statements were made, not misleading in anymaterial respect. The Issuer makes no 2 4representation with respect to information in the Official Statement relating tothe Underwriter, the Trustee, the Bank or any other party. (c) The execution, delivery and performance of the ProgramDocuments and the taking of any and all other actions and the execution,delivery and performance of all such documents as may be required of it pursuantto the provisions of the Program Documents including, without limitation, theauthorization of the use by the Underwriter of the Official Statement inconnection with the offering, sale and distribution of the Bonds, have been dulyauthorized by the Issuer. (d) This Purchase Contract has been duly executed and delivered bythe Issuer and when executed and delivered by the other parties hereto willconstitute a legal, valid and binding obligation of the Issuer, enforceable inaccordance with its terms, except as limited by bankruptcy, insolvency,reorganization, moratorium and other similar laws affecting the rights ofcreditors generally. Upon the execution and delivery of the Program Documents bythe Issuer and the other parties thereto, the Program Documents will constitutelegal, valid and binding obligations of the Issuer, enforceable in accordance with their respective terms, except as limited by bankruptcy, insolvency,reorganization, moratorium or other similar laws affecting creditors' rightsgenerally. (e) If at any time the Issuer becomes aware that any event shallhave occurred of which the Issuer believes it has unique knowledge not availableto the Underwriter and which might cause the Official Statement to contain anyuntrue statement of material fact or omit to state any fact necessary to makethe statements therein not misleading in any material respect, the Issuer shallnotify the Underwriter. In addition, the Issuer shall promptly advise theUnderwriter of the institution of any action, suit, proceeding, inquiry orinvestigation of which it has any knowledge seeking to prohibit, restrain orotherwise affect the use of the Official Statement in connection with theoffering, sale or distribution of the Bonds. The Issuer promptly shall furnishthe Underwriter any information concerning the Issuer which the Underwritermight reasonably request in connection with any amendment of or supplement tothe Official Statement. (f) The execution, delivery and performance of the ProgramDocuments and the consummation of the transactions contemplated thereby will notconflict with, or constitute a breach of, or default under any indenture,mortgage, deed of trust, lease, note, commitment, agreement or other instrumentor obligation to which the Issuer is a party or by which the Issuer or any ofits respective properties is bound, or under any law, rule, regulation,judgment, order or decree to which the Issuer or any of its respectiveproperties are bound which breach might have a material adverse effect on theability of the Issuer to perform under the Program Documents. The Issuer is notnow and never has been in default under any order or decree of any court or anyorder, regulation or demand of any federal, state, municipal or governmentalagency or any document, instrument or commitment to which the Issuer is subjector in the payment of the principal of, or premium or interest on, or otherwisein default with respect to, any Bonds, notes or other obligations which it hasissued, assumed or guaranteed, directly or indirectly, as to payment ofprincipal, premium or interest. (g) To the Issuer's knowledge, there is no action, suit,proceeding, inquiry or investigation by or before any court, governmentalagency, public board or body pending, or to the knowledge of the Issuer,threatened against the Issuer (nor, to the best of its knowledge, is there anybasis therefore), which (i) affects or seeks to prohibit, restrain or enjoin theissuance, sale or delivery of the Bonds or the issuance of the Letter of Creditor the use of the Official Statement or the execution and delivery of theProgram Documents or (ii) affects or questions the validity or theenforceability of the Bonds, (iii) questions the completeness or accuracy of theOfficial Statement or (iv) questions the power or authority of the Issuer tocarry out the transactions contemplated by the Program Documents or the power ofthe Issuer to acquire, own, construct, equip, operate or lease the Project. (h) To the Issuer's knowledge, it has made all filings with andreceived all approvals, consents and orders of any governmental authority,legislative body, board, agency or commission having jurisdiction which arenecessary to permit the Issuer to perform its obligations under the ProgramDocuments, to carry out the transactions contemplated by the Program Documentsand to acquire, own, construct, equip, operate and lease the Project. 3 5 (i) Any certificate signed for the Issuer by an authorizedrepresentative thereof and delivered to the Underwriter or the Issuer inconnection with the transactions contemplated by the Program Documents shall bedeemed to be a representation and warranty by the Issuer to the Underwriter asto the statements therein. SECTION 5. CONDITIONS TO THE OBLIGATIONS OF THE UNDERWRITER. Theobligation of the Underwriter to accept delivery of and pay for the Bonds on theClosing shall be subject, at the option of the Underwriter, to the accuracy in all material respects of the representations, warranties and agreements on thepart of the Issuer contained herein as of the date hereof and as of the Closing,to the accuracy in all material respects of the statements of the officers andother officials of the Trustee, the Bank and the Issuer made in any certificatesor other documents furnished pursuant to the provisions hereof or of the ProgramDocuments, and to the performance by the Issuer of its obligations, asapplicable, to be performed hereunder and under the Program Documents at orprior to the Closing and to the following additional conditions: (a) At the Closing, the Bonds, the Program Documents, the Letterof Credit and the Official Statement shall have been duly authorized, executedand delivered by the respective parties thereto, in substantially the formsheretofore submitted to the Underwriter with any such changes as shall have beenagreed to in writing by the Underwriter, and said agreements shall not have beenamended, modified or supplemented, except as may have been agreed to in writingby the Underwriter, and there shall have been taken in connection therewith,with the issuance of the Bonds and with the transactions contemplated therebyand by this Purchase Contract, all such actions as Bond Counsel andUnderwriter's Counsel shall deem to be necessary and appropriate. (b) The representations and warranties of the Issuer contained inthis Purchase Contract shall be true, correct and complete in all materialrespects on the date hereof and on the Closing, as if made again on the Closing,and the Official Statement (as the same may be supplemented or amended with thewritten approval of the Underwriter) shall be true, correct and complete in allmaterial respects and shall not contain any untrue statement of fact or omit tostate any fact required to be stated therein or necessary to make the statementstherein, in the light of the circumstances under which such statements weremade, not misleading. (c) Between the date hereof and the Closing, the market price ormarketability, at the initial offering prices set forth in the OfficialStatement, of the Bonds shall not have been materially adversely affected, inthe reasonable judgment of the Underwriter by reason of any of the following: (1) legislation enacted or introduced in the Congress orrecommended for passage by the President of the United States, or a decisionrendered by a court established under Article III of the Constitution of theUnited States, or an order, ruling, regulation (final, temporary or proposed) orofficial statement issued or made: (i) [RESERVED] (ii) by or on behalf of the Securities and ExchangeCommission, or any other governmental agency having jurisdiction of the subjectmatter, to the effect that the Bonds, as secured by the Letter of Credit,including any or all underlying arrangements, are not exempt from registrationunder the Securities Act of 1933, as amended or that the Indenture is not exemptfrom qualification under the Trust Indenture Act of 1939, as amended; (2) the declaration of war or engagement in major militaryhostilities by the United States or the occurrence of any other nationalemergency or calamity relating to the effective operation of the government of,or the financial community in, the United States; (3) the declaration of a general banking moratorium byfederal, New York or California authorities, or the general suspension oftrading on any national securities exchange; (4) the imposition by the New York Stock Exchange or othernational securities exchange, or any governmental authority, of any materialrestrictions not now in force with respect to the Bonds or obligations of thegeneral character of the Bonds or securities generally, or the material increaseof any such restrictions now in force, including those relating to the extensionof credit by, or the charge to the net capital requirements of, underwriters; 4 6 (5) an order, decree or injunction of any court of competentjurisdiction, or order, filing, regulation or official statement by theSecurities and Exchange Commission, or any other governmental agency havingjurisdiction of the subject matter, issued or made to the effect that theissuance, offering or sale of obligations of the general character of the Bonds,or the issuance, offering or sale of the Bonds, including any or all underlyingobligations, as contemplated hereby or by the Official Statement, is or would bein violation of the federal securities laws as amended and then in effect; (6) the withdrawal or downgrading of any rating of the Bondsby a national rating agency or any rating of the Bank by a nationally recognizedrating service; (7) the occurrence of any adverse change of a materialnature in the business, financial condition, results of operation or propertiesof the Bank, the Issuer, or of any change or development in, or affectingparticularly, the economy or the Issuer generally; or (8) any event occurring, or information becoming knownwhich, in the reasonable judgment of the Underwriter, makes untrue in anymaterial respect any statement or information contained in the OfficialStatement, or has the effect that the Official Statement contains any untruestatement of material fact or omits to state a material fact required to bestated therein or necessary to make the statements therein, in the light of thecircumstances under which they were made, not misleading. (d) At or prior to the Closing, the Underwriter shall havereceived the following documents, in each case satisfactory in form andsubstance to the Underwriter: (1) the Program Documents, duly executed and delivered bythe respective parties thereto, with such amendments, modifications orsupplements as may have been agreed to in writing by the Underwriter, theOfficial Statement, duly executed by a duly authorized officer of the Issuer,and a copy of the Letter of Credit; (2) a final opinion, dated the date of the Closing, of BondCounsel, in the form attached as Appendix A to the Official Statement andaddressed to the Issuer, and a separate letter addressed to the Underwriter (ora comparable statement in the supplemental opinion) to the effect that the finalopinion may be relied upon by the Underwriter to the same extent as if it hadbeen addressed to it, together with supplemental opinion dated the date of theClosing and addressed to the Underwriter substantially in the form of Exhibit Ahereto; (3) the opinion of counsel to the Bank dated the date of theClosing and addressed to the Issuer, the Rating Agency and the Underwriter,substantially in the form of Exhibit B hereto; (4) the opinion of counsel to the Issuer, dated the date ofClosing and addressed to the Issuer, the Bank, Bond Counsel and the Underwriter,substantially in the form of Exhibit C hereto; (5) [RESERVED]; (6) the opinion of Underwriter's Counsel, dated the date ofClosing, addressed to the Underwriter, substantially in the form of Exhibit Dhereto; (7) a certificate of the Issuer, dated the date of Closing,signed by the Issuer, confirming the representations set forth in Section 5hereof as if given on the Closing; (8) a certificate of the Trustee dated the date of Closing,signed by a duly authorized officer of the Trustee, to the effect that: (i) such officer is a duly authorized officer of the Trustee; 5 7 (ii) the Trustee is a trust company and is duly organized and in good standing and qualified to do business in the State of California, is authorized to carry out corporate trust powers and has all necessary power and authority to enter into and perform its duties under the Indenture and upon the execution and delivery thereof by the Trustee, the same shall constitute legally valid and binding obligations of the Trustee, enforceable in accordance with their respective terms; (iii) the trusts, duties and obligations of the Trustee under the Indenture have been duly accepted by the Trustee; (iv) the Trustee is duly authorized to enter into the Indenture and to authenticate and deliver the Bonds to the Underwriter under instruction by the Issuer pursuant to the terms of the Indenture, and the Indenture constitutes a legally binding obligation of the Trustee, enforceable in accordance with its respective terms; (v) to the best knowledge of such officer, the acceptance by the Trustee of the duties and obligations under the Indenture and the execution and delivery of the Indenture and compliance with provisions thereof, will not conflict with, or constitute a breach of or default under, the Trustee's duties under said documents or any law, administrative regulation, court decree, resolution, charter, bylaws or other agreement to which the Trustee is subject or by which it is bound; (vi) the representations and agreements of the Trustee in the Indenture are true, complete and correct in all material respects as of the Closing; (vii) to the best of such officer's knowledge, no litigation is pending or threatened (either in state or federal courts) against the Trustee (A) to restrain or enjoin the execution or delivery of any of the Bonds or the collection of Revenues (as defined in the Indenture) pledged under the Indenture, or (B) in any way contesting or affecting any authority for the authentication or delivery of the Bonds or the validity or enforceability of the Bonds or the Indenture; and (viii) the Bonds in the principal amount of $11,615,000 have been validly authenticated, registered and delivered by the Trustee; (9) the opinion of counsel to the Trustee, dated the date ofClosing and addressed to the Issuer, the Bank and the Underwriter, substantiallyin the form of Exhibit E hereto; (10) a certificate of the Issuer, dated the date of Closing,signed by an authorized representative as is acceptable to the Underwriter, tothe effect that: (i) the representations and agreements of the Issuer contained in the Program Documents are true and correct in all material respects as of the Closing; (ii) the Issuer has complied with all agreements, covenants and conditions to be complied with by the Issuer at or prior to the Closing under the Program Documents; (iii) to the best of such official's knowledge, no event affecting the Issuer has occurred since the date of the Official Statement which either makes untrue or incorrect in any material respect as of the Closing the statements or information concerning the Issuer contained in the Official Statement or is not reflected in the Official Statement but should be reflected therein in order to make the statements and information concerning the Issuer therein not misleading in any material respect; and (iv) except as set forth in the Official Statement, to the best knowledge of the Issuer after reasonable investigation, no litigation is pending or, to the knowledge of the Issuer, threatened in any court in any way affecting the existence of the Issuer, or in any way challenging the respective 6 8 powers of the several offices of the officials holding those respective offices, or seeking to restrain or to enjoin the issuance, sale or delivery of the Bonds, or the collection of Revenues (as defined in the Indenture) pledged under the Indenture, or the pledge thereof, or in any way contesting or affecting the validity or enforceability of the Bonds or the Program Documents or contesting in any way the completeness or accuracy of the Official Statement, or contesting the powers of the Issuer or its authority with respect to the Bonds or the Program Documents (but in lieu of or in conjunction with such certificate, the Underwriter may, in its sole discretion accept certificates or opinions of counsel to the Issuer, acceptable to the Underwriter, that in the opinion of such counsel the issues raised in any such pending or threatened litigation are without substance or that the contentions of all plaintiffs therein are without merit); (11) a certificate of the Bank dated the date of Closing,signed by an authorized representative thereof, to the effect that: (i) all conditions precedent to the issuance of the Letter of Credit, including those specified in the Reimbursement Agreement, have been satisfied or have been waived by the Bank; (ii) to the actual knowledge of such authorized representative, there is no action, suit, litigation, proceeding, inquiry or investigation at law or in equity or by or before any judicial or administrative court, agency, body or other entity, pending or threatened against the Bank or any of its properties, wherein an unfavorable decision, ruling or finding (A) would adversely affect the validity or enforceability of the Letter of Credit or (B) would otherwise adversely affect the legal ability of the Bank to comply with its obligations under the Letter of Credit; and (iii) the information contained in the Official Statement under the heading "THE BANK" and the sub-heading "Letter of Credit", is true and correct in all material respects and such information does not contain any untrue or misleading statement of a material fact necessary to make the statements therein, in the light of the circumstances under which they were make, not misleading; (12) [RESERVED]; (13) evidence satisfactory to the Underwriter to the effectthat the Bonds have received a rating satisfactory to the Underwriter fromStandard & Poor's; and (14) such additional legal opinions, certificates,proceedings, instruments and other documents as the Underwriter, Bond Counsel or Underwriter's Counsel may reasonably request to evidence compliance by the Bank,the Trustee and the Issuer with legal requirements, the truth and accuracy, asof the Closing, of the representations of the Issuer, the Bank and the Trustee,and the due performance or satisfaction by the Issuer, the Bank and the Trusteeat or prior to such time of all agreements then to be performed and allconditions then to be satisfied by the Issuer, the Bank and the Trustee. SECTION 6. AMENDMENT OF OFFICIAL STATEMENT. After the Closing, (1) theIssuer will not adopt any amendment of or supplement to the Official Statementto which, after having been furnished with a copy, the Underwriter shall objectin writing and (2) if any event relating to or affecting the Issuer or the Bankshall occur as a result of which it is necessary, in the opinion of theUnderwriter, to amend or supplement the Official Statement in order to make theOfficial Statement not misleading in the light of the circumstances existing atthe time it is delivered to the Underwriter, the Issuer shall cause to beforthwith prepared and furnished to the Underwriter (at the expense of theIssuer for ninety (90) days from the Closing and otherwise at the expense of theUnderwriter) a reasonable number of copies of an amendment of or supplement tothe Official Statement (in form and substance satisfactory to the Underwriter)that will amend or supplement the Official Statement so that it will not containan untrue statement of material fact or omit to state a material fact necessaryin order to make the statements therein, in the light of the circumstancesexisting at the time it is delivered to the Underwriter, not misleading. 7 9 SECTION 7. OBLIGATIONS OF ISSUER. The Issuer's obligations hereunder shallbe subject to (i) there being no order, decree, injunction, ruling or regulationof any court or the enactment of any legislation with the purpose or effect ofprohibiting the issuance, offering or sale of the Bonds, (ii) receipt of thedocuments listed above other than those documents delivered by the Issuer andthose documents specifically addressed solely to the Underwriter and (iii) theperformance by the Issuer and the Underwriter of their obligations to beperformed hereunder at or prior to the Closing. SECTION 8. INDEMNIFICATION. (a) The Issuer shall indemnify, protect, defend and hold harmlessthe Underwriter and each person who controls the Underwriter, within the meaningof the Securities Act of 1933, as amended, or the Securities Act of 1934, asamended (collectively, the "Securities Acts"), against any and all losses,claims, damages, liabilities, costs and expenses (including, without limitation,fees and disbursements of counsel and other expenses) incurred by them or any ofthem in connection with defending any loss, claim, damage, liability or anysuit, action or proceeding, joint or several, to which they or any of them maybecome subject under the Securities Acts, or any other federal or state law orregulation, at common law or otherwise, insofar as such losses, claims, damages,liabilities, costs and expenses (or any suit, action or proceeding in respectthereof) arise out of or are based upon any untrue statement or alleged untruestatement of a material fact contained in the Official Statement or in anyamendment or supplement thereto approved by the Issuer (which approval shall notbe unreasonably withheld) or arise out of or are based upon the omission oralleged omission to state therein a fact required to be stated therein ornecessary to make the statements therein, in the light of the circumstancesunder which they were made, not misleading; provided, however, that the Issuershall not be liable in any such case to the extent that any such loss, claim,damage, liability or action arises out of, or is based upon, any untruestatement or alleged untrue statement of a material fact contained in thatparticular part of the Official Statement, or any amendment thereof orsupplement thereto, under the captions "THE BOOK-ENTRY ONLY SYSTEM" or "THEBANK." Notwithstanding the foregoing, this indemnity shall not cover any losses,claims, damages or liabilities caused solely by the gross negligence of theindemnified party or solely by breach of this agreement by the indemnifiedparty. (b) The Underwriter shall indemnify, protect, defend and hold harmless the Issuer against any and all losses, claims, damages, liabilities,costs and expenses (including, without limitation, fees and disbursements ofcounsel and other expenses) incurred by them or any of them in connection withdefending any loss, claim, damage, liability or any suit, action or proceeding,joint or several, to which they or any of them may become subject under theSecurities Acts, or any other federal or state law or regulation, at common lawor otherwise, insofar as such losses, claims, damages, liabilities, costs andexpenses (or any suit, action or proceeding in respect thereof) arise out of orare based upon any untrue statement or alleged untrue statement of a materialfact contained in the "THE UNDERWRITER" caption of the Official Statement or inthe "THE UNDERWRITER" caption of any amendment or supplement thereto approved bythe Issuer (which approval shall not be unreasonably withheld), or arise out ofor are based upon the omission or alleged omission to state therein a factrequired to be stated therein or necessary to make the statements therein, inlight of the circumstances under which they were made, not misleading.Notwithstanding the foregoing, this indemnity shall not cover any losses,claims, damages or liabilities caused solely by the negligence of theindemnified party or solely by breach of this agreement by the indemnifiedparty. (c) Promptly after receipt by any party entitled toindemnification under this Section 8 of notice of the commencement of any suit,action or proceeding, such indemnified party shall, if a claim in respectthereof is to be made against the indemnifying party under this Section 8,notify the indemnifying party in writing of the commencement thereof; but theomission so to notify the indemnifying party shall not relieve it from anyliability which it may have to any indemnified party otherwise than under thisSection 8 or from any liability under this Section 8 unless the failure toprovide notice prejudices the defense of such suit, action or proceeding. Incase any such action is brought against any indemnified party, and it notifiesthe indemnifying party, the indemnifying party shall be entitled to participatein, and to the extent that it may elect by written notice delivered to theindemnified party promptly after receiving the aforesaid notice from suchindemnified party, to assume the defense thereof, with counsel satisfactory tosuch indemnified party; provided, however, if the defendants in any such actioninclude both the indemnified party and the indemnifying party and theindemnified party shall have reasonably concluded that there may be legaldefenses available to it and/or other indemnified parties which are differentfrom or additional to those available to the indemnifying party, the indemnifiedparty or parties shall have the right to select separate counsel to 8 10assert such legal defenses and to otherwise participate in the defense of suchaction on behalf of such indemnified party or parties. Upon receipt of noticefrom the indemnifying party to such indemnified party of its election so toassume the defense of such action and approval by the indemnified party ofcounsel, the indemnifying party shall not be liable to such indemnified partyunder this Section 8 for any legal or other expenses subsequently incurred bysuch indemnified party in connection with defense thereof unless (i) theindemnified party shall have employed separate counsel in connection with theassertion of legal defenses in accordance with the proviso to the next precedingsentence (it being understood, however, that the indemnifying party shall not beliable for the expenses of more than one separate counsel, approved by theUnderwriter, the Issuer in the case of the subparagraph (a), representing theindemnified parties under the subparagraph (a) who are parties to such action),(ii) the indemnifying party shall not have employed counsel satisfactory to theindemnified party to represent the indemnified party within a reasonable timeafter notice of commencement of the action or (iii) the indemnifying party hasauthorized the employment of counsel for the indemnified party at the expense ofthe indemnifying party; and except that, if clause (i) or (iii) is applicable,such liability shall be only in respect of the counsel referred to in suchclause (i) or (iii). (d) The Issuer shall not be liable for any settlement of any suchaction effected without its consent by any indemnified party, but if settled with the consent of the Issuer or if there be a final judgment for the plaintiffin any such action against the Issuer or any indemnified party, with or withoutthe consent of the Issuer, then the Issuer agrees to indemnify and hold harmlesssuch indemnified party to the extent provided herein. SECTION 9. EXPENSES. Whether or not the sale of the Bonds by the Issuer tothe Underwriter is consummated, the Underwriter shall be under no obligation topay any costs or expenses incident to the performance of the obligations of theIssuer hereunder. All costs and expenses to effect the authorization,preparation (including word processing and printing costs), issuance, sale anddelivery, as the case may be, of the Official Statement (together with anyamendments or supplements thereof), the Bonds, the Program Documents, the Letterof Credit, any rating agency fees, Trustee's fees and expenses, Trustee'scounsel fees and disbursements, financial consultant fees and disbursements, thefees and disbursements of Bond Counsel, fees and disbursements of counsel forthe Issuer and the amount to be paid to the Underwriter pursuant to Section 1 ofthis Purchase Contract, shall be paid out of the sources provided therefor inthe Indenture, or if the Bonds are not delivered by the Issuer to theUnderwriter, such costs and expenses shall be paid by the Issuer. Allout-of-pocket expenses of the Underwriter, including fees and expenses of itscounsel (except for word processing costs incurred in the production of theOfficial Statement), Blue Sky expenses and the cost of obtaining federal fundsfor the Purchase Price of the Bonds hereunder shall be paid by the Underwriter. In the event that, for any reason, the Issuer fails to deliver the Bondsas provided herein by 10:00 a.m. Pacific Standard time, on December 1, 1998, theIssuer will pay to the Underwriter any losses resulting from the Underwriterbeing required to hold Bonds prior to delivery to ultimate purchasers thereof.This preceding sentence shall not be construed as a waiver of any condition tothe Underwriter's obligations under the Purchase Contract. SECTION 10. SURVIVAL OF CERTAIN REPRESENTATIONS AND OBLIGATIONS. Therespective agreements, covenants, representations, warranties and otherstatements of the Issuer and each of their respective officials or officers setforth in or made pursuant to this Purchase Contract shall remain in full forceand effect, regardless of any investigation, or statements as to the resultsthereof, made by or on behalf of the Underwriter and will survive delivery ofand payment for the Bonds. SECTION 11. NOTICES. Any notice or other communication hereunder shall bein writing, and, if sent to the Underwriter, will be mailed, delivered ortelecopied and confirmed to the Underwriter care of Dain Rauscher Incorporated,One Market Plaza, 1100 Steuart Street Tower, San Francisco, California 94105,and if sent to the Issuer shall be mailed, delivered, or telecopied andconfirmed at its address respectively set forth above. SECTION 12. GOVERNING LAW. This Purchase Contract shall be governed by andconstrued in accordance with the laws of the State of California, without givingeffect to the principles of conflict of laws in the State of California. SECTION 13. COUNTERPARTS. This Purchase Contract may be executed inseveral counterparts, each of which shall be an original and all of which shallconstitute but one and the same instrument. 9 11 SECTION 14. SUCCESSORS. This Purchase Contract shall be binding upon andinure to the benefit of the parties hereto and their respective successors, andno other person shall acquire or have any right or obligation under or by virtueof this Purchase Contract. Very truly yours, Dain Rauscher Incorporated, as Underwriter By: /s/ John Geesman ------------------------------------ John Geesman Managing Director By: /s/ Pamela Becker ------------------------------------ Pamela Becker Vice PresidentTHE FOREGOING SHALL BE EFFECTIVE AND IS HEREBY ACCEPTED AND AGREED TO AS OF THIS1ST DAY OF DECEMBER, 1998:AMERICAN XTAL TECHNOLOGY, INC.By: /s/ Guy Atwood, V.P. --------------------------------Authorized Representative 10 12 EXHIBIT A TO BOND PURCHASE CONTRACT FORM OF SUPPLEMENTAL OPINION BOND COUNSEL The supplemental opinion of Bond Counsel should be dated the date of theClosing and addressed to the Underwriter, and opine that: (i) the Bonds are not subject to the registration requirements of the Securities Act of 1933, as amended (the "Securities Act") pursuant to Section 3(a)(2) of the Securities Act. The Indenture is exempt from qualification pursuant to the Trust Indenture Act of 1939, as amended (the "Trust Indenture Act") in reliance upon an exemption contained in the Trust Indenture Act. No opinion is expressed with respect to the Letter of Credit; (ii) the Purchase Contract has been duly authorized, executed and delivered by the Issuer and (assuming due authorization, execution and delivery by and validity against the other party thereto) is a valid and binding agreement of the Issuer; and (iii) the statements contained in the Official Statement, dated November 23, 1998, with respect to the Bonds, under the captions "THE BONDS," "SECURITY AND SOURCES OF PAYMENT FOR THE BONDS" and "SUMMARY OF THE INDENTURE," insofar as such statements expressly summarize certain provisions of the Bonds and the Indenture are accurate in all material respects. 11 13 EXHIBIT B TO BOND PURCHASE CONTRACT FORM OF OPINION COUNSEL TO THE BANK The opinion of counsel to the Bank should be dated the date of the Closingand addressed to the Issuer, the Rating Agency and the Underwriter, and opinethat: (i) the Bank is a corporation duly organized, validly existing and in good standing under the laws of the State of California; (ii) the Bank is qualified to conduct a commercial banking business in California, and, as part of such commercial banking business, has the power and authority to execute and deliver the Reimbursement Agreement and the Letter of Credit; (iii) the Letter of Credit constitutes the legal, valid and binding obligation of the Bank, enforceable against the Bank in accordance with its terms, except (i) as limited by bankruptcy, insolvency, reorganization, moratorium and other laws relating to or affecting generally the enforcement of creditors' rights and remedies against the Bank as the same may be applied in the event of the bankruptcy, insolvency, liquidation, reorganization, or similar situation or moratorium applicable to the Bank; and (ii) general principles of equity including, without limitation, concepts of materiality, reasonableness, good faith and fair dealing, and limitation upon the specific enforceability of any remedies, covenants or other provisions of relevant documents and upon the availability of injunctive relief or other equitable remedies, regardless of whether considered in a proceeding in equity or in law; (iv) the issuance of the Letter of Credit by the Bank is exempt from the registration requirements of the Securities Act of 1933, as amended (the "Act") pursuant to Section 3(a)(2) of the Act; and (v) the statements contained in the Official Statement under the Captions "SECURITY AND SOURCES OF PAYMENT FOR THE BONDS - The Letter of Credit" and "SUMMARY OF THE REIMBURSEMENT AGREEMENT," insofar as such statements purport to summarize certain provisions of the Letter of Credit and Reimbursement Agreement, present an accurate summary of such provisions in all material respects. 12 14 EXHIBIT C TO BOND PURCHASE CONTRACT FORM OF OPINION COUNSEL TO THE ISSUER The opinion of counsel to the Issuer should be dated the date of theClosing and addressed to the Bond Counsel and the Underwriter, and opine that: (i) the Issuer is a corporation duly organized and validly existing under the laws of the state of Delaware and has full legal rights, power and authority to (a) execute and deliver and to perform its obligations under the Program Documents and (b) transact in the State of California the business in which the Issuer is now engaged; (ii) the Program Documents have been duly authorized, executed and delivered by the Issuer and, assuming proper authorization, execution and delivery by the other parties thereto, constitute legal, valid and binding obligations of the Issuer enforceable against Issuer in accordance with their respective terms except to the extent the enforceability thereof may be limited by bankruptcy, insolvency, moratorium, reorganization, other laws affecting or relating to the rights of creditors generally, the application of equitable principles and judicial discretion, and by the implied covenant of good faith and fair dealing; (iii) the execution and delivery by the Issuer of the Program Documents and performance by the Issuer of its obligations thereunder will not result in a violation of, a breach of, or a default under the bylaws and articles of incorporation of the Issuer or any statute, indenture, mortgage, deed of trust, note agreement, other agreement or instrument to which the Issuer is a party or by which it is bound and no approval or other action by any governmental authority or agency of the State of California or the United States of America is required in connection therewith; provided however that no opinion concerning compliance with the federal securities laws or securities or "Blue Sky" laws of the various states is expressed; and (iv) except as disclosed in the Official Statement, no action, suit, proceeding, inquiry, or investigation at law or in equity before or by any judicial or administrative court or agency is pending or threatened against the Issuer or its assets, properties or operations, which if determined adversely to the Issuer would likely materially adversely affect the transactions contemplated by the Program Documents. 13 15 EXHIBIT D TO BOND PURCHASE CONTRACT FORM OF OPINION COUNSEL TO THE UNDERWRITER The opinion of counsel to the Underwriter should be dated the date of theClosing and addressed to the Underwriter, and opine that: (i) under existing laws, the Bonds may be offered and sold without registration under the Securities Act of 1933, as amended, and the Indenture is not required to be qualified under the Trust Indenture Act of 1939, as amended; and (ii) because the primary purpose of their professional engagement was not to establish factual matters and because of the wholly or partially non-legal character of any determinations involved in the preparation of the Official Statement as counsel to the Underwriter, they are not passing upon and do not assume any responsibility for the accuracy, completeness or fairness of any of the statements contained in the Official Statement and make no representation that they independently verified the accuracy, completeness or fairness of the statements contained in the Official Statement; however, on the basis of their conferences with the representatives of the Issuer, representatives of the Bank and representatives of the Underwriter and in reliance thereon and on the certificates, opinions and other documents they have examined, no information has come to their attention which would cause them to believe that the Official Statement as of its date and as of the date of their opinion contains any untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading. 14 16 EXHIBIT E FORM OF OPINION COUNSEL TO THE TRUSTEE The opinion of counsel to the Trustee should be dated the date of Closingand addressed to the Issuer, the Bank and the Underwriter and opine that: (i) the Trustee has been duly organized and is a lawfully existing trust company and is qualified to do business in the State of California and has full corporate power to undertake the trust of the Indenture; (ii) the Trustee has duly authorized, executed and delivered the Indenture and by all necessary corporate action has authorized the acceptance of the trust of the Indenture; and (iii) assuming the due authorization, execution and delivery by the other parties thereto, the Indenture constitutes a valid and binding obligation of the Trustee, enforceable against the Trustee in accordance with its terms except as enforcement may be limited by bankruptcy, insolvency, moratorium or other similar laws, or equitable principles relating to or limiting creditors' rights generally. 15 1 EXHIBIT 10.11 REMARKETING AGREEMENT AMERICAN XTAL TECHNOLOGY, INC. PROJECT REMARKETING AGREEMENT, dated and effective as of December 1, 1998, betweenAMERICAN XTAL TECHNOLOGY, INC., a Delaware corporation (the "Issuer"), and DAINRAUSCHER INCORPORATED (the "Remarketing Agent"). WHEREAS, on December 1, the Issuer issued its Variable Rate Taxable DemandRevenue Bonds Series 1998 in the aggregate principal amount of $11,615,000 (the"Bonds"), pursuant to that certain Trust Indenture dated as of December 1, 1998(the "Indenture"), between the Issuer and Harris Trust Company of California, astrustee (the "Trustee"); and WHEREAS, to support the payment of the principal of, interest on andPurchase Price of the Bonds, U.S. Bank National Association, Fremont, California(the "Bank"), issued its irrevocable direct pay letter of credit (the "Letter ofCredit") to the Trustee; and WHEREAS, the outstanding Bonds are subject to purchase upon notice anddelivery to the Trustee or the Tender Agent (as such term is defined in theIndenture) as provided in the Indenture; and WHEREAS, the Issuer and the Remarketing Agent desire to make contractprovisions regarding the Remarketing Agent's role as the remarketing agent forthe Bonds, in addition to those set forth in the Indenture. NOW, THEREFORE, for and in consideration of the covenants herein made, theIssuer and the Remarketing Agent hereby agree as follows: SECTION 1. DEFINITIONS. All capitalized terms used in this RemarketingAgreement, which are not otherwise defined herein, shall have the meaningsascribed to them in the Indenture. SECTION 2. DUTIES. In reliance upon the representations and agreements,but subject to the terms and conditions contained in the Indenture and in thisRemarketing Agreement, the Issuer hereby appoints the Remarketing Agent, and theRemarketing Agent hereby accepts the appointment, as exclusive remarketing agentin connection with the offering and sale of the Bonds from time to time in thesecondary market, subsequent to the initial offering, issuance and sale of theBonds. The Issuer and Remarketing Agent acknowledge that this appointment of theRemarketing Agent is made with the approval of the Issuer and the Bank. The Remarketing Agent will perform the duties specified for theRemarketing Agent under the Indenture, all of which are incorporated herein byreference, and this Remarketing Agreement. In acting as Remarketing Agent, theRemarketing Agent will act as agent and not as principal except as expresslyprovided in this Section. The Remarketing Agent may, if it determines to do so in its solediscretion, buy as principal any Bonds but it will not in any event be obligatedto do so. SECTION 3. DISCLOSURE STATEMENT. (a) If the Remarketing Agent determines that it is necessary ordesirable to use a disclosure statement ("Disclosure Statement") in connectionwith its offering of the Bonds, the Remarketing Agent will notify the Issuer andthe Issuer will provide the Remarketing Agent with a Disclosure Statementsatisfactory to the Remarketing Agent and its counsel in respect of the Bonds.The Issuer will supply the Remarketing Agent with the number of copies of theDisclosure Statement and documents related thereto as the Remarketing Agent requests from time to time and will amend the Disclosure Statement (and/or thedocuments incorporated by reference in it) so that at all times the DisclosureStatement and any documents related thereto will not contain any untruestatement of a material fact or omit to state a material fact necessary to makethe statements in such documents, in the light of the circumstances under whichthey were made, not misleading. In addition, the Issuer will take all stepsreasonably 1 2requested by the Remarketing Agent which the Remarketing Agent or its counselmay consider necessary or desirable to register the sale of the Bonds by theRemarketing Agent under any Federal or state securities law or to qualify theIndenture under the Trust Indenture Act of 1939, as amended, and will providethe Remarketing Agent such officers' certificates, counsel opinions,accountants' letters and other documents as may be customary in similartransactions. If the Issuer does not perform its obligations under this Section,the Remarketing Agent may immediately cease remarketing efforts. (b) The Issuer has authorized the use by the Remarketing Agent ofthe Official Statement in connection with the remarketing of Bonds. For purposesof this Remarketing Agreement, the Official Statement and any other documentsprovided to the Remarketing Agent pursuant to paragraph (a) of this Sectionshall be considered to be the Disclosure Statement. SECTION 4. REPRESENTATIONS, WARRANTIES, COVENANTS AND AGREEMENTS OF THEREMARKETING AGENT. The Remarketing Agent, by its acceptance hereof, represents,warrants, covenants and agrees with the Issuer as follows: (a) It is authorized by law to perform all of the duties requiredof it by the Indenture and this Remarketing Agreement. (b) The execution and delivery of this Remarketing Agreement andthe consummation of the transactions contemplated herein and in the Indenturewill not conflict with or constitute on the part of the Remarketing Agent abreach of or a default under its charter documents, its by-laws, or any statute,indenture, mortgage, deed of trust, lease, note agreement or other agreement orinstrument to which the Remarketing Agent is a party or by which it or itsproperties are bound, or any order, rule or regulation of any court orgovernmental agency or body having jurisdiction over the Remarketing Agent orany of its activities or properties. (c) This Remarketing Agreement has been duly authorized, executedand delivered by the Remarketing Agent. (d) It has full power and authority to take all actions requiredor permitted to be taken by it or under, and to perform and observe thecovenants and agreements on its part contained in, this Remarketing Agreementand any other instrument or agreement relating thereto to which it is a party. (e) It has, on or before the date hereof, duly taken all actionnecessary to be taken by it prior to such date for: (i) the execution, deliveryand performance of this Remarketing Agreement and any other instrument oragreement relating thereto to which it is a party and which have been executedby the Remarketing Agent in connection with the transactions contemplated by theforegoing documents, and (ii) the carrying out, giving effect to, consummationand performance of the transactions and obligations contemplated hereby and bythe Official Statement. (f) This Remarketing Agreement and any other instrument oragreement relating thereto to which it is a party which have been executed bythe Remarketing Agent in connection with the consummation of the transactionscontemplated hereby and by the Official Statement will constitute its legal,valid and binding obligations, enforceable against it in accordance with theirrespective terms, except as enforcement may be limited by bankruptcy,insolvency, reorganization, moratorium or similar laws, or equitable principles relating to or limiting creditors' rights generally. (g) The Remarketing Agent will use its best efforts to remarketthe Bonds pursuant to the Indenture. SECTION 5. REPRESENTATIONS, WARRANTIES, COVENANTS AND AGREEMENTS OF THEISSUER. The Issuer, by its acceptance hereof, represents, warrants, covenants,and agrees with the Remarketing Agent as follows: 2 3 (a) It has full power and authority to take all actions requiredor permitted to be taken by it or under, and to perform and observe thecovenants and agreements on its part contained in, the Program Documents (asthat term is defined in the Bond Purchase Contract) and any other instrument oragreement relating thereto to which it is a party (collectively, the "ClosingDocuments"). (b) It has, on or before the date hereof, duly taken all actionnecessary to be taken by it prior to such date for: (i) the execution, deliveryand performance of the Closing Documents, which have been executed by the Issuerin connection with the transactions contemplated thereby, and (ii) the carryingout, giving effect to, consummation and performance of the transactions andobligations contemplated hereby and by the Official Statement; provided that norepresentation is made with respect to compliance with the securities or BlueSky laws of the various states of the United States. (c) The Closing Documents which have been executed by the Issuerin connection with the consummation of the transactions contemplated hereby andby the Official Statement will constitute its legal, valid and bindingobligations, enforceable against it in accordance with their respective terms,except as enforcement may be limited by bankruptcy, insolvency, reorganization,moratorium or similar laws, or equitable principles relating to or limitingcreditors' rights generally. (d) The execution and delivery of the Closing Documents which havebeen executed in connection with the consummation of the transactionscontemplated hereby and by the Official Statement, the compliance with theterms, conditions or provisions thereof, and the consummation of thetransactions therein contemplated do not and will not violate any law,regulation, order, writ, injunction or decree of any court or governmental bodyor result in a breach of any of the terms, conditions or provisions of, orconstitute a default under, or result in the creation or imposition of anymortgage, lien, charge or encumbrance of any nature whatsoever upon any of theproperties or assets of the Issuer pursuant to any mortgage, resolution,agreement or instrument to which the Issuer is a party or by which it or any ofits properties is bound other than those provided for in the Closing Documentsor contemplated by the parties. (e) All authorizations, consents and approvals of, notices to,registrations or filings with, or actions in respect of any governmental body,agency or other instrumentality or court required in connection with theexecution, delivery and performance by the Issuer of the Closing Documents andwhich have been executed in connection with the consummation of the transactionscontemplated hereby and by the Official Statement have been obtained, given ortaken and are in full force and effect; provided that no representation is madewith respect to compliance with the securities or Blue Sky laws of the variousstates of the United States. (f) To the knowledge of the Issuer, other than as described in theOfficial Statement, there is no action, suit, proceeding, inquiry orinvestigation before or by any court, public board or body pending or threatenedagainst or affecting him wherein an unfavorable decision, ruling or finding islikely to have a materially adverse effect on the financial condition orsolvency of the Issuer or the ability of the Issuer to perform its obligationsunder the Closing Documents or any other agreement or instrument to which it is a party and which is used or contemplated for use in consummation of thetransactions contemplated hereby or by the Official Statement. (g) The Issuer will cooperate with the Remarketing Agent in thequalification of the Bonds for offering and sale and the determination of theeligibility of the Bonds for investment under the laws of such jurisdictions asthe Remarketing Agent shall designate and will use its best efforts to continueany such qualifications in effect so long as required for the distribution ofall the Bonds by the Remarketing Agent; provided that the Issuer shall not berequired to incur any expense, consent to service of process in any suchjurisdiction or qualify to do business in any jurisdiction where it is not nowso subject. SECTION 6. CONDITIONS TO REMARKETING AGENT'S OBLIGATIONS. The obligationsof the Remarketing Agent under this Remarketing Agreement have been undertakenin reliance on, and shall be subject to, the due performance by the Issuer ofits obligations and agreements to be performed hereunder and to the accuracy ofand compliance with the representations, warranties, covenants and agreements ofthe Issuer contained herein, on and as of the Date of Delivery of thisRemarketing Agreement. The obligations of the Remarketing Agent on and as of 3 4each date on which Bonds are to be offered and sold pursuant to this RemarketingAgreement are also subject to the following further conditions: (a) Each of the Closing Documents shall be in full force andeffect and shall not have been amended, modified or supplemented in any waywhich would materially adversely affect the Bonds, except as may have beenagreed to in writing by the Remarketing Agent, and there shall be in full forceand effect such additional resolutions, agreements, certificates and opinions,which resolutions, agreements, certificates and opinions shall be satisfactoryin form and substance to the Remarketing Agent; and (b) No Event of Default (as such term is defined in any of theClosing Documents) shall have occurred and be continuing and no event shall haveoccurred and be continuing which, with the passage of time or giving of noticeor both, would constitute such an Event of Default. SECTION 7. INDEMNIFICATION AND CONTRIBUTION. (a) The Issuer will indemnify, protect, defend and hold harmlessthe Remarketing Agent, each of its directors, officers, agents and employees andeach person who controls the Remarketing Agent within the meaning of Section 15of the Securities Act of 1933, as amended (such Act being herein called the"Act" and any such person being herein sometimes called an "Indemnified Party"),against any and all losses, claims, damages or liabilities, joint or several, towhich such Indemnified Party may become subject under any statute or at law orin equity or otherwise, and shall reimburse any such Indemnified Party for anylegal or other expenses incurred by it in connection with defending any actions,but only to the extent that such losses, claims, damages, liabilities or actionsarise out of or are based upon (i) an allegation or determination that theBonds, the obligations of the Issuer under the Indenture or this RemarketingAgreement, or the obligations of the Bank under the Letter of Credit should havebeen registered under the Act or the Indenture should have been qualified underthe Trust Indenture Act of 1939, as amended (the "Trust Indenture Act"), or (ii)any untrue statement or alleged untrue statement of a material fact contained inany Disclosure Statement or any amendment thereof or supplement thereto, or theomission or alleged omission to state therein a material fact necessary to makethe statements therein not misleading, but the Issuer shall not be liable in anysuch case to the extent that any such loss, claim, damage, liability or actionarises out of, or is based upon, any such untrue statement or alleged untruestatement or omission or alleged omission made therein in reliance upon and inconformity with written information furnished to the Issuer by the RemarketingAgent specifically for use in connection with the preparation thereof, or if theperson asserting any such loss, claim, damage or liability purchased Bonds from the Remarketing Agent, if delivery to such person of the Disclosure Statement orany amendment or supplement to it would have been a valid defense to the actionfrom which such loss, claim, damage or liability arose and if the same was notdelivered to such person by or on behalf of the Remarketing Agent. Thisindemnity agreement shall not be construed as a limitation on any otherliability which the Issuer may have to any Indemnified Party. Notwithstandingthe foregoing, this indemnification shall not cover any losses, claims, damagesor liabilities caused solely by the negligence of the Indemnified Party orsolely by breach of this agreement by the Indemnified Party. (b) The Remarketing Agent shall indemnify, protect, defend andhold harmless the Issuer, and each of its directors, officers, agents oremployees and each person who controls the Issuer within the meaning of Section15 of the Act (for purposes of this paragraph (b), an "Indemnified Party")against all losses, damages or liabilities, joint or several, to which suchIndemnified Party may become subject under any statute or at law or in equity orotherwise, and will reimburse any such Indemnified Party for any legal or otherexpenses incurred by it in connection with defending any actions, insofar assuch losses, damages, liabilities or actions arise out of or are based upon anyuntrue statement or alleged untrue statement of a material fact contained in aDisclosure Statement or any amendment thereof or supplement thereto, or theomission or alleged omission to state therein a material fact necessary to makethe statements therein not misleading, but only with reference to writteninformation, if any, relating to the Remarketing Agent furnished to the Issuerby the Remarketing Agent specifically for use in the preparation of a DisclosureStatement. The Issuer and the Remarketing Agent agree that any statements setforth in the Official Statement or a future Disclosure Statement furnished inwriting by or on behalf of the Remarketing Agent for inclusion in such documentsshall be contained in a subsection entitled "Remarketing of Bonds" and that theRemarketing Agent's indemnification pursuant to this paragraph (b) shall belimited to such Section. This 4 5indemnity agreement shall not be construed as a limitation on any otherliability which the Remarketing Agent may otherwise have to any IndemnifiedParty, but in no event shall the Remarketing Agent be obligated for doubleindemnification. Notwithstanding the foregoing, this indemnity shall not coverany losses, claims, damages or liabilities caused solely by the negligence ofthe Indemnified Party or solely by breach of this agreement by the IndemnifiedParty. (c) An Indemnified Party (as defined in paragraph (a) or paragraph(b) of this Section 7) shall, promptly after the receipt of notice of thecommencement of any action against such Indemnified Party in respect of whichindemnification may be sought against the Remarketing Agent or the Issuer, asthe case may be (in either case the "Indemnifying Party"), notify theIndemnifying Party in writing of the commencement thereof. In case any suchaction shall be brought against an Indemnified Party and such Indemnified Partyshall notify the Indemnifying Party, the Indemnifying Party may, or if sorequested by such Indemnified Party shall, participate therein or assume thedefense thereof, with counsel reasonably satisfactory to such Indemnified Party,and after notice from the Indemnifying Party to such Indemnified Party of anelection so as to assume the defense thereof, such Indemnified Party shallreasonably cooperate in the defense thereof, including without limitation, thesettlement of outstanding claims, and the Indemnifying Party will not be liableto such Indemnified Party under this Section 7 for any legal or other expensessubsequently incurred by such Indemnified Party in connection with the defensethereof other than reasonable costs of investigation incurred with the consentof the Indemnifying Party, which consent shall not be unreasonably withheld;provided, however, that unless and until the Indemnifying Party assumes thedefense of any such action at the request of such Indemnified Party, theIndemnifying Party shall have the right to participate at its own expense in thedefense of any such action. If the Indemnifying Party shall not have employedcounsel to have charge of the defense of any such action or if any IndemnifiedParty shall have reasonably concluded that there may be defenses available to it or them which are different from or additional to those available to theIndemnifying Party (in which case the Indemnifying Party shall not have theright to direct the defense of such action on behalf of such Indemnified Party),legal and other expenses incurred by such Indemnified Party shall be borne bythe Indemnifying Party. Notwithstanding the foregoing, the Indemnifying Partyshall not be liable for any settlement of any action or claim affected withoutits consent, which consent shall not be unreasonably withheld. (d) In order to provide for just and equitable contribution incircumstances in which the indemnification provided for in paragraph (a) or (b)of this Section 7 is due in accordance with its terms but is for any reason heldby a court to be unavailable from the Issuer or the Remarketing Agent on groundsof policy or otherwise, the Issuer and the Remarketing Agent shall contribute tothe aggregate losses, claims, damages and liabilities (including legal or otherexpenses reasonably incurred in connection with investigating or defending same)to which the Issuer and the Remarketing Agent may be subject (i) in suchproportion as is appropriate to reflect the relative benefits received by theIssuer on the one hand and the Remarketing Agent on the other from theremarketing of the Bonds or (ii) if the allocation provided by clause (i) aboveis not permitted by applicable law, in such proportion as is appropriate toreflect not only the relative benefits referred to in clause (i) above but alsothe relative fault of the Issuer and the Remarketing Agent in connection withthe failure to register or qualify certain instruments as described in Section7(a)(i) or in connection with the statements or omissions which resulted in suchlosses, claims, damages or liabilities, as well as any other relevant equitableconsiderations. The relative benefits received by the Issuer on the one hand andthe Remarketing Agent on the other shall be deemed to be in the same proportionas the aggregate principal amount of the Bonds remarketed pursuant to thisAgreement bear to the total remarketing fees received by the Remarketing Agent.The relative fault of the Issuer on the one hand and of the Remarketing Agent onthe other shall be determined by reference to, among other things, whether theuntrue or alleged untrue statement of a material fact or the omission or allegedomission to state a material fact relates to information supplied andopportunity to correct or prevent such statement or omission. The amount paid orpayable by a party as a result of the losses, claims, damages and liabilitiesreferred to above shall be deemed to include any legal or other fees or expensesreasonably incurred by such party in connection with investigating or defendingany action or claim. (e) The Issuer and the Remarketing Agent agree that it would notbe just and equitable if contribution pursuant to this Section 7 were determinedby pro rata allocation or by any other method of allocation which does not takeaccount of the equitable considerations referred to in the immediately precedingparagraph. 5 6Notwithstanding the provisions of this Section 7, (i) the Remarketing Agentshall not be required to contribute any amount in excess of the remarketing feeapplicable to the Bonds remarketed pursuant to this Remarketing Agreement; and(ii) no person guilty of fraudulent misrepresentation (within the meaning ofSection 11(f) of the Act) shall be entitled to contribution from any person whois not guilty of such fraudulent misrepresentation. (f) The indemnification and contribution obligations of allparties to this Remarketing Agreement contained in this Section 7 shall remainoperative and in full force and effect, regardless of (i) any investigation madeby or on behalf of the Remarketing Agent, by or on behalf of any personcontrolling the Remarketing Agent or by or on behalf of the Issuer or (ii) anytermination of this Remarketing Agreement. (g) For purposes of this Section 7, each person who controls theRemarketing Agent within the meaning of Section 15 of the Act shall have thesame rights as the Remarketing Agent and each person who controls the Issuerwithin the meaning of Section 15 of the Act shall have the same rights as theIssuer. Any party entitled to contribution shall, promptly after receipt of notice of commencement of any action, suit or proceeding against such party inrespect of which a claim for contribution may be made against another party orparties notify such party or parties from whom contribution may be sought, butthe omission so to notify such party or parties shall not relieve the party orparties from whom contribution may be sought from any other obligation it orthey may have hereunder. SECTION 8. FEES AND EXPENSES. In consideration of the Remarketing Agent'sservices under this Remarketing Agreement, the Issuer will pay the RemarketingAgent an annual amount equal to one eighth of one percent (1/8 of 1%) of theaggregate principal amount of Bonds outstanding under the Indenture, payablesemi-annually in arrears on the first Business Day of each January and Julycommencing in July, 1999, and computed on the basis of the aggregate principalamount of the Bonds then outstanding. The Issuer also will pay all expenses inconnection with the preparation of any Disclosure Statement and the registrationof the Bonds and any other documents relating to the Bonds under any securitieslaws, qualifying the Indenture under the Trust Indenture Act and will reimbursethe Remarketing Agent for all its direct out of pocket expenses incurred by itas Remarketing Agent under this Remarketing Agreement and the Indenture,including counsel fees and disbursements. This expense reimbursement obligationshall not be construed as covering the expenses of the initial issuance of theBonds. SECTION 9. DEALING IN BONDS BY TENDER AGENT, BANK AND REMARKETING AGENT.The Tender Agent, the Bank or the Remarketing Agent, in their respectiveindividual capacities may in good faith buy, sell, own, hold and deal in any ofthe Bonds, and may join in any action which any Bond owners may be entitled totake with like effect as if it did not act in any capacity hereunder. The TenderAgent or the Remarketing Agent, in their respective individual capacities,either as principal or agent, may also engage in or be interested in anyfinancial or other transaction with the Issuer, and may act as depository,trustee or agent for other obligations of the Issuer as freely as if it did notact in any capacity hereunder. SECTION 10. INTENTION OF PARTIES. It is the intention of the partieshereto that no purchase, sale or transfer of any Bonds, as herein provided andprovided in the Indenture, shall constitute or be construed to be extinguishmentof any Bonds or the indebtedness represented thereby or the reissuance of anyBonds. SECTION 11. FAILURES. The Remarketing Agent will not be liable to theIssuer, the Trustee, the Tender Agent or the Bank on account of the failure ofany person to whom the Remarketing Agent has sold a Bond to pay for such Bond orto deliver any document in respect of the sale. It is understood and agreed thatthe Remarketing Agent shall not be obligated to advance its own funds topurchase, or to effect the purchase of, any Bonds. SECTION 12. REMARKETING AGENT'S PERFORMANCE. (a) The duties and obligations of the Remarketing Agent asRemarketing Agent shall be determined solely by the express provisions of thisRemarketing Agreement and the Indenture, and the Remarketing Agent shall not beresponsible for the performance of any other duties and obligations than as arespecifically set 6 7forth in this Remarketing Agreement and the Indenture, and no implied covenantsor obligations shall be read into this Remarketing Agreement or the Indentureagainst the Remarketing Agent. (b) The Remarketing Agent may conclusively rely upon any notice ordocument given or furnished to the Remarketing Agent and conforming to therequirements of this Remarketing Agreement or the Indenture and shall beprotected in acting upon any such notice or document reasonably believed by itto be genuine and to have been given, signed or presented by the proper party or parties. (c) The Remarketing Agent shall not be liable for any actionstaken or omitted to be taken pursuant to this Remarketing Agreement, except forits own gross negligence or willful misconduct. SECTION 13. TERMINATION. This Remarketing Agreement will terminate uponthe retirement of the Bonds or the effective resignation or removal of theRemarketing Agent as Remarketing Agent in accordance with the Indenture. TheRemarketing Agent will resign as Remarketing Agent under the RemarketingAgreement if requested to do so by the Issuer in writing and may resign at anytime. Following termination, the provisions of Section 7 hereof will continue ineffect, and each party will pay the other any amounts owing at the time oftermination. SECTION 14. MISCELLANEOUS. (a) Except as otherwise provided, any notice or othercommunication herein required or permitted to be given shall be in writing or bytelex or facsimile transmission or by telephone with subsequent writtenconfirmation and may be personally served or sent by United States mail, firstclass postage prepaid, and shall be deemed to have been given upon receipt bythe party notified. For the purposes hereof, the address of the parties (untilnotice of a change thereof is delivered as provided in this section shall be asfollows: Remarketing Agent: DAIN RAUSCHER INCORPORATED Short-Term Department 115 Broadway, 17th Floor New York, NY 10006 Tel: (212) 669-5528 Fax: (212) 669-5535 Issuer: AMERICAN XTAL TECHNOLOGY, INC. Mr. Guy D. Atwood 4311 Solar Way Fremont, CA 94538 Tel: (510) 683-5900 ext. 192 Fax: (510) 683-5901 The Remarketing Agent and the Issuer may, by notice given under thisRemarketing Agreement, designate other addresses to which notices or othercommunications shall be directed. (b) This Remarketing Agreement will inure to the benefit of and bebinding upon the parties hereto and their respective successors and assigns. Theterms "successors" and "assigns" shall not include any purchaser of any of theBonds merely because of such purchase. (c) All of the representations, warranties and covenants made inthis Remarketing Agreement shall remain operative and in full force and effect,regardless of (i) any investigation made by or on behalf of any party hereto,(ii) delivery of and any payment for any Bonds hereunder, or (iii) terminationor cancellation of this Remarketing Agreement. 7 8 (d) Section headings have been inserted in this RemarketingAgreement as a matter of convenience of reference only, and it is agreed thatthe section headings are not a part of this Remarketing Agreement and will notbe used in the interpretation of any provisions of this Remarketing Agreement. (e) If any provision of this Remarketing Agreement shall be heldor deemed to be or shall, in fact, be invalid, inoperative or unenforceable asapplied in any particular case in any jurisdiction or jurisdictions, or in alljurisdictions because it conflicts with any provisions of any constitution, statute, rule or public policy, or any other reason, such circumstances shallnot have the effect of rendering the provisions in question invalid, inoperativeor unenforceable in any other case or circumstance, or of rendering any otherprovisions of this Remarketing Agreement invalid, inoperative or unenforceableto any extent whatsoever. (f) This Remarketing Agreement may be executed in severalcounterparts, each of which shall be regarded as an original and all of whichshall constitute one and the same document. (g) The terms of this Remarketing Agreement shall not be waived,altered, modified, amended or supplemented in any manner whatsoever except bywritten instrument signed by all of the parties hereto. (h) This Remarketing Agreement shall be governed by and construedin accordance with the laws of the State of California. IN WITNESS WHEREOF, the Remarketing Agent and the Issuer have causedthis Remarketing Agreement to be signed in their names by the undersignedofficers, hereunto duly authorized, all as of the day and year first abovewritten.REMARKETING AGENT:DAIN RAUSCHER INCORPORATEDBy: /s/ Pamela Becker -------------------------------------- Authorized RepresentativeISSUER:AMERICAN XTAL TECHNOLOGY, INC.,By: /s/ Guy Atwood -------------------------------------- Authorized Representative 8 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTSWe hereby consent to the incorporation by reference in the RegistrationStatement on Form S-8 filed with the Securities and Exchange Commission onNovember 13, 1998 of American Xtal Technology Inc. of our report dated January28, 1999 appearing on page 37 of this Annual Report on Form 10-K.PRICEWATERHOUSECOOPERS LLPSan Jose, CaliforniaMarch 30, 1999
Continue reading text version or see original annual report in PDF format above